Blast From the Past: A Punch in the Face for Capitalism (Sarbanes-Oxley)

I originally posted this 11 September 2005.  It bears repeating in view of the current Wall Street mess.  It’s tempting to send some of these people to jail, but the rest will simply bail, and we won’t necessarily be the better for it.

Long ago, I attended a prep school in South Florida. Our Junior English class was in the corner of the building, with nice windows giving a view of the wraparound sidewalk and whoever strolled it. One day, we were listening to our teacher go on about something (he’s since gone on to his reward as a Provost of a small college on the West Coast) when we noticed the Assistant Headmaster and one of our fellow students at a standoff on the sidewalk.

It just wasn’t any student: it was a scion of the Oxley family, the clan who started out with a fortune made in oil and ended up as the leading family of polo (complete with Ralph Kramden’s poloponies) in South Florida. (They only recently sold the polo practice field near the school for a development.) My experience with the Assistant Headmaster was that he wasn’t one to take a lot of guff from a student, and Oxley, having shown up to school an hour or two late, wasn’t getting very far. So Oxley, in public school fashion, took a swing at the Assistant Headmaster.

We suddenly realised we literally had ringside seats to the fight. But our cheering Oxley on was to no avail: that was Oxley’s last day at our school, and things settled down after that until someone else was caught with pot, or worse.

Today we’re trying to sort things out from another “punch in the face” from another Oxley, this time Rep. Michael Oxley (R-OH) in the form of the Sarbanes-Oxley bill, passed three years ago in the wake of scandals such as Enron, Global Crossing and the like. The basic purpose of Sarbanes-Oxley is to regulate the relationship between publicly held corporations and their accountants, and to force corporate executives to “certify” their financial results, under criminal penalty.

This legislation was passed in the great American tradition of “there ought to be a law…” We have a crisis, it costs people money, Congress (the opposite of progress) reacts by passing legislation to “fix” the problem, everybody congratulates themselves for being good boys and girls, and then everyone forgets until something else comes up, when the cycle comes up all over again.

It’s true that the relationship between corporations and the “independent” accountant-auditors they retain can be more complicated than they are in theory. This is for two reasons. The first is that the corporation pays for the audit, which builds in an element of subservience into the process. The second is that accounting firms have attempted to diversify their own services with management consulting and other types of revenue-generating activity that takes them beyond boring auditing. Having seen the latter in action myself, I think that accounting firms are better off sticking to their original mission.

Having said this, knee-jerk reactions such as Sarbanes-Oxley ignore two important facts.

The first is that people actually are going to jail under existing law for the crimes committed that inspired this legislation. Congress didn’t wait to find this out. They had already been treated to Arthur Anderson’s demise, which was an object lesson no one missed. Such events beg the question as to whether this legislation was necessary in the first place.

The second is that raising the bar of liability for any action only inspires people to avoid it altogether. In the case of Sarbanes-Oxley, putting additional liabilities on executives of publicly held corporations will only inspire people to shy away from such corporations, i.e., to stick with privately held ones. Results of this range from companies avoiding going public to those which are going “dark” (becoming privately held corporations.) Anyone who has been involved in a corporation whose stock in unlisted knows that both the availability and marketability of the stock is limited. This means that, to varying degrees, any privately held corporation is an “inside deal,” benefiting those who were invited to partcipate.

The growth in participation by ordinary investors in our economy has been facilitated by publicly held stock freely available, either directly or through mutual funds. As the long-term impact of Sarbanes-Oxley takes root and people work to avoid the liabilities it imposes, the access of a broad range of investors—especially small ones—will be progressively worsened. This will accelerate the concentration of wealth in the hands of a few, which is always dangerous in a democracy, making it easy for demagogues like Huey “The Kingfish” Long to play on peoples’ desperation.

And since the subject of Louisiana has come up, we’re sure that, in the wake of the general bureaucratic failure that followed Hurricane Katrina, we’ll see congressional hearings with the object of passing legislation to prevent such failures from happening again. However, it should be evident that the slow relief response wasn’t a lack of procedures or warning. Plans and procedures were in place; the bureaucracies involved, however, didn’t forcefully put them into action. They looked at Katrina like a deer into oncoming headlights. Such failures cannot be fixed by legislation, but by putting people into office and position that will forcefully carry the plans out, as Rudy Giuliani did four years ago in New York.

Liberals used to love to say that “You can’t legislate morality.” They quit saying that when their “morality” was what they wanted to impose. You can’t legislate character and decisiveness either, and we would be better off if Congress would quit trying.

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