Americans need jobs. The private sector of the American economy will create jobs when government removes the obstacles it has placed in the way of job creation and when the demand for goods and services rises. The government should promptly review the vast increase in government regulation of the economy that has occurred in recent decades and modify or repeal statutes and override regulations that discourage the private sector from creating jobs. Congress could start by reviewing and fixing section 404 of the Sarbanes–Oxley Act of 2002, as amended in 2010 by the Dodd–Frank Wall Street Reform and Consumer Protection Act.
Section 404 Imposes Unwarranted Costs on the Private Sector
Section 404 of the Sarbanes–Oxley Act, as amended, requires the Securities and Exchange Commission (SEC) to issue rules to require companies whose stock is publicly traded (for example, on the New York Stock Exchange) and whose aggregate worldwide value is $75 million or more, to:
(1) include in its annual report filed with the SEC a statement of the responsibility of the company management for “establishing and maintaining an adequate internal control structure and procedures for financial reporting” ;
(2) include in its annual report filed with the SEC an assessment of the effectiveness of the company’s internal control structure and procedures for financial reporting; and
(3) have the registered public accounting firm that does the company’s audit report “attest to, and report on, the assessment made by the management . . . .”
To acquire and verify the accuracy of information needed to write an assessment of internal controls in an organization of any significant size and, further, to get an auditing firm to attest to that assessment, costs money—lots of it. As New York City Mayor Michael Bloomberg and U.S. Senator Charles E. Schumer said jointly, referring to the U.S. regulatory framework as “a thicket of complicated rules” in 2007, “[t]he flawed implementation of the 2002 Sarbanes–Oxley Act (SOX), which produced far heavier costs than expected, has only aggravated the situation . . . .” Later that year, in calling for changes in the implementation of section 404 rather than changes in section 404 itself, then-President George W. Bush said that “complying with certain aspects of the law, such as Section 404, has been costly for businesses and may be discouraging companies from listing on our stock exchanges . . . .” The Heritage Foundation conducted a study in 2008 that showed major increases in the audit fees companies paid as a result of section 404. The costs of implementing section 404 were many multiples of what the SEC had estimated.
Congress Started Fixing Section 404 but Has Not Completed the Job
Congress waited patiently from 2007 to 2010 for the SEC and the Public Company Accounting Oversight Board (PCAOB), whose rules the SEC approves, to change rules in a way that would solve the problem of unwarranted costs imposed on the private sector by the rules implementing section 404 of the Sarbanes–Oxley Act. While the SEC tinkered with the rules, it did not solve the problem to the satisfaction of Congress. Congress took action in 2010 to address part of the problem, granting by statute to companies whose stock is publicly traded and whose aggregate worldwide value is $75 million or more an exemption from the requirement in section 404(b) for the company to have the registered public accounting firm that does the company’s audit attest to, and report on, management’s assessment of the company’s internal control structure and procedures.
While Congress took a laudable first step in exempting the smaller companies from section 404(b), Congress should complete promptly the job of reviewing the full impact of section 404, including on medium-sized and large-sized companies, and repealing section 404 or fixing it to eliminate unwarranted costs. Companies could use freed funds, no longer absorbed by section 404 implementation, to invest in their lines of business, creating much-needed jobs.
Congress Should Re-examine Whether Section 404 Is Needed and, If So, How to Cut Its Costly Burden on Businesses
Congress should reconsider carefully the requirements in section 404 for company management to assess the effectiveness of its internal control structure and procedures and then for the company’s registered public accounting firm to attest to that management assessment. Given the traditional role of each state in regulating the corporate governance of corporations incorporated in that state, Congress should first examine anew whether federal law should address those subjects, or whether they should be left to state law. In a society based on limited government and free enterprise, and in light of the traditional role of the states in our federal system, Congress should start its examination with a presumption in favor of repealing section 404 and leaving the subjects addressed by section 404 to the states.
If Congress nevertheless concludes anew that federal law should address the subjects covered in section 404, then Congress should consider how to attain, at a lower cost to the affected companies, whatever benefits Congress believes the federal law confers. For example, company managements and auditing firms, fearful of the legal risks they face as they make and attest to assessments of internal controls required by section 404, may press for a degree of assurance of accuracy that is costly to attain and exceeds the degree necessary to provide comfort to markets about the soundness of the company’s accounting. Congress could address such concerns through a variety of statutory changes, such as amending section 404 to include a reasonable standard of material weakness with respect to internal controls, specifying that section 404 creates no liability to any parties, other than to the United States to the extent otherwise provided by law, or rendering criminal penalties inapplicable absent intentional criminality. Congress also could consider further exemptions from all or part of section 404 based on the market capitalization of companies, the function of the company, or other criteria. Recognizing that companies and auditing firms may incur transition costs to implement changes with respect to section 404, Congress should attempt to minimize the costs of implementing the needed changes.
Congress Should Review Section 404 Promptly
Congress should take promptly every step it reasonably can to discourage unwarranted regulations and encourage economic growth and job creation. The government should not force businesses to use their funds to meet the costs of compliance with excessive government regulation when companies could invest those funds to create jobs and meet demand for their products or services. Congress should proceed immediately to reexamine section 404 of the Sarbanes–Oxley Act of 2002 and repeal or modify it as necessary, to free businesses to invest more of their funds in creating jobs and economic growth rather than in complying with government overregulation.
David S. Addington is Vice President for Domestic and Economic Policy at The Heritage Foundation.