What a Difference a Year Makes

September 17, 2008

One year ago discussions surrounding corporate law policy were driven by the Sarbanes-Oxley ‘backlash.”  The Paulson Committee and others were warning about how excessive regulation and litigation would lead to the ruin of Wall Street.  Turns out that Wall Street was eminently capable of ruining itself.

Now politicians on both side of the aisle are pushing the need for more regulation, and railing against greed, excessive salaries and golden parachutes.  Seems we are all populists now (at least for the next 50 days).  It will be interesting to see if the current crisis leads to a short term flurry of reforms of the type that followed the 2001 accounting scandals or to a more rigorous rethinking of how we regulate financial markets and corporate governance.  Let’s hope for the latter.

More on the Costs and Benefits of Section 404 of Sarbanes-Oxley

July 2, 2007

Robert Prentice (Texas – McCombs School of Business) has posted Sarbanes-Oxley: The Evidence Regarding the Impact of Section 404 on SSRN.  The article assesses evidence regarding costs and benefits of Section 404 of the Sarbanes-Oxley Act.  Like the articles posted below, Prentice concludes it is too early to tell whether Section 404 is working.  He goes further, however, to argue that the current harsh criticism of 404 is likely to undermine its prospects for success in the long-term.  Prentice thus takes on Sarbanes-Oxley’s critics (including Larry Ribstein and Roberta Romano) who savage the the legislation for lacking solid empirical bases for its policies.  These critics, he says, commit the very sins they condemn when they attack Section 404 before conclusive evidence is available regarding its effectiveness.  Here is the abstract:

Sarbanes-Oxley is the most important securities legislation since the 1930s, and whether it is ultimately considered a success will likely turn on perceptions of its controversial internal controls provision, Section 404. Indeed, whether the law is a success will likely turn on perceptions of 404. SOX 404 has been savagely attacked, especially for its burdensome cost to corporations and its adverse impact on the competitiveness of American capital markets. This article surveys the relevant empirical academic literature. Although that literature does not purport to (and does not) settle the overall question of whether SOX’s benefits generally, or SOX 404’s specifically, outweigh attendant costs, it does illustrate that the harshest criticisms of SOX are overblown. Importantly, SOX 404 has demonstrably improved corporate financial reporting in the short-term. Its potential for having long-term beneficial impact is largely dependent upon its being perceived as legitimate by capital market participants. At the moment, its legitimacy is being undermined by criticism that ignores much of the important evidence.

Two New Papers Seek to Assess the Costs of Sarbanes-Oxley

June 27, 2007

Two working papers were recently released on SSRN which seek to assess the impact of the Sarbanes-Oxley Act on smaller firms.   Both papers conclude that more study is needed. 

Ehud Kamar, Pinar Karaca-Mandic and Eric Talley have posted  Sarbanes-Oxley’s Effects on Small Firms: What is the Evidence?  The paper reviews a number of studies on the impact of Sarbanes Oxley on smaller firms.  The authors conclude that prior studies lend support to the propostion that Sarbanes-Oxley had a disproportionate impact on smaller firms, but the evidence is not conclusive. 

Christian Leuz has posted Was the Sarbanes-Oxley Act of 2002 Really this Costly? A Discussion of Evidence from Event Returns and Going-Private Decisions.  Leuz disputes the conclusions of several studies finding increased net costs for Sarbanes-Oxley.  He argues that several of these studies’ key findings may not be attributable to Sarbanes-Oxley, but may instead reflect broader market trends. Leuz concludes we do not have much SOX-related evidence that one-size-fits-all regulation imposes significant costs on firms, and that there is evidence that Sarbanes-Oxley has increased the scrutiny on firms and produced certain benefits.

SEC Approves New Interpretive Guidance for Compliance with Section 404 of Sarbanes-Oxley

May 24, 2007

The Securities and Exchange Commission has approved new interpretive guidance on compliance with Section 404 of the Sarbanes-Oxley Act. Here is the SEC’s Press Release.

Section 404 is perhaps the most maligned provision of the Sarbanes-Oxley Act.  Critics argue that the costs of 404 compliance are excessive and are disproportionately burdensome for smaller public companies.  According this New York Times article the guidance provides a relaxed set of compliance guidelines for smaller companies (with a market capitalization of less than $75 million).  The Public Company Accounting Oversight Board (PCAOB) is expected to adopt compatible auditing standards.

The Disclosure-Conduct Distinction?

May 24, 2007

In his written comments to the SEC on proxy reform posted below, Professor Stephen Bainbridge argues for a restricted view of the SEC’s authority to regulate the director election process.  His argument relies heavily on the reasoning of Business Roundtable v. SEC and the disclosure-conduct disctinction the Business Roundtable court sought to preserve.

The “disclosure-conduct” distinction heralded in Business Roundtable is based on the oft-repeated generalization that the federal securities laws are disclosure-based rather than conduct-oriented.  As I have discussed, such an assertion curiously ignores many provisions of the federal securities laws that directly proscribe conduct.  After the adoption of Sarbanes-Oxley which contains a number of significant corporate governance provisions, the disclosure-conduct distinction as a demarcation of SEC authority becomes far less tenable.

In an essay, Revisiting Business Roundtable and Section 19(c) in the Wake of the Sarbanes-Oxley Act, 23 Yale Journal on Regulation 249 (2006), Jeffrey Wu questions the continued viability of the Business Roundtable holding.  Here is the abstract:

Although section 19(c) of the Exchange Act authorizes the SEC to modify stock exchange rules “in furtherance of the purpose” of the Exchange Act, federalism has frustrated the SEC’s attempt to use that power to effect corporate governance reform. In Business Roundtable v. SEC, the D.C. Circuit vacated the SEC’s “one share, one vote” rule, on grounds that Congress did not intend for the SEC to intrude into corporate governance, which traditionally has been considered the domain of state law. However, the Sarbanes-Oxley Act has changed the federalism calculus of section 19(c). Because Sarbanes-Oxley’s amendments to the Exchange Act established a new federal policy of fighting fraud through corporate governance reform, federalism has lost much of its vitality as a constraint on SEC authority. Accordingly, the SEC should now have the power to use section 19(c) to promulgate corporate governance standards in furtherance of the purpose of Sarbanes-Oxley, particularly its audit committee provisions.

The Sarbanes-Oxley Cure?

May 11, 2007

For an antidote to all the Sarbanes-Oxley doom and gloom that surrounds us see Jay Brown’s recent post  at his Race to the Bottom blog discussing a recent Joel Seligman and Harvey Goldschmid opinion piece System is Working in the National Law Journal.