The Hindu Business Line : From Monica Lewinsky to Sarbanes-Oxley

SOX, as you know, is the Sarbanes-Oxley Act, a post-Enron legislation enacted in the US in 2002. SOX gave birth to PCAOB, the Public Company Accounting Oversight Board.

"A private-sector, non-profit corporation... to oversee the auditors of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, fair, and independent audit reports," is from `about us' on www.pcaobus.org.

The latest news on the site is dated February 6; it announces the leaving of the Board's general counsel. No word on the Board's site about a February 7 development: a complaint filed in the US District Court for the District of Columbia, "challenging the formation and operation of the PCAOB".

Who are behind the challenge? Free Enterprise Fund. Thus, on the Fund's site, www.freeenterprisefund.org, the SOX `initiative' is prominent, and top among `news' in the homepage is a link to `lead editorial' in Wall Street Journal dated February 8.

"Not just another `think tank,' but a `do tank' dedicated to specific, targeted and effective action to defeat job-killing proposals and enact free market reforms," reads the Fund's mission. FEF speaks of promoting economic growth, lower taxes, and limited government through television and radio issue advertising campaigns, providing timely and tactical policy guidance to members of Congress and publishing strategic game plans on vital economic and fiscal issues.

Joining FEF as plaintiff is Beckstead and Watts, LLP, `a public accounting firm that specialises in audits of small publicly traded corporations'. Their grievance is that the Board and all the power and authority exercised by it violate the Constitution. The Board's structure and operation, including its freedom from Presidential oversight and control and the method by which its members are appointed, contravene the principles of the US Constitution, avers the Fund.

Broad powers and burdensome standards

FEF alleges that the Board uses `massive unchecked powers,' and `exercises broad discretion to set policy and impose regulations governing the conduct of public accounting firms.' Such powers include the power to promulgate auditing standards and rules, including rules that expand upon the Act's list of non-audit services that accounting firms are prohibited from offering to a client contemporaneously with an audit.

"Any violation of the Board's rules constitutes a violation of the federal securities laws, subjecting accountants and accounting firms to potential threat of civil and criminal liability." Also, the PCAOB can impose "sanctions of up to $2,000,000 for inadvertent violations and up to $15,000,000 for knowing or reckless ones."

According to the FEF, the Board has exercised its broad powers to impose burdensome standards that accounting firms are required to follow when auditing public companies, which ultimately bear the costs of these added procedures. An example cited in the complaint is of Auditing Standard No. 2, which sets forth "over 150 pages of detailed requirements concerning the scope and reporting of an accounting firm's audit of a public company's internal controls over financial reporting."

Smaller accounting firms, such as Beckstead and Watts, have been especially hard hit by the costs of complying with the Board's standards, says the Fund. "Seven inspectors from the Board visited the office of Beckstead and Watts over a two-week period, from May 17 to 28, 2004. These inspectors evaluated Beckstead and Watts's audits in the same manner that one would evaluate the audits of a Fortune 1000 company," narrates the complaint. It seems the accounting firm "has incurred legal fees in defending itself against the investigation proceedings, and its professional reputation has been damaged by the inspection report posted on the Board's public website."

Costs 25 times the estimate

In the Board's first year of operation alone, the Act's regulations resulted in more than $35 billion in compliance costs imposed on the nation's businesses, says the Fund, citing a finding of the American Electronic Association. This sum was about 25 times more than the initial SEC estimates of $1.24 billion.

"A University of Nebraska at Omaha study found that audit fees for Fortune 1000 companies, on average, increased a staggering 102.99 per cent from 2003 to 2004." Another study from the University of Rochester estimated SOX impact as "a staggering stock market loss of $1.4 trillion."

FEF mentions as `anecdotal evidence' the following: "One CEO of a $19 million company said of 404 compliance: `I am spending almost three times more on this than on health care for my employees.' Yellow Roadway has 200 employees assigned fulltime to Section 404 compliance, diverting resource from expanding their core business while shaving more than 8 cents per share from its earnings."

Section 404, as you may be aware, requires management to produce an internal control report, affirming "the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting."

According to Scott McNealy of Sun Microsystems, SOX is "throwing buckets of sand in the gears of a market economy." And a poll of IBM clients revealed that SOX compliance ranked as "the biggest ineffective and wasteful use of time for IT departments."

FEF paints the scenario bleakly thus: "As a result, many smaller accounting firms have been forced to give up auditing public companies altogether, reducing public companies' range of choices among accountants and increasing concentration in the accounting industry."

Board's bloating budget that taxes companies

The complaint drew the attention of the court to the salary levels in the Board: that in 2003, the chairman received "an exorbitant salary of $5,56,000", and each of the other four members received "a similarly excessive salary of $4,52,000."

The Fund is appalled that "despite its vast authority and the far-reaching consequences of its actions, the Board is immune from the supervision and control of the President," and that the Board's members are not appointed or removable by the President, but "by the SEC, itself an independent agency".

Even the SEC's powers of review are circumscribed, asserts the Fund. "The SEC may remove Board members only if they have `wilfully violated' applicable laws or regulations, `wilfully abused' their authority, or `failed to enforce' applicable laws and regulations `without reasonable justification or excuse.'"

In the eyes of the Fund, the Board is "the recipient of improperly and unconstitutionally delegated legislative power, including, but not limited to, its broad power to enact law, its authority to set its own budget without any constraint or legislative cap, and its authority to fund that budget through the imposition of a tax on all public companies."

The complaint gives an overview of the SOX Act and informs that as of January 26, 2006, 1,611 accounting firms were registered with the Board.

The PCAOB calculates an accounting support fee for each year, to be collected from `issuers' (that is, all companies whose securities are registered under the Securities Exchange Act of 1934).

"This is equal to the budget of the Board less the sum of all registration fees and annual fees received during the previous calendar year from public accounting firms."

Interestingly, the amount payable by the issuers is based on the ratio of the average monthly equity market capitalisation. "As of February 1, 2006, approximately 10,000 issuers had paid an accounting support fee."

A measure of control on the receivables is hardwired into the law, by insisting that no registered public accounting firm shall sign an unqualified audit opinion with respect to an issuer's financial statements unless the issuer has outstanding no past-due share of the accounting support fee.

SOX, a classic case of government overreaction

`Sarbanes-Oxley: Government Excess in Response to Corporate Excess,' reads a 7-page executive summary, dated February 8, on FEF's site. "This law must be revisited," insists the Fund.

"A successful campaign to pare back the excesses of the law will have to follow three parallel tracks — litigation, public relations, and legislation."

In the Fund's view Sarbanes-Oxley `a classic example of government overreaction', and the Act is `hamstringing' US companies. "It imposes economic and social costs far in excess of anything wrought by Enron and WorldCom combined, and it must be reformed."

The Fund is aghast that the Act `criminalises' corporate behaviour when there is no intent of wrongdoing. Most pernicious is the creation of `the extraordinarily powerful new federal bureaucracy,' the Board, "constituted in an undemocratic, unaccountable, and un-Constitutional way."

Starr line-up

Don't dismiss the Fund's complaint as sheer rant, because the legal line up on the attacking side includes Kenneth Starr, Dean of the Pepperdine Law School, the special prosecutor in the Monica Lewinsky affair and the author of the Starr Report (available on www.time.com, with the `warning' that it contains `sexually explicit language'). A report dated January 27 on www.sanfranciscosentinel.com is about Starr appealing to Governor Arnold Schwarzenegger for clemency for a condemned inmate.

Others luminaries on the Fund's side are Viet D. Dinh, Professor of Law, and Co-Director, Asian Law & Policy Studies Program Georgetown University, known for his key role in developing the USA Patriot Act; and Michael A. Carvin, Partner of Jones Day, who was one of the lead lawyers to argue before the Florida Supreme Court on behalf of now-President George W. Bush in the 2000 election Florida recount controversy. The Competitive Enterprise Institute (CEI) is also putting its shoulders to the wheel.

Looking back, one remembers how the Naresh Chandra Committee Report had noted in 2003 that powers akin to that of the PCAOB were, in India, distributed across a plethora of regulatory agencies — the DCA, SEBI, the RBI, the ICAI, the ICSI, the ICWAI. These, apart from the power to proceed under the Information Technology Act, 2000, and residual powers under the Code of Civil Procedure and the Code of Criminal Procedure.

Therefore, an Indian version of PCAOB would have necessitated the withdrawing of all those powers from the existing regulatory agencies and pooling in a super agency. Good, perhaps, that the idea didn't find favour here?

AccountSpeak@TheHindu.co.in

D. Murali

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