The accounting scandals that received so much government and media attention involved about a half dozen firms. Out of the thousands of publicly listed companies, the malefactors comprised a few ten-thousandths of one percent.
Such an insignificant percentage is not a sign of a breakdown in business ethics and accounting morals. Laws already on the books sufficed to deal with the wrongdoers. No draconian new legislation was necessary.
When murders occur, we apply the law. We don't pass legislation holding people responsible for not doing enough to prevent murder.
Judging by their behavior, government and media view accounting scandals as far more serious than mere murder. Hysteria took over from sound judgment and rational deliberation. The result was the Sarbanes-Oxley Act, [PDF] which criminalizes accounting mistakes.
The Sarbanes-Oxley Act requires the Chief Executive Officer (CEO) and Chief Financial Officer (CFO) to attest at their personal risk of huge fines and prison sentences that their company's financial statements contain no material mistake, the correction of which would result in a restatement of earnings.
There is no way two executives can know whether a foreign subsidiary made an accounting error or a computer glitch produced an incorrect figure. To protect executives from human and computer mistakes, companies are being advised by their lawyers and accountants to implement more systems of internal controls.
In the event of an error, executives can hopefully avoid prison and fines by demonstrating to prosecutors that every possible procedure has been implemented to prevent material errors. By eliminating both fraud and negligence as causes of the accounting mistake, executives hope to avoid career destruction from having attested to an accounting statement that turned out to contain a material error.
By putting every public company under the thumbs of government and prosecutors, Sarbanes-Oxley guarantees that no expense will be spared in implementing protective procedures. Entire new departments will be created that contribute nothing to productivity, output, sales, or cost reduction. The expense will reduce reported profits and adversely affect share prices.
Even worse, complying with the new reporting requirements of Sarbanes-Oxley will divert the attentions of managements and boards of directors to self-protection away from the business purposes of companies.
Other parts of the ill-considered "reform" will drive up costs. Accounting firms are required to more quickly rotate the team of outside auditors overseeing a company's books. Faster rotation means that accountants who know a company well and can sense when something is not right are replaced with auditors who are totally unfamiliar with the company.
The purpose of this "reform" is to prevent auditors from becoming too friendly with management. But its practical effect will be to reduce auditors' knowledge of companies precisely at a time when faster reporting requirements increase the chance of mistakes.
Chief safeguards of justice in Anglo-American law are the principles of mens rea—no crime without intent—and actus rea—evidence of a criminal act. These protective principles have been breached by prosecutors.
Recall the case of the medical doctor who was prosecuted for $300 in erroneous Medicare billings in accounts totaling one million dollars.
Such a tiny insignificant sum was, in reality, proof of a highly sophisticated and careful billing practice, but prosecutors misconstrued the $300—three-ten thousandths of one percent (.0003)—as fraudulent billing.
In the mid 1990s I reported the sad story of 73-year old Ben Lacy, a northern Virginia apple juice producer, who was prosecuted by the U.S. Department of Justice (sic) for making a few mistakes in filling out wastewater report forms.
Federal prosecutors indicted Mr. Lacy on their theory that the mistakes comprised a conspiracy to mislead the government with fraudulent information.
The mistakes had a simple explanation. The wastewater reports were due before the written results could come back from the testing lab. To meet the deadlines, the lab would read the results over the telephone, and the results would be entered on the forms. On a few occasions over a multi-year period, incorrect results were entered or correct figures entered on the wrong line. The vast majority of the reports were accurate, and there was no evidence of systematic misreporting in order to cover up unlawful behavior.
However, the facts meant nothing to the federal prosecutors. They had a quota for white-collar crime, and Mr. Lacy was part of that quota. The Department of Justice (sic) forced Mr. Lacy to spend his life savings defending himself in court before dropping the nonsensical charges.
The most egregious fault of Sarbanes-Oxley is the act's supposition that executives and accountants are crooks requiring government repression at all costs. Sarbanes-Oxley legislates the fantasies of the anti-business political left-wing. To be incorporated in the U.S. is proving to be a fatal business disadvantage.
Paul Craig Roberts is the co-author with Lawrence M. Stratton of The Tyranny of Good Intentions: How Prosecutors and Bureaucrats Are Trampling the Constitution in the Name of Justice.
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