A federal appeals court, in a 2-1 split decision announced Friday, held that the accounting oversight board created in 2002 as part of the Sarbanes-Oxley reforms is constitutionally permitted. The decision has been described as a victory for supporters of Sarbanes-Oxley and the Public Company Accounting Oversight Board. But it may in fact be its last gasp.

"Our bet is that federal high court can, in its wisdom, be counted on to reverse," the editorial writers at the New York Sun write. "We give it a year before the Nine tell American businesses that they are free to produce a little more and audit a little less."

After the jump, we explain why the Sun is probably right.

Larry Ribstein, who writes on Ideoblog, asks:
Is there potential [Sarbanes-Oxley] internal controls liability for Bear executives? If not, and melt-downs like this can happen after SOX (worth $80+/share one day, $2 the next), then what was it, exactly, that SOX did for us? Could it be that SOX didn't eliminate risk after all? ... So two possible lessons from Bear: We didn't need SOX, and it didn't do any good.

Lessons from Bear on SOX [Ideoblog]

We can't remember the last time we saw a glossy, informative corporate annual report. These days most seem to be just 10K wraps--SEC filings with a glossy cover--and we read the data on our computer monitors. So who killed the annual report? Sarbanes-Oxley. [READ MORE]

Annual Report, R.I.P. [The American]

We’re generally fans of the Wall Street Journal opinion page. But yesterday the page ran an exceptionally unconvincing pair of articles—one by First Trust economist Brian Westbury alleging that business coverage was unduly bearish and the other by former Goldman Sachs partner Thomas Healey arguing that Sarbanes Oxley is an amazing success.

Let’s start with Healey’s piece on Sarbanes Oxley. The first thing indicator that something is wrong with Healey’s argument is the hyperbolic language he uses. “The last five years have made it irrefutably clear. Sarbanes-Oxley (Sarbox) is a textbook case of how regulation should ideally work in a democracy,” Healey writes. Lots of over-confidence there. Irrefutably clear? It’s like he’s surprised we’re even debating Sarbanes Oxley. And all that talk about democracy is just jingoistic smoke. You can almost sense the message: if you oppose Sarbanes Oxley you’re against democracy. Anti-american, even.

And that’s just when he’s getting started. By the time he’s done he’s really gone over the edge. “As Sarbanes-Oxley prepares to mark its fifth anniversary, there's only one valid conclusion to draw. This milestone in responsible corporate governance and accountability has more than fulfilled its mission to the public,” he writes. Get that Sarbanes Oxley critics? Your conclusions are invalid! Invalid! Invalid!

We almost feel gross reading this kind of thing. It’s like a guy who keeps telling you his girlfriend is really, really hot. You want to give him points for his dedication and enthusiasm but at some point you start suspecting she’s a minger.

The space between Irrefutable and Invalid were filled up with arguments in favor of Sarbane Oxley that struck us as surprisingly weak. We came away thinking: Is this really the best the supporters of Sarbanes Oxley can offer? This Healy guy is a former Goldman partner, Reagan treasury official and a senior fellow at Harvard’s Kennedy school. But look what he comes up with:

• “A powerful argument for Sarbox can be made simply by examining the performance of financial markets since the landmark act was passed.” This is worse than just an ordinary post-hoc, ergo-hoc fallacy. It only seems plausible if you concentrate on what is easy to see—a five year bull market—and ignore how well the economy might have performed without the economic drag of the regulation. Sure Sarbanes Oxley didn’t cause a five year bear market—but that’s like saying that just because a victim survived, you shouldn’t charge the guy who stabbed him with the crime. It’s an argument but it’s not quite as powerful as Healey imagines.

• ”Considerable attention has been given to the fact that U.S. companies spent an estimated $6 billion in 2006 complying with the provisions of Sarbox…That's not an insignificant expense, but critics should weigh this against another incontrovertible fact: The cost of compliance pales in comparison to the $60 billion stockholders lost on Enron alone.” Let’s use some more Latin: this is a non-sequitur. There’s no convincing evidence that Sarbanes Oxley could have prevented the collapse of Enron or warned investors in time to get earlier. Without such evidence, counting Enron’s $60 billion on the ledger for Sarbanes Oxley makes no sense. What’s more, that $6 billion is just the direct cost of complying with Section 404 and doesn’t count many of the indirect costs of the regulation. So we’re dealing with imaginary benefits and under-counted costs.

• “Finally, there's the oft-heard charge that Sarbox is an insidious threat to the U.S. financial markets. How else to explain the fact the U.S. has been steadily losing IPOs to other countries? The facts tell a different story. Truth is, the U.S. continues to be the world's leading financial market, commanding 45% of global mutual fund assets and 70% of global hedge funds.” This is more “the victim survived” sleight-of-hand. Look at this good thing, and ignore the costs.

Healey’s case for Sarbanes Oxley is so weak we’re tempted toward the conspiratorial notion that maybe he’s secretly an opponent who is attempting to undermine the regulations by marshalling super-bad arguments for them. A double agent of some sort. After all, if the arguments in favor of Sarbanes Oxley were really this bad, it would be on the fast-track to repeal, right?

Well, it would be if we lived in a democracy where regulation worked “ideally.” But we’re stuck with the one we got.

Sarbox Was the Right Medicine [Wall Street Journal]

We like Alan Murray—and not just because he was so easy to beat up on when we were up against him on Squawk Box. He’s a smart guy but he’s a bit too credulous sometimes. And he constantly trips himself up on the grand illusion of our time—that moral problems can be solved by technical means. To cure a problem such as corporate fraud, all that is needed is a set of cleverly designed regulations. It is apparently very easy for the intelligent to forget that not all problems can be solved by the application of intelligence, even Alan Murray’s intelligence.

In the video above—and in his column on page 11 of today’s Wall Street Journal—you can hear him quickly jump from describing the Tom Wolfe-ian character of Conrad Black to the conclusion that we should be cautious about reforming or repealing Sarbanes-Oxley because, you know, it’s supposed to make doing bad things harder.

Larry Ribstein isn’t so sure. First of all, he wonders, what evidence is there that Sarbanes-Oxley really would do much to prevent the kind of intentional wrong-doing alleged in the Black case? “Indeed, it’s unclear that SOX would have prevented even Enron, which had a completely independent audit committee,” Ribstein writes.

But the real problem with Murray’s argument is even worse—like so many of the arguments for regulations that stem from anecdotal tales of wrong-doing, it fails to even attempt a basic cost-benefit test.

As Ribstein writes:

…even accepting Murray’s conclusion, this is not an excuse for SOX. Is it really worth huge costs to thousands of legitimate companies to (possibly!) prevent one Conrad Black? Do we really need a massive federal law to “mak[e] it clear that directors work for shareholders, not management.” In firms where directors and managers don’t already know this despite an already large structure of federal and state criminal and civil remedies and regulation, is SOX 404 really going to make a difference?

You know sometimes you walk into a restaurant and you see a couple of people you know. You stroll by the table to say hello and immediately you get that feeling—the one that tells you that you are interrupting something. Something intimate. This isn't just a dinner. Not just friends out for drinks. This is a date. You are making it awkward.

That's how we felt when we recently ran into a certain CNBC personality and a well-known financial type. No. Not that one. We're talking about Liz Claman and Warren Buffett, who we ran into chatting on CNBC as we passed the television on the way to where we keep the whiskey. (Sure it's only 11 am but we've got one of those phantom hangovers where we feel like crap despite only drinking half a bottle of red last night. Hair of the dog that bit us in our dreams.) Those two are mighty close these days.

What was the point of all this? Oh, right. Grandpa Buffett let loose with an interesting figure this morning. According to Buffett, Berkshire-Hathaway spent $24 million on auditing this year, a figure he says would have been closer to $10 million without Sarbanes-Oxley. This is just one, anecdotal data point but still. That's an enormous cost multiplyer. If SarbOx is costing anything like this with many other companies, we're looking at a serious wealth transfer because of a regulation whose benefits are hard to quantify. Does anyone really think SarbOx is making investors 2.4 times safer?

The evidence for the perversity of Sarbanes-Oxley costs keeps mounting. Public companies are losing the most capable executives to privately held firms offering better compensation, less regulatory oversight and less risk of criminal prosecution for business failure. Capital markets are seeing companies exit public markets in favor of ownership by firms funded by pooled private capital. And now the world of company debt is getting darker and less public thanks to Sarbox.

From Bloomberg:

Sarbanes-Oxley, the U.S. law designed to stamp out corporate fraud, is prompting more companies to keep secrets in the bond market.

Siemens AG, Australian retailer Woolworths Ltd., Miller Brewing Co. of Milwaukee and at least 100 other companies are selling bonds that aren't registered with the Securities and Exchange Commission instead of debt that requires more disclosure. The securities increased 50 percent in the past two years, five times faster than the rest of the U.S. market, according to data compiled by Lehman Brothers Holdings Inc.

``It's a darker world of the bond market,'' said Matthew Eagan, who helps oversee $97 billion in fixed income, including unregistered bonds, at Loomis Sayles & Co. in Boston. ``It's off the radar.''

The private bond sales are flourishing because companies face almost no penalty for keeping their finances away from the public. The millions of dollars in costs to comply with the Sarbanes-Oxley Act of 2002 can wipe out savings from public debt because investors demand only 11 basis points more in yield to buy unregistered securities, Lehman data show.

That is to say, as the cost of compliance with Sarbox and other regulations on public debt approaches the interest-rate difference between private, unregistered debt and public debt, the incentives to have a registered offering vanish.

Sarbanes-Oxley Backfires in Unregistered Bond Sales [Bloomberg]

Okay. That'san exaggeration. But one of the most annoying things we hear from a lot of the defenders—think Ben Stein or Thomas Palley—of Sarbanes-Oxley is that critics are just shills for investment banks or corporate executives. That's never been true. DealBreaker's long been critical of Sarbox and we can't even get most corporate executives to answer our calls, much less pay us off to shill for them. (Not that we would, but we're just saying...)

So it was nice to see that a majority of economists responding to the latest WSJ.com forecasting survey said that Sarbox has had "a negative economic impact." What's more, an overwhelming consensus of the surveyed economists agreed that our specific cocktail of regulation, litigation and enforcement is hurting US capital markets.

That clicking sound you hear is the clock ticking on this law. Time is up. Faster please.

Economists: A Pox on Sarbox [Wall Street Journal]

Maybe the only things thinner than the ranks of the defenders of Sarbanes-Oxley these days are the arguments the defenders are marshaling to hold off the charge of the reformers. Thomas Palley's recent attempt—"In Defense Of Sarbox"—is so batty it more or less made us want to pick the pale, beaten body of Palley up off the street, bring him inside, comfort him and then wrap a forty-pound black iron chain around his waist while we broke the itch for bullshit from his brain. (Uhm, see above--and otherwise completely irrelevant--video for an explanation of that metaphor.)

Palley's basic defense of Sarbox is, well, actually he pretty much left that part out. Instead he kind of just attacked some of the critiques of Sarbox, and even those attacks were more pouts than fully thought out arguments.

Look. This isn't going to be pretty. So we're putting the ugly, chain-tugging, break-you-even-if-it-hurts-us-more-than-it-hurts-you-Tommy-boy bits after the jump. Normally we wouldn't be so mean but Tommy's website tells us he's got degrees from Oxford and Yale and he's a Doctor of some sort. So presumably he can take it.

In Defense Of Sarbox [Thomas Palley.com via FelixSalmon.com]

In perhaps the bluntest statement on Sarbanes-Oxley to date by a corporate insider, Shutterfly founder and (until yesterday) board chairman Jim Clark announced his resignation from the board of directors because Sarbanes-Oxley was taking all the fun out it.

As I understand it, Sarbox dictates that I not Chair any committee due to the size of my holdings, not be on the compensation committee because of the loan I once made to the company, not be on the governance committee, and it even dictates that some other board member must carry out the perfunctory duties of the Chairman. What’s left is liability and constraints on stock transactions, neither of which excite me.

It seems pretty clear to me that lawmakers have gone too far in considering a large shareholder to be inappropriate in the roles, but it is equally clear that I have no ability to change this in the near term. My only solution is to become an outsider. I wish to be treated as such effective immediately.

Jim Clark's Resignation Letter [SEC]
Shutterfly chairman quits, attacks Sarbanes-Oxley [Reuters]
Shutterfly Loses Chairman, Who Blames Sarbanes-Oxley [DealBook]

That’s a big Yes, according to Kenneth Starr (yes, that Ken Starr). We’ll leave it to others to discuss the legal reasoning behind Starr’s argument. Something to do with the method by which the members of the all-powerful Public Company Accounting Oversight Board (PCAOB) are appointed. What’s really interesting, as Larry Ribstein points out, is that SOX was written so sloppily that it doesn’t contain a constitutional savings clause—a section of the law that says if one part is struck down, the rest of it can remain in force. In other words, if the PCAOB portion of SOX goes, so goes the whole thing.

A Verdict on Sarbanes-Oxley: Unconstitutional [Walll Street Journal]

A blue-ribbon Capitol Hill panel yesterday rolled out a plan to keep Wall Street the world's financial center by rolling back rules that hurt small companies and sent others to list their stocks on foreign shores. Run by former Goldman Sachs President John Thornton and ex-Bush administration official and current Columbia University Business School dean Glenn Hubbard, the panel wants to replace the very structure of the nation's 74-year-old regulatory system of policing Wall Street with a flexible one modeled after London's watchdog unit, which uses broad principles to keep the markets clean. Hal Scott, the director of the group's report, told The Post that average Sarbanes-Oxley compliance fees of $4.3 million "are absolutely killing the U.S. in terms of maintaining listings dominance."

SARBOX DETOX NOW: PANEL [NY Post]

Paulson makes case for tougher enforcement of securities laws

Paulson says need to apply business rules lightly

Just as long as those guys in Washington are giving the market clear signals.

Last week we asked you where you thought Donald Rumsfeld would head next. Nearly thirty percent of respondents said “Halliburton”—which is pretty disappointing since that seems the least likely of choices. You don’t really think Rumsfeld wants that kind of heat do you? Usually, we defer to our readers votes on these matters but this time we have to part company—Rummy’s almost certainly not heading to Halliburton.

So where is he going? Sunday’s Chicago Tribune runs through a host of possibilities: defense industry (too much “revolving door” heat), biotech (seems likely), some company in Chicago (Rummy’s totally hooked up in the Windy City) or one of the companies where his close friend Edward Brennan sits on the board.

But the article also raises the possibility that Rumsfeld might want to stay off the boards of any public company. In the era of Sarbanes-Oxley, it might just not be worth it to take the scrutiny that comes with serving as a director. Try to resist the temptation to say that “a feature, not a bug” of SOX.

Work shouldn't be hard to find for Rumsfeld [Chicago Tribune]

Christopher Byron’s column in today’s New York Post asks why ousted members of Congress try so hard to land seats on corporate boards when they typically land positions on penny-stock companies in an age when Sarbanes-Oxley has upped the risks of sitting on a board. But the analysis is mostly backward looking and not half cynical enough.

Look, do you think it’s just a coincidence that members of Congress want board seats and managed to raise the cost of sitting on a corporate board? Sure it is. By raising the costs through SOX penalties, Congressmen have probably freed up a few seats on corporate boards for themselves. But that's just an "unintended consequence" of the legislation, of course.

Politicos Parachutes Get Torn

Since the new Democratic chairman of the House Finance Committee, Barney Frank, has already given notice that he doesn’t expect any legislative reforms of Sarbanes-Oxley to come out of his committee, attention has turned to the SEC for possible regulatory reforms. Today the Wall Street Journal reports that regulators have said they will “propose guidance next month to help companies and auditors interpret Section 404 in a way likely to save the time and money.”

The Wall Street Journal is trumpeting this as a great victory for “business” but we’re not so sure. The “guidance” coming from the SEC could be the relief businesses feeling the strain of Sarbanes-Oxley compliance have been craving. Or it could be like handing a glass of rusty nails to a thirsty man. One things seems clear, the SEC isn't preparing any substantive amendments to the SOX rules. GodThe Devil only knows what the lawyers and accountants will do with the so-called "guidance." (Most likely take it as an opportunity to "guide" hourlies even higher.)

Business Wins Its Battle to Ease A Costly Sarbanes-Oxley Rule

The Republican controlled Capitol Hill brought us Sarbanes Oxley. With more and more frequency, we're hearing talk that maybe it will take Democrats to reform it. Like Nixon going to China, its possible that only a party not seen as already in bed with business will be able to muster the votes necessary to scale back the compliance-above-all culture spawned by the last round of business scandals.

Today, accurately or not, many executives equate Democrats with higher taxes, regulatory excess, and lawsuits run amok. With most pundits forecasting major Democratic gains in the Nov. 7 midterm elections, business is bracing for the worst.

It may not have to

On issues ranging from Sarbanes-Oxley rules to immigration to retirement security, business may find some unlikely allies in Democrats such as Charles B. Rangel of New York, Barney Frank of Massachusetts, and John D. Dingell of Michigan. "Should they be in charge, they're going to want to create a coalition that enables them to continue being in charge," says Jay Timmons, a senior vice-president at the National Association of Manufacturers and a longtime aide to Senator George F. Allen (R-Va.).

Who's Afraid Of Charlie Rangel? [Business Week]

Today’s Wall Street Journal bring us a column jointly written by New York mayor Michael Bloomberg and Senator Charles Schumer calling for reforms—such as re-examination of Sarbanes-Oxley and a taming of our shareholder class-action litigation frenzy—to make New York at least as friendly to finance as London.

With the benefit of hindsight, the Sarbanes-Oxley Act of 2002, which imposed a new regulatory framework on all public companies doing business in the U.S., also needs to be re-examined. Since its passage, auditing expenses for companies doing business in the U.S. have grown far beyond anything Congress had anticipated. Of course, we must not in any way diminish our ability to detect corporate fraud and protect investors. But there appears to be a worrisome trend of corporate leaders focusing inordinate time on compliance minutiae rather than innovative strategies for growth, for fear of facing personal financial penalties from overzealous regulators.

Second, what lessons can we learn from other nations' legal environments? The total value of securities class-action lawsuits in the U.S. has skyrocketed in recent years, to $9.6 billion in 2005 from $150 million in 1997. The U.K. and other nations have laws that far more effectively discourage frivolous suits. It may be time to revisit the best way to reduce frivolous lawsuits without eliminating meritorious ones.

Keep in mind that Charles Schumer co-wrote this—not Hank Paulson or Arthur Levitt. Charles effin Schumer. Almost makes you think the Democrats might be just about grown up enough to be trusted with running the Senate again.

To Save New York, Learn From London [Wall Street Journal]

Our heads are still aching from drinking one (okay, three or four) too many margaritas in honor of Jeff Skilling, the guy at the helm when Enron hit the iceberg of its financial gambles who yesterday got hit with a sentence of 24-years or life (whichever comes first). So it is comforting this morning to know that it’s not just us tequila-quaffing kids who are skeptical about increasing the risk of criminal liability for American corporate executives.

U.S. Treasury Secretary Henry Paulson said he is considering recommending changes to the 2002 Sarbanes-Oxley corporate governance law because its restrictions have overwhelmed some American companies. While the "net result'' of stricter reporting standards for executives has been positive, Sarbanes-Oxley has also contributed to "an atmosphere that has made it more burdensome for companies to operate,'' Paulson said in an interview today from Washington.

"We're going to need to look at how we can address some of these issues,'' Paulson said. "This is something we're giving a lot of thought to.''

Paulson's comments come as business groups press the Bush administration to loosen the Sarbanes-Oxley restrictions. The U.S. Chamber of Commerce and other groups say the law stifles innovation and puts corporate officials, who must certify the accuracy of their financial results, at risk of prison terms.

"We as a country do as good a job as any nation of shining a light on a problem when a problem occurs,'' Paulson said in the interview. "Oftentimes the pendulum will swing too far.''

If he keeps this up, we're going to start feeling bad about the whole "tree-hugger" thing.


Paulson Says Sarbanes-Oxley Adds to Companies' Burden [Bloomberg]

The tone of this Bloomberg story on how dozens of companies are finding that their options timing shenanigans are getting them in hot water with bondholders strikes us as a little bit one-sided. Here’s the lede, with emphasis added.

As soon as Vitesse Semiconductor Corp. said it was under investigation for securities law violations that may delay routine regulatory filings, the Camarillo, California, maker of computer chips also learned it was about to be held up for ransom in the bond market.

How Vitesse bonds and the debt of dozens of companies are being exploited by hedge funds, including Citadel Investment Group LLC, Whitebox Advisors LLC and Aristeia Capital LLC, is the story of fine print in prospectuses allowing creditors to demand immediate payment of principal when earnings reports are delayed.

At stake is as much as $36 billion of bonds that may be retired if the funds have their way, according to data compiled by Bloomberg. While no one expects that amount to be redeemed early, almost $200 million in premature payments may be made, says New York-based law firm Latham & Watkins LLP.

Briefly, here’s what seems to be happening. The companies are finding they cannot deliver financial statements on time due to questions about option timing. In a distant past they may have delivered the statements and then sought to restate them later rather than default on their bonds, but SOX requirements that the financials be certified by executives would put those executives on the line for the misstatements. So now its preferable to default than to file a timely if wrong statement.

Now this is no doubt annoying to the shareholders and managers of the companies involved. But the companies did sign on to the covenants agreeing that failure to file financial statements would amount to a default. And it’s not as if the Sarbanes Oxley requirements are new. If they wanted looser covenants, they could have sought to refinance.

Or they could have avoided playing around with the dates of their options grants.

Options Scam Lets Citadel, Hedge Funds Exploit Bonds [Bloomberg]

Update: Paul Kedrosky has a very different take.

[Disclaimer: When John Carney was an attorney he often worked for banks and financial institutions which arranged bond issuances and most likely hold some of the bonds in question. He drafted and negotiated loan documents, including bond covenants, for clients. He worked at Latham & Watkins from 2004 to 2005.]