Archives: Sarbanes-Oxley

The SEC adopted a rule to adjust the maximum amounts it may recover for civil monetary penalties imposed under the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Company Act of 1940 and the Investment Advisers Act of 1940 for inflation.  The SEC’s new rule-was effective upon publication, and also adjusts certain penalties under the Sarbanes-Oxley Act of 2002.

The rule was adopted pursuant to the Federal Civil Penalties Inflation Adjustment Act of 1990.  This statute requires federal agencies to adopt regulations at least once every four years to adjust for inflation the maximum amount of civil monetary penalties in their administered statutes.  The adjustments apply to violations after the effective date of the rule change.

This change will increase civil penalties for those subject to SEC actions, and is yet another factor to consider for those in SEC enforcement investigations and proceedings.

Two Senators introduced a bill that would make disciplinary proceedings of the Public Company Accounting Oversight Board open to the public. 

According to the lawmakers, the Sarbanes-Oxley Act of 2002 made the PCAOB proceedings confidential through charging, hearings, initial decision, and appeal.  Unfortunately, the secretive nature of the process enables firms that engage in misconduct to drag out the proceedings for years while the investing public is kept in the dark.  The new bill would make the PCAOB proceedings available to the public, similar to proceedings before other regulators such as the Securities and Exchange Commission. 

Openness is a good thing, hopefully, this legislation might see the light of day.

Auditors engaging in non-audit consulting?  A major accounting firm pushing for more consulting work?  Recently, the SEC’s chief accountant indicated that there were concerns at the SEC regarding auditor independence as a result of this push for non-auditing work from accounting firms.

In particular, the concern related to auditing firms boosting their non-audit consulting business.  This is particularly troubling given this was a issue was one of the impetuses giving rise to the  enactment of the Sarbanes-Oxley Act.  This SEC concern relates to there being developed a conflict of interest.  Such a conflict may result in a diminution of auditor independence. 

Although the SEC has spoken on this topic, no action has yet been announced.  We would not be surprised if we did not SEC attempt to “nail some hides to the shed.”

Alas, the Dodd-Frank whistleblower protections cover informants overseas.

The United States Court of Appeals for the Fifth Circuit, recently, held that the Dodd-Frank whistleblower protections cover informants that report to the SEC information about FCPA violations.  The court, citing that the plain language of the act, indicated that such individuals were covered.  This is an intriguing development given the recent issues relating to extraterritorial jurisdiction that the United States Supreme Court has even considered.

As such, companies must be aware of these issues going forward and consider the proper precautions.

We have not talked about the Sarbanes-Oxley Act in sometime, so let’s jump right in!! 

Interestingly, over the last 10 years since Sarbanes-Oxley became effective, audit costs for public and private companies have increased significantly.  We recently came across a survey published by Financial Executives International, indicating, that these fees increased somewhat over the last 10 years.  Additionally, the vast majority of those polled by the survey did not support the PCAOB’s mandatory audit rotation plan, stating that it would increase costs significantly. 

In reporting troubling results, the survey stated that only 37% of private companies had risk management processes in place.  That means a significant majority of private companies could be at risk.  One wonders if this leads to trouble in the future.

Finally, there was some positive aspects of the survey.  The report found that those companies with centralized operations on both the public and private level saved money in audit fees as opposed to those who had decentralized operations. 

Today’s post is the penultimate of this series covering the recently signed JOBS Act, and covers the Act’s Title I – Reopening American Capital Markets to Emerging Growth Companies.  Check back later this week for more on Crowdfunding and a recap on who the JOBS Act really helps and who needs to be watch out. Or, instead of periodically checking back, you can simply subscribe to the Securities Compliance Sentinel for updates sent straight to your inbox’s spam folder.    

Title I of the Act, Reopening American Capital Markets to Emerging Growth Companies (or RACMEGC, so named because the Congressional acronym gurus probably exhausted themselves coming up with the JOBS Act), purports to address the IPO decline by creating a category of “Emerging Growth Companies” and relieving those companies of some reporting requirements.  Unlike most of the JOBS Act, this part became effective immediately upon the President’s signature last week – no need to wait for the SEC. 

So, what’s an “Emerging Growth Company” (EGC)?  Essentially, an EGC is an issuer with gross revenues under $1 Billion last year (and that hasn’t issued more than $1 Billion in debt during the last 3 years).  An issuer can remain an EGC for up to 5 years following its IPO.  If an issuer is deemed a large accelerated filer, then they lose EGC status. 

EGCs are exempt from some of the disclosure and reporting requirements of Dodd-Frank and Sarbanes-Oxley (SOX).  The Dodd-Frank stuff is boring: they don’t need to hold the (non-binding, merely advisory, totally feeble) Say-On-Pay votes, or the make disclosures on executive pay.  Shareholders have only thrown a hissy fit about executive pay when a Company’s stock price is in the dumps, and these weren’t particularly costly reporting requirements to comply with (most companies should have at least a vague idea of what they pay their named executive officers), so nothing too exciting yet. 

But Title I goes on to exclude EGCs from Section 404(b) of SOX, which requires a public company’s auditors to sign off on the company’s internal control.  It also preempts (for EGCs only) any move by the Public Company Accounting Oversight Board to require audit firm rotation or have the auditing firm include a discussion and analysis in its reports.  (Both are being considered by the PCAOB right now).  Moreover, the JOBS Act fiddles with Section 7(a) of the Securities Act, so an EGC won’t need to present more than 2 years of audited financial statements in its IPO registration statement and only need to give the financial data required by Item 301 of Reg. S-K for the same period they give audited financials.  Right now, the requirements are the last 3 and 5 years, respectively; the JOBS act effectively makes both 2 years. 

Rightly or wrongly, SOX has been blamed by many for the decline of the American IPO.  Unlike the other provisions of the JOBS Act, this change at least seems aimed at making it easier (read: cheaper) for an “emerging” company to go public.  That said, I think once you get around $1 Billion in revenues, you aren’t emerging anymore: you’ve emerged. 

 $1 Billion is quite a lot of money.  Certainly more than I have in under my mattress. SEC Commissioner Luis Aguilar estimated that this threshold would cover 98% of IPOs.  Professor Ritter has that number closer to 94%.  Either way, this means that it covers pretty much damn near everyone.  This provision has seen almost as much ink spilled over it as Crowdfunding.  One claim I keep seeing is that investors will avoid EGCs like teetotalers avoid dimly lit dive bars, favoring companies that bask in the disinfecting rays of sunlight that come from more disclosure.  I don’t buy it.  You might see a few companies that qualify for EGC status making more rigorous disclosures anyway, but I suspect these will be limited to issuers with checkered pasts.  Of course, if I’m wrong, then there is no harm in reducing this regulatory burden, because any rational issuer will prefer to take on the more onerous disclosures in order to appease investors (and thereby improve the stock price, which tends to be the metric that drives management decisions).

FINRA’s membership application program (“MAP”) is changing.  FINRA’s review of initial membership and continuing membership applications for broker-dealers will now be centralized in the MAP.

Further, as part of MAP, continuing membership applications will be transitioned to an electronic format, just as new applications are treated.  FINRA is currently finalizing the MAP, but it has already implemented certain aspects, including, among other things, a centralized work flow.  That is, a party submitting a FINRA Rule 1017 application is assigned an examiner based upon FINRA’s work flow, and that examiner may not be in the same district as the member firm. 

FINRA hopes this process will streamline its ability to respond to changes in membership activity, and utilize its resources more efficiently.

Gail Collins weighed in on the JOBS Act today in a column glibly titled “The Senate Overachieves”.  Normally, I love her work – everything she does is glib, and I honestly feel there is a glib shortage in America – but this time I believe her winking nonchalance has descended into full-on flippancy.  Worse than that, I’m pretty disappointed that she couldn’t work into the column that Mitt Romney once drove to Canada with the dog strapped to the roof.  But I digress.

Securities regulation is a serious matter (and kind of my job).  That doesn’t mean we can’t have fun discussing it, but great zingers can only go so far.  Dismissing reforms because they let smaller businesses avoid excessively expensive auditing requirements makes sense, even if this means reducing (by a small amount) Sarbannes-Oxley’s reach.  Just because Sarbannes-Oxley and Dodd-Frank were passed to correct egregious regulatory gaps doesn’t mean that they cannot still overreach.  If anything, it makes just such overreaching more likely.

Crowdfunding does present a larger potential for hucksters to shill worthless stock.   But that is still fraud, and still illegal, regardless of the medium used to do it. 

For what it’s worth, I think a lot of securities regulation are misguided attempts to treat symptoms of the problems rather than the problems themselves.  So long as there are massive incentives to innovate new products and skirt regulatory requirements, firms will do so, and will pay their lawyers handsomely to make it happen within the confines of the law.

Rather, I believe that approaches towards fixing the fundamental flaws in the market must be addressed.  No recession or crisis will be caused by minimized auditing of mid-cap companies, or small start-ups raising a few hundred thousand over the internet.  As I noted in my last post, regulations that incentivize companies to stay small in order to avoid disproportionately larger regulatory burdens are counterproductive.

Instead, we need to work to realign the incentives of market participants with the incentives of the economy in general.  The Economist mentioned the interim Kay review last week, “it is easy to forget what the main economic functions of the equity markets are supposed to be.”  I agree with John Kay, the review’s author: the markets should promote long-term growth, not short-term profits.  And, for what it’s worth, Warren Buffet, Judge Richard Posner and Nassim Taleb, among others, also agree (oh my, am I clumsy! Just dropping those names all over the place!).

So, Gail’s barbed wit hit the wrong target this time, not unlike how some regulations aimed to prevent awful abuses end up frustrating legitimate businesses from growing.  The JOBS Act has its flaws too: the “emerging growth companies” that get to avoid some of the registration requirements of the ’33 Act are defined to include companies with $1 Billion in revenue.  If you make $1 Billion, you aren’t emerging anymore.  You’ve emerged.  But these call for sensible amendments, not lambasting the entire bill

Thought you might be interested in a recent podcast I did concerning my securities law practice.  http://web.me.com/cordpar/Client_Development_Tips/Law_Consulting_Coaching_Podcast/Entries/2011/10/28_Developing_a_Securities%2C_White_Collar_and_Complex_Litigation_Practice.html

Everyone loves small businesses, even if they might not be the job-creating economic saviors we want them to be.  No one likes bailing out Wall Street, but Main Street?  That’s something we can all agree on!

On Wednesday, a subcommittee of the House Committee on Financial Services advanced a few interesting bills aimed at reducing regulatory burdens for small cap corporations. 

While some were approved by voice votes, suggesting broad bipartisan appeal, two ran down party lines, portending a difficult path ahead. 

Surprisingly, the subcommittee’s Democrats voted against H.R. 2930, or the “Entrepreneur Access to Capital Act,” a bill which will undoubtedly go by the pithier “Crowdfunding Act.”  (Note: by “undoubtedly” I mean “hopefully,” and by “pithier” I mean “coined-by-Jim-Saksa”).  “Crowdfunding” refers to the idea of letting a large number of investors give small amounts of money to a start up without the hassle of registering with the SEC.  Right now, non-profits can raise money this way from websites like Kiva and DonorsChoose.  Crowdfunding basically says: why not let start-ups raise capital this way, too?  (For a quick introduction to the concept, read Annie Lowrey’s article on Slate).  This bill would allow new businesses to raise up to $5 million before triggering registration requirements, provided that individual investments were limited to the lesser of $10,000 or 10% of the investors income.  These smaller companies could make general solicitations online without having to go through the pains of an IPO. 

I’m dumbfounded by Democratic opposition to this bill.  Crowdfunding has an innate connection to the green and creative economies – markets that Democrats like to support with public funds.  Why don’t we skip the Leviathan/middle man and let a community of small investors give their money directly to risky small ventures?  Moreover, at least one Democrat seems to dig the idea: there’s a version of it in President Obama’s Jobs Act.  And the same Democrats who voted no on Crowdfunding then voted yes for a few complementary bills.    

One, H.R. 2167, raises the shareholder threshold for mandatorily registering with the SEC from 500 to 1,000 shareholders (for companies with market capitalization under $10 million).  Both this and the Crowdfunding act address the complaint that regulatory costs related to raising capital is too high for many small businesses – and the need to protect investors too low – to justify obligatory SEC registration.  If anything, the Crowdfunding bill is less deregulatory, as its individual investor amount limits protect potentially naïve investors from betting everything on the next Pets.com. 

Another bipartisan winner, H.R. 2940, directs the SEC to expand the registration exemptions under Rule 506, allowing issuers to market securities to accredited investors via general solicitation under Regulation D.  This law change is potentially huge.  Right now, Rule 506 allows a company to raise an unlimited amount of money from an unlimited amount of accredited investors (plus 35 non-accredited individuals, provided that they are “sophisticated”, which sadly has very little to do with being able to appreciate the delicate complexities of Louis XIII de Rémy Martin).  The only real limitation preventing this from becoming a way to do a wealthy-person-only IPO (minus a whole host of reporting requirements) is the prohibition on general solicitation.  Think about this: the Crowdfunding Act could help the next Facebook get off the ground; this law could help the current Facebook stay underground

Finally, the “Small Company Job Growth and Regulatory Relief Act” also passed down party lines, but Democratic opposition was less-than-unexpected this time around, as it aims to substantially weaken Section 404(a) of the Sarbanes-Oxley Act.  Section 404 requires management and the external auditor to both sign off on the adequacy of a reporting company’s internal controls in its 10-K.  Right now, the SEC exempts companies with market capitalization rates under $75 million.  Representative Fincher’s bill wants to raise that amount just a teensy bit, to $500 million.  Personally, I don’t see Democrats backing a bill that makes life easier for CEOs and CFOs anytime soon.

These bills have only just emerged from subcommittee, so they are all a long ways away from passage.  The House Committee on Financial Services must give them the OK before it can be put before the entire House, and then a companion bill must make its way through the Democratically-controlled Senate.  Regardless, should any of these bills make it through the legislative warzone that is the 112th Congress, they could have a major impact on how small businesses raise initial capital.