Section 404 of the Sarbanes-Oxley Act came under fire again on Monday, this time by panelists testifying in New York before the Regulatory Affairs subcommittee of the House Committee on Government Reform.
“Seeing Mr. Lay and Mr. Skilling convicted has done more good [to deter fraud and protect investors] than all of the bills in Congress,” stated Neal Wolkoff, chairman of the American Stock Exchange.
Complying with Section 404, which governs internal controls over financial reporting, has been criticized as particularly burdensome by executives of companies with a market capitalization under $100 million. Wolkoff, who also was critical of the provision’s disproportionate effect on smaller companies, called for an exemption similar to that recommended by the Securities and Exchange Commission’s Advisory Committee on Smaller Public Companies.
Wolkoff also blamed Section 404 for an exodus of issuers to stock exchanges outside the United States. He cited exchanges such as the London-based Alternative Investment Market, which “aggressively markets” the fact that listing on a U.S. exchange carries the extra cost of 404. Wolkoff also stated that Canadian and Australian issuers looking to raise additional capital “don’t consider us because it is too difficult to list in the United States” even though they would gain “the advantage of liquidity.”
Asked whether the American Stock Exchange had lost business due to the marketing efforts of the Alternative Investment Market, Wolkoff acknowledged that his exchange has been successful in recent months, but he maintained that it was “a difficult success.”
Foreign issuers do seem to be funneling capital, once earmarked for the United States, to other countries, said Rep. Patrick McHenry (R-N.C.), who chaired Monday’s meeting. Citing a report from The Wall Street Journal, McHenry observed that in 2000, nine out of every ten dollars raised by foreign companies for an initial public offering were raised in New York; by 2005, nine out of ten IPO dollars were raised in either London or Luxembourg.
Panelists also took their shots at the auditing industry. (No auditors were invited to speak on Monday; McHenry said their issues would be addressed another time.) Mallory Factor, chairman of the Free Enterprise Fund, which promotes limits on government, testified that according to accounting-sector executives, profitability at their firms has “soared” since passage of Sarbanes-Oxley. Factor characterized Section 404 as a “disaster” and a regulatory overreaction to scandals at Enron and WorldCom, maintaining that “to get out of one hole, Congress dug a deeper one.”
Cromwell Coulson, chief executive of The Pink Sheets, a company that provides pricing and financial information on over-the-counter traded stocks, asserted that Congress or regulators have to “cut off the accountants.” Coulson likened 404 to a town law requiring everyone to have their house painted once a year, a scenario in which “the painter [the auditor] decides the cost and when he is done.” If what a 404 audit should comprise were better defined, said Coulson, management would be able cite the law and, at the appropriate time, inform auditors that “you are done.”