In July 2002, President George W. Bush proudly signed the Sarbanes-Oxley Act (SOX), which reached his desk after passing by votes of 99-0 in the Senate and 423-3 in the House of Representatives. The new law had multiple titles and myriad sections, but its overarching purpose was simple: "To protect investors by improving the accuracy and reliability of corporate disclosures."
Fifteen years later, SOX's success is manifest in many ways, starting with the foundation of our financial system: investor confidence. Survey upon survey over the past 10 years reveals the durable confidence of investors in the U.S. capital markets. Even during and in the immediate aftermath of the 2008-2009 financial crisis, a solid majority of investors continued to express confidence in our market system—a system built on the reliable and transparent corporate disclosure that fuels the largest and deepest capital markets in the world.
Strong U.S. investor confidence over the last decade is just one measure of SOX success. Another positive sign is encouraging trends in financial restatements by companies. And audit committees, whose roles and responsibilities were greatly strengthened by SOX, continue to hone their capabilities and enhance their disclosure to investors regarding their oversight of the financial reporting process.
This body of evidence seems overlooked by some who persist in arguing that the law has led to all manner of economic woe. Principally at issue here is SOX Section 404, which does two things. SOX 404(a) requires management to evaluate the effectiveness of the company’s system of internal control over financial reporting (ICFR) which has been required by federal law since 1977. SOX 404(b) requires a registered public accountant to attest to and report on management’s ICFR assessment.
SOX critics would like to scale back 404(b) so that fewer companies are subject to this important provision. Doing so would be detrimental for several reasons.
First, Section 404 works for businesses, not against them. Some argue that the provision has raised auditing costs for companies and deterred capital formation. Research shows, however, the accountability inherent in Section 404 benefits companies considerably. Academics have found companies that voluntarily comply with Section 404 have a lower cost of capital than those that do not—and that includes smaller companies.
Another plus: companies that comply with SOX 404 have fewer financial restatements, according to a 2013 study from the Government Accountability Office. That same report found that 80 percent of all companies viewed the quality of their company’s internal control structure as benefiting from auditor attestation, results consistent with today's views. In an April 2017 poll of 105 chief financial officers, 85 percent said that the ICFR audit has either greatly (34 percent) or somewhat (51 percent) helped their company.
Equally important are the benefits for investors. The law's detractors argue in favor of expanding exemptions for smaller companies from SOX 404. A recent academic study, however, is illuminating on the costs and benefits of 404 exemptions. Studying a set of exempt companies from 2007 to 2014, the study's authors found that those companies saved $388 million in 404(b)-related audit fees. But the researchers also found that the 404(b) exemption had the effect of lowering the aggregate market value of those same companies by $935 million. Given that cost-benefit picture, it's not surprising to learn that a solid 73 percent of financial advisors say that their clients would benefit if all public companies were subject to Section 404's requirements.
Few laws are perfect, and there may well be ways to improve on SOX. Yet a vital part of financial reform is to recognize what works. SOX should be considered one of the finest examples of business and government fashioning a template for fairness and disclosure—one that that works effectively for businesses, shareholders and markets.
Bertsch is the Executive Director of the Council of Institutional Investors, Fornelli is the Executive Director of the Center for Audit Quality, and Peters is Head of Regulatory Engagement at CFA Institute.
The views expressed by this author are their own and are not the views of The Hill.