Securities and Exchange Commission Chairman Christopher Cox said today that section 404 of the Sarbanes-Oxley Act should be made to work for smaller companies without exempting them.
Testifying before the Senate Banking Committee for the first time since he was confirmed as chairman of the SEC, Cox also addressed concerns from several senators that the regulatory environment was driving an increasing number of companies to list on foreign exchanges. The United States, he argued, should not “participate in a race to the bottom” but should continue to set a high standard for securities regulation.
Senators questioned Cox on a wide range of range of issues, including the regulation of credit rating agencies and hedge funds, short selling, foreign competition for U.S. exchanges, and a host of other matters.
But for many companies, Cox’s most important comments concerned the ongoing debate over the application of Section 404 of the Sarbanes-Oxley Act to smaller public companies. Compliance with Section 404, which requires that companies document the status of their internal controls over financial reporting, has proved to be the most expensive requirement of the act. It has also bedeviled smaller companies that lack the resources to maintain the sorts of controls available to larger companies.
“My goal as chairman is to find a way to make 404 work,” said Cox. “It should not be a question of whether to apply it to companies of all sizes, but how.”
Cox’s comment comes just one day after an advisory committee created by the SEC a year ago submitted its formal report on ways to ease 404 burdens on smaller companies. That report sparked controversy for its recommendation that smaller companies be partially or fully exempted from the rules. Members of the advisory committee have complained that critics and the media have focused on the exemption recommendations, overlooking the idea that 404 might work for small companies if there were a way to tailor its requirements to smaller companies.
In his testimony, Cox seemed receptive to that view. “There ought to be a way — and the advisory committee’s recommendations contemplate this — there ought to be a way to make this work,” he said. “There seems to be lacking a framework applicable to smaller companies.” He noted that an effort to create a more suitable framework for smaller companies is currently underway by COSO, the Committee of Sponsoring Organizations that developed the controls framework used by most companies in complying with 404. “That might be a place where we can hang our hat,” he noted.
Cox also praised the work of the committee, noting that they had “performed admirably.” Section 404 itself “just a few lines of text” in the Sarbanes-Oxley Act, he noted. By contrast, he said, holding out his arms, “the implementation through AS 2 is hundreds of pages, and the practice that has developed is another of accounting standards is another [extensive] gloss on the statute.” AS 2 is the standard developed by the Public Company Accounting Oversight Board to guide accountants in evaluating a company’s internal controls. “We are going to be aggressively working on implementation with the PCAOB so we get all the benefits [of 404] without needless costs,” said Cox.
Cox noted that the SEC welcomed congressional oversight, pointing out that the agency was working to implement “a relatively recent congressional action.”
However, Cox was also quick to counter suggestions from several senators that 404 was hurting the competitiveness of the U.S. capital markets. “To the degree that perception exists in Europe, and I believe it does, that the costs of regulation are comparatively unpleasant, we need to make sure we do everything we can to achieve our high standards without unnecessary costs,” he said.
But, echoing a point made by Sen. Paul Sarbanes, Cox cited studies showing that companies listing in the United States realize a premium over listings on other exchanges. He noted that, as a congressman, he had worked with the conference committee that put Sarbanes-Oxley together, and said the United States need not fear competition from looser regulatory standards. “I think we can implement it in a way that will make investors want to invest here,” he said. “We are seeing Sarbanes-Oxley imitated in other countries. We don’t have to be supine here.”