Are we about to see a softer Sarbanes-Oxley?

For NYSE-listed companies, it would be Christmas, Thanksgiving and the 4th of July rolled into one. But will the day ever come when the US Government accepts a softer version of Sarbanes-Oxley (SOX)?

by Knowledge@Wharton
Last Updated: 23 Jul 2013

SOX was passed by Congress and signed into law in 2002. Introduced following corporate scandals at Enron, WorldCom and other companies, it was intended to protect investors through increased disclosure and stiffened internal controls.

But earlier this month the Securities and Exchange Commission announced that it will revisit some of SOX's rules. Its main focus will be to look again at Section 404, which requires auditors of most publicly listed companies to report on the effectiveness of internal controls and procedures for financial reporting. Section 404 has caused a major headache for many companies because the financial burden of compliance is so high.

But while the clamour for reform of SOX is intense, there are also those who believe the act does a good job at protecting investors and should not be watered-down without serious consideration. According to an article published last week on Knowledge@Wharton, the issue "defies easy categorisation, with few people coming down firmly either for a revamping of SOX or against it". The article quotes Wharton management professor Martin Conyon, who says: "Sarbanes-Oxley was enacted at a time of extreme distrust regarding corporations. The demand for tightened standards was rather high. If that demand was scaled back, perhaps it is time for the level of regulations to change."

But, Conyon adds, concern about the high costs associated with SOX should not overshadow its benefits for investors. "Investors may be willing to absorb higher costs in order to gain a greater level of confidence in the system," he says.

The SEC's decision to revisit Section 404 may be partly due to the fact that the high cost of complying has led many smaller firms to delist from the major stock exchanges or list with services such as the "Pink Sheets" - an electronic medium that does not bound companies by SOX disclosure requirements.

According to research by Christian Leuz of the University of Chicago's Graduate School of Business, of the 484 firms that delisted from the major exchanges between 1998 and 2004, 372 did so after 2002 - when SOX was enacted. Other commentators have noted that the introduction of SOX has directly benefited foreign exchanges, as many non-US companies reject New York and choose instead to list in London or elsewhere.

But according to Knowledge@Wharton, many groups remain firmly in favour of SOX. It quotes a letter sent to the SEC in February by the Center for Audit Quality, an accounting industry organisation, which said that SOX had "helped enhance the integrity of capital markets and restore investor confidence". The letter goes on to say: "As the SEC advances its proposals in this area, we strongly believe that change should flow primarily from the desire to reinforce the significant benefits of effective internal controls over financial reporting, rather than a drive to cut costs."

Source: Knowledge@Wharton

Review by: Nick Loney

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