A House subcommittee held a hearing to examine the impact of the Sarbanes-Oxley Act of 2002, which marks its 10th anniversary this coming Sunday.
The law was passed in the wake of the Enron, WorldCom and Tyco accounting scandals and the demise of Big Four accounting firm Arthur Andersen. Among other things, it created the Public Company Accounting Oversight Board, mandated requirements for outside audits of internal controls, and included provisions for auditor independence, audit partner rotation, enhanced financial disclosures and senior executive sign-off of financial reports.
“The requirement that CEOs and CFOs personally certify their company’s financial statements is the crown jewel of Sarbanes-Oxley,” said Financial Executives International president and CEO Marie Hollein in testimony Thursday before the House Financial Services Capital Markets and Government-Sponsored Enterprises Subcommittee. “This personal responsibility sets the tone from the top, increasing accountability and driving better corporate governance.”
Michael J. Gallagher, chairman of the Center for Audit Quality’s Professional Practice Executive Committee, pointed out that Sarbanes-Oxley provided benefits such as strengthened audit committees and corporate governance; enhanced auditor independence; improved transparency and accountability for financial reporting, in part through new requirements for public companies and their auditors focused on internal control over financial reporting; and independent oversight of the audit profession by the PCAOB. While the compliance costs have been high for many companies, especially initially, the costs have declined significantly since SOX was first implemented, he noted.
“We believe the Act has been successful in achieving its objectives,” said Gallagher. “In many ways, it has also set new standards for corporate governance and auditor oversight that many other jurisdictions around the world have embraced. Also, we continue to examine ways to build upon the successful reforms of the Act to enhance financial reporting and audit quality and promote greater investor protection.”
University of Mississippi law professor Mercer Bullard believes that the law’s greatest contribution was the creation of the PCAOB. “The PCAOB has directly addressed the insidious lack of independence in the self-regulation of accounting under which no major accounting firm had ever been issued an adverse or qualified report,” he said. “In its brief history, the PCAOB has identified hundreds of accounting deficiencies in almost 2,000 inspections of firms’ quality controls. It has appropriately exercised its authority to resolve issues with these firms and, when necessary, to conduct investigations and commence enforcement proceedings. The PCAOB has made significant improvements in the standard-setting process while working assiduously to consider the interests of all affected parties, including especially small businesses. I strongly encourage Congress to continue to support the work of the PCAOB and afford appropriate deference to its independent, expert judgment.”
Not everyone is fond of celebrating Sarbanes-Oxley, though. John Berlau, a senior fellow at the Competitive Enterprise Institute, which was involved in challenging the constitutionality of the PCAOB before the Supreme Court, told the subcommittee, “This hearing marks the occasion of the 10th anniversary of the passage and signing of SOX, and I must confess that on past anniversaries of this law, I had not found much to celebrate. I had looked at the cost burden of just one section of this law, the internal control mandates of Section 404, originally estimated by the Securities and Exchange Commission to cost a public company an average of $92,000 per year. The SEC has recently said that this burden is more like an average of $2.3 million per year. And the worst part is that the SEC has found that the cost burden for smaller companies is still more than seven times greater that than that imposed on large firms relative to their assets.”
Berlau said Congress should get rid of Section 404 and other onerous SOX provisions for all public companies. But he added that he is encouraged by the recent passage of the JOBS Act, which would relax some of the Sarbanes-Oxley requirements for so-called “emerging growth companies.”
“All in all, with the JOBS Act passage, there is reason to celebrate SOX’s birthday this year, and I and thousands of investors and entrepreneurs who are little less burdened by this law are ready to break out the birthday cake and champagne,” said Berlau.
Columbia University law professor John C. Coffee Jr. criticized the JOBS Act as an overreaction to accusations that Sarbanes-Oxley regulations have discouraged companies from going public. “The perception that overregulation is responsible for the decline in IPO volume has strong adherents and was obviously the motor force for the JOBS Act that passed earlier this year,” he noted. “Although I believe that some provisions of the JOBS Act were reasonable in updating or streamlining existing exemptions, I regard other aspects of the JOBS Act as a major retreat from our longstanding commitment to principles of transparency and full disclosure. What has been the impact of the JOBS Act? Of course, it is too early for any serious assessment. But already there is anecdotal evidence that it is attracting to the U.S. offerings that other markets would not list."
Coffee cited the approaching IPO of the British soccer team Manchester United. "Other jurisdictions would not permit Manchester United to list ‘dual class’ shares that effectively disenfranchised public shareholders," he pointed out. "The shares held by the public in Manchester United will have only one tenth the voting rights per share of the shares held by the control group. The U.S.’s willingness to list shares that do not carry full voting rights plus the exemptions available to emerging growth companies under the JOBS Act appears to have won the U.S. this offering. Nonetheless, it may have been a Pyrrhic victory, and other nations are mocking the U.S.’s success. A recent story in the New Zealand Herald notes that, under the JOBS Act, Manchester United is classified as an ‘emerging growth company,’ even though it is 134 years old and has been steadily operating at a loss. A leading Singapore paper has praised the Singapore Exchange for not lowering its standards to those of the U.S. Should the U.S. be proud of its achievement? The Manchester United offering will not create jobs in the U.S. (as the issuer is a British sports team), but it does suggest that the U.S. is actively competing in a race for the bottom.”
Vitae Pharmaceuticals president and CEO Jeffrey S. Hatfield testified on behalf of the Biotechnology Industry Organization, about the expenses of an IPO since Sarbanes-Oxley. He pointed to a 2011 survey conducted by the IPO Task Force in which 86 percent of CEOs cited “accounting and compliance costs” and 80 percent cited “SOX and regulatory risks” as key concerns about going public.
“Biotech companies that would otherwise look to the public market to fund their late-stage trials are reconsidering, fearful of the costly regulations that often stifle their progress by siphoning off research dollars,” he said.
“In the biotech industry, an informed investor is a good one,” Hatfield added. “However, the information that these investors want and need does not always align with what is required by SOX. Section 404(b) requires an expensive external attestation of a public company’s internal controls, to be disclosed to investors on an annual basis. The true value of a biotech company is found in scientific milestones and clinical trial advancement toward FDA approvals rather than financial disclosures of losses incurred during protracted development terms.”
