Thinking Outside the SarbOx

Why go to Washington when Washington will come to you?

This morning I had the opportunity to attend a Wall Street "field hearing" held by the House Government Reform Subcommittee on Regulatory Affairs, examining the effects of the Sarbanes-Oxley Act of 2002, the jerky-kneed, ill-defined legislative reaction to high-profile securities scandals like Enron and WorldCom.

Given the lofty financial burdens and the risk of civil and criminal penalties associated with SarbOx compliance, many growing businesses are finding it no longer makes sense to go public on U.S. stock exchanges.  The resulting fall-off in public offerings and migration of such offerings overseas has led some legislators to question whether it may be time to revisit and better define some of the provisions of the well-intentioned, but perhaps overreaching legislation.

The hearing was chaired by Rep. Patrick McHenry (R-NC) and also included Reps. Charlie Dent (R-PA), Sue Kelly (R-NY), and Tom Feeney (R-FL).  The one Democratic member slated to attend the hearing was my own Congresswoman Carolyn Maloney (D-NY).  They had a nice seat set up for her and her placard was in place; McHenry even gestured to the empty chair to introduce her in absentia, but she never showed (at least not while I was there).  Odd, since she had the shortest distance to travel.

While I only attended the first half of today's hearing, the witnesses I heard (Neal Wolkoff, CEO of the American Stock Exchange; Cromwell Coulson, CEO of The Pink Sheets; and Mallory Factor, Chairman of the Free Enterprise Fund) repeated nearly identical refrain - that the costs of SarbOx (to American companies, domestic exchanges, and indeed to investors) easily outweigh the benefits of incremental transparency and investor confidence.  Further, there seemed to be a consensus that these benefits could equally be achieved via less heavy-handed regulation with better defined provisions (notably the meaning of "de minimus errors" and the scope of internal and external audits).

According to the witnesses, regulators have interpreted the enacted legislation more stringently than was intended, leading to what amounts to little more than a "full employment program for accountants".  Coulson compared Sarbanes-Oxley to a requirement that you paint your house every year, only the painter is the one who decides when the job is finished, and he's paid by the hour.

As an alternative to the current legislation (estimated by Factor to have led to the loss of more than $1 trillion in shareholder value), Feeney discussed the Compete Act, a bicamerally proposed alternative to Sarbanes-Oxley's controversial Section 404, allowing companies with less than $700 in market cap to opt in or out of compliance, leaving investors to decide whether or not to discount non-compliance.

The theory is that smaller, innovative companies in fields like biotech and emerging sciences are disproportionately penalized by SarbOx and that the cost of compliance can even be the difference between profitability and losing money.  Feeney and his co-sponsors hold that investors seek a different class of risk when investing in these growth sectors and that they can be made aware of the non-compliance of opters-out, discounting their shares however they see fit.

I'm not sure what the effects of the discrete threshold for optional compliance would be (might companies seek to spin off segments just ahead of share price appreciation, or worse, game the tone of financial disclosures to keep share price artificially low, in order to keep below $700 million), but the idea of optional compliance does seem to make some sense.  Clearly, if the statistics presented by the witnesses are even close to accurate, SarbOx is a big net negative for our financial markets (they reported that foreign exchanges' first and last marketing points are now that they represent "Sarbanes-Oxley Free Zones") and requires some kind of redress if we're to maintain our prominence (or even our relevance) in the international capital markets.

Showcasing the fine Congressional tradition of tortured acronyms, the full text of the "Competitive and Open Markets that Protect and Enhance the Treatment of Entrepreneurs (COMPETE) Act" is available here.