6 ms·

The Worst Ideas of the Decade - Sarbanes-Oxley

96 points by chwolfe 17y ago

ShabbyDoo 17y ago
I see parallels in California's ill-conceived desire to "protect" porn stars through mandatory condom use: http://www.forbes.com/2009/12/07/entertainment-pornography-condoms-opinions-contributors-alexandre-padilla.html http://www.forbes.com/2009/12/07/entertainment-pornography-c... One of the arguments against Sarbane-Oxley is that it created incentives for smaller public companies to privatize and thus reduced the overall level of economic transparency -- just like forced condom use could cause the self-regulated adult industry to go underground. W.r.t. Sarbanes, it seems that the US government would better serve the "greater good" by creating a few standardized sets of accounting/audit/disclosure requirements from which public companies could pick. Presuming that investors actually valued disclosure laws, companies could pick a set of rules which they think would maximize their valuation. Let's say you are a small cap whose profitability would be significantly affected by the cost off complying with onerous SEC requirements. You could opt into a looser set of rules, but the market could punish you with a lower valuation as a result. Perhaps this lower valuation for less transparency/trust would be better than the reduced valuation from spending an extra $2.3M to comply with Sarbanes regulations. As a libertarian, I'm not keen on government involvement in markets, but the above proposal is a compromise of sorts.
- conover 17y ago
  Exactly. Why not rate a company's financial transparency like bonds are rated? The market can factor that rating into the valuation.
  - byrneseyeview 17y ago
    One simple proxy: implied volatility of put options. Since put option buyers only make money when the stock falls--dramatically, and quickly--they are the most effective way to bet that someone is cooking the books.
    - joubert 17y ago
      How would they know the books are being cooked?
      - byrneseyeview 17y ago
        How would a rating agency? The options traders have money on the line; the rating agency is betting its reputation--which means it can exploit mispricings in the reputational marketplace by doing a bad job and hiring good PR people and lobbyists. This is the purest, most cynical way to explain ratings agencies in general.
  - joubert 17y ago
    Probably because one needs standardized accounting methods, otherwise looking at two sets of financial statements would be like looking at a tractor on the one hand, and a strawberry on the other.
- joubert 17y ago
  What makes you think governments (or government-sponsored bodies) do not set accounting standards already? (they do). The problem is more that the US accounting standards are rule-based, instead of principles-based (e.g. IFRS). Moreover, there's a distinction between listing requirements and GAAP.
dhimes 17y ago
I'm always skeptical when Congress legislates process. They are almost always better off sticking to outcomes. In this case, hold the execs responsible for company fraud, but let them figure out how to make sure their company stays legal.
- bdonlan 17y ago
  The problem is when the execs start feeling like they will never be caught - or worse, when they start tricking themselves into thinking that what they're doing isn't fraud. Sure, they'll be caught eventually and punished, but the damage is done.
  - rbanffy 17y ago
    Make all the top level execs liable. That way, one will watch the other and the odds of all of them entering deliberate fraud (or tricking themselves into it) is reduced. It was also suggested on this thread that a carrot-and-stick (fines for the less compliant, tax reduction for the more compliant) would be pretty clever.
    - numair 17y ago
      A proposal only an insurance company could love.
    - litewulf 17y ago
      Or, it would just mean that all the top level execs would work to protect each other.
      - lallysingh 17y ago
        Or blackmail one another.
        rbanffy 17y ago
        And then all you need is one failing to pay to bring down the whole castle of cards.
grellas 17y ago
Sarbox has driven up audit costs for startups as well. A decade ago, all kinds of small practitioners would be willing to do routine audits for $10K or less for early-stage companies. Now that cost easily runs into the high five figures, if not more. Of course, startups usually do not do formal audits until they bring on investors who will insist upon them, i.e., typically VCs. Thus, this is just one more reason for a startup to try to bypass such funding sources and pursue less restrictive sources if possible (why add yet another $100K to the annual burn rate when you want above all to preserve cash and use it wisely?). Combine this (and other factors) with the crimp that Sarbox has put on companies going public, and you have an environment where the value of VC funding (which typically is key to launching a startup on the road to going public) has depreciated. A founder might look at this and think that this has little or no impact on his bootstrap or angel-funded startup that he plans to sell to Big Company X. But the effect on valuations is real. As with any negotiation, if you have fewer levers to use in the negotiating process, you will be at a relative disadvantage. If your company has no alternative but to be acquired in order to achieve a liquidity event, the buyers on the other side (i.e., potential acquirers) will factor this into their pricing to your detriment. These sorts of changes may have hurt VCs but they have hurt entrepreneurs as well in limiting or eliminating funding options that were readily available to such parties in the pre-Sarbox era, leaving all parties poorer in the process. These are real costs (as are the ones that fall on public companies directly, as noted in this piece), while the benefits of Sarbox to date have been dubious at best. Of course, the accountants, lawyers, regulators, etc. who benefit from the regulatory complexity through increased business and/or power will beg to differ, but this doesn't mean they are right. On a final note, the Supreme Court case noted in this piece does raise the prospect that Sarbox will be declared unconstitutional and, should that happen, there may indeed be some real prospects for reform. The justices seemed skeptical about the constitutional argument during oral argument, however, and this may therefore go nowhere as a potential solution to the problems raised.
- joubert 17y ago
  Why would Sarbox drive up audit costs for non-public companies (i.e. startups and small business owners)? Financial statement audits for private companies are exempt from SOX. PS: I used to be an external auditor at PwC.
lkrubner 17y ago
My impression is that there was a stretch when some combination of the public mood and the government's emphasis conspired to encourage small startups. The 1980s and 1990s were clearly good in this respect. The mood of the last decade has been increasingly punitive. Sarbanes-Oxley is the most clear example of this. What once would have been treated as a civil matter is now treated as a criminal matter. Entrepreneurs are now faced with jail time instead of lawsuits. This can only have a chilling effect on innovation. I think it is urgent that everyone who cares about entreprenurial culture in America to make the argument that innovation in business depends in part on tolerance, and that, in practical terms, this means most matters of conflict should be treated as civil rather than criminal cases. A comparison might be made to the evolution of bankruptcy law. Before the mid 1800s, most Western countries treated bankruptcy as a criminal matter, rather than a civil one. The liberalization of bankruptcy law was one of the factors that allowed our modern economies to gain the dynamic nature they now enjoy. The public's mood changed during the 1800s as it became more obvious that many times entrepreneurs failed with their first venture. They needed a second chance, when they were often more successful. John Bayer, who created what became Bayer aspirin, is an outstanding example of this - at first he tried to build a liquor business, but it failed. His father-in-law was suffering arthritis, and therefore drinking large amounts of willow bark tea - the only known source acetylsalicylic acid. John Bayer then put the willow bark tea through the distillery equipment he'd bought for his liquor business - and thus asprin was created. The point is, he needed a second chance to become successful. Many entrepreneurs are in this category. Since this is Hacker News, I would guess that most of us know someone who has tried to do a startup, and failed on their first attempt. Many of us also know entrepreneurs who tried again, and met with greater success on successive tries. Tolerance of failure is the first pre-requisite of a dynamic economy. More so, if you have any friends who have attempted to launch a startup, ask yourself under what circumstances you think your friends should go to jail. I posted a similar comment some months ago, and I mentioned how many lives might be saved by the next wave of medically-focused startups. Someone responded: "When you cross the line into experimenting with medical treatments, you're not gambling with other people's money, you're gambling with lives. You can't just equate it to any other kind of start up, it has to be held to a higher standard." I want to repeat, many, many industries can lead to people's deaths. There is nothing unique about medical innovation. If you build a new kind of jet engine, which gets through testing but which then is responsible for a spectacular crash, then your product has killed a few hundred people. And yet, unless there was fraud in the documentation of the tests, there have not been criminal cases in the past. Right from its creation, decades ago, the FAA has taken a strong line against criminal - the feeling has always been that criminal prosecutions would stifle the free flow of information, and the only way to save lives over the long-term is through the free flow of information. Many other fields can cause people to die - industrial automation, the transport and disposal of toxic chemicals, the construction of buildings (which could then fail and kill people). All industries are in need of innovation all of the time, yet innovation brings with it risk, including the risk of death. How much innovation will we get if we make these matters criminal? I should emphasize, just in case people forget, that fraud has always been criminal. It has been criminal for centuries. So the move to criminalize more aspects of business is not a move to make fraud criminal. If you think that the Sarbanes-Oxley Act made fraud criminal, then you are mistaken. Fraud has always been criminal. Sarbanes-Oxley is representative of the new trend. The overall goal was to encourage greater accuracy in the reporting of a company's financial health. This goal could have been reached through a variety of methods, including both the carrot (rewards) and the stick (punishments). Rewards could have included tax breaks for meeting some additional level of compliance. Punishments could have included fines levied against companies that failed to meet a higher level of compliance. These approaches would not have raised the risk of jail time for CEO's. Instead, Sarbanes-Oxley decided to go with the heaviest kind of punishment of all - to treat infractions as criminal offenses, potentially meriting jail time. This punitive attitude is going to have a chilling effect on the amount of innovation we can expect in any field.
pg 17y ago
As well as the cost there's also greatly increased liability for corporate officers: http://www.kirkland.com/sitecontent.cfm?contentID=223&itemId=2510 http://www.kirkland.com/sitecontent.cfm?contentID=223&it...
- ajross 17y ago
  To be fair: that's completely by design. S/O was a direct reaction to the perception that the perpetrators of the Enron and Worldcom scams were essentially unprosecutable because of the difficulty of proving their knowledge of the events. So the new law puts the presumption of knowledge onto the senior executives via the certification requirement. Now, one might argue that this is bad, or has unintented consequences. But it's not a surprise. It's the intended effect. If you lie (even, perhaps, unintentionally -- though I don't think there's been a test case of that yet) on your company's financial statements in the modern USA, you are a criminal.
  - grellas 17y ago
    Indeed, it is by design but this is a field in which it is easy to get blindsided for conduct that has never been regarded as culpable on the part of management by any historical (pre-S/O) standards. Bottom line: for those who matter (i.e., those who build companies and make key decisions on whether to take them public), this is another serious disincentive to take a company public.
Calamitous 17y ago
So, best shortening of the worst idea: Soxley or Sarbox?
- mmt 17y ago
  SOX is the one I've heard most often.
  - tptacek 17y ago
    I hear Sox and Sarbox. I've never heard Soxley. (Sarbox is a [weak] security audit driver, so it's something we talk about a bit).
michael_dorfman 17y ago
It was never clear how more accounting and reporting regulations were supposed to squelch fraud. Really? That one seems pretty obvious to me. Standardized accounting practices and more transparency via required reporting makes fraud harder to commit and easier to detect. The reductio ad absurdam almost writes itself.
- dkarl 17y ago
  Plus, many of the new rules were targeted at kinds of fraud that have actually been perpetrated. If you don't patch a security hole, people won't get tired of exploiting it. They'll just keep on exploiting it until you do something to make it harder or more dangerous.
DanielBMarkham 17y ago
Just from a writing perspective, you gotta love the opening lines: .The dumbest government policies are almost always the fruit of the bipartisanship that sets Beltway hearts beating with patriotic arrhythmia. Think the Patriot Act, No Child Left Behind, the authorization of force in Iraq and the TARP.... To me it's the right mix of colloquial and editorial writing. Very nicely done lead.
barmstrong 17y ago
As with many government regulations, good intentions but results that are almost the opposite. It reminds me a bit of this interview with Milton Friedman, which changed my perspective on life immensely: http://www.youtube.com/watch?v=JfdRpyfEmBE http://www.youtube.com/watch?v=JfdRpyfEmBE
rortian 17y ago
An op-ed should really never be on HN. It really sucks that this site has turned into this.

96 points by chwolfe 17y ago

I see parallels in California's ill-conceived desire to "protect" porn stars through mandatory condom use: http://www.forbes.com/2009/12/07/entertainment-pornography-condoms-opinions-contributors-alexandre-padilla.html http://www.forbes.com/2009/12/07/entertainment-pornography-c... One of the arguments against Sarbane-Oxley is that it created incentives for smaller public companies to privatize and thus reduced the overall level of economic transparency -- just like forced condom use could cause the self-regulated adult industry to go underground. W.r.t. Sarbanes, it seems that the US government would better serve the "greater good" by creating a few standardized sets of accounting/audit/disclosure requirements from which public companies could pick. Presuming that investors actually valued disclosure laws, companies could pick a set of rules which they think would maximize their valuation. Let's say you are a small cap whose profitability would be significantly affected by the cost off complying with onerous SEC requirements. You could opt into a looser set of rules, but the market could punish you with a lower valuation as a result. Perhaps this lower valuation for less transparency/trust would be better than the reduced valuation from spending an extra $2.3M to comply with Sarbanes regulations. As a libertarian, I'm not keen on government involvement in markets, but the above proposal is a compromise of sorts.

conover 17y ago
Exactly. Why not rate a company's financial transparency like bonds are rated? The market can factor that rating into the valuation.
- byrneseyeview 17y ago
  One simple proxy: implied volatility of put options. Since put option buyers only make money when the stock falls--dramatically, and quickly--they are the most effective way to bet that someone is cooking the books.
  - joubert 17y ago
    How would they know the books are being cooked?
    - byrneseyeview 17y ago
      How would a rating agency? The options traders have money on the line; the rating agency is betting its reputation--which means it can exploit mispricings in the reputational marketplace by doing a bad job and hiring good PR people and lobbyists. This is the purest, most cynical way to explain ratings agencies in general.
- joubert 17y ago
  Probably because one needs standardized accounting methods, otherwise looking at two sets of financial statements would be like looking at a tractor on the one hand, and a strawberry on the other.
joubert 17y ago
What makes you think governments (or government-sponsored bodies) do not set accounting standards already? (they do). The problem is more that the US accounting standards are rule-based, instead of principles-based (e.g. IFRS). Moreover, there's a distinction between listing requirements and GAAP.

dhimes 17y ago

I'm always skeptical when Congress legislates process. They are almost always better off sticking to outcomes. In this case, hold the execs responsible for company fraud, but let them figure out how to make sure their company stays legal.

bdonlan 17y ago
The problem is when the execs start feeling like they will never be caught - or worse, when they start tricking themselves into thinking that what they're doing isn't fraud. Sure, they'll be caught eventually and punished, but the damage is done.
- rbanffy 17y ago
  Make all the top level execs liable. That way, one will watch the other and the odds of all of them entering deliberate fraud (or tricking themselves into it) is reduced. It was also suggested on this thread that a carrot-and-stick (fines for the less compliant, tax reduction for the more compliant) would be pretty clever.
  - numair 17y ago
    A proposal only an insurance company could love.
  - litewulf 17y ago
    Or, it would just mean that all the top level execs would work to protect each other.
    - lallysingh 17y ago
      Or blackmail one another.
      - rbanffy 17y ago
        And then all you need is one failing to pay to bring down the whole castle of cards.

grellas 17y ago

Sarbox has driven up audit costs for startups as well. A decade ago, all kinds of small practitioners would be willing to do routine audits for $10K or less for early-stage companies. Now that cost easily runs into the high five figures, if not more. Of course, startups usually do not do formal audits until they bring on investors who will insist upon them, i.e., typically VCs. Thus, this is just one more reason for a startup to try to bypass such funding sources and pursue less restrictive sources if possible (why add yet another $100K to the annual burn rate when you want above all to preserve cash and use it wisely?). Combine this (and other factors) with the crimp that Sarbox has put on companies going public, and you have an environment where the value of VC funding (which typically is key to launching a startup on the road to going public) has depreciated. A founder might look at this and think that this has little or no impact on his bootstrap or angel-funded startup that he plans to sell to Big Company X. But the effect on valuations is real. As with any negotiation, if you have fewer levers to use in the negotiating process, you will be at a relative disadvantage. If your company has no alternative but to be acquired in order to achieve a liquidity event, the buyers on the other side (i.e., potential acquirers) will factor this into their pricing to your detriment. These sorts of changes may have hurt VCs but they have hurt entrepreneurs as well in limiting or eliminating funding options that were readily available to such parties in the pre-Sarbox era, leaving all parties poorer in the process. These are real costs (as are the ones that fall on public companies directly, as noted in this piece), while the benefits of Sarbox to date have been dubious at best. Of course, the accountants, lawyers, regulators, etc. who benefit from the regulatory complexity through increased business and/or power will beg to differ, but this doesn't mean they are right. On a final note, the Supreme Court case noted in this piece does raise the prospect that Sarbox will be declared unconstitutional and, should that happen, there may indeed be some real prospects for reform. The justices seemed skeptical about the constitutional argument during oral argument, however, and this may therefore go nowhere as a potential solution to the problems raised.

joubert 17y ago
Why would Sarbox drive up audit costs for non-public companies (i.e. startups and small business owners)? Financial statement audits for private companies are exempt from SOX. PS: I used to be an external auditor at PwC.

lkrubner 17y ago

My impression is that there was a stretch when some combination of the public mood and the government's emphasis conspired to encourage small startups. The 1980s and 1990s were clearly good in this respect. The mood of the last decade has been increasingly punitive. Sarbanes-Oxley is the most clear example of this. What once would have been treated as a civil matter is now treated as a criminal matter. Entrepreneurs are now faced with jail time instead of lawsuits. This can only have a chilling effect on innovation. I think it is urgent that everyone who cares about entreprenurial culture in America to make the argument that innovation in business depends in part on tolerance, and that, in practical terms, this means most matters of conflict should be treated as civil rather than criminal cases. A comparison might be made to the evolution of bankruptcy law. Before the mid 1800s, most Western countries treated bankruptcy as a criminal matter, rather than a civil one. The liberalization of bankruptcy law was one of the factors that allowed our modern economies to gain the dynamic nature they now enjoy. The public's mood changed during the 1800s as it became more obvious that many times entrepreneurs failed with their first venture. They needed a second chance, when they were often more successful. John Bayer, who created what became Bayer aspirin, is an outstanding example of this - at first he tried to build a liquor business, but it failed. His father-in-law was suffering arthritis, and therefore drinking large amounts of willow bark tea - the only known source acetylsalicylic acid. John Bayer then put the willow bark tea through the distillery equipment he'd bought for his liquor business - and thus asprin was created. The point is, he needed a second chance to become successful. Many entrepreneurs are in this category. Since this is Hacker News, I would guess that most of us know someone who has tried to do a startup, and failed on their first attempt. Many of us also know entrepreneurs who tried again, and met with greater success on successive tries. Tolerance of failure is the first pre-requisite of a dynamic economy. More so, if you have any friends who have attempted to launch a startup, ask yourself under what circumstances you think your friends should go to jail. I posted a similar comment some months ago, and I mentioned how many lives might be saved by the next wave of medically-focused startups. Someone responded: "When you cross the line into experimenting with medical treatments, you're not gambling with other people's money, you're gambling with lives. You can't just equate it to any other kind of start up, it has to be held to a higher standard." I want to repeat, many, many industries can lead to people's deaths. There is nothing unique about medical innovation. If you build a new kind of jet engine, which gets through testing but which then is responsible for a spectacular crash, then your product has killed a few hundred people. And yet, unless there was fraud in the documentation of the tests, there have not been criminal cases in the past. Right from its creation, decades ago, the FAA has taken a strong line against criminal - the feeling has always been that criminal prosecutions would stifle the free flow of information, and the only way to save lives over the long-term is through the free flow of information. Many other fields can cause people to die - industrial automation, the transport and disposal of toxic chemicals, the construction of buildings (which could then fail and kill people). All industries are in need of innovation all of the time, yet innovation brings with it risk, including the risk of death. How much innovation will we get if we make these matters criminal? I should emphasize, just in case people forget, that fraud has always been criminal. It has been criminal for centuries. So the move to criminalize more aspects of business is not a move to make fraud criminal. If you think that the Sarbanes-Oxley Act made fraud criminal, then you are mistaken. Fraud has always been criminal. Sarbanes-Oxley is representative of the new trend. The overall goal was to encourage greater accuracy in the reporting of a company's financial health. This goal could have been reached through a variety of methods, including both the carrot (rewards) and the stick (punishments). Rewards could have included tax breaks for meeting some additional level of compliance. Punishments could have included fines levied against companies that failed to meet a higher level of compliance. These approaches would not have raised the risk of jail time for CEO's. Instead, Sarbanes-Oxley decided to go with the heaviest kind of punishment of all - to treat infractions as criminal offenses, potentially meriting jail time. This punitive attitude is going to have a chilling effect on the amount of innovation we can expect in any field.

pg 17y ago

As well as the cost there's also greatly increased liability for corporate officers: http://www.kirkland.com/sitecontent.cfm?contentID=223&itemId=2510 http://www.kirkland.com/sitecontent.cfm?contentID=223&it...

ajross 17y ago
To be fair: that's completely by design. S/O was a direct reaction to the perception that the perpetrators of the Enron and Worldcom scams were essentially unprosecutable because of the difficulty of proving their knowledge of the events. So the new law puts the presumption of knowledge onto the senior executives via the certification requirement. Now, one might argue that this is bad, or has unintented consequences. But it's not a surprise. It's the intended effect. If you lie (even, perhaps, unintentionally -- though I don't think there's been a test case of that yet) on your company's financial statements in the modern USA, you are a criminal.
- grellas 17y ago
  Indeed, it is by design but this is a field in which it is easy to get blindsided for conduct that has never been regarded as culpable on the part of management by any historical (pre-S/O) standards. Bottom line: for those who matter (i.e., those who build companies and make key decisions on whether to take them public), this is another serious disincentive to take a company public.

Calamitous 17y ago

So, best shortening of the worst idea: Soxley or Sarbox?

mmt 17y ago
SOX is the one I've heard most often.
- tptacek 17y ago
  I hear Sox and Sarbox. I've never heard Soxley. (Sarbox is a [weak] security audit driver, so it's something we talk about a bit).

michael_dorfman 17y ago

It was never clear how more accounting and reporting regulations were supposed to squelch fraud. Really? That one seems pretty obvious to me. Standardized accounting practices and more transparency via required reporting makes fraud harder to commit and easier to detect. The reductio ad absurdam almost writes itself.

dkarl 17y ago
Plus, many of the new rules were targeted at kinds of fraud that have actually been perpetrated. If you don't patch a security hole, people won't get tired of exploiting it. They'll just keep on exploiting it until you do something to make it harder or more dangerous.

DanielBMarkham 17y ago

Just from a writing perspective, you gotta love the opening lines: .The dumbest government policies are almost always the fruit of the bipartisanship that sets Beltway hearts beating with patriotic arrhythmia. Think the Patriot Act, No Child Left Behind, the authorization of force in Iraq and the TARP.... To me it's the right mix of colloquial and editorial writing. Very nicely done lead.

barmstrong 17y ago

As with many government regulations, good intentions but results that are almost the opposite. It reminds me a bit of this interview with Milton Friedman, which changed my perspective on life immensely: http://www.youtube.com/watch?v=JfdRpyfEmBE http://www.youtube.com/watch?v=JfdRpyfEmBE

rortian 17y ago

An op-ed should really never be on HN. It really sucks that this site has turned into this.