Coyote Blog

Remember Enron?  One of the aspects of the Enron case that the media latched on to was the document destruction at Arthur Anderson, destruction AA claims was routine but prosecutors and many in the media tried to classify as obstruction of justice.  So I thought this bit from Reason was interesting:

For decades, newsrooms have
shredded or thrown away notes some time after using them both to save space and
to prevent prosecutors like Fitzgerald from demanding them as part of an
investigation. This "routine expungement is a longstanding practice in many
news organizations," says Sandra Davidson, a professor of communications law at
the University of Missouri School of Journalism.

Hmmm, sounds familiar, huh?  The article goes on to point out the obvious - that the Sarbanes-Oxley provisions rushed into law and cheer-led by most journalists may come back to bite the media:

And for the press, the "obstruction of justice" provision [of Sarbanes-Oxley]
may cover more than just withholding notes from the government once an
investigation has begun. It may also endanger the common practice of routinely
destroying notes to protect anonymous sources.... Sarbanes-Oxley, because it
covers document destruction even "in contemplation" of a federal investigation,
could apply to the press's "routine expungement" practices, scholars say. "If
you're destroying documents to prevent them from being subpoenaed," says
Rotunda, "you have a risk that a vigorous prosecutor will think of that as
obstruction of justice."

Personally, I think you are insane to be a CEO or a board member of a public company under Sarbanes-Oxley.  There is no way I am going to sign a document on threat of prison that no one of the thousands of employees who work for me did anything to screw up the books.  Heck, I run a private company owned only by me where there is no incentive other than to report the numbers like they are, I sit next to my bookkeeper who is the only other one who touches the books, and I still find errors from time to time in past periods.

But what got me going on this post was a TV interview I tuned in the middle of last week.  I can't find a version online or even the name of the people interviewed, but the gist of the discussion was how Sarbanes-Oxley was going to prevent Enron-type situations that bankrupt investors.

I wonder how many people believe this?  Because Enron was going down, with or without the accounting shenanigans.  Its trading-based business model followed a life-cycle that should be familiar to anyone who has been in trading -- that is, they had unbelievable margins early on, but as others figured out what they were doing and duplicated it, the margins narrowed.  As trading margins narrow, the only way to maintain profits is to increase volume, leveraging up your capital into larger and larger trades at narrower and narrower spreads.  This volume strategy requires a very low cost of capital, which means low borrowing costs and a high stock price.  By hiding debt and losses in off-book subsidiaries, the Enron managers may have delayed the ultimate reckoning (by keeping equity prices high and its bond yields low), but the accounting games were not the cause of the failure.  In the same way, the march of long distance rates towards zero ultimately brought down Worldcom, not accounting.  In the latter case, if you borrow lots of money to buy long-distance companies, as Worldcom did,  assuming say 20 cent per minute long distance rates and then the rate goes to 5 cents, you are probably in trouble.

I am all for curbing the imperial CEO and giving shareholders and boards more power to police accounting and establish transparency.  I am not sure SarbOx does any of this.  My gut feel is that five years from now we will view SarbOx as more of an enabler for state attorney general self-promotion (as each races to try to prosecute some high-profile CEO for arcane accounting errors) and tort bar shenanigans.

I am honsetly curious, do any of you, as equity holders, feel better about your equities today with SarbOx than without it, especially given the added expense every company has had to take on?  It would be interesting to test the market's perceived value of SarbOx by allowing shareholders to vote to opt in or out of SarbOx.  Not only would their voting be interesting, but, if they opt out, it would be interesting to see if the stock price goes down (meaning SarbOx has perceived value) or up (meaning SarbOx is mostly perceived as extra regulatory expense).