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Congress and the Assault on SOX

What is clear by now is that if there was a problem with SOX, it was that the legislation did not go far enough.  The law only addressed one compensation issue, loans to executive officers.  SOX dealt with the concern by prohibiting them, leaving the matter otherwise untouched.  Likewise, SOX never addressed the responsibility of the directors for risk assessment, something the Delaware courts suggest is not their responsibility at all.   

So it is a bit startling to see that the House Financial Services Committee, over the objection of its Chair and, apparently, the chair of the SEC, voted in favor of a bill that would weaken rather than strengthen SOX.  The so called "Investor Protection Act of 2009" (HR 3817) was amended to exempt companies with less than $75 million in market capitalization from Section 404(b), the provision that requires outside auditors to "attest" to management's assessment of the internal controls and procedures.  The amendment was approved by a 37-32 vote before the entire Act was approved by the Committee by a vote of 45-28.

And the reason?

  • The "one size fits all" regulatory approach to implementing section 404 of Sarbanes Oxley has had a disproportionately negative impact on small and medium sized companies. The current and pending compliance burden has sent many companies to market overseas or dissuaded them from going public here in America.

This is devoid of any real content and harks back to the era when SOX was attacked by all manner of made up statistics, that it reduced foreign listings, that it caused companies to go dark, most of which proved incorrect.  For a discussion of these arguments, see Criticizing the Critics: Sarbanes Oxley and Quack Corporate Governance

There is no evidence that suggests that small US companies have been dissuaded from conducting IPOs by Section 404(b).  Indeed, the statement was made just when the IPO pipeline seems to be opening up and the evidence (developed in an SEC Study) indicates that the costs of complying with Section 404(b) are coming down. 

It is not a bad idea to take cost into account when addressing smaller businesses.  But there is no evidence that this is what is taking place in these circumstances.  The amendment not only exempted these businesses but required the Commission to conduct a study of methods of reducing "the burden" of complying with Section 404(b) for companies with a market capitalization between $75 and $250 million. 

The importance of Section 404(b) is to require another set of eyes, outside the company, to assess what management has done in developing internal procedures and controls.  With Delaware and the Delaware courts imposing few real obligations on management and the board to protect the interests of shareholders, the internal governance system is not sufficiently robust to ensure that adequate internal procedures are put in place.  Like the pay czar, to fix governance problems increasingly requires a solution outside the corporate governance process. 

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