An advisory panel to the Securities and Exchange Commission (SEC) has formally recommended that thousands of smaller publicly traded companies be exempted from the strict accounting and reporting requirements imposed by the 2002 Sarbanes-Oxley law, passed in the wake of the collapse of Enron.
“The benefits that are derived by investors are really not worth the costs,” said Robert Robotti, president of Robotti & Co., LLC and a member of the advisory panel.
Although most of the SEC commissioners, including commission chairman and former Congressman Chris Cox, have expressed skepticism about such an exemption, Herbert Wander, chairman of the Advisory Committee on Smaller Public Companies, has expressed confidence they will approach his committee’s recommendations with an open mind. The commission will start meeting on the issue May 10.
The committee believes the strict accounting methods imposed on companies by Section 404 of the Sarbanes-Oxley act are disproportionately onerous for smaller companies. It recommends companies with a market capitalization of $128 million or less, called micro-caps, not be subjected to the requirement that executives attest personally on a form that their companies have internal controls to ensure the accuracy of statements filed with the SEC. It also recommends that “smaller public companies,” with market capitalization of less that $787 million, be exempt from the requirement that outside auditors attest to their financial controls being effective.
Although size may not be the ultimate criterion — smaller companies have played games with securities in the past, and some will almost certainly do so in the future — the SEC should look favorably on its panel’s recommendations. Beyond that — assuming Congress doesn’t have the sound judgment to revise or repeal Sarbanes-Oxley itself — it would do well to revisit the initial regulations it wrote to implement Sarbanes-Oxley.
The major effect of Sarbanes-Oxley is to enforce, at great cost and with onerous reporting requirements and personal liability, the latest “generally accepted” accounting standards. But accounting standards evolve as practitioners develop more effective techniques, and locking the current “best practices” into federal law creates a risk of deterring innovation.
Furthermore, although there was evidence of accounting shenanigans, the Enron bankruptcy was not brought about by lax accounting standards but by fraudulent transactions and hiding them from view. Deceptive accounting is more often a consequence of financial crisis than the cause. The market caught onto Enron before federal regulators did, and there is little or no evidence that having more detailed reporting requirements in place would have prevented its problems.
Sarbanes-Oxley amounts to a tax in that it imposes unnecessary costs on companies, reducing the value of stocks and increasing the risks of doing business. Fortunately, it includes a provision inviting the SEC to develop rules accommodating a “principles-based” rather than a “rules-based” accounting system. The SEC would do well to do so quickly.
In the meantime, exempting smaller companies from Sarbanes-Oxley requirements makes sense.