Sarbanes-Oxley, the Atomic Flyswatter

Nov 5, 2008

Today’s post by Michael Arrington of “TechCrunch,” is on Newt Gingrich’s call for the repeal of the Sarbanes-Oxley Act. Often referred to as “SOx,” this law was enacted in 2002 in the wake of some sensational accounting scandals, to ensure stricter compliance with accounting standards by U.S. public companies. Very eloquently, Gingrich asserts that SOx has accomplished very little at very great expense.

Why am I writing about this? Well, this whole issue is about the value of information. Consider this:
  1. It is always possible to get “better” – i.e., more, or more accurate, or more coherent – information.
  2. It costs money to get “better” information.
  3. Whether it’s “worth” it to spend the money to get the “better” information depends on the extent to which the “better” information enables you to make “better” – i.e., more profitable, less expensive, etc. – decisions.

Gingrich estimates that SOx compliance costs over $4MM per U.S. public company. As a longtime public company CFO, I’d say that sounds about right. That’s a total of about $100B per year (yes, that’s a “B,” not an “M”). Moreover, I’d say the initial cost of SOx compliance – training, upgrading systems, consulting etc.—has run about $500B (again, that’s a “B”).

So did U.S. public investors get their money’s worth? How much is “better” information “worth”? Well, how much did the “worse” information cost stockholders? One way to estimate that is to look at the total amounts from stockholder suit judgments and settlements on Enron, MCI Worldcom, and the handful of others. My unscientific estimate of that is a total of $50 billion. Even if we assume that every dollar of those stockholder losses could have been prevented by the existence of SOx (an incredibly arguable assumption), that’s still a terrible deal.

Let’s also remember that since SOx compliance costs are paid by the companies, the stockholders are spending their own money. Why would they spend hundreds of billions of dollars to save tens? Because it’s the law.

Given the results of yesterday’s election and the recent financial meltdown, legislative action to reduce the amount of oversight of U.S. public companies is unlikely. You would be better off lobbying for the repeal of the more noxious or socially unjust provisions of the Laws of Thermodynamics. But there’s still plenty of room to apply common sense, instead of just the rules.

“Painting with Numbers” is my effort to get people talking about financial statements and other numbers in ways that we can all understand. I welcome your interest and your feedback.

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