Congress Goes Full Bore on Governance Legislation

Executives who worry about corporate compliance or governance should be watching Congress closely right now: No matter what your particular responsibility is, Washington seems to have plans for you.

Within the last several weeks, multiple bills have emerged in both the House and Senate to overhaul corporate governance, executive compensation, regulatory enforcement, and regulatory oversight of the financial sector in particular. Passage of any final legislation is probably still months away, but lawmakers and lobbyists are working hard on the details now.

Pincus

“There are a huge number of important issues in play,” says Andrew Pincus, a partner in the law firm Mayer Brown. “They’re all on the table in a very significant way, and companies trying to figure out what the landscape is going to look like have to recognize that many or all of them could be contained in some final bill.”

Most notable is the House version of the proposed Investor Protection Act. Approved by the Financial Services Committee on Nov. 4, the bill would permanently exempt non-accelerated filers from Section 404(b) of the Sarbanes-Oxley Act, which requires public companies to get an auditor’s attestation for their internal controls over financial reporting.

Large companies have had to comply with Section 404 since 2004. Smaller companies, however, have dodged compliance thanks to a series of extensions from the Securities and Exchange Commission. When the SEC granted another extension in October and forcefully said that would be the last one, SOX critics in Congress promptly inserted language into the Investor Protection Act to do an end-run around that pronouncement.

The legislation also directs the SEC and the Comptroller General to conduct a study to determine how the SEC could reduce Section 404 compliance costs for companies with market capitalizations from $75 million to $250 million.

The Section 404(b) exclusion exists as an amendment to the proposed Investor Protection Act, and could well be stripped out as the bill seeks full House and Senate approval. Even if it does survive, all public companies will still need to comply with Section 404(a), which requires management to review and disclose the effectiveness of internal control over financial reporting. Large filers will still need to comply with Section 404(b) as usual.

SEC officials declined to speak about the possible exemption directly, but Chairman Mary Schapiro has written to U.S. Rep. Paul Kanjorski, chairman of the sub-committee on capital markets, to argue that SEC studies have shown that investors have greater confidence in financial reports when a Section 404 audit is performed.

The Dodd Bill “represents the federalization of corporate law and puts in place a one-size-fits-all governance structure that runs counter to 150 years of corporate existence in the United States.”

—Tom Quaadman,

Director,

Center for Capital Markets Competitiveness

And Commissioner Luis Aguilar gave a spirited defense of Section 404 last week, calling an exemption as “inconsistent with the objectives of reform that strengthens investor protection.” If the House bill passes in its current form, he said, more than 6,000 public companies could be exempt from the auditor attestation requirement.

Section 404 aside, the bill includes numerous other notable provisions. It would grant the SEC greater enforcement powers and increased funding, and create a bounty program for corruption whistleblowers. It would also reaffirm SEC authority to require shareholder access to the proxy statement, to thwart any lawsuits that might be filed against the Commission when it unveils a proxy access rule sometime early next year.

The usual groups have voiced the usual praise and complaint about the legislation: Corporate lobbyists supporting the Section 404(b) exemption while denouncing proxy access, investor advocates taking the opposite stance. And conspiracy theorists are already hard at work speculating on some sort of quid pro quo, where the White House gave its quiet blessing to the Section 404(b) amendment in exchange for proxy access.

FASB Under Fire

An entirely separate bill, the Financial Stability Improvement Act, did prompt corporate and investor advocates alike to line up in strong opposition to another idea: taking oversight of the Financial Accounting Standards Board away from the SEC and giving it to a new, still-uncreated systemic risk regulator.

That idea has many corporate accounting types worried about FASB’s independence. In a joint letter from the U.S. Chamber of Commerce, the Center for Audit Quality, and the Council of Institutional Investors—three names that rarely agree on any corporate governance reforms—they warned that by putting FASB under the jurisdiction of a systemic risk regulator, accounting rules will be viewed though the “narrow lens of a few large companies from specific industries.”

THREE JOIN FOR INDEPENDENCE

Below is an excerpt of the letter from the U.S. Chamber of Commerce, the Council of Institutional Investors, and the Center for Audit Quality to the House Financial Services Committee on proposed changes to FASB oversight:

Dear Chairmen Frank and Kanjorski and Ranking Members Bachus and Garrett:

As representatives of key stakeholders in the U.S. capital markets, we are writing to

discourage the Committee from taking actions that would potentially impact the

independence of accounting standard setting. As the Committee considers reforms to the

U.S. financial system as part of the Financial Stability Improvement Act of 2009 (H.R.

3904), we are concerned with recent proposals that would realign the oversight of the

Financial Accounting Standards Board (FASB) within the structure of systemic risk.

We believe that interim and annual audited financial statements provide investors and

companies with information that is vital to making investment and business decisions. The

accounting standards underlying such financial statements derive their legitimacy from the

confidence that they are established, interpreted and, when necessary, modified based on

independent, objective considerations that focus on the needs and demands of investors – the primary users of financial statements. We believe that in order for investors, businesses and other users to maintain this confidence, the process by which accounting standards are

developed must be free—both in fact and appearance—of outside influences that

inappropriately benefit any particular participant or group of participants in the financial

reporting system to the detriment of investors, businesses and capital markets. While

dialogue and input between standard setters and all stakeholders might be improved, a

realignment of oversight within the structure of systemic risk regulation could have adverse

impacts on investor confidence, which is of critical importance to the successful operation of

the U.S. capital markets.

In adopting the Sarbanes-Oxley Act of 2002, Congress recognized the benefits of having

accounting standards set by an independent body and established a process for the

establishment and oversight of financial reporting policy. In doing so, Congress designated

the Securities and Exchange Commission (SEC) as the primary agency with oversight over

accounting standard setting, given the important role accounting standards play in the

Commission’s mission to protect investors, maintain fair, orderly and efficient markets, and

facilitate capital formation. Efforts to place oversight of, or significant influence on, the

FASB in another entity whose primary focus is not to serve the interests of investors and the capital markets runs the risk of impeding the FASB’s ability to promulgate and issue

standards for financial reporting that faithfully represent the economic activity of business

transactions and provide information that meets the needs of investors and companies for all

sectors of the economy.

By placing the FASB under the jurisdiction of a structure charged with managing systemic

risks to the financial markets, accounting rules will be viewed though the narrow lens of a

few large companies from specific industries, rather than considerate of the applicability of

financial reporting policies to over 15,000 public companies. Such a narrow focus can skew

standards such that it makes understanding of transactions that businesses engage in on a

daily basis more difficult and undermine the confidence of investors. We believe that the

SEC has been and continues to be best suited to provide the oversight of the FASB for such a broad and diverse economy.

As such, we strongly support an independent standards-setting process, subject to public

scrutiny and free of undue pressures. The economic crisis only increases the need for

procedural safeguards to protect against interventions that, while well-intentioned, are

ultimately misplaced. Procedure, appropriate oversight and independence are important to

ensure the legitimacy of the standards-setting process, and to protect the goals of

transparency, relevance, and usefulness in financial reporting that are critical to the success

of the U.S. capital markets.

We would welcome the opportunity to respond to any questions you may have.

Source

U.S. Chamber of Commerce, CII, and CAQ Letter (Nov. 3, 2009).

The House Financial Services Committee is scheduled to continue the markup of the Financial Stability Improvement Act this week.

Senate Bill

The Senate outlined its own ideas for reform in a draft bill unveiled Nov. 10 by U.S. Sen. Christopher Dodd, chairman of the Banking Committee. That plan (which runs more than 1,100 pages) calls for the SEC to become self-funded through fees it imposes on the registrants it oversees. SEC commissioners have been clamoring for that reform for years.

Dodd’s bill also includes a litany of corporate governance reforms: shareholders advisory votes on executive compensation (that is, say-on-pay votes) and on severance packages for top executives; shareholder access to the proxy statement; compensation committees comprised entirely of independent board directors; and clawback policies for executive pay rewarded based on inaccurate financial statements.

The bill would also create a new Consumer Financial Protection Agency that would consolidate the consumer protection responsibilities of six existing agencies and would establish a new Agency for Financial Stability, responsible for identifying, monitoring, and addressing systemic risks posed by large, complex companies, products. It also calls for a single federal bank regulator, the Financial Institutions Regulatory Administration, and would give the SEC and the Commodity Futures Trading Commission joint authority to regulate over-the-counter derivatives.

Quaadman

Tom Quaadman, director of the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness, says the Chamber’s biggest concerns among the proposed reforms are the proposed Consumer Financial Protection Agency, the one-size-fits all corporate governance rules—particularly, the push for a federal proxy access rule—and the proposed creation of a systemic risk regulator that could designate some institutions as systemically important.

“What we’re faced with would not eliminate regulatory dead zones or do away with regulatory arbitrage, but in fact would make it worse, creating more agencies and in some cases duplicate or triplicate regulation,” he says.

Indeed, Quaadman says the Senate bill’s approach to governance is even more troubling than the House’s bill. The House bill merely reaffirms the SEC’s authority to decide proxy access; the Senate bill outright requires the SEC to draft a proxy access rule within 180 days.

The Dodd bill “represents the federalization of corporate law and puts in place a one-size-fits-all governance structure that runs counter to 150 years of corporate existence in the United States,” Quaadman says.

A timetable for action on the Senate bill remains uncertain. In the past, Dodd has said his committee might not take formal action on a regulatory overhaul until early next spring.