10 years on, Sarbanes-Oxley revisited on Hill
WASHINGTON (MarketWatch) -- Ten years after Congress passed the post-Enron Sarbanes-Oxley Act of 2002, lawmakers on Thursday squabbled over whether a key provision has hurt job creation and driven IPOs abroad, or helped to restore trust to financial markets.
The measure debated at a House Financial Services Committee subcommittee was one that has been debated frequently since the law was passed in 2002 -- a long-contested provision that requires corporations to have outside audits of their internal controls in financial reporting.
This provision, known as the so-called section 404(b) rule, requires an outside auditor to declare that the company's internal controls over financial reporting are correct.
The audit provision and statute were approved on July 30, 2002, after a series of high-profile corporate and accounting scandals from major companies at the time, including Enron and WorldCom.
Republicans argue the law has discouraged executives from taking their firms public through initial public offerings and limited job creation in the United States. However, Democrats and institutional investors back the provision for larger companies, saying it's helped limit fraud and restore trust to the system.
Already, businesses with $75 million or less in publicly traded shares are exempt from the rule, after a provision granting that exemption was approved as part of the Dodd-Frank bank-reform law.
Republicans backed a bill introduced by Rep. Michael Fitzpatrick, Republican of Pennsylvania, that would expand such relief to more small businesses. That bill would also exempt firms with between $75 million and $250 million in publicly traded shares, as well as those firms with less than $100 million in annual revenue.
Rep. Scott Garrett, Republican of New Jersey and the chairman of the House Financial Services subcommittee holding the hearing, noted that 404(b) didn't prevent investors from losing money at a number of big firms where there was independent attestation for internal controls, including J.P. Morgan Chase & Co. (JPM) , Lehman Brothers, Bear Stearns, MF Global, Fannie Mae and Freddie Mac.
Section 404(b) "didn't prevent investors from losing any money with these firms. It didn't even slow it down," said Garrett.
He and other Republicans contended there is an intangible opportunity cost with the compliance requirement driving IPOs overseas that is "priceless."
"The businesses that are not in this country, the jobs that are not in this country, the families dislocated because they can't get a job anymore, the communities that have been decimated because they don't have jobs, whether it is manufacturing, construction or biotech -- that is opportunity cost," according to Garrett.
The number of IPOs has dropped recently, according to Dealogic. The research firm notes there were 559 IPOs in 1996; that number dropped significantly to below 100 in 2001, 2002 and 2003, as well as in 2008 and 2009. IPOs by U.S. companies on overseas exchanges have remained relatively low, reaching a peak of 22 in 2007. In 2010 there were 11 IPOs in this category, nine in 2011 and one so far in 2012, Dealogic reported.
However, Rep. Carolyn Maloney, Democrat of New York, backed SOX 10 years later, saying the statute was approved to restore trust after some high-profile and reputable U.S. companies collapsed. She pointed out that roughly 60% of all U.S. public companies are already exempted from SOX attestation through the Dodd-Frank exemption.
"We have to remember why SOX was created in the first place … to restore trust," she added. "There was an accounting scandal, so we worked to address it."
Columbia Law School Prof. John Coffee, who testified at the hearing, pointed out that an April 2011 study conducted by the Securities and Exchange Commission found that corporations with an auditor-attestation provision in 2009 generally had a lower rate of restatements that firms that did not have such a requirement.
The study concluded that the SEC found no evidence that adding a broader exemption to 404(b) for firms with $75 million and $250 million in publicly traded shares would encourage companies in the United States or abroad to list their IPOs in America.
There is "strong evidence" that the internal-control auditing requirement "improves the reliability of internal-control disclosures and financial reporting," the agency's study said.
Coffee backed Maloney's point that the law was intended to restore trust in the financial system, adding that IPOs never recovered from the Internet bubble and bust of 2000-01.
"Investors pay a price based on how they perceive risk and return," he commented. "If they believe the risk of fraud is high, they will pay a lower price and thus companies will find capital much more expensive."
Coffee also criticized the Fitzpatrick bill, noting that a firm with revenues of $90 million and a public float of $600 million would be exempt from regulation. "Such high price/earnings ratio companies are probably those most needing oversight over the adequacy of their audit controls."