Sarbanes-Oxley Section 404 and Its Administrative Legacy

Abstract

The passage of the Sarbanes-Oxley Act of 2002 was a watershed moment in U.S. financial history, and Section 404 is the most contested and expensive provision within the Act. Since the passage of the Act, an army of academic scholars have studied the various economic effects of Section 404, relying on sophisticated event study designs. Thanks to these studies, we now know a great deal about Section 404, even though scholars continue to debate about the provision’s overall welfare implications. Less well-known, however, is the administrative history of Section 404—namely, the experience of the U.S. Securities and Exchange Commission (SEC) in implementing Section 404. Twenty years ago, when the SEC set out to implement Section 404 provisions as rules, the agency came up against a novel set of challenges: it confronted a number of administrative questions of first impression. The variety of issues the SEC had to wrestle with presaged larger administrative issues the agency would go on to address in the coming decades. In fact, many of the challenges and the conundrums presented by Section 404 rules were not fully appreciated until those issues surfaced again in subsequent statutes, such as the Dodd-Frank Act of 2010 and the JOBS Act of 2012. But it was the Sarbanes-Oxley Act—and Section 404 in particular—that really forced the agency to deliberate on a number of thorny issues and prepared the agency for more storms to come. In this sense, Section 404 left behind an indelible administrative legacy for the SEC. The SEC has become a far more seasoned agency in terms of dealing with mandated rulemakings, proceeding cautiously with its given parameters, considering costs and benefits of its rules and regulations, and understanding the dynamics of the notice-and-comment rulemaking process. This Article—prepared for the Sarbanes-Oxley at Twenty Conference—reviews the SEC’s administrative history of implementing Section 404 and highlights these larger administrative questions. In so doing, the Article discusses how the agency learned from its early challenges.

Keywords: Sarbanes-Oxley; Section 404; Securities And Exchange Commission; Administrative Law; Cost-Benefit Analysis; Financial Regulation; Agency Rulemaking; Corporate Governance; Notice-And-Comment Rulemaking

JEL Classification: K2, K22, K23, D61