If there is one issue that may somewhat unite the GOP presidential field and the Obama administration, it’s disdain for a nearly ten-year-old law signed by George W. Bush. The Sarbanes-Oxley Act of 2002, rushed through Congress as a “fix” after the Enron and WorldCom implosions, added billions in regulatory costs in the supposedly deregulatory Bush era. And it has little to show for itself in preventing subsequent financial scandals.
Now, as presidential candidates are championing the cause of paring red tape, the burden of Sarbox’s accounting mandates on small and midsize public companies has been picked up by nearly every GOP candidate from new front-runner Newt Gingrich to media favorite Jon Huntsman. Even the Obama administration has joined the Sarbox critique to a surprising extent.
From Paul to Gingrich to Huntsman to Obama
“I would repeal Sarbanes-Oxley, which adds a substantial amount of paperwork cost,” Gingrich replied in mid-November, when asked by a high-school student in Osage, Iowa, how he would grow the economy. And in the past few months, Gingrich’s has called for Sarbox’s repeal at presidential debates, at the Iowa State Fair, and in interviews with Bloomberg Television and CNN’s Piers Morgan.
Mitt Romney, Rick Perry, and Herman Cain have criticized aspects of Sarbox, and Michele Bachmann and Ron Paul (who was one of three House members to vote against the law in 2002) stand with Gingrich in calling for repeal. So does Huntsman, whose “Time to Compete” jobs plan proclaims that “this hastily written law has only added a massive compliance tax on companies without providing any real measures to prevent corporate fraud.”
But perhaps the most surprising recent critic of Sarbox has been the Obama administration. Election-year politics may be playing a role, as Obama is presenting himself as a pragmatist on regulation and this is one costly law that Obama does not have ownership of (as opposed to Obamacare and the Dodd-Frank financial overhaul). Still, the recent recommendations of the president’s Council on Jobs and Competitiveness were substantive, and, given this administration’s pro-regulation philosophy, extraordinary.
Pointing out that “the data clearly shows that job growth accelerates when companies go public,” the Jobs Council noted with dismay that there were fewer U.S. venture-backed initial public offerings (IPOs) in 2008 and 2009 than in any year since 1985. The data also show that even the recession years of the early ’90s had more IPOs than any year since Sarbox went into effect.
The council blamed, among other things, “unintended consequences stemming from . . . Sarbanes-Oxley regulations.” It then called for exemptions from many provisions of Sarbox for companies with up to $1 billion in market capitalization.
Sarbox Empire Strikes Back — with Some GOP Help
Given this remarkable consensus on the need for Sarbox deregulation, one would think it would be smooth sailing for a bill that doesn’t even go as far as the Obama jobs council recommends. H.R. 3213, sponsored by freshman Rep. Stephen Fincher (R., Tenn.) and slated for a vote this week in the House Committee on Financial Services, creates an exemption for companies with up to $350 million in market capitalization — a far lower figure than the $1 billion put forth by Obama’s council. And it exempts these companies from just one subsection of Sarbox — Section 404(b), which mandates audits for “internal controls.”
But exemption even from this subsection alone would do many entrepreneurs a world of good. The Securities and Exchange Commission (SEC) initially estimated that Section 404 compliance costs would be $91,000 per year. In 2009, however, an SEC study found that companies actually spend, on average, $2.3 million annually on compliance with just this one Sarbox section. Moreover, the study revealed that the long-term burden on smaller companies is more than seven times greater than that imposed on large firms.
But this costly burden to entrepreneurial firms has been a bonanza for those who audit them. Known facetiously as the Accountants Full Employment Act, Sarbox works like a never-ending earmark to the accounting industry. And like most recipients of earmarks — the “government rich” as Peter Schweizer refers to them in his new book, Throw Them All Out — the accounting lobby is loath to give up its government-granted riches.
Through groups such as the Center for Audit Quality, a membership organization for auditors, the accounting industry cloaks its self-interest as advocacy for good corporate governance. Unfortunately, it has found at least two Republicans on the Financial Services Committee who seem willing to do its bidding: Reps. John Campbell (R., Calif.), and Steve Pearce (R., N.M.).
Even though he represents Orange County, one of the most conservative areas in the nation, Campbell has had some significant fights with the fiscal Right. He is the GOP champion of government-sponsored housing enterprises, and this month he was one of four members — and the only Republican — on the financial-services committee to vote against limiting the salaries and bonuses of Fannie Mae and Freddie Mac executives.
And as Andrew Stiles reported in National Review Online, Campbell fought hard against most other House Republicans in his push for an increase in Fannie and Freddie’s loan limits to $729,750, in essence government backing for mortgages for McMansions. Without citing much economic data — indeed contradicting authorities from the American Enterprise Institute’s Edward Pinto to an Obama administration white paper — Campbell expressed fear to Roll Call that the housing market and economy would “crater” without an increase in these mortgage limits.
Yet Campbell does not seem to share the concerns of many researchers that innovative job-creating firms are cratering under the weight of Sarbanes-Oxley. A certified public accountant by trade, Campbell is echoing the arguments of the accounting industry against Fincher’s bill.
At a markup session of the House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises in October, Campbell proclaimed that the Fincher bill went “way too far — too much in the wrong way — and too fast.” Noting the “very robust” auditing standards under Sarbox, Campbell argued, “We can’t know if they (companies) have internal controls for sure without auditing them.”
In his remarks and in an interview with me just after the markup, Campbell stressed that he would urge the Public Company Accounting Oversight Board (PCAOB), the Sarbox-created auditing regulator, to tailor rules to make compliance easier for small firms. However, the PCAOB has been urged to do that for the nine years it has been in existence, and the SEC still finds that smaller firms bear a disproportionate Sarbox burden.
In the markup, Campbell agreed to a reduction in the threshold for exemption from $500 million to $350 million. This is less than half of the $1 billion threshold for Sarbox exemption recommended by the Obama jobs council. Yet Campbell indicated that even with this compromise, he may vote no when the bill comes before the entire committee, as it should this week.
And the compromise didn’t satisfy Pearce, who became the only GOP member to vote “no” in the markup. In a rambling speech, Pearce stressed, “I am as big a deregulator as there is in Congress,” but said he was “looking with some concern” at the bill. He then seemed to make the argument that Congress shouldn’t worry about Sarbox and the SEC, since the Environmental Protection Agency is the real problem. This is akin to an argument that doctors should only worry about patients’ hearts and not their livers.
Pearce and Campbell’s defection gave Democrats the cover they needed to take their instinctive pro-regulatory position despite Obama’s implied support for Fincher’s approach. “I want to compliment Mr. Campbell . . . but [the bill] still goes too far,” said Carolyn Maloney (D., N.Y.), in joining all committee Democrats in voting no. Maloney had expressed support for Sarbox relief in the past.
A claim made by Maloney, Pearce, Campbell, and the accounting lobby is that internal-control audits are essential for fraud detection. Yet financial analysts looking at the subprime scandals in Sarbox’s wake have come to the almost opposite conclusion. By requiring resources to be spent on auditing “internal controls” that were trivial for shareholders yet lucrative for auditors — such as employee passwords and possession of office keys — Sarbox Section 404 actually diverted attention away from ensuring accurate reporting of a company’s financial condition.
Commenting on corporate misstatements during the mortgage bubble, respected analyst Janet Tavakoli had this to say on Sarbox to housing journalist Robert Stowe England in his new book Black Box Casino: “Sarbanes-Oxley did nothing. It didn’t work. It was a total waste.”
At this writing, it looks as if there is hope for relief from this “waste.” According to an advocate for small public firms, Representative Pearce — whose office didn’t return my query — may be reconsidering after discussions with the entrepreneurial sector. And a broad swath of the center-right coalition — from CEI and Americans for Prosperity to the Christian Coalition — has signed on to a letter telling conservative members of Congress to “free honest entrepreneurs and their shareholders from the yoke of Sarbanes-Oxley’s burdensome mandates.”
Still, it would be a travesty if the powerful accounting industry yokes just enough GOP members to the left of the Obama administration on this needed regulatory relief.
— John Berlau is director of the Center for Investors and Entrepreneurs at the Competitive Enterprise Institute.