404 Delay Goes On; SWF Regulation; More

The ceaseless fight over nonaccelerated companies’ compliance with Section 404 of Sarbanes-Oxley droned on this month, as the Securities and Exchange Commission received a deluge of comments on its proposal to extend the compliance deadline for the auditor attestation part of Section 404.

The SEC published its plan in February, which stated that nonaccelerated filers (those with a market capitalization of $75 million or less) would not need to comply with Section 404(b), the auditor attestation, until fiscal years ending on or after Dec. 15, 2009. That extra year gives the SEC time to study whether the new, relaxed compliance guidelines for Section 404 that the Commission published last summer are helping companies save money.

Large companies have been subject to Section 404 since 2004, but with significantly higher costs than projected when original SOX implementation rules were adopted. Nonaccelerated filers must still comply with 404(a), which requires company management to assess the effectiveness of the company’s internal controls over financial reporting, for fiscal years ending on or after Dec. 15, 2007.

The comment period on the proposed extension ended March 10. Critics, including California Public Employees’ Retirement System and the Council of Institutional Investors, reiterated their fierce opposition to any delay.

The proposed deferral of the requirement “makes the application of SOX 404 requirements less efficient and effective by reducing investor confidence in the assessment completed by management,” wrote Russell Read, CalPERS chief investment officer. The pension giant recommended that the SEC maintain its current requirement that nonaccelerated filers include the auditor attestation in their annual reports for fiscal years ending on or after Dec. 15, 2008.

CII general counsel Jeff Mahoney called the proposal deferral—which would be the fifth one for nonaccelerated filers—“inappropriate.”

“Any company tapping the public markets to raise capital should be required to have appropriate internal controls in place that have been subject to a meaningful review and attestation by external independent auditors,” Mahoney wrote. “That is particularly true for the generally riskier smaller public companies that would be the beneficiaries of the proposal’s deferral.”

Meanwhile, supporters of the proposed extension, including the Office of Advocacy of the U.S. Small Business Administration, the Center for Capital Markets Competitiveness of the Chamber of Commerce, and the Center for Audit Quality, lauded the SEC’s move.

“By further delaying compliance with Section 404(b) for nonaccelerated filers, small businesses will be able to leverage the experience of larger companies and the auditing profession to ensure implementation costs are appropriately minimized,” CCMC Executive Director Michael Ryan wrote. He said the SEC “should remain flexible in setting a 404(b compliance date for nonaccelerated filers based on the progress and findings of the study.”

The CAQ, which also supported the delay, noted that it will allow time for forthcoming guidance from the Public Company Accounting Oversight Board and expected guidance on monitoring control activities from the Committee of Sponsoring Organizations to be integrated into auditor assessments.

The SEC staff is collecting and analyzing “real world” cost-benefit data from companies currently complying with Section 404 under the new rules published last year. The SEC has said the results will inform any future decisions it makes on Section 404 implementation. The SEC expects to complete its research by late summer or early fall.

SEC Official Downplays Growth of SWFs

While the rapid growth of sovereign wealth funds has raised concerns about foreign government investment in the United States, a top SEC official urged lawmakers not to overreact.

If the United States prohibits SWFs from investing in the U.S. market for fear they might exert unwanted political influence, “there is a risk we might actually end up doing precisely this ourselves through the prohibition,” Ethiopis Tafara, director of the SEC’s Office of International Affairs, told two House sub-committees March 5.

Tafara said a better approach would be “to address the underlying issues of transparency, independent regulation, depoliticizing of investment decisions, and conflicts of interest.”

Tafara noted that the SEC already has rules and enforcement tools to address many of the concerns SWFs raise. Such funds are currently estimated to hold more than $2.5 trillion in assets and are forecasted to increase five-fold by the middle of the next decade, he said.

He further noted that SWF investment in the U.S. capital market offers potential benefits to U.S. companies, such as a lower cost of capital and a more liquid market for their securities.

Tafara

He did also acknowledge the concern that foreign governments might not be as eager to help with cross-border securities enforcement if the subject of the probe is the foreign government itself. If the SEC were to pursue wrongdoing by an SWF or a sovereign business and its home jurisdiction didn’t cooperate, Tafara said, “our Commission’s response would be firm.”

Even without cooperation, Tafara said, “We know from experience that market manipulation, insider trading, and other illegal activities that take place in the American market often leave sufficient evidence that the SEC can proceed with an enforcement action against the offender.”

Moreover, ownership by an SWF doesn’t protect a business or investment fund here from liability under U.S. securities law. “It is a well-established principle of American jurisprudence and international law that sovereign immunity does not extend to a state’s commercial activities in another jurisdiction,” Tafara told lawmakers.

SEC Posts Technical Amendments to Some Rules

The SEC has published a final rule that includes technical amendments to several of its rules, including its e-proxy and tender offer rules, to make clarifications, correct and update cross-references, and fix typos.

The amendments clarify that Rules 14a-3(a)(3)(i) and 14a-16(m) don’t permit the use of the notice-and-access model with respect to business combination transactions as defined in Rule 165 under the Securities Act, as well as transactions for cash consideration that require disclosure under Item 14 of Schedule 14A. The SEC also amended the language in Rules 14b-1 and 14b-2 to correct references in those rules.

The adopting release also includes technical corrections to the rules and regulations applicable to takeover transactions and rules relating to cross-border tender and exchange offers to correct cross-references that referred to a schedule that’s no longer in use and to update them to remove a reference to an inapplicable statute, as well as to correct some typographical errors.

Other changes update the SEC’s contact information and amend the delegated authority of the Divisions of Corporation Finance and Market Regulation relating to issuer tender offers.

The amendments are effective upon publication in the Federal Register.

Frank Demand: Stepped-Up Regulation of Financial Services

The Federal Reserve’s bailout of Bear Stearns has prompted calls from Congress to step up regulation of the financial services sector.

In a speech to the Greater Boston Chamber of Commerce last week, Barney Frank, chairman of the House Financial Services Committee, called on Congress to consider establishing—or empowering the Federal Reserve to act as—a “financial services risk regulator” to assess risk across financial markets and to intervene when appropriate.

He also called for lawmakers to consolidate duplicative regulation, to reassess capital, margin and leverage requirements, and to monitor the auction rate securities and municipal bond markets.

Frank unveiled a proposal on March 13 that would provide at least $10 billion in loans to states to address the foreclosure crisis and would expand the Federal Housing Authority loan program to offer guarantees to refinance at-risk borrowers into viable mortgages.

Hearings on the proposal are scheduled for April 9 and 10.