A U.S. House of Representatives subcommittee on Thursday debated the benefits and costs of the Sarbanes-Oxley Act of 2002 (SOX)—and a bill that would decrease its scope—as the corporate governance law approached its 10th anniversary.
The House Subcommittee on Capital Markets and Government Sponsored Enterprises heard sharply divided opinions from representatives, business leaders, and academics who discussed the bill that President George W. Bush signed into law on July 30, 2002.
The testimony came one week after Rep. Michael Fitzpatrick, R-Pa., introduced H.R. 6161, known as the Fostering Innovation Act, which would exempt certain small companies from Section 404(b) of SOX. Section 404(b) requires a publicly held company’s auditor to attest to, and report on, management’s assessment of its internal controls for financial reporting.
Michael Gallagher, chairman of the Professional Practice Executive Committee of the Center for Audit Quality, which is affiliated with the AICPA, testified that he sees the positive impact of SOX every day in his job as a managing partner of PricewaterhouseCoopers’ audit quality functions. Gallagher said SOX has led to fewer financial restatements, improved disclosures, and earlier identification of fraud.
“The benefits of Sarbanes-Oxley are substantial,” Gallagher said. “And in my view, it serves capital markets and investors well.”
Gallagher said the rigorous internal control analysis by management provides assurance that’s important to U.S. capital markets. “The benefit [is] to the cost of capital because of that assurance and that higher level of rigor from that internal control,” he said.
Jeffrey Hatfield, president and CEO of privately held Vitae Pharmaceuticals, told lawmakers that the costs of complying with Section 404(b) can be greater than $1 million a year for an average biotech company. He said those costs come at the expense of research and development that could lead to medical breakthroughs.
“If I think of the patients with chronic kidney disease, with diabetes, with Alzheimer’s—all things that we work on—and we tell them that we didn’t get them the cure but we’re compliant with regulation, I think that’s tough,” Hatfield said.
Hatfield said the cost of SOX compliance is a significant factor in the reluctance of many biotech companies to go public.
Impact on IPOs
U.S. public offerings, which happened at a rate of 311 per year from 1980 to 2000, declined to 102 per year from 2001 to 2009, according to researchers at the University of Florida and two Hong Kong universities.
Experts and members of the subcommittee debated Thursday whether the decline was due in part to SOX.
John Coffee, a Columbia University law professor, testified that an intellectual war has been raging over whether the decline in U.S. capital markets has been caused by over-regulation or a loss of investor confidence. He said he believes investor confidence has suffered significantly in the United States because of recent scandals.
The JOBS Act, passed earlier this year, may be attracting new IPOs to the United States, Coffee said in written testimony. But aspects of the law represent a major retreat from transparency and full disclosure, he added. The JOBS Act exempted emerging growth companies from SOX 404(b).
The rate of restatements was 46% higher among issuers that filed just 404(a) reports than those that filed auditor attestations under Section 404(b) during a four-year period, Coffee testified, citing a 2011 SEC study.
Coffee said H.R. 6161 would basically exempt 1,000 companies from 404(b) compliance. “If you take 1,000 companies and there’s a 46% difference in the rate of restatement, that’s an awful lot of fraud, and I think it’s going to have investors quite nervous,” he said. “…You’re giving a very large exemption permanently, not for five years the way the JOBS Act does. And I think the SEC is right to say the case has not been made for that large an exemption.”
But some said the impact of SOX wasn’t as conclusive. John Berlau, a senior fellow at the Competitive Enterprise Institute, quoted research by Harvard Law School professor Hal Scott that says it’s empirically unclear whether SOX 404 achieves its intended benefit, despite the costs.
Financial Executives International President and CEO Marie Hollein said that without the trust that comes with market integrity and sound corporate governance, investors would withdraw, capital markets would wither, companies would not grow, and jobs would become scarce.
She called the SOX provision requiring CEOs and CFOs to personally certify their companies’ financial statements the “crown jewel” of SOX.
“This sets the tone from the top, increases the accountability and drives better corporate governance,” she said.
Representatives weigh in
Like the panelists, the members of the subcommittee were split.
“I haven’t heard a single thing from this panel saying that SOX hasn’t actually improved investor protection,” said Rep. Jim Himes, D-Conn.
Rep. Scott Garrett, R-N.J., who chairs the subcommittee, said attestations and compliance with SOX did nothing to prevent failures during the recent economic crisis.
“We are seeing so many IPOs going overseas and not going over here,” Garrett said. “What’s that expression out there? That’s priceless. The businesses that are not in this country. The jobs that are not in this country. The families that have been dislocated because they can’t get a job anymore. The communities that have been decimated because they don’t have jobs, whether it’s in manufacturing, construction, biotech, and the like. How do you put a price on that?”
Garrett called the passing of SOX a “typical, knee-jerk reaction” by Congress. The law passed nearly unanimously, with a vote of 423-3 in the House and 99-0 in the Senate.
Ten years later, though, SOX’s merits—and which companies should have to abide by the law—are hotly debated.
—Ken Tysiac (
) is a JofA senior editor.