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by Joel Trammell
Sarbanes-Oxley (Sarbox) compliance puts a heavy burden on IT teams to implement identity management systems to track who made changes to financial information, when they did it, and how they did it. This is an expensive and time-consuming process. But we often take a look at solving the problem without taking a step back from it and consider whether or not it is a good idea in the first place - the history of engineering is filled with elegant solutions that produce more problems than they solve.
The Sarbanes-Oxley Act of 2002 was passed as a result of numerous corporate scandals such as the ones at WorldCom (MCI), Enron and Tyco International. Unfortunately, the Act was passed without much thought given to the economic impact of the new rules and was crafted so quickly that many of the provisions are overly vague. The most burdensome area for companies is Section 404. Here is a summary from Soxlaw:
Issuers are required to publish information in their annual reports concerning the scope and adequacy of the internal control structure and procedures for financial reporting. This statement shall also assess the effectiveness of such internal controls and procedures.The registered accounting firm shall, in the same report, attest to and report on the assessment on the effectiveness of the internal control structure and procedures for financial reporting.
This simple idea has increased the accounting costs for every public company (or company considering going public) by at least $2 million dollars per year. It is effectively a tax on public companies - paid to accounting firms and IT vendors.
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Because of the vague nature of the requirements and the personal liability the act places on the CEO and CFO, companies are forced to pay exorbitant costs to receive certification. For a large company (like General Motors) these costs may be insignificant. The cost for small and midsize companies, however, represents a significant portion of yearly profits.
The end effect of this legislation is that U.S. sole proprietorships and partnerships are less likely to pursue an IPO. Instead, growing companies look to be acquired.
This dearth of IPOs makes the U.S. less competitive in the global markets - it limits innovation and economic growth that new public companies have historically provided. If Google had sold out to Microsoft or another competitor before going public, the Google founders would have still made more money than they could ever spend - but the hundreds of Google employees that have since become millionaires and the many exciting and valuable new applications they are creating would have probably disappeared.
The acquisition model also increases the amount of corporate wealth and market consolidation, and the next generation of mid-sized, growing companies will find it harder to gain a foothold in new markets against horizontally expanding mega-businesses.
The Dec. 21, 2006 issue of the Wall Street Journal had this bit of commentary from Michael S. Malone:
Not least -- but worst -- there is the Sarbanes-Oxley Act of 2002, whose self-monitoring rules Big Corporate initially resisted, but now embraces as an effective way to track internal financial operations. That alone should make you suspicious, because when established businesses like new rules it's usually because it makes them more competitive against start-ups. Entrepreneurs have no constituencies, they don't hire lobbyists or form PACs (like Google just did). Meanwhile, in an almost perfectly timed punchline, China's biggest bank, ICBC, recently went public on the Hong Kong and Shanghai exchanges. The $19-billion IPO was the largest in history, arriving as Hong Kong becomes the world leader in IPOs.The closer you look at Sarbanes-Oxley the more you realize it is almost perfectly designed to crush new business creation. The latest estimate for the annual cost of implementing Sarbox in a public corporation is $3.5 million. Pocket change for a Fortune 500 company; the entire annual profit of a newly public firm. Is it really any wonder that smart entrepreneurs look for a corporate sugar daddy instead of an IPO?
Google made the decision to go public, but how many other companies will not because of these issues?
Just this week in BusinessWeek magazine was this quote:
More than any particular deal, the most important IPO news of 2006 may be that this was the year when the U.S. lost its claim as the premier location for companies looking to go public.
This is bad news for the US economy.
While Sarbox may have been well intentioned, it attempted to solve a problem that had already been solved. Without Sarbox in place the leaders of Enron, Worldcom and Tyco were all prosecuted. Fraud has always been illegal, and, as these cases showed, could be prosecuted without Sarbox.
So, in the end, Sarbanes-Oxley turns out to have a very limited positive effect, and the negatives - increased corporate consolidation, a less competitive U.S. economy, and decreased innovation, greatly outweigh it.
Joel Trammell is CEO of NetQoS.
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