Sarbanes-Oxley No Panacea For DO Insurers

The Sarbanes-Oxley Act hasn't cleaned up the accounting practices of corporate America enough to improve loss costs for directors and officers liability insurers, an accounting expert said here yesterday.

The legislation, officially known as The Public Company Accounting and Investor Protection Act of 2002, set rules of corporate governance and financial disclosure for public companies, as well as penalties for executives involved in corporate fraud, in the wake of large corporate meltdowns like Enron.

But while Sarbanes-Oxley (SOX) “has cleaned up some of the transparency and quality of earnings issues,” it's also creating some new ones, according to Marc Siegel, director of research for Rockville, Md.-based CFRA, a forensic accounting firm.

“I don't think [directors and officers liability insurers] are safer from losses as a result of SOX,” he told roughly 1,400 D&O brokers, underwriters and litigators and the Professional Liability Underwriting Society D&O Symposium in New York.

Mr. Siegel said “accounting games” typically start when the economy is bad, and if there is a downturn SOX will be revealed as no panacea.

In particular, he said that while companies have become more diligent and transparent about quality of their reported earnings, they are also highlighting different components of their results–other than earnings–as evidence of their well-being to investors.

“They're saying, 'Look at our cash flows, [which] are really strong'…because there's more discretion on cash flows. You don't have to be transparent.”

Public companies are also talking about “other metrics,” like same-store sales, he said. “Those aren't even accounting metrics. Auditors don't look at those [and] SOX doesn't cover them.”

“We're seeing metrics management rather than earnings management,” Mr. Siegel said.

If investors, analysts and underwriters are making decisions based on results a company is portraying with these new metrics–and if those results are manipulated or managed in any way–then “you'll continue to see [D&O insurance] problems,” he advised.

Greg Flood, chief operating officer for National Union, a unit of New York-based American International Group, said he believed the “regulatory zeal that came out of Enron, WorldCom” and other meltdowns “really created more securities claims” than SOX prevented.

“In our business, we're insuring the frailty of decision-making [and] the frailty of human nature, [and it's] more than likely that somebody's going to fail,” he said. “So I'm not so sure, as an insurer, that SOX has been a lot of help.”

He also observed that prior to SOX the U.S. exchanges were getting a lot of listings of American Depository Receipts from foreign companies. “Last year, only 10 percent of all foreign companies accessed capital markets here in the United States. The complexities of SOX were just too daunting,” he said. Other speakers suggested that foreign issuers were better risks from a D&O underwriter's perspective.

At an earlier session, Susan Muck, a defense lawyer for Fenwick & West in San Francisco, highlighted “the proliferation of internal investigations at public companies” as an “unintended consequence” of Sarbanes-Oxley that will “have a dramatic impact” on D&O insurers.