March 23, 2005

Surging commodity prices, led by oil, a plunging dollar, and the woes of U.S. manufacturing that are reflected in General Motor’s sharp downward revision of earnings all would make ample topics for this column this week.  But you must excuse me for putting those issues on hold while I discuss implications from the conviction of Bernie Ebbers. 

Bernie Ebbers was the CEO of Worldcom, whose collapse, along with Enron and a few other corporate scandals, led to the Sarbanes-Oxley reforms in corporate governance.  No CEO ever again can use the excuse that massive losses were kept from him or her by underlings.  (Personal fraud remains possible, but company management soon should observe that something is not right when fraud happens). 

Frankly, while the jury returned its verdict on Ebbers, the proverbial jury remains out on whether the additional billions of dollars spent to document controls and conform to the new corporate governance environment is helping or hurting shareholders.  Corporate earnings certainly are more clear, but they also are reduced by compliance costs. 

My pet peeve is that Sarbanes-Oxley legislation is one more example of righting the cruise liner but swamping the row boat.  Corporate processes are not that different whether the company is doing a billion dollars in business or only a few million.  The accountants just add zeros to the invoices.  (There may also be a lot more invoices, but the process used to determine invoice accuracy is not materially different between large and small companies).   

For large corporations, the governance requirements are costly but easily absorbed.  For small companies, the costs are overwhelming.  I know of small mutual funds whose compliance costs are too high to justify their continued operations.  I know small public companies who are seeking to go private because they cannot absorb the additional six figure audit fees required to meet Sarbanes-Oxley requirements. 

Nevertheless, the Sarbanes-Oxley blunderbust, along with some corporate convictions and the demise of Arthur Anderson, should dramatically change the corporate landscape. 

How can a CEO assume ignorance, as several have, when they now must attest that they, along with their chief financial officer, approve the financial representations of their companies on a quarterly basis?  How can accountants declaim that they could not identify the frauds at Enron or Worldcom when they help guide the documentation of company controls. 

And how can a board of directors turn a blind eye when they know that insurance may not be enough to protect their wealth from abused shareholders?

I would be surprised that any board of directors ever again approves a loan to a CEO to protect him from margin calls, as they allegedly did with Ebbers.  I doubt that any audit committee would miss dramatic changes in company performance as subsidiaries are formed, as in Enron’s case. 

Audit committees would certainly question the default reserves provided for receivables or the surge in capitalization and slowing in expenses related to services purchased from other communications companies, as at Worldcom.  And Audit committees cannot plead ignorance either, because they have at least one financial expert in their midst.

In short, what has happened to perpetrators of corporate scandals and to some of their boards of directors will significantly alter corporate behavior.  It also alters corporate costs.  Directors facing greater risks will want more compensation before serving.  CEOs may argue for even more compensation than their already rich packages. 

Unfortunately, Congress has not seen fit to make the compliance burden depend upon market capitalization or revenues of a company.  Once again, in the eyes of government regulations, a company is a company whether it has billion dollar cash flows or is an infant that still gives stock instead of cash to compensate valued employees. 

Certainly, the pain suffered by investors and employees who were misguided by company fraud is very real.  Let’s not compound that hurt by stopping the development of new companies because the costs of “going public” become too high.


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