Corporate Regulation
Must Be Working --
There's a Backlash

Quietly -- and sometimes not so quietly -- the backlash against corporate-governance regulation is raging. But these efforts couldn't be more misplaced. Corporate reform hasn't gone too far; it has just begun.

There are two main targets of the backlash forces: Sarbanes-Oxley, especially "Section 404," which calls for tightened corporate internal controls, and institutional investors, who are increasingly flexing their muscles in the boardroom.

Corporate lobbies such as the Business Roundtable and the Chamber of Commerce are rumbling that the costs of Sarbanes-Oxley are onerous, that their members can't fill their boards and that shareholders are being obstreperous. Investment bankers blame SOX, as the Sarbanes-Oxley law is called, for preventing mergers. (They don't seem to note that M&A is up this year or that one reason for merger reluctance might be the disastrous performance of so many mergers.) The NYSE's John Thain penned an op-ed in this newspaper wondering if regulation had gone so far that foreign companies had decided against listing on the exchange he happens to be running.

In letters to Denise Nappier, the Connecticut state treasurer, and other states' pension officials, the Chamber of Commerce condemned them for challenging the managements of poorly performing companies such as Safeway, using lines of argument that happened to echo Safeway's own poorly performing leadership. The chamber was so eager to fire off a defense of Safeway's executive suite that it addressed her as "Mr. Nappier." Hey, when you are that wrong on the big stuff, what's one small honorific?

All it took was one good year in the stock market. And the business community "seem[s] to have lost their memory about what transpired in the last few years," says Lynn Turner, managing director of research at the proxy advisory firm Glass Lewis and former chief accountant at the Securities and Exchange Commission.

Here is a reminder -- merely of what happened last year. While high-profile corporate scandals have slowed, the problems with corporate accounting haven't been solved. There were 323 companies that restated their results last year, down only slightly from 330 a year earlier and way up from 1999, according to Boston-based Huron Consulting Group. In 58 instances of auditor changes, the outgoing accounting firm reported problems with internal controls, according to Glass Lewis. "How many auditors do you think are still working with their companies without telling us that they have poor controls, given that we heard about these only after a terrible battle?" Mr. Turner asks. After the New York Stock Exchange chairman whinged about Sarbanes-Oxley, it took Paul Volcker and Arthur Levitt to pen a defense, which ran this week in the Journal. Are there any executives who will stand up to agree with them?

Actually, yes. The absurd aspect of this backlash against SOX is that companies are finding out that tightening their internal controls is actually good for their business. Don't believe it? "We have seen value in the 404 work. It helps build investors' trust and helps give them more confidence," says General Electric's finance chief Keith Sherin. "We've gotten positive benefits from it."

But from other important figures, we get fuzzy math. In complaining about over-regulation and Sarbanes-Oxley, AIG's chairman and chief executive, "Hank" Greenberg, said in a speech at his company's annual meeting that the insurer was spending almost $300 million a year on total regulatory and corporate-governance expenses. He called that "an enormous burden."

Really? That $300 million seems like a big number, but it is only about 1.5% of AIG's operating expenses, including insurance-acquisition charges last year. An AIG spokesman says of that figure, the costs from Sarbanes-Oxley were $40 million last year.

Mr. Sherin says that GE spent $30 million last year implementing Section 404 of Sarbanes-Oxley. About two-thirds of that money is spent on its own employees. "I consider that to be an investment," Mr. Sherin says.

Are the auditor costs out of control? Not exactly. According to Glass Lewis, total audit fees for 461 of the Fortune 500 companies rose 15% last year from 2002 to an average of $4.8 million. The 15% increase may sound large, but companies still managed to eke out record profit margins. These companies paid their auditors $1.3 million on average for audit-related fees pertaining to internal controls. These modest sums hardly indicate that Section 404 requirements are overwhelming.

But there should be costs. Sarbanes-Oxley can't be free and still have an impact. Small companies probably feel the burden more, but they don't need to be public. Same goes for foreign corporations, which needn't list in the U.S.

Though still raking in steadily increasing and outsized compensation, CEOs haven't been in such an insecure position since the 1980s. And so of course, they would rail against the perceived threats. But this time around, it isn't short-term raiders who are menacing them, but serious-minded shareholders who demanding good long-term performance and transparency. That is a good thing for the markets.