After months of talk about solutions that would rev up job growth and the economy, today the House Financial Service Committee may finally adopt a true bipartisan stimulus. Led by Democratic Reps. Carolyn Maloney of New York and John Adler of New Jersey, two amendments will likely be introduced to the Investor Protection Act that would truly stimulate the economy by partially liberating investors, entrepreneurs and innovators from the shackles of a seven-year-old “investor protection” law that has added billions in costs while providing little if any benefits to investors and doing nothing to prevent the recent financial crisis: the Sarbanes-Oxley Act of 2002.
Maloney, whose most recent legislative accomplishment was the Credit Card Holders Bill of Rights that was signed by President Obama in May and hailed by liberal groups, has teamed with conservative Rep. Scott Garrett, R-N.J., to introduce an amendment to extend the exemption for smaller public companies – those with less than a $75 million market cap – from the costly audit of internal controls from the law’s Section 404 to at least June 2011 and until the Securities and Exchange Commission and Government Accountability Office each perform a study. This is important because the current exemption expires next June, and SEC Chairman Mary Schapiro recently said that there will absolutely, positively be no further extension, despite the limited research on the effects of Sarbox on the very smallest companies and the extensive research showing often devastating burdens on midsize and even large ones.
Rep. Adler goes one further. His amendment would exempt small and midsize companies – those with market caps of less than $700 million, the mark above which the SEC classifies companies as “large accelerated filers” – from Sarbox Section 404 until the SEC promulgates “regulations that take into consideration the different characteristics and limitations of various sized companies,” according to a “Dear Colleague” from Adler. In the letter, obtained by OpenMarket but not yet posted on the web, Adler states: “My amendment will increase America’s competitiveness within the global economy and create jobs here at home. When a company goes public, investors invest capital, the company expands and jobs are created.”
Indeed, new research from the University of Pittsburgh’s Kenneth Lehn and others demonstrates in detail the damage Sarbox is doing to job growth by showing how its costs reduce business spending on research and development and other precursors to job growth. Rammed through Congress in 2002 in the rush to “do something” after the Enron and WorldCom accounting scandals, Sarbox has had many perverse effects recognized by Republicans and Democrats. In 2006, now-Speaker Nancy Pelosi decried the law’s “unintended consequences” for entrepreneurs.
University of Rochester researcher Ivy Zhang has found that Sarbox has racked up $1.4 trillion in direct and indirect costs to the U.S. economy, with no quantifiable economic benefits. By far, the biggest cost is from Section 404’s internal control mandates, which the American Electronics Association calculated as costing U.S. public companies $35 billion a year, and as much as quadrupled an individual company’s auditing and compliance costs, according to the Foley & Lardner law and consulting firm. This section’s price tag is largely because the Public Company Accounting Oversight Board, the powerful yet unaccountable regulator created by Sarbox (and whose constitutionality is being challenged in a case before Supreme Court this term in which CEI attorneys are serving as co-counsel), required full-blown audits for internal controls as well as a company’s number. That is what turned Sarbox into what has been called “The Accountants Full Employment Act,” in which accountants are reviewing “internal controls” such as possession of office key, the number of letters in an employee password and other items of little relevance to the average shareholder.
Tech journalist John Battelle reported that Sarbox was even frustrating for a company as big as Google, because of the extensive red tape that went along with documenting innovative technology. According to Battelle, becoming Sarbox compliant when Google went public in 2004 was “no small feat,” because “the law requires an audit trail of every third party transaction, and Google has millions of them a week in its [search] engine.” And keep in mind that Google already had a market cap of more than $1 billion when it went public in 2004. So the smaller innovative companies with the potential to be the Googles and Microsofts of tomorrow might not be able to get over this Sarbox hurdle and raise the capital they need by going public.
And new, groundbreaking research shows that Sarbanes-Oxley hits cutting edge software and biotechnology firms especially hard, reducing the amounts they spend on research and development that could lead to new fields that create new job. A 2008 paper from University of Pittsburgh economist Kenneth Lehn that was selected for a conference of the Federal Reserve Bank of Atlanta finds that “greater evaluation and testing of
internal controls [is] required for firms with activities involving specialized knowledge.” And Lehn’s study includes data from 2007, after the SEC and PCAOB supposed “tailored” Sarbox to make compliance easier for smaller companies.
A letter from The Biotechnology Industry Organization that Lehn cites states that biotech firms “are directing precious resources from core research and development of new therapies for patients” to costly Sarbox compliance.
And ironically, the bells and whistles of Sarbanes-Oxley’s “internal controls” may ironically be taking the core focus off of rooting out fraud. In 2007 Countrywide Financial Corp. was praised for its Sarbox controls by the Institute of Internal Auditors. Two years and many scandals later, its former executives have been charged with securities fraud. And certainly, overall transparency doesn’t increase when companies go private or delay going public, as many have chosen to do because of Sarbox’s costs.
In addition to the valuable Adler and Maloney-Garrett measures, Rep. Michelle Bachmann, R-Minn., will likely introduce a worthy amendment to keep the underlying Investor Protection Act from expanding Sarbox and the PCAOB’s reach to include non-public broker dealers (an incredible power grab that jettisons the whole justification for Sarbox protection of average investors – they might have to change the name to the NCAOB – Nonpublic Company Accounting Oversight Board) until the Supreme Court rules on the entity’s constitutionality.
Her amendment will also likely propose transferring the responsibility of appointing powerful members of the PCAOB from the SEC to the President, with Senate confirmation. This is what CEI and other attorneys argue in the court case is constitutionally required, since PCAOB members are important “principal officers” with authority to make rules that have such a large impact on the U.S. economy. The Bachmann amendment is also bipartisan in spirit, as it gives more power to President Obama, but also institutes the constitutional accountability needed for this powerful agency.