Is available here. Here is the description:

Congress passed the Sarbanes-Oxley Act in response to major corporate and accounting scandals–and many consider the act to be the most significant change in corporate governance and securities regulations in the past seventy years.

SOX requirements have brought about far-reaching changes for public corporations, private corporations, and nonprofits. Every manager and director should be aware of how the business landscape will be affected.

The Complete Guide to Sarbanes-Oxley answers in nontechnical language such questions as:

• What does SOX mean to me now?

• Do I have to worry about it?
• How much legal and accounting help do I need?
• What information technology requirements will I face?

If you’re a business owner, you need The Complete Guide to Sarbanes-Oxley!

Interested readers may also want to take a look at Butler & Ribstein’s AEI analysis of the Sarbanes-Oxley Debacle as well as Kate Litvak’s latest empirical examination of the affect of SOX on the cross-listing premium.

Kate Litvak (UT Law, and friend of TOTM) , whose excellent paper (discussed around the blogosphere here and here), “The Effect of the Sarbanes-Oxley Act on Non-US Companies Cross-Listed in the US,” has been selected as the best paper for the forthcoming special issue of the Journal of Corporate Finance associated with the Boundaries of Regulation conference. This is quite an impressive accomplishment for a junior scholar doing interdisciplinary work in a highly technical field like finance, or for that matter, anybody else. Congratulations Kate!

This recent article in the NYT (log in required) caught my eye. It discusses the growing market for temporary financial services to companies. Since SOX this market has grown by 68% to $8.9 billion, and is expected to grow another 10% this year. The companies looking for temporary help include nonprofits, public corporations, and start-ups.

While the post-SOX boom suggests that public companies are the largest user of these services, the article also notes that start-ups have been renting CFOs for the past fifteen years. This practice makes a lot of sense from the entrepreneur’s perspective. Start-ups are short of cash and may be unable to keep a permanent finance person on staff. But when it comes time to solicit angel or venture capital funding, bringing in an expert can help entrepreneurs with financial projections in a business plan and during negotiations over valuation, all at an hourly rate. This hire-as-needed model works well for lawyers – why not for finance types? The article was quite rosy on the idea, but I wonder if there are any downsides? Perhaps liability concerns for the temp (the article mentions the possible need for a D&O policy)?

Securities fraud class-actions are down. In an op-ed in yesterday’s WSJ, Joseph Grundfest observed that both the number of such actions and the dollar value of total damages claims have dropped dramatically since mid-2005. Why has this decline occurred? Grundfest considers several possible reasons.

First, the decline might be due to the criminal prosecution of Milberg Weiss, the leading securities fraud plaintiff firm. Grundfest rejects that explanation:

[T]here is no shortage of plaintiff class-action lawyers in America, and the barriers to entry in class-action securities fraud are quite low. The lawyers who abandoned Milberg in droves haven’t forgotten how to file class action complaints, and their incentives to sue every firm in sight remain as strong as ever.

Next, Grundfest considers whether the decline is due to recent “strong equity markets, combined with low volatility.” He rejects that explanation because “the change in the litigation market is rather sudden in comparison to a relatively smooth shift in the larger stock market patterns” and because “current activity levels are low even when measured by pre-boom standards” (i.e., even when compared to levels preceding the boom-bust period of the late 1990s).

Finally, Grundfest considers a theory he deems more plausible: there are fewer securities fraud class actions because there is less fraud, and there is less fraud because the government (post-Enron, WorldCom, and Sarbanes-Oxley) has more effective tools for prosecuting fraud:

From this perspective, class-action securities litigation is in decline because there is a new, tougher and superior enforcement mechanism in place. The SEC and the Department of Justice now insist that any corporation suspected of a sufficiently serious fraud conduct an internal investigation that will finger the executives responsible. The corporation must also cooperate in prosecuting these executives. This enforcement technique is stunningly effective, if often overbearing. It eliminates the government’s need to conduct expensive and lengthy investigations and provides the authorities with extraordinary leverage over every executive suspected of wrongdoing. Private litigation doesn’t have an equivalent deterrent effect because it can’t threaten executives with jail and because damages are almost always paid by corporations and insurers, not the executives who cause the fraud.

I’m wondering what others think about this theory. It would be interesting to see whether both accounting fraud and non-accounting fraud claims have decreased by similar proportions. The recent government enforcement efforts have been focused on accounting fraud, so if we’re seeing a greater decrease in accounting fraud claims than in non-accounting fraud claims, then Grundfest’s “supply side” story may be plausible. If non-accounting fraud claims have been decreasing by a similar proportion, then it would seem the decrease should be attributed to something else.

In any event, I’d be reluctant to infer from Grundfest’s statistics that increased prosecutorial activity is desirable. I’d echo Larry Ribstein’s query:

Does the dip in securities litigation suggest that the corporate criminal prosecutions have been worth these costs? … [E]ven if we do have less fraud to litigate, I’d wonder whether it’s been worth the price. Do we have less risk-taking? A zero fraud world is not necessarily paradise.

Grundfest, of course, is well-aware that stepped up prosecutorial activity can have serious negative effects. Not too long ago, he wrote eloquently about the downsides of such prosecutorial activity in the New York Times. Some highlights:

The Supreme Court has overturned Arthur Andersen’s conviction for obstruction of justice in the Enron case. But to Andersen, the court’s ruling doesn’t matter, the original trial at which it was convicted didn’t matter and the verdict at any coming trial won’t matter. Andersen was destroyed when it was indicted.

… Andersen’s demise did serve as a stern reminder to corporate America that prosecutors can bring down or cripple many of America’s leading corporations simply by indicting them on sufficiently serious charges. No trial is necessary.

… Prosecutors are aware of their power, as are potential corporate defendants. Both sides have therefore reached an entente cordiale in which no major corporation has been forced out of business since Andersen’s demise. Instead, corporations have entered into deferred-prosecution agreements, paid huge penalties, and undertaken fundamental internal reforms, all under conditions that allow the corporation to survive.

… The upside of this arrangement is clear. Corporations now have an even more powerful incentive to abide by the law, to root out wrongdoing, and to cooperate with governmental authorities. Unbridled prosecutorial discretion will not end fraud in corporate America, but wrongdoing will certainly decline as executives learn that they are expendable if a prosecutor simply threatens the corporation.

… The downside is just as clear. The prosecutor’s decision to indict is largely immune from judicial review. The prosecutor acts as judge and jury. Traditional due process safeguards, like the right to confront witnesses, can’t protect the potential corporate defendant. The innocent can therefore be punished as though they are guilty, and penalties imposed in settlements need not bear a rational relationship to penalties that would result at a trial that will never happen.

Henry Manne is back with another article in the WSJ.  This time Manne goes toe-to-toe with the “corporate democrats.”
Profs Ribstein (”Shareholder democracy is just one of the burdens that public corporations have to bear these days”)  and Bainbridge (”it’s a brilliant spanking of the shareholder activists, which I highly commend to your attention”) have already chimed in on this one.  Still, it is worth posting a few key paragraphs:

The hidden agenda of many corporate democrats is even more apparent when they argue that large corporations are indeed like small republics and should, therefore, like all governments, be democratized or constitutionalized. This is usually no more than an assertion that the large size of an otherwise private enterprise is sufficient to convert what would otherwise be a private ordering into something suffused with a public interest — in other words, an argument for more socialism. The very success of a private concern becomes the reason for destroying its privateness — a neat rhetorical trick if it was not so patently absurd.

Sometimes this argument is made a bit more logical by saying that large size necessarily means that external costs will be visited on the rest of society. This is the basis for the currently popular claim that so-called “stakeholders” should have a real voice in how the corporation conducts its affairs. But even if there are occasional costly externalities associated with corporate activities, rearranging corporate governance, which is obviously functioning adequately for investors now, is an irresponsible and costly way to solve that real political problem.

We need corporate activists today more than ever, but we need them to lobby and argue for repeal of our many costly and ill-serving bits of corporate regulation. They might start with Sarbanes-Oxley, then go back in time to cover the Williams Act and state anti-takeover provisions, the Investment Company Act of 1940, the Securities and Exchange Act of 1934 and the Securities Act of 1933. I know this is pie-in-the-sky idealism, but it does not change the fact that, on balance, the world would be a far better place without these laws or anything like them.

I don’t have anything to add to this other than a recommendation to go read it in full.

Airlines and Antitrust.

Kenneth Starr on Sarbox. The punchline:

Even the statute’s co-author, Rep. Mike Oxley, has conceded that Sarbanes-Oxley was hastily written and enacted. In its rush to “do something” about corporate scandals, Congress overstepped the bounds of its authority. It is time to call Congress back, both to help our economy and reaffirm that our constitutional system imposes clear limits on the government’s urgent desire to “do something.” Congress must be reminded that the “solution” is at times worse than the problem.

UDPATE: Ribstein comments on Starr’s constitutional case against the PCAOB.

Holman Jenkins reports that a group of economists led by Milton Friedman and Harry Markowitz are getting behind the idea of putting an end to the expensing of options. It is a great column. Jenkins goes on to discuss options backdating and makes the following points, which will sound unfamiliar to TOTM readers:

• “In no generic sense can one say executives “inflated” their pay or “stole” from shareholders. Backdated packages were not more “lucrative” — it’s fallacious to assume that the alternative package consisted of an identical number of options at a less advantageous price.”

• “Backdating did not provide “guaranteed” or “risk free” profits. It did not “undermine the incentive purpose” of options.”

• “It seems likely that companies, after all, did correctly report the number of options and their price to shareholders. Let it be remembered, too, that millions of these options were cancelled or expired unexercised.”

Geoff made exactly these points in this space months ago (and also more recently, here). Personally, I am thrilled to see a column that focuses on the real questions surrounding backdating: (1) Why do firms backdate? (2) What are the consequences of backdating? and (3) What is the theory of harm, if any, upon which we are going to base civil and criminal prosecutions? It is remarkable, but not incredibly surprising, how little attention has been paid to these questions in favor of the Gretchen Morgenstern-style rants that Professor Ribstein enjoys dismantling weekly.

Geoff’s earlier post frames the backdating issue in terms of the important economic (and legal) questions involved. For example, Geoff makes the following basic (and sadly overlooked) points:

1. Backdated options have incentive effects too.
2. Regulatory quirks involving accounting rules may have provided firms the incentive to backdate.
3. If we are to believe that some 2,000 companies engaged in some form of backdating, many did not appear to be hiding it.
4. There may be no harm whatsoever resulting from backdating. To borrow from Geoff: “It’s not like the options cruise along for a period of time out of the money (and priced by the market accordingly) and then are miraculously turned into at the money or in the money options the moment they are exercised. Rather, the day the options are issued, they are issued with a strike price AS IF they had been issued on an earlier date when the market price was lower. But there’s no lie here – it’s just a convenient way of providing more compensation.”
5. And finally, there are a number of instruments available to compensate executives with or without backdating. I’m not sure if anyone really believes that in the absence of backdating the actual level of compensation would decrease, despite the fact that this assumption seems necessary to the theory of harm most frequently discussed.

Assuming for the moment that backdating is as rampant as the Lie study, media reports, and sudden wellspring of law firm and litigation consultant “backdating” teams suggests, it might be prudent to ask: “why?” and something along the lines of “so what?” The only answers to the “so what” question have been assertions about shareholder exploitation and comparisons to Enron. As to “why backdating,” there seems to be little interest in figuring out what economic and institutional conditions led to the widespread adoption of option backdating and whether the practice is an efficient element of a compensation contract or something more sinister. Rather, we get mostly claims that backdating is a function of widespread fraud or compensation committee naiveity. As I explain below the fold, I don’t think either of these theories get us very far in terms of explaining backdating. (more…)

According to this CFO.com article, London Stock Exchange listed companies are concerned that the acquisition of the LSE by a U.S. exchange will subject the companies to SOX (recall that Nasdaq’s $4.2 billion unsolicited bid for the LSE was rejected but it has since acquired 24% of LSE shares). And LSE companies should be concerned considering the high costs of SOX compliance but questionable benefits. However, according to the article:

Callum McCarthy, chairman of Britain’s Financial Services Authority, stated that the FSA and the Securities and Exchange Commission agree that U.S. ownership of the LSE would not “in and of itself” mean that U.S. regulations would apply to LSE-listed or -quoted companies . . . .

The statement could have certainly gone further in comforting LSE companies. They can, however, take more comfort from market realities. If the Nasdaq were to acquire the LSE, it would do everything possible to keep it outside the reach of SOX. A primary objective of Nasdaq acquiring a foreign exchange is to be able to provide a non-SOX listing option so that it can get a piece of the increasing number of deals now being done outside of the U.S. in large part due to SOX. As the W$J recently noted (see here):

In 2000, nine of every 10 dollars raised by non-U.S. companies through new stock offerings were raised in the U.S. Last year the reverse was true: nine of every 10 dollars were raised abroad.

Following up on this post, according to this Reuters article the Justice Department has filed a “statement of interest” asking the court to dismiss the PCAOB constitutionality case.

[T]he lawsuit was filed “at the wrong time, in the wrong court” and should be dismissed. It said a challenge to the constitutionality of PCAOB must first be reviewed by the U.S. Securities and Exchange Commission.

Back in 2001 I published an article entitled Going Public Through an Internet Direct Public Offering: A Sensible Alternative for Small Companies? DPOs had been (and continue to be) touted as a financing alternative for a small company that needs capital but can’t attract angel or VC financing or an underwriter to take it public. I concluded that, except in limited circumstances, small companies should view DPOs only as a financing option of last resort (although it probably ranks above going public through a reverse merger). The big problem, of course, is that it is very difficult to attract investors when, among other things, there is no underwriter backing the deal with its reputational capital, established sales force, and aftermarket support and federal and state securities laws greatly limit permissible marketing activities. DPOs generally make sense only for a company with a strong affinity group (e.g., a micro-brewer or maker of organic pasta).

There have been a number of significant changes to federal securities laws since 2001. Two changes are of particular relevance to the advisability DPOs, one for the better and one for the worse. (more…)

Recall that in February the Free Enterprise Fund filed a suit claiming that the Public Company Accounting Oversight Board (PCAOB) established under Sarbanes-Oxley violates the appointments clause of the Constitution, among other provisions (see here and here). PCAOB filed a motion to dismiss this week. Click here for details.

Click here for the SEC’s press release with the details. Note that there is no mention of exempting small companies from SOX 404 compliance although the compliance date for non-accelerated filers will once again be extended. The release, however, implies that this will be the last extension and charaterizes it as short. At the latest, all filers will be required to comply with the Section 404(a) management assessment for fiscal years beginning on or after Dec. 16, 2006.

Now available on the SEC’s website is a transcript of a April 27, 2006 speech by SEC Commissioner Paul Atkins given to the Investment Adviser Association. There’s nothing particularly surprising in the speech given Atkins’ well-publicized opposition to many of former Chairman Donaldson’s initiatives, but it is still a good read.

In particular, he focuses on the mutual fund rule requiring independent chairmen and 75% independent boards. Here’s a quote:

To be honest, the tortured history of this rule is quite a curiosity for me. It is an unlikely subject of such a pitched battle. Its proponents have praised it as being the supposed “centerpiece” of the SEC’s regulatory scheme for mutual funds. But, as the court of appeals has now pointed out twice to the SEC, the agency has failed to take an honest look at the costs and benefits of the rule, as the law requires us to do. Never mind that some of the more egregious offenses in the late-trading and market-timing scandals occurred at funds with independent chairmen and 75% independent boards. Never mind that the rule is inherently anti-competitive in that its burdens fall especially heavily on start-ups, who have a harder time coaxing and paying non-affiliated people to serve on boards, much less to commit the time necessary to serve as chairman.

(more…)

The momentum seems to be building among legal academics that the SEC may lack the authority to exempt small companies from SOX 404 compliance.  As many may recall, Bill previously analyzed this issue in the inagural post of this blog and concluded that the SEC most likely did not have the requisite statutory authority (he provided a follow-up analysis here).  Larry Ribstein shares this sentiment.  Apparently, they are not alone.  

Yesterday, the SEC Advisory Committee on Smaller Public Companies concluded its deliberations and approved a draft Final Report to be submitted to the SEC next week.  The Final Report continues to recommend exemptive relief from Section 404 for certain small-cap and micro-cap issuers.  However, I found interesting a revision from the prior draft in the discussion concerning the SEC’s authority to promulgate an exemption.  Specifically, footnote 110 notes that “a different view as to the Commission’s authority under Section 36(a) was expressed in a letter from Professor James D. Cox and 19 other law professors, although the professors acknowledged that ‘[s]pecific disclosure requirements tailored to the unique risks and likely regulatory benefits of smaller public companies are entirely appropriate and consistent with the rulemaking authority the Commission enjoys under Section 3(a) of the Sarbanes-Oxley Act.’”  Sadly, the letter doesn’t cite Bill’s analysis, but it is still worth a read. It can be found on the SEC website (see here).