May 2, 2005

Seeking a Cure for Sarbox Eliminating frauds and errors is impossible; just trying is costly By SCOTT S. POWELL

Sarbanes-Oxley is Thwarting Innovation and Free Markets

RUMBLINGS OF DESPAIR ABOUT SOMETHING called Sarbox might suggest that a new disease threatens us. But it's actually slang for the Sarbanes-Oxley Act of 2002, a set of regulations intended to prevent the next Enron or WorldCom by improving corporate governance. As Sarbox enters its first year of enforcement, some find that it may be the most costly and counterproductive regulation ever imposed on public companies.

Sarbox dictates federal standards of corporate governance in areas previously left to states. Complying with Sarbox will levy $35 billion of additional costs on Corporate America this year -- 20 times more than the SEC originally estimated. Washington bureaucrats can now impose a one-size-fits-all approach to structure corporate boards, determine their duties and those of officers, and set the standards and processes for internal controls. In so doing, Sarbox defies common sense and the American tradition of competition to promote innovation and best business practices.

How did this happen? In July of 2002, media coverage of destitute former employees contrasted with outlandish executive excess, the collapse of audit firm Arthur Anderson and the bankruptcies of Enron and WorldCom sent the stock market into freefall. Facing outraged investors and elections just four months away, Congress felt it had to do something.

Few congressmen could oppose a bill that promised to restore corporate accountability and Wall Street confidence. The Senate, indeed, passed it, 99-0. Now we are reminded that laws passed by unanimous vote generally prove to be bad legislation.

Sarbanes-Oxley does introduce some beneficial reforms, such as establishing an oversight board for public accounting, increasing penalties for fraud, providing more protections for whistleblowers, requiring more transparency of insider stock sales and material events, and reducing conflicts of interest in corporate governance. But much of this good is outweighed by the cost of Section 404 of Sarbox, which has empowered external auditors to regulate internal company controls.

High-level fraud is still likely to go undetected because regulators are looking in the wrong places. Section 404 audits focus on such minutiae of operational details that they won't detect or prevent the kind of fraud, such as capitalizing instead of expensing billions of dollars, that took WorldCom down. Since the act passed, public auditors' revenues have doubled, but their role as a second line of

defense against executive malfeasance and corporate crime is no better today than before.

Sarbox has rewarded auditors' previous failures with a full employment act for fussy inspectors and a bonanza of new revenues, while accomplishing little to stop the next mega-corporate crime -- all paid for by shareholders. In effect, Sarbanes-Oxley has facilitated the largest transfer of corporate wealth from the producing class to the consuming class since the alleged Y2K computer glitch lined the pockets of computer and software consultants.

The impact of Sarbanes-Oxley extends beyond public companies. Mischief has now spread to the bond market, where newly empowered auditors and regulators have ignored two decades of common-sense practice and forced public companies to reclassify the accounting of auction-rate bond securities for no good purpose. The changes will have no material affect on the investment income of corporations or the liquidity of the auction rate bonds in which they invest. But it caused temporary instability in the $250 billion auction-rate note market, previously considered by many to be one of the best and most convenient cash management venues on Wall Street. Many corporate treasurers panicked and bailed out for no good reason, effectively reducing the investment income on their companies' cash equivalents.

While the law pushed some companies to adopt new internal control systems, many have delayed systems upgrades out of fear that the inevitable disruptions would precipitate a Sarbox compliance nightmare. Regardless, the new regulations require corporations to document and certify internal controls every year -- annuitizing a windfall for the Big Four accounting firms.

Privately, many CEOs and CFOs acknowledge the massive waste and misdirection of resources, but some remain silent because 404 provides them a measure of protection against liability in the event that a system or human error requires a material restatement. One S&P 500 corporate executive taking early retirement acknowledged that 404 has less to do with controls such as ERP (enterprise resource planning), ORM (operational risk management) or BPM (business performance management), and everything to do with CYA (cover your ass).

Sarbox illustrates the madness of overregulation and the folly of Congress trying to legislate risk- and error-free business operations. This might be tolerable were it a one-time cost and if it did not interfere with management's flexibility and ability to run the business. "But with Sarbox nobody has any bandwidth to think about innovative ideas or new models," says a top project manager at Cingular, the nation's largest cellular service provider. Jeffrey Garten, dean of Yale's School of Management, predicts: "CEOs are going to become more risk-averse, and big investments in risky projects will be held back."

New initiatives have gone right out the door at many companies, with project after project postponed or cancelled. William Zollars, CEO of Yellow Roadway, the largest trucker in the U.S., says "it requires an army of people to do the paperwork." In addition to diverting some 200 employees to work on Sarbox in the fourth quarter of 2004, Zollars spent nearly $10 million on outside accountants and auditors, more than 3% of his firm's annual profit.

Yellow Roadway may be getting off cheaply, as some authorities put the average large company compliance price tag at more than $35 million. Scott McNealy, CEO of Sun Microsystems, says the billions spent nationally on Sarbanes-Oxley compliance weighs on the stock market and is like "throwing buckets of sand in the gears of a market economy."

The greatest impact of Sarbox is on small public companies and venture capital start-ups, which generate more than 70% of new jobs in the U.S. Compliance is more painful for smaller companies because costs are spread over fewer heads and less revenue. As a result, not only are many start-ups hesitant to go ahead with IPOs, but approximately one-fifth of existing small public companies in the U.S. have considered going private because of the costs of Sarbox. The exodus also involves foreign-domiciled companies listed on one of the U.S. stock exchanges, who now want to delist and get out of Dodge to avoid the high cost and wastefulness of Sarbanes-Oxley.

What can be done? The SEC may exercise its prerogative, make exceptions and use its exemptive power to render optional the various regulatory provisions found excessive. But a better solution is in legislation recently introduced by Rep. Jeff Flake (R-Ariz.) that treats all companies equally and simply makes Section 404 of Sarbanes-Oxley voluntary. Firms could determine the appropriate level of controls by management discretion or by shareholder vote, with full disclosure to the SEC and in annual reports.

Such a scaled-back Sarbanes-Oxley II would let shareholders and managers have more say than government in deciding how corporate resources should be spent. And it would help keep the U.S. competitive, while it would restore balance at home and reaffirm the primacy of free-market initiatives and innovation.

Heck, it might even be fun to go to work again.

____________________

Scott Powell is a Senior Vice President at RBC Capital Markets; a Board Member of BMG Seltec Inc., and a Visiting Fellow at the Hoover Institution

May 2, 2005

Seeking a Cure for Sarbox Eliminating frauds and errors is impossible; just trying is costly By SCOTT S. POWELL

Sarbanes-Oxley is Thwarting Innovation and Free Markets

RUMBLINGS OF DESPAIR ABOUT SOMETHING called Sarbox might suggest that a new disease threatens us. But it's actually slang for the Sarbanes-Oxley Act of 2002, a set of regulations intended to prevent the next Enron or WorldCom by improving corporate governance. As Sarbox enters its first year of enforcement, some find that it may be the most costly and counterproductive regulation ever imposed on public companies.

Sarbox dictates federal standards of corporate governance in areas previously left to states. Complying with Sarbox will levy $35 billion of additional costs on Corporate America this year -- 20 times more than the SEC originally estimated. Washington bureaucrats can now impose a one-size-fits-all approach to structure corporate boards, determine their duties and those of officers, and set the standards and processes for internal controls. In so doing, Sarbox defies common sense and the American tradition of competition to promote innovation and best business practices.

How did this happen? In July of 2002, media coverage of destitute former employees contrasted with outlandish executive excess, the collapse of audit firm Arthur Anderson and the bankruptcies of Enron and WorldCom sent the stock market into freefall. Facing outraged investors and elections just four months away, Congress felt it had to do something.

Few congressmen could oppose a bill that promised to restore corporate accountability and Wall Street confidence. The Senate, indeed, passed it, 99-0. Now we are reminded that laws passed by unanimous vote generally prove to be bad legislation.

Sarbanes-Oxley does introduce some beneficial reforms, such as establishing an oversight board for public accounting, increasing penalties for fraud, providing more protections for whistleblowers, requiring more transparency of insider stock sales and material events, and reducing conflicts of interest in corporate governance. But much of this good is outweighed by the cost of Section 404 of Sarbox, which has empowered external auditors to regulate internal company controls.

High-level fraud is still likely to go undetected because regulators are looking in the wrong places. Section 404 audits focus on such minutiae of operational details that they won't detect or prevent the kind of fraud, such as capitalizing instead of expensing billions of dollars, that took WorldCom down. Since the act passed, public auditors' revenues have doubled, but their role as a second line of

defense against executive malfeasance and corporate crime is no better today than before.

Sarbox has rewarded auditors' previous failures with a full employment act for fussy inspectors and a bonanza of new revenues, while accomplishing little to stop the next mega-corporate crime -- all paid for by shareholders. In effect, Sarbanes-Oxley has facilitated the largest transfer of corporate wealth from the producing class to the consuming class since the alleged Y2K computer glitch lined the pockets of computer and software consultants.

The impact of Sarbanes-Oxley extends beyond public companies. Mischief has now spread to the bond market, where newly empowered auditors and regulators have ignored two decades of common-sense practice and forced public companies to reclassify the accounting of auction-rate bond securities for no good purpose. The changes will have no material affect on the investment income of corporations or the liquidity of the auction rate bonds in which they invest. But it caused temporary instability in the $250 billion auction-rate note market, previously considered by many to be one of the best and most convenient cash management venues on Wall Street. Many corporate treasurers panicked and bailed out for no good reason, effectively reducing the investment income on their companies' cash equivalents.

While the law pushed some companies to adopt new internal control systems, many have delayed systems upgrades out of fear that the inevitable disruptions would precipitate a Sarbox compliance nightmare. Regardless, the new regulations require corporations to document and certify internal controls every year -- annuitizing a windfall for the Big Four accounting firms.

Privately, many CEOs and CFOs acknowledge the massive waste and misdirection of resources, but some remain silent because 404 provides them a measure of protection against liability in the event that a system or human error requires a material restatement. One S&P 500 corporate executive taking early retirement acknowledged that 404 has less to do with controls such as ERP (enterprise resource planning), ORM (operational risk management) or BPM (business performance management), and everything to do with CYA (cover your ass).

Sarbox illustrates the madness of overregulation and the folly of Congress trying to legislate risk- and error-free business operations. This might be tolerable were it a one-time cost and if it did not interfere with management's flexibility and ability to run the business. "But with Sarbox nobody has any bandwidth to think about innovative ideas or new models," says a top project manager at Cingular, the nation's largest cellular service provider. Jeffrey Garten, dean of Yale's School of Management, predicts: "CEOs are going to become more risk-averse, and big investments in risky projects will be held back."

New initiatives have gone right out the door at many companies, with project after project postponed or cancelled. William Zollars, CEO of Yellow Roadway, the largest trucker in the U.S., says "it requires an army of people to do the paperwork." In addition to diverting some 200 employees to work on Sarbox in the fourth quarter of 2004, Zollars spent nearly $10 million on outside accountants and auditors, more than 3% of his firm's annual profit.

Yellow Roadway may be getting off cheaply, as some authorities put the average large company compliance price tag at more than $35 million. Scott McNealy, CEO of Sun Microsystems, says the billions spent nationally on Sarbanes-Oxley compliance weighs on the stock market and is like "throwing buckets of sand in the gears of a market economy."

The greatest impact of Sarbox is on small public companies and venture capital start-ups, which generate more than 70% of new jobs in the U.S. Compliance is more painful for smaller companies because costs are spread over fewer heads and less revenue. As a result, not only are many start-ups hesitant to go ahead with IPOs, but approximately one-fifth of existing small public companies in the U.S. have considered going private because of the costs of Sarbox. The exodus also involves foreign-domiciled companies listed on one of the U.S. stock exchanges, who now want to delist and get out of Dodge to avoid the high cost and wastefulness of Sarbanes-Oxley.

What can be done? The SEC may exercise its prerogative, make exceptions and use its exemptive power to render optional the various regulatory provisions found excessive. But a better solution is in legislation recently introduced by Rep. Jeff Flake (R-Ariz.) that treats all companies equally and simply makes Section 404 of Sarbanes-Oxley voluntary. Firms could determine the appropriate level of controls by management discretion or by shareholder vote, with full disclosure to the SEC and in annual reports.

Such a scaled-back Sarbanes-Oxley II would let shareholders and managers have more say than government in deciding how corporate resources should be spent. And it would help keep the U.S. competitive, while it would restore balance at home and reaffirm the primacy of free-market initiatives and innovation.

Heck, it might even be fun to go to work again.

____________________

Scott Powell is a Senior Vice President at RBC Capital Markets; a Board Member of BMG Seltec Inc., and a Visiting Fellow at the Hoover Institution

May 2, 2005

Seeking a Cure for Sarbox Eliminating frauds and errors is impossible; just trying is costly By SCOTT S. POWELL

Sarbanes-Oxley is Thwarting Innovation and Free Markets

RUMBLINGS OF DESPAIR ABOUT SOMETHING called Sarbox might suggest that a new disease threatens us. But it's actually slang for the Sarbanes-Oxley Act of 2002, a set of regulations intended to prevent the next Enron or WorldCom by improving corporate governance. As Sarbox enters its first year of enforcement, some find that it may be the most costly and counterproductive regulation ever imposed on public companies.

Sarbox dictates federal standards of corporate governance in areas previously left to states. Complying with Sarbox will levy $35 billion of additional costs on Corporate America this year -- 20 times more than the SEC originally estimated. Washington bureaucrats can now impose a one-size-fits-all approach to structure corporate boards, determine their duties and those of officers, and set the standards and processes for internal controls. In so doing, Sarbox defies common sense and the American tradition of competition to promote innovation and best business practices.

How did this happen? In July of 2002, media coverage of destitute former employees contrasted with outlandish executive excess, the collapse of audit firm Arthur Anderson and the bankruptcies of Enron and WorldCom sent the stock market into freefall. Facing outraged investors and elections just four months away, Congress felt it had to do something.

Few congressmen could oppose a bill that promised to restore corporate accountability and Wall Street confidence. The Senate, indeed, passed it, 99-0. Now we are reminded that laws passed by unanimous vote generally prove to be bad legislation.

Sarbanes-Oxley does introduce some beneficial reforms, such as establishing an oversight board for public accounting, increasing penalties for fraud, providing more protections for whistleblowers, requiring more transparency of insider stock sales and material events, and reducing conflicts of interest in corporate governance. But much of this good is outweighed by the cost of Section 404 of Sarbox, which has empowered external auditors to regulate internal company controls.

High-level fraud is still likely to go undetected because regulators are looking in the wrong places. Section 404 audits focus on such minutiae of operational details that they won't detect or prevent the kind of fraud, such as capitalizing instead of expensing billions of dollars, that took WorldCom down. Since the act passed, public auditors' revenues have doubled, but their role as a second line of

defense against executive malfeasance and corporate crime is no better today than before.

Sarbox has rewarded auditors' previous failures with a full employment act for fussy inspectors and a bonanza of new revenues, while accomplishing little to stop the next mega-corporate crime -- all paid for by shareholders. In effect, Sarbanes-Oxley has facilitated the largest transfer of corporate wealth from the producing class to the consuming class since the alleged Y2K computer glitch lined the pockets of computer and software consultants.

The impact of Sarbanes-Oxley extends beyond public companies. Mischief has now spread to the bond market, where newly empowered auditors and regulators have ignored two decades of common-sense practice and forced public companies to reclassify the accounting of auction-rate bond securities for no good purpose. The changes will have no material affect on the investment income of corporations or the liquidity of the auction rate bonds in which they invest. But it caused temporary instability in the $250 billion auction-rate note market, previously considered by many to be one of the best and most convenient cash management venues on Wall Street. Many corporate treasurers panicked and bailed out for no good reason, effectively reducing the investment income on their companies' cash equivalents.

While the law pushed some companies to adopt new internal control systems, many have delayed systems upgrades out of fear that the inevitable disruptions would precipitate a Sarbox compliance nightmare. Regardless, the new regulations require corporations to document and certify internal controls every year -- annuitizing a windfall for the Big Four accounting firms.

Privately, many CEOs and CFOs acknowledge the massive waste and misdirection of resources, but some remain silent because 404 provides them a measure of protection against liability in the event that a system or human error requires a material restatement. One S&P 500 corporate executive taking early retirement acknowledged that 404 has less to do with controls such as ERP (enterprise resource planning), ORM (operational risk management) or BPM (business performance management), and everything to do with CYA (cover your ass).

Sarbox illustrates the madness of overregulation and the folly of Congress trying to legislate risk- and error-free business operations. This might be tolerable were it a one-time cost and if it did not interfere with management's flexibility and ability to run the business. "But with Sarbox nobody has any bandwidth to think about innovative ideas or new models," says a top project manager at Cingular, the nation's largest cellular service provider. Jeffrey Garten, dean of Yale's School of Management, predicts: "CEOs are going to become more risk-averse, and big investments in risky projects will be held back."

New initiatives have gone right out the door at many companies, with project after project postponed or cancelled. William Zollars, CEO of Yellow Roadway, the largest trucker in the U.S., says "it requires an army of people to do the paperwork." In addition to diverting some 200 employees to work on Sarbox in the fourth quarter of 2004, Zollars spent nearly $10 million on outside accountants and auditors, more than 3% of his firm's annual profit.

Yellow Roadway may be getting off cheaply, as some authorities put the average large company compliance price tag at more than $35 million. Scott McNealy, CEO of Sun Microsystems, says the billions spent nationally on Sarbanes-Oxley compliance weighs on the stock market and is like "throwing buckets of sand in the gears of a market economy."

The greatest impact of Sarbox is on small public companies and venture capital start-ups, which generate more than 70% of new jobs in the U.S. Compliance is more painful for smaller companies because costs are spread over fewer heads and less revenue. As a result, not only are many start-ups hesitant to go ahead with IPOs, but approximately one-fifth of existing small public companies in the U.S. have considered going private because of the costs of Sarbox. The exodus also involves foreign-domiciled companies listed on one of the U.S. stock exchanges, who now want to delist and get out of Dodge to avoid the high cost and wastefulness of Sarbanes-Oxley.

What can be done? The SEC may exercise its prerogative, make exceptions and use its exemptive power to render optional the various regulatory provisions found excessive. But a better solution is in legislation recently introduced by Rep. Jeff Flake (R-Ariz.) that treats all companies equally and simply makes Section 404 of Sarbanes-Oxley voluntary. Firms could determine the appropriate level of controls by management discretion or by shareholder vote, with full disclosure to the SEC and in annual reports.

Such a scaled-back Sarbanes-Oxley II would let shareholders and managers have more say than government in deciding how corporate resources should be spent. And it would help keep the U.S. competitive, while it would restore balance at home and reaffirm the primacy of free-market initiatives and innovation.

Heck, it might even be fun to go to work again.

____________________

Scott Powell is a Senior Vice President at RBC Capital Markets; a Board Member of BMG Seltec Inc., and a Visiting Fellow at the Hoover Institution

May 2, 2005

Seeking a Cure for Sarbox Eliminating frauds and errors is impossible; just trying is costly By SCOTT S. POWELL

Sarbanes-Oxley is Thwarting Innovation and Free Markets

RUMBLINGS OF DESPAIR ABOUT SOMETHING called Sarbox might suggest that a new disease threatens us. But it's actually slang for the Sarbanes-Oxley Act of 2002, a set of regulations intended to prevent the next Enron or WorldCom by improving corporate governance. As Sarbox enters its first year of enforcement, some find that it may be the most costly and counterproductive regulation ever imposed on public companies.

Sarbox dictates federal standards of corporate governance in areas previously left to states. Complying with Sarbox will levy $35 billion of additional costs on Corporate America this year -- 20 times more than the SEC originally estimated. Washington bureaucrats can now impose a one-size-fits-all approach to structure corporate boards, determine their duties and those of officers, and set the standards and processes for internal controls. In so doing, Sarbox defies common sense and the American tradition of competition to promote innovation and best business practices.

How did this happen? In July of 2002, media coverage of destitute former employees contrasted with outlandish executive excess, the collapse of audit firm Arthur Anderson and the bankruptcies of Enron and WorldCom sent the stock market into freefall. Facing outraged investors and elections just four months away, Congress felt it had to do something.

Few congressmen could oppose a bill that promised to restore corporate accountability and Wall Street confidence. The Senate, indeed, passed it, 99-0. Now we are reminded that laws passed by unanimous vote generally prove to be bad legislation.

Sarbanes-Oxley does introduce some beneficial reforms, such as establishing an oversight board for public accounting, increasing penalties for fraud, providing more protections for whistleblowers, requiring more transparency of insider stock sales and material events, and reducing conflicts of interest in corporate governance. But much of this good is outweighed by the cost of Section 404 of Sarbox, which has empowered external auditors to regulate internal company controls.

High-level fraud is still likely to go undetected because regulators are looking in the wrong places. Section 404 audits focus on such minutiae of operational details that they won't detect or prevent the kind of fraud, such as capitalizing instead of expensing billions of dollars, that took WorldCom down. Since the act passed, public auditors' revenues have doubled, but their role as a second line of

defense against executive malfeasance and corporate crime is no better today than before.

Sarbox has rewarded auditors' previous failures with a full employment act for fussy inspectors and a bonanza of new revenues, while accomplishing little to stop the next mega-corporate crime -- all paid for by shareholders. In effect, Sarbanes-Oxley has facilitated the largest transfer of corporate wealth from the producing class to the consuming class since the alleged Y2K computer glitch lined the pockets of computer and software consultants.

The impact of Sarbanes-Oxley extends beyond public companies. Mischief has now spread to the bond market, where newly empowered auditors and regulators have ignored two decades of common-sense practice and forced public companies to reclassify the accounting of auction-rate bond securities for no good purpose. The changes will have no material affect on the investment income of corporations or the liquidity of the auction rate bonds in which they invest. But it caused temporary instability in the $250 billion auction-rate note market, previously considered by many to be one of the best and most convenient cash management venues on Wall Street. Many corporate treasurers panicked and bailed out for no good reason, effectively reducing the investment income on their companies' cash equivalents.

While the law pushed some companies to adopt new internal control systems, many have delayed systems upgrades out of fear that the inevitable disruptions would precipitate a Sarbox compliance nightmare. Regardless, the new regulations require corporations to document and certify internal controls every year -- annuitizing a windfall for the Big Four accounting firms.

Privately, many CEOs and CFOs acknowledge the massive waste and misdirection of resources, but some remain silent because 404 provides them a measure of protection against liability in the event that a system or human error requires a material restatement. One S&P 500 corporate executive taking early retirement acknowledged that 404 has less to do with controls such as ERP (enterprise resource planning), ORM (operational risk management) or BPM (business performance management), and everything to do with CYA (cover your ass).

Sarbox illustrates the madness of overregulation and the folly of Congress trying to legislate risk- and error-free business operations. This might be tolerable were it a one-time cost and if it did not interfere with management's flexibility and ability to run the business. "But with Sarbox nobody has any bandwidth to think about innovative ideas or new models," says a top project manager at Cingular, the nation's largest cellular service provider. Jeffrey Garten, dean of Yale's School of Management, predicts: "CEOs are going to become more risk-averse, and big investments in risky projects will be held back."

New initiatives have gone right out the door at many companies, with project after project postponed or cancelled. William Zollars, CEO of Yellow Roadway, the largest trucker in the U.S., says "it requires an army of people to do the paperwork." In addition to diverting some 200 employees to work on Sarbox in the fourth quarter of 2004, Zollars spent nearly $10 million on outside accountants and auditors, more than 3% of his firm's annual profit.

Yellow Roadway may be getting off cheaply, as some authorities put the average large company compliance price tag at more than $35 million. Scott McNealy, CEO of Sun Microsystems, says the billions spent nationally on Sarbanes-Oxley compliance weighs on the stock market and is like "throwing buckets of sand in the gears of a market economy."

The greatest impact of Sarbox is on small public companies and venture capital start-ups, which generate more than 70% of new jobs in the U.S. Compliance is more painful for smaller companies because costs are spread over fewer heads and less revenue. As a result, not only are many start-ups hesitant to go ahead with IPOs, but approximately one-fifth of existing small public companies in the U.S. have considered going private because of the costs of Sarbox. The exodus also involves foreign-domiciled companies listed on one of the U.S. stock exchanges, who now want to delist and get out of Dodge to avoid the high cost and wastefulness of Sarbanes-Oxley.

What can be done? The SEC may exercise its prerogative, make exceptions and use its exemptive power to render optional the various regulatory provisions found excessive. But a better solution is in legislation recently introduced by Rep. Jeff Flake (R-Ariz.) that treats all companies equally and simply makes Section 404 of Sarbanes-Oxley voluntary. Firms could determine the appropriate level of controls by management discretion or by shareholder vote, with full disclosure to the SEC and in annual reports.

Such a scaled-back Sarbanes-Oxley II would let shareholders and managers have more say than government in deciding how corporate resources should be spent. And it would help keep the U.S. competitive, while it would restore balance at home and reaffirm the primacy of free-market initiatives and innovation.

Heck, it might even be fun to go to work again.

____________________

Scott Powell is a Senior Vice President at RBC Capital Markets; a Board Member of BMG Seltec Inc., and a Visiting Fellow at the Hoover Institution

May 2, 2005

Seeking a Cure for Sarbox Eliminating frauds and errors is impossible; just trying is costly By SCOTT S. POWELL

Sarbanes-Oxley is Thwarting Innovation and Free Markets

RUMBLINGS OF DESPAIR ABOUT SOMETHING called Sarbox might suggest that a new disease threatens us. But it's actually slang for the Sarbanes-Oxley Act of 2002, a set of regulations intended to prevent the next Enron or WorldCom by improving corporate governance. As Sarbox enters its first year of enforcement, some find that it may be the most costly and counterproductive regulation ever imposed on public companies.

Sarbox dictates federal standards of corporate governance in areas previously left to states. Complying with Sarbox will levy $35 billion of additional costs on Corporate America this year -- 20 times more than the SEC originally estimated. Washington bureaucrats can now impose a one-size-fits-all approach to structure corporate boards, determine their duties and those of officers, and set the standards and processes for internal controls. In so doing, Sarbox defies common sense and the American tradition of competition to promote innovation and best business practices.

How did this happen? In July of 2002, media coverage of destitute former employees contrasted with outlandish executive excess, the collapse of audit firm Arthur Anderson and the bankruptcies of Enron and WorldCom sent the stock market into freefall. Facing outraged investors and elections just four months away, Congress felt it had to do something.

Few congressmen could oppose a bill that promised to restore corporate accountability and Wall Street confidence. The Senate, indeed, passed it, 99-0. Now we are reminded that laws passed by unanimous vote generally prove to be bad legislation.

Sarbanes-Oxley does introduce some beneficial reforms, such as establishing an oversight board for public accounting, increasing penalties for fraud, providing more protections for whistleblowers, requiring more transparency of insider stock sales and material events, and reducing conflicts of interest in corporate governance. But much of this good is outweighed by the cost of Section 404 of Sarbox, which has empowered external auditors to regulate internal company controls.

High-level fraud is still likely to go undetected because regulators are looking in the wrong places. Section 404 audits focus on such minutiae of operational details that they won't detect or prevent the kind of fraud, such as capitalizing instead of expensing billions of dollars, that took WorldCom down. Since the act passed, public auditors' revenues have doubled, but their role as a second line of

defense against executive malfeasance and corporate crime is no better today than before.

Sarbox has rewarded auditors' previous failures with a full employment act for fussy inspectors and a bonanza of new revenues, while accomplishing little to stop the next mega-corporate crime -- all paid for by shareholders. In effect, Sarbanes-Oxley has facilitated the largest transfer of corporate wealth from the producing class to the consuming class since the alleged Y2K computer glitch lined the pockets of computer and software consultants.

The impact of Sarbanes-Oxley extends beyond public companies. Mischief has now spread to the bond market, where newly empowered auditors and regulators have ignored two decades of common-sense practice and forced public companies to reclassify the accounting of auction-rate bond securities for no good purpose. The changes will have no material affect on the investment income of corporations or the liquidity of the auction rate bonds in which they invest. But it caused temporary instability in the $250 billion auction-rate note market, previously considered by many to be one of the best and most convenient cash management venues on Wall Street. Many corporate treasurers panicked and bailed out for no good reason, effectively reducing the investment income on their companies' cash equivalents.

While the law pushed some companies to adopt new internal control systems, many have delayed systems upgrades out of fear that the inevitable disruptions would precipitate a Sarbox compliance nightmare. Regardless, the new regulations require corporations to document and certify internal controls every year -- annuitizing a windfall for the Big Four accounting firms.

Privately, many CEOs and CFOs acknowledge the massive waste and misdirection of resources, but some remain silent because 404 provides them a measure of protection against liability in the event that a system or human error requires a material restatement. One S&P 500 corporate executive taking early retirement acknowledged that 404 has less to do with controls such as ERP (enterprise resource planning), ORM (operational risk management) or BPM (business performance management), and everything to do with CYA (cover your ass).

Sarbox illustrates the madness of overregulation and the folly of Congress trying to legislate risk- and error-free business operations. This might be tolerable were it a one-time cost and if it did not interfere with management's flexibility and ability to run the business. "But with Sarbox nobody has any bandwidth to think about innovative ideas or new models," says a top project manager at Cingular, the nation's largest cellular service provider. Jeffrey Garten, dean of Yale's School of Management, predicts: "CEOs are going to become more risk-averse, and big investments in risky projects will be held back."

New initiatives have gone right out the door at many companies, with project after project postponed or cancelled. William Zollars, CEO of Yellow Roadway, the largest trucker in the U.S., says "it requires an army of people to do the paperwork." In addition to diverting some 200 employees to work on Sarbox in the fourth quarter of 2004, Zollars spent nearly $10 million on outside accountants and auditors, more than 3% of his firm's annual profit.

Yellow Roadway may be getting off cheaply, as some authorities put the average large company compliance price tag at more than $35 million. Scott McNealy, CEO of Sun Microsystems, says the billions spent nationally on Sarbanes-Oxley compliance weighs on the stock market and is like "throwing buckets of sand in the gears of a market economy."

The greatest impact of Sarbox is on small public companies and venture capital start-ups, which generate more than 70% of new jobs in the U.S. Compliance is more painful for smaller companies because costs are spread over fewer heads and less revenue. As a result, not only are many start-ups hesitant to go ahead with IPOs, but approximately one-fifth of existing small public companies in the U.S. have considered going private because of the costs of Sarbox. The exodus also involves foreign-domiciled companies listed on one of the U.S. stock exchanges, who now want to delist and get out of Dodge to avoid the high cost and wastefulness of Sarbanes-Oxley.

What can be done? The SEC may exercise its prerogative, make exceptions and use its exemptive power to render optional the various regulatory provisions found excessive. But a better solution is in legislation recently introduced by Rep. Jeff Flake (R-Ariz.) that treats all companies equally and simply makes Section 404 of Sarbanes-Oxley voluntary. Firms could determine the appropriate level of controls by management discretion or by shareholder vote, with full disclosure to the SEC and in annual reports.

Such a scaled-back Sarbanes-Oxley II would let shareholders and managers have more say than government in deciding how corporate resources should be spent. And it would help keep the U.S. competitive, while it would restore balance at home and reaffirm the primacy of free-market initiatives and innovation.

Heck, it might even be fun to go to work again.

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Scott Powell is a Senior Vice President at RBC Capital Markets; a Board Member of BMG Seltec Inc., and a Visiting Fellow at the Hoover Institution