DA! You must be dumb, blind and stupid

Implications:

1. Sarbanes Oxley has cost US businesses billions of dollar, making the cost of doing business in the US higher than other capital markets around the world.

2. The biggest benefactor of Sarbanes Oxley is the big 4 accounting firms who also got a windfall from the demise of Arthur Andersen. The combination of expanded scope and smaller pie has increased their profitability to record levels.

Analysis: This article quotes our VP, Dick Cheney, "I think you can make a case that Sarbanes-Oxley went too far." Our new Treasury Secretary, Henry Paulson, also says "the pendulum may have swung too far." My response is a simple "DA."

Since Enron, our government has created the demise of Arthur Andersen and implemented the Sarbanes-Oxley regulations. Let's see the ramifications of each.

The indictment of Arthur Andersen, which was later overruled by the Supreme Court, but unfortunately too late, left 4 large accounting  firms instead of 5. A reduction of 20%. The remaining 4 firms hired former Arthur Andersen partners and employees, so these "criminals" end up doing the same work, only for another firm. At the same time, the amount of audit work required increases significantly due to Sarbanes-Oxley. The result of these two events, is that hourly billing rates at these four firms have increased by over 75% and chargeability per professional increased by over 33%, the two variables which have the greatest impact on the profitability of an auditing firm. This combination also results in audit fees going up by over 100% since Enron with very little incremental value to businesses. What was the government thinking when they got rid of Arthur Andersen and its 110,000 employees? Was this punishment commensurate with the crime, if there even was a crime? The result is that business is paying up the nose for basic audit services. At the same time, the remaining firms have limited the types of services they can provide their clients, despite having the resources and capabilities to provide these value added services.

Sarbanes-Oxley not only was a windfall for the accounting firms, but it was a burden on business. Internal audit departments have spent over 50% of their available resources on Sarbanes-Oxley type compliance, thereby forfeiting other valuable services that it had previously performed. Management has also devoted considerable resources, thereby having less time available to run their businesses and compete on an international basis. Boards of directors have also spent a considerable amount of time focusing in on Sarbanes-Oxley compliance at the expense of time spent focusing on other business activities. Who can measure the cost of management time and board time on these activities at the expense of focusing more on the business?

So why has it taken Mr. Cheney and our government over 4 years to realize that "we went too far?" What can we do about it now?

First, I would suggest that we maintain the requirement of CEO's and CFO's certifying to quarterly results, but don't define the process that they must use to support their opinion. Let management use their judgement. Knowing the ramifications of certifying to false financial statements, I am sure that most CEO's and CFO's will make sure that adequate procedures are maintained to support their opinions.

Second, tone down the PCAOB and let the auditors use their judgement on how to satisfy themselves as to the proper controls of the company. The cost of PCAOB compliance is quite significant. Not only does the government have to employ thousands of people to conduct these detailed reviews, but CPA firms must spend thousands of hours facilitating the PCAOB on each engagement reviewed. All these costs end up being passed on to their clients and absorbed by businesses.

I am not suggesting that governance procedures did not need strengthening and that there was no good from Sarbanes-Oxley. Certainly board rooms have increased their effectiveness and boards have taken their roles more seriously. This was long over due. But to legislate the auditing profession and allow them to reap such large financial rewards on services that create relative little incremental value is wrong. It's about time that we pull back and let judgement vs. rules prevail.