Discovering Why SOX Became Necessary ..................................................
In the late 1990s, a stock market bubble was created: More and more compa-
nies were going public, and the share prices of listed companies kept going up.
Some companies forgot to serve their shareholders and instead focused on the
numbers. They were more interested in making analysts happy than making
their shareholders happy. In addition, extreme competition for experienced
executives pushed company leadership to offer shares as part of their compen-
sation, which meant there was more of a drive to keep the prices going up.
Enron, for example, threw any bad deals into off-the-books partnerships to hide
their bad assets, and their accounting practices no longer represented the real-
ity of their finances. Then there were conflicts of interest for companies such
as Arthur Andersen, which provided consulting services and audit services to
Enron at the same time. Still, as the gatekeepers, Arthur Andersen should have
drawn attention to the corporate fraud that was taking place (in fact, however,
Arthur Andersen went out of business partly because its employees gave the
order to shred documents at Enron.) When it became public knowledge that
companies were indulging in willful fraud and corruption, there was a decline
of public trust in accounting and financial reporting. People were losing billions
of their investment dollars. In 2000, 2001, and 2002, the stock market ended
every year down compared to the previous year. The US government needed to
make investors confident in the market again, and so SOX was born.
Have corporate scandals such as those seen at Enron happened before? In
his book The Complete Guide to Sarbanes-Oxley (Adams Media), UCLA law
professor Stephen M. Bainbridge says that they have, many times:
“History teaches us that market bubbles are fertile ground for fraud. Cheats
abounded during the Dutch tulip-bulb mania of the 1630s. The South Sea
Company, which was at the center of the English stock market bubble in the
early 1700s, was a pyramid scheme. Fraud was rampant before the Great
Crash of 1929. Hence, it was hardly a shock to find fraudsters and cheats
when we started turning over the rocks in the rubble left behind when the
stock market bubble burst in 2000.”
After the 1929 stock market crash and the resulting Great Depression, Congress
passed several statutes to regulate the securities markets. In 1933, it passed
the Securities Act, which legislated against fraud in the sale of securities, and
allowed issuers to sell any securities, even unsound ones, provided they gave
buyers enough information to make an informed investment decision.
The content of these 80-year-old laws requires companies and auditors to
maintain strict financial controls. However, because this was clearly not hap-
pening, it became necessary for the US government to re-release the laws.
They did just that in 1992, reinstating the older laws.
Chapter 4: How Sarbanes and Oxley Changed Our Lives 91
