I have blogged about Sarbanes-Oxley, and what a disaster it is, before. The Wall Street Journal had a spot-on editorial yesterday pointing out that the existence of SARBOX did nothing to prevent the debacle at Refco. Beyond this obvious, and convincing enough, point the Refco fraud is even more damning of SARBOX given its particulars. The Refco fraud was not a fraud that simmered and built up undetected over many years, advancing by small degrees. This company was the subject of major investor interest and scrutiny, and presumably the high level of due diligence that such interest brings with it, many times in recent history. Thomas Lee Partners, the famous private equity investor, bought in as recently as 1999 and ole' Tom Lee himself and two of his representatives sat on the Board of Directors all along. Refco had a revolving credit facility, so there was a bank, or a syndicate of banks, presumably who got to take a look at the inner workings at Refco. Then Refco went public in August of this year. That means that several large investment banks got to crawl all over its books as well as the auditors. So in a few short years several institutions, sophisticated institutions mind you, got involved at various stages and each and every one flubbed the job. That is not my lament. If the private sector falls flat on its behind, too bad so sad, they'll have to learn to get it right, which they invariably do. But what of the regulations like SARBOX that impose huge costs and are now demonstrably worthless in preventing frauds?
There are numerous examples of smaller companies that are facing high six figure to low seven figure bills to comply with SARBOX. For a small company, this is not just serious money (at one company that I have invested in, these costs are 50% of its total annual net income), it is just simply unaffordable. Many of these companies are considering, and I believe they will opt, to "go dark." This means they will reverse split their stock to bring the number of shareholders below 300, so they will not be required to meet any public reporting requirements. Their shares can still trade on the bulletin boards but liquiidity will suffer and thus market capitalization. Many will eventually sell out to private equity firms at depressed values because their shares cannot achieve full value in an active, liquid market. Is this what SARBOX was supposed to do - cutoff participation in the capital markets and hurt small companies? Clearly not, but our esteemed Suasage Factory Workers have no clue what they are doing, so this is what we get. SARBOX needs repeal at best, heavy modification at worst.