Paul and Michael are common enough names in the West, but two gentlemen with these first names, Messrs Sarbanes and Oxley, respectively, have, as Sarbanes-Oxley or SOX, become the name by which one of the most used and most feared financial disclosure norms in the world is known.
The Sarbanes-Oxley Act of 2002, created months after Enron Corp., WorldCom and several other companies were hauled up for accounting fraud in the US, created some of the most stringent financial disclosure norms for public listed companies in that country, including holding a company’s senior executives legally responsible for the veracity of their financial statements. The co-authors of the Act, former senator Paul Sarbanes (a Democrat) and former representative Michael Oxley (a Republican), say US markets are attractive for Indian companies looking to raise money through share sales, although they will have to bear the extra costs of complying with SOX.
In an interview with Mint, the duo talk on contemporary issues such as the legislation being considered by the US Congress to avoid a repeat of the subprime crisis; Michael Oxley’s “unbelievable” visit to the stock exchange; and why Republican John McCain would win if the US presidential elections were held in India.
Sarbanes-Oxley addressed the corporate scandals of Enron, WorldCom and others. Do you think there is a need for a similar legislative response to the subprime and credit derivative crisis?
Sarbanes: Neither of us is in the Congress anymore. But that is a critical issue, although it is a different issue in terms of how it will be addressed. I don’t think there is any obvious statutory way to resolve this, although Congress is considering some measures.
Former US Congressman Michael Oxley (left) and former US Senator Paul Sarbanes say it is critical for companies to provide accurate financial statements (Photograph by: Abhijit Bhatlekar /Mint)
Oxley: Barney Frank (representative from Massachusetts) has a Bill. Chris Dodd (senator from Connecticut) either has a Bill, or is about to put in a Bill.
One of the tenets of our Act was transparency. Clearly, one of the problems with the subprime mortgage crisis is the lack of transparency in the secondary market. These are somewhat parallel problems to the lack of transparency going back to Enron and WorldCom. There is consensus on some of the areas and others are pretty controversial.
Do you anticipate more red flags to come up in firms involved that were Sarbanes-Oxley compliant?
Sarbanes: A lot of those mortgages (were) originated by agents that are not within a regulated environment and that is clearly part of the problem. It does show the need to be more vigilant about the practices that work in our market because the markets can be very sensitive and very fragile as we are witnessing right now. And the extended repercussions can go well beyond the particular problem. It just feeds on itself and some of that is happening right now.
Do you think risk management systems at banks need to be stronger, and do boards need to be liable for decoding derivative risks?
Oxley: One thing that I think (Congressman) Barney Frank has been working on, which I support, is FHA (Federal housing administration) reform. That was the insurer of these kinds of loans, but because we had no documentation loans and no downpayments, FHA was somewhat irrelevant. I think just about 3% of mortgages were under FHA year before last.
So, I think legislation to reform FHA to be more effective and attractive is important.
Sarbanes: When I was in Congress, I did try and address some predatory lending practices. We were not able to move that through, but I think that needs to be looked at because there are instances in which people were being exploited.
We will also have to give more attention to developing economic literacy. More and more complex financial instruments are being developed all the time. That makes it even more difficult for ordinary investors to understand what is going on. The same challenge is faced by countries around the world.
Some critics of Sarbanes-Oxley in India say that making a company compliant with the Act could raise audit fees by 30-40%.
Sarbanes: We get the same criticism in the US and elsewhere. If a company doesn’t have a well-developed system of financial controls—a number of companies do, but some don’t—there is going to be a certain initial cost to establish such a system and put it in place. It really ought to be regarded as a capital investment because in subsequent years, the costs decline.
But you have to make sure that you meet these acceptable standards as otherwise we are taking risks with companies being listed on a public exchange.
Several Indian firms are listed in the US, but some experts say the high cost of Sarbanes-Oxley compliance has created a trend towards listing in Europe and other markets.
Sarbanes: The requirements in the European markets are beginning to parallel fairly closely with what is required in the American markets. Secondly, when you go public and are listed on the exchange, investors anywhere can purchase your stock. It becomes critical that companies provide accurate and transparent financial statements. It is part of the responsibility a company takes on when it goes public.
Oxley: A recent study by the Ohio State University and University of Toronto concluded that the foreign companies that list in the US normally get around a 30% premium on their stock valuation. And that has remained rather steady for a number of years, both pre-Sarbanes-Oxley and post-Sarbanes-Oxley.
Do you think that the financial capital has moved to London?
Oxley: No, that’s a myth. It is true that the capital markets have matured dramatically. So, companies have some options here and we have to be on our toes to provide an attractive option for them.
Sarbanes: Two basic things have happened. One is you have significant economic growth elsewhere in the world.
Oxley: Yeah, I was at the stock market yesterday here. It was unbelievable.
Sarbanes: There is capital elsewhere to handle these IPOs (initial public offerings) and other demands. Countries have been urged for years to develop their capital markets. They are developing their capital markets and they have the economic back-up to make them very viable. So, I think it is to be expected that just like you have globalization in other forms of economic activity, it’s taking place here as well.
Sarbanes: I think that any capital market that tries to sell itself on the basis that it is easier is really flirting with potentially serious problems. No one is immune. When we first passed the Bill, the Europeans said ‘well you need it in the US, we don’t need it here’. And the next thing you know, we had (corporate scandals like) Parmalat and Ahold.
Oxley: They got eSox.
In the 2004 US presidential election, outsourcing was an issue and Democratic primary candidates Hillary Clinton and Barack Obama have also raised the topic. What is your view on outsourcing?
Oxley: In the Democratic race for president, there is a rising protectionism sentiment that I think is really not good for India or any other country, not to mention our country. It has gotten to the point where the debate whether it is Nafta (North American Free Trade Agreement) or just trade in general has really deteriorated. While the Republican candidate has his flaws, he is a free trader. From India’s perspective clearly, I would say McCain would carry most of the precincts in India if it was just that issue.
Sarbanes: I don’t think worldwide we have yet worked through the rationale behind globalization and its benefits for the broad part of the population. This is exacerbated, in many countries, by the growing inequalities in income and wealth. These issues emerge in our presidential elections. I don’t have any problem with the people at the top benefiting, but I want the people right on down the line to benefit as well.