Will the Supreme Court Free Us From the Scourge of Sarbanes-Oxley?

On Monday, the U.S. Supreme Court will hear oral arguments in a case on whether Sarbanes Oxley, with all of its costly regulatory burdens on American business, is constitutional. This case has been called the most important separations-of-powers case in decades. And the outcome of this case will help determine whether American businesses can remain competitive on the world’s stage or America will sink into joblessness and decline.

Sarbanes-Oxley (SarbOx) was enacted in 2002, in the wake of publicity and public outrage over the corporate scandals at Enron and WorldCom. The lawbreakers were ultimately brought to justice under laws already on the books at that time. But members of Congress felt that they needed to address the scandals quickly, and so, all members of the Senate and all but three members of the House voted for passage of this hastily drafted bill. Even Nancy Pelosi now admits that this law has had a lot of “unintended consequences.”

SarbOx has made the cost of doing business as a US public company much higher. By 2005, SarbOx was already costing U.S. companies $35 billion annually, much greater than the $1.4 billion the SEC originally projected. And SarbOx has been particularly detrimental to small and medium sized companies that find it difficult to pay the costs of compliance. The costs for firms grossing less than $100 million annually have been 42 times larger as a percent of revenues than for firms grossing over $5 billion. Large businesses have seen some of their smaller competitors fall away because of these compliance burdens and so, do not generally advocate for the law’s repeal.

SarbOx as implemented by the Public Company Accounting Oversight Board (PCAOB) requires full external audits of each company’s internal control measures each year and suggests potential criminal liability for violations, including for senior officers uninvolved in any wrongdoing. To comply with these requirements, public companies often have to hire two accounting firms to perform audits. This is why SarbOx is often referred to as a “full employment plan” for accountants—and why the law benefits the same profession that designed and implemented the scandalous financial schemes that SarbOx was meant to combat.

The implementation of SarbOx has been one of several key factors harming our economy and driving down the dollar. A study concluded that Sarbanes-Oxley has reduced the stock value of American companies by a staggering $1.4 trillion dollars. This is capital that could be invested in infrastructure improvements, job creation, and innovative technologies or research and development.

SarbOx acts as a costly barrier to entry into our financial markets, effectively driving business overseas and raising the cost of capital for our start-up and growth stage companies. At a certain point in the life of a small business, owners must raise capital to invest in infrastructure, expand the business and explore new markets. Historically the most efficient way for a company of a certain size to raise new money has been through an initial public offering on a US exchange, which generally offers a lower cost of capital than private equity or other sources. Now, companies that list on U.S. exchanges, except the very smallest, become subject to the burdensome and costly SarbOx regulations. So, these companies now usually decide to accept more expensive financing, list overseas, or postpone their expansion plans—harming our markets and costing the U.S. jobs.

U.S. and foreign companies are now listing on the London Exchange and other non-U.S. exchanges in record numbers. In 2005, only 20 companies made their initial public offering on the New York Stock Exchange and Nasdaq, compared to 129 on the London Exchange—a record for that exchange. And 9 of the 10 largest initial public offerings that year were issued on non-US exchanges. In contrast, 9 out of the 10 largest IPOs issued in 2000 (before SarbOx was enacted) were on US exchanges. IPOs virtually ceased in the United States--in 2008, for example, only 29 IPOs were issued in all of the U.S.

An increasing number of US-listed companies are going private or listing on non-US exchanges in order to get out from under burdensome SarbOx regulation. One study found 20% of public companies are considering going private due to SarbOx.

While it has been terrible for financial firms in the U.S., SarbOx has been great for firms in London and other non-US financial capitals. The London Stock Exchange actually puts in its marketing materials that companies that list in London are not subject to the constraints of SarbOx. One London commentator writes that “the people of London should say a hearty thank you to Maryland Democrat Paul Sarbanes and Ohio Republican Michael Oxley,” for the flows of capital coming to London from the US. Another commentator proposes “a pair of gold plated statutes [in London] depicting these two fine politicians throwing handfuls of dollar bills to a multitude of grateful City of London bankers, fund managers, stock brokers and other sundry capitalists, as great numbers of companies decamp from New York and list in London instead.”

But the Supreme Court may strike down the Sarbanes-Oxley Act as unconstitutional based on the case that it will hear on Monday. The challenge to SarbOx, which I originated several years ago when I chaired the Free Enterprise Fund, involves an unprecedented violation of the Constitution’s separation of powers and appointments clause. The members of the PCAOB are appointed by the SEC. Thus, the PCAOB board members are not appointed by the President with the advice and consent of the Senate. And the President and Congress have no supervisory or oversight authority over the activities of the PCAOB. Even the SEC does not direct or supervise the PCAOB. Yet this powerful board can establish and enforce its own regulatory requirements, including criminal offenses punishable as felonies, set its own penalties, and initiate costly investigations as it chooses. The PCAOB sets it own budget and has the power to levy fees--otherwise known as “taxes”--on public companies in order to finance its activities.
The members of the PCAOB set compensation for themselves, and it should come as no surprise that they pay themselves well. The PCAOB pays its Chairman a staggering $654,406 a year and its other members $531,995 each. And the Chairman and members cannot be removed by the president or by any top official reporting to him.

If the high court finds SarbOx unconstitutional in this case of first impression, the PCAOB will be enjoined from further activity until Congress revisits the Sarbanes Oxley Act--freeing our markets from SarbOx burdens until that time. This would give U.S. businesses a break until a more sensible future Congress can adopt policies that actually promote economic growth and would be just what our economy needs as we face worsening unemployment and a declining dollar.

Mallory Factor is the co-chairman and co-founder of the Monday Meeting, an influential meeting of economic conservatives, journalists and corporate leaders in New York City. Mr. Factor is a well-known merchant banker and speaks and writes frequently on economic and fiscal topics for news stations, leading newspapers and other print and online publications. Mr. Factor can be reached at mallory.factor@malloryfactor.com.