Anti-fraud law fails first major court test

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Scrushy scrutiny
June 28: Columbia University Law School professor John Coffee discusses the significance of the acquittal of HealthSouth founder and fired Chief Executive Richard Scrushy.

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There is no question the law has added to companies' costs — everything from filling out new forms and hiring outside auditors to buying new computer systems. Estimates vary on just how expensive the regulations have become. The cost of reviewing internal controls averaged $4.36 million per company, including a 66 percent increase in spending on consulting, software and other vendors and a 58 percent increase in the fees charged by external auditors, according to the FEI survey.

And the “paperwork” involved in complying with new tighter controls involves more than just paper. One consulting firm recently estimated that businesses will spend more than $4.4 billion on e-mail archiving alone by 2009 — up from $465 million this year.

Public companies are also required to kick in fees to underwrite the operations of the Public Company Accounting Oversight Board, an agency set up by Sarbanes-Oxley to oversee the audit process. The independence provided by that funding mechanism could make the PCOAB one of the most potent pieces of the new law, according to Broc Romanek, a former SEC attorney who is now editor of TheCorporateCounsel.net.

“They’re not at the mercy of the Congress,” he said. “They’ll do all the investigations and wrap them up and turn them over to the SEC.”

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With nine regional offices, the PCOAB’s budget is $137 million this year — up 33 percent from a year ago. It employs 326 people, up 75 percent from a year ago, with a planned headcount of 452 by the end of 2005, according to Romanek.

Not far enough?
Eventually, of course, the added cost of the new rules will come out of a company’s profits — which could hurt shareholders in the long run. But professional money managers argue that the added cost of the new rules is money well spent if it prevents much bigger investor losses due to corporate fraud.

“It rings hollow when people say, ‘Well look, you're making us spend all this money for all these internal compliance audit features,’ that I, as an investor, already thought you had,” North Carolina State Treasurer Richard Moore told CNBC recently. “So when in doubt, I come down on the side that Sarbanes-Oxley was a good piece of legislation.”

And some think the law hasn’t gone far enough — especially in the area of executive compensation, including lavish pay packages for corporate leaders who are booted from failing companies.

“That’s an area that Sarbanes-Oxley did not touch on at all — that is wildly broken and that goes to the heart of corporate governance issues,” said Romanek.

As corporate America works to comply with the new accounting rules, a new chapter in enforcement of anti-fraud regulations begins with the nomination this month of California Rep. Christopher Cox to replace William Donaldson as SEC chairman. Securities lawyers say that, if confirmed, Cox may well have a more sympathetic ear to complaints that the accounting regulations have gone too far.

But now that companies have completed audit reviews and identified weakness, the law may already have had the desired effect.

“It’s really the first time folks have had to deal with (audit reviews) in terms of actual compliance this past year,” said Zuppone.

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