SEC's Atkins Flogs Agency For Poor Cost/Benefit Analyses

In an unusual bit of self-flagellation, Securities and Exchange Commissioner Paul Atkins delivered some blistering criticism against the SEC for issuing regulatory decisions that fail to adequately consider the cost relative to the benefit.

In a recent speech to the National Association of State Treasurers, Atkins criticized the SEC for its positions on mutual fund governance regulations, hedge fund registration, National Market System rules, and the Sarbanes-Oxley Section 404 internal control reporting requirements.

“Three recent actions by the SEC, which were taken over two dissenting voices (one of which was mine), represent the type of regulatory mandate that we ought to avoid going forward,” he said.

Atkins

Atkins noted the SEC even rebuked the D.C. Circuit Court’s criticism of SEC’s decision-making when the court sent back to the SEC its rulemaking on mutual fund governance. The D.C. Court said SEC violated the Administrative Procedure Act and the Investment Company Act by overlooking cost considerations when making its rules.

“ … [W]e ‘responded’ to the court’s request for further deliberation by rubber stamping the original rulemaking within eight days of the court’s decision,” Atkins said. He said he expects similar challenges to SEC’s positions on the impending Feb. 1 registration deadline for hedge fund advisors.

“The new hedge fund adviser registration requirement will divert precious time and attention to the oversight of advisers that manage the money of a relatively tiny number of sophisticated investors—fewer than 200,000,” Atkins said. “This takes attention and personnel away from mutual funds and retail investment advisors, where more than 95 million people have their investments.”

Atkins said he believes the SEC will face similar criticism as Regulation NMS rulemaking takes effect. “The Commission explicitly punted many determinations to the no-action process,” he said. “Difficult decisions lie ahead and should not be made without due appreciation for costs.”

"They Screwed Up"

Atkins saved his strongest criticism for the regulatory path of Sarbanes-Oxley, especially Section 404. “Perhaps nothing in recent memory has more starkly illustrated the need to perform honest and probing cost/benefit analyses before requirements take effect than the regulatory regime that has grown under Section 404 of the Sarbanes-Oxley Act,” he said

Frederick Lipman, a director with the Association of Audit Committee Members and a partner with the law firm Blank Rome, found Atkins remarks surprisingly candid. “He admitted they screwed up,” he said.

EXCERPT

The excerpt below is from Commissioner Paul Atkins' remarks before the National Association of State Treasurers, Incline Village, Nevada, September 20, 2005:

“As we enter the second year of the 404 process, however, it is becoming increasingly evident that everyone greatly underestimated the costs. When the SEC first released its implementation rules for 404 we estimated aggregate costs of about $1.24 billion or $94,000 per public company. In the SEC’s defense, we made this estimate before the Public Company Accounting Oversight Board, or PCAOB, released its 300 page Auditing Standard No. 2. Unfortunately, our estimates were not just low, they were incredibly low. Surveys indicate that actual costs incurred for 404 compliance were TWENTY times higher than what we estimated.

“We have taken several steps to attempt to correct the situation. The SEC hosted a roundtable in April to hear what went wrong and what needed to be done to address any excesses that may have arisen with Section 404 implementation. We learned that the internal controls rule and the PCAOB standard were being applied in an overly-prescriptive manner. In May, both the SEC staff and the PCOAB issued statements that were geared towards moving companies and auditors off their granular approach and towards a more risk-based model. Nevertheless, we are now starting to hear that cost reductions for year two of the section 404 process will not approach the 50% reductions on which many had been counting. Cost reductions from year one will instead be in the neighborhood of 5-20%, and I predict that the reduction will be at the low end of this range.”

The SEC dramatically underestimated the cost of implementing internal control reporting requirements, Atkins said, though he added, “In SEC’s defense, we made this estimate before the Public Company Accounting Oversight Board, or PCAOB, released its 300-page Audit Standard No. 2.”

Now, Atkins says, expected cost reductions for year-two implementation are not materializing. “Cost reductions from year one will instead be in the neighborhood of 5 to 20 percent, and I predict that the reduction will be at the low end of this range.”

Atkins said shareholders should not be expected to wait indefinitely for more reasonable costs. “What types of changes should shareholders demand?” he asked. Noting complaints seem more focused on implementation of PCAOB’s audit rules, Atkins said, “investors should insist that the SEC fulfill its statutory charge and actively oversee the PCAOB’s actions rather than simply rubber stamping them.”

The current environment in which accountants and companies fear being second-guessed must change, Atkins said. “The SEC and the PCAOB … need to give further comfort to auditors and management that they will not be second-guessed when they use their professional judgment,” he said. “Getting this point across is very difficult, particularly in the current environment with its regulators and litigators equipped with piercing hindsight.”