Wednesday, September 21, 2011

Sarbanes-Oxley Section 404: Will We See More?

Appearing at her second Congressional hearing in as many weeks relating to small business capital formation, SEC Division of Corporation Finance Director Meredith Cross testified to the House Financial Services Committee earlier today on various initiatives the SEC is considering to better facilitate small business capital formation, while still adhering to its investor protection mandate. See the link to the hearing webpage, which includes links to all testimony and some related proposed legislation.

I found her prepared remarks on Sarbanes-Oxley Section 404 to be of the most interest, as summarized below. (Please note the disclaimer that appears on the right side of this blog).

Note: I did not listen to the live webcast of the hearing, this summary is based on written testimony and draft legislation; if other bloggers out there live-blogged (or live-tweeted) the hearing, I invite you to post a comment or send me an email with a link to your blog post or twitter handle.).

In her testimony today, SEC’s Cross noted that the Dodd-Frank Act amended Sarbox by exempting non-accelerated filers (i.e. companies with less than $75 million market cap). A footnote in her testimony linked to the SEC’s study, also mandated by the Dodd-Frank Act, as to whether further exemptions or other improvements could be made with respect to the rules pertaining to Sarbox 404, for companies with over $75 million market cap and less than $250 million market cap; that study concluded there should be no further exemptions, and that further study would be given to potential improvements.

She reiterated in her testimony today, in language similar to that used in the SEC’s Sarbox study referenced above, that:

The staff encourages activities that have the potential to further improve both the effectiveness and the efficiency of the evaluation of internal controls, while maintaining important investor protection safeguards. For example, with this objective in mind, the staff continues to work with the PCAOB to monitor inspection results and assess the extent to which publishing observations can be useful.

She added:

The staff is also observing COSO’s (Committee of Sponsoring Organizations of the Treadway Commission) project to review and update its internal control framework, which is the most common framework used by management and auditors alike in performing assessments of internal control over financial reporting.

NOTE: We previously reported that an Exposure Draft of the update to COSO’s 1992 Internal Control-Integrated Framework is expected to be released for public comment later this year.

Congress Gets Into The Act

Various members of Congress have circulated proposals to further amend Sarbanes-Oxley Section 404 by increasing the threshold level of exemptions from the Sarbox Section 404(b) auditor’s report on internal control (i.e., increasing the exemption level provided in the Dodd-Frank Act) and in some cases by providing certain opt-outs for companies up to a threshold level of, in some proposals, $1 billion, with some bills specifying the company would need to disclose if it took advantage of that opt-out (aka, what some may describe as ‘comply or explain.”)

For example, Cross referenced draft legislation proposed by Rep. Stephen Fincher (R-TN). Fincher’s draft bill, the Small Company Job Growth and Regulatory Relief Act of 2011 would further amend Sarbox 404 by:

· increasing the threshold level of companies exempted from the Sarbox 404(b) auditor’s report on internal control, from the current level of $75 million, to a level of $500 million, and

o provide an additional exemption for companies between $500 million and $1 billion of market cap: “(1) for the first five years following the registration of securities of an issuer that first registers after the enactment of the Small Company Job Growth and Regulatory Relief Act of 2011,” or (2) any report filed pursuant to subsection (a) by an issuer that has opted out of subsection (b), by consent of its shareholders by majority vote.”

It appears to me (see the disclaimer on the right side of this blog) that Rep Fincher’s bill is proposing a permanent opt-out from Sarbox 404(b) – if and only if there is majority shareholder approval - for companies with less than $1 billion market cap.

In contrast, a similar bill in circulation, “The Startup Expansion and Investment Act,” sponsored by Rep. Ben Quayle (R-AZ), appears to provide a ‘comply or explain;’ type opt out for a time limited period (10 years) for companies with less than $1 billion market cap. As described in Rep Quayle’s press release:

Specifically, the bill allows new companies with a market capitalization under $1 billion to opt-out of regulations within section 404 of the Sarbanes-Oxley Act for the first ten years after going public. To inform investors, a company must clearly disclose in its annual reports that it chose to opt out of section 404.

Props to former SEC Chief Accountant Lynn E. Turner for bringing the Quayle bill to my attention through an email news listerv he provides. Of course, he added his own commentary to his email, (subject line “Short Memories”), in which he stated, “Clearly people have forgotten the hundreds of billions in dollars of losses investors suffered during the corporate financial reporting frauds, and the tens of thousands of jobs lost [from those frauds].”

CFA Institute, CAQ, and CII Caution Against Further Sarbox Exemptions

Yesterday, a joint letter was sent by the CFA Institute, the Center for Audit Quality, and the Council of Institutional Investors, to the Chairman (Rep. Spencer Bachus) and Ranking Member (Rep. Barney Frank) of the House Financial Services Committee (sponsor of today’s hearing), stating:

We understand that the Committee is considering legislation that could weaken certain investor protections of the Sarbanes-Oxley Act of 2002 (SOX). The Center for Audit Quality, the Council for Institutional Investors, and CFA Institute are writing to urge you to resist efforts to further weaken SOX by exempting even more public companies from compliance with Section 404(b) of the Act, which requires an independent audit of a company’s assessment of its internal controls as a component of its financial statement audit.

Read more in the CFA Institute, CAQ, CII Sept. 20 letter.

SEC IG Issues Report on Conflicts of Interest

In the interim period between the two Congressional hearings addressing crowdfunding and other small business capital formation matters, the SEC’s Inspector General publicly released his report and recommendations entitled: Investigation of Conflict of Interest Arising from Former General Counsel's Participation in Madoff-Related Matters. The report examined the involvement of former SEC General Counsel David M. Becker in certain matters relating to the Madoff liquidation, in light of his having inherited some funds from his late mother’s estate which came from liquidation of an investment in Madoff securities. Becker had received clearance from the SEC Ethics Officer to participate in matters relating to the Madoff liquidation. Among parties sued by the Madoff bankruptcy Trustee for clawback of a certain portion of funds received were the Becker estate.

In response to the IG’s report, SEC Chairman Mary L. Schapiro made the following statement:

Last March, after learning about the Trustee’s suit against the Becker estate, I asked for the Inspector General to look into the matter.

I take his report, which was published today, very seriously.

It would be inappropriate for me to comment on the Inspector General’s referral to the Department of Justice.

I do want to state that I’ve known David for many years to be a talented, highly skilled lawyer and a dedicated civil servant who served under three Chairmen.

As the Inspector General recommends, we will seek another vote of the Commission on the question of the SEC’s position on the valuation of Madoff victim accounts.

I believe that the decision the Commission made on that issue was appropriate under the law and in the best interest of investors.

Moving forward, we plan to implement the other recommendations contained in the report as well.

Of note in Cross’s testimony before the House Financial Services Committee today, as shown in footnote/endnote number 1 to her written testimony, was that Cross has voluntarily recused herself from matters relating to ‘crowdfunding,’ and that Lona Nallengara, Deputy Director of the Division of Corp Fin, would provide testimony on crowdfunding specifically, with Cross providing the remainder of today’s testimony. As explained in the footnote:

Ms. Cross’s participation in this testimony does not include matters related to crowdfunding. Prior to joining the Commission staff in June 2009, Ms. Cross served as counsel to a company in connection with its registration under the Securities Act of 1933 of notes offered and sold through its “peer-to-peer” lending platform. Although Ms. Cross has no financial or other interest in her former client or her prior employer, in light of the small number of participants in that market, in order to avoid any appearance concerns, she does not participate in matters involving peer-to-peer lending. Further, since there are some similarities between peer-to-peer lending and some crowdfunding concepts, even though Ms. Cross has been advised by SEC Ethics Counsel that there is no conflict of interest, Ms. Cross has determined that in order to avoid any appearance concerns, she will no longer participate in crowdfunding matters. For purposes of this testimony, Mr. Nallengara will address crowdfunding matters.

It appears that Cross’s voluntary recusal from matters relating to crowdfunding (including from providing formal testimony on the matter today), and the related disclosure in footnote 1 of her testimony, reflects an abundance of caution to avoid even the appearance of any potential conflict of interest, particularly in light of the IG’s report and recommendations released yesterday.

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Friday, September 16, 2011

Schapiro, Pitt, Others Testify On Congressional Proposals On SEC Modernization, Accountability

SEC Chairman Mary L. Shapiro, former SEC Chairman Harvey L. Pitt, and other former high ranking officials of the SEC testified at a Congressional hearing yesterday on "Fixing the Watchdog: Legislative Proposals to Improve and Enhance the Securities and Exchange Commission."

Shubh Saumya of the Boston Consulting Group was also among those testifying at the hearing, vis-a-vis BCG's recommendations issued to the SEC in March 2011 and followup planning and action taken as noted in the Special Study published by the SEC on September 9: Report on the Implementation of SEC Organizational Reform Recommendations.

Also testifying at the hearing were former SEC Commissioner Paul Atkins, former SEC Secretary Jack Katz, former SEC Deputy Chief Litigation Counsel Stephen Crimmins, and George Mason Law Prof J.W. Verret.

Among the more interesting reporting coming out of the hearing:
See also our post earlier today on a separate Congressional hearing taking place yesterday, relating to the SEC's consideration of 'crowdfunding' and potential exemptions from SEC registration requirments.

SEC Considers Exempting Crowdfunding From Reg. Requirements, Corp Fin’s Cross Tells Congress; Forms Advisory Committee on Small and Emerging Co’s

At a Congressional hearing yesterday, the SEC's Director of the Division of Corporation Finance testified that the SEC staff is currently considering- and a newly formed Advisory Committee on Small and Emerging Companies will also consider and provide input on - potential methods to enhance the ability of small businesses to raise capital, including by potentially increasing the minimum size of offerings that would be exempted from SEC registration requirements, including (but not limited to) small business or startup fundings conducted online and/or through social media referred to via as 'crowdfunding.'

The term 'crowdfunding' and a possible tie to an exemption from SEC Registration requirements to loosen regulatory burdens on startup companies to encourage capital formation and job growth was popularized recently in a White House Fact Sheet posted in connection with President Barack Obama's proposed American Jobs Act and related initiatives including the Startup America partnership, and further publicised in a number of blog posts by the Administration, e.g. here and here. The reference to 'crowdfunding' in the White House Fact Sheet is cited below.

A personal observation - and please see the disclaimer on the right side of our blog: it is very interesting to see continued references to the challenges of complying with the Sarbanes-Oxley Act, presumably in particular Section 404 on internal control reporting, with respect to challenges to small business and start-ups in particular. This issue was debated not only after Sarbox (resulting in some amendments to the initial SEC and PCAOB rulemaking implementing Sarbox 404) but also during and after the Dodd-Frank Act which provided certain additional exemptions and calls for studies. The continued interest in Sarbox could be the thinking among some that there is something of a fixed cost and/or minimal staffing component to certain of the Sarbox 404 requirements.

Crowdfunding is referenced in the White House Fact Sheet as follows:

"As part of the President’s Startup America initiative, the Administration will pursue efforts to reduce the regulatory burdens on small business capital formation in ways that are consistent with investor protection. This includes working with the SEC to explore ways to address the costs that small and new firms face in complying with Sarbanes-Oxley disclosure and auditing requirements. The administration also supports establishing a “crowdfunding” exemption from SEC registration requirements for firms raising less than $1 million (with individual investments limited to $10,000 or 10% of investors’ annual income) and raising the cap on “mini-offerings” (Regulation A) from $5 million to $50 million. This will make it easier for entrepreneurs to raise capital and create jobs."
In her testimony yesterday before the House Committee on Oversight and Government Reform's Subcommittee on TARP, Financial Services and Bailouts of Public and Private Programs, Corp Fin Director Meredith Cross described 'crowdfunding' and the SEC's consideration of same as follows:

Generally, the term “crowdfunding” is used to describe a form of capital raising whereby groups of people pool money, typically comprised of very small individual contributions, to support an effort by others to accomplish a specific goal. This funding strategy was initially developed to fund such things as films, books, music recordings, and charitable endeavors. At that time, the individuals providing the funding were more akin to contributors than “investors” and were either simply donating funds or were offered a “perk,” such as a copy of the related book.

Another personal observation: (I remind you again of the disclaimer posted on the right side of this blog): My own experience with 'crowdfunding' earlier this year was in responding to a request for funding a project posted by a singer-songwriter friend (NB, that would be you), which he posted on facebook , to fund a new CD and songbook. His facebook post, in turn, linked to specific info about his project posted on the crowdfunding webite , including his funding goal, and total amount raised toward that goal. Those wishing to make a contribution to the project could do so via electronic fund transfer via Amazon. An apparent ongoing debate about vs. other crowdfunding sites is the fact that kickstarter runs an 'all or nothing' funding collection program, either the goal is met and everyone's pledges are paid, or the goal is not met and (presumably) no one's pledges are collected. Read more about the all-or-nothing kickstarter model and other facts on's FAQs. Significantly, this was not an 'investment' and did not purport to be a 'security' but I offer this example up for those of you interested in learing about some of the crowdfunding mechanisms out there, such as those referenced in Cross' testimony. (Postscript: my singer-songwriter friend NB met his funding goal.)

Following are some additional highlights from Cross's testimony on crowdfunding yesterday:

As these capital raising strategies did not provide an opportunity for profit participation, initial crowdfunding efforts did not raise issues under the federal securities laws.

…Proponents of crowdfunding are advocating for exemptions from the Securities Act registration requirements for this type of capital raising activity in an effort to assist early stage companies and small businesses.

...For example, the Commission received a rulemaking petition requesting that the Commission create an exemption from the Securities Act registration requirements for offerings with a $100,000 maximum offering amount that would permit individuals to invest up to a maximum of $100.

…in considering whether to provide an exemption from the Securities Act registration requirements for capital raising strategies like crowdfunding, the Commission needs to be mindful of its responsibilities both to facilitate capital formation and protect investors.

The Commission’s rules previously included an exemption, Rule 504, which allowed a public offering to investors (including non-accredited investors) for securities offerings of up to $1 million, with no prescribed disclosures and no limitations on resales of the securities sold. These offerings were subject only to state blue sky regulation and the antifraud and other civil liability provisions of the federal securities laws.

In 1999, that exemption was significantly revised due in part to investor protection concerns about fraud in the market in connection with offerings conducted pursuant to this exemption.

In assessing any possible exemption for crowdfunding, it would be important to consider this experience and build in investor protections to address the issues created under the prior exemption.

Some of the questions to consider with regard to crowdfunding include:
what information — for example, about the business, the planned use of funds raised, and the principals, agents, and finders involved with the business — should be required to be available to investors;

what restrictions should there be on participation by individuals or firms that have been convicted or sanctioned in connection with prior securities fraud;

should a Commission filing or notice be required so that activities in these offerings could be observed;

should securities purchased be freely tradable; and

should websites that facilitate crowdfunding investing be subject to regulatory

Advisory Committee on Small and Emerging Co's
SEC's Cross also told the Congressional subcommittee that input on crowdfunding and other capital formation issues would be sought from the SEC's new Advisory Committee on Small and Emerging Companies. This new advisory committee, and its members, were announced earlier this week in this SEC press release.

Bills Introduced To Exempt Certain Crowdfunding
As reported by Bloomberg's Phil Mattingly today, a number of Congressional bills have already been submitted to provide certain exemptions from SEC registration requirements for crowdfunding. See Mattingly's article, U.S. House Republicans Embrace Obama Push to Ease SEC Rules.

Wednesday, September 7, 2011

NEW! FEI Blog Part of FEI's New Website!

Earlier today, Financial Executives International launched a new and improved version of its website, The FEI Financial Reporting Blog will now be housed among its brother and sister posts on FEI's website, providing you one-stop shopping for the latest info on FEI's outstanding conferences, webcasts, advocacy and accounting policy committee activities, career development, and more! For direct access to the blog, you can continue to visit

Those of you who utilize our RSS feed, please note the feed will change, you will need to pick up the feed that appears on our new website next to the FEI Financial Reporting Blog. Our twitter site, has not changed.

*** Our email delivery will also change over to a new method in the coming month or so. If you should notice you do not receive emails that are posted on our site, please feel free to contact me with questions about your email delivery or any other questions regarding the blog or our new website, and I or our IT team will be happy to get back to you to address any concern you have.

And of course, we will continue to bring you cutting edge news and analysis of the latest and greatest happenings in the world of financial reporting from the FASB, IASB, SEC and PCAOB, by means of the written word and the occasional music video by which we are known!

We invite you to take a tour of FEI's new website; there is also a feedback box to provide real-time feedback.

Some finishing touches are still being added to the blog page on this new site, including our blog roll of esteemed blogger colleagues and areas for sponsoring advertisers. Once again, if you have any questions regarding the blog, please do not hesitate to contact me at

Tuesday, September 6, 2011

SEC Seeks Comment On Plan For Retrospective Review of Existing Reg's

The SEC published today a request for comment on its plan for conducting its retrospective review of its existing regulations, to be conducted in accordance with a Presidential order issued on July 11 of this year. See SEC's press release and request for information. Comments are due by October 6.

As noted in the SEC's press release:

The Commission is seeking public comment on the process it should use to conduct retrospective reviews, such as how often rules should be reviewed, the factors that should be considered, and ways to improve public participation in the rulemaking process....

President Barack Obama issued an order on July 11 that recommended that independent regulatory agencies consider how they might best analyze rules that
may be outmoded, ineffective or excessively burdensome, and modify, streamline
or repeal them. The order also recommends analysis of regulations that might need to be strengthened or modernized, which may entail new rulemaking.

FAF Proposal On Private Co Standard Setting Coming In A Matter of 'Weeks,' Says FAF's Polley

In the Sept., 2011 "From the President's Desk" letter issued earlier today, Financial Accounting Foundation President & CEO Terri Polley said that after receiving an enormous amount of written and in-person feedback on the topic of how best to set accounting standards for private (nonpublic) companies, the FAF plans to release a proposal on this matter for public comment "in the coming weeks."

Close to 2,500 'unsolicited' (i.e., prior to a formal request for comment) letters have been filed with the FAF/FASB on the subject of private co standard-setting so far, with the initial letter having been filed in the spring by FEI's Committee on Private Company Standards, chaired by George Beckwith.

As noted in Polley's letter, in addition to the longer term strategic decisions being undertaken by the FAF on how best to set accounting standards for private co's (including consideration of the report and recommendations of the Blue Ribbon Panel on Private Co Accounting, issued earlier this year, which recommended formation of a separate board focused on private co accounting standards), FASB is conducting public hearings next month on particular issues and how best to handle those matters for private companies.

FASB Project Aims For Less Disclosures, With More Utility

The Financial Accounting Standards Board is bringing its consideration of its Disclosure Framework project, first launched in 2009, to the forefront, bringing the results of staff research and a proposed decision framework for the board's first formal consideration last week.

The Disclosure Framework project was prompted, in large part, (although not solely by), recommendations contained in the Report and Recommendations of the SEC Advisory Committee on Improvements to Financial Reporting (aka CIFiR or The Pozen Committee).

As noted in FASB's summary of its Aug. 24 meeting at which the Disclosure Framework project was discussed, the board essentially agreed with the decision approach recommended by the staff, shown in the board handout, including the fact that the Disclosure Framework would be approached more from the perspective of a Concepts Statement than an individual accounting standard (Accounting Standards Update) per se.

Something that jumped out at me in reading FASB's meeting summary was a sentence that seemed to very crisply identify the objective of the Disclosure Framework project, in terms even more precise than those used when the project was first announced in FASB's 7/28/09 press release.

Specifically, FASB stated in its summary last week that:

The desired result [of the Disclosure Framework project] is a net
reduction in disclosure volume
and a net increase in the
of the information disclosed.

One caveat before leaping on the 'reduction in disclosure volume' and 'increase in utility' goals: (I remind you of the disclaimer posted on the right side of this blog) - keep in mind the operative term, "net" - that there will be a "net" reduction in disclosure volume (so, leaving the door open for new disclosures to be added, with a concurrent reduction in some other disclosures).

Still, the hoped for net decrease in disclosure combined with a net increase in utility of those disclosures would be a welcome development for all those involved in the financial reporting process including preparers, auditors, investors, directors, educators, and others.