Posted on 01/24/2004 11:10:38 AM PST by frithguild
In the first weeks of 2004, just when nearly all figures indicated the economy finally was moving full-speed ahead, the government released a job-growth report that many took as disappointing. Just 1,000 new jobs had been netted in the month of December, according to the Department of Labor's survey of nonfarm payrolls.
The news wasn't all bad. The mass layoffs had all but stopped, and employment appeared to have stabilized, with the unemployment rate at 5.7 percent being the lowest level in 14 months. In a recovery, employment is considered by most economists to be a "lagging indicator," and new-jobs figures are expected to go up only after employers make investment plans because of other positive economic news. Also, as Insight has pointed out, many economists say the payroll, or "establishment" survey, understates the number of jobs by missing new businesses and the self-employed [see "The Stealth Bush Boom," Nov. 11-24, 2003].
Even so, given the other economic news, some forecasters had predicted net jobs in December would increase by as much as 150,000. "Job figures surprise analysts, investors," read the headline on Yahoo! News introducing the Associated Press story on the figures.
The job numbers did not come as that much of a surprise to many who follow small business, specifically small entrepreneurial public companies. These observers said legislation promoted to stop corporate abuses at companies such as Enron and Worldcom has burdened business generally, and new entrants particularly, with mounds of costly and complicated red tape.
"In Congress' passion to do something about Enron-like situations, once again small businesses got financially hammered," says Jack Wynn, president of the National Small Public Company Leadership Council. Citing the Small Business Administration, Wynn tells Insight that small businesses create 73 percent of new jobs. "You're not going to have job growth without small businesses," he says. "If small businesses are overburdened by regulation, it's no surprise they're not creating jobs."
The particular regulation Wynn is talking about comes from the Sarbanes-Oxley Corporate Reform Act, which defenders claim is at least partly responsible for the recent stock-market boom because it restored investor confidence. The law, referred to as Sarbanes-Oxley, passed overwhelmingly in the summer of 2002 in the weeks after the $104 billion bankruptcy of Worldcom followed by six months the $63 billion bankruptcy of Enron. Accounting shenanigans that misled and disguised the companies' debts prompted President George W. Bush and Rep. Michael J. Oxley (R-Ohio), chairman of the House Financial Services Committee, to adopt with very minor adjustments the sweeping proposals of Sen. Paul Sarbanes (D-Md.), then chairman of the Banking, Housing and Urban Affairs Committee in a Democrat-controlled Senate.
Today, Oxley and his staff still stand by the law, even though an AMR Research survey found that compliance costs will be $5.5 billion this year. "I would never argue that Sarbanes-Oxley is without cost, but you've got to understand there was $7 trillion in market capitalization that was lost," Peggy Peterson, director of communications and deputy staff director for Oxley's committee, tells Insight. "Mike Oxley has said often in speeches that he thinks and hopes Sarbanes-Oxley was helpful in restoring confidence in the market, and that it was a contributing factor to the economic recovery we've seen to date. I don't think you can specifically attribute those gains to Sarbanes-Oxley, but I think if the market were falling immediately after [passage of] Sarbanes-Oxley, people would sure be blaming it."
When Bush signed the bill at a Rose Garden ceremony in 2002, he gave it an odd form of praise for a conservative, saying it contained "the most far-reaching reforms of American business practices since the New Deal." Indeed it is far reaching, and it is costing businesses billions of dollars with very little benefit to shareholders, a growing number of critics say. Agreeing with Wynn on the impact to small business and the economy in general, Brian Wesbury, chief economist of the Chicago brokerage firm Griffin, Kubik, Stephens & Thompson, tells Insight, "It is a drag on the economy, and therefore over time we will not create as many jobs as we would otherwise."
Sarbanes-Oxley goes where the federal government has never gone before in securities regulation, not just prohibiting conduct but prescriptively mandating the duties of certain employees and board members, designing the structure of boards of directors, and dictating one-size-fits-all processes for testing internal controls for nearly all public companies. It also is displacing the traditional role of states in regulating corporate governance and may signal what University of California-Los Angeles law professor Stephen Bainbridge has called in Regulation magazine, "The creeping federalization of corporate law."
Like the USA PATRIOT Act that sailed through Congress in the weeks after the terrorist attacks of 2001, passage of Sarbanes-Oxley was driven by the political need of Congress to appear to be "doing something" in response to a crisis, observers say. It passed the Senate 99-0, and cleared the House with only three dissenting votes. The dissenters were GOP Reps. Ron Paul of Texas, Jeff Flake of Arizona and Mac Collins of Georgia. "One thing you can count on is that any piece of legislation that passes unanimously or overwhelmingly will always be bad legislation, because nobody will have taken the time to read it," notes Fred Smith, president of the Competitive Enterprise Institute, a free-market Washington think tank. "You don't have to read it if everyone else is voting for it, because you're going to be covered no matter how stupid it turns out to be. So one of the great lessons of Sarbanes-Oxley should be that no piece of legislation should go into law if it passes unanimously, or with just Ron Paul or Jeff Flake voting against it."
Flake stands by his position and says that at least a half-dozen GOP congressmen who voted for the bill, after hearing from their big- and small-business constituents, have told him he was right. "I felt at the time that we were acting more out of a need to inoculate ourselves politically on this issue rather than address the problem thoughtfully," says Flake, who formerly served as president of Arizona's free-market Goldwater Institute. "Obviously there are businesses that were acting in a fraudulent manner. We still have that today, and there are laws on the books that thankfully are being used more aggressively today to get at these businesses. But when we react so quickly sometimes without the best knowledge of how to do this, without some of these investigations taking their course, without these enforcement agencies giving us full recommendations, then we have unintended consequences."
And it turns out that, although the legislation was rushed, the ideas were not new. They had been pushed by Sarbanes and by Clinton Securities and Exchange Commission (SEC) Chairman Arthur Levitt. Despite the fact the SEC had not reviewed Enron's books for the last three years on Levitt's watch and gave Enron specific exemptions from securities laws [see "Who Cleared that Enron Exemption?" March 4, 2002], he was made a media hero for the "reforms" he touted that allegedly would have prevented the Enron disaster for shareholders. One of the trendy reforms Levitt and others pushed for was "independent" directors. Sarbanes-Oxley picks up on this by requiring that audit committees be made up solely of directors who are independent, which the act defines as receiving no salary or fees from the company other than for service as a director. It then says chief executive officers (CEOs), who are forced in another part of the law to take responsibility and possibly face criminal penalties for earnings misstatements, have no say in hiring the auditor. The hiring, oversight and compensation of the auditor must be decided entirely by the audit committee, and the auditor must report directly to the committee, not company management.
Encouraged by Sarbanes-Oxley and the SEC, the New York Stock Exchange and the NASDAQ stock market have proposed that boards have a majority of independent directors. Yet the data does not bear out the theory that companies with boards made up of strong independent directors will look out more for shareholders' interests. "The quantitative research done to date is inconclusive at best," reports Strategy+Business, the journal of the management consulting firm Booz Allen Hamilton. The journal reported that a large-sample study by professors from Stanford Law School and the University of Colorado found that "firms with more-independent boards are not more profitable; indeed, there were hints in the data that they perform worse than other firms."
One firm that ranks badly in a corporate-governance model is the holding company Berkshire Hathaway, which has a board that includes the wife and a son of legendary CEO Warren Buffet. Yet shareholders don't seem to mind that much, notes Alan Reynolds, senior fellow at the libertarian Cato Institute. "It fails all the independent-director tests, but boy would you sure like to own the stock over the last few years," he says.
And, ironically, one firm that would have been able to comply almost perfectly with the Sarbanes-Oxley "independence" requirements was Enron. Indeed, 86 percent of its board was independent, and its audit committee was chaired by a former dean of the Stanford Business School and professor of accounting there. Yet when the scandals broke, the professor claimed he didn't understand the complex audits of Enron and Arthur Andersen.
"If I want to B.S. the board, they will never ever know the difference," T.J. Rodgers, the outspoken libertarian CEO of leading Silicon Valley firm Cypress Semiconductor Corp., tells Insight. "Strapped for time, the board must trust and rely on management. The board can ask the auditors to check things, but even the auditors can't spend enough time to prevent problems. What prevents problems very simply is management choosing to run a clean ship, period."
Except for himself, every member of Rodgers' board is independent. But, while consulting the board, management always picked the auditor. What the new audit requirements are doing, Rodgers says, is greatly reducing the productive time he can spend with the board to discuss ways to grow the business. Lawyers advise him that because of the law's prohibitions of CEO influence over the audits he shouldn't even be in the room when the audit committee meets. "Big Brother has decided actually to micromanage the meeting schedule for the board, so now I lose a half-hour of board time, which is absolutely critical to me because my board is very active, very intelligent and, by the way, doesn't agree with me on a lot of things. They're certainly not a rubber-stamp board."
With the new mandated responsibilities of board members, directors' fees have doubled, according to a survey of 32 midsized companies by the law firm Foley & Lardner. The survey also found that accounting, audit and legal fees also doubled under Sarbanes-Oxley, and the costs of directors' liability insurance skyrocketed from $329,000 to $639,000. Moreover, the average price of being a public firm nearly doubled from $1.3 million to almost $2.5 million. For businesses such as Cypress this is costly, but for small businesses it could be prohibitive. Just finding an independent director can be difficult, Wynn says. He adds that the Bush SEC is doing the best it can for small firms given the constraints of the new law.
The SEC is at least exempting small-business issuers - those with revenues of less than $25 million - from having to meet the audit-committee requirements until 2005. For most firms they went into effect Jan. 15. But the SEC says the law provides no authority for the agency to issue permanent exclusions. Flake observes sardonically,"Small business is one of the areas we could have focused on if we hadn't been rushed to pass this law."
Little wonder the number of companies going private increased 63 percent in 2002 from the year before, even though 2001 was worse economically. But this was not a "marked increase," Peterson claims. And when asked if Chairman Oxley planned to introduce any changes to the law, including relief measures to help small business, she gave Insight a flat "Nope."
She says, "If you're a small company, if you decide that you want to be a publicly traded company, that means you're offering issues to the public, and the public investor needs to be assured that you are going to achieve certain accounting standards and certain standards of corporate governance."
But the Competitive Enterprise Institute's Smith says the one-size-fits-all rule is as silly as it is expensive. Investors already know that a small public company usually carries more risk than a "blue-chip" firm. The law's proponents "want a world of investment with no risk," Smith says.
Yet it was risk-taking entrepreneurial companies such as Microsoft, which were able to get access to public capital when they were small, that fueled the boom of the 1980s and 1990s. And Insight has reported on the role played in the Clinton bust by Clinton and Levitt's reversal of some of Ronald Reagan's deregulatory SEC policies toward the end of the Clinton years [see "Recession Shock," Dec. 31, 2001]. Revised figures from the Commerce Department now confirm that the negative growth began on
Clinton's watch in the third quarter of 2000. But while economist Wesbury praises Bush for reversing Clinton policies on taxes and the harassment of Microsoft, he says the administration has dropped the ball with securities regulation.
But Sarbanes-Oxley is creating some jobs, Wesbury points out. The requirements for specific internal-control processes and 48-hour disclosure of any "material information" have been a boon for software builders, consulting firms and, ironically, the very Big Four accounting firms that were blamed for the corporate scandals. "Despite what all my friends in those businesses tell me, overall those are nonproductive jobs," Wesbury says.
The survey also found that accounting, audit and legal fees also doubled under Sarbanes-Oxley, and the costs of directors' liability insurance skyrocketed from $329,000 to $639,000. Moreover, the average price of being a public firm nearly doubled from $1.3 million to almost $2.5 million.
Instead the auditors were making their profit on other services. Which gave them a powerful incentive to stick their head deep in the sand when it came to the actual auditing.
Even without the new law, director's liability insurance would have skyrocketed anyway as ripped off stockholders sued directors for negligence (at the least). Heck, if I was on a board, I'd take the additional costs out of the CEO's salary. *g*
To be honest, though, any attempts to fix things was going to involve difficulties. And lord knows, there's many more conflicts in the auditor/company relationship that still need to be dealt with. But if the executives don't like it, they can quit and find some other well-paying job (though, even Congressmen don't get paid that well *eg*).
Lots of "productive" jobs for people who do the dotting and crossing.
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