Tiempo

Where BCRA supporters had posited Enron as a symptom of sickness in government, the Sarbanes-Oxley Act located Enron’s problems squarely in the realm of business. The latter bill sought (among other things) to ensure the integrity of accounting audits; to hold CEOs and CFOs more strictly responsible for their companies’ financial statements; to prevent executives from trading company stocks during periods of “blackout” when their employees are unable to do so; and to strengthen the Securities and Exchange Commission (SEC). In theory, each of these measures could have helped to prevent “what went wrong at Enron,” conceived as a set of ethical breaches in business and accounting.

In specifics, many of the law’s provisions were quite narrowly tailored. This was the legislative consequence of construing Enron as “incredibly an aberration,” in the words of one congressman. If the scandal was unique, then the reform it necessitated could be finely targeted to prevent another aberration of this kind. Sarbanes-Oxley emphasized, for example, separating accounting firms’ auditing and consulting services, meaning that none could do both jobs for the same corporate client. This measure was intended to eliminate conflicts of interest such as the one Arthur Andersen appeared to have with Enron. Likewise Sarbanes-Oxley created a national review board for accounting services, the Public Company Accounting Oversight Board (PCAOB), which itself would also be regulated to prevent partiality among members. The rationale was that

better federal supervision would guarantee investors’ trust in the financial statements of

companies in which they bought or held stock. Such a reform, in response to Enron, suggested the bankruptcy provoked a crisis in confidence as to securities’ value. This was not to happen again.

A History of Fraud and the Regulation of Representation

Sarbanes-Oxley’s legal premises can be traced back to the foundations of contract law and to prohibitions against fraud and forgery. Essentially, Sarbanes-Oxley was about

representations of value in business dealings, and about who officially vouched for them—and could thereby be blamed if they were false. Business regulations have always struggled to keep abreast of new modes of swindling, though with its ever-quickening pace, innovation in

commercial practices and in technology always seems slightly ahead. If Enron’s fraud instantiated this pattern, thus easing the passage of Sarbanes-Oxley, the last major regulatory overhaul in this vein had come about under similar circumstances.

In assessing the worth of large, publicly traded corporations, and particularly their effect on stock markets, Sarbanes-Oxley’s most relevant precursor was the securities reforms of the New Deal era. It was then that the SEC was created, that public companies first had to release formal financial statements, and that many of the rules of stock trading first took effect. Most of these measures were intended to prevent another bubble, and subsequent burst, based on the harsh lesson beginning in October 1929. There was also a distinct business scandal, however, that helped provoke New Deal reforms. It anticipated Enron not only in that regard, but also because the scandal was predicated on changing energy markets as well as stock speculation.

Samuel Insull made his name, and a great deal of money, buying electrical utilities. His large holding company garnered wide admiration and many investors, but from late 1931 through early 1932 it suddenly plummeted into bankruptcy. Over one million investors saw their savings devastated.87 One FTC lawyer, who had watched some of them attempt to recover their money, described “just the average run of people—clerks and school teachers there in Chicago, small

87

Hon. Richard D. Cudahy and William D. Henderson, “From Insull to Enron: Corporate (Re)Regulation After The Rise and Fall of Two Energy Icons,” Energy Law Journal of the Federal Energy Bar Association

shopkeepers in Illinois, farmers from Wisconsin—and…they had lost every penny.”88 Insull had made one irresponsible investment decision after another, and in the absence of any

consolidated, coherent disclosure of the assets of his holding company, nobody had known—and nobody chose to question—its real worth, or even whether it was solvent. For these reasons and many others more technical, Enron’s success and subsequent collapse were quite similar to Insull’s.

The most important long-term consequences of Insull’s scheme were legislative. Here Franklin Delano Roosevelt was the opportunistic politician who seized upon scandal to accomplish his preordained objective. Campaigning for the presidency at the time, Roosevelt cited Insull as a baron of the “power trust” run amok. The candidate argued that concentrated private ownership of utilities was gouging consumers and threatening democracy. He also advocated securities law reform, which would protect investors from “the reckless promoter, the Ishmael or Insull” who inflated his own stock’s value by lying.89

Roosevelt, of course, won, but Insull’s operation as a precipitating scandal also figured into that era’s political shift. First, Insull, like Enron, inspired a series of high-profile congressional hearings. Named later for the chief counsel of the relevant Senate subcommittee, Ferdinand Pecora, the hearings were part of an investigation into stock exchange practices. The timing—fall 1932—was no coincidence. The Pecora hearings, in context of a crashed stock market,

staggering deflation, and rising unemployment, helped catalyze support for greater regulation in securities trading.90 Insull’s story and the Pecora hearings facilitated reforms such as the Securities Act of 1933, the Securities Exchange Act of 1934, the Public Utility Holding Act of 1935, and the Federal Power Act of that same year. The premise overall was that big business, and the power industry, should not be left to state-level regulation. (Recall that Enron, in its time, was still lobbying the opposite position: that even the states should not regulate energy markets). Insull would come to symbolize the “corrupt old order;” the era before securities and utilities law,

at least in theory, made his kind of swindle impossible.91 Needless to say, fraud would continue both in stocks and in energy. But in a detailed comparison of Insull’s case with Enron’s, Judge Richard Cudahy and legal scholar William Henderson argue that some of the reforms that Insull inspired may actually have prevented Enron’s collapse from triggering a severe market downturn in 2001-2002.92

For all their similarities, one notable difference between the Insull scandal and the Enron scandal is that only the former prompted new legislation regulating energy. Insull’s fraud was identified with his particular industry, whereas Enron—appropriately—was barely even

considered an energy company in the postmortem. Enron’s only major, publicized misdeed that was actually industry-specific was its trading exploitation in California’s energy crisis. The company has always been much more closely associated with accounting fraud. Accordingly, 2002 saw accounting reform. On the rare occasions when energy-related abuses did enter the congressional discussion, they were usually merely used as examples, among others, of Enron’s crookedness.

2002: A Calling to Account

The Sarbanes-Oxley Act has been attributed by some to “Sudden Acute Regulatory Syndrome.” This recurring phenomenon in business regulation arises from a catalyzing event (in this case, Enron’s collapse) which leads to the quick adoption of new rules even over the objections of industry leaders and lobbyists. The latter are usually able to exert at least some influence over the regulatory policies that govern their own business.93 Larry Ribstein likens such political conditions to a “regulatory bubble;” an extreme but temporary inflation of lawmakers’ willingness to “invest” or “buy into” the movement to create more rules.94 Like the libertarian idea of government as a special interest group, the concept of a regulatory bubble is intriguing in its conflation of politics with markets. If speculative bubbles in the financial world often begin with

91

Ibid., 71.

92

Cudahy and Henderson, “From Insull to Enron.”

93

Larry E. Ribstein, “Sarbanes-Oxley After Three Years,” New Zealand Law Review 3 (2005): 365-81. 368- 69.

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rash groupthink and end in disaster, it should not be surprising if regulatory bubbles arise out of somewhat similar contexts, and have consequences that may well be regrettable in hindsight.

Yet almost immediately after the Enron bankruptcy, the voice of the free-market ideal was already back, loud and clear. Though a regulatory bubble was expanding at this time, in other words, not everyone was willing to speculate. Sen. Robert Bennett (R-UT), for example, was reluctant to support new reform measures, and offered an interpretation of the Enron collapse that signified little need for a Sarbanes-Oxley when he said “the market is the fastest, quickest punisher of stupidity. And that's what happened.” Other legislators emphasized the overwhelming strength of corporate America, and insisted that an aberration like the Enron scandal should not tarnish its image. Even bill co-sponsor Rep. Michael Oxley (R-OH) warned,

The fact that the vast majority of American businessmen and women are enterprising, honest and hard-working is what has made America in its brief 200-plus years the most prosperous civilization the world has ever known…There is no law Congress can pass which would match the entrepreneurial talents of the American people. Indeed…we can run the risk of restraining those talents when we rush to legislate in times of crisis. In this area Congress must proceed with extreme caution, because there is a direct correlation between the amount of freedom in a society and its ultimate success or failure.

From the “other side of the aisle,” Rep. Paul Kanjorski (D-PA) joined in:

Nobody should assume that because there have been a very small number of people who had been irresponsible, that this represents the American free-enterprise system. Most accountants in this country are fundamentally honest and perform their work in the highest professional standards…Most corporate executives and board members of this country work very hard, very diligently and in the highest professional manner to perform their function.95

If Congress at this time did more to maintain the corporate capitalist status quo than it did to pre-empt “another Enron,” such remarks may help explain why. For here we are reminded how bounded the melodramatic narrative had been all along. These legislators, though more than willing to vilify Enron executives, still maintained nobody should get too carried away in the effort to restore calm and order. A just resolution would require only limited reform. Indeed, to

undertake any major overhaul in regulation would itself be an act of injustice; an arbitrary victimization of the “diligent,” “hard-working,” “professional” and “talented” majority in American business. Such comments echoed the growing chorus of praise for small business owners and

employees, often touted as the backbone of the American economy and the embodiment of entrepreneurial spirit and dedication. But they also drew upon a common strategy in arguing against increased business regulation: that it would hurt honest, hard-working people in small operations. Big business often manages, in defending itself from stricter supervision, to “hide behind” small business—and it has help, in doing so, from legislators.

Initially, President Bush had been far from enthusiastic about the Sarbanes-Oxley Bill. In March 2002 he had announced a plan for reform that emphasized responsible self-governance in corporate America, as opposed to corrective legislation. Executives, he said, must answer to the “demands of conscience.” Over the following months, however, doubt only mounted as numerous public companies issued “revised” financial statements. By mid-July, the New York Stock

Exchange was weaker than it had been for five years. It became clear that Bush should not appear to be standing in the way of corporate accountability reform. He gave a speech in New York City plugging “Corporate Responsibility,” but investors and financiers were clearly

unconvinced; one could literally watch the stock market falling on the ticker tape as he spoke. On July 30, 2002, after it had been passed unanimously by the Senate, Bush signed the Sarbanes- Oxley Act into law.96 “We hope all of this will begin to calm the economic situation,” said primary sponsor Sen. Paul Sarbanes (D-MD) in a press conference in the White House driveway, “and provide a framework within which we can move forward and assure our investors…that they can count on the American capital markets to reflect fairness and integrity and transparency.”97

In fact, Sarbanes and Oxley had written the bill before the Enron bankruptcy, but none of its proposals had yet even been studied by that time.98 By most accounts, the legislation was passed in a hurried and haphazard fashion, before much research had been done as to the

96

Jayne W. Barnard, “Historical Quirks, Political Opportunism, and the Anti-Loan Provision of the Sarbanes- Oxley Act,” Symposium article, The Twenty-Eighth Annual Law Review Symposium in the Wake of the Sarbanes-Oxley Act, 334, 336; Tosha Huffman, “Section 404 of the Sarbanes-Oxley Act: Where the Knee- Jerk Bruises Shareholders and Lifts the External Auditor,” Brandeis Law Journal 43 (2004/2005): 239-58. 240, 247.

97

By “all of this,” Sarbanes was here referring to the bill but also to some additional resources being granted to the SEC that it might better carry out its oversight functions. (Federal News Service White House Briefing:

Stakeout Media Availability with Sen. Paul Sarbanes [D-MD], Chairman of the Senate Banking, Housing and Urban Affairs Committee, Following the Signing of the Corporate Accountability Bill, 30 July 2002.)

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wisdom of its provisions.99 Jean Baudrillard wrote, “The denunciation of scandal is always an homage to the law.” A disturbance to a society’s moral structure, he argued, can be ritually alleviated by being labeled a deviation from the law in such a way as to affirm the power of the legal order, which supports “capital.” 100 President Bush and Congress, in the wake of Enron’s collapse, were clearly attempting something along these lines. For it is arguable that the Sarbanes-Oxley Act brought little in the way of “reform;” either because this new legislation still fell short of practical efficacy, or because it simply reassembled and reiterated policies that had already been on the books.101 In any event, it has been subject to sustained criticism from a remarkable variety of angles.

In business circles, the new Sarbanes-Oxley regulations are collectively nicknamed “SOX” out of familiarity and, usually, contempt. Primarily in terms of work hours, the cost of compliance provokes much grumbling. To avoid the expenses of SOX compliance, some companies have “gone private” (removed themselves from the stock market); or “gone dark” (reduced public ownership to below 300 shareholders, which is the maximum allowed for a firm that does not comply).102 Neither phenomenon is particularly promising for the American investment climate. More troubling, though, is the fact that smaller businesses as well as large are required to follow SOX policies. For them, the associated costs can be prohibitive,103 such that they may shut down, or that people may be deterred from launching modest startup ventures in the first place. The one business constituency distinctly unopposed to Sarbanes-Oxley is accountants. The law is a boon for external auditors, as it effectively grants them a captive market for a new set of services that only they can provide.104 “SOX Auditing” and also consulting on “SOX Compliance” are distinct services—almost a professional sub-field in their own right—and

Ribstein, “Sarbanes-Oxley After Three Years,” 367; Huffman, “Section 404 of the Sarbanes-Oxley Act,” 258.

100

Jean Baudrillard, Simulacra and Simulation (Ann Arbor: The University of Michigan Press, 1994), 14.

101

Huffman, “Section 404 of the Sarbanes-Oxley Act,” 246, 249, 257.

102

Ribstein, “Sarbanes-Oxley After Three Years,” 378.

103

Ibid., 374.

104

quite lucrative. Thus if accounting firms seemed to have erred in the Enron scandal, Sarbanes- Oxley in this respect ironically rewarded them.

The Sarbanes-Oxley Act also falls short in its purported goal to increase whistleblower protection. So far, very few claims for relief from retaliation have been filed under the 2002 law— and the courts have ruled, in most cases, in favor of employers.105 Sarbanes-Oxley also imposed a statute of limitations that may serve ultimately to condone corporate offenses, because they are often so complex that they go undetected until years after the fact.106 In other words, if a

corporate employee discovers “too late” some arcane evidence of fraud, he can only take action at his own risk. He has no legal protection as a whistleblower.

Finally, some lesser-known components of Sarbanes-Oxley’s whistleblower rules suggest that, far from being custom-designed for someone like Sherron Watkins, they actually would have excluded her. First, the terms of the law limit one’s options, upon discovery of whistle-worthy activity, as to whom it can safely be reported. An employee is only protected if she brings her information to a federal agency, which Watkins never did. Furthermore, a would-be

whistleblower’s motives are subject to scrutiny. Only one who can prove she acted in “good faith” is guaranteed legal protection. For reasons outlined previously, Watkins may well have failed that test—especially with all the money and legal talent that Enron would have enlisted to discredit her. No one on either side of Sarbanes-Oxley debates, however, even acknowledged this fact.

Thus even if Sarbanes-Oxley was intended to pre-empt another Enron, narrowly conceived, here it failed even to do that. Particularly in its whistleblower provisions it departed significantly from the circumstances of Enron’s case—delivering the real message, to anyone reading fine print, that Watkins as whistleblower-hero was to remain an exception, protected by incidental circumstance, rather than the norm. More substantively, in the broader goal of empowering corporate employees to report any transgressions they witness, these same

loopholes in Sarbanes-Oxley are problematic even with Watkins entirely aside. For in her motives

105

John B. Chiara and Michael D. Orenstein, “Whistler’s Nocturne in Black and Gold—The Falling Rocket: Why the Sarbanes-Oxley Whistleblower Provision Falls Short of the Mark,” Hofstra Labor and Employment Law Journal 23 (Fall 2005): 235-67. 235, 251.

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and in her decisions, Watkins was probably typical: thinking and acting, for the most part, in her own interest. Indeed, what else could be expected? Whistleblowers who care only for the public