The Sarbanes Oxley Act of 2002

H.R.3763 - The Sarbanes-Oxley Act of 2002

A lot has been made, perhaps without justification, of the July 30, 2002 passage of H.R. 3763, The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley" or The Act). Having read the Act, I suspect that the great praise is unfounded. I intend to address three issues presented within the act. First, I will address stock options as considered (or neglected, as the case may be) by Sarbanes-Oxley. Second, I will address the creation of a Commission designed to oversee audits and corporate accounting practices, and the potential efficacy of this Commission. Finally, I will address the modifications to the Federal Sentencing Guidelines as it relates to corporate fraud.

The failure to directly address accounting practices as they relate to stock options and other corporate incentives in Sarbanes-Oxley indicates the flaw in Federal regulation of corporate practices.

Sarbanes-Oxley was designed to address the fraudulent accounting practices undertaken by the accountants for Enron and WorldCom. One of the biggest problems with regard to the accounting used in preparation of financial statements by corporations has been the issue of non-salary executive compensation. Corporations, as part of a combined incentive and retention program, often offer executives stock options and enhanced performance pay. The key debate, with regard to accounting practices, has been how these incentives should be depicted on annual and quarterly corporate financial reports.

The position of the Internal Revenue Service has been that corporations, in order to fairly obtain the tax benefits often garnered on corporations based on their compensation plans, should list these compensation plans (options, in particular) as expenses on their financial reports. See Simon Kennedy and Brendan Murray, IRS Proposes Stock Options be Expensed for Some U.S. Affiliates, Bloomberg News Wire Service(Jul. 26, 2002). If corporations were to expense executive compensation plans, this would reduce their overall profits. However, there are those, including the celebrated and successful CEO of Berkshire Hathaway, Warren Buffett, who argue that this reduced profit figure is a more accurate reflection of a corporation's performance. See Warren E. Buffett, Who Really Cooks the Books, NY Times (Jul. 24, 2002). "When a company gives something of value to its...

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...reased (the maximum possible fine is now $25 Million per violation, instead of $2.5 Million), as have prison terms (20 years maximum). Still, the problem remains: who cares if they are fined $25 Million if they make $250 Million? There needs to be stronger enforcement policies. A theory I think might be useful is to borrow from the Racketeering Influenced Corrupt Organizations Act (RICO). Fines should not be set as a constant. They should reflect the social cost of the crime. Thus, as with RICO, fines should be set at a level three times that of the social cost of the criminal act (a.k.a., treble damages). Imagine how reluctant Milken would have been to engage in insider trading had he known that he would make -$600 Million as a result of $300 Million in social costs?


Sarbanes-Oxley is a very well-intentioned act. However, it lacks teeth in areas where it needs them, and goes too far in areas where actual enforcement of pre-existing laws would solve the present regulatory problem. The Act, I suspect, may be the source of more problems in the future. Further, it is unlikely to work as the curative salve it is intended to be for the stock market/economy.
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