The Legacy of the Sarbanes-Oxley Act, 15 Years On

What does Sarbanes-Oxley mean? That’s when two members of U.S. Congress fiddle and half a million accountants in Europe start dancing.”[1]

President Donald Trump pledged during his electoral campaign to repeal some of the reforms that came about after the 2008 financial crisis, including the Dodd-Frank Act of 2010[2], declaring that the coming administration would seek to remake the way the U.S. oversees the financial sector. This has led some commenters to go even further back in time and call for the repeal of the Sarbanes-Oxley Act of 2002 (‘Sarbanes-Oxley”).[3]

Sarbanes-Oxley[4] was enacted by Congress to restore investor confidence and curb various corporate excesses[5] after the blight of accounting irregularities and financial turmoil that shook the U.S. corporate landscape and eventually engulfed industry heavyweights such as Enron[6], WorldCom[7], Global Crossing[8] and Adelphia[9]. Sarbanes-Oxley was described by President George W. Bush as the “most far-reaching reform of American business practices since the time of Franklin Delano Roosevelt.”[10] However, others have been less than thrilled with the heavy burdens imposed by the Act[11] and its extraterritorial impact[12] – that is, when one country imposes its laws on persons operating outside its territory – since this measure is perceived as imposing substantial, and hidden, costs on international commerce and industry, while creating new conflicts between jurisdictions. Although Sarbanes-Oxley was only intended to address domestic concerns, the importance of U.S. capital markets in the global economy unfortunately resulted in the Act possessing international spill-over effects.

The extensive range of the Act not only had an impact in corporate America, but also in international securities markets in which the United States is a dominant player.[13] For instance, foreign auditing firms, who audit foreign and U.S. issuers, must register with Sarbanes-Oxley’s Public Company Accounting Oversight Board (“PCAOB”). Ten years after the enactment of Sarbanes-Oxley, 2,400 accounting firms were registered with the board, with almost 40 percent of those located outside the United States.[14] Likewise, the lack of an express exemption for foreign private issuers in Sarbanes-Oxley had a substantial impact on globalization. Accordingly, the Act applies not only to all corporations and subsidiaries whose securities are listed on a U.S. stock exchange, but also to non-U.S. issuers who are required to file annual Form 20-F[15] or Form 40-F[16] reports, as well as to all companies that register their securities for sale in the U.S., including through the use of the American Depositary Receipt program.[17]

Perhaps the most internationally challenging provision of Sarbanes-Oxley is the requirement for organizations listed on U.S. stock exchanges to establish mechanisms for the “receipt, retention and treatment” of anonymous employee reports regarding fraud in accounting, auditing, and financial reporting[18] (i.e., “whistleblower hotlines”). As a result, multinational groups listed on U.S. stock exchanges find themselves in an unenviable position: On one hand, they are required to set up specific whistleblowing procedures in their establishments located outside the United States, but, on the other hand, they also need to comply with local legislation and be sensitive to cultural differences that may exist.[19] This is no easy feat, as there are potential conflicts between Sarbanes-Oxley and foreign law (such as EU data protection and privacy legislation).[20] In particular, courts have generally found that whistleblower activity that occurs outside the United States is not protected by the anti-retaliation provisions contained in section 806 of Sarbanes-Oxley[21]: In 2006, the First Circuit held that the Sarbanes-Oxley Act did not protect whistleblowers working in foreign countries.[22] The court pointed out that Carnero, the employee who was allegedly fired after disclosing to the parent company that its subsidiaries had created false invoices and inflated sales figures, might have been protected had the whistleblowing occurred at a domestic subsidiary over alleged misconduct in the United States. Nevertheless, the court found that Congress did not intend to apply Section 806 extraterritorially, as it was silent in that regard, whereas other sections of the Act, such as Section 1107 regarding criminal penalties for retaliation against anyone giving information to law enforcement officers, expressly provided for application outside of the United States. Likewise, the U.S. Department of Labor’s Administrative Review Board held in 2011 that section 806 “does not allow for its extraterritorial application” due to its silence as to extraterritoriality.[23]

Last but not least, the number of U.S. companies going private (so-called “going dark”[24]) has increased dramatically after the enactment of Sarbanes-Oxley, with many firms citing it as a principal reason for choosing to do so: In 2003 and 2004, over 300 U.S. companies deregistered their common stock for reasons other than a merger, acquisition, liquidation, registration withdrawal, or going-private transaction.[25] Large foreign issuers, such as Porsche of Germany[26] and Daiwa and Fuji Photo Film of Japan[27], have cited Sarbanes-Oxley’s compliance costs as their reason for abandoning plans to list on U.S. exchanges.[28] Gucci, Creative Technology Ltd., and other prominent foreign issuers have also chosen to withdraw from the U.S. market because of Sarbanes-Oxley.[29] Some commenters found that the U.S. has had a steep decline in the number of publicly listed companies since the mid-1990s: The total number of listed companies fell from 8,000 to 4,100 from 1996 to 2012, while the rest of the world saw an increase from 30,700 to 39,400.[30] The fact that the phenomenon is specific to the U. S. appears to indicate that the cause of this decline is due to U.S. rules and regulations. Some people point the finger at Sarbanes-Oxley, stating that the number of IPOs per year has fallen from an average of 528 to only 135, a decline of nearly 75 percent.[31]

Nonetheless, the fact that the decline in the number of publicly listed companies began in 1996, [32] which is six years before the enactment of Sarbanes-Oxley, suggests that Sarbanes-Oxley should not be solely blamed for the decline. In addition, since the enactment of Sarbanes-Oxley, more than 40 countries and jurisdictions around the world have adopted more or less similar regulatory regimes to oversee the accounting profession and improve audit quality.[33]All is not necessarily doom and gloom for U.S. investors, since the lost listings may be primarily those of firms that are, on average, smaller and less profitable than the firms that listed on a U.S. exchange after Sarbanes-Oxley.[34]

Interestingly, the firms most likely to have opted for listing on a foreign exchange after the enactment of Sarbanes-Oxley are “smaller and less profitable than the average firms than (a) the average foreign firm predicted to list in the U.S. absent the impact of Sarbanes-Oxley and (b) the average foreign firm that did actually list in the U.S. following the enactment of Sarbanes-Oxley.”[35] The survey also identified a “small set of large, profitable firms from predominantly emerging markets that choose to list on U.S. exchanges following the enactment of Sarbanes-Oxley despite being predicted to list on a UK exchange,”[36] which tends to prove that U.S. listing is still considered to be an important signal of the firm’s quality. Thus, it may turn out that Sarbanes-Oxley has been quite successful after all if one of its purposes was to screen out marginal foreign firms and attract high-quality foreign firms.

Last but not least, the drop in the number of publicly listed companies may actually be a blessing in disguise. The continuing pressure from financial markets on publicly listed companies to maximize short-term results means that private companies tend to invest much more of their earnings than publicly listed companies.[37] If publicly listed companies are less able to invest and build long-term value, then economic growth may be hampered and the return on investment for investors may be reduced.[38] Research has also found benefits in the financial reporting quality after Sarbanes-Oxley came into force.[39] In short, Sarbanes-Oxley may have actually achieved its intended purpose.

ENDNOTES

[1] See Klaus C. Engelen, Preventing European “Enronitis,” INT’L ECON., June 22, 2004, at 40.

[2] See Jesse Hamilton and Elizabeth Dexheimer, Trump’s Transition Team Pledges to Dismantle Dodd-Frank Act, BLOOMBERG, Nov. 10, 2016, available at https://www.bloomberg.com/news/articles/2016-11-10/trump-s-transition-team-pledges-to-dismantle-dodd-frank-act; see also Ryan Tracy, Donald Trump’s Transition Team: We Will ‘Dismantle’ Dodd-Frank, WALL ST. J., Nov. 10, 2016, available at http://www.wsj.com/articles/donald-trumps-transition-team-we-will-dismantle-dodd-frank-1478800611.

[3] John Berlau and Daniel Cody, Obama’s Regulations Aren’t the Only Trump Target, WALL ST. J., Dec. 29, 2016, available at http://www.wsj.com/articles/obamas-regulations-arent-the-only-trump-target-1483053980.

[4] Sarbanes-Oxley Act of 2002, 15 U.S.C. § 7201 et seq., PL 107-204, 116 Stat 745 (2002).

[5] See Lawrence A. Cunningham, From Convergence to Comity in Corporate Law: Lessons from the

Inauspicious Case of SOX (Boston Coll. Law Sch., Pub. Law & Legal Research Paper Series, Paper No. 24, 2003), available at http:// ssrn.com/abstract=462142.

[6] For authoritative accounts of Enron’s accounting schemes, see John Coffee, What caused Enron? A capsule social and economic history of the 1990s, 89 CORNELL L. REV. 269, 297-98 (2004); William W. Bratton, Enron and the Dark Side of Shareholder Value, 76 TUL. L. REV. 1275 (2002); Brian Kim, Recent Development: Sarbanes-Oxley Act, 40 HARV. J. ON LEGIS. 235 (2003).

[7] Harold S. Bloomenthal, Sarbanes-Oxley Act in Perspective § 1, at 3 (2002).

[8] Dennis K. Berman et al., Global Crossing Ltd. Files for Bankruptcy, WALL ST. J., Jan. 29, 2002, at A3.

[9] See Robert Frank & Deborah Solomon, Adelphia and Rigas Family Had a Vast Network of Business Ties, WALL ST. J., May 24, 2002, at A1.

[10] Elisabeth Bumiller, Bush Signs Bill Aimed at Fraud in Corporations, N.Y. TIMES, July 31, 2002, at A1.

[11] See Roberta Romano, The Sarbanes-Oxley Act and the Making of Quack Corporate Governance, 114 YALE L. J. 1521 (2005); Larry E. Ribstein, Market vs. Regulatory Responses to Corporate Fraud: A Critique of the Sarbanes-Oxley Act of 2002, 28 J. Corp. L. 1 (2002); W. Carson McLean, Note, The Sarbanes-Oxley Act: A Detriment to Market Globalization & International Securities Regulation, 33 SYRACUSE J. INT’L L.& COM. 319 (2005); Del Jones, Sarbanes-Oxley: Dragon or White Knight?, USA TODAY, Oct. 20, 2003, at 1B.

[12] Paul Lanois, Between a Rock and a Hard Place: The Sarbanes-Oxley Act and its Global Impact, Journal of International Law & Policy (2007): 1-19.

[13] Lanois, supra note 12.

[14] Steven B. Harris, The Legacy of Sarbanes-Oxley and Its Implications for Dodd-Frank, Conference on Investor and Consumer Protection in the New Financial Marketplace, March 2, 2012, available at https://pcaobus.org/News/Speech/Pages/03022012_HarrisGWU.aspx

[15] Registration of securities of foreign private issuers, pursuant to section 12(b) or (g) and annual and transition reports pursuant to sections 13 and 15(d). See 17 C.F.R. § 249.220f.

[16] This form is primarily for Canadian issuers. See 17 C.F.R. § 249.240f.

[17] An American Depositary Receipt (“ADR”) is a negotiable certificate issued by a U.S. bank representing a specified number of shares (or one share) in a foreign stock that is traded on a U.S. exchange.

[18] 15 U.S.C. § 78j-1(m)(4)

[19] Lanois, supra note 12.

[20] See Paul Lanois, Sarbanes-Oxley, Whistleblowing, And European Union Data Protection Laws, PRACTICAL LAWYER, 53(4), 59.

[21] 18 U.S. Code § 1514A

[22] Carnero v. Boston Scientific Corp., 433 F.3d 1, 18 (1st Cir. 2006), cert. denied, 548 U.S. 906 (2006), holding that Sarbanes-Oxley’s whistleblower protection “does not reflect the necessary clear expression of congressional intent to extend its reach beyond our nation’s borders.”

[23] Villanueva v. Core Laboratories NV and Saybolt de Colombia Limitada, ARB No. 09-108, Dec. 22, 2011

[24] “Going dark” means that a company delists its shares from the exchange on which it is traded. See Claudia H. Deutch, The Higher Price of Staying Public, N.Y. TIMES, Jan. 23, 2005.

[25] Christian Leuz, Alexander J. Triantis & Tracy Yue Wang, Why Do Firms Go Dark? Causes and Economic Consequences of Voluntary SEC Deregistrations, Mar. 2006, available at http://ssrn.com/abstract=592421.

[26] Craig Karmin, SEC’s Exemption Gets Some Praise, WALL ST. J., Jan. 13, 2003, at C16 (reporting that “German auto maker Porsche AG announced that it was no longer considering a listing on the New York Stock Exchange, citing conflicts with Sarbanes-Oxley“).

[27] Craig Karmin, Foreign Firms Lose Urge to Sell Stock in U.S., WALL ST. J., July 24, 2003, at C1.

[28] See William J. Carney, The Costs of Being Public After Sarbanes-Oxley: The Irony of “Going Private”, 55 EMORY L.J. 141, 152 (2006).

[29] Id.

[30] Craig Doidge, G. Andrew Karolyi and Rene M. Stulz, Why Are There So Few Public Companies in the U.S.? NATIONAL BUREAU OF ECONOMIC RESEARCH DIGEST ONLINE, Sep. 2015, available at http://www.nber.org/digest/sep15/w21181.html

[31] Frank Holmes, SOX Kills IPOs; Silicon Valley Is American Phenomenon; How Markets Are Betting, Value Walk, Jan. 1, 2017, available at http://www.valuewalk.com/2017/01/sox-kills-ipos-silicon-valley-american-phenomenon-markets-betting/

[32] Doidge et al, supra note 30.

[33] Harris, supra note 14.

[34] Joseph Piotroski & Suraj Srinivasan, The Sarbanes-Oxley Act and the Flow of International Listings, Jan. 2007, available at http://ssrn.com/abstract=956987

[35] Id.

[36] Id.

[37] See Claire Brunel, Comparing the Investment Behavior of Public and Private Firms, NATIONAL BUREAU OF ECONOMIC RESEARCH DIGEST ONLINE, Jan. 2012, available at http://www.nber.org/digest/jan12/w17394.html.

[38] See Dominic Barton and Mark Wiseman, Focusing Capital on the Long Term, Harvard Business Review, January-February 2014, available at https://hbr.org/2014/01/focusing-capital-on-the-long-term

[39] John C. Coates and Suraj Srinivasan, SOX after Ten Years: A Multidisciplinary Review, Harvard Law and Economics Discussion Paper No. 758, Jan. 12, 2014, available at https://ssrn.com/abstract=2343108.

This post comes to us from Paul Lanois, senior legal counsel at Credit Suisse. It is based on his article, “Between a Rock and a Hard Place: The Sarbanes-Oxley Act and its Global Impact,” available here.