Renewed Calls For SEC, 404 Reform; More

As Corporate America awaits action on changes to improve the implementation of Section 404 of the Sarbanes-Oxley Act, critics who say the high cost of compliance and the stringent regulatory environment are hurting U.S. competitiveness have stepped up public pressure on Congress and the Securities and Exchange Commission to ease those burdens.

Both the Treasury Department and the U.S. Chamber of Commerce hosted conferences last week focusing on the competitiveness of the U.S. capital markets. The Chamber and the Committee on Capital Markets Regulation—commonly known as the Paulson Committee, after Treasury Secretary Hank Paulson—issued reports saying the U.S. regulatory environment has become too stringent and questioning whether the benefits of Section 404 outweigh the costs.

The latest push for regulatory rollback comes as the SEC and the Public Company Accounting Oversight Board are mulling public comments on proposals they issued in December to “fix” Section 404 implementation. Both proposals could see further changes based on the comments received, and SEC commissioners would still have to vote to adopt any final SEC guidance or to approve any new rule adopted by the PCAOB.

Meanwhile, the clock is ticking on the deadline for non-accelerated filers to begin complying with the first part of Section 404, that companies provide an assessment of their internal controls over financial reporting; those opinions must be included in annual reports for fiscal years that end on or after Dec. 15, 2007. Attestations by outside auditors will come one year after that, unless the SEC further extends those compliance deadlines while it crafts its amended regulations.

Paulson

During opening remarks at the March 13 Treasury conference, Secretary Paulson called for an assessment of the U.S. regulatory system to look for ways to improve it with “an eye toward more rigorous cost-benefit analysis of new regulation.”

“The addition of new regulators over many years, and the tendency of these regulators to adapt to the changing market by expanding, as opposed to focusing on the broader objective of regulatory efficiency, is a trend we should examine,” Paulson said. He also said the United States should also consider moving toward a more principles-based regulatory system.

Since the massive accounting scandals of 2000 and 2001, American public companies have grappled with reforms aimed at restoring investor confidence including Sarbanes-Oxley, new listing rules, and other regulatory and enforcement actions. At the same time, foreign capital markets have become more competitive and private pools of capital, such as hedge funds, have grown tremendously.

The fundamental question to ask, according to Paulson: “Have we struck the right balance between investor protection and market competitiveness—a balance that assures investors the system is sound and trustworthy, and also gives companies the flexibility to compete, innovate, and respond to changes in the global economy?”

He also said there are “legitimate questions” about the sustainability of the accounting profession’s business model and said regulators should consider whether that system is “producing the high-quality audits and attracting the talented auditors we need,” whether enough competition exists in the accounting profession, and how desirable moving toward more principles-based accounting standards may be.

Related coverage and remarks can be found in the box above, right.

U.S. Chamber Calls For Reform Of SOX, SEC

Even as Secretary Paulson and others called for reform of Section 404, the U.S. Chamber of Commerce went much further last week, warning that the 75-year-old system of market regulation in the United States is a declining relic in today’s globalized world, and should be changed wholesale.

The committee’s 177-page report including six main recommendations:

Reform and modernize the federal government’s regulatory approach to financial markets and market participants;

Give the Securities and Exchange Commission the flexibility to address issues relating to the implementation of Sarbanes-Oxley by making it part of the Securities Exchange Act of 1934;

Convince public companies to stop issuing earnings guidance, or, alternatively, move away from quarterly earnings guidance with one earnings per share number to annual guidance with a range of EPS numbers;

Call on domestic and international policymakers to consider proposals by others to address the significant risks faced by the public audit profession from catastrophic litigation, as well as the Commission’s suggestion that national audit firms be allowed to raise capital from private shareholders other than audit partners;

Increase retirement savings plans by connecting all employers of 21 or more employees without any retirement plan to a financial institution that will offer a retirement arrangement for those employees; and

Encourage employers to sponsor retirement plans and enhance the portability of retirement accounts through the introduction of a simpler, consolidated 401(k)-type program.

Investor groups and some institutional investors supported the call to eliminate quarterly guidance. Amy Borrus, deputy director at the Council of Institutional Investors, says the recommendation is “spot-on.”

“Too many companies, investment managers, and investors have short-term horizons that ultimately are harmful to the markets and U.S. competitiveness,” Borrus says. “Boards should support management’s efforts to move away from quarterly earnings guidance.”

Similarly, Barbara Roper, director of investor protection at the Consumer Federation of America, supported the ideas of eliminating earnings guidance and boosting retirement savings programs. But she is skeptical that those agenda items are what the group will “be pursuing aggressively.”

Roper

Roper says the “reasoned tone of the report hides some very anti-investor proposals,” many of which are aimed at “defanging the regulators.” She calls the recommendation to merge the Sarbanes-Oxley Act into the Securities Exchange Act “Step 1 in the plan to exempt small companies from [Section] 404, and completely unwarranted.”

Giving certain companies a pass on Section 404 “would be confusing for investors and bad public policy,” Borrus says. “All companies tapping the U.S. capital markets should have to play by the same rules.”

“The report’s fundamental argument that over-regulation and overall aggressive enforcement have damaged U.S. securities markets is wrong,” Roper contends. “If you look past the key statistics they highlight … the case is obvious that there are other forces at work.”

As for the litigation threat to audit firms, Roper says if audit firms want enhanced protection, “the least we can expect of them is that they provide the kind of transparency and basic corporate governance practices that we expect from public companies. Otherwise, we can’t measure the degree of the threat they face or their ability to weather that threat.”

An executive summary of the report can be found in the box above, right.

SEC’s Campos: Decline In U.S. Capital Markets ‘A Myth’

As business groups push for less regulation, Securities and Exchange Commissioner Roel Campos defended the U.S. system recently and refuted criticisms that overly stringent regulation has caused American capital markets to lose their competitive edge.

While critics have cited the London Stock Exchange and Britain’s “light-touch” regulatory system as viable, attractive alternatives to the SEC and the New York Stock Exchange, Campos warned that touting lower standards risks driving capital away.

Campos

“Most capital will go to where it is best protected,” Campos said in a March 8 speech in London. If a jurisdiction promotes itself as having lower standards, it risks driving capital away to other markets where capital is perceived to be better protected, he said.

He also criticized reports by the Interim Report of the Committee on Capital Markets, known as the Hubbard Report, and the report titled “Sustaining New York’s and the US’ Global Financial Services Leadership,” more commonly referred to as the Bloomberg-Schumer Report; both, he said, “present a myth: that the U.S. markets are somehow in decline” (see box at right for the reports).

“Significant non-U.S. investors and their CEOs and directors tell me every day that they will continue to invest hundreds of billions of dollars in the U.S. equity markets over other markets because they love the protections rendered by Sarbanes-Oxley, along with the deterrence of the enforcement program at the SEC,” he said.

In other news, Campos also said issuers can expect the SEC to act soon on its foreign private issuer deregistration re-proposals, which would allow FPIs to deregister if their U.S. trading volume is less than 5 percent of the issuer’s trading volume in its home market. He noted a suggestion by several commenters that the SEC modify the denominator used for the trading volume test to include worldwide trading volume “has merit.”

While Campos said he wouldn’t “prejudge” anything without a full picture of the comments, he said, “I think we’ll be in a position to move on this rule in the near future and to consider seriously using worldwide trading volume.”

Finally, he cautioned that convergence between International Financial Reporting Standards and U.S. Generally Accepted Accounting Principles—and the elimination of the requirement that foreign companies reconcile their financial statements with GAAP—is “still a work-in-process.”

Campos noted a lack of FPIs filing audited financial statements with the SEC that use, or are compliant with, IFRS as promulgated by the International Accounting Standards Board. While the SEC expected roughly 300 companies file their 2005 financial statements prepared using IFRS, only about 40 did so. Instead, many issuers are filing financial statements based upon national jurisdictional adaptations of IFRS, which meet the SEC’s filing requirements, but “don’t appear to fit under the one set of global accounting standards” envisioned by the convergence roadmap,” he said.

“I am hopeful that auditors could prepare opinions stating that the audited financial statements were prepared according to IFRS as promulgated by the IASB, and not solely the ‘Jurisdiction X IFRS,’” he said, adding, “We need to get to the bottom of this issue, and see more companies filing audited financial statements in the manner contemplated by the roadmap.”