Washington, D.C. – Implementation of Sarbanes-Oxley is not complete and in order to help smaller companies comply, the Public Company Accounting Oversight Board and the Securities and Exchange Commission need to continue proactive collaboration, according to U.S. Senator Mike Enzi, R-Wyo.
Enzi, a member of the Senate Small Business and Banking Committees, emphasized the importance of regulatory guidance for management and accountants instead of legislative reform in a statement he submitted for the record at the "Sarbanes-Oxley and Small Business: Addressing Proposed Regulatory Changes and Their Impact on Capital Markets" hearing of the Small Business Committee today.
"I strongly urge both the Commission and the Board to continue to work to overcome this disadvantage for small companies. This includes guidance for Section 404 audits that are top-down and risk-based. Auditors must be encouraged to use their professional judgment without fear of liability and small companies must be confident that, if they follow management guidance, they will create effective and compliant internal controls," Enzi said. "It has been five years since the passage of the Sarbanes-Oxley Act and it is time to overcome the final hurdles preventing implementation of this law for all public companies."
The full text of Enzi’s statement is below.
Statement of Senator Mike Enzi
Senate Committee on Small Business Hearing on:
"Sarbanes-Oxley and Small Business: Addressing Proposed Regulatory Changes and their Impact on Capital Markets"
April 18, 2007
As a member of the Senate Committee on Small Business and the Senate Banking Committee, I have been at the forefront of this issue since Sarbanes-Oxley was first drafted in 2002. During those early days, the United States capital markets were in a tailspin. The accounting scandals at Enron and WorldCom damaged America’s confidence in our markets, and our economy was in decline as a result. After passage of Sarbanes-Oxley, we have seen confidence rise once more, and our economy continues to expand, creating jobs and wealth for more Americans than ever before. The Sarbanes-Oxley Act is contributing to this expansion because investors again feel confident when they invest in American financial markets. Public company operations are more transparent and CEOs are held accountable for the actions of their employees.
One needs only to read the papers to see the benefits of Sarbanes-Oxley. The options backdating scandal that is being investigated by the SEC has reached some of the largest and most recognizable companies in America. Yet the scope of this scandal was limited to practices prior to the enactment of Sarbanes-Oxley. There is little doubt the Act has helped in this regard.
However, the implementation of Sarbanes-Oxley is not complete, and this is the reason why we are here today. About half of all publicly-traded companies, those under $75 million in market capitalization, have yet to implement the requirements of Sarbanes-Oxley as they relate to internal controls, commonly referred to as Section 404. The concerns about the price of Section 404 voiced by small businesses are well-founded, and action should be taken to reduce these costs. I expect Chairman Cox and Chairman Olson to discuss some of these ideas today. However, as most small businesses have yet to experience a 404 audit, there is also a lot of mystery and speculation surrounding the projected costs. Today is an opportunity to clarify the small business situation and dispel some of the rumors.
All public companies should be responsible stewards of the public’s trust, and therefore should be able to withstand a certain level of public scrutiny. This is the heart of Sarbanes-Oxley and Section 404. It is also central to the mission of the Public Company Accounting Oversight Board (the "Board"), which oversees accountants who audit large and small companies.
The Board is in a strategic position that gives them the opportunity to lower the cost of audit fees borne by small companies through their guidance. And they have taken multiple steps to lower costs, including encouraging a change to the audit culture itself. For example, I was pleased when the revised guidance issued last December by the Board emphasized auditor’s use of the work of others. Allowing auditors to look at the big picture by reviewing past audits and management’s evaluation can significantly reduce the costs of Section 404 audits to smaller businesses. By removing the "Principle Evidence Provision," the Board is promoting a significant change within the auditor community, and the industry must be receptive to it if small businesses will see reduced costs.
There is also a continued role for the Board in working with smaller audit firms as they attempt to perform Section 404 audits for the first time. In April 2006, the Government Accountability Office (GAO) issued a report requested by Senator Snowe and me requiring an investigation of the potential costs of Sarbanes-Oxley on small businesses. One of the developments predicted by this report was a bigger role for smaller accounting firms performing 404 audits. In anticipation of this, the Board has been holding forums across the country to assist small firms to prepare for these audits. These forums have been invaluable, and the proactive approach exhibited by the Board will no doubt reduce costs for small companies in the future.
I am optimistic that the larger accounting firms, who have been auditing large companies for four years now, will also be able to assist smaller firms to overcome the steep learning curve. There is a wealth of knowledge to be gained from the first four years of accelerated filers and their auditors, and using that knowledge can reduce costs for those reporting for the first time.
Another concern described in the GAO report was the effect of "deferred maintenance" by smaller public companies. All public companies have been required to establish and maintain internal controls since 1977. It is clear that many smaller companies have faced particular challenges in this regard, due to the economies of scale and the different management structure of smaller companies. I am very concerned that this will lead to higher costs when small businesses are required to comply with Section 404.
The Securities and Exchange Commission (the "Commission") has taken a proactive approach in this area as well. In the revised guidance, the Commission established a two-year strategy for smaller companies, requiring internal control evaluation from management in Year One, and an external audit in Year Two. This is the right approach for small business, and introducing a level of scalability for small public companies in the Commission’s guidance has enormous potential for reducing costs.
I am pleased that the Commission and the Board have worked collaboratively on their Section 404 guidance. Complementary guidance, along with a close attention paid to the nature of smaller companies, is the best strategy for successful implementation of Section 404 of the Sarbanes-Oxley Act.
The Committee on Small Business knows that the economies of scale create a disproportionate burden for smaller companies, in Sarbanes-Oxley implementation or any other federal regulation. This was confirmed by the GAO study released last year on Section 404. Yet the key to overcoming this disadvantage is clear and concise guidance from the Board and the Commission, not legislative reform. This was the conclusion reached by the McKinsey Report on global competitiveness, also known as the Schumer-Bloomberg Report, and industry roundtables held by the Department of the Treasury and the Chamber of Commerce held earlier this year.
I strongly urge both the Commission and the Board to continue to work to overcome this disadvantage for small companies. This includes guidance for Section 404 audits that are top-down and risk-based. Auditors must be encouraged to use their professional judgment without fear of liability, and small companies must be confident that, if they follow management guidance, they will create effective and compliant internal controls. It has been five years since the passage of the Sarbanes-Oxley Act, and it is time to overcome the final hurdles preventing implementation of this law for all public companies.
I look forward to the testimony of Chairman Cox and Chairman Olson, and continuing my dialogue with them as they refine their guidance. Implementation of Sarbanes-Oxley is key to the success of our markets. Accountability, transparency, and strong internal controls benefit investors and businesses alike.