The Cost of Sarbanes-Oxley: A Peek into 'Peek-a-Boo'

By Andrew Freiburg 

Not a single venture capital-backed tech company went public on NASDAQ during the second quarter of 2008.  This marked a first in the history of the exchange.  But, initial public offerings in general have been few and far between in recent years.

A growing number of people in Silicon Valley, on Wall Street, and even inside the Belt Way are blaming this drought on the Sarbanes-Oxley Act of 2002, which imposes rigorous accounting standards on publicly traded companies and thus makes it more difficult and expensive to become one.  Edgelings last week published one of the most scathing editorials yet on the topic, from venture capitalist Tim Draper, who claimed that, should Sarbox be repealed:

“No one will notice.  Everyone will benefit.”

In the interest of fairness, we wondered who might care if SOX actually was repealed tomorrow.  One group with a clear vested interest is the the Public Company Accounting Oversight Board (PCAOB), the private, non-profit corporation explicitly created by Sarbanes-Oxley and often called “Peek-A-Boo” on account of its mission: to audit the auditors of public companies, and make sure Enron never happens again.  We asked PCAOB staff a series of questions designed to answer one big one:

What do you people do, and would anyone notice if you weren’t doing it?

According to the most recent numbers available, from May of 2008, the PCAOB employs 484 people at nine offices across the country.  The 2008 budget is a touch above $134 million dollars, and paid by “issuers,” meaning either public companies or investment banks that work with them. 

By law, accounting firms must register with PCAOB in order to be eligible to audit public companies.  Once registered, these firms are periodically inspected by PCAOB and tested for adherence to standards set by PCAOB.  A report is then issued; approximately 700 so far. 

Parts of these reports are then made available on the PCAOB website.  However: “Portions of an inspection report that deal with criticisms of, or potential defects in, the firm’s quality control systems are not made public if the firm addresses those matters to the Board’s satisfaction within 12 months after the report date.”

Sometimes, the PCAOB proceeds with disciplinary proceedings, such as a member company being de-registered from PCAOB’s list.  The PCAOB has initiated, by our count, a grand total of 17 disciplinary proceedings since its inception in 2003, including fining Deloitte & Touche $1 million in December of 2007. Many of the 17 firms are smaller companies with less than 10 employees and the infractions sited often amounted to a relatively few million dollars, not the Enron scale multi-billion dollar problem.

Overall, the PCAOB declares that it seeks to prevent, rather than punish, catastrophes such as Enron.  PCAOB Chairman Mark W. Olson told Congress in May: “The Board has focused on implementing a supervisory model of regulation intended to focus firms on the need for high quality auditing, by helping them see where they are falling short and providing feedback and guidance that facilitates their efforts to improve.”

Chairman Olson added: “One way to measure the PCAOB’s success over time is the extent to which we have contributed to the enhanced reliability of, and improved confidence in, financial reporting.”

Asked about the catastrophes currently affecting U.S. capital markets, the gross mis-valuation of mortgage-backed securities and such, PCAOB spokesperson Shauna Riley referred us to the FASB, which handles accounting-related issues, whereas PCAOB handles auditing-related issues.

We have to ask ourselves: with an army of auditors and a six-year budget of more than a half billion dollars, if there is a real value-add, shouldn’t the PCAOB have uncovered more than 17 disciplinary extremely minor infractions among the nations 5,500 public companies?  That works out to be about $35M per hand slap.  I guess we found one group that would notice if SOX disappeared tomorrow. 

More to come.