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May 17, 2005

Sarbanes-Oxley: The Accountants Aren't Helping

From the Wall Street Journal (page C3 in the print edition):

Regulators issued a rebuke to accounting firms, saying their interpretation of a controversial Sarbanes-Oxley rule had been too strict and resulted in unnecessary costs for some public companies.

The Securities and Exchange Commission and the Public Company Accounting Oversight Board urged accountants to be more flexible in their approach to a rule requiring that companies assess their internal controls over financial reporting. Regulators said auditors had become "overly cautious" and "mechanical" and needed to exercise judgment when interpreting the rule.

The guidance comes in response to growing complaints from businesses about the cost of complying with the regulation, which requires that companies assess their internal controls to ensure their financial reporting is accurate and reliable...

Executives have complained about the rule, saying auditors are performing massive reviews that aren't tailored to a company's size or specific risks. They complain auditors are driving up costs by looking at things that have no bearing on the accuracy of a company's financial statements.

Studies have estimated the cost to companies at about $3 million a year. Some companies have said they have stopped hiring and are considering moving work overseas to deal with the costs.

I continue to think this is a much under-appreciated story.

UPDATE:  A few days old, but here is a related post from Brad DeLong.

UPDATE II: The SEC report is here.

April 21, 2005

More On The Aftermath Of Sarbanes-Oxley

Even as I was asking, The Financial Times was offering an article documenting woes in the wake of the Sarbanes-Oxley of 2002 (access requires subscription).

It seems that the more obvious demands imposed by Sarbanes-Oxley in financial accounting - the expense, the time investment, the extra audits - are just the tip of the iceberg. The required mix of "proper" business controls and personal liability is causing a chain reaction that affects boards, organisational structures, professional advisers and the daily efficiencies of all public companies - and many private ones, even though technically they are not covered by the act.

The results are having an impact on the way companies hire, structure their organisations, work with lawyers and accounting firms and even choose software systems. They are also driving higher-than-anticipated expenditure in unexpected areas...

Sarbanes-Oxley has also forced a change in companies' relationships with auditors and lawyers. "What it has done is made your outside accountants regulators," says Anthony Abbate, president and chief executive officer of Interchange Bank, a New Jersey-based finance house, and an outgoing member of the Federal Reserve Board.

In the past, he or his chief financial officer could ask an auditor for an opinion on a proposal. Now, he says, "they don't even want to hear about what you're doing. If they say, 'Yes, you can do it,' or they remain silent, they become complicit and subject to their own regulatory body. So you're basically flying on your own."

It appears that not even the "going dark" option is a full solution.

With companies coming to realise the knock-on effects of Sarbanes-Oxley, some are busily trying to jump ship by going private. But in the long run, that will not be a solution.

For a start, private companies such as Wise Metals Group, a Baltimore-based producer of aluminium cans, have become subject to the same tough regulation since starting to offer public bonds...

Private-company status is also no haven from Sarbanes-Oxley. If a private company wants to leave open the possibility of an acquisition, particularly by a public company, it will probably have to show that it is compliant with Sarbanes-Oxley.

The article does note some unexpected positive aspects of Sarbanes-Oxley, but even these might be filed in the category of "creative destruction":

But if there are unintended consequences, they are not all negative. Mr [Michael] Critelli [chief executive of Pitney Bowes] found that the regulation could be used as a tool to force changes he wanted to make at Pitney Bowes - such as increasing shared services. "It turned out to be a blessing," he says.

Combine this with the post-recession oil shocks, and it's almost a wonder that the U.S. economy has done as well as it has.

April 20, 2005

Thoughts On The State Of The U.S. Economy...

... from John Irons and Arnold Kling in the newest edition of the Wall Street Journal Online's Econoblog feature.  John laments the impotence of fiscal policy as a stabilization tool --

This is one of the real risks of the deficit -- that we won't be able to use spending or tax policy to soften an economic downturn.

-- but if you ask me, this goes in the column of backhanded blessings.  For my money, tax and expenditure policy should always be about the long run.

For his part, Arnold makes an observation that I have long felt deserves more consideration than it gets:

I think that for the last year and a half, Sarbanes-Oxley has had a major dampening effect. In any year, a large corporation can pursue no more than two or three key initiatives. Senior management doesn't have time to pay attention to more than that and still run the baseline business. And without senior management focus, people lower down cannot get cooperation across departments or division, which you usually need to execute a new initiative. For a lot of companies, Sarbanes-Oxley compliance has been one of the top three priorities for the past year or two, which means that at most one or two other major projects have been on the plate.   

I'd really be interested in seeing some serious post mortem on this.

UPDATE: Thanks to Roland Patrick for point me to his post at Let's Fly Under the Bridge related to the effects of Sarbanes-Oxley.  In his post he links to an Orange County Register article on the topic, which includes this observation:

Since that regulatory law passed in 2002, hundreds of publicly traded companies, including several in Orange County, have taken this step, which is simpler and cheaper than buying out shareholders and going private. Hundreds more could soon follow, says attorney Thomas Magill, partner at Gibson, Dunn & Crutcher LLP in Irvine, who assisted Anacomp in going dark.

If you are interested in this topic, read the whole thing.