The Sarbanes-Oxley Act of 2002 was designed to protect investors by increasing the accountability to shareholders to boost confidence in American capitalism after a wave of corporate scandals. Three years later, with an unproven record and numerous side effects, the costs of implementing the law question its viability.
The statute aims to improve the accuracy and reliability of corporate disclosures. It was designed to review the dated legislative audit requirements and was the most significant and controversial change to United States securities laws since the New Deal.
The most controversial provision is Section 404. This section makes managers responsible for maintaining an "adequate internal control structure and procedures for financial reporting," and demands that companies' auditors "attest" to the management's assessment of these controls and disclose any "material weaknesses."
The costs of this law have been tremendous. According to a study from the William E. Simon Graduate School of Business Administration at the University of Rochester, the net private cost will be $1.4 trillion. This number represents the costs minus the benefits as perceived by the stock market as the new rules were enacted. If this number were true, the Sarbanes-Oxley act would have to prevent a great deal of unforeseen losses due to fraud before it could be considered worthy.
A survey by the Financial Executives International, an association of top financial executives, found that companies paid an average of $2.4 million more than anticipated for audits last year. As a result of the law, demand for accountants has surged. The additional man-hours necessary to comply with this law have further contributed to these astounding costs.
Other less visible - and more difficult to measure - costs have been incurred as well. Some non-American companies have threatened not to list on the New York Stock Exchange because of the cost of the legislation. Other companies delisted from American stock exchanges in part because of Sarbanes-Oxley. A study
performed by the law firm Foley & Lardner showed that roughly 20 percent of public companies said that they were considering going private to avoid the costs of the act. It would be regrettable if a law that intended to improve the quantity and quality of financial information available to investors led many companies to seek relatively unregulated jurisdictions.
As many of the new accounting rules and regulations are still going into effect, it is too soon for a definitive judgment on the law. One of the largest accounting firms, Pricewaterhouse Coopers, told the Securities and Exchange Commission, "The costs are tangible, quantifiable and immediate, while many of the benefits are intangible, harder to quantify and longer term."
Ratings companies such as Moody's, a front-line consumer of financial reports, takes a positive view of the impact of Section 404. An April company report said, "We perceive that companies are strengthening their accounting controls and investing in the infrastructure needed to support quality financial reporting."
But will the law really help reduce financial fraud in corporate America? And will it do so to a degree that will justify its formidable costs? There's really no way to tell yet. We may have to wait for the first post-Sarbanes-Oxley corporate scandal to reveal whether the law was worth its large cost.
