Sarbanes-Oxley (SOX), Belts and Suspenders: The Regulatory Aftermath of the Corporate Accounting Scandals
By Richard Mahoney and Russell Roberts
The Sarbanes-Oxley Act of 2002 tries to reduce corporate malfeasance. But in practice, how does regulation of this kind affect behavior in the boardroom and the CEO’s office? We asked Richard Mahoney, the former Chairman and CEO of Monsanto and currently the chair of the Governance Committee of a Fortune 500 company to give his impressions from the trenches of how the law has affected corporate life.
“In aggregate, the rules of SOX and the Exchanges cover more than 100 major provisions, many with several subsets, so compliance is no trivial exercise.”
not only depressed stock prices but for many, a
depressing and unwanted financial education. Many
novice investors learned, to their astonishment, that
stocks go down as well as up and that 401K plans being
saved for a handsome retirement can mean “part-time”
retirement or no retirement at all.
The Scandals That Spawned the Sarbanes-Oxley Act of 2002
The full text of Sarbanes-Oxley can be found at Findlaw’s website under Industry Centers/Corporate Governance.
The market drop had another result, potentially more
damaging. A dozen or more companies, the most
prominent of which was Enron, were alleged to be “cooking
the books”—inflating earnings in an attempt to keep stock
prices up in a rapidly declining market. Other complaints
against various companies included alleged self-dealing
insider schemes and lavish personal use of shareowner
In the wake of these well-publicized scandals caused by a
failure of corporate governance, Congress passed the
“Sarbanes-Oxley Act of 2002″—”SOX” for short—named
after Senator Paul Sarbanes (D-Maryland) and
Congressman Paul Oxley (R-Ohio). Following that
passage, the Securities and Exchange Commission (SEC)
began the process of drafting specific rules for
corporations as required by the new law. Also that year,
the New York Stock Exchange (NYSE) and NASDAQ
developed listing standards—new and tougher
requirements that must be met by companies listed on
While the number of companies caught up in the
widespread investigations is only a small fraction of the
approximately 3,000 NYSE companies and perhaps 9,000
public traded companies, it was enough to, deservedly,
warrant congressional scrutiny and the tightening of listing
provisions of the stock exchanges.
Legislating Morality-Some Costs and Benefits
These measures hope to “legislate morality”—or, at the
very least, punish immorality.
In most cases, laws and rules that rushed into effect in the heat
of scandal or notoriety are poorly crafted—drawn more
with intent to punish alleged offenders than to cure a
problem. Think of Love Canal and the “Valley of the
Drums” with the resulting Superfund—(having served for
year on the National Superfund Commission, an attempt to
fix it, I can say with confidence it was among the worst
single pieces of legislation ever enacted.) Other examples
abound in environment, workplace, antitrust and many
other areas where the exposure of egregious actions by a
few caused “lock the barn after the horse is out” laws and
regulations for the many.
SOX, in view of that heritage, is not too badly drawn. While
very expensive to implement, it will likely produce some
improvement in governance. In the case of the NYSE
rules, these were circulated in advance for comment and
some unproductive elements were revised in that process.
These Exchange rules are more qualitative—”do it this
way rather than that”—while the SOX rules are more
heavily into “compliance scorekeeping.”
In aggregate, the rules of SOX and the Exchanges cover
more than 100 major provisions, many with several
subsets, so compliance is no trivial exercise. As chairman
of the Governance Committee of a major corporation, I
spent hours and hours trying to understand the many
pages of rules, though that time commitment has now
tapered off as the implementation phase has begun. But
the corporate staff has spent many multiples of the time I
did and their work continues as a major time commitment.
In addition, our outside law firm is invaluable in helping to
interpret the rules—but also very expensive. In all,
corporate America will spend many billions of dollars
carrying out these rules. One can only hope that
shareowner value will rise in some reasonable proportion.
The New Environment Corporations Face
In a short space it is impossible to cover all—or even a
large portion—of the provisions. What follows is a
summary of what, in my experience, are the major ones.
Time and future litigation, of course, may change the
priorities and certain companies will have a very different
list depending on their circumstances and interpretation.
1. The CEO signs off on the major financial reports,
certifying that he/she has personally reviewed their
preparation and approves the statements (SOX, NYSE).
While CEO “certification” of financials has always been
required (along with civil or criminal penalties for
malfeasance) the specificity of SOX and the spotlight on
the requirement is causing a major commitment of time and
money to make these certifications. It will be very difficult
for a CEO to plead ignorance as a defense. It may prove
to be a good deterrent, but it comes at a very steep
compliance cost because of the many redundant reviews
2. Requirements for regular executive sessions of the
Board (NYSE)—only independent directors present. Like
CEO certification of the finances in 1. above, many
companies had already been doing this—often in the CEO
performance review and of course, on those occasions
where the CEO needed replacing. Some boards have now
decided to hold these sessions at each meeting and the
practice has generated some positive results as the
members get used to talking freely without a crisis or a
3. Composition and functioning—primarily of Audit and
Compensation Committees but also Governance and other
committees (SOX, NYSE). Very tough rules defining true
independence and operating methods. In a variety of
ways, it tries to ensure that the Nominating Committee (or
other similarly named committee) will really take the lead in
fact, rather than just in concept, in seeking new directors—an attempt to restrict the CEO as the principal seeker of
new directors, a common past practice.
4. SOX and NYSE have special provisions for the Audit
Committee; a major provision is that at least one director
must be designated as a qualified financial expert—with
“qualified expert” precisely and narrowly defined. While
this may seem reasonable and easily complied with, few
want to be so designated, even though a “safe harbor” provision for that person is included—at this time a great
source of confusion and conflicting interpretations. For
example, some CEOs, but not necessarily all, can qualify—but not too many are volunteering. Ideally, for the
persons involved, several members of the committee
would qualify and thus somewhat deflect the spotlight from
one to several. Many companies are raising the fees for
directors—especially Audit Committee members—reflecting the additional time commitments and the added
pressure from the rules.
5. Various corporate codes of conduct are prescribed
along with various charter requirements for committees.
This kind of approach has seldom worked in the past (it’s
easy to write, easy to violate) but it does call attention to
the subjects at their issuance—and they provide “gotcha” standards if violated.
6. Tight rules for outside auditors. They are now retained
by and report directly to the Audit Committee. Many
lucrative consulting assignments formerly permitted are
now curtailed. SOX requires rotating the lead reviewing
auditor (the person, not the firm) at least every five years.
To get the flavor of the incredible level of detail required by the law, take a quick look at these Frequently Asked Questions about Sarbanes Oxley Compliance posted at the SEC’s web site.
7. Shareowner approval of all compensation plans
involving the issuance of stock (NYSE).
8. Any number of requirements call for website posting of
procedures and practices as well as “whistleblower” provisions and protections. Called by some the
“webmaster full employment act.”
9. A very important proposal by the SEC is now circulating
for comments. It would allow, under certain limited
circumstances, direct nominations of directors by
shareowners. At present, shareowners can only
“suggest” nominees and even then, weakly. This is
potentially a large issue with plenty of room for mischief if
poorly drafted and interpreted.
10. SOX has pages and pages of very specific prohibitions
and “must do” items. It is virtually a catalogue of all the
offenses found in the highly publicized cases—and many,
many more items added in the drafting. For example, it
tightens the requirements for reporting stock sales by
senior executives, prohibits loans to top officers and a
number of other prohibitions of practices found in the highly
publicized cases. Because the list is so extensive, if rigidly
enforced in minute detail, 100% compliance will be a real
challenge. Likely it will be modified over time for clarity and
compliance, but in the meantime, it’s a minefield.
Will It Work?
Fred McChesney has argued that state legislation was sufficient deterrent to punish Enron and others. His take on the political economy of corporate scandals is here.
Does prescriptive legislation work? History says “not
often,” especially if it has pages and pages of rules, sub-rules and yet tinier rules written in what is called in the
trade “flyspeck bold” print. Confusion often sets in when
one tries to follow the roadmap of too many things like Para 7A.(1)(f)(3) (as amended)(See legislative record for
However the practices that brought about these new rules
were so egregious that something had to be done. Many
elements of these rules will prove to the right “thing” and
some will be only a bureaucratic exercise. Time will be the
judge of the ratio.
*Richard Mahoney is the Distinguished Executive in Residence at the Weidenbaum Center on the Economy, Government, and Public policy at Washington University in St. Louis and is the former Chairman and CEO of Monsanto. He has served on three Fortune Boards of Directors and currently serves one as Chairman of its Governance Committee.
To read more and comment on Sarbanes-Oxley, see the “Cost of Sarbanes-Oxley” on EconLog.