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Revisiting Sarbanes-Oxley

Jonathan Ortmans, President, Public Forum Institute

We have heard several entrepreneurship-based proposals recently to get our economy back on track, but one piece seemed to be missing this whole time in the debate: re-evaluating Sarbanes-Oxley for young firms. We have long known that the compliance costs associated with SOX—particularly section 404—have been discouraging many companies from going public, thereby blocking their access to capital and growth. Researchers have suggested that Congress address this issue in some way, and a measure to allow shareholders of companies with market cap below $1 billion to opt-in under SOX was one of the ideas floated in the Startup Act released mid-July. The measure is now gaining track in Congress.

Last week, Rep. Ben Quayle introduced a bill called the Startup Expansion and Investment Act (H.R. 2941), which 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 disclose in its annual reports that it chose to opt out of section 404. Currently, the market capitalization threshold to be exempt from complying with section 404 is $75 million. This high-impact, low-cost reform could significantly expand the number of companies that access the public markets.

SOX was enacted in the aftermath of the 2002 corporate financial reporting scandals to protect shareholders. Among other strict requirements, SOX imposed stiffer auditing requirements on public companies, required CEOs to certify the accuracy of their companies’ financial statements, subjected auditors to oversight by the new Public Company Accounting Oversight Board and prohibited them from engaging in consulting business for clients they audited. The New York Stock Exchange and the NASDAQ subsequently changed their listing requirements, requiring a majority of corporate boards to have “independent” directors. As a result, substantial man-hours and other resources have since been devoted to SOX compliance (over $1 million annually in some cases). Since capital markets are out of reach for startups, entrepreneurial firms have looked elsewhere when trying to “exit,” such as selling to larger companies. And we know that this option risks killing the entrepreneurial energy that was fueling the startup’s success.

Some believe the tighter controls imposed by Sarbanes-Oxley to protect shareholders have come at the expense of new jobs and innovation. In a struggling economy scrambling for new jobs, opening capital markets for entrepreneurial financing, including stock exchanges, is important and it would be a smart move for our nation to allow companies with market cap below $1 billion to opt-in under the Sarbanes-Oxley Act.

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