The limitations of the Sarbanes-Oxley Act

So what did Scrushy do to run so afoul of the government? Prosecutors contend that he devised a scheme to ensure that HealthSouth would make sufficient net income to meet the expectations of Wall Street analysts without regard to true operating performance. Their indictment charges that management created $2,700,000,000 of fictitious income between 1996 and 2003 specifically to "fill the gap" between reality and Wall Street targets. As a part of the fraud, the prosecutors allege that Scrushy obtained large compensation packages for those helping him manipulate the financial statements. Additionally, he personally accumulated in excess of $250,000,000 over the fraud period.

The situation at HealthSouth began to unravel in August of 2002 when accounting staff advised management that they no longer would make false entries. According to the indictment, a senior officer also refused to sign a financial report until Scrushy agreed to a plan to correct accounting problems and promote the senior officer to CFO of a HealthSouth spinoff. Finally, on or about November 13, 2002, Scrushy and other co-conspirators certified and filed a doctored quarterly financial statement with the SEC. This is the event that allowed prosecutors to indict Scrushy under provisions of the Sarbanes-Oxley Act.

The ability of HealthSouth to "make its numbers" and the resulting impression of profitability drove the company's stock price up to $30 a share; the ensuing disclosure of fraud saw it collapse to pennies. The stock has since recovered to about six dollars a share. This is of little solace to those who bought at $30.

Sarbanes-Oxley was passed to deter this type of abuse, yet it was powerless to prevent the certification of HealthSouth's fraudulent financial statements. While an extra 20 years of potential prison time might have reassured the markets, it provided little, if any, additional deterrent to the criminal element. By definition, criminals do not obey the laws of the land. The penalties may be more stringent and the chances of getting caught greater, but it is safe to say that neither Congress nor the SEC can legislate individuals into doing the right thing. If you are a criminal, what is another 20 years if you already face over 600 years in prison? Additional time behind bars in excess of a life sentence may be a good, inexpensive policy to communicate the government's intention to get tough on white collar criminals, but we should not pretend that it will prevent fraud.

There is no arguing that Sarbanes-Oxley has raised the stakes for board members, executives, and employees. The consequences of illegal and unethical business practices now are front and center in the nation's conscience. The number of enforcement actions have increased 40% since 2001 as the SEC and the Department of Justice aggressively pursue wayward managers.

Additionally, the record of the Act since its inception does contain some real accomplishments. It seems to have provided a balm that has contributed to some confidence-healing. Companies are getting their financial houses in order. Restatement of financial statements is at a record high, as companies correct past accounting and disclosure errors or adjust to refined accounting guidance. Financial analysts are reporting improvements in the quality of earnings and financial disclosures.