The current financial crisis is sure to bring about a wave of new laws and regulations.  These will have far-reaching and perhaps long-lasting effects on not only financial institutions, but on all firms as well as investors and other parties.  Some are already questioning whether any new regulations will be effective, and whether their benefits will exceed their costs.  I have recently come across a few papers that compare our current environment to the one that existed at the time SOX was enacted – following the collapse of Enron and the bankruptcy of WorldCom.  The authors warn lawmakers about the possibility of adopting bad policy decisions in an attempt to appease current political pressures.  As a side note, the papers I cite here could be a great help to any accounting researchers needing a literature review on SOX, the current financial crisis or financial regulations in general.   As I’m sure many of you know, the special issue of JAR in May 2009 has several papers that address the financial crisis, regulation and SOX.  Regulation and Sarbanes-Oxley, by Oliver Hart, describes why regulation is needed in the contracting process.  He argues that regulation must address some imperfection in the contracting process (he discusses 4 such imperfections).  However, he states that, “rather than being based on sound principles, regulation often seems to be a consequence of the public’s need for action in response to a crisis, and that this was the case with SOX”.  Hart draws an analogy to the current financial crisis.  He indicates that the massive government intervention into the financial sector lacks sound principles, and that “the best explanation for the government’s action seems to be the same as with SOX”.

The second paper, by Lawrence Cunningham and David Zaring, is called The Three or Four Approaches to Financial Regulation: A Cautionary Analysis Against Exuberance in Crisis Response.  It can be found at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1399204.  The authors discuss the three parts of the financial crisis – the market collapse, massive government intervention, and reform – and evaluate three or four likely approaches to reform that will come out of the crisis.  These approaches range from centralized to decentralized government, from sweeping changes to incremental modifications, and address the role of the executive branch and state law.  In the end, the authors’ evaluation of these approaches, “suggests some enduring merits of the traditional US fragmented approach and the accomplishment of extensive reforms to it that significantly concentrated the structure of US financial regulation”.

The final paper, by Roberta Romano of Yale Law School, is called Does the Sarbanes-Oxley Act Have a Future? This paper can be found at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1404967.  In this paper Romano notes that the enactment of SOX received nearly unanimous congressional support, but after only a few years its critics had grown in number and intensity, with the intent to make serious changes to the legislation.  Among the foremost criticisms of SOX are the burdensome regulatory cost, the disproportionate impact on smaller public firms, and the weakening in the competitiveness of U.S. capital markets.  Romano further argues that “the core lesson to be learned from federal financial market regulation is that modification or repeal of poorly conceived legislation can take years, if not decades, to accomplish, despite the best judgment of those best informed – the academic and business community – that the legislation is, in significant parts, profoundly flawed”.  She draws a parallel to the current financial crisis, noting that Congress appears to be preparing for more sweeping changes to the regulatory framework of financial institutions.  Instead of coming to the realization that SOX didn’t prevent the collapse of many financial firms over the past year, Romano states that Congress has merely moved SOX down on the priority list while it deals with the current crisis.  She concludes that it will take considerable time before SOX is revised and that this should serve as a cautionary tale in attempts to overhaul the regulatory framework of financial institutions.

In times of crisis, are policy makers simply expected to act?  Or are they expected to fix the problem?  It appears that many parties demand the former, but we all hope for the latter.  Perhaps only hindsight, available at some future date, will allow us to evaluate the merits and failings of any regulatory reforms coming out of the current crisis.