Post date: July 18, 2003

Professor Bernard Wolfman discusses the Sarbanes-Oxley Act, recent tax cuts and whether law school does a good enough job teaching ethics.

What sort of problems was Congress trying to address with Sarbanes-Oxley?

The Sarbanes-Oxley Act was a response to the Enron type of scandal and abuse-the executives who were, in effect, robbing their own companies, depriving shareholders of money that should’ve been there for them; and lawyers who were more interested in cozying up to the executives, and, despite becoming aware of improper conduct, found it in their interests just to ignore the improprieties they saw.

And then there were the auditors-the CPAs that audited the financial accounts of the company and the financial statements. It turned out they had inherent conflicts of interest because, in many cases, they served as consultants to the company, advising them about transactions that they might enter, about tax shelters that they might buy, and indeed, some of these auditors were selling the tax shelters.

Were these foreseeable problems?

It’s possible that the SEC could have, in advance, made clearer that these things were improper. But I think the problem lay with the failure of professionals-lawyers and accountants-to live up to the highest standards that were already there.

So how does Sarbanes-Oxley fix things?

Well, it told the SEC to strengthen the rules that it enforces. It even created a sub-board of the SEC called the Accounting Oversight Board, to deal with these things. It requires lawyers for a corporation, both inside and outside, who observe improper conduct by, say the CFO, to report it higher up in the chain of command of the corporation. And if the first rung doesn’t do anything about it, they’re supposed to take it to the next rung, and so on. But the big issue is, what happens when the top rung does nothing? There was a proposal that then the lawyers should go public, to sort of yell out the window about what’s going on. That hasn’t been enacted.

How does it deal with auditors?

The proposed rules would have made it improper for an auditor to provide non-audit services-expert services, consulting services-to its audit clients. At the time the proposed rules were pending, I wrote on this subject to the effect that the rule did not go far enough. I certainly agree that, of course, the auditor should not be allowed to sell, say, a tax shelter to a client that it’s auditing. But, it seemed to me that the same essential conflict of interest is present if the auditor were to sell consulting services, to any other company. Each of the final four [large accounting firms] sell, essentially, the same kind of tax shelters and other consulting services as any of the others. And so, if auditor X has not sold any tax shelters to its audit client, but auditor Y has done so, auditor X is not going to be very skeptical about that product because it has sold exactly the same kind of product to auditor Z’s client. And so, the conflict of interest is inherent. The only way that conflict, in my view, can be eliminated, is to provide that auditors should stick to their auditing.

The final rule not only didn’t do what I recommended, but the SEC retreated from its own proposed rules. It now leaves to the audit committee of the board of directors of each company the question of whether the auditor for that company should be permitted to do other things. I think that’s very unfortunate. So do I think, therefore, that the Act has done what it ought to do? No, I don’t. And I think we will, in due course, see recurrences of events such as we’ve observed in the past.

Senator Sarbanes is a graduate of HLS. Have you had a chance to share your concerns with him?

I haven’t spoken with him, but with his staff. Sarbanes would, himself, have gone further. I do not know at what point he would’ve rested; I do know that he would indeed have wanted to go further. It’s clear that this bill was a compromise, and I believe that had Sarbanes [had his way], we’d have an act (maybe Oxley wouldn’t be part of it) that would be much stronger.

The “Big Eight” accounting firms are now down to the “Final Four.” Is this a problem?

Oh, sure it’s a problem, because there’s less and less choice. I think it could be remedied if there were a change in tradition, and that is a change that says to large companies that you don’t need to have one of these big four as your accountants. There are thousands of accounting firms out there, and there’s no reason in the world why public companies should be so restricted in their choice. Roughly 91 percent of public companies use the big four as their auditors. That’s the first thing that can, and should, change. It’s possible-although I don’t know exactly how they’d go about it-that the SEC can do something to encourage reaching beyond that final four oligopoly.

Do you think law schools do a good enough job teaching these ethical issues?

I think we do a good job. It isn’t for lack of the lawyers involved having the proper education in law school. I think what they’re caught up in is the culture that says despite what the rules might say or how they might be construed, the world out there doesn’t frown on this. I don’t know about other law schools, but I think the various courses we have in professional responsibility at HLS, and the reference to some of these issues in our substantive courses, do indeed introduce our students to ethical issues. But-and I wish it were otherwise-legal education is not self-enforcing.

Turning our attention to recent tax policy issues, what are your thoughts on the tax bill that was signed last spring?

It was awful.

Why?

First of all, there is no theme to it, there’s no policy to it except reducing rates marginally for the benefit of the wealthiest in the country. It also, overall, has the effect of increasing the deficit. That’s the last thing we want. I think it will be bad for the economy. It is bad in that it’s just a giveaway to the most well-heeled constituency. What we do need, and will benefit from, is a review of the whole rate structure, one not so bent in favor of those at the top as the current structure has become. It’s not on the horizon, however, certainly not in this Congress, nor with this administration.