Corporate Governance

The Benefits of Regulation and the Benefits of Sarbanes Oxley

By J Robert Brown Jr.

By now, the big news out of the Supreme Court's decision in FEF v. PCAOB is that SOX survived essentially untouched.  It was always farfetched that even if the Court struck down the PCAOB it would somehow invalidate the rest of the law. 

But what is more amazing is that the opposition to SOX, something that was far more virulent when the case was filed (for a discussion of the unfounded criticism, go here), continued in what can only be described as an often myopic view that refuses to take into account the benefits of the Act.  In the current era, its clear that sometimes prudent regulation makes the markets work better.  There is considerable doubt that removal of the regulatory barrier imposed by Glass-Steagall was a good thing for the markets.  SOX has likewise generated advantages. 

So with that in mind, we turn to the editorial in the Wall Street Journal today titled "Sarbox Survives."  It is a lament to the Supreme Court's failure to strike down SOX.  It contains, however, this disingenuous statement:

• At least until ObamaCare, few laws have cost so much to so little good end as Sarbox. The law has imposed hundreds of billions of dollars in costs on business with no noticeable decline in financial scandals (Madoff, Stanford). Congress is about to exempt small public companies from Sarbox's rules as part of the financial reform, and we can only hope that Members use this opening provided by the Supreme Court to ease it further.

There are several things to point out about the statement.  First, SOX reformed governance among public companies.  Stanford and Madoff were essentially investment advisors, an entirely different type of market participant untouched by the Act.  The fact that the most important frauds came in areas not regulated by SOX supports rather than detracts from the Act.

Second, the data in fact shows that SOX has had a positive effect.  As the Stanford Securities Site illustrates, the number of class action fraud suits has continued to decline since the adoption of SOX.  Last year was the lowest number filed, with one exception (2006) since the statistics were first compiled in 1997.  This year looks to be even lower.  And these low numbers are even more remarkable because the come at a time when the markets were convulsed by the financial crisis. 

In short, financial fraud, at least measured by law suits, is down.  This has to be attributed at least in part to SOX.  SOX, after all, did seek to prevent financial reform (rather than regulate investment advisors).  In what SOX tried to do, it was a success.  While one can still try to argue that the costs outweigh the success, it is ideological rather than analytical to not recognize the benefits.  

Full post as published by The Race to the Bottom on June 30, 2010 (boomark / email).