The Cost of Compliance: Evaluating Sarbanes-Oxley After Four Years

September 2007

IN THIS ISSUE

— Increasing accountability, or just accountants fees? Sarbanes-Oxley debated
— The pros and cons of detecting corporate cons
— In the next issue

GREETINGS!

Welcome to the September edition of our newsletter. As we commemorate the fifth anniversary of President Bush signing the Sarbanes-Oxley Act into law in July 2002, we should assess what it has improved, what negative effects it has had, and how the law might evolve.

INCREASING ACCOUNTABILITY, OR JUST ACCOUNTANTS FEES? SARBANES-OXLEY DEBATED

When Sarbanes-Oxley swept into action in the summer of 2002, the nation’s investors were still reeling from the effects of scandals at Enron, Tyco, and others, where the officers and directors treated the shareholders’ monies as their own piggy bank. Yet in their zeal to clean up a corrupted system, many think Congress may have gone too far.

The first complaint heard about Sarbanes-Oxley was that the costs of compliance would be seen as onerous. On estimate said that increased costs of compliance associated with the law could be as much as one percent of a firm’s overall revenue when discussing smaller firms (those with $2 billion or less in annual revenue.) This can significantly affect a business’ bottom line, with most of the increase reportedly going into the pockets of auditors who have been given an increased workload because of the law’s regulations.

THE PROS AND CONS OF DETECTING CORPORATE CONS

Proponents of the Sarbanes-Oxley bill hailed it as a means of changing a corrupt corporate culture. Yet like other recent reforms, most notably campaign finance reform, there appears to be a growing consensus that legislation only changed the landscape, not the attitudes of the players on the field. A 2005 survey of Certified Fraud Examiners conducted by an Atlanta research firm found that while the law is an effective tool in fraud detection efforts, its regulations likely won’t deter anyone from attempting to commit fraud in the future. Only 17 percent of respondents in the survey said Sarbanes-Oxley’s regulations would change the corporate culture in any lasting manner; most respondents, trained to detect and deter fraud, said perpetrators would instead opt to maneuver around the law’s regulations as they gained more clarity.

Most respondents in Oversight Systems’ survey of fraud examiners, in fact, said that fraud was more prevalent in 2005 than it had been in the “new economy” daze of 2000. One unintended consequence of Sarbanes-Oxley may have been the surge in private equity buyouts of public firms, leery of the increased scrutiny of being a public company in a U.S. market overseen by such regulation. Another consequence? According to a September 2006 column in The Economist, one result is a shift in foreign investment, with firms from countries with less transparent corporate cultures opting to list their shares in London rather than New York.

No wonder, then, that last year legislative efforts began to attempt to alter Section 404 of the act, dealing with internal controls. While few doubt that Sarbanes- Oxley was a good step in raising corporate accountability, its effectiveness as a fraud deterrent is far from a settled topic.

IN THE NEXT ISSUE

In the next issue, we’ll look at how to research the actions of private equity vehicles such as hedge funds and other closely-held investment partnerships.