How To Get Reform Right
Five years ago the names Enron and Worldcom went from being icons of American corporate success to the poster children for corporate excess and greed. In the wake of these two scandals, where shareholders lost billions of dollars, Congress felt the need to act, or more accurately react, to preserve shareholder confidence in the capital markets. After a flurry of hearings featuring the oft repeated invoking of the Fifth Amendment, Sarbanes-Oxley (SOX) was born.
SOX, for which I voted in favor, became one of the most far reaching pieces of legislation passed out of the Financial Services (formerly Banking and Consumer Credit) Committee. SOX would affect every publicly traded company listed in the United States, domestic or foreign. For the first time the public auditing profession, charged with safeguarding the interest of the public investor through its role as an auditor, would have its own watchdog in the newly created Public Company Accounting Oversight Board (PCAOB). Under penalty of law, CEOs and CFOs would have to certify that their companys financial statements were accurate. Perhaps most importantly, Boards of Directors would have to take their fiduciary responsibilities more seriously and not settle for being part of managements rubber stamp gang. Oh, and lest I forget, there was the inclusion of Section 404, the now ominous audit of internal control.
After the first year of implementation, the reviews on the various elements of SOX were mixed. The consensus opinion was that the bill had done a lot of good. Boards were acting the way boards are supposed to act, like representatives of the companys shareholders as opposed to tools of management. Companies small and large acknowledged that it forced them to take a closer look at their internal controls and a result they have improved their management systems. Public auditing firms are having their practices questioned and reviewed to make certain that they are meeting the highest standards. This is critical because we cant afford the loss of another top tier accounting firm. All of the aforementioned have been beneficial to improving corporate governance. That might cause one to ask, why then the mixed reviews? As I stated earlier, lets not forget Section 404, the audit of internal control.
As my colleague Rep. Feeney likes to jest, Sections 1 through 403 are fine. Its Section 404 thats the problem. Its not unusual that when Congress rushes to act after a perceived crisis well intended legislation has unintended consequences. During the PCAOBs rule making process for the implementation of Section 404 many companies commented that the inclusion of an audit of internal control to a consolidated audit of the financial statements could dramatically increase the cost. How right they were. According to a survey by Ciesielski and Weirich fees have increased more than 100% from 2001 to 2004 at 496 S&P500 companies. A recent study by the law firm Foley $ Lardner showed that public companies with less than $1 billion in annual revenue have seen audit fees nearly triple in the past four years. They state that for these companies audit fees were more than $1.2 million for fiscal year 2005 compared to $332,000 before accounting reforms.
My colleagues and I spent a fair amount of time in 2006 listening to the concerns of publicly traded companies regarding Sarbanes-Oxley. We and our staff have held roundtable discussions and individual meeting with business organizations including the U.S. Chamber of Commerce, The Financial Services Roundtable, the Biotechnology Industry Organization and the Institute of Management Accountants to name a few. Of course one of our major stops was in New York to listen to companies traded on NASDAQ and the New York Stock Exchange. The concerns for smaller cap companies focus on the cost of compliance relative to their revenue. One story I heard was about a small cap biotechnology firm that had raised $4 million that year and had to spend 25% of that or $1 million on audit fees. For larger firms the focus tends to be on clarification of materiality and the conflicting guidance on compliance given to companies by the SEC versus the guidance given to auditors by the PCAOB.
After spending the better part of a year learning more about systems of internal control, and audit compliance than I ever hoped to, my colleagues and I introduced the COMPETE Act in the 109th Congress and have reintroduced it in the 110th Congress. The COMPETE Act which stands for Competitive and Open Markets that Protect and Enhance the Treatment of Entrepreneurs was written to reform three elements of the existing SOX law. 1) To provide clarity and relief to the current implementation of Section 404 by making it a risked based and top down audit. I want to avoid more stories like the company that recently came in to my office and discussed how her external auditors spent as much time reviewing her coffee fund as they did her money wire transfers. 2) Provide external auditors with greater leeway to rely on the work of others who have already reviewed the internal controls including managements attestation and for regulated companies like banks, the work of federal and state regulators. 3) Create more opportunities for tier 2 and tier 3 companies to form coalitions or partner with tier 1 one companies to increase the number of auditing firms available to serve the Fortune 1000.
The purpose of Sarbanes-Oxley was to restore investor confidence in the U.S. capital markets. Unfortunately, we over reached a bit and now SOX is threatening the U.S. position as the global financial market leader. How do we know this? A Citigroup study showed that as of 2000, 9 out of 10 international IPOs were done in the U.S. By 2005, 1 out of 10 was done in the United States Government officials in Asia and the EU has directly commented on how the U.S. implementation of SOX has helped them capture more international IPOs. Just last week, members of a U.S. business association visited my office and stated that one of their colleagues did not attend because he was in the process of an initial public offering in Australia. The McKinsey report commissioned by New York Mayor Bloomberg and Senator Charles Schumer, and the U.S. Chamber of Commerce recommendations acknowledge that an unreformed SOX is a key element, and I emphasize that it is just one element, that threatens our dominance in the global financial markets.
There are many who ask why I am sponsoring legislation to reform SOX. They say that the SEC and the PCAOB are proposing new rules for management and auditor guidance so why not let the regulators handle it and avoid opening a can of legislative worms? My response is that I hope the regulators can resolve these issues and nullify the need for my legislation. But if they dont I have a responsibility as a Member of Congress, a member of the Financial Services Committee, and a representative from the financial capital of the world, to keep New York, NY and the USA the guiding light for global capital investment.