A pox on Sarbox: the unintended and rotten consequences of the Sarbanes-Oxley law.(PUBLIC POLICY II)

AS a very young teenager on my first unsupervised afternoon in New York City, I promptly lost $10 playing three-card monte. Afterwards, I vowed that I'd never get pulled into this kind of rigged game again. I had learned an important lesson: Ignore what the dealer is saying and keep your eye on the money card. This can be a good strategy in other areas of life, too. Take, for example, the Sarbanes-Oxley law ("Sarbox")--a measure that claims to make the stock market safer, but actually has the effect of taking money from small investors and giving it to multimillionaires.

In 2002, on the heels of business scandals at Enron and WorldCom, Congress passed Sarbox to restore investor confidence in the integrity of U.S. public markets. Sarbox imposed a grab-bag of requirements on public companies--everything from criminal penalties for executives who willfully misreport financial results to restrictions on insider trading. Much of the energy behind this legislation was generated by the market meltdown that had eliminated about 50 percent of the value of the S&P 500 stock-market index in the 28 months leading up to the passage of the law. Asset bubbles are almost always followed by stricter regulation of markets. Human nature being what it is, bubbles in their later stages typically invite an abnormally high amount of fraud, and the resulting regulations are often excessively focused on preventing whatever particular flavors of malfeasance were most recently prevalent. Targeting wrongdoing is easy to understand, plays to our need to believe that somebody must be to blame for our sudden loss of wealth, and allows politicians to be seen doing something. Such regulations are usually produced very quickly, and often have effects that the authors never anticipated. The drafting and implementation of Sarbox is an excellent example of this dynamic.

NOT QUITE AS PLANNED

The most consequential component of Sarbox has turned out to be something that was not the subject of deep inquiry at the time: the "Section 404" requirement that companies specify, ...