Ron Paul vs. SOX

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Ron Paul: Best friend to small businesses seeking relief from the costly effects of Sarbanes Oxley regulations and to the workers who will be caught in the crossfire.

Since 2004, companies have had to comply with a very costly Federal regulation titled The Sarbanes-Oxley Act of 2002.  Sarbanes-Oxley (or Sarbox) is a controversial law passed in response to a number of corporate accounting scandals including Enron and WorldCom.  The legislation is wide ranging and contains 11 sections ranging from Corporate Board responsibilities to criminal penalties.  The Act also covers issues such as audits by independent auditors, corporate governance, internal control assessment, and enhanced financial disclosure.  Companies spent an average of 4.36 million each adhering to Sarbox in 2004, the first year in which compliance with the law’s audit rules were required (even that number is contested, one study puts the figure at $5.1 million per company).  It should come as no surprise that the Securities and Exchange Commission (SEC) that was pushing for the Act had estimated that companies would only spend $91,000 per year: a slight discrepancy with the actual figures.  The bill passed the House by a vote of 423-3 and the Senate by 99-0.  Can you guess which friend of the small businessman was one of the three who voted against it?  Ron Paul.

Ron Paul, in a statement to the House, explained that interference from Congress through de-valuing the dollar with the help of the Federal Reserve led to false boom cycles that fooled investors. The easy credit environment made it possible for Enron to secure hundreds of millions in uncollateralized loans. He also explained that the SEC already has numerous rules with which corporations must comply. In a truly free market, investors understand that investments carry risks and will research a company on their own. However, in a highly regulated society the investor is lulled into a false sense of security: as long as the company is complying with SEC regulations, they must be okay, right? He stated: "In our heavily regulated economy, however, investors and analysts equate SEC compliance with reputability. The more we look to the government to protect us from investment mistakes, the less competition there is for truly independent evaluations of investment risk." Additionally, Enron was able to secure large sums of corporate welfare due to lobbying efforts that cost taxpayers unnecessary additional losses. To prevent such heinous fraud from occurring in the future, the American people need less regulation, not more. We should not punish innocent companies, he remarked, but "[i]nstead, we should focus on repealing those monetary and fiscal policies that distort the market and allow the politically powerful to enrich themselves at the expense of the American taxpayer."

The most contentious aspect of Sarbox is Section 404, which requires management and the external auditor to report on the adequacy of the company’s internal control over financial reporting. This is the most costly aspect of the legislation for companies to implement, as documenting and testing important financial manual and automated controls requires enormous effort. From an economic perspective, individual investors are hit hard:  They may be able to diversify their investments, but since each company must spend significant amounts of money and resources on Sarbox compliance, this cost cannot be diversified, but is instead multiplied for each investor.

According to Capitalism Magazine’s Alex Epstein, “Sarbanes-Oxley is a fundamentally corrupt law that must be repealed.”  The costs arise because instead of going after crooks and prosecuting them, this Act forces all businessmen to prove to the government that they are not “cooking their books.”  We seem to have lost the "innocent until proven guilty" concept.  Moreover, the Act holds a businessman criminally liable for any mistake in a financial report if the government can prove the mistake was made knowingly.  Mr. Epstein further explains: 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,” … “takes up hundreds and hundreds of hours of the auditors, the CEO, the CFO and the audit committee.” As put by another writer: "In its four years, Sarbox has damaged the American economy as badly as a group of unsupervised four-year-olds would damage a playroom."

Indeed, it was Congressional fiddling that led to the circumstances that set up the Enron scandal in the first place. Congress could not let businesses alone and set up pay ceilings and other regulations that led to end-runs on those impositions. Innovative businesses began to find other ways to pay their top executives and created an atmosphere of duplicity between partners and accounting firms.

As a result of the draconian provisions of Sarbox, the number of American companies deregistering from public stock exchanges nearly tripled during the year after Sarbanes-Oxley became law, while the New York Stock Exchange had only 10 new foreign listings in all of 2004.  Journalist Robert Novak, in his column of April 7, 2005, said that, “[f]or more than a year, CEOs and CFOs have been telling me that 404 is a costly nightmare" and "ask nearly any business executive to name the biggest menace facing corporate America, and the answer is apt to be number 404…a dagger aimed at the heart of the economy." On September 12, 2006, a group of organizations in the biotechnology, electronics, health, and medical-device industries issued a call for reforming Sarbox. These companies are what drive our innovation and growth in this country. Without them the economy will suffer terribly.

For those of you familiar with Ron Paul, it should come as no surprise that on April 14, 2005 he introduced the Due Process and Economic Competitiveness Restoration Act, which would have repealed Section 404 of Sarbox.  For those of you familiar with Congress, it should come as no surprise that this bill did not pass.  I suggest that you read Dr. Paul’s short introduction of his bill in its entirety.  It is well reasoned and addresses the damage this bill does to society.  He perceptively writes: “Laws criminalizing honest mistakes done with no intent to defraud are more typical of police states than free societies.”

More recently, on April 24, 2007, the Senate once again rejected any attempt to loosen the requirements of Section 404 for small businesses.  The cost of complying with 404 impacts smaller companies disproportionally, as there is a significant fixed cost involved in completing the assessment.  By a 62-35 vote, the Senate set aside an amendment that would make compliance with section 404 optional for companies with a total market value of less than $700 million.

The country did not need a new law. There were already plenty of laws in place that outlaw fraud. The Enron trials were based on statutes that had nothing to do with Sarbox and they were found guilty. Here is one example of a plea agreement that did not rely on Sarbox. The system worked. The bad guys went to jail. Nevertheless, Congress felt that it had to do something, and that something was to overreact.

As usual, Congressional continual overreaction will have significant effects on the American economy. Thanks in large part to Sarbox and its financial costs and threats of criminal penalties, there is now a massive move toward privatization of major U.S. Corporations and is potentially the most “profound economic shift in the U.S. in the last ten years.”   Those at the top, the investment bankers, the executives and hedge fund investors will do quite well from this new corporate structure.  The money however, will come with the price of significant reductions in benefits for employees. Pension funds may be reduced, health benefits will almost certainly be reduced, and layers of management will be trimmed.  Thus the implication of privatizing all of these companies will be devastating for the workers. 

As Paul Craig Roberts stated: "By making top executives criminally liable for material errors, regardless of whether fraud is intended, Sarbanes-Oxley violates two protective principles of our legal system: mens rea (no crime without intent) and actus rea (evidence of a criminal act). Violating these legal principles is a far greater offense than accounting fraud."

On July 18, 2007 Ron Paul did an interview with Audit Trail and laid out his views on the subject nearly five years to the day that Sarbox was passed.   Ron Paul stated:

The damage inflicted on American businesses and capital markets by Sarbanes-Oxley has strengthened my conviction that this legislation should be repealed. In 2000, nine of every ten dollars raised by foreign companies were raised in the United States. In 2005, nine of the ten largest offerings were not registered in the United States, and, of the largest twenty-five global offerings, only one took place in the US. The number of public companies going private increased from 143 in 2001 to 245 in 2004. Sarbanes-Oxley is a, if not the, major reason companies are fleeing America's capital markets. Furthermore, according to some estimates, Sarbanes-Oxley has cost the very investors the law claims to protect at least $1.4 trillion. How could anyone regret voting against such a harmful bill?

He is most surprised that a consensus remains with both parties that Sarbox is heralded as a great achievement even though it was poorly drafted and small businesses need relief from the unintended consequences (blowback if you will) of the law.  He concludes that “Reform, or even repeal, of Sarbanes-Oxley remains one of my top priorities.” 

Once again, blowback will be hurting Americans.  This time the attack comes from a hastily passed bill that was intended to help consumers and instead has had a devastating effect on the economy and we are not finished feeling its effects yet.  When will the Federal Government learn that as a group, they can barely take care of their own affairs, let alone determine how best to manage every business in the country?  Time after time we see laws passed in response to one problem only to create another, worse situation.  Nor does Congress ever do anything small in reaction to a big fraud or an attack; they must grandstand and make as much of a mess of the entire economic system as possible.  That is to say, nearly all members of Congress; with the exception of a very rare few who have studied and understand economics, such as Ron Paul. 

Ron Paul reads complex economic bills and understands all the consequences that will come from their passage: the intended and unintended. He continually voices his dissent in a lonely room. Yet, time after time he is proven right. He was right when he voted against going to war in Iraq, he was right about the dangers of the loss of our liberties from the Patriot Act, and he was right about the effect on the economy of the Sarbanes-Oxley Act. Even when the evidence of the contrary is right in front of their faces, Congress is still patting itself on the back for passing Sarbox.

Is it any wonder why his supporters are so passionate about Ron Paul becoming President?

July 26, 2007

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