Sarbanes-Oxley Smackdown on Record Labels

The Sarbanes-Oxley Act of 2002, which goes into effect on November 15, was passed in the wake of the Enron accounting scandal. Interestingly, it will have profound ramifications for the recording industry according to an essay by Richard Menta:

The Sarbanes-Oxley act was designed to protect investors by improving the reliability of corporate disclosures. It places very stringent reporting conditions with criminal penalties for executive management and the board of directors if they fail in their due diligence in providing accurate and fair information.

Due Diligence

“Due diligence” is they key word here. Before Sarbanes-Oxley, one would have to prove outright fraud on the part of executive management before some legal action could be taken. With Sarbanes, the standard has been lowered greatly. The firm’s books now have to be perfectly transparent and orderly. If they aren’t, the CFO, the CEO and members of the board of directors will be in violation of the law and can go to jail.

And when the government says orderly it means orderly. Publicly traded corporations now have to account for every single penny and that accounting has to be perfect with easily accessible records for audit purposes. The point of all this is so that there is absolutely nothing hidden from investors who risk their savings nor are there any practices that might mislead them with regards to the actual income that the company honestly generates.

The real kicker of this law is section 404, which requires the CEO and CFO to sign off that they know – not think they know, but know for certainty – that the numbers are accurate. That signature holds them personally responsible for any deficiencies in the company’s financial statements..

The criminal penalties for executive managers and board members who fail in their due diligence are severe. The maximum fine ranges from $1 million to $5 million with a maximum prison term of from 10 to 20 years.

A lot of pensioners lost their money in the Enron scandal. They wanted blood and the Sarbanes-Oxley Act gave it to them. Companies must begin to comply with the new amendments for their first fiscal year ending on or after Nov. 15, 2004.

The Record Industry and its Artists

There have been many accusations over the accounting practices employed by the record industry. That will stop now for all of the publicly traded labels. It will also stop for the one privately owned major label Bertelsmann. Even though technically Bertelsmann does not have to comply with the act (it only applies to publicly traded firms) and is not subject to its criminal penalties, Sarbanes-Oxley sets a standard known as best practice which potentially can be used against them in civil court down the road.

How can artists utilize this law? Let’s take Courtney Love as an example. She has been battling the record labels for years, claiming they have been systematically cheating her of the full money owed to her.

After Nov 15th, her record label’s books must be in order and must be able to provide her with an accurate statement of the true revenues, expenditures and pay outs regarding her music. Automatically, her proper reimbursement should come in.

The good news is it probably will.

But if she feels that there are still shenanigans going on, here is where it gets interesting.

Theoretically, Courtney can buy one share of stock in her label and then attend the next stockholders meeting. There, she can state that her experience with her own account with the company leads her to believe there is deception about. Then she accuses the entire board, the president and other executive managers of failure to comply with the Sarbanes-Oxley Act.

Remember, the requirement here is due diligence. Even accidental failure to comply subjects executive management to fines and jail time because they failed the diligence requirement. That requirement was a response to Enron’s CEO’s claim that he didn’t know what was really going on. Today a CEO better know what’s going on or they go to jail for recklessly exposing their company – and its stockholders – to unnecessary risk.

Once Courtney makes her claim she can demand an external audit at the company’s expense to prove the accounting is solid. This will include an audit of her account where she saw the symptoms that lead to her accusation.

If the numbers prove faulty, she as a stockholder can order the arrest of the entire board and executive management for failure to comply with the Sarbanes-Ocley Act. Furthermore, the Act opens it up for her to pierce the corporate veil and personally sue these same executives in civil court.

See how powerful the new law is. Now multiply Miss Love with the many other artists who feel they are being cheated and you have one heck of a class action suit. A suit that can go after the personal assets of each and every board member.

Needless to say, the executives will not let it get that far. With the corporate protections stripped away, self-preservation will become the rule. The numbers that Love so desperately tried to pull from her label should now become fully accessible as will those of other artists.

Sic ’em, artists – I bet we’ll see “voluntary” changes to label accounting practices just prior to November 15 – coinkydink? You decide.

More on record industry accounting practices here, here, here and here.