How could anyone in his right mind oppose former Securities & Exchange Commission chairman Arthur Levitt, former Federal Reserve chairman Paul Volcker, and former chairman of Vanguard Funds John Bogle in their efforts to enforce Section 404 of Sarbanes-Oxley for all companies no matter their size?
Well, a look at the facts might change a few minds.
Section 404 of Sarbanes-Oxley, the sweeping 2002 corporate governance law, keeps many senior executives up at night because it requires them to sign off that the company's internal financial controls have been tested and are shipshape. While it's been a boon to auditors and securities lawyers, it has been a financial burden for many companies, especially smaller ones. The annual cost of implementing Section 404 runs between $1 million and $4 million. That might be little more than a rounding error for a Fortune 500 company, but for smaller capitalized companies, it could be the difference between make or break.
Responding to a chorus of criticism, the SEC delayed implementation of 404 for smaller companies and formed an advisory panel. The panel recommended that companies with less than $128 million in market cap and with less than $125 million in annual revenue be exempted from Section 404's costly requirements.
The reasoning is sensible. Various experts said the reporting requirements of 404 led to an uptick in the number of companies that opted out of the public markets and went private, where there are obviously no reporting requirements. It made more economic sense for them to go private than be burdened with additional regulatory costs. Others have said if they are compelled to implement 404, they'll go private.
The panel also heard that the reporting requirements of 404 might discourage companies from going public. This is especially relevant as cash-rich private equity firms busily hunt for investing opportunities.
Embracing 404 in its entirety could make it impossible for investors to participate in a company's growth and appreciation if smaller companies avoid the public markets. The chance to hitch a ride with a newly born star, such as Starbucks or even Microsoft, could disappear.
Now the SEC wouldn't stand in the way of a small company that believed that by fully implementing 404 more investors would be attracted to its stock. For now, the panel would simply exempt these companies from the costly reporting burdens until a less expensive way is developed to provide such internal controls and oversight. It would allow the company to decide for itself, and similarly, an investor could factor in the significance of a company's abiding by, or opting out.
This is a delicate and tricky balance: Access to the public capital markets is critical to driving growth in our economy, but government has a role in keeping the game honest. Shifting the balance in reaction to the recent spate of financial corporate shenanigans will damage the necessary dynamism of the public markets, rather than deter any company executive from crossing the line.
Fred Bratman is president of Hyde Park Financial Communications.