The Sarbanes-Oxley Act of 2002—Restoring Investor Confidence

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To the many Americans who lost their livelihoods and pensions when Enron, WorldCom, and other buccaneer corporations collapsed under the weight of their malfeasance and corruption earlier this decade, there is little to be said that can console them or ease their suffering. History will no doubt pass a harsh verdict on these companies and their leaders. But if there is a silver lining in these scandals, it is that we learned an important lesson about transparency in corporate governance, and because of that we instituted essential reforms aimed at restoring confidence in the system and preventing such disasters from happening again. These corporate crimes cost our economy thousands of jobs, countless life savings and some eight trillion dollars in market capitalization. Thankfully, those responsible are being held accountable for their fraud and corruption. But in a larger sense the problems that riddled Enron and WorldCom reflected a more fundamental breakdown of our system of corporate governance. It was a system that depended solely on market discipline, the threat of civil liability and a system of penalties—criminal penalties in some cases—to deter financial dishonesty. We assumed that the gatekeepers of information—the lawyers, analysts, accountants, directors, and executives—would do their jobs to maintain financial transparency. Clearly that wasn’t enough. We often think of money as the currency of a free market system, but in truth the system rises and falls on the confidence of its investors. Those who invest capital do so based on an understanding and knowledge of the risks and potential rewards involved. Enron and WorldCom thus became both examples and symbols of a broken system. Investors turned skittish because they no longer had full and complete trust in all the financial information they were being given. We needed reform, and that was the genesis of the Sarbanes-Oxley Act of 2002. Sarbanes-Oxley has been able to restore investor confidence because it rebuilt and strengthened the two most vital pillars of corporate governance: transparency and accountability. In hindsight, the lack of transparency under the old system seems apparent. I remember studying in law school the reasons why “piercing the corporate veil” was so difficult, and it was largely because the legal standard essentially gave deference to corporations and anyone seeking to pierce that veil had to demonstrate extraordinary circumstances in a court of law. That was pretty much the standard that prevailed through the Enron and WorldCom scandals. Corporations may have used the word “transparency” in their disclosure statements, but in truth transparency requirements did not take into account a number of activities undertaken by