Sanity Comes to Sarbanes

SANITY COMES TO SARBANES by Michael S. Malone

After nearly a decade of doing everything it can destroy the creation of new high tech companies, Congress finally does something right . . .and the whining has already begun.

This week, by a vote of 37-32, the House Financial Services Committee voted to amend the Sarbanes-Oxley Act to permanently exempt companies valued at less than $75 million from the audit portion of that law.  The bipartisan sponsors of the bill were two Congressmen:  John Adler (D) and Scott Garrett (R), both from New Jersey. 

Apparently, in what may be the first actual support of small business creation in America in its year in office, the amendment was also backed by the White House, in particular chief of state Rahm Emanuel.  It seems that the Obama administration has finally begun to realize that you can’t create jobs at the same time that you are strangling the job creators.

Kudos to them all.  As anyone who has read this column for any length of time (or my editorials in the Wall Street Journal) knows, I am a sworn enemy of Sarbanes-Oxley – not because its motives are wrong, but because it stands as a classic example of using a legislative meat-axe when a scalpel was required.  Since it was passed in 2003, by my estimate, S-Ox has cost American industry just short of one-quarter trillion dollars . . .money that one might imagine American companies could use right about now. 

But that loss, to my mind, is far less than the damage done to the high tech industry – the single greatest source of new jobs, new innovation, and economic health we have – by the loss of two generations of new companies that were unborn, died early from lack of funding, or were swallowed up by big companies because they couldn’t Go Public with stock.  Indeed, in the years since S-Ox passed, there have been almost no high tech IPOs, compared to hundreds in the decade before.  All thanks, in large part, to Sarbanes-Oxley.

It’s easy to appreciate why Sarbanes-Oxley was passed, but much harder to understand (beyond bureaucratic inertia, of course) why such a destructive law – one that has accomplished little of what it set out to do, while simultaneously destroying new wealth creation, reducing national competitiveness, and furthering the gap between the haves and have-nots in America – has continued to stay on the books.  Or why it still has defenders.

A little background:  Sarbanes-Oxley was passed in the wake of the collapse of the dot.com bubble in 2000.  These days we’ve become pretty used to fast-moving, technology-aided economic bubbles, but back then this was something new and unsettling.  A lot of speculators (including millions of everyday folks) had thought they’d become rich in the late-1990s . . .only to see those dreams dashed when it all crashed in the first months of the new century.

This, of course, led to both anger and dark mutterings about criminal behavior – the latter seemingly proven when the scandals broke over Enron, Worldcom and other corporate Ponzi schemes.  Combine that with the sudden implosion and death of thousands of dot.com companies, taking billions of wealth with them, and it seemed that the entire tech industry was just one big criminal conspiracy – and the evil-doers had to be reined in by government . . .and punished.

Thus, Sarbanes-Oxley, of which the two most important parts were:  a) that corporate officers sign off on the integrity of their company’s internal financial controls; and b) the company pays for an outside audit of (a).   The first requirement seemed benign enough – until company directors realized that their personal assets would be vulnerable to the damages done by some unknown employee deep in the bowels of the company committing fraud or absconding with company funds.  That led to an exodus of some of the wisest and most veteran talent in high tech from the corporate boards when their expertise might have done the most good.   In other words, just when they needed to get smarter to compete in the global marketplace, US companies got dumber. 

But it was b), the audit requirement, that was the real company killer.  Some estimates put the cost of such an audit at as much as $10 million – and even the most upbeat estimate by S-Ox proponents, put it at close to $1 million.  Either way, it was enough to keep thousands of hot high tech companies from even considering Going Public – and donating all of their profits to a S-Ox audit-and-compliance company.  Thus, the end of high tech IPOs – the greatest wealth redistribution engine ever – and a decade of mergers and acquisitions.

The irony of all this, and the lessons that seem to have been lost on everybody inside the Beltway, is, first, that Sarbanes has done nothing to stop either economic bubbles or corporate criminal behavior; and second, that the system actually worked in the first place.  The bad guys got caught.  And the dot.com bubble, far from being a conspiracy, was in fact the natural trajectory of a high tech boom, in which the mortality rate of new companies is always 90+ percent.  Sure, it was messy, and cost thousands of new start-ups – but it also gave us Amazon, eBay, Orbitz, Google, etc.  That’s how it works; the only difference that it was the first time regular folks had ever experienced it.

Sarbanes-Oxley was controversial from the beginning.  Elected officials loved it because it made them look tough on corporate crime.  Big business hated it, because of the cost and the exposure – but once they survived the director exodus and realized that, being rich, they could use S-Ox as a cudgel to crush their small and emerging competitors – they embraced it.  Entrepreneurs complained, of course, but they can’t afford lobbyists and have no political power . . .so who listens to them?  And all that the general public heard was that these new regulations would keep them from ever seeing another Enron.

Tell that to Bernie Madoff.  The reality is that Sarbanes-Oxley has not only accomplished nothing that it promised to do, but it has sorely damaged the economic health of this country.  What could have been accomplished by spending 1 percent of this amount on beefing up enforcement at the Justice Department and SEC instead turned into a monster that helped to weaken our economy just as we were sliding into the biggest recession in our lifetimes.  And now, lacking a new generation of hot young tech companies to lead us out, we face a long, slow slog back to prosperity.

What at the time seemed like a futile rear-guard action against the excesses of the Nineties, now instead looks like a rehearsal for the ‘shackling of evil industry by government fiat’ that has characterized Congress for the last five years and the White House since last January.  If you want to see where all of the big bills currently sitting in Congress lead, you only need look at the rich and powerful apparatus that has now grown up around the money-printing machine that is Sarbanes-Oxley – and listen to their howls now that it is being threatened.

Even as the committee vote was being announced, its chairman, Barney Frank – who is probably more to blame than anyone in Washington for our current economic crisis – complained that its passage would open the door for less ethical behavior by corporations (you just can’t make this stuff up).   At Reuters, that bastion of balanced journalism, columnist Rolfe Winkler moaned that the decision continued “the race to the regulatory bottom.” 

Over at the CFA Center for Financial Market Integrity, Kurt Schacht intoned, “This is an insult to investors given what they’ve experienced over the past year” – apparently not noticing the irony.  He then added, hilariously, “Small companies have had plenty of time to plan for this” – apparently meaning that somehow during hard times companies are better positioned to give away all of their profits to accountants.

Meanwhile, Lord & Benoit, a consulting company that has grown rich helping its clients survive S-Ox, announced a seminar that would make the case that because Sarbanes-Oxley increases trust in companies, it is now crucial to getting us out of this recession.  Good luck with that.

Now don’t get me wrong.  I’m not against the idea of Sarbanes-Oxley.  Indeed, many executives at big companies have told me that meeting those regulatory demands has helped them to better understand their companies and to streamline their operations.  What I’m against is the punitive, unfair, and biased nature of the S-Ox – that, and the fact it rewards parasites even as it punishes producers.  Were it voluntary, and coupled with rewards for good behavior – like the Baldridge Award – I’d cheer it.

Thankfully, even the Federal government – if only because it is under duress to actually create real jobs — is finally figuring out the evil and mischief that S-Ox represents.  In fact, this week’s vote merely made permanent what was temporary waiver for under-$75M companies announced a few months ago.  Better yet, the new bill also calls for a study to move the waiver up to $250 million – a figure much more in line with fast growing tech firms, which can reach that valuation before they even show a profit. 

When that day comes, I’ll break out the champagne – then sit back and watch as big corporations, their ox now being gored for a change, howl for relief.