The Fall of the House of Finance: More Sarbanes Oxley on the Way by Fay Voshell
Apr 21st, 2010 by David Anderson
Some time ago, I was sitting in my opthamologist’s office and chanced on a magazine I’d never heard of–Stocks, Futures and Options. In it was an interview with George Friedman, who noted the financial elite have lost all credibility. He added the political elite have stepped in to the vacuum. He also said the government and the financial communities “regard one another as incompetent.”
The difficulty, Friedman added, is magnified by the fact the “government is not financially efficient. It is built to be politically efficient…Obama has to demonstrate that our institutions or government is capable of effective action, because what would terrify people and create a new crisis is if the political elite appear to have the same incompetence as the financial elite. All hell would break loose…On one side, the political state is saying the financial community is a bunch of greedy scoundrels, while the financial community says the government is a bunch of incompetent bureaucrats.”
We are at the impasse Friedman so eloquently and succinctly delineates. The fact of the matter is that the American people no longer have confidence in either their financial institutions or their government. Some 76% of the American public don’t trust the government. And most don’t trust financial insitutions such as Goldman Sachs.
Friedman’s assessment has come true, and all hell is breaking loose.
In the effort to put itself in the driver’s seat, reclaim the confidence of the American people–or at least divert attention away from its incompetence–and to fatally weaken Wall Street, the administration is seeking further control over the financial sector. Doubtless we will be looking at another Sarbanes Oxley Act–on speed.
The result will be an economy that is furthered weakened.
The above mentioned Sarbanes Oxley Act has already weakened corporations by demanding a flood of paper work and extra employees to manage accounting procedures. None of the reforms has actually dealt with the underlying problems the Enron scandal exposed and to which congress reacted, as Friedman points out, with political rather than economic efficiency. What Friedman, an Obama supporter who believes the president can restore trust to government, does not note is that political “efficiency” exhibited as total regulatory control always cripples economic efficiency.
Sarbanes Oxley is a perfect illustration of the truth that political solutions have a way of retarding or crippling industry. As Alan Reynolds of the Cato institute notes:
The Sarbanes-Oxley law was unnecessary, inadequate and harmful. It was unnecessary because the SEC already had the authority to do everything the law demands about accounting or corporate boards. Sarbanes-Oxley was inadequate, if not irrelevant, because it failed to deal with any fundamental institutions, laws or incentives that might have contributed to major bankruptcies in the wake of the 2001 recession. The 1968 Williams Act has made it too difficult to take over mismanaged companies, for example. And higher tax rates on dividends before 2003 helped devious managers camouflage overstated earnings (companies can’t pay dividends with bogus earnings).
Sarbanes-Oxley has proven harmful to the U.S. economy, and to the value of stocks still listed on U.S. exchanges, because it greatly increases the costs and risks of doing business as a publicly traded U.S. corporation and it increases the risks of serving as a director or officer. Sarbanes-Oxley has essentially the same effect as a large but unpredictable increase in corporate taxes. Congress must at least lighten the heavy load of this ill-considered regulatory tax, assuming insufficient humility and courage to repeal it. Even in politics it is generally wiser to admit mistakes and fix them than to fall into the familiar bad habit of assuming that good intentions excuse bad results.
Stephen Boyko, author of We’re All Screwed warns that toxic regulation will crush the free market system. He writes:
Bad rule writing has resulted in bad legislation, such as the Sarbanes Oxley Act of 2002, and has created an ineffective system for regulating the U.S. capital markets. If we don’t act fast, the 2008 subprime stack market crash could potentially result in more toxic regulation. [A prescient comment, as more toxic regulation is on its way.]
He advocates an answer: “fostering entrepeneurialsm; segmenting the market to account for size, capital and scope; and using a three dimensional model for regulation.”
While GeorgeFriedman probably would not say so, Milton Firedman would say the more the political sphere of influence intrudes into the economic sphere of influence, the more likely the slide into socialism and tyranny.
The halt to this slide will only occur by embracing two major reforms. The first is a return to true federalism with an emphasis on states’ initiatives, whence have come some brilliant economic models. My own state of Delaware once had such a model intitated by Governor Pete duPont, but it has been seriously eroded under the last few administrations.
The second is a return to a balance of governmental and economic spheres of influence. Any institution’s integrity and effectiveness cannot remain if it is unceasingly violated and controlled by another. (This truism is valid for any institution, be it religious, governmental, economic, military or educational.)
If at one time American industrialists had too much power over the federal and state governments, that certainly is not the case now. Beginning with Theodore Roosevelt and accelerating steadily throughout the last century, the ascension of federal control over the states, traditionally a breeding ground for economic innovation and the financial institutions of our country, now at least temproarily discredited and under increased scrutiny and attack, is nearly complete.
It looks like this current administration is poised to push the accelerator to the floor by pushing the enactment of another Sarbanes Oxley Act.
More onerous regulation is not the answer for giving renewed health to our financial institutions. There are plenty of regulations already on the books, some legitimate; some not. A massive effort to distinguish between the necessary and unecessary regulations already on the books is long overdue and would result in a burst of economic prosperity scarcely imaginable in these dark economic times.
You are correct Fay. The sad thing is the impact of Sarbannes Oxley was predicted before it ever passed.
I am concerned about the new regulatory bill myself. We need some reform, but it seems like at least half of it is going the wrong way and the other half is window dressing. It looks like it is more harm than good.
A new bill passed by Senator Blanche Lincoln’s committee is a good start, but it may go to far. It bans the banks from dealing in risky derivatives. Great, but it also seems to ban them from options. Options are one of the best ways to limit risk and protect your capital. They are not like futures. It is like the committee has little understanding of financial instruments, but danes to regulate them. We could actually do more harm than good by the bill. It is actually a good concept returning to a proven structure which protected Canada from the global banking crisis. Democrats just seem to overdue everything when it comes to regulation. That is one reason I have a sever bias to the market. If you let it be, it will be.
David, as you can see, we both believe concern is justified. I have other concerns I am mulling over and writing about as well; namely, the choice of Goldman Sachs as a target. I think there’s subterranean stuff going on–much more than meets the eye.
Judging by some of the opinions expressed about Sarbanes-Oxley you have to wonder if anybody really is familiar with the details of this law. Why we have it. Did Fay Voshell read the law?
Officially known as ‘Public Company Accounting Reform and Investor Protection Act’ it was passed by a solidly Republican Congress 334-90 and signed into law by President Bush in 2002.
This happened after Enron, Tyco, WorldCom, and other huge corporations managed to bilk investors out of billions, kill the life savings of hundreds of thousands of Americans. It was obvious to everybody existing white collar criminal law was not adequate to deter high level corporate corruption.
Over eager executives invented ways to scam investors by “cooking the books” using phony accounting methods outright fraud to publish bogus earnings estimates and reports. Investigators found the large accounting firms like Price Waterhouse et al were knowing participants in this fraud. That meant that you and me invest $50,000 in a stock because the company reported huge profits, but what we don’t know is the numbers are totally fake. Even if we due diligence and find Author Anderson Accounting vouched for the numbers, how are we to know the accounting firms are not obligated to question phony numbers? When the stock goes up because of the fake earnings numbers, the insider executives sell at a huge profit. When it all collapses we are left with nothing, they walk away super rich. To top it off, there was no law preventing the CEO from saying he knows nothing about how those profit numbers came about. No law saying the accounting firm is responsible for truthful numbers.
What a gig. Be a CEO. By 100,000 shares at 10. Tell the market profits will double next quarter. Stock goes to 30. You sell. The numbers were all phony. No laws to stop you.
And so began Sarbanes-Oxley.
Here are the major provisions of the act:
•CEOs and CFOs are held responsible for their companies’ financial reports
•Executive officers and directors may not solicit or accept loans from their companies
•Insider trades are reported more quickly
•Insider trades are prohibited during pension-fund blackout periods
•Mandatory disclosure of CEO and CFO compensation and profits
•Mandatory internal audits and review and certification of those audits by outside auditors
•Criminal and civil penalties for securities violations
Since 2002, most of our largest corporations reported record profits and earnings. The net effect is to protect us, the investors, the pension funds. Hardly the crippling this post suggests.
Many of the major complaints that Sarbanes-Oxley impedes business have been addressed by an ongoing amendment process. But the law is unfortunately made necessary by the rise of mega white collar crime. Crime at the highest level of our economic structure that cost us, the public, more the Sarbanes ever could.
Opponents say companies can make more money if they don’t have to comply with these new compliance laws. They can also make more money if we let then dump waste into the river. It’s not always all about the money. It’s about a fair deal for the average Joe who is not an insider.
So before you buy into this deregulate because government hurts business nonsense I suggest:
1) Study the ‘Public Company Accounting Reform and Investor Protection Act’. Or at least look at summaries of this law. What is there not to like, especially if you are a shareholder.
2) Find out why a Republican Congress passed it 334-90.
3) Then, if you invest in the stock market, ask yourself if we really want to go back to the days when CEO’s could claim with impunity that they knew nothing about the finances of the companies they run. That was the defense for Enron CEO Ken Lay. He said all the bogus profits reports were put out without his knowledge. We passed these new laws so that kind of crap is harder to get away with.
We all know there is a criminal element out there. This law protects us. Fay is suggesting government is the problem, when it’s really the criminals that are the problem. Next thing you know the anti-government folks are going to want to loosen up the embezzlement laws.
Here’s what convicted white collar mega felon ‘Crazy Eddy” has to say:
http://whitecollarfraud.blogspot.com/2006/10/memo-to-warren-buffet-from-ex-felon-on.html
They passed the law because they needed to pass a law. Unfortunately, they passed the wrong law. The law had some good points, but it also had some bad points and in fact almost caused a second great depression. That is more harm than good. Look in the archives and look at the Mark to market rules. It did more harm than good.
It can be done well just like the financial reform. We have concerns that it is not being done well.
David, you say
“We have concerns that it is not being done well.”
From what I read in this post, is more than “concerns”. I think it was more like a step towards tyranny and socialism. That industry is crippled. Sarbanes-Oxley accomplished nothing except screwing business. America would be better if the government stopped bothering business with anti-corruption laws.
This post was obviously making the case for easing corruption laws so “industry” can make more money faster with less paperwork. All part of a very flawed view of law and order when it comes to white collar crime.
Ever wonder why everybody in prison is poor and black when the most expensive crime is committed by white guys in $2000 suits? It’s because the big boys can bend the law their way. The anti-Sarbanes lobby is a perfect example.
Financial businesses need to be contained to their place in the economy, in the same way fire needs to be contained to the boiler room. Keep it in place, and you stay cozy and warm. But if it breaks loose you have a problem.
It seems Fay is calling to break it loose. Personally, I am not in such a big hurry to get to the next crisis and bailout. We need to warm up the house first.