The Objective Standard Blog

Wednesday, March 28, 2007

Repeal Sarbanes-Oxley by Alex Epstein

Posted by ARI Media at 8:01 PM

Imagine opening tomorrow's newspaper and reading this: "Citing all-too-frequent child abuse and neglect, Congress has proposed the Parenting Reform Act. Under the proposed law, all parents must swear that they have not 'caused unreasonable physical harm or danger' to their children. To verify compliance, all parents will be required to submit their children to a monthly full-body inspection by the new Parental Oversight Board, and account for every cut, scrape, and bruise that inspectors find. If a parent cannot prove the 'reasonableness' of any injuries to the Board's satisfaction, it could result in a loss of custody and 20 years in prison."

Our reaction to this proposed law would be outrage. It is unjust and destructive, we would say, for the government to make arbitrary accusations of abuse and neglect, to conduct baseless investigations, and then to force an innocent parent to try to disprove them.

We should say the same about an existing law that perpetrates such horrors, not against parents, but against businessmen: Sarbanes-Oxley.

Sarbanes-Oxley has been under debate lately—pitting those who say the law must be amended against those who say it must be preserved. But both sides are wrong: Sarbanes-Oxley is a fundamentally corrupt law that must be repealed.

Sarbanes-Oxley was passed nearly five years ago, in the anti-business frenzy following the collapse of Enron—a frenzy in which any corporate crimes were characterized as a black mark on all businessmen. Instead of simply gathering evidence and prosecuting individual perpetrators accordingly, our leaders passed a law that forces all businessmen to prove to the government that they are not cooking their books.

Under Sarbanes-Oxley, the government, without any evidence of possible fraud, has free reign to scour a company's books to determine whether they "fairly" represent the company's finances and do "not contain any untrue statement of a material fact or omit to state a material fact."

What is "fairly"? What is "material"? Since these terms are undefined, they mean anything government bureaucrats want them to mean. For example, the government under Sarbanes-Oxley can declare a CFO a defrauder for reasonably deciding to capitalize an expenditure instead of expensing it (there are many such judgment calls in accounting).

Further, how can the government hold a businessman criminally responsible for any mistake in a financial report, which is the product of hundreds of people making thousands of individual judgments and decisions? Sarbanes-Oxley says the mistake is "knowing" if the internal controls management establishes to prevent error and fraud are not "adequate." But since the government does not define "adequate," anytime a regulator decides there "should have been" still one more control to prevent even the most inconsequential of errors—management is guilty of fraud.

If parents knew that the government could throw them in jail for every judgment call and innocent error that resulted in a skinned knee, they would avoid "risky" situations like trips to the park, and spend their time tracking their child's every move and their own so that they could rebut the government's arbitrary accusations. The same is true for businesses under the potential guillotine of Section 302 of Sarbanes-Oxley—behavior practically mandated by the extensive testing and documenting of internal controls required by Section 404. Whole companies avoid any action the government might frown upon, and pour endless time and energy into monitoring and cataloging anything that a government inspector might conceivably believe is relevant to financial reporting.

Such behavior is now rampant in corporate America. One study documents businesses engaging in practices like "requiring an auditor to attend a meeting to prove it took place" and "proving that all of the physical keys to an office in Europe have been accounted for since it opened in 1995"! "Even a completely harmless error that nobody cares about," says a lawyer who handles Sarbanes-Oxley compliance, "takes up hundreds and hundreds of hours of the auditors, the CEO, the CFO and the audit committee."

That America's honest, productive businessmen are spending their time and shareholder money to "prove" they are not criminals—when they could be spending those hours and dollars on R&D, new product launches, or mergers and acquisitions—is a monumental injustice. Is it any wonder that misery among top executives is reported throughout corporate America, that top executives are departing at record rates, that more and more public companies are going private, that only a small fraction of the largest IPOs last year took place in the United States?

Sarbanes Oxley must be repealed—not "relaxed," as many business groups are timidly suggesting. And we must start treating businessmen as American citizens: innocent until proven otherwise.

Alex Epstein is a junior fellow at the Ayn Rand Institute in Irvine, Calif. The Institute promotes Objectivism, the philosophy of Ayn Rand—author of "Atlas Shrugged" and "The Fountainhead."

Labels: Business and Economics, Individual Rights and Law