Two House Democrats are planning to introduce amendments Tuesday to exempt small- and medium-sized companies from a key post-Enron reform. Consumer advocates and investor groups say that the proposed exemptions would severely undercut protection for investors and increase the chances for financial fraud.
Reps. John Adler of New Jersey and Carolyn Maloney of New York will attempt to amend the Investor Protection Act of 2009 -- a bill designed to beef up investor protection -- by adding in provisions that will undermine the Sarbanes-Oxley Act, the 2002 law designed to increase investor confidence that was enacted after accounting scandals at Enron and WorldCom rocked investors. The law was supposed to improve the accuracy, reliability, and transparency of corporate financial reporting by requiring firms to audit their financial statements and internal controls.
Adler, a member of the pro-business New Democrat Coalition, is proposing to exempt publicly-traded firms with market capitalization less than $700 million from a provision of Sarbanes-Oxley mandating an external audit of the firm.
Specifically, Adler's provision calls for "less stringent requirements" for these firms, and would require the Securities and Exchange Commission -- the federal watchdog overseeing the capital markets -- to develop rules that would ease the "burden" on these firms. But until the SEC developed those rules, firms worth less than $700 million would be completely exempt from mandated external audits.
"With the nation once again suffering the devastating effects of a financial scandal in which poor financial reporting played a significant role, investors should be able to trust that their representatives in Congress will pursue reforms that strengthen, rather than weaken, investor protections," wrote Barbara Roper, director of investor protection at the Consumer Federation of America, in a letter to Adler obtained by the Huffington Post. In addressing Adler, Roper writes, "Your...amendment fails that test."
A former high-ranking official at the SEC was even more blunt.
"What Adler is really doing is dialing for dollars," said Lynn E. Turner, chief accountant for the SEC from 1998 to 2001. "He's got a job that he wants to keep, and he has to run for that job every two years. So this is probably a strong indication that Adler couldn't care less about investors, and cares much more about getting the money so he can keep his job."
The U.S. Chamber of Commerce has been fighting for just such a reprieve for its member companies for years, arguing that one such post-Enron provision -- requiring public companies and their independent auditors to publicly disclose the effectiveness of the company's internal controls -- has been implemented in a way that creates "extraordinary and unnecessary burdens that are disproportionate to identified benefits."
Adler's spokeswoman, Kathryn Prael, released the following brief statement in response to questions from the Huffington Post:
"Congressman Adler's amendment will exempt small businesses from cost prohibitive regulations. Small businesses are the backbone of our local economies and this necessary reform will help keep and create jobs for hard working Americans."
"Small businesses" are not mentioned anywhere in Adler's amendment. And under the Congressman's definition, "small businesses" can be worth up to $700 million.
Investor groups, though, argue that Adler's amendment will have the opposite effect. The lack of a reliable, independent outside opinion on a firm's financial health will undermine investor confidence, "whose trust in the markets is an essential ingredient in any financial recovery," wrote representatives of the Council of Institutional Investors and American Association of Individual Investors, among others, in a letter to House Financial Services Committee Chairman Barney Frank, Rep. Paul Kanjorski (the chairman of the subcommittee on capital markets) and the committee's two ranking Republicans.
Moreover, the investor groups write, "we believe the costs have often been exaggerated by...opponents, particularly with regard to the costs for small companies, and that the benefits more than outweigh those costs."
In fact, costs have been decreasing, the groups note, citing a September SEC study, because as firms have gotten used to the new regime, their costs to comply have gone down.
Also, the groups note, the cost to comply is lower than the cost to investors when companies are forced to restate earnings. Since these are public companies, investors' concerns should be paramount.
"The cost to the companies is probably a drop in the bucket to what [restatements] cost investors," Turner said. "And investors are willing to pay for it because it costs them less."
Americans for Financial Reform, a coalition of 200 groups pushing for an overhaul of banking and financial regulation, wrote in their letter to Frank that "given the enormous costs associated with restatements, small public companies, and those who invest in them, have a great deal to gain by improving the quality of their financial reporting."
Maloney's amendment, co-sponsored with Rep. Scott Garrett, a New Jersey Republican, would exempt from the independent audit requirement entirely those publicly-traded firms with market capitalization less than $75 million.
But it's just those firms that need the extra set of eyes checking their numbers, investors argue.
"The need for strong internal controls is particularly important for the generally riskier smaller public companies that would be the beneficiaries of any exemption," wrote Jeff Mahoney, general counsel for the Council of Institutional Investors, a nonprofit association of public, union and corporate pension funds with combined assets that exceed $3 trillion.
Roper of the Consumer Federation of America said the amendment is "worse than I would have expected from [Congresswoman] Maloney."
Maloney could not immediately be reached for comment late Monday.
Though these firms are required to obtain outside audits, the SEC has granted them annual deferrals from complying with the law for the last seven years. The latest deferral was granted earlier this month, though the SEC said, in effect, that this was the last one.
"Why would anyone come out and propose that we keep this hidden?" Turner asked. If enacted, the amendments would shield "thousands of companies across the U.S." from effective oversight, he added.
"It makes all the sense in the world to make sure these companies have good internal controls, and to have a different set of eyes to make sure it really does exist," Turner said.
"Why would you want to hide that from investors?"
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