The Ebbers conviction–which reflects the operation of the traditional system–raises the question of why that was not deemed to be sufficient after Enron and WorldCom, and whether the costs of the new preventive mechanisms outweigh their benefits. Before Sarbanes-Oxley, wrongdoing of this kind was thought to be deterred by punishing the wrongdoers after the fact and compensating, through civil damage recovery, those who have suffered losses. The signal element of the act is that it places responsibility on people and systems–directors, auditors, accountants, and internal controls–to prevent fraud and other forms of financial manipulation pre-emptively–that is, before they occur. There are reasons to believe that the Sarbanes-Oxley Act and its implementation by the Securities and Exchange Commission (SEC) went well beyond what was necessary to address the financial and accounting frauds at Enron, WorldCom, and several other companies. But the data on market activity around the time it became clear that the act would become law clearly shows that, if anything, the act caused a decline in investor confidence rather than a restoration. The only other way that the act can be justified is through some generalized effect in restoring investor confidence, thus raising all corporate values. Even if this were a fair distribution of costs, it seems highly unlikely that the benefits will outweigh the costs. Accordingly, to justify the act on a cost-benefit basis, it would be necessary to find that the benefits received by the shareholders of these few unknown companies will be greater than the costs that will be borne by the shareholders of all companies–including those who would have suffered no fraud losses even if the act had never been adopted. Even if we assume that the strictures of the act will be effective, they will only reduce or prevent losses for those companies where losses from financial fraud would have occurred but for the act’s requirements.
Opponents note that imposition of civil or criminal penalties after the fact–the way that financial fraud has traditionally been handled–would have been sufficient, and that it is not good policy to burden all businesses in order to catch a few wrongdoers. Supporters of the act have argued that Ebbers’s wrongdoing demonstrates the need for a law that mandates strict oversight of corporate managements. The recent conviction of Bernard Ebbers, the former chairman of WorldCom, has once again raised the question of whether the Sarbanes-Oxley Act was necessary or cost-effective. This essay is available here as an Adobe Acrobat PDF.