The limitations of the Sarbanes-Oxley Act

USA Today (Society for the Advancement of Education), March, 2005 by Scott Green

Not all structural changes were initiated by government, however, as market pressures also can have a positive impact on corporate governance. By example, shareholder activists waged battles with corporations throughout the 1990s. They fought against poison pills (corporate actions that prevent an unsolicited takeover) and brought about greater transparency for boards and regulators by attacking secret executive compensation.

All of this previous legislation and private sector action had the desired effect of restoring confidence in companies and the financial system at a critical time, and still have some influence today. Nonetheless, these efforts did not prevent the crises that followed. Corporate legislation has a sort of biological clock where its impact is maximized shortly after it is enacted. Over time, the ability of new legislation to restore and maintain confidence in public markets will fade and deterrents will weaken as the disposed learn new ways to sidestep the installed safeguards. When the next massive fraud surfaces, legislation again will be considered to reassure the nation and instill confidence in markets. This can be a virtuous cycle as long as the imposed regulations do more good than harm. Just as good legislation can contribute to confidence-building, overly burdensome regulation can result in a loss of American initiative and competitiveness.

The Sarbanes-Oxley Act was designed to address specific abuses relevant to the latest generation of frauds. Its focus is on corporate financial reporting and the related responsibilities of the nation's gatekeepers. At WorldCom, the appearance of corporate health was accomplished by passing top-side entries that turned expenses into assets. This is relatively simple to execute. Even less complicated is to omit the disclosure of liabilities altogether, as was the case at Adelphia Communications. On the other hand, Enron constructed a false picture of financial health by transferring assets through a sophisticated network of entities that had the effect of masking tree performance and impairment of these assets. Regardless of the specific methodology, each company managed to present a bankrupt company as a healthy going concern through manipulation of its financial statements.

Prosecuting executives

The prosecution of the executives of these firms largely is occurring under a number of laws that existed prior to the passage of the Sarbanes-Oxley Act. Nevertheless, there seems to be no shortage of statutes on which to base indictments. In fact, one of the first major cases utilizing the deterrents built into the Sarbanes-Oxley Act is the much-anticipated prosecution of Richard Scrushy, the former chairman and CEO of HealthSouth Corporation, among the nation's largest health care providers. In the original 85-count indictment brought by the Department of Justice is the prosecution's allegation that Scrushy personally certified financial statements filed with the SEC that he knew to be false. This count, made available by the Sarbanes-Oxley Act, together with the other counts, means that, if convicted of all of the current charges, Scrushy could have been sentenced to up to 650 years in jail, been required to pay $36,000,000 in fines, and have had to forfeit over $275,000,000 of real estate, airplanes, yachts, and other property. Interestingly, false certification under the Sarbanes-Oxley Act only counts for about 20 of the 650 possible years of jail time. As this case goes to trial, prosecutors have refined their charges by focusing on 45 of the strongest counts, including false certification of financial statements under Sarbanes-Oxley.