In Defense of Sarbanes-Oxley

In the story of the rapidly vanishing high-technology IPO, the Sarbanes-Oxley law bringing independence and accountability to financial disclosures has become the chief villain. Bill Gurley and Fred Wilson were some of the first, in the summer 2008, to complain of Sarbanes-Oxley. But their timing was poor: due to barely understood and hardly disclosed financial risks, global capital markets collapsed a few months later.

Once that happened, the case against the Sarbanes-Oxley law definitely got worse: at one board meeting I attended at the beginning of the crisis, a director talked of stocking up on bottled water. But the fact that the Bush & Obama governments prevented a global economic apocalypse hasn’t deterred more complaints about regulation in general — and about Sarbanes-Oxley in particular. Whenever the topic of IPOs comes up, as it did this weekend on TechCrunch, you’ll see a comment like this, which now stands as the most popular for the post:

What congress created with Sarbanes-Oxley and other regulations was a rule saying, basically: “Don’t let ordinary Americans invest in any new tech companies. Only big companies and the very rich are allowed to do that.” If you try to regulate away every risk, you regulate away the ability to do most regular things too.

Ah yes, moral hazard! Buyer beware! Let ordinary Americans take risks! Well, hey, I love risk. If Grandma wants to buy 10,000 shares of the latest incarnation of Enron or Lehman Brothers, I’m all for it. I just want her to be able to know what she’s buying. She may not care for detailed product plans or revenue forecasts. But she at least should be able to get a sense of whether, in the past, you know, the company made money or lost money.

Since that is the only object of the Sarbanes-Oxley law, I’m not sure which part of it is so objectionable. Is it the requirement that the CEO and CFO of a publicly traded company be accountable for the accuracy of its financial statements? Or the rule that “independent” auditors can’t be paid in side-deals by the business they’re supposed to be auditing?  Or is it the ban on off-balance sheet investments, which precluded investors from knowing about the very existence of liabilities that bankrupted a company like Enron?

These are the main requirements imposed by the bipartisan bill, which passed by a vote of 423 – 2 in the House and 99-0 in the Republican-controlled Senate, before being signed into law in 2002 by President George W.  Bush. Like any regulation, the law imposes some costs on a business, requiring the accounting department of a publicly traded company to institute  basic controls that can cost hundreds of thousands per year. But I think these are worth it if the company wants to sell stock to any consumer — even if it means some marginal IPO candidates delay going public to get their house in order.

I am sure there are many silly laws. I often get the feeling, walking through Washington DC, that the government is big. I agree with Fred Wilson that the development of alternative markets for startups to get liquidity is a good thing. But a law requiring the CEO to take responsibility for accurate financial statements is a good thing too. And the dearth of tech IPOs has almost nothing to do with that.


  • Dale B. Halling

    You can't be serious. Sarbox has failed to achieve any of its goals and is killing US innovation (see…). In 1996 the US had 60% of the worldwide IPOs in 2005 we had only 20%. Unfortunately, SOX is just one of several laws since 2000 we have passed that are killing innovation in the US. The incredible innovation of the 90s was based on technology start-up companies built on intellectual capital, financial capital, and human capital. All three of the pillars have been under attack since 2000. Our patent laws have been weakened reducing the value of intellectual capital. Sarbanes Oxley has made it impossible to go public reducing financial capital for start-ups and the FASB rules on stock options have made it harder to attract human capital to start-ups. The Decline and Fall of the American Entrepreneur: How Little Known Laws and Regulations are Killing Innovation…, explains these problems in more detail.

  • GlennKelman

    Dale, which companies could have gone public but didn't because of SOX? What SOX rules do you find onerous and unnecessary?

    • joewallin

      Glenn, the particular section of Sarbanes-Oxley that was especially nettlesome, onerous, and costly was Section 404.

      • GlennKelman

        Very good point Joe. I agree that validating the quality of internal controls is cumbersome. In this respect, I think the law could be better. But its general purpose is, for me, so worthwhile that it outweighs this cost.

        • joewallin

          That's a fair point of view. My objection to most new laws that Congress seems to pass is that they are exceptionally burdensome from a complexity/regulatory compliance/cost perspective. 2,000 page bills are very expensive to figure out, must less comply with. Bigger companies have an advantage because they are more able to afford/figure out/comply with the massive regulatory burdens placed on them. In this way, big companies and big govt squeeze and crush small upstart competition. Just my opinion.

  • Dale B. Halling

    Glenn, it is clear that numerous companies decided to go public in the UK instead – the bankers in London have been thinking of putting up a statute to Sarbanes and Oxley. We know that numerous US companies decided to go private. In fact the US is the only major country with fewer public companies today than a decade ago. The estimated cost of complying with just SOX is $4-5Million a year which means a company needs at least $500M a year in sales to justify going public. SOX did not prevent fraud, it did not lower the cost of capital, and it did not increase investor returns. There is no evidence that SOX has done anything good, but there is plenty of evidence of the damage it has caused.

    The only beneficiaries of SOX are the accounting and the lobbying profession.

    The only benefic

    • GlennKelman

      Honestly, which companies in our industry — tech — went public in London instead of the U.S.?

  • Dale Halling

    Some technology companies went public in London, but this is not good for the US either. It means we lose both the skills and income that would have been made by going public in the US. You have not pointed out one good result from SOX. Perhaps you want to point to how it avoided the next market crash – nope, or how it avoided accounting scandals – nope, see AIG, Lehman, Fannie, Freddie, Madoff, or how it increased the returns for investors – nope, this is the calendar decade that the stock market did not show a gain. Where are the supposed benefits of SOX???????