SEC Chairman Cox: Sarbanes-Oxley not unique in world, U.S. just early adopter

Securities and Exchange Commission Chairman Chris Cox today testified before the House Financial Services Committee. A copy of his testimony can be read here. The title of today's Committee session was "Sarbanes-Oxley at Four: Protecting Investors and Strengthening the Markets" and the central question was whether the Sarbanes-Oxley Act of 2002 is undermining the competitiveness of U.S. capital markets.

(Mark Olson, chairman of the Public Company Accounting Oversight Board, the U.S. auditing company regulator, also testified. His written testimony can be read here.)

Cox's testimony made several key points:

1. Sarbanes-Oxley has, for the most part, proven extremely successful, improving investor confidence, increasing corporate transparency, and improving auditor oversight. Overall, most SOX provisions are a net contributors to the nation's economy.
2. A little-noticed fact about SOX has been that most of its key provisions have been adopted by other countries around the world. "As we consider the effect of Sarbanes-Oxley on U.S. competitiveness, it is important to keep in mind how broadly many of its tenets have been taken up overseas. It would appear, four years later, that America's approach is not unique -- we just happened to be early adopters. "
3. The one part of SOX that hasn't worked well is Section 404, and the SEC believes that this is an issue of implementation that can be corrected and the SEC is working to correct.

This last point seems clear, and if you are into the technical aspects of SOX, what he said will be heartening. Cox admitted that Section 404 has proven more expensive than Congress or the SEC expected, particularly for smaller companies (Cox was a Congressman when SOX was passed). While Section 404 may be benefiting larger companies, there are questions whether the costs outweigh the benefits for smaller issuers. However, since it is uncertain whether the SEC has the legal authority to exempt smaller companies from Section 404's internal control provisions, Cox said the SEC has instead decided to postpone implementation for smaller companies until the PCAOB has time to adopt improved implementation rules which will not be so expensive.

On this same issue, Congressman Tom Feeney (R-Florida) suggested that Section 404 could be improved by introducing a de minimis standard of 5 percent of the company's gross sales. In other words, if the company's internal controls are off by 5 percent of the company's sales (in Walmart's case, let's say $2 billion), the company wouldn't have to revise its financial statements or worry about correcting the internal controls. I don't know about you, but if my internal controls were off by $2 billion, I think I'd want to know about it. (Feeney also asked whether all the recent corporate accounting restatements were necessary and did investors really care if the company got its financial statements wrong. There's an easy answer to that one, Tom--what did the company's stock do when the need for a restatement became public? If the stock dropped, investors probably cared.)

Cox's comments on the international aspects of SOX were also interesting. In response to a question asking about the recent UK Balls Clause and possible cross-border mergers between the New York Stock Exchange and Euronext or NASDAQ and the London Stock Exchange, Cox responded that the SEC has stated repeatedly that it has neither the intention nor the legal power to impose Sarbanes-Oxley abroad. Congressman Mel Watt (D-North Carolina) then asked how U.S. investors investing abroad in less transparent markets ("France" being the example given) could be protected if Sarbanes-Oxley did not apply to them. Cox answered that while "regulatory arbitrage a real issue," the SEC "works closely" with its foreign regulatory counterparts, and "we want to have an understanding that we live in a high standards world. We [in the U.S.] have the highest standards and the largest market, and I like to think this is not unrelated." Cox pointed out that the number of other large markets adopting SOX-like provisions (clearly referring to a recent study by the SEC's Office of International Affairs) indicates that other markets see the value of having higher quality regulatory standards.

When asked about why so many foreign IPOs have occurred abroad rather than in the United States, Cox pointed out (as this blog did here--glad to see he's a reader) that the largest of these foreign IPOs involved state-owned companies with a preference for listing in their home markets and that many were "unable to live up to our standards of transparency." The rest list elsewhere for a variety of reasons, including the high litigation risks in the United States, but also the increasing pools of liquidity that can be tapped in developing markets around the world. Cox added that, in a sense, the U.S. is a victim of its own success, since it for years has been advocating markets as a solution to poverty and development, and other countries had "finally taken us up on this." As a result, increased market competition was something that U.S. exchanges were going to have to get used to, but that this competition was good for both America and the world.

Nice to see a Republican who actually still believes in markets.