It's a pleasure to be here to talk about the economic consequences of Sarbanes-Oxley, a matter which we know some things about and have opinions on a great many more.

Explicit Costs

Let's start with the obvious thing that we do know, which is that the Sarbanes-Oxley Act, in Section 404 in particular, has created a tremendously costly amount of paperwork and bureaucracy. There used to be an old joke that the service economy meant everybody takes in everybody else's laundry. The Sarbanes-Oxley economy means that everybody audits everybody else.

There's no doubt that this is tremendously costly. We don't know exactly how much. Estimates range from millions of dollars per firm for large firms and many billions of dollars in the aggregate. And we don't know specifically but we do know the explicit costs alone are extremely high.

The implicit costs of diversion of employee and management behavior are high. The accounting and legal costs are high. Virtually every audit committee around the country is watching its audit fees escalate by huge amount, going up as much as 50 to 100 percent.

And, as we'll get to later, the opportunity costs are also very high, although it is very hard to know exactly how high. Whatever these costs are, in general we know they are disproportionately higher for smaller companies.

Smaller companies are less inclined to maintain their own bureaucracies to cope with the external bureaucracies and obviously have a smaller base of business to spread the cost over.

Part of the reason for this disproportional impact on smaller companies is that the implementation of Section 404 in particular has taken the ultimate brute force approach. I would say it makes the airline security line, where you have to take your shoes off, look like a piker. We're going through every little detail of what these companies are doing with little sense of proportion or materiality.

In sum, we have what I think of as an Orwellian principle that we're going to impose huge costs on the shareholders, who have no choice as to whether they wish to bear these costs or not, in the name of protecting these very same shareholders. It is the view of most of us that these costs far outweigh the benefits which are likely to arise from them.

Bonanza for Accounting Firms

There is another set of economic consequences, the economic consequences for the accounting firms. Beyond doubt, Sarbanes-Oxley has been an remarkable bonanza for them.

One journalist has called it the greatest wealth transfer of modern times, from shareholders of corporations to accounting firms. I'm not sure that's true, but it is a large wealth transfer.

It's also a power shift. Sarbanes-Oxley has created great power for the external auditors over the companies and their managements because as a public company, you can't do anything, indeed you have a hard time existing, if you can't file SEC statements and you can't file those if you're not audited. And you can't get the audit certificate if you don't do all of this Sarbanes-Oxley paperwork dictated by the accountants.

So they've gotten tremendous power even though they may not feel that power because they're very frightened themselves. That very fear tends to increase the amount of the paperwork demanded and their actual power.

Now it's an old and true saying that power corrupts. When power is corrupting, we think about conflicts of interests. One of the themes of the Sarbanes-Oxley Act in general is an obsessive worry about conflicts of interest. It implies doubt that anyone can handle conflicts of interest (although it is a dubious proposition that human beings are unable through their judgment and their responsibility to cope with conflicts of interest).

But note what Sarbanes-Oxley did. It created an enormous conflict of interest for the accounting firms themselves. It is obvious that the more massive the Sarbanes-Oxley routines, the more detailed their reviews, the more books, procedures and risk control descriptions which are generated, the more time it takes, and the more often they are reviewed, the more profitable the accounting firms become. Now if that isn't a conflict of interest, I've never seen a conflict of interest.

The “Pollock Proposal”

One appealing response to this is the “Pollock Proposal,” which is to expand Sarbanes-Oxley to cover the accounting firms themselves. That is to say, if you are going to be an accounting firm and run all over the world imposing costs and procedures on everybody else, you should have to go through this yourself.

Actually I get a great deal of amusement thinking about the rather disjointed multinational accounting partnerships spread over dozens of countries and how they, themselves, would do if faced with having to have all the risk certifications that they impose on everyone else.

I think we ought to do this as a prerequisite to practicing on other people. If you have to go through this yourself, maybe your views would become more reasonable.

Expand this principle to the SEC. I think the SEC itself and all its operations should have to go through Sarbanes-Oxley internal risk controls. They're a complex organization with a major responsibility to the public.

I did note the other day that Chairman Greenspan said that he finds that Sarbanes-Oxley has been "surprisingly successful." This leads me to believe, as a matter of logic, that he will undoubtedly now apply the Sarbanes-Oxley requirements to the Federal Reserve Banks themselves.

 I'm sure the Federal Reserve Banks are anxious to have the experience of going through Sarbanes-Oxley controls, although I'll note in passing that Federal Reserve Banks in their own accounting statements do not even follow GAAP. They have their own accounting principles which the Federal Reserve itself made up.

So it might be a little bit of cost and effort and work and a reallocation of resources for the Federal Reserve Banks to put Sarbanes-Oxley controls on themselves. But certainly, as responsible organizations, I'm sure that they want to do this.

Rule-Followers vs. Judgment-Makers

Now I think that the whole Sarbanes-Oxley discussion has two longer-term trends underlying it, both of which are quite important. The first is the evolution of accountants in America into rule-followers, as opposed to judgment-makers.

In other words, in the FASB era or the FASB regime, what used to be debates in the accounting profession about what was right have turned into a centralized small committee--namely the FASB--making up rules that everybody else follows.

Steven Zeff, the most prominent and interesting historian of the evolution of accounting, describes a profound change in the accounting profession from one that used to have very lively intellectual debates publicly in its journals about what were the right accounting standards, to one which lets all that just float to the FASB and itself becomes a group of rule-followers.

One of the biggest items in audit committee meetings, which I have sat and I do sit through in large number, is the accountants coming in to tell you the new rules they have to follow. And there is very little or no discussion about what the rule should be. It's rather, This is the rule. We have to do it.”

That rule-following behavior is, I think, a very important element in why the accounting firms have implemented Sarbanes-Oxley in the brute force, extremely costly way they have.

I'm going to give you six quotes from an excellent letter that the Mortgage Bankers Association wrote to the SEC about this accounting behavior. For those of you who haven't seen this letter, I recommend it. I'm sure the MBA would be happy to provide copies to anybody who is interested.

The MBA writes:

“The Sarbanes-Oxley Act has created an atmosphere of near paranoia, where auditors generally conclude that more testing and documentation is always better regardless of the cost or benefits. This is sapping our resources to the detriment of investors.”

“This activity results from highly ambiguous terms such as ‘remote likelihood,’ ‘more than inconsequential,’ ‘reasonable assurance,’ ‘material weakness,’ or ‘significant deficiency.’”
 
“The amount of testing being performed within our industry appears to be aimed at providing absolute assurance, which is, of course, an illusory concept.”

“Our members think that any concept of materiality is gone. Everything and anything is deemed to be material because the public accounting firms themselves have increased their aversion to risk to an extreme degree.”

“Almost every significant audit-related decision is now being referred to the firm's national offices rather than being addressed at the practice level.”

“We've been told that auditors can no longer help with the application of GAAP because that might be a conflict of interest to advise your client.”

Consultation regarding the proper application of accounting standards may be viewed as an internal control deficiency! This has to be the ultimate reduction to absurdity of the notion of the independence of auditors. I'm going to speak a little bit later about what I call the “independence fetish.”

The “Investor Confidence” Slogan

The second long-term trend is what I call the fallacy of the “investor confidence” slogan. Anybody who knows anything about investing knows that confidence in investing is not a virtue. In fact, it might be considered stupidity.

The true virtue of all investors is skepticism, not confidence. And yet we have our government in many ways, including in Sarbanes-Oxley, telling people they wish to make investors confident. This is something that the government should not be promoting. If you are intrigued by this idea, I refer you to an essay of mine (which you can find on the AEI website) called "The Government Should Not Try to Promote Investor Confidence".[1]

One of the things that happens when you try to promote investor confidence is you get an overemphasis on accounting as an element in investment decisions. I want to quote from an article here, which I think has the matter exactly right.

"Professional investors," the writer says, "who manage large portfolios of stocks, regard published earnings with the utmost skepticism, as they should. Officially reported earnings and assets, no matter how illustriously certified, do not play a major role in professional investment decision making. They know they must depend on other information. The company's greatest assets will never appear on any audited statement. These are the quality of management and its corporate philosophy. And the smart investor will do well to remember that the company's intangibles are what really count and that no accounting system measures them."

An excellent statement. It comes from an article in Forbes which was published in 1967. The article begins by saying, "We have an accounting crisis. No one has confidence in accounting numbers." This is 1967, ladies and gentlemen.

This just confirms a lesson taught me by one of my mentors when I was a trainee in the bank: There are no new ideas in finance. There is only cyclical recurrence. This realization of the inherent limitations of accounting is one of them.

So we have a couple of trends worth worrying about: the trend of the accounting profession becoming rule-followers as opposed to judgment-makers, and overemphasis on the investor confidence slogan.

Regulatory Response

Let me come to the role of two regulators in this, namely the SEC and the Public Company Accounting Oversight Board, or PCAOB. When faced with pretty overwhelming evidence of the results of their own rules in generating this exceptionally expensive morass of bureaucracy and paperwork, what did the SEC and the PCAOB do?

Well, they blamed the poor accountants. They rebuked them for lack of judgment and flexibility. I say “poor accountants.” Of course, we already have said that Sarbanes-Oxley has made the accountants much richer. But, in this context, politically or psychologically poor.

Now the great sage Confucius described the way of the higher man in these words: "The way of the higher man is like the archer. When the arrow misses the center of target he seeks for the cause of the failure in himself."

Apparently the SEC and PCAOB did not follow the way of the higher man as described by Confucius and wanted to blame it all on the accountants. At the least, I would say that's ungentlemanly.

I think the SEC and the PCAOB both need to realize that their own rules are obviously part of the cause of the problems. They should share in the responsibility and the need to rethink the rules as well as admonishing the accountants.

In this context, I think we can reemphasize how much the creators of these rules would benefit from the rewarding experience of having the Sarbanes-Oxley requirements all apply to themselves. I do think it would result in improved rules.

Opportunity Costs

Let me come to opportunity costs. All of us who think about economics know these are the real costs. I've had several CEOs say something like this: “We're not working on any new products. We're not working on any business strategy. We're not working on anything except Sarbanes-Oxley compliance.”

It's hard to know how much reality as opposed to personal irritation there is in these comments. But it is my guess there is a fair amount of reality. There certainly is a large diversion of organizational effort to Sarbanes-Oxley projects.

Risk Aversion and Governance

Equally important is the notion of introducing greater or excessive risk aversion into management. In an April article, The Economist Magazine criticized corporations in the following words, "What they have not done is to place bold bets on their own future growth." In other words, that's something companies should do. They should place bold bets on their own future growth.

But I want you to think about this in the context of Sarbanes-Oxley. Placing bold bets? That's what this law is encouraging? I don't think so. The notion of risk aversion or the attitudes toward risk may be the biggest economic cost of Sarbanes-Oxley, if there were some way to figure out what it really is.

This brings us to corporate governance. Obviously a big part of Sarbanes-Oxley is about corporate governance. One way to think of what Sarbanes-Oxley has done is to use the board of directors as one big audit committee, as opposed to an advisor in helping the business succeed.

As I mentioned before, there is a danger in making a fetish of the idea of independence with the implied belief that no one can handle conflicts of interest. A better view, I think, is that anybody who doesn't have conflicts of interest probably isn't very interesting to have in a discussion of any significant issue.

I'd like to suggest that we ought to think about knowledge as a more important factor in boards of directors than independence. What good does it do to be independent if you don't know anything or if your knowledge is rather superficial?

What makes good decisions, what makes you able to make bold bets (because they're really not so bold then) is knowledge of the relevant business, the relevant factors, the relevant markets, the relevant risks, the relevant technologies and so on.

Who has most of the knowledge? The insiders, not the outsiders.

So if you're thinking about structuring boards (I'll just say in passing, I serve on several of them), in my view, you don't wish to go overboard on the notion of independence. And you do wish to think equally about knowledge.

Some years ago, a British colleague of mine, who ran a building society in Newcastle, England, said he liked to watch Latin American soccer (or football as he called it), because the Latin Americans played to win whereas, he said, the Europeans played not to lose.

Think about business. Do you want companies playing not to lose? Or do you want companies playing to win? Certainly as a social strategy, we don't want the entire society playing not to lose. That is a guaranteed anti-growth, anti-innovation strategy.

But, of course, when you play to win, some people are going to lose. Playing to win means you're taking the risk of really losing. So I think a serious topic and one worth a good bit of thought is what is the nature of the psychological atmosphere you want in boards of directors. Risk aversion? Independence?

I think it is probably pretty clear that independent directors will tend to be more risk averse. They have much more downside risk vs. upside potential, would be much more afraid of losing, with a greater tendency to play not to lose, than inside directors. So how do we strike the balance?

Against a lot of current fashion, I'd like to suggest that, having had a whole generation of moving away from inside directors, maybe we ought to be correcting the balance somewhat with more insiders on the board.

One of the things that worries people who talk about boards and Sarbanes-Oxley is the influence of the CEO. It seems to me that having the CEO be the management director, with ten or twelve (or, in a bank, 15 or 18), outside directors actually increases the power of the CEO as opposed to reducing it.

Having more senior managers there interacting with the other directors may create more balance than when the CEO is the only pipeline of information between the management and the board. By moving to boards of independent outsiders, you've actually increased the power of the CEO.

Recommendations

That brings me to three reforms that I'd suggest to reduce the net economic cost, the cost in excess of the benefits, of Sarbanes-Oxley.

With regard to governance by boards of directors, there is only one reform that I think is really meaningful. That is ensuring significant stock ownership by all directors. A material, significant amount of stock should be owned by every director after having been on the board a few years.

And by this I mean stock, not options. In my view, options do not align incentives. Simply consider that dividends reduce the value of options, whereas dividends are a large part of historical returns to stock ownership .

The simplest way to do align incentives--and it is almost embarrassing that being so simple it doesn't get more discussion in governance--is to ensure that directors have significant ownership in the form of stock, not options. Although I don't recommend this as a regulation or a statute, this is something that should be done by policy by the corporations themselves.

Second, regulatory reform. The SEC and the PCAOB have to acknowledge their own role in creating the morass of Sarbanes-Oxley cost and bureaucracy, not just blame it on the accountants, and then try to write more sensible, balanced rules.

And thirdly, Congress. Congress should acknowledge its own role in creating Sarbanes-Oxley. They did something in a hurry, subject to a lot of political fear. The best effort that I'm aware of to fix Sarbanes-Oxley is a two-page bill introduced by Congressman Jeff Flake, a Republican of Arizona, which I recommend to everybody.

It's H.R. 1641. It simply makes Section 404 of Sarbanes-Oxley voluntary, as opposed to mandatory, by doing simple things like replacing the word “shall” with the word “may.”

I think this approach is clever and that everybody should at least read H.R. 1641. In my view, it's worthy of a lot of support.

Think about this. If investors demand the kind of heavy internal control documentation 404 demands, then the companies will do it because we investors will demand it.

If, on the other hand, investors conclude that resources would be better spent elsewhere like on research, or developing new products, or marketing, then companies will do that and the investors will respond. So I heartily recommend H.R. 1641.

In conclusion, I think it's clear that we have very important out-of-pocket, direct, observable expenses and transfers of wealth going on with Sarbanes-Oxley; the more theoretical but nonetheless important opportunity costs; and the theoretical but perhaps even more important effects on the psychology or risk-reward atmosphere in boards of directors and managements.

It's certainly an important topic for us all to be thinking about and I greatly appreciate the chance to be here and discuss it.

Question and Answer Period

Mr. Brown: Alex, thank you for those remarks. They reflect a frankness, a candor, and an ability to drill down to the elements that is a characteristic of your writings on this and other subjects. And I'm sure that there are many who have questions for Alex, so I’ll open it up to the callers.

Francis H. Schott: Sir, in your discussion, which is very valuable and appreciated, I missed some recognition of the troubles which gave rise to Sarbanes-Oxley. I happen to be, unfortunately, a past stockholder of Enron and of AIG. And, both times, I claim to be an informed investor.

But from the public records that I could obtain from those companies and from what the broker said and all that, I claim that I had no real responsibility for recognizing or no opportunity for recognizing the mess that these companies were in and the fraud that they were committing.

Now you can't just disregard the reason for Sarbanes-Oxley. Just tell me how the investor is actually supposed to evaluate companies if he doesn't have some help from regulators.

Mr. Pollock: Thank you. A very good question.

First of all, I hope that you weren't over-concentrated in either of those stocks since fraud is a pervasive risk that is going to exist no matter what controls are put in, and as part of your skepticism, which you clearly have, you need to make sure that you are well diversified.

Internal control obviously is important. The question is at what cost, at what brute force approach. My prediction is that with all of the cost of this, it will not reduce occurrences over time of fraud, which is one of the fundamental investment risks, any more than all of the other reforms which have been going on decade after decade.

Look through the history of accounting. I read the 1960s quote from the Forbes article talking about this. The actual name of the article is "The Credibility Gap".

No one can trust the accounting numbers, although we have had the formation of the FASB, the formation of required audit committees, and the creation of independent partner reviews of audits. With one thing after another, we're always striving for bureaucratic fixes. And this is the one which has been perhaps the costliest of all.

The problem is real. I doubt that the fix is worth the cost and it may not really be a fix.

Mr. Brown: Alex, I'd like to jump in with a question here from Washington. To what extent do you believe that the democratization of equity investing has led to the conditions where this type of a solution is to be preferred? In other words, the skepticism, the caveat emptor that you are proposing, is that better suited for a less democratized world of equity investors?

Mr. Pollock: When you read the rhetoric of securities regulation, it's always talking about the individual investor as somebody you are trying to protect.

But I think, as noted in my remarks (and which is discussed at more length in the essay), that the government should not try to promote investor confidence, that the worst thing you can do to individual investors is get them to be confident. That's what makes them foolish.

Nobody was more confident that investors in the dot-com bubble. It was obvious that everything was going to go up. It's similar to investors in houses today who know they can't lose.

To try to talk investors into the proposition that they can read from the accounting statements, which are highly abstract symbolical representations of the past, what the future performance of an investment might be, is not doing them a favor. It's doing them a disservice.

Arthur J. Murton, FDIC: Alex, I have a question. Some people have suggested that the banking industry had its Sarbanes-Oxley a decade earlier with the FDICIA (FDIC Improvement Act) reforms following the banking crisis.

And at that time, there was a lot of gnashing of teeth about what these reforms would mean, and how heavy-handed they were, and the credit crunch that ensued, and so forth.

But then looking over the decade that has followed, not only did those reforms not appear to be an impediment to the banking industry, but the industry has enjoyed a decade or so of very strong performance.

And so I wonder if we're just going through an adjustment period with Sarbanes-Oxley?

Mr. Pollock: As you say, the banking industry had its own collapse followed by its own version of Sarbanes-Oxley. Every 50 years is the cycle, in fact.

If you look at the history of the 1930s, many of the same events took place. You have the collapse. You have the fraud. You have high-profile trials. You send the Chairman of the New York Stock Exchange to jail. Only in this reprise the NYSE Chairman only got publicly humiliated, not sent to jail.

And you get a series of very heavy-handed regulatory reactions, which certainly was the regulatory response of the 1930s, which among other things, created your agency, the FDIC.

So without a doubt, there is a cyclical nature to this. As I mentioned at the beginning, there is nothing new in finance, only cyclical recurrence.

One is bust, followed by scandal, followed by over-reaction, followed by heavy regulation, followed by adjustment away from it.

I think there were probably some pretty damaging over-reactions in the early 1990s. On the other hand, those changes lay on top of a longer-term trend over the last couple of decades of a much more competitive financial system where you had a lot of barriers to competition being removed. We had those two things going on at the same time.

But I fully grant your basic cyclicality point.
 
Norman Gertner, FDIC: I had a very quick comment and then a question. My comment is that in New York, where I work, I happen to know several accountants who are not necessarily getting rich over this.

In fact, their view of this is that they are very frightened of it. Even with the new rules, they feel they're not able to spot wrongdoing and they don't even want to go near some of this work because they feel it's too risky.

But my question really is want--in the post-Enron environment--is your view of the proper role of the auditor now?
 
Mr. Pollock: First of all, I think your comment is excellent. I mentioned in my comments that while, in fact, there has been a big power shift to the accountants, they don't feel powerful. They feel scared. And just for the reasons you cite.

They're afraid of making mistakes. Therefore you get the result that everything is material. They're also afraid of the increased regulatory authority over them punishing them for making mistakes. So you get an asymmetric risk-return ratio. That is to say if everything goes right, you get your fee. But if something goes wrong, your career is over.

So I think your comment is very good and accurate.

My own view is that we need the accounting profession to turn back into a profession. The rule-following trend actually turns the accountants into a bureaucratized, semi-mechanical operation.

Instead of that, we need to go back to the fundamental, old-fashioned idea that the auditor is exercising judgment to present--through this highly debatable, very inexact, full of guesses and estimates activity known as accounting--as fair a view of the operations of the business enterprise as possible.

Part of doing that, in my opinion, would be to stop thinking that accounting is about the future and to realize that accounting is properly about recording the past and telling you what has happened up to some past date.

To get rid of the whole idea, which I must say seems to me nonsensical, that financial statements are supposed to predict future investment performance. This idea leads you to start filling financial statements with all kinds of so-called fair values which have to do with guesses about the future and guesses about discount rates, and treating financial statements and accounting as if they were some kind of financial projection as opposed to an accurate rendering of the past, which is the only thing they are actually capable of being.

The final point in my view of how the accounting profession should evolve is that, somehow or other, it should be made more competitive. I don't know how to do this, given to where we've gotten to. But one way to help might be to stop having a requirement that public companies have audited statements.

Almost all companies had audited statements before it was made a regulatory requirement to have them, first by the New York Stock Exchange and then by the SEC when it was formed. Maybe we're at a point where markets are mature enough that you could say this is voluntary.

Of course, almost everyone would do it anyway. But it might help change the fundamental feeling of the audit, as I say, from mechanical rule following to something more professional.

Michael Hsu, America’s Community Bankers: Mr. Pollock, I wonder if you could explain on your first reform of significantly increasing ownership of stock by the board.

Could you please explain what that means insofar as this whole debate on Sarbanes-Oxley? Or are you suggesting some sort of controlling level of ownership by the board?

Mr. Pollock: That's a good question. The answer to the second part is no, absolutely not. Just a significant level of personal ownership.

I did see one study of corporate performance over time compared to board structure. The only regularity the author could find between anything about the board and how well the corporation did was the extent of stock ownership by the directors themselves.

The idea is really simple. If you want to ensure that directors think like stockholders and act in the interest of stockholders, just make sure they own stock. Not just 100 shares, but some material amount for all the directors. That would give, I think, as your question was suggesting, something more of the feeling of a private company really being managed by the owners. But you wouldn't need anything like control. You just need the principle.

As I said, I do not recommend this in any way be a statutory or regulatory move. But it does seem to me that corporations, as they address their own policies about how the board should work, ought to be emphasizing this.

There is a very easy way to achieve it. You simply pay board retainers in stock. This creates an automatic accumulation within a fairly short amount of time, three or four years, of significant personal stakes.

This would not have to be restricted stock. It could be ordinary, tradable stock. But, of course, when board members sell, that's a public event.

So it seems to me that by doing things in a fairly simple way, you achieve something of fundamental importance in the way the boards will operate.

Harry G. Glenos, AmSouth Bank: My only question is about the accounting profession and its self-regulation as you have discussed.

I'm remembering other instances where real changes by the accounting profession have been very beneficial.

There was a brief period in the early 1980s where the rule was changed so you had to take foreign exchange transactions directly to income or foreign exchange valuation. Then that was reversed a few years later.

And then, more recently, there were the changes with regard to employee retirement healthcare and having to actuarially take a present value of future medical expenses and make companies to put huge sums of money away for that based on a forecast.

What reform could happen to prevent this? Do we need outsiders on the FASB? Or is there some way that we could bring some independence to their rulemaking?

Mr. Pollock: Thank you. I well remember the old foreign exchange rule, which was an absolute disaster, the biggest disaster they've had until FAS 133, which is an even bigger disaster. And as you say, it was changed shortly thereafter.

The whole idea of the Financial Accounting Standards Board was to try to create an independent body. It does have non-accounting firm members on it. Before the Financial Accounting Standards Board, there was a committee of the American Institute of Certified Public Accountants. The discussion at the time, in the early 1970s, was that they weren't independent enough. They were subject to pressure from their clients. So they wanted an independent board. That became FASB.

FASB under Sarbanes-Oxley, we ought to mention, has become even more independent because Sarbanes-Oxley creates a tax on all public companies, which now finances FASB. FASB used to have to get donations in order to support its not inconsiderable expenses.

Now it doesn't have to convince anyone to give it money. The Congress actually enacted a tax (they don't call it a tax but it is a tax) to support FASB, to make them more independent.

My view is that the problem is more with the fundamental idea of having a super-committee to make up rules like this. I sympathize with the theorists who say that we ought not to have uniform rules. We ought to have competitive accounting standards that companies can choose among, just as if you're a bank, you could choose a federal charter or a state charter or a thrift charter. I think there is something to be said for that.

I also have an article coming out this summer, which is called "FAS-133: What is Accounting Truth?” It argues that truth is more likely to lie in multiple representations of financial statements than it is in a single representation, saying that you ought to try to look at things from different angles. There is probably no single angle which ever can capture the truth of something complex like a large business.

You have to have different cuts at the problem or different sorts of reports. No single one of them is the answer. The answer is approximated by considering many of them.

That actually fits in with a project the FDIC is working on to use XBRL to get financial statements elements into electronic form. With that kind of technology, you make it possible to create multiple sets of statements, so you can choose your own theory.

 I think it's a very good question. And there is no easy answer to it.

Cyrus A. Ansary, Investment Services International: Alex, I'm mindful of what happened in the period of the 1960s and some part of the 1970s when we saw corporate raiding solely for purpose of either getting greenmail or just making a quick dollar by taking advantage of the assets of a company and selling them all or selling some of them. That corporate rating became the norm for approximately 10 or 15 years. And it resulted in a substantial backlash at the legislative and regulatory level whereby the managements of major corporations banded together and created by legislation and regulation that created barriers against shareholders having the freedom to jump in or raiders having the freedom to jump in and making tender offers and so on to take over companies for quick financial gain.

Obviously, the raiders were using the regulatory framework to make quick money. And that, of course, was an abuse of the freedom of outsiders and shareholders. But then the resulting backlash was that the regulatory framework, by the Williams Act and many other regulations and statutes, made it extremely difficult for outsiders and for shareholders to actually hold management accountable for some of the things they do.

I think we obviously went way overboard in protecting management. And the result is the kind of thing that happened with Enron, and Tyco, and World Com and others where management really had little accountability and the result was the kind of fraud and deceit that we have found.

Now, number one, I wonder whether you would comment about all that. And number two, I have found out from personal experience that the engagement letters that the four major accounting firms now sign with their clients are several times the size of the previous engagement letters and, in fact, restrict the responsibility of the auditors even far more than they used to be, which also follows your own line of thinking, so that they're very scared and everybody ends up passing the buck on to the independent director as the result of Sarbanes-Oxley.

So I wonder of you would comment on both of those matters.

Mr. Pollock: I would say your comments are right in virtually every respect. As I was listening to them, I was reminded, as one of my colleagues says, that all finance is political finance, so we would expect this legislative reaction to happen.

Maybe the best way to close here is with a quotation from that greatest of writers on banking, Walter Bagehot, who said:

"The times of rising securities prices are almost sure to generate much fraud. When some people actually are getting rich, and everybody thinks they're getting rich, it provides the occasion for ingenious mendacity.”

Bagehot wrote that in 1873. I don't think it's changed since.

Alex J. Pollock is a resident fellow at AEI.

Notes

[1] See: http://www.aei.org/publications/pubID.22232/pub_detail.asp