Foes Aim to Limit Company Oversight
A federal panel’s proposal that smaller public companies should be shielded from certain rules meant to keep their books squeaky clean is the latest shot in a growing rebellion against corporate reforms.
The final report by the Securities and Exchange Commission’s Advisory Committee on Smaller Public Companies is scheduled for release today.
Although the SEC is not expected to endorse the proposals, the recommendations underscore widespread unhappiness with rules that are intended to guarantee accurate financial reporting and maintain better records of internal accounting procedures.
Smaller public firms, many of them in the high-tech industry, have complained of ambiguous regulatory demands and high compliance costs.
“It’s hurting American competitiveness,” contends Rep. Tom Feeney (R-Fla.). “It’s hurting job creation. It’s hurting investors. And I think we’re going to have to fix it.”
Regulators approved the rules after Congress passed the Sarbanes-Oxley corporate reform law at the height of the Enron Corp. scandal in 2002. But the backlash goes further. For example, critics have taken the SEC to court over a rule that would require mutual funds to have independent chairs and another requiring hedge fund advisors to register with the agency.
Beyond that, an alliance of free-market conservatives is mounting a legal challenge to Sarbanes-Oxley itself, asserting that the provision creating a new regulatory board to oversee accounting is unconstitutional. The advocates have enlisted legal heavyweights for their cause, including Kenneth W. Starr, the former independent counsel who investigated President Clinton.
Although their narrow target is the Public Company Accounting Oversight Board, there is little question that they wish to peel back much of the regulatory framework imposed on corporate America in recent years. If their legal quest succeeds, the Sarbanes-Oxley law would end up back in Congress, where it could face calls for other revisions.
“Our court challenge is part of a larger effort to push back on overregulation in our capital markets and advocate for much-needed reform of Sarbanes-Oxley,” said Mallory Factor, chairman of the Free Enterprise Fund, a conservative advocacy group and party to the lawsuit.
By virtually all accounts, there is little political will to throw out the law that remains the government’s marquee response to a wave of corporate scandals that destroyed people’s life savings and rattled the nation’s faith in the integrity of financial statements.
Sarbanes-Oxley increased corporate disclosure requirements, restricted board members’ conflicts of interest, required top officers to certify their company’s financial statements and -- in a provision that was guaranteed to get the attention of top executives -- ratcheted up prison terms for fraud.
Indeed, the continuing criminal trial of former Enron honchos Kenneth L. Lay and Jeffrey K. Skilling is just one reminder of the widespread lapses that led to Sarbanes-Oxley and a government crackdown on fraud.
“I think the law is working as intended,” Sen. Paul S. Sarbanes (D-Md.) recently told the Consumer Federation of America, adding: “Our corporate governance practices are changing for the better.”
Moreover, the latest evidence suggests the costs of compliance have declined as companies adapt to various mandates that have kicked in over the last few years.
Last week, for example, consulting firm CRA International reported that Sarbanes-Oxley costs plunged 44% in the second year for the largest public corporations to an average of $4.8 million. The cost for smaller firms, with sales of $75 million to $700 million, dropped 31% to $860,000.
“My perspective would be they definitely are learning to live with it,” said Nicholas DiFazio, Deloitte & Touche’s partner for regulatory matters. “As companies get two to three years of experience, the costs are coming down.”
Beyond that, he said, shareholders are winners when companies keep their financial houses in tip-top shape, and the firms themselves sometimes discover billings they have neglected to make. “You get a group of our partners on the phone, and [these stories] are numerous,” he said.
Nonetheless, those who argue that regulation has gone overboard are mounting a series of strategic attacks.
A key target of the SEC’s Advisory Committee on Smaller Public Companies is Section 404 of Sarbanes-Oxley, which deals with internal controls that address such matters as the accurate recording of sales.
For instance, as it prepared the final draft of its report last week, the advisory panel endorsed a proposal that exempted all but the largest public companies from a requirement that they enlist independent auditors to affirm that they are fully complying with the internal control rules. The measure would exempt 80% of public companies.
Previously, the panel called for a broader exemption from Section 404 mandates for a tier of the smallest public companies.
“Larger companies can afford to suffer through some of these burdens, but it can be disastrous for medium and smaller companies,” said Feeney, who may sponsor legislation on the matter if regulators do not take up the advisory panel’s recommendations.
The SEC has promised to seriously consider the advisory group’s recommendations. But some commissioners, including Chairman Christopher Cox, have expressed doubts about giving small companies a complete pass on internal control requirements. Rather, the SEC is more likely to come up with modifications for small companies that stop short of what the advisory panel proposed.
“You really don’t need the same framework for a mom-and-pop operation as you do for General Electric,” said Harvey J. Goldschmid, a former SEC commissioner and professor at Columbia University Law School. “That being said, there is a need for internal controls at all companies.”
Meanwhile, a legal challenge to a central provision of Sarbanes-Oxley is moving forward, with filings next month and arguments set for June in U.S. District Court in Washington.
The legal argument, brought by free-enterprise advocates and Beckstead & Watts, a Nevada accounting firm, is that the Public Company Accounting Oversight Board -- created under Sarbanes-Oxley after auditors failed to prevent a battery of financial scandals -- is unconstitutional. They say members of the board should be appointed by the president, not the SEC, because the board performs an executive function in its oversight of the accounting industry.
In fact, the oversight board is the lever they hope to use to prompt a full-scale review of the law that created it.
“It’s aimed at Sarbanes-Oxley,” Factor explained, noting that legal success would send the law back to Congress for revising, potentially reopening broader debate on many issues related to the law.
“We’re not against transparency. We’re not against the bad guys going to jail,” he said. “But putting these huge, burdensome costs on business, making us uncompetitive in financial markets -- give me a break.”
Those more sympathetic to the regulatory regime dispute that assessment, but not the fact that the lawsuit has the potential to reverberate through the SEC and beyond.
“They’re shooting at the heart of Sarbanes-Oxley in very important ways,” Goldschmid said. The accounting board “is a critically important provision. This is no small change.”
