Is SOX Driving Small Companies Overseas?

The SEC's committee on smaller businesses kept one eye on IPO activity abroad as it finalized its suggestions for tweaking Section 404.

Is increased initial public offering activity overseas the result of regulatory burdens in the U.S.? On Wednesday, members of the Securities and Exchange Commission’s Advisory Committee on Smaller Public Companies fretted over that question as they discussed the SEC’s implementation of the Sarbanes-Oxley Act.

The committee held a public phone conference to discuss the draft of its final report, which suggests that the requirements of Section 404, the internal controls provision of the Sarbanes-Oxley Act, be loosened for smaller companies.

During the meeting, members asked whether the U.S. regulatory regime is frightening away small companies and contributing to capital formation abroad or whether IPO activity on foreign stock exchanges merely indicates a globalization of the capital markets.

James Thyen, co-chair of the committee and chief executive officer of Kimball International, cited a comment letter by the National Venture Capital Association, which noted that venture-backed initial public offerings have declined precipitously. Last year, 90 percent of foreign issuers listed primarily in London and Luxembourg and only 10 percent of them listed in the United States, according to the NVCA. Thyen cautioned, however, that those numbers could reflect other factors in the global capital markets.

Committee member James Connolly, president of IBA Capital Funding, remarked that the Alternative Investment Market on the London Stock Exchange has aimed a significant marketing effort at small companies in the United States and that competition for their listings is on the rise, with the Dubai Stock Exchange and others also now open for business. “Nasdaq is voting with their capital,” added Connolly, noting that the exchange’s recent purchase of 15 percent of the London Stock Exchange indicates Nasdaq’s own acknowledgement of foreign competition.

Given the level of competition, observed committee member Janet Dolan, former CEO of Tennant Company, the question is “what is this regulation and our ongoing regulatory scheme doing to our competitiveness?”

Dolan was not the only committee member to wonder aloud if a growing reputation for strict capital market regulations — even beyond those currently written into law — would hurt the U.S. “Many of the foreigners are fearful of what regulation could come during the next market break in the U.S.,” observed Thyen. “It’s not just the existing regulation that is creating a chilling effect, it’s what could happen in the future.”

In response, Alex Davern, CFO of National Instruments Corporation, which has operations in multiple countries, including Ireland, said “CFOs in the Irish market have echoed that fear.”

The committee also discussed three additional recommendations, which will be included in the final report for the SEC’s consideration, though not specifically endorsed by the committee. The first of those came from Richard Jaffee, committee member and chairman of the board at Oil-Dri Corporation of America. Jaffee disagreed with report’s formulas for defining a small company, arguing that the numbers should be indexed to inflation.

The second recommendation aimed to make it easier for companies to raise additional capital after they have already filed to go public. Under current integration rules, if a company goes into registration and depletes its money before its IPO, it is very difficult to conduct a parallel private offering, noted Richard Leisner, a committee member and a partner at Trenam Kemker. Leisner proposed that the issue could be resolved by adding a footnote to the SEC’s existing no-action letter in such a situation.

The final recommendation suggested that non-auditors such as certified consultants be allowed to compete to attest to financial statements. The concept should allow market dynamics to lead to greater effectiveness, commented Ted Schlein, a managing partner at Kleiner Perkins Caufield & Byers.

The committee voted unanimously to present the final report to the SEC, which it will do by April 23. Subsequently, the SEC and the Public Company Accounting Oversight Board will co-host a roundtable on Section 404 on May 10. There is no deadline for a final ruling by the SEC on whether it will change 404 regulations for smaller companies.

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