Market Experts Criticize Sarbanes-Oxley, Urge Capital Formation Reforms

At a hearing before the House Financial Services Subcommittee on Capital Markets, Securities and Investment, market experts discussed the decline in public offerings, the effects of the Sarbanes-Oxley Act of 2002 (“SOX”) and other federal corporate governance requirements. The panelists made recommendations for promoting capital formation, particularly in the area of public offerings. (See Committee Memorandum and Written Testimonies.)

Most of the witnesses criticized SOX Section 404, which imposes internal control requirements. New York Stock Exchange President Thomas W. Farley asserted that “designing, implementing, and maintaining complex systems required to satisfy SOX’s internal controls over financial reporting requirements can command millions of dollars in outside consultant, legal, and auditing fees, in addition to other internal costs.” John Berlau of the Competitive Enterprise Institute argued that Section 404 “has done little to prevent massive mismanagement or outright fraud at troubled firms.”

By contrast, University of Denver Sturm College of Law Professor J. Robert Brown argued that SOX has been unfairly maligned, and said that its mechanisms raise investor confidence with higher quality disclosures. However, Professor Brown echoed the expressed sentiment that the current system of financial disclosure must be updated overall and that current disclosure requirements are excessive or unnecessarily complicated. U.S. Chamber of Commerce Center for Capital Markets Competitiveness Executive Vice President Thomas Quaadman said that compliance costs have risen as a result of the SEC’s “overly complex and confusing disclosure regime, which even institutional investors have a difficult time understanding.” Mr. Quaadman cited a 2011 IPO Task Force report finding that “92% of CEOs found that the administrative burden of SEC reporting requirements was a significant challenge to going public.”

Several panelists advocated for enhancements to the JOBS Act as a way to catalyze growth of the public markets. Mr. Quaadman and Mr. Farley lauded the recent extension of a JOBS Act provision that will allow all companies to submit confidential draft registration statements (see previous coverage). aTyr Pharma Vice President of Finance John Blake advocated for the extension of a JOBS Act provision that grants certain SOX compliance exemptions for former emerging growth companies (“EGCs”) that have surpassed the five-year window for classification as EGCs.

Lofchie Comment:  However Congress and the SEC may come out on the trade-off between corporate regulation and the expense of that regulation, this hearing makes plain that Congress and the regulators are focused on substantive issues such as capital formation and corporate disclosure (and not on questions such as conflict minerals disclosure, as if the SEC had the means to end civil conflicts in Africa). As a result, now that they are focusing on real questions, it seems possible for Congress and the SEC to reach reasonable answers on issues of importance to the U.S. economy. See also SEC Chair Jay Clayton Lays out Regulatory AgendaA Regulatory Philosophy at Last (Statement of Former SEC Commissioner Paul Atkins).