Congress passed the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley) with overwhelming popular support, but the statute soon generated strong criticism by many experts on public company regulation. There was early concern that the law overregulated public companies, creating incentives for domestic and foreign companies to avoid selling securities to the public in the United States. The law may be the most controversial addition to the core securities laws of the 1930s. It has certainly been the most scrutinized and studied.
This The Business Lawyer symposium examines the effectiveness and influence of Sarbanes-Oxley two decades after it was enacted in 2002. The papers were presented at a conference sponsored by the Lowell Milken Institute for Business Law and Policy that convened at UCLA School of Law on October 21, 2022. The participating scholars brought different areas of expertise and perspectives on Sarbanes-Oxley to the table.
Viewed after twenty years, the effectiveness of Sarbanes-Oxley is difficult to assess, but the law’s influence is undeniable. The history of the regulation of public companies in the United States can be divided into the periods before and after Sarbanes-Oxley.
The conference began with a presentation on the events that prompted the passage of Sarbanes-Oxley. In The Need for Sarbanes-Oxley, I argue that rather than solely a response to the bankruptcies of Enron and WorldCom, Sarbanes-Oxley addressed a larger set of securities frauds that began in the late 1990s, years before the economy fell into recession. The SEC initially addressed these accounting frauds by prompting self-regulatory organizations to change their listing rules. Because a less invasive approach had already been attempted before Enron and WorldCom, there was more pressure on Congress to adopt mandatory regulation to restore confidence in the integrity of public company financial statements.
A substantial criticism of Sarbanes-Oxley is that it enacted reforms in haste without extensive analysis of their costs and benefits. In Sarbanes-Oxley 404 at 20, Stephen Bainbridge evaluates the evidence on the effectiveness of the most controversial of these reforms, the requirement that managers assess their company’s internal controls over financial reporting and that an auditor review that assessment. On the benefits side, there is some evidence that Section 404 has been successful, but there are many confounding factors that make it difficult to isolate the impact of the provision. The number of adverse managerial assessments and auditor attestations has remained substantial, undermining the argument that Section 404 improved the quality of public company accounting. The costs of Section 404 compliance are still high and disproportionately impact smaller firms.
To the extent that public company reporting has improved, one explanation is more visible and vigorous enforcement by the Securities and Exchange Commission (SEC). In How Fair Funds Strengthened SEC Enforcement, Urska Velikonja contends that the Sarbanes-Oxley Fair Funds provision, which permits the SEC to collect compensation for victims of securities law violations, increased the effectiveness of SEC penalties. The power to compensate investors increased the size of SEC penalties, magnifying their deterrent effect. Moreover, the SEC has pointed to its role in compensating investors to increase political support for its enforcement program.
Even as Sarbanes-Oxley has strengthened the accuracy of accounting, James Cox raises concerns that more work needs to be done. In SOX’s Impact on the Quality of Financial Reporting, he observes that accounting restatements acknowledging a material error in a company’s financial reports have declined, but some of this decline may reflect a shift to characterizing such errors as revisions, which are not material. Auditors are still not sufficiently independent to resist pressure from companies to downplay the significance of errors. There are still questions about whether the SEC and Public Company Auditing Oversight Board are too closely tied to the industry to be effective watchdogs. Though some of Sarbanes-Oxley’s disclosure initiatives failed to reach their full potential, Cox concludes that later efforts have helped move the vision of Sarbanes-Oxley forward.
Not only are there questions about the success of Sarbanes-Oxley, there is uncertainty about whether predictions that it would undermine the competitiveness of U.S. stock markets have come to fruition. In Sox X-Border, Carlos Berdejó closely examines developments in Chile and Brazil in assessing the law’s impact on foreign companies. The number of companies from these countries that cross list in the United States declined after Sarbanes-Oxley. Some of the law’s governance provisions are not a good fit for foreign companies, which tend to have greater concentration in ownership. However, it is difficult to conclude that the main reason for the fewer cross-listings is that Chilean and Brazilian companies are concerned about the costs of U.S. corporate governance. Both countries enacted stronger governance regulation after Sarbanes-Oxley. Such efforts may make companies in these jurisdictions more attractive to foreign investors, lessening the need for them to sell securities to bond their reputation to U.S. regulation.
Sarbanes-Oxley’s influence extends beyond the regulation of public company financial reporting. The final four papers of the symposium discuss the influence of the law in a variety of arenas.
In Functional Federalization of Corporate Governance After Sarbanes-Oxley, Paul Rose analyzes the federalization of U.S. corporate governance in the decades after the passage of Sarbanes-Oxley. He contends that while the law was part of a trend toward federal preemption, it may not be the most signif?icant driver of greater federal intervention. He contends that the SEC’s pursuit of shareholder-centric governance has been more significant in displacing state regulation of corporate law. Efforts to regulate proxy advisors and climate change disclosure are examples where federal regulation is expanding in the name of shareholder interests.
In Sarbanes Oxley 404 and Its Administrative Legacy, Alex Lee shows how Section 404 of Sarbanes-Oxley impacted the SEC as an administrative agency. Before Sarbanes-Oxley, it was rare for Congress to mandate rulemaking by the SEC. Now, such rulemaking is a substantial part of the SEC’s work. He describes the issues of first impression that the SEC faced in implementing Section 404 over almost a decade. The lessons the SEC learned from this experience have improved its ability to analyze regulations through cost-benefit analysis and retrospective review. The agency’s efforts have resulted in the mitigation of some of the burdens of Section 404.
Sarbanes-Oxley has not only changed public corporations, it has shaped non-profit governance. Alina Ball describes in Social Enterprise Governance Post-Sox how non-profits have adopted measures similar to those required by Sarbanes-Oxley. Just as Sarbanes-Oxley has been criticized in the private sector, questions have been raised about the effectiveness of such measures. As public companies have become more public-minded, it is possible that innovations from the non-profit sector will influence the governance of public companies.
Miriam Baer’s paper, Corporate Compliance’s Achilles Heel, looks to the future in identifying challenges that the compliance systems shaped by Sarbanes-Oxley will face in an increasingly politically polarized world. Baer argues that the standard theoretical approach that focuses so heavily on the compliance function's structure should be supplemented with a recognition of how polarization impacts personal interactions. As high-level and lower level corporate teams become more polarized, companies will encounter new challenges in regulating and monitoring themselves. Compliance officers, in turn, should also find it more difficult to gather information from within the firm if employees pervasively distrust each other. By the same token, if federal regulation and enforcement also becomes more politicized, state and local enforcement institutions may need to step in to fill a politically-induced void.
The work of the scholars in this symposium shows that even after twenty years, Sarbanes-Oxley is a law worth writing about. Its influence on public company regulation ensures that it will remain a subject of scholarly inquiry for many years to come.
Thank you to Joel Feuer and the staff of the Lowell Milken Institute for organizing the conference where these papers were presented. Thank you to Adam Swank and Micah Sperling for excellent work in editing the papers in this volume.
