Better Accounting:Need of the hour

History shows Sarbanes-Oxley Act was not successful in controlling Financial scams. It costed too much money without being able to control Accounting malpractices like Satyam scam(NYSE:SAY) and Madoff scandal. I believe there are still large number of such scams yet to be disclosed.

I think following are the reason for its failure:

• The Act was too much inefficient in its implementation. It depended on too much documentation. When you have too much documents to create for a small and simple process change you become frustrated and the quality of data takes its toll. You just reuse a previously created document and change the name,date etc. and save it as a new version. You may ignore the fact that the facts and figures may have changed with time and those changes need to be documented properly. With the progression of hierarchy the number of documents to review increases enormously and it becomes quite impossible to review the documents for its truthfullness. It is even more difficult for the external parties(like analysts, auditors etc.)to review the correctness as they have even less time to review and less information about the company operations.This weakness has been exploited by dishonest company executives many of te times. This caused multiple cases of accounting scandals and completely wrong credit rating information.
• US government(and consecutively other governments) allowed huge amount of Capital transaction Over-the-Counter(OTC) and through unregulated Hedge funds and Private Equity Flows. These industries have multiple weakness: Huge unaccounted money transfer, Highly inefficient Asset management Fees and Speculative Highly Levereged Transactions causing systemic risks. At the same time this creates an ethical problem of double standards: Mutual Fund companies are regulated but Hedge Fund Companies are unregulated; although both are typically in the same business.

To solve the problem the governments(it should be a coordinated effort of all the governments throughout the world) should work on two things:

• We need to invent a better way of accounting to minimise the frauds. We need to minimise unwanted documentation but capture correct,reviewable and verifyable Data items standardized across the board. Also to minimize manual effort we can create Automated Business rule process for Data Validation etc.
• Standardized and uniform regulation, more conservative reserve requirements, controlling (at least regulating) the Hedge Fund and OTC Market transactions.