The ERM Current™

Last week, the U.S. House of Representatives proposed amendments to the Investor Protection Act of 2009 that will in essence seek to roll back some of the reforms implemented as a result of the Sarbanes-Oxley Act of 2002.  Specifically, Representatives Carolyn Maloney and Scott Garrett are seeking to exempt public companies with a market capitalization of less than $75 million from the requirement to have their internal controls audited by an external firm.

Their approach is to request the SEC to perform a study on the costs of compliance for these firms and then, determine the need for the requirement. While this may be a reasonable request, it has already been made and the SEC completed a similar study this year.  As a result, the SEC confirmed the need for the external audit and announced it will be required of all companies next year.  The Huffington Post reported that several investor advocate groups as well as a former SEC chairman were outraged by the proposed amendment.  Read more at: http://www.huffingtonpost.com/2009/10/27/house-democrats-john-adle_n_334876.html

For those that thought the Sarbanes-Oxley Act (“SOX”) is now just a relic of the past, think again.  Section 404 of the Act required massive investments by large companies to bolster their internal controls over financial reporting.  However, another section of the Act, Section 304, is just now starting to be utilized by the Securities and Exchange Commission (“SEC”) as an enforcement mechanism to “clawback” executive pay.  Here is the language from Section 304 in its entirety.

Section 304 — Forfeiture of Certain Bonuses and Profits

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1. Additional Compensation Prior to Noncompliance With Commission Financial Reporting Requirements. If an issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws, the chief executive officer and chief financial officer of the issuer shall reimburse the issuer for–
   1. any bonus or other incentive-based or equity-based compensation received by that person from the issuer during the 12-month period following the first public issuance or filing with the Commission (whichever first occurs) of the financial document embodying such financial reporting requirement; and
   2. any profits realized from the sale of securities of the issuer during that 12-month period.
2. Commission Exemption Authority. The Commission may exempt any person from the application of subsection (a), as it deems necessary and appropriate.

The wording of the legislation is not specific as to who should forfeit their compensation when a company is found to have misstated its financials.  As a result, the SEC is targeting the CEOs and CFOs of these companies regardless of their involvement in the wrongdoing.  The first enforcement action is against the CEO of CSK Auto Corporation and seeks $4 million in restitution from the CEO.   Here is what the SEC alleges in their action.

“The personal compensation received by CEOs while the companies they serve engage in wrongdoing can be clawed back,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “The costs of such misconduct need not be borne by shareholders alone.”

“Jenkins was captain of the ship and profited during the time that CSK was misleading investors about the company’s financial health,” said Rosalind R. Tyson, Director of the SEC’s Los Angeles Regional Office. “The law requires Jenkins to return those proceeds to CSK.”

According to the SEC’s complaint filed in U.S. District Court for the District of Arizona, Jenkins made $2,091,020 in bonuses and $2,018,893 in company stock sales that should have been reimbursed to CSK pursuant to SOX Section 304.

This action is proof that the risks associated with compliance and regulation are increasing and are very real.  Are you certain that your company is SOX compliant?  If not, Wheelhouse Advisors can help.  To learn more, visit www.WheelhouseAdvisors.com.

A few weeks ago, The ERM Current™ included a blog entry about former US House Speaker Newt Gingrich’s call for the repeal of the Sarbanes-Oxley Act.  Many of Mr. Gingrich’s claims supporting his rationale that Sarbanes-Oxley is responsible for our current economic downturn were simply wrong.  Well, someone else also noted his poorly constructed argument and provided an alternative view last week in an op-ed article for the San Diego Business Journal.  Wade Lindenberger provided a compelling counter-point argument in his column as well as a practical view of the evolving nature of Sarbanes-Oxley Act compliance efforts.  He noted,

“In a time like this, people are always looking to blame something for the financial meltdown and turmoil. Sure, we are in a serious financial situation right now, but Sarbanes-Oxley is not to blame. In the six years since Sarbanes-Oxley was enacted, failures like Enron and WorldCom, which resulted mainly from finance and accounting shenanigans, have been nonexistent. The most recent failures of companies like Bear Stearns and Lehman Bros. resulted from poor business decisions and absentee risk management, all driven by good old-fashioned greed.”

Those who continue to seek to repeal Sarbanes-Oxley are simply attempting to skirt the real issues at hand and also avoid future accountability for business-related fraud.  Mr. Lindenberger sums up the situation nicely by stating the following,

“When it comes down to it, the steps legislated by Sarbanes-Oxley are really nothing more than what we would expect from any thorough, well-run company.”