20 September 2006

FT: SEC chairman issues defence of Sarbox

Christopher Cox, chairman of the Securities and Exchange Commission, on Tuesday issued a robust defence of the Sarbanes-Oxley legislation saying it was “important to keep in mind” that many of its elements had been adopted by other regulators overseas.

“I would like to highlight a little noticed fact: While competitors in other countries are using Sarbanes-Oxley as a reason for foreign companies to list in their jurisdictions, many of those same countries are adopting provisions of the act as part of their own regulatory regime.”

His comments came at a hearing where US lawmakers will grill the heads of the two regulatory agencies responsible for overseeing implementation of the controversial Sarbanes-Oxley auditing and compliance law. Sarbanes Oxley has stirred controversy in the US, with many in the business and financial community blaming its more onerous compliance requirements for forcing foreign company listings to go abroad to London and Hong Kong. Some politicians have warned that Sox is threatening the competitiveness of US capital markets.

Mr Cox said, “As we consider the effect of Sarbanes-Oxley on US competitiveness, it is important to keep in mind how broadly many of its tenets have been taken up over seas.” As examples he cited the establishment of independent auditor watchdogs like Public Company Accounting Oversight Board [PCAOB], which oversees US auditors. He also pointed out the fact that the European Union had recently adopted a directive requiring all EU member states to create an auditor oversight body.

The House of Representatives Financial Services Committee held its sixth hearing into “Sox” since the law was passed in 2002 on Tuesday. It came as concern over US regulatory “creep” – including Sox - have been stoked by US inspections of the UK offices of Ernst & Young. Securities and Exchange Commission chairman Christopher Cox testified on the implementation of Sox, in particular on recent proposed changes to Section 404 made by his agency that are aimed at easing the burden of compliance for smaller companies.

Section 404 requires company CEOs to have a company’s internal controls checked by auditors and has been criticized as expensive and onerous by many small- and medium-sized business. Also testifying was Mark Olson, chairman of the Public Company Accounting Oversight Board, created in 2002 to oversee auditors. The PCAOB has raised eyebrows in the UK by dispatching inspectors to the London offices of Ernst & Young. The inspections stem from a contentious requirement of the Sarbanes-Oxley act and a new example of its “extra-territorial” reach beyond the US.

Last week the UK government moved to address such concerns by proposing legislation that would give the Financial Services Authority power to veto any rulings made by UK exchanges under future US ownership that could emerge as a by-product of US congressional legislation. Sox came under attack again on Tuesday from a US business lobby group. Mallory Factor, chairman of the Free Enterprise Fund, a Washington-based non-profit organisation, said: “Sarbanes-Oxley has become a classic example of overreaction - a massive expansion of regulatory power in response to a series of extraordinary events. And yet after all the costs and burdens are added up, America’s businesses are no better governed, are less transparently operated, and their shareholders are poorer.”

The SEC and the PCAOB have been working together to make compliance with Section 404 more cost efficient for smaller public companies. The PCAOB is also working to revise Auditing Standard 2, which governs the audit of internal controls. The SEC last month proposed allowing foreign and US companies a year’s “transition” before having to comply with Section 404 once they have gone public. For newly public companies, the SEC has also proposed that they not be required to provide a management report on internal controls or an outside auditor’s report on such controls in the first annual report that it files with the SEC.

The SEC’s aim is to offer a “phased-in” approach to Section 404 compliance for companies with a market capitalisation of under $75m. A public comment period on the issues closed on Monday. In its comments, Ernst & Young broadly supported the approach. But it warned that there might be “some complications or unintended consequences”. “For example, a phased implementation approach might confuse some investors as to the level of assurance they are receiving on the effectiveness of internal control over financial reporting in the year where only management’s assessment of internal control is required,” the company said.

Last week John White, the SEC’s director of the division of corporation finance, urged companies to involve their outside auditors in the first year of compliance, even though they were not obliged to do so. Critics of Sox and the changes proposed by the SEC have also expressed frustration at the complexity of the law and such changes. Mr White appeared to acknowledge the problem, saying: “Although I wouldn’t want to be the historian charged with maintaining the archives of all these [SEC press] releases and extensions over the past three years, we can pick up from that record that the Commission has remained very attentive throughout Section 404’s implementation to the challenges that internal reporting has posed.

© Financial Times