Sarbanes-Oxley: Paul Kangas Interview
Friday, April 06, 2007KANGAS: To discuss whether the Sarbanes-Oxley law has accomplished what it set out to do, joining us from Washington is Alex Pollock, resident fellow at the American Enterprise Institute and in Indianapolis, Lynn Turner, director of research at Glass Lewis and Company and former chief accountant of the Securities and Exchange Commission. Gentlemen welcome.
UNKNOWN: Thank you, good to be here.
KANGAS: Since Sarbanes-Oxley took effect, have corporate earnings reports become more reliable and can investors now sleep easier?
LYNN TURNER, RESEARCH DIR., GLASS, LEWIS & CO.: I do think the reports are getting better. We're not quite there yet. We still see some issues from time to time. But I think as illustrated by the number of companies that have gone out and cleaned up their reporting, corrected errors that they've had in the past, I think we are getting better and have made some real progress here.
KANGAS: Alex, you've been quoted as saying that the Sarbanes-Oxley act was a normal historical overreaction to the market bust earlier in this decade and is bad for investors. Is that an accurate quote, and if so, how did this law end up hurting investors rather than helping them?
ALEX POLLOCK, RESIDENT FELLOW, AMERICAN ENTERPRISE INSTITUTE: That is an accurate quote on both accounts. First, a normal bust follows a normal boom and then there's always a political reaction which ends up costly. The one thing we know about the effects of Sarbanes-Oxley is that it produced much more cost, paperwork and bureaucracy than anybody intended or anybody thought and the thing to remember is that cost is always paid by investors. That's by definition, bad for investors if costs are greater than benefits. But even if costs are just a lot more than they need to be, that by definition is bad for investors and that's all in spite of the idea that this is supposedly protecting investors.
KANGAS: Go ahead.
TURNER: Let me jump in here a little bit. I think Alex has got a valid point. You always ought to look at the cost versus the benefits and there have been costs. Time and time again investors have stood up and publicly said that they'd be willing to pay for those additional costs to get more accurate financial data, funds both here in the U.S. as well as internationally have turned around and said that. And the benefits are very real here. The companies last year that had many of these numerous restatements, many of the weaknesses in their controls significantly underperformed the market 15 to 20 percent. That is a real cost to investors that people aren't talking about.
KANGAS: Lynn, Sarbox standards on internal controls, under the law's section 404, were supposed to make it harder for companies to fake their quarterly earnings numbers. But your firm says more than 1,500 public companies had to restate their numbers last year. That's a new record, and if Sarbox was supposed to improve company internal controls, why are we seeing errors going up and not down?
TURNER: That's a very fair question. Sarbox has cost companies in a very good way quite frankly, to come in and take a look at their financials, look at their transparency and get things fixed. And I think we should give a hand to the corporate executives who are doing that and getting these corrections made. While it's painful to go through them, we are going to get more accurate numbers for investors so that they can make better decisions about where to put their money in the market and I think that's great.
KANGAS: Right, OK.
POLLOCK: If I may jump in...
KANGAS: Go ahead Alex.
POLLOCK: ...on the question of restatements and offer another explanation. I think it probably is due to Sarbanes-Oxley that we're getting a lot of restatements, but an alternative explanation is due again to the perverse incentives of the accounting firms. They now have maximum reason to impose what, anecdotally at least in many cases, are debatable restatements, and they have maximum incentive to produce the most bureaucracy and heavy-handed documentation they can because, of course, it's maximally profitable for the accounting firm to do that.
KANGAS: But Lynn, what about the argument Sarbox has led to a huge increase in auditing costs for public companies?
TURNER: Well, let's start out with the fact that during the '90s, there was tremendous competitive pressure put on the auditors to reduce their fees, which they did. And when they reduced their fees, they quit doing the work that were necessary to really provide a basis for their opinion to investors as to whether the financials were right or wrong. So we cut costs then and we saw what happened when we cut costs when we saw the erroneous financial statements coming out of Enron and WorldCom. Well, I've been and it's well known I'm a critic at the accounting firms. I don't think this is about the accounting firms trying to line their pocket.
KANGAS: Alex, as we can see in the chart, micro cap companies, which have been exempt from Sarbox section 404, were actually responsible for more than half of last year's earnings restatements. But rather than tighten up on smaller companies, a bill now before Congress would make it voluntary for them to comply with section 404. Do you think that's a good idea?
POLLOCK: I do indeed. In fact, I'd make section 404 voluntary for everybody if it were up to me. If you have a voluntary approach -- and I emphasize here not exemption, a choice where you get to explain to your investors what choice you've made, then will give investors the chance to express their opinions. If indeed they love all these 404 controls so much, they will indeed pay more for the securities and you can believe that companies will follow suit.
KANGAS: Gentlemen, obviously you don't see eye-to-eye on this issue, but we thank you for your insights. Our guests, Lynn Turner, director of research at Glass Lewis and Alex Pollock, resident fellow of the American Enterprise Institute.
