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February 22, 2008 7:36 PM Age: 9 yrs

Accountability and Sarbox Coffee

Category: Eleanor Bloxham, CG Commentary & Opinion, AC RSS
Source:  Eleanor Bloxham

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After all this time, I would expect the enthusiasts for Sarbanes-Oxley (“Sarbox”) legislation bashing would have moved on. But apparently that isn’t the case.  A commentary by Lisa Peeks in the NY Sun newspaper on an article by Nicole Gelinas on the Act is a recent case in point.

Going back to the 2002 Act, the purpose of the Act as outlined in the Act itself is to “protect investors by improving the accuracy and reliability of corporate disclosures, made pursuant to the securities laws and for other purposes.”

And the Act itself does a good job of outlining remedies to address improvement in the accuracy and reliability of corporate disclosures.  There are continuing reasons for concern, of course, which I have written and spoken about since its passage -- and now the subprime meltdown has revealed some of these issues in even starker contrast to a broader audience than before.

Why do these concerns remain -- and what are the issues with Sarbox? The main issue is that, to date, not all elements envisioned in Sarbox to improve the accuracy and reliability of corporate disclosures have actually been implemented.

In particular there are sections in the Act which still today require further work from an implementation stand point.

For example, these sections include:

Sec 302

Section 302 “Corporate Responsibility for Financial Reports” states the responsibilities to ensure: “the report does not contain any untrue statement of a material fact or omit to state a material fact…” (Section 302 (a) (2))   and “fairly presents in all material respects the financial condition and results of operations of the issuer”. (Section 302 (a) (3))   

With all the work on financial reporting, what aspects of this section require further implementation?

Although it may seem that the reporting issues have been addressed ad-nauseum, the focus has for the better part of five years been on reported accounting numbers. The gift of the recent subprime mess is that it has sparked a renewed interest in strategic risk and economic evaluations at the Board of Directors level. While I wrote soon after the Act was published, that an understanding of strategic and economic risks representing the financial condition were necessary in order to comply with this section of the Act, the subprime mess has been a clear demonstration that it is impossible to comply with the intent of this section without understanding the economics and potential risk trade-offs in the business. Those steps are pre-conditions required in order to properly disclose material facts and the true financial condition and results of operations.

Simply following accounting rules won’t do it.

Section 401

The section of the Act entitled “Enhanced Financial Disclosures” deals with the reporting of off- balance sheet and special purpose entity liabilities.

What needs to happen to further implement this section?

The areas of off-balance sheet and special purpose entity disclosure require a re-look in light of the subprime mess. In particular, the focus should be on what is required to ensure that what the Act desired is in fact implemented i.e. that “financial statements of issuers [are in fact] reflecting the economics of such transactions to investors in a transparent fashion”. (Section 401(c) (2) (C))

Section 702

This section is entitled “Commission Study and Report Regarding Credit Rating Agencies”.  

What is still required to protect investors with respect to this section of the Act?

Given the issues related to ratings of late, of course, there needs to be a re-review, particularly with the goal of fixing “any impediments to the accurate appraisal by credit rating agencies of the financial resources and risks of issuers of securities”.   (Sec. 702 (a)(2)(C))

But the need goes beyond the current crisis – because in my experience which has in this arena been since the early 1990s, the tail (the rating agency) is often wagging the proverbial dog (the client company) with an [unintended] negative outcome.

What’s going on? Well, as a general matter, many rating agency analysts do not understand the economics of the particular business they are rating. Because of this, these analysts encourage companies to maximize certain ratios the analysts think are important despite the fact that maximization of these ratios by companies is often not good for business. Companies, which are seeking to placate the rating agencies to obtain lower costs of capital, take actions to maximize ratios the rating agencies think are important, but which do not serve the corporations or their investors or creditors in the long run. Companies end up maximizing a ratio, resulting in a non-economic decision, resulting in harm to the company and overall, harm to our economy, which could be avoided with “accurate means of appraisal” which Sarbox was seeking to address.

Shortcomings Can Be Overcome

While there are clear challenges, it is also clear that the shortcomings in Sarbox implementation can be overcome and there are moves afoot to do that.

Of course, improvements in disclosure will only protect investors if:

  • Boards and companies follow through to the spirit not just the letter of requirements
  • Regulators encourage and enforce where necessary
  • Boards, analysts and investors actually use the prophylactic of better reporting given to them to make decisions more wisely

Where individual will is possible, the system works if we can rely on individuals to do their parts – and take advantage of education (whether they be boards, companies, regulators, analysts, investors or rating agencies) to make continuing progress.

While we might like to leave the ugly present of current imperfection at the doorstep of Sarbox, I think that is shortsighted.

Sarbox hasn’t solved all the world’s problems nor all the problems of investors -- nor will it ever… but Sarbanes-Oxley has raised awareness and encouraged stronger board oversight. Disappointing as the legacy of Sarbox may be in protecting investors, it has done much good.

Any regulation has its limitations – and Sarbox, like any regulation can only go so far. Hey, Sarbox doesn’t even make coffee – and I suspect it never will.


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Eleanor Bloxham is a strategic governance and valuation authority, author and advisor, and CEO of The Value Alliance ( and Corporate Governance Alliance. She welcomes your comments at

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