The Influence of the Sarbanes-Oxley Regulations on Securities Markets - Article Example

Running Head: The Influence of the Sarbanes-Oxley Regulations The Influence of the Sarbanes-Oxley Regulations on US and Other Securities Markets Name of Student Name of Subject Course Name of Professor 7 March 2008 1. Introduction The Sarbanes-Oxley (SOX) Act of 2002 did not result to the restoration of the claimed loss of investors’ confidence in the US securities market. It instead resulted to increase cost of doing business and has in fact driven out US investors to look for other securities markets out side the US because of added cost and conflict with foreign laws. This paper seeks to prove this assertion as an identified influence of the Sarbanes-Oxley regulations on US and other securities markets. 2. Analysis and Discussion The Sarbanes-Oxley Act of 2002 was being broadcasted by Media and US politicians that it has attained its purpose of restoring investors’ confidence in the securities market as a result of the scandals involving Enron and WorldCom. Evidence however shows otherwise. 2.1 In the first there is little evidence that a crisis of confidence occurred as a result of Enron and WorldCom. Wallison (2004) investigated that idea that investors lost confidence in corporate America securities market due to the scandals that have entered the American psyche as to a result of scandals caused by Enron, WorldCom, and the other corporate scandals. He was aware of the fact that speeches have been made by SEC officials asserting the need for new regulations to restore this depleted investors’ confidence that business leaders, media commentators, and politicians have spoken arising out of the corporate scandals as though it were a fact. He argued that there actually was little evidence that said crisis actually occurred -- at least among investors. Wallison (2004) explained that if there was a crisis of confidence, it would seem to have been only among the political class and the media and was not in the markets or in the financial disclosure. He then inferred that the lost confidence is rather in the good sense of the nation’s political leadership. 2.2. The Wrong View of the Market resulted to Wrong Solution From Wallison’s analysis of wrong perception of about alleged loss of confidence, the author was in effect saying the that it was just an act of faith among financial commentators and policy makers that the Sarbanes-Oxley Act was necessary to restore investor confidence in the securities markets after Enron and WorldCom, and the other corporate scandals of 2001 and 2002. If the author is correct then the problem is wrongly defined and necessarily the solution which the SOX will not be responsive in return. This paper tries to evaluate whether there is basis to his claim on the basis of evidence presented. Wallison (2004) asserted that as a result of the view of lost confidence on the part of investors, he believed that just about every new regulation proposed by the Securities and Exchange Commission (SEC) is said to be part of the process of helping investors get over their loss of confidence in the stock market and financial disclosure. He was also saying that the countless speeches by lawmakers and business leaders repeat the same formulation in order to provide support for their positions on one or another public policy issue. Part of the solutions he pointed out that were curved to address the problem is the SEC’s proposal to enhance the ability of shareholders to nominate non-management directors, while the other was the plan of the Financial Accounting Standards Board to require corporations to expense employee stock options are only two examples of this phenomenon. 2.3 What was actually wrong about loss of confidence? Wallison (2004) stated that a closer study of the events in the stock market before and after Enron and WorldCom had provided very little support for the proposition that investors having suffered any loss of the confidence in the stock market as a result of these events. Finding the events not surprising, he debunked that dishonestly and manipulation of financial reports has always been an unavoidable part of free markets, which ultimately reflect all aspect of human behaviour, good and bad. He maintained the possibility that there for some companies to have misstated their financial results and said misstatement were probably already priced into the market. He was in sense arguing that it is not correct to expect that investors would lose confidence in the securities market as a whole as what happened has always happened in human affairs. Wallison (2004) added that fact the sophisticated investors already understand the deficiencies of generally accepted accounting principles (GAAP) as a financial disclosure mechanism and it is for this reason that said investors have always used cash flows (Brigham and Houston, 2002) rather than balance sheet numbers and earning per share (Meigs and Meigs, 1995; Droms 1990) to assess the value of companies. The author was saying that investors would not suddenly be shaken by the news that GAAP financial statements might be overstated, or that auditors (Whittington & Pany,1995) might not have found the many ways that corporate management can hide adverse results and display favourable ones. He however qualified that same is not necessarily true of members of the media and the Washington political class, who–while having understood the inadequacies and human weakness of those within their own worlds—yet appear to believe that everyone else is inexperienced and primitive. He justified by the fact the politicians and reporters’ lack of personal experience with markets, financial statements, or the assessment of financial values and thus making an unfounded belief that financial statements are more important to investors than in fact they are (Wallison, 2004). 2.4 Political and media worlds are not the investors but political can go ahead making laws In painting two separate worlds between that of politicians and media people from the real investors, Wallison (2004) arrived at separate at separate reactions to Enron and WorldCom. He found unfortunate that the political class has the ability to create laws, under pressure from the media under the under the dual misapprehension of the two groups that investors have never considered that dishonesty and financial manipulation occur in the stock market, and that by regulating the way financial statements are audited they would make a material difference in investor’s respect for GAAP financial statements. He then concluded that the for that reason SOX should be seen as a response to how the media and political class thought investors should react, rather than how investors actually reacted. To support his hypothesis, Wallison (2004) noted that fact that the act was rushed through Congress in July 2002, amid claims that Enron, WorldCom and other corporate scandals cause a dramatic loss of investors’ confidence in the honesty of corporate America and the accuracy of financial reports. To be so fast in making legislation in response to a crisis is really surprising. Wallison (2004) pointed out difficulty to be definitive about the state of mind of a group as large as investors, since so many other things are happening at any given time that no one factor can be considered to be completely determinative of what was reality. He challenged that by looking look only at what actually took place in the stock market during the relevant period, one would find it reasonable to explain SOX as the consequence of a loss of confidence in Corporate America by what the media and the political class would like to think and not as a loss of confidence by investors 2.5 What is the best proof of loss of confidence by investors? The stock market responses could be judged using the Dow Jones Index. Using the same as basis, Wallison (2004) explained that majority of people who remember that period in the late 2001 will recall that after Enron’s collapse nothing much happened. This is despite New York Times having run a series of articles about Enron’s political connections, with suggestions of widespread corruption in the political and financial worlds. As proof of his assertion one can refer to Figure 1 below which shows that the market was large unaffected. He therefore pointed out that the Dow Jones Industrial Average continued to rise, probably on the success of the U.S. effort in Afghanistan. He therefore saw no loss of investors’ confidence, although of course it is possible to argue that Dow would have risen further if Enron Scandal had not occurred. But looking from an objective point of view, the scandal appeared to have created a negative reaction in the market strong enough to overcome the general optimism that followed the invasion of Afghanistan. Source: Wallison (2004) Wallison (2004) explained by suggesting a look at Figure 1 covering the period September 1, 201, to June 30, 2002, where he proved that his assertion is clear. He explained that the Dow was rising after the United States Afghanistan on October 19, 2001, and it continued rising after Enron disclosed it false accounting on November 9,2001. The disclosure if the fraud has indeed lowered business confidence should have caused prices to go down. Wallison (2004) added that even a after Bush’s “Axis of Evil” speech on January 29, 2002, and in March 2002, four months after Enron and three months before WorldCom, it began a long decline, falling about 3,000 pints until early September 20002. WorldCom and Sarbanes-Oxley happened during this period but did not seem to have any significant influence on the steepness of the Dow’s ongoing decline at this point 2.6. Sarbanes Oxley law was an overreaction to address wrongly perceived loss of confidence of investors As expected because of their own definition of the problem, the press and the political class appeared to have fallen into panic, arguing that the act was necessary to combat a crisis of investor confidence in the stock market. This could be evidenced by the appearance on cable news and talk shows of Former SEC chairman Arthur Levitt, who kept arguing that accountants had been induced by the consulting work they did for their auditing clients, casting doubt on the accuracy of their audit reports and certifications. This was of course trying to consistently suggest that Enron and WorldCom were symptomatic of systemic problem as asserted by Wallison (2004), citing Media Monitor XVI, no. 5 (September/October 2002). Wallison (2004) further argued that the close movements of the Dow at that time could be used to paint the reaction of investors, where he found it difficult to find a correlation between key events in the Enron-WorldCom- Sarbanes-Oxley saga and the behaviour of the markets. 2.7 A closer look at the Market Fluctuations reveals a different story It was found that the stock market was quite stable until July 9 and 10, when President George Bush and Congress called for immediate action to deal with the corporate fraud. Wallison (2004) also found the Senate having rushed the Sarbanes bill to the floor, and it was passed almost unanimously on July 10. He observed that from these two days, the Dow plunged, falling 179 points on the day President Bush spoke, and another 283 points on July 10. What he was saying was that if the SOX restored investors’ confidence how come the reaction of the market is different (Wallison, 2004). Wallison (2004) explained that the president’s speech and the Senate action were clear signals that tough and heavily regulatory bill was coming, so it is reasonable to interpret the huge declines in the Dow on July 9 and 10 as a highly negate investor reaction to the new legislation. He noted that news media interpreted the declines on these two days as further evidence of a crisis of investor confidence, but used the correlation between legislative action and the declines in the Dow which showed that it is more likely that investors had lost confidence in the country’s political leadership than in the stock market. To prove this point he found the claim of restored investors’ confidence because of SOX enactment preposterous since the following two weeks, from July 10 to July 24, when the Sarbanes bill worked its way through the congressional process, no increase in increase in the Dow was noted. The irony was that it even fell another 1,000 points (Wallison, 2004). He elaborated that the fact the bill was passed by Congress on July 24 and was sent to the president for his signature, was already forgone conclusion. He explained that the gain of 936 points by Dow between July 24 and July 29 was an unlikely result of the congressional action on the bill, which had become virtual certainty as early as July 10. His argument was of course based on the absence of political opposition to the said legislation. What the author was saying was that it could not be the reaction of investors to react positively on the approval of the SOX to attributed Dow increase from July 24 and July 29 since he believes that July 10, was the more substantial date to react due to the due to absence of opposition to the law that really come out that time. He cited a poll result conducted in July 2002 by NBC News and Wall Street Journal whether respondent would favour new laws to prevent fraud or focus instead on enforcing existing laws. The response yielded 335 for the first question and 63% for the second question. This is strengthened by the argument that shortly after the president signed the law, on July 30, the Dow fell another 700 points which an exact opposite to the claim the investor’s lost confidence was restored (Wallison, 2004). 2.8 What really are the effects of Sarbanes-Oxley? Wallison (2004) found very little evidence that Enron, WorldCom, or Sarbanes-Oxley had anything another than a short-term and significant effect on stock prices. He even emphasized that even said seeming influence is ambiguous and unclear. He argued that if Enron and WorldCom had indeed caused crisis in investor confidence, there should have been a sharp and sustained decline after the news. What he found instead was choppiness as evidenced by the Dow rising and falling by large percentages over a brief period after WorldCom. This was also the time that Congress was legislating and the media was telling investors that the investors had lost confidence in corporate America. He pointed out that about two months following the said period, the market restarted a long-term downward trend which he would rather associate with the then oncoming war in Iraq by the US. The lack of effect of SOX as restoring investor confidence could have been revealed for almost eight months after the Act was passed but there seems to none at all. Contrary to the claim of restoring investors’ confidence, the Sarbanes-Oxley Act of 2002 cost American companies upwards of $1.2 trillion. Since compliance with the Act’s requirements is an added cost of doing business, it actually initiated a capital flight from US stock exchanges going to London Stock exchanges and making the latter to become the new hub for capital markets (World Net Daily, 2008). One reason is that the Act also required the SEC to adopt rules governing independence and roles of audit committees but unfortunate with the law and practice of other countries (Cunningham, 2003). In this sense the Act which had the intention of protecting investors that would create better market for securities resulted in the advantage of other securities markets outside the US. 3. Conclusion Based on the foregoing analysis, there was a wrong definition of the problem and therefore a wrong solution was prescribed. The claim that the SOX has restored investors’ confidence as a way of addressing problems caused by Enron scandal was found out to be baseless using the Dow Jones Industrial Average as basis. Evidence is lacking that the Enron Scandal has caused declined in the Dow Jones Industrial Average and no evidence is also available to indicate the sure passage of Sarbanes-Oxley Act on July 10, 2002 resulted to increase in the Dow Jones. The signing of the SOX by US President last July 30, 2002 was not even a moment to prove its claim on July 30, as the Dow fell another 700 points at that time. There is therefore no basis to claim restoration of investor’s confidence. Its effect was contrary a decline of wanting to enlist in US stock exchanges. Because of the need to comply with Act’s requirements, an added cost of about a trillion dollar to American companies came about as result. For these reason some companies have chosen other securities market outside US, specifically that of the London Stock Exchange. 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