Sarbanes-Oxley: Could it be Eliminated?

The world continues to change, and not always in the same direction. Just as we are moving to an environment of more regulation in the wake of the crises of the last two year, someone is trying to yank the wheel of the regulatory machine and pull it in the other direction, toward less regulation.

 Michael Carvin and Noel Francisco are two Washington lawyers attempting to topple the mighty Sarbanes-Oxley Act, also known as Sarbox, or SOX. For an explanation of Sarbox, see my previous post.

Why attempt such a thing?

They are representing Brad Beckstead, a CPA in Nevada, who is not happy with the Pubic Company Accounting Oversight Board (PCAOB). The PCAOB was created under Sarbox to regulate auditors. The intent was to not have a rerun of the Enron scandal, when auditor Arthur Andersen performed a less than rigorous audit of Enron.

One of the intentions of Sarbanes-Oxley is to audit the auditors. Makes a lot of sense in theory. What Brad Beckstead says is that the Sarbanes-Oxley act was written for the big four accounting firms and Fortune 500 companies, and for smaller public companies the cost of audit and compliance is prohibitive.

No less than Ken Starr, the U.S. Solicitor General under President George H.W. Bush, makes the argument that there are many problems with Sarbanes-Oxley as it stands now. This call for adjustment of Sarbanes-Oxley does not come only from the political right. Senator John Kerry, a Democrat, introduced a bill in 2006 to reduce the regulatory burden on companies with a market capitalization less than $75 million.

Back to the BusinessWeek article.

The impetus for Beckstead to challenge Sarbox happened in 2004, when in a “grueling” audit in 2004, the PCAOB “picked apart his business”. He had to close his auditing practice because of the cost of compliance. Fortunately, this situation was noticed by the Free Enterprise Fund, an advocacy group aiming to reduce government and promote economic growth.

Carvin and Francisco argue that the PCAOB, currently appointed by the SEC, should be appointed by the President. The main problem is that the PCAOB is not under the control of the President; it is appointed by the Securities and Exchange Commission (SEC). Why does this matter? Because of the great economic impact of the PCAOB. It does not even have congressional oversight. Defenders of the PCAOB say it is not as powerful an organization as its detractors suggest.

But – if Sarbox is overturned, what about the post-Enron regulating spirit? Will it all fall? Former chairman of the SEC Harvey Pitt said that the Sarbanes-Oxley act was part of a national response to the accounting scandals in the early 2000s. Some have pointed out that if Sarbox is reexamined, what about other appointments? Sure enough in recent weeks, we have seen interest in reexamining the whole situation regarding the Federal Reserve.

In the wake of the Enron and other accounting scandals, the hope was that another debacle happening at publicly owned companies and affecting innocent ordinary people would not happen again. Instead, we ended up with the housing boom and bust, the subprime mortgage mess and the subsequent financial crisis affecting all of us in the United States, and extending far beyond our country’s borders.

There are some who argue that in this time of great recession, Sarbox is functioning as a giant drag on the economy for mid-size to smaller public companies. The cost of compliance has multiplied from the days before Sarbox, many public companies have chosen to delist, private companies have chosen to finance with debt instead of equity, and worst of all, the act has not prevented further wrongdoing.

But former Senator Sarbanes, former Representative Oxley and former PCAOB chair Mark Olson all defended Sarbox and argued that internal controls have strengthened, fraud has been prevented and investors were given more confidence. (Whatever confidence investors had, I’m sure has evaporated during the recent financial events!) Brad Beckstead, who prompted the Free Enterprise Fund to action, calls the Sarbanes-Oxley act a barrier to entry for small and startup companies because audit and compliance costs are so high. Even the Government Accountability Office (GAO) reported that the costs of compliance have increased by approximately eight times. Eight! Common sense tells us smaller companies must be having a difficult time in this recession; consider the result if they could cut some costs.

Unrelated to Sarbox, in Fall of 2009 a Democrat, Senator Dodd, is calling for a reexamination of the financial regulatory system. Seems like they always find some way to jump into action after a crisis, but never before. However, in true Democrat fashion he wants to put into place something even bigger and more powerful. Regarding the Federal Reserve, BusinessWeek points out the Fed governors have fixed terms and the President has limited ability to remove them. Somehow the American people don't seem to be bothered by that fixed system.

Should small companies be exempt from Sarbox? Beckstead certainly thinks so. Even John Kerry, a Democrat, thinks so. Carvin and Francisco seem to have their work cut out for them, decreasing regulation in a regulation-happy administration. Stay tuned for more news on December 7.

Sarbanes – Oxley 101

Sarbanes – Oxley is a piece of compliance legislation that was enacted in 2002 after the accounting scandals at Enron, WorldCom, Adelphia, Tyco and Peregrine Systems. This act is intended to increase regulation of boards and management of publicly owned companies, and the accounting firms which audit those companies. The act is also known as the Public Company Accounting Reform and Investor Protection Act, and created the Public Company Accounting Oversight Board(PCAOB).

This act relates only to publicly owned companies.

There are 11 sections of the act, enforceable by the SEC. The sections cover corporate accountability and governance, and set in place stronger penalties for violations.

The act was designed to strengthen internal controls in publicly owned companies, improve transparency, bolster investor confidence.

Supporters say these controls have worked, and have been beneficial to cutting down on potential future scandals. Critics say the cost of compliance is too high and restrains economic growth.

Look Who’s Stalking Wal-Mart

This Week BusinessWeek’s Michelle Conlin reports on Target, and how it changed strategy to survive the recession.

I’m sure we’ve all heard Target’s tag line, “Expect More, Pay Less”. In the past ten years, I’ve enjoyed looking at the innovative pop-art advertising with “fabulous people, wearing fabulous clothes, doing fabulous things”. Seems like a great way to run a store. Target was a leader in recruiting high-fashion designers to bring their wares down to the affordability level of everyday people. That’s how they came up with the faux-name “Tarzhay” indicating an exclusive boutique.

Then the recession hit. They still use their expression Expect More, Pay Less”, but BW points out they now emphasize the second part of the expression, not the first part. BW points out Wal-Mart may have been trying to follow Target’s style influence before, but now, Target is following Wal-Mart, through emphasizing low prices.

Target had a new CEO in May, 2008, Gregg Steinhafel. Steinhafel has a different management style that the previous CEO, says BW, but he didn’t bring much change in substance. The company did not expect him to bring about changes in strategy. However, the recession hit, and like so many other companies, Target was suddenly in a game of adapt or perish.

When the economy plummeted in Fall 2008, Wal-Mart was in prime territory with its discounts. Target’s stock price went south in the latter part of 2008, and needed to act fast. But, chasing price can be tricky for a retailer. When prices fall the customer is happier, but profits are smaller. The retailer can’t just keep lowering prices across the board as a strategy; no profits mean the end of the business. There needs to be a value proposition other than price to keep the business afloat and keep the customers walking in the door.

But somehow the beautiful people in the Target ads weren’t enough.

Target has identified their “target” shopper (forgive the pun), who is a working mother in her 40s. BW reports Target used to see this woman as a fashionista, now she is a “frugalista”. But somehow in real life she perceives Target to be more expensive than Wal-Mart. Target is fighting this perception, and in its new strategy, it emphasizes price. Target is now providing even more affordable fashions, and doesn’t miss an opportunity to show savings for the customer.

Groceries are an increasingly important part of this strategy. The grocery business is not easy: spoilage and razor-thin margins make it difficult for anyone and Target is no exception. But everyone needs groceries, certainly Target’s “target” shopper, and groceries bring people in the door. Dry goods which don’t spoil have been in Target’s stores for years now. One can sell boxes of granola bars as easily as a box of soap. When Target executive realized the average shopper was going to the grocery store twice a week and to Target only three times a month, they decided to overcome the obstacles to offer fresh and frozen items as part of new food marts within existing stores.

Target had a successful introduction of grocery items in Philadelphia, and results are good enough to implement the concept in 350 more stores in 2010. The only thing Target executives regret is not acting more quickly. Now we will hear more about grocery within Target, and more price messages in 2010; less of the fabulous people.

Is this the Target of the future? BW thinks the new price message at Target is “less like a strategy than a tactic to buy time”. One successful brander from an independent company believes Target has to “reinvent itself”. What will that mean? Sounds like if you want a discount, run out to Target now, and we’ll see about the future. BW ends the article with “The world doesn’t need a second Wal-Mart”.

Wall Street vs. America

This week BusinessWeek reports on deals done between investment banks and local municipalities which, like so many other things in this economy, have gone bad, leaving the little guy in the lurch. The photo in the article is of an abandoned public school, indicative of the destruction these deals have wrought.

What happened? Cities, states and local municipalities have an ongoing need to raise capital to finance special projects and ongoing operations. To raise capital, they have historically issued municipal bonds, which are underwritten and sold by an investment bank. Investors like to buy these bonds because they are usually free of federal tax, are considered safe, and rated by a reputable agency. That system worked well in the past, and that’s how funds have materialized to build bridges, new roads, buildings and other large projects we need on a regular basis.

Like so many other things in the recent economy, this formerly working system changed in the past few years. Over time, investment banks have become more sophisticated about how to add fees, raise funds, and ensure something is still left for them if a deal should fall apart. The folks working in municipal governments haven’t experienced the same learning curve. During the boom, many municipalities signed on to deals which would protect the investment banks should things fall apart. The municipalities, not as sophisticated, thought good times would continue and did not think to build contingencies into their plans. BW reported on what has happened as a result of the economy going south.

Detroit as we know, is a city with more than just a few problems. Detroit last had a heyday in the sixties, and has never recovered. Recently, things have gotten even worse. Unemployment is 28%, home prices are down 39% since 2007, and they have a $300 million budget deficit, according to BW’s reporters. Not only that, they did some deals with investment banks during the boom which have returned to haunt them. When debt is issued, it is often customary for the issuer to include contingencies which require extra payments if the borrower(in this case, the city of Detroit) should have a fall in credit rating. Not surprisingly, Detroit’s credit rating dropped, and now they owe millions of dollars in extra payments to these financial firms.

Cities like Detroit are squeezed already – who isn’t? – so coming up with the extra funds would be difficult in good times, and next to impossible in bad times like this. Detroit has become a mere shadow of its former self, and basic services such as bus routes, education and even garbage pickup have been severely impacted.  Detroit has to make a $4.2 million payment to the investment banks each month, which it is paying for out of casino revenue. Consider what would happen if this shell-shocked city had those funds to spend on basic services!

How did this come to happen?

Steve Jobs: CEO of The Decade

Fortune’s cover story this week is Steve Jobs: how he defied the downturn, cheated death and changed our world. There is so much to say, they have nine articles about him. Everything else in the issue is minor.

Where do I start? Fortune points out for many businesses, 2000 – 2009 has not been the best decade. Starting with the dot-com bust, Enron, and now the flurry of bad news in the last two years, we don’t have a lot of success stories.

But then there’s Apple. Who doesn’t have an Apple product? iPods,  iPhones, and Mac computers are only three products, but most people between the ages of 7 and 85 have tried an Apple product at some point.

Fortune points out that Steve Jobs isn’t perfect. Like many wildly successful people, he can have a difficult personality and demands the best from everyone. But, he’s had both a cultural and business impact, not to mention a battle with disease and doing all he can in the context of a bad economy.

Steve Jobs is 54. This means he may still do more, and we’ll be writing a similar article about him 10 years from now. Fortune discusses other iconoclasts who have changed an industry: Henry Ford of ford Motors, Juan Trippe of PanAm, and Conrad Hilton of the eponymous hotels.

Jobs is a businessman and a celebrity. Apple has a higher valuation than Google. In this bad economy, Apple is sitting on $34 billion of cash or cash equivalents. The iPhone is a leader, the iPod is a leader and Apple stores are now the cool place to hang out for so many people of all ages.

Jobs’ current run of success started back in 1997 when he returned to Apple. I’m old enough to remember when John Sculley, recruited from corporate giant PepsiCo, was running Apple. One can only wonder what would have happened to Apple had Steve jobs not come back. Consider what would happen in a world without iPods!

Why Wait for Health Reform? 10 Ways to Cut Costs Now

This week Catherine Arnst at Business Week reports on “10 Ways to Cut Health-Care Costs Now”. Her point is that the health-care bill which is in Congress now is really all about covering the uninsured, not about reducing costs for health-care.

A few years ago Massachusetts opted for universal health-care. At the time they passed the bill, there was no word of cutting costs. Just like a diner at a nice restaurant who ends up getting a large bill after an enjoyable meal, Massachusetts is finding out after a few years it must do something about enormous costs.

BW asked the practical question, what can be done about costs right now? More importantly, they estimate that if half of all the waste, fraud and unnecessary spending were cut, it would be possible to provide health insurance for all. Thomson Reuters just released an extensive report about health-care spending in the U.S. which the BW article is based on.

What is the basic problem with the health-care system right now?

The Commercial Real Estate Bust – “Extend and Pretend”

BusinessWeek’s cover story this week is “Why the Commercial Real Estate Bust Looks So Scary”.

Goldman Sachs has been receiving a lot of attention recently for their big profits and mammoth bonuses – don’t you wish you were on the receiving end of one?

Some of Goldman’s investors aren’t so fortunate. BW opens with a report on the Arizona Grand Resort, a deal which Goldman securitized and sold to investors in 2006. It turned out to be one of the largest busts of the recent economy: the resort defaulted on a $190 million loan.

There’s a great story about lending. If you owe the bank $100,000 and you can’t pay, then you have a problem. If you owe the bank $1 million or more and you can’t pay, then the bank has a problem.

In this case, Goldman sold the loan to investors. Goldman kept its fees, and seems to be in pretty good shape now. What if you are one of the investors in the bonds backed by this loan? Too bad.

The Apps Economy - Redux, Redux

Thanks to one of my readers for alerting me to the New York Times cover article: “Virtual Goods Start Bringing Real Paydays”. This is my third post on this topic, so for a background, see the previous posts.

Claire Cain Miller and Brad Stone point out how rapidly “it is becoming commonplace” for users of social games to use real money to buy virtual products. I wrote about this before, saying how brilliant it is, and how profitable. Who wouldn’t want a 100% profit margin?

The NYT says the marketplace for these virtual goods is now $5 billion – yes, “billion” with a “b”.

Where do we sign up to invest?

“It is a fantastic business” says Jeremy Liew of Lightspeed Venture Partners. Yes, it certainly is. Lightspeed is a venture capital firm which has invested $10 million in virtual goods companies. Zynga, my favorite company, isn’t the only one. Playfish and Playdom are two others with “significant” revenue and profits. Asia is a place which has lead in many areas over the years, and it is no stranger to virtual goods, which are very popular there.

And, it is not just techies, everyday people cough up money for pixels.

Green Energy Transmission

I’m sure when most of us think of wind power, we envision a lot of windmills in a giant flat plain, with the wind howling away. However, all those plains are in the West, not the lumpy, bumpy eastern third of the United States where I grew up. Ever thought about what to do with the wind energy, or how to transport it to the East?

Next on the agenda of green energy is high-voltage transmission lines. John Carey at BusinessWeek reported on whether or not the U.S. should subsidize high-energy voltage lines for Green energy. Harry Reid – when he’s not working on a healthcare bill – likes the idea, and wants to expand the power line system to transport wind energy, and more importantly for a politician like Reid, to create jobs in Nevada, his constituent state.

Who pays for this?

The GDP Mirage

This week Michael Mandel, chief economist at BusinessWeek, reports on “The GDP Mirage”.

What is it?

GDP is a measure of all the goods & services produced by the U.S. economy. We use it as a benchmark. The change in GDP is what we are referring to when we discuss the perennial question, “how’s the economy?”

On October 29, The Bureau of Economic Analysis reported that GDP rose 3.5% in the third quarter of 2009. That’s quite a number! Especially when you consider we haven’t seen any numbers like that since Q2 of 2007, over two years ago.

Most media outlets and pundits are reporting that the recession is over. Mandel disagrees. How dare he issue such a contrarian viewpoint when we are all looking for good news? Because he’s probably right. Mandel’s argument is that the GDP as it is currently measured fails to track intangibles which are a necessary ingredient of the economy in 2009.

The intangibles he mentions are R&D, product design and worker training. Certainly those sound important to me. We would never have gotten to this stage of development if companies hadn’t spent on these things in the past!

So, why are the companies cutting these important intangibles?

The Apps Economy, Redux

Zynga was not only the cover story in BusinessWeek, they’ve made it into Fortune. For an explanation of Zynga, see my previous post.

What is a social game? Fortune explains it as a free online application accessed through Facebook, MySpace and similar sites. They’re free! But Zynga has cleverly thought of a way to get you to pay for them.

They will sell you components – which you have to pay for in real money – to keep playing the free game. The game never ends and you can play it in a short stretch of time. Brilliant! And it’s not just young techies who do this. Fortune profiled a 37-year-old mother of three who is a devotee of Farmville. She spent $100 in the last few months on it. Someone restrain me from starting...

Here’s my question – why don’t other free sites follow the model and start charging for something?