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I swear… Oaths are only a small step in the business of cleaning up American companies

THIS week, hundreds of chief executives and chief financial officers at the biggest American companies have undertaken a curious task. They have sworn in front of a notary that, "to the best of my knowledge," their latest annual and quarterly reports neither contain an "untrue statement" nor omit any "material fact." Some goody-goodies such as ExxonMobil, Oracle and Federal Express rushed to get their oaths in early. Others waited until the last minute.

More is to come. The oath is a one-off, but the Sarbanes-Oxley act, rushed into law at the end of July, will require many more chief executives and CFOs, including (to their irritation) foreign companies quoted in New York, to certify at regular intervals that both their reports and their financial statements contain no untruths and omit no material facts.

As a way of reassuring a sceptical public that chief executives are truthful, all this has a certain primitive charm. Voters, in the run-up to the midterm elections, certainly feel a sense of primitive fury. Every week seems to unearth another bunch of beasts in the boardroom who have made fortunes while destroying much of the value of the nation's mutual funds and 401(k) pension schemes. A troupe of grotesque characters have convinced many investors that company bosses are a greedy and dishonest bunch: Linda Wachner, say, now suing Wamaco, the company she bankrupted, to be treated as a preferred creditor for a multimillion pay-off, or Dennis Kozlowski, who extracted the cost of a $6,000 gold-and-burgundy floral-patterned shower curtain and much, much more from the unfortunate shareholders in Tyco.

An oath, with its touch of mediaeval mysticism, certainly concentrates the mind. And it narrows the legal loophole that has allowed chief executives such as Jeffrey Skilling of Enron and Bemie Ebbers of WorldCom to protest that they had no idea — no idea — that their finance chaps were fiddling the figures. Given that a fifth of CFOs have apparently said that their chief executives had put pressure on them to misrepresent their results in the past five years, this stretches credulity.

Something must be done

However, if the Skillings, Ebberses and their sort didn't know what was going on down in the finance department, they certainly should have done. After all, accounting fraud is already a crime. Indeed, the very suggestion that the 950 or so bosses making these new declarations might previously have allowed their firms to publish reports that — to the best of their knowledge — contained untrue figures or omitted material facts ought to alarm investors, not calm them. If this is the true state of things, something more radical is needed. Yet the danger is that this week's oaths and Sarbanes's certificates may create the impression that enough is now being done.

The main impact of certification is likely to be the establishment of a paper trail, to show that top brass has signed off on reports and accounts. Other aspects of the Sarbanes-Oxley legislation will matter more, such as the act's ban on subsidised personal loans to top executives and its insistence on prompt disclosure of share dealings to repay company loans. Most important are likely to be proposals that toughen the audit process, such as the insistence that accountants rotate the audit partner overseeing a firm's accounts and that auditors can no longer sell certain non-audit services to audit clients.

The new five-member board to oversee the accounting industry is also potentially powerful — as long as it acquires members of the calibre of Paul Volcker, a former chairman of the Federal Reserve Board, and Chuck Bowsher, a former Comptroller General, rather than a pack of industry poodles. Auditors have too often chosen to ignore skeletons in corporate cupboards. A forthcoming survey by CFO, a sister magazine of The Economist, finds that auditors had challenged practices at 38% of respondents in the past year-but that in 57% of cases, the company persuaded the auditor to accept the questionable practice. That is too many for comfort.

Yet audit reform, although crucial, is not enough. Too little in the new legislation will change behaviour. The desire to take action fast has resulted in missed opportunities. As Nell Minow, a corporate activist, likes to point out, federal law has much less to say on the duties of company boards than on day-care centres. Here was a missed chance to encourage states to compete to protect shareholders' rights with light but effective rules, by allowing shareholders, rather than executives, to pick the state in which a company is incorporated.

Here too was a missed chance to make it easier for shareholders to put up candidates as board directors, and thus discourage powerful chairmen from choosing their suppliers and golfing chums for the job. That would prevent the sort of thing that happened at Tyco, whose compliant board granted Mr Koziowski a contract saying that conviction for a felony that did not directly injure the company would not be grounds for dismissal. And here was a lost chance to infuse real transparency and meaning into the role of institutional investors, by insisting that they disclose their proxy votes. That would discourage behaviour such as that of Deutsche Asset Management, which had a business relationship with Hewlett-Packard and switched its vote on the HP-Compaq merger in HP's favour at the last minute.

Quick legislation is usually bad legislation. The Sarbanes act may be better than most. But its impact will be mild, compared with two other forces. One is that of example. White-collar crime rarely results in prison, still less in long sentences. Simply seeing a few CFOs go, handcuffed, to court has already had an electric effect in comer offices. The other is that of investors. It was investors, with their relentless hunt for double-digit earnings growth, who encouraged executive fiddling in the final years of the stock-market bubble. Now, when some companies have decided to treat stock options as expenses, the value of their shares has risen. Others have acquired new executives who boast of their integrity. If the market comes to admire honesty, transparency and good corporate governance, executives will rush to acquire those characteristics. Even in morality, the market rules — in the end.

The Economist