Remarks on The Sarbanes-Oxley Act of 2002: Ten Years Later

Thank you for inviting me to participate in the "Ross Roundtable on The Sarbanes-Oxley Act of 2002: Ten Years Later."

You asked us to discuss briefly the success or failure of the Sarbanes-Oxley Act from the point of view of our various constituencies.

I do not think of myself as representing any particular constituency. I was, however, the Staff Director and Chief Counsel of the Senate Banking Committee under Chairman Paul Sarbanes and was intimately involved in the crafting of the Sarbanes-Oxley Act.

In addition, I am currently a Board Member of the Public Company Accounting Oversight Board—the regulatory body created by the Sarbanes-Oxley Act. I am also the Chairman of the Board's Investor Advisory Group and Chairman of the Investor Working Group of the International Forum of Independent Audit Regulators. I will direct my remarks from those vantage points.

I am honored to be a member of the panel with Kayla Gillan, my predecessor at the PCAOB, as well as Stephen Brown from TIAA-CREF; Matthew Cedergren from the Stern School; Charles Elson, Director of the John L. Weinberg Center of Corporate Governance at the University of Delaware; Adam Emmerich from Wachtell, Lipton, Rosen & Katz; Robert Herz, former Chairman of the Financial Accounting Standards Board; and Paul Washington of Time Warner.

At the outset, I must state that the views I express are my own and do not necessarily reflect the views of the Board, any other Board member, or the staff of the PCAOB.

I am regularly asked about the effectiveness of the Sarbanes-Oxley Act and for my response to those who argue that it should be repealed.

You probably won't be surprised that I believe the Act has been very effective and should not be repealed. Let me give you 10 quick reasons for my response, which I will keep to five minutes as you have asked.

1. It restored investor confidence.

The Sarbanes-Oxley Act was not just a response to Enron despite the failures its collapse exposed. As the Los Angeles Times reported January 26, 2002, less than two months after Enron filed for bankruptcy: "There was a total failure by everyone, a complete breakdown in the system, in all the checks and balances. It was a failure by Wall Street analysts who just went along for the ride, and by the auditors who were collecting so much money they couldn't walk away from it, and by government agencies who are supposed to monitor those companies."

The Senate and House were already working on legislative responses to those failures when other corporate giants began to falter and collapse, including Tyco, Adelphia and, what was then the largest restatement in corporate history, WorldCom.

Former House Financial Services Committee Chairman, Michael Oxley recently described the effects of those business failures saying, "It was a severe shock to our system, to the core of the capital system that depends on honesty and integrity and on having investors believing in the companies they invest in." He added, "That was really the shock to me, as a pro-business Republican, who was looking at what I thought was the disintegration of the capital market."

Chairman Oxley was not exaggerating. In July 2002 alone, the Dow dropped over 15 percent. And between the time the House passed its bill in April and the Senate acted in July, the Dow declined almost 23 percent, or over 2,000 points. If nothing else, the Sarbanes-Oxley Act stopped cold the stock market hemorrhage at the time.

The need for the Act was clear in the final votes: 99-0 in the Senate and 423-3 in the House. Chairman Oxley called it a "blow out."

2. It established the PCAOB, ending more than 100 years of self-regulation by the accounting profession.

Ten years later, 44 non-U.S. countries have established independent regulatory regimes for auditors patterned after the PCAOB.

3. It dealt with the conflicts of interest in the accounting profession by prohibiting accounting firms from performing certain auditing and consulting services for the same company the firm was auditing.

For example, it prohibited a company from setting up a valuation system for valuing financial assets and then auditing that system.

4. It mandated independent audit committees and required issuers to disclose whether a "financial expert" is on the audit committee.

Audit firms now must report to an independent audit committee.

5. It increased corporate accountability and dealt with tone at the top by requiring CEOs and CFOs to personally certify their companies' financial statements.

It is my belief that this is one of the most important provisions in the Act that has had the greatest impact — and it came directly from then Securities and Exchange Commission Chairman Harvey Pitt.

6. It instituted "clawback" provisions, requiring CEOs and CFOs to give up bonuses or other financial incentives based on financial results that later had to be restated.

7. It essentially ended the backdating of stock options.

8. It established whistleblower protections for employees of public companies.

9. It required public companies to disclose off-balance sheet arrangements in quarterly and annual financial reports to the SEC and investors.

10. It restricted loans that public companies can make to officers and directors.

And, of course, it required publicly traded companies to have a system of internal controls over financial reporting. This precedent had already been established in the Foreign Corrupt Practices Act (1977) and the Federal Deposit Insurance Corporation Act (1991).

Under the Sarbanes-Oxley Act, management has to establish, assess and report on the issuer's system of internal controls over financial reporting, and auditors must report on the effectiveness of that system of internal controls. Studies show that better internal controls result in better financial reporting and more investor confidence in financial reports.

For the most part, I find that when people talk about repealing the Sarbanes-Oxley Act, they are talking about those provisions dealing with internal controls. When I ask what other provisions they believe should be altered, there is no clear response.

I would note that since the passage of the Act, financial restatements have steadily decreased since 2005. Fewer securities class action lawsuits are being filed — down by as much as 60 percent by some reports — and audit quality is generally recognized as having improved, although clearly more work needs to be done.

The stated purpose of the Act is "to protect investors by improving the accuracy and reliability of corporate disclosures."

I certainly think it has done that, and I would echo Senator Sarbanes in his recent comment on the future of the Sarbanes-Oxley Act:

"My hope is that the Act becomes so much a part of the way business is done in this country; so much a part of establishing the standards, that it is not seen as something separate and apart. It really becomes part of the very structure of the business world. And what comes out of that, of course, are higher standards, more ethical behavior and to the benefit of everyone."

Thank you and I look forward to our panel discussion.

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