Presumed Guilty: The Injustice and Destruction of Sarbanes-Oxley

Imagine opening tomorrow's newspaper and reading this: "Citing all-too-frequent child abuse and neglect, Congress has proposed the Parenting Reform Act. Under the proposed law, all parents must sign a sworn statement pledging that they have not ‘caused unreasonable physical harm or danger' to their children. To verify their compliance, all parents will be required to submit their children to a monthly full-body inspection by the new Parental Oversight Board, and account for every cut, scrape, and bruise that inspectors find. If a parent cannot prove the ‘reasonableness' of any injuries to the Board's satisfaction, it could result in a loss of custody and 20 years in prison.

"‘If a child has a bruised leg,' one of the bill's supporters said, ‘we need to know about it--and we need to know how it happened. If it happened playing soccer, we need signed accounts from the coach and the referee. Otherwise, how can we be sure his father didn't just get drunk and beat him? And if a child gets a lot of bruises playing soccer, we need an explanation of why his parents continue to expose him to such danger.'"

Our reaction to this proposed law would be outrage. It is unjust and destructive, we would say, for the government to make arbitrary accusations of abuse and neglect, to conduct baseless investigations, and then to force an innocent parent to try to disprove them.

We should say the same about an existing law that perpetrates such horrors, not on America's parents, but on its businessmen: Sarbanes-Oxley.

Sarbanes-Oxley was passed three years ago, in the anti-business frenzy following the Enron and WorldCom accounting frauds--crimes that were characterized not as the work of a handful of cheats, but as a black mark on all businessmen. Instead of simply gathering evidence and prosecuting individual perpetrators accordingly, our leaders passed a law that forces all businessmen to prove to the government that they are not cooking their books.

Under Sarbanes-Oxley, the government, without any evidence of possible fraud, has free reign to scour a company's books to determine whether they "fairly" represent the company's finances and do "not contain any untrue statement of a material fact or omit to state a material fact."

What is "fairly"? What is "material"? Since these terms are undefined, they mean anything government bureaucrats want them to mean. Just as the government under the fictional Parenting Reform Act could declare a parent a child-abuser for enrolling his child in soccer, so the government under Sarbanes-Oxley can declare a CFO a defrauder for reasonably deciding to capitalize an expenditure instead of to expense it (there are many such judgment calls in accounting).

Further, how can the government hold a businessman criminally responsible for any mistake in a financial report, which is the product of hundreds of people making thousands of individual judgments and decisions? Sarbanes-Oxley says the mistake is "knowing" if the internal controls management establishes to prevent error and fraud are not "adequate." But since the government does not define "adequate," anytime a regulator decides there "should have been" still one more control to prevent even the most inconsequential of errors--management is guilty of fraud.

If parents knew that the government could throw them in jail for every judgment call and innocent error that resulted in a skinned knee, they would avoid "risky" situations like trips to the park, and spend their time tracking their and their child's every move so that they could rebut the government's arbitrary accusations. The same is true for businesses under the potential guillotine of Section 302 of Sarbanes-Oxley--behavior practically mandated by the extensive testing and documenting of internal controls required by Section 404. Whole companies avoid any action the government might frown upon, and pour endless time and energy into monitoring and cataloging anything that a government inspector might conceivably believe is relevant to financial reporting.

Such behavior is now rampant in corporate America. One study documents businesses engaging in practices like "requiring an auditor to attend a meeting to prove it took place" and "proving that all of the physical keys to an office in Europe have been accounted for since it opened in 1995"! "Even a completely harmless error that nobody cares about," says a lawyer who handles Sarbanes-Oxley compliance, "takes up hundreds and hundreds of hours of the auditors, the CEO, the CFO and the audit committee."

That America's honest, productive businessmen are spending their time and shareholder money to "prove" they are not criminals--when they could be spending those hours and dollars on R&D, new product launches, or mergers and acquisitions--is a monumental injustice. Is it any wonder that misery among top executives is reported throughout corporate America, that top executives are departing at record rates, that businesses are "hunkering down"? Is it any wonder that the direct and indirect costs of Sarbanes-Oxley to shareholders have been estimated by a University of Rochester economist as $1.4 trillion?

Sarbanes-Oxley is a moral and economic atrocity. It is past time to repeal this monstrous law and start treating businessmen as American citizens: innocent until proven otherwise.

Alex Epstein is a writer for the Ayn Rand Institute (www.aynrand.org) in Irvine, California. Visit his website at www.AlexEpstein.com.