Sarbanes-Oxley report card is mixed: three years after the law was enacted, has it made a demonstrable difference in the level of corporate fraud? Opinion is divided, at best, though there's a general feeling that corporate governance has improved.

Is Sarbanes-Oxley working? For a multitude of stakeholders and interested parties--including top executives and managers in Corporate America, auditing firms, forensic accountants, all manner of consultants, government regulators, Washington lobbyists, politicians, shareholders, lawyers, journalists, economists, the courts and even the general public--this remains a burning question.

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Three years after its passage, is the law enacted in the aftermath of looting and plundering at such billion-dollar companies as Enron, WorldCom, Global Crossing and Tyco preventing, detecting and/or exposing fraud?

There is no easy answer. Despite billions of dollars collectively spent by corporate giants and lesser-sized public companies to achieve compliance with the myriad provisions in the 2002 law, there appears to be incremental progress, but the jury is still out. So far, Sarbanes-Oxley is not the deal-closing magic bullet many law-makers may have hoped for.

"What I think we've seen is a mixed bag," says Harvey Kelly, a forensic accountant and managing director at Alix Partners, a New York-based restructuring and financial consulting firm. "We are still seeing inappropriate accounting practices and improper financial reporting, both in the form of wrong numbers being published and in the failure to follow accounting rules, as well as incomplete and improper disclosures."

Kelly, who heads the corporate investigations practice at the firm and is author of Accounting Irregularities and Financial Fraud, nonetheless sees many positive signs. "One of the most pronounced effects that corporations are facing is an explosion of whistle-blower-type activity," he says. "They're following up on even ambiguous allegations, rumors, anonymous tips and articles that they read in the newspaper. I definitely think that there's a sea change in how Corporate America reacts to those claims.

"Today," he adds, "accounting concerns bubble up much more rapidly to the attention of the audit committee than they did before Sarbanes-Oxley. Audit committees are increasingly taking the initiative to see that investigations are performed independent of existing management. They're responding much more rapidly--taking these matters out of the hands of management and hiring outside law firms and forensic accountants and trying to nip problems in the bud. That is a very positive development."

The question of Sarbanes-Oxley's worth and effectiveness remains the subject of much debate. It is grist for numerous panel discussions, roundtables and speeches involving actors at the highest levels of both the private sector and government, particularly after the arduous process of complying with Section 404, the internal controls section of the law.

Nearly half--47 percent--of 106 member companies answering a March survey by the Business Roundtable reported spending $10 million or more to comply with the panoply of rules and regulations. Another 29 percent reported incurring costs in the $6 million-$10 million range. Financial Executives International (FEI) research has found companies replying to its surveys said they have spent an average of over 26,000 hours and $4.3 million in efforts to comply just with 404.

How much bang is there for the buck? Neal Schmale, CFO at Sempra Energy in San Diego, which has spent $10 million on compliance, admits that something had to be done to prevent more Enrons from occurring.

Cost-Benefit Questions

But Schmale may speak for many CFOs when he says candidly, "I'm sure there are many companies that benefited, but we already had a good control system in place. It's been a big costly effort, and it's hard to say whether, in hindsight, things are that much different. So far, there's no situation where I can tell you that, if it hadn't been for Sarbanes-Oxley, we might not have found some numbers that were wrong."

One salutary result of the law is that it has helped scrub a decidedly tarnished image of Corporate America. "Our general view is that, from the public perception point of view, Sarbanes-Oxley is working," says Thomas Lehner, public policy director at the Business Roundtable, the Washington, D.C.-based association of chief executives from the country's biggest corporations. Yet Lehner's enthusiasm is qualified.

"There's no law in the world that will stop fraud if there are three, four or five people who are serious" about cooking the books, Lehner admits. "But what we want to avoid," he adds, "are cataclysmic situations where tens of thousands of employees lose their jobs and hundreds upon hundreds of institutional and individual investors lose their money."

Toby Bishop, president of the Association of Certified Fraud Examiners, a trade association in Austin, Texas, hails from the United Kingdom, but he might as well be from Missouri. He is downright skeptical about whether the money that companies have ponied up to comply with Section 404 have done much to fraud-proof companies. "With regard to preventing, detecting and deterring major frauds," Bishop says "it's not as effective as expected. I think people are confusing a downturn in reported major frauds as an indication that measures are working."

Corroborating Bishop's more jaundiced view is an October survey of 208 certified fraud examiners by Oversight Systems, an Atlanta-based software company that makes computer programs that "act like a virtual auditor," says founder and CEO Patrick Taylor. A whopping 67 percent of professional fraud-busters in the survey felt that institutional fraud is more prevalent than five years ago.

A weakness in Sarbanes-Oxley, Bishop asserts, is that a CEO or CFO bent on fraud can "override" controls. Noting that "tips" are among the best ways to detect and uncover fraud, Bishop laments the fact that whistleblower programs required by Sarbanes-Oxley have not been given a higher priority. "When I talk to companies on how they manage their [whistleblower] hotlines and their code of conduct, I get disappointing answers," he says. "It leads me believe that there is weak fraud prevention."

But believers in the law say that the benefits of Sarbanes-Oxley are being realized in its broader superstructure and by a changed business environment. Because of the law, for example, the stock exchanges have reinvigorated their own listing requirements for public companies. Many of the listing requirements for the New York Stock Exchange and the Nasdaq--ranging from provisions that everyone on the audit committee must demonstrate "financial literacy" to requirements that boards have a majority of independent directors--parallel the regulations enshrined in Sarbanes-Oxley and provide an added level of oversight.

Boards Are Changing

According to the Business Roundtable's survey, 93 percent of responding companies have adopted standards of board independence that either meet or exceed market standards. And more than 80 percent of companies report having an independent chairman, lead director or presiding director--a 12 percent increase over a year earlier. Although the percentage of companies reporting that they separated the duties of chairman and CEO in 2005 is fairly low, at 9 percent, that is slightly more than double the 4 percent of a year earlier.

Many experts profess that, along with a system of checks and balances, Sarbanes-Oxley is bringing more attention and concern about ethical behavior to executive suites and boardrooms. "The law made it clear that the CEO and the CFO must sign off on the integrity of the company's financial statements," says Taylor of Oversight Systems. "So if there's a problem, they can't point the finger at someone else."

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Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware, argues that "Sarbanes-Oxley contributes to the overall climate of tougher enforcement and regulation. It has forced people to reconsider their whole approach to corporate governance. It has emphasized the independence of directors and forced people to be more careful how they approach accounting issues."

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One example of the changed climate, Elson says, was the fact that the Delaware Chancery Court agreed to hear the shareholder case against Disney directors who approved the $140 million severance package to ex-Disney executive Michael Ovitz. While the shareholders lost the case--they had alleged that Ovitz's was a sweetheart deal--Elson attributes the "tougher climate" occasioned by Sarbanes-Oxley to "the fact that the case went to trial and that there was potentially personal liability for the directors under state law."

And thanks to Sarbanes-Oxley, public accounting firms now have a full-time overseer in the form of the Public Company Accounting Oversight Board (PCAOB), which routinely monitors the auditors' performance and publishes results on its website. This oversight body has played an important role in bolstering investor confidence in the integrity of the numbers being reported by public companies, argues Nell Minow, the activist president of The Corporate Library and a longtime corporate governance gadfly.

"We still get cases like Refco," Minow says, referring to a recent scandal at the commodities trading company where the CEO is alleged to have misappropriated $300 million. "And we didn't get a conviction at HealthSouth," where former CEO Richard Scrushy was acquitted on charges of fraud. "So is Sarbanes-Oxley working perfectly? No. Was it hastily drafted? Yes."

McDonough Role Praised

But she remains a fan of the law. Minow is especially approving of the leadership at PCAOB exhibited by the board's outgoing chairman, William McDonough, noting that it has engaged in a huge number of investigations. She also praises the PCAOB for acting largely as a bully pulpit, more interested in having accounting firms correct deficiencies than punishing them. In fact, she pronounces the board's work "an unqualified success."

In addition, Minow hails Sarbanes-Oxley for Sections 305 and 1105, little-noted provisions in the law that allow the SEC to keep corporate directors with bad records off a board. "The SEC (Securities and Exchange Commission) used that power to debar the former CEO of Xerox from serving," she remarks.

Alyssa Ellsworth, managing director at the Council of Institutional Investors in Washington, D.C., credits Sarbanes-Oxley for much of the revival of the market for initial public offerings. There were 242 IPOs in 2004, she notes, compared with a mere 83 in the previous year. "It's very hard to measure prevented abuses, but investors have a lot more trust today," she says. "Sarbanes-Oxley has been a good solid step in rebuilding investor confidence."

Patricia Harned, president of the Ethics Resource Center in Washington, D.C., says that one of the results of a recent survey of 3,015 employees is that more and more companies are complying with Sarbanes-Oxley, but the levels of misconduct aren't changing. "I don't think that the law can really solve misconduct," she says.

What does generate ethical behavior, she says, is strong backing for, and observance of, a code of ethics by senior management--what management experts often call "the tone at the top." In the center's sweeping survey, only 37 percent of employees at companies where the executive leadership was committed to ethical behavior reported misconduct at any level in the organization, compared with 87 percent witnessing misconduct at companies where top executives were not so committed.

"That's a huge difference," Harned says of the 50 percentage points separating the two groups. "It tells us that top management can have a dramatic effect on employee behavior at all levels," she says. "But it begins by establishing a code of ethics and then training everyone on the code. And you need a mechanism whereby supervisors and employees can report any misconduct that they see up the line."

Corporate governance advocates continue to see governance weaknesses that Sarbanes-Oxley has so far failed to address. For example, CII's Ellsworth frets not only about what some critics of outsized CEO pay call "executive overcompensation," but the ways in which she says companies can bury that information in SEC filings and effectively shield it from shareholders.

Minow would also like to see shareowners have a greater say in both selecting and vetoing directors on corporate boards, but notes that is largely a matter of state law. "As long as Corporate America has a strangle-hold on the system of electing new directors, we're not going to see any change," she says.

But don't expect much more reform legislation or a spate of SEC rulemaking any time soon, no matter how much it may improve corporate governance. As the Business Roundtable's Lehner asserts, companies are still adjusting to the demands of Sarbanes-Oxley, which continues to demand a lot of time, energy and money. "We don't want to become so preoccupied with checking boxes," he says, "that we become the best-managed but worst-run companies in the world."

Paul Sweeney is a freelance writer in Austin, Texas, and a frequent contributor to Financial Executive. He can be reached at 512.499.8749.

RELATED ARTICLE: takeaways

* Experts say it's hard to make a case, statistically, that the Sarbanes-Oxley Act has had a significant impact on corporate fraud, at least to date.

* However, there is a widespread belief that corporate governance and management attention to tips or complaints are more thorough.

* Rules on director independence are being cited as examples of a new climate around corporate ethics that is likely to help deter fraud or unethical behavior.

* It's widely believed that investor sentiment and trust have improved as a result of the controls and pressures exerted by Sarbanes-Oxley.