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SOX: An uneven legacy

Thomas Quaadman | March 13, 2018

In 2002, Congress passed the Sarbanes Oxley Act (“SOX”) in response to the accounting scandals at Enron and WorldCom. This legislation represented a major transformation of the federal role in financial reporting and corporate governance. While strong policies have been implemented, the persistent rush for the exits by public companies and the failure to create new public companies persists. This has been a drag on the American economy.

From the New Deal until SOX, corporate governance was structured under state law, while financial reporting was a mix of federal and state law as well as private sector oversight. With some exceptions, federal securities laws were a disclosure-based regime, giving investors access to material information needed to make informed investment decisions.

SOX gave birth to a new era of direct federal regulation and intervention. This legislation established the Public Company Accounting Oversight Board, under the auspices of the Securities and Exchange Commission, to set audit standards and regulate the audit industry. The SEC was also granted power to officially designate an accounting standard setter. SOX required public companies to report on the effectiveness of internal controls, established auditor independence rules, reformed financial disclosures, and enhanced penalties for fraud and white-collar crimes. CEOs and CFOs must sign personal attestations that they had reviewed financial disclosures that complied with the law.

Federal powers were further expanded in 2010 with the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Dodd-Frank included a series of new disclosures on Conflict Minerals and Resource Extractions and also mandated new regulations on claw-backs, whistleblowers, compensation committee independence, and required say-on-pay votes.

The experience of SOX has been an uneven one at best. The state of the public company model, however, is worse today than it was when SOX was enacted. We cannot wait another 15 years to fix these problems if we want to restore the United States to long-term prosperous growth.

Following the passage of SOX, compliance issues abounded. Financial restatements spiked for a period of time, and businesses spent large sums to build out financial reporting structures focusing on controls. The PCAOB came out with a new standard for auditor attestation of internal control that further contributed to businesses revamping their processes and the documentation thereof.

Over the course of time, however, financial restatements fell and internal control costs started to drop. Even so, new problems emerged. Internal control costs were regressive, placing a disproportionate burden on small and mid-size companies. PCAOB standards were too prescriptive, creating problems for both auditors and businesses.

With the support of the U.S. Chamber of Commerce, the SEC attempted to make internal control costs scalable and the PCAOB came out with a new standard to address the prescriptive problems. Congress passed the 2012 Jumpstart Our Business Startups Act (“JOBS Act”) to remove obstacles preventing businesses from going public.

So where do we stand today?

The decline in public companies continues with the United States having less than half the public companies today than in 1996. The cause isn’t only anemic IPO markets, but businesses are not staying public and regulatory compliance costs are contributing to the problem.

Carving out a proactive role on these fronts, in October 2013, the Chamber sent a letter to SEC Chair Mary Jo White with a set of proposals to modernize financial reporting. In May 2015, the Chamber wrote to the SEC and PCAOB outlining internal control stresses caused by the PCAOB’s inspection program. We suggested the creation of an issuer advisory group and held a series of joint discussions with the SEC and PCAOB seeking to find solutions. Under the SEC’s leadership, progress was made but more remains to be done. We look forward to working with all parties to build on that foundation. Later this winter, the Chamber will issue an IPO report and propose additional financial reporting modernizations.

The experience of SOX has been an uneven one at best. The state of the public company model, however, is worse today than it was when SOX was enacted. We cannot wait another 15 years to fix these problems if we want to restore the United States to long-term prosperous growth.