In news accounts about fights over new regulation, the story is almost always the same. The media portray the drama as that of well-intentioned experts wanting more regulation to protect the public good versus the business lobby ferociously opposed to the imposition of these new rules.
Media outlets have largely followed this narrative in covering the financial regulatory legislation that passed the House in December and is pending in the Senate. And so have politicians. On “60 Minutes,” President Obama chastised financial interests that he said were “fighting tooth and nail with their lobbyists … against financial regulatory reform.”
Yet with regard to at least one provision of the bill, a big sector of the financial industry has actually been fighting tooth and nail against a loosening of a burdensome regulation it profited from. Accounting firms are lobbying to prevent an exemption for smaller companies from the Sarbanes-Oxley Act of 2002. And while they claim to be advancing the goals of investor protection, they also may be motivated by the windfall the law has created for the industry by requiring public firms to purchase so many accounting services.
In November, the House Financial Services Committee surprisingly passed a modestly deregulatory amendment to a financial bill that otherwise creates more extensive regulation. Introduced by Reps. John Adler, a freshman “New Democrat” of New Jersey, and Scott Garrett, a free-market Republican also from New Jersey, the measure would permanently exempt smaller public companies from one costly provision of Sarbanes-Oxley—Section 404(b) that requires companies “internal controls” over financial reporting be subject to extensive annual audits. The exemption is now set to expire in June 2010, and the Securities and Exchange Commission has said it will not be renewed.
Sarbanes-Oxley was passed in 2002 in response to events of the last financial crisis—the implosion of the tech and the corporate fraud at Enron and WorldCom. Rushed through Congress, the law was sold as reining in accountants for public companies.
Yet the same accounting firms supposedly disciplined by this law have been using their lobbying muscle to keep SarbOx in place for all firms. “We strongly support investor protections, and do not believe that giving lesser protections to investors of small companies is appropriate,” wrote the Texas State Society of Certified Public Accountants to members of the state’s delegation in the U.S. House of Representatives. This and other state accounting societies, as well as the industry-funded Center for Audit Quality, poured in letters of support for a floor amendment backed by Financial Services Chairman Barney Frank (D-Mass.) and Reps. Paul Kanjorski (D-Pa.) and John Sarbanes (D-Md.)—the latter is the son of the law’s original author, former Sen. Paul Sarbanes (D-Md.)—to take out the Adler-Garrett provision exempting the smaller firms.
These groups may truly believe that subjecting smaller firms to extensive internal control audits serves the public interest, but it is also indisputable that Sarbanes-Oxley has become the piggy bank of the industry. Calling the law “a boon for bean counters,” Business Week notes that Sarbanes-Oxley rules have brought accounting firms an average of $825,000 in additional fees per public company client. The Sarbanes-Oxley Compliance Journal (that compliance with this law would even merit its own journal speaks volume to the law’s onerous nature,) reports “the consensus is that it is roughly four times as expensive to go public today.”
Yet many economists, policy makers, and members of Congress of both parties are questioning whether what is good for the Big Four accounting firms is an unfettered good for America. Because of the law’s broad and vague definition of “internal controls,” accounting firms have been focusing their proverbial green eyeshades on items that have little relation to accurate financial statements, such as which employees have office keys and how many letters are in an employee password. But these controls failed to stop the many of the subprime shenanigans. Disgraced financial lender Countrywide was publicly praised for its Sarbanes-Oxley compliance controls as recently as 2007 by the Institute of Internal Auditors. Now, its former executives are under indictment for securities fraud.
The law’s process can significantly delay going public even for a company as large as Google, Inc. Tech journalist John Battelle reports in his book “The Search” that because Google “made its money literally pennies at a time, from millions upon millions of microtransactions,” it “had to significantly restructure its advertising reporting system from the ground up.” If SarbOx imposes this type of burden on a company like Google, which had a market valuation of more than $1 billion before it went public, imagine the burden for smaller companies trying to raise capital. This helps explain why in the post-Sarbox years, initial public offerings slowed dramatically in the U.S., with there being less IPOs in the boom year of 2006 than in 1991, when the country was mired in a recession.
In the House, with the exception of letters from the Biotechnology Industry Organization and the Independent Community Bankers of America, there wasn’t that much lobbying from industry groups in support of this regulatory relief. The much-discussed U.S. Chamber of Commerce, which represents firms small and large, was neutral on the Adler-Garrett exemption for smaller companies. Nevertheless, the arguments about Sarbanes-Oxley’s overreach and its impact on new businesses and new jobs carried the day. One hundred and one Democrats and all but one Republican voted to defeat the Frank-Kanjorski amendment by a comfortable margin, keeping the exemption in the final bill that passed the House on Dec. 11.
The Obama administration played a curious role in this policy fight. Bloomberg reported that initially, White House Chief of Staff Rahm Emanuel urged committee Democrats to support the exemption, despite the SEC’s stance against it. White House Deputy Press Secretary Jen Psaki told the Wall Street Journal in November, “Our focus must be on addressing the threats posed to investors and consumers by large, interconnected companies rather than placing an undue burden on small businesses.” Yet the White House barely lifted a finger to beat back Frank’s attempts to remove the exemption. If Obama wants to really show that he is “not an ideologue,” as he maintained to House Republicans last week, giving his firm support to this limited regulatory relief for smaller companies from the unduly burdensome SarbOx is a great place to start
Now, the fight moves to Senate, where some industries will fight for more and others will fight for less regulation in this and other provisions of that body’s financial bill. There is nothing inherently wrong with an industry fighting more or less regulation; policies should be judged on their merits. But as Washington Examiner lobbying columnist Timothy P. Carney wrote in his new book “Obamanomics,” the media must shatter “the Big Myth [that] Big Government and Big Business are rivals, that regulation curbs Big Business, and that above all Big Business wants a laissez-faire economy.”
John Berlau is director of the Center for Investors and Entrepreneurs at the Competitive Enterprise Institute, a free-market think tank based in Washington, D.C.