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Dodd-Shelby Amendment Gives SEC and PCAOB Time To Reform Internal Controls Mandates

An amendment to the America COMPETES Act (S. 761) would give the SEC and PCAOB more time, but not unlimited time, to reform the internal control reporting mandates under section 404 of the Sarbanes-Oxley Act. The amendment expresses the sense of the Senate that the SEC and the PCAOB should implement the section 404 mandates in a manner that limits the burdens placed on small and mid-size public companies. The amendment was introduced by Banking Committee Chair Christopher Dodd (D-CT) and co-sponsored by Sen. Richard Shelby (R-AL), the committee's ranking member. The amendment passed 97-0. S.761 passed by a vote of 88 to 8.

The Senate also supported a Dodd-Shelby motion to table an amendment offered by Sen. Jim DeMint (R-SC). The DeMint amendment would have made section 404 compliance optional for smaller companies with market capitalization of less than $700 million, with revenue of less than $125 million, or with fewer than 1,500 shareholders, thereby exempting over 70% of companies from key parts of Sarbanes-Oxley. The amendment was tabled on a bipartisan vote of 62-35.

By these two votes, the Senate made a strong statement in two respects, according to Dodd. First, the Senate will continue to protect investors in public companies. Second, it supports efforts currently underway to ensure that small and mid-size businesses are not unduly burdened by rules intended to protect investors. The Senate rejected an approach that would weaken investor protection and make it more likely that investors would be harmed by the malfeasance that caused the collapse of Enron and WorldCom.

The Dodd-Shelby amendment endorsed section 404 for greatly enhancing the quality of corporate governance and financial reporting for public companies and increasing investor confidence. The amendment praises the SEC and PCAOB for determining that Auditing Standard No. 2, the current auditing standard implementing section 404, has imposed unnecessary and unintended cost burdens on small and mid-sized public companies. The amendment also notes that the SEC and the PCAOB are nearing completion of a two-year process intended to revise the standard in order to provide more effective regulation. The Senate wants the SEC and the PCAOB to complete the adoption of the final guidance and standards under section 404.

Dodd emphasized that the SEC chair has wide latitude within which to operate here, since the statute gives broad discretion. The SEC has notified the Senate that it will be done with this work in a few weeks.

Dodd has a long history of involvement in federal securities regulation, particularly in areas involving financial accounting and the audits of public companies. His guiding principle has been that investor confidence in the accuracy of the outside audit of corporate financial statements is absolutely crucial to the successful functioning of the securities markets. Dodd was a principal architect of Title I of the Sarbanes-Oxley Act, which created the PCAOB.

The Dodd-Shelby amendment reflects recent statements by SEC Chair Christopher Cox that Sarbanes-Oxley did not need to be amended, but that the regulators need to change the way the law is implemented. The implementation of the law has caused the excessive burden, not the law itself.

According to Dodd, the amendment recognizes the very significant role of the Sarbanes-Oxley Act in improving and maintaining the integrity of the capital markets, as well as the important role of small businesses in economic growth and job creation. The SEC and the PCAOB have properly determined that the existing implementation of section 404 has not fully achieved the intent of the statute, Dodd said. Last December, the SEC and the PCAOB proposed management guidance and revised auditing standards to more appropriately implement the statute, in a manner that will not have an unintended or inappropriate impact on small businesses.

The two agencies are currently considering about 200 comment letters on their proposals dealing with section 404. The letters come from a wide variety of interested parties, offering views on the strengths of the proposals and suggestions for those improvements. Dodd praised the deliberative process of rulemaking being conducted by these agencies and commended the SEC for responding very well to the concerns about the section 404 requirements, particularly with respect to smaller public companies.

Dodd agrees that Sarbanes-Oxley should not be opened up to an amendment at this time. He believes that it would be irresponsible for Congress at this juncture to jump in and greatly reduce the number of companies that would have to comply with section 404.

The SEC must be allowed to do its job, according to Dodd. If the Commission does not do the job, and the burdens of section 404 still exist, Dodd would welcome an opportunity to address the matter. In his view, the amendment sends a message to the SEC and the PCAOB that the Senate is watching what they do very carefully.

Shelby was also willing to give the SEC and PCAOB time to make the significant changes needed to reduce the unacceptable costs and burdens of section 404 compliance. The problems are very complex, he said, and the regulators should be given a chance to fix them.

While Shelby is willing to give the SEC and PCAOB some additional time to fix the problem, he is not willing to give them unlimited time. He said the Banking Committee will closely monitor their progress and hold them accountable should there be any unnecessary delays.

He observed that the proposed SEC guidance and new PCAOB standard are mutually reinforceable and should significantly improve the implementation of section 404, making it more efficient and effective for small and medium-sized businesses. That is what the Senate wants. Shelby is buoyed by the fact that the agencies recognize that the unnecessary costs imposed by section 404 are a real problem for both large and small companies.

James Hamilton