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Business demands still more SEC give

March 5, 2007 Financial Week

Lobbies Congress to ease SarbOx burden on small companies’ internal controls

By Stephen Barlas

Business groups and individual companies have viciously attacked the SEC’s reform proposals for Section 404 of Sarbanes-Oxley, with some actively pushing for Congress to ease the regulatory burden.

And Congress is ready to act.

Rep. Greg Meeks (D-N.Y.), teaming up with fellow House Financial Services Committee member Rep. Tom Feeney (R-Fla.), is preparing legislation to make changes to Section 404. In an interview, Mr. Feeney said the bill will be introduced this week.

“Even chairman Frank admits something needs to be done,” Mr. Feeney emphasized. “The question is whether the SEC and PCAOB are prepared to completely resolve the problem, or whether corrective legislation is necessary. I prefer a comprehensive legislative fix.”

Chairman Frank is Rep. Barney Frank (D-Mass.), head of the House Financial Services Committee.

One business group, the Biotechnology Industry Organization, backs the efforts of Messrs. Meeks and Feeney.

“We have been supportive of the intents and goals of congressmen Meeks and Feeney,” said Alan Eisenberg, an executive vice president at BIO, “and look forward to working with them as they get their legislation introduced.”

BIO has been a leading trade association pleading with the SEC to change the Section 404 requirements. Public companies with market capitalizations below $75 million currently enjoy a reprieve, which has been extended a number of times, from filing 404 reports and having the auditor attestations done.

In addition to businesses, consumer groups weighed in loudly against the reform proposals, which could push the Democrat-controlled Congress even further toward stepping in and changing SarbOx. After all, Democrats consider themselves consumer-friendly.

“The guidance is so vague as to be unenforceable,” said Barbara Roper, director of investor protection at the Consumer Federation of America, in her comment letter to the SEC. “As a result, and particularly if the SEC brings that mind-set to its enforcement, managers are likely to be able to claim compliance with the guidelines, and the safe harbor that it provides, for even the shoddiest of internal control assessments.”

A preponderance of the public comments from the business community griped that proposed SarbOx changes—from both the Securities and Exchange Commission and the Public Company Accounting Oversight Board—don’t really clarify the vagueness of the official guidance for small and large companies and come up short on whittling away at Section 404 costs.

Marie K. Lee, counsel and director of finance and tax policy at the American Electronics Association, said the proposals will not be effective “in their current form in significantly reducing the excessive compliance burdens our member companies, and in particular smaller companies, face.”

The association’s office in Washington, D.C., was the venue for a visit by incoming House Speaker Nancy Pelosi (D-Calif.) a few days after the November elections. During that visit, Ms. Pelosi emphasized the Democrats’ determination to fix problems with Section 404 now that they were in power on Capitol Hill.

Asked whether Ms. Pelosi plans to make good on that promise in the wake of the negative comments flooding the SEC and PCAOB, a spokesman replied: “We’re reviewing comments, as is the Financial Services Committee, and we’ve seen a mix of reaction. We want to thoroughly review these comments before we decide possible next steps.”

Last April, an SEC advisory committee recommended the commission develop “scaled” or proportional regulation for companies deemed small-cap or micro-cap, to offer some relief to smaller companies. Instead, the SEC attempted to move ahead and inject its Section 404 guidance with scalability, an effort which, at least in the view of many small business groups, failed miserably.

Thomas M. Sullivan chief counsel of advocacy at the Small Business Administration, said that based on comments from small business executives at an SBA roundtable in January, the SBA believes “the Section 404 requirements will still impose large and disproportionate costs on small public companies.”

The SEC’s attempt to sharpen its definition of “material weakness” fell flat too, particularly in light of the PCAOB definition, which seems miles apart from the SEC’s.

David Chavern, chief operating officer of the U.S. Chamber of Commerce, prefaced his comments, as did many others, by saying both the SEC and PCAOB proposals represent a legitimate and significant attempt to address the widespread concerns of the business community and the difficulties that public companies have faced.

But then he lowered the boom, calling the definition of “material weakness,” which is central to Section 404 analysis, “unnecessarily vague.” He added that the PCAOB has reworded its standard for material weakness from “more than a remote likelihood” in Auditing Standard 2 to “reasonable possibility” in Auditing Standard 5.

Other commentators cited the disconnect between the Interpretative Guidance and AS2.

“We believe that the proposed standards, although improved from the existing PCAOB Audit Standard No. 2, are still more detailed and prescriptive than the proposed guidance,” explained Arnold C. Hanish, executive director and chief accounting officer at Eli Lilly, in his comment letter.

“These differences,” he continued, “will result in external audits that are more conservative than management assessments, which will cause companies to incur unnecessary costs to remain aligned with their external auditors.”

Mr. Chavern of the U.S. Chamber added that because the SEC guidance is “vague as to the specific procedures that companies should follow to establish and evaluate their internal controls,” the proposed safe harbor—companies would be safe from enforcement if they follow the guidance—“does little to reduce the uncertainty that has been inherent in the compliance process to date.”

At least one chief financial officer admitted that the SEC and PCAOB proposals will result in costs that will in fact be lower than what they would have been minus the proposed changes. Question is, would it be a big enough savings?

“We think the implementation of the [guidance] may result in a reduction in issuer compliance costs on a rough order of magnitude of 10% savings in the initial year of adoption and a potential savings of 15% to 20% in subsequent years,” stated Michael E. Keane, vice president and CFO of Computer Sciences Corp.

“Since compliance costs under 404 have been widely reported to approximate $1 million per $1 billion of revenue,” he said, “we estimate this potential savings at 0.02% of public company revenues.”







Barney`s New Pulpit

March 2007 Financial Executive Magazine

By Stephen Barlas



Rep. Barney Frank, the new chairman of the House Financial Services Committee, has a reputation as one of Congress’ wittiest members. Observers say his rhetoric may be harsher than his strategy, but his approach to issues like executive compensation and Sarbanes-Oxley reform may not be welcomed by business executives.



Rep. Barney Frank (D-Mass.), the new chairman of the House Financial Services Committee, is the Robin Williams of Capitol Hill. He piles witty quips on top of one another like some counterman at a kosher deli heaping sliced meat on rye. At the same time, though, Frank is a serious politician, in many ways the heart and mind of the liberal wing of the Democratic Party. So, his one-liners are often fortified with substantial intellectual protein. Sometimes, though, there is also a lot of ham between the bread.

When the Securities and Exchange Commission (SEC) quietly put out a news release a few days before Christmas last year announcing a change in its reporting rules for executive pay, Frank went into shtick mode. “I didn’t even know they had a chimney at the SEC, and then all of sudden this came slipping down it,” he complained.

The SEC’s change to the pay reporting rules was done to align corporate disclosure requirements with disclosure requirements as laid out in FASB standard FAS 123(R). Soon after delivering his jibe, Frank spoke to SEC Chairman Christopher Cox, who allayed his concerns.

The Massachusetts Democrat, who is widely respected by both Democrats and Republicans as probably the smartest, quickest member of the House, immediately quieted down. But within days, he was off again, lampooning Republican economic theology positing that tax cuts result in a “rising tide that lifts all boats.”

Frank, who represents the very liberal Fourth District in Massachusetts, just west of Boston, has always championed affordable housing above all else. At the National Press Club that day, he joked, “If you think about that analogy, the rising tide is a very good idea if you have a boat. But if you are too poor to afford a boat and you are standing tiptoe in the water, the rising tide goes up your nose.”

Twenty-six years after taking a seat in the House, Frank is still a wise guy, in both senses of that word. His hair is gray these days, and his face is a touch jowly. But age has not cooled his passion. While the contemporary glasses which occasionally slide down his nose may make him look a touch professorial, his rhetorical style is anything but academic.

The openly gay Democrat is a dominating, combative verbal presence, his fingers twining and unfolding in front of him as he talks, hands slapping the table in front of him, karate-style, for emphasis. With the Democrats taking control of Congress, the 66-year-old Harvard-trained lawyer — who worked for former Boston Mayor Kevin White before coming to Washington, where he started as a Capitol Hill staffer — has real power. But as the 110th Congress gets underway, he faces the challenge of morphing from Robin Williams into Ted Williams, the laconic Red Sox great who always let his actions speak louder than his words.

Frank’s performance over the next two years could have a big impact on corporate financial executives, even though corporate issues with SEC ramifications are not at the top of Frank’s agenda. But they may rise quickly. Already, the Senate Finance Committee has begun to address the issue of executive compensation, one of Frank’s big issues. He will not want to be left behind.

Frank, who was unavailable for an interview, now has the power, as committee chairman, to pass his pet bill from 2006, the Protection Against Executive Compensation Abuse Act, which would give shareholders a say on executive pay. Whether he has the legislative skill to ferry such legislation through the House is another question. Business groups have been highly critical of the bill, and some even refused to appear at a hearing Frank held last May. Other issues that could quickly appear on the Financial Services Committee’s agenda include changes to Section 404 of the Sarbanes-Oxley Act, stock options accounting, hedge funds and terrorism insurance.

These kinds of issues hold a lower priority for Frank than some of the others over which his committee has jurisdiction: housing, banking and insurance. Rick Lazio, a former Republican congressman from New York who served with Frank on the committee when it was called Banking, Housing and Urban Development, explains that most Democrats who joined that committee did so because of their desire to have a positive impact on inner-city housing.

Lazio is now executive vice president for public policy at JP Morgan Chase & Co. When he left Congress at the end of 2001, he was chairman of the housing subcommittee. Frank was the top Democrat there. Lazio says he and Frank worked on a bipartisan basis to move bills out of committee on such things as home ownership and housing assistance for seniors and the disabled.

Lacking any deep personal interest in corporate financial reporting issues, Frank has tended to take positions there, and elsewhere, for that matter, aligned with liberal and labor interest groups. The AFL-CIO rated Frank as voting “right” on 93 percent of “their” votes in 2005, a slight drop from his 95 percent lifetime rating; this lifetime rating is two percentage points higher than Sen. Edward Kennedy’s.

Frank certainly won points with the AFL-CIO in 2002, when the Sarbanes-Oxley bill came to the House floor for a vote. Rep. Dennis Kucinich (D-Ohio), one of the Democrat’s most outspoken liberals, proposed an alternative bill that would have substituted a federal regulatory agency for what became the Public Company Accounting Oversight Board (PCAOB). It also included provisions holding CEOs accountable for their financial statements and subjecting them to criminal penalties for knowingly lying.

The bill required those who make false or misleading statements to surrender their stock bonuses, and it also barred guilty officers and directors from serving at other public companies. Only 39 House members voted for the Kucinich alternative, called the Investor, Shareholder, and Employee Protection Act of 2002. Frank was one of them.

More Willing to Listen

It is only fair to note, however, that Frank’s rise to the top spot on the committee has, over the past four years, resulted in a greater willingness to listen to business groups, and for a number of reasons. “I have seen Barney over the years evolve to be very competent pragmatic leader,” says Lazio. “He is very quick to point out what he would view as hypocrisy, and has this acerbic wit. But over the last few years, as the top Democrat on the committee, Barney developed an effective partnership with Mike Oxley, the former Republican chairman. He knows how to get things done.

“He’s been successful in effectively organizing Democrats on the committee,” Lazio adds. “And, he has become for many in financial services, someone who understands the substance, accepts the basic requirements of a market system and with whom you can have an intelligent discussion about reasonable solutions.”

That pragmatic streak was on display in March 2006 when Frank, doing somewhat of an about-face, advocated at committee hearings that the SEC and PCAOB be allowed to ease the Sarbanes-Oxley rules they had written. At hearings at which officials from FASB, the AICPA and former FEI President Colleen Cunningham testified, Frank stated: “I hope they will be willing to make some appropriate adjustments — not exemptions, but adjustments — in how this applies, particularly in part, based on size. And I hope we would tell them that if there were any things that they thought made sense, that they thought they might like statutory authority to do, they should ask us.”

Barney Frank reasonable? Well, he is certainly trying to sound that way. Witness his speeches and television interviews in the wake of the 2006 congressional elections, as he began to lay out his concept for a “grand design” between business and labor in the legislative arena, offering business concessions on such issues as free trade in exchange for its concessions to the labor unions on such things as health care.

“He is trying to reassure the markets that he is not a wild-eyed liberal. That is what is important about his comments, setting aside the particulars,” says a public policy director for a major business lobby who confessed he is not sure what Frank has in mind.

But as Frank attempts to become a little less of a liberal lightening rod, there are questions about whether he can become more of a legislative lightning bolt. His record as a legislator is spotty. Despite considerable public outrage over executive pay, Frank was unable to get a single House Republican to support his executive pay bill last year, a fact he bemoaned in November.

The bill would allow shareholders to review and approve a company’s comprehensive executive compensation plan. One of its more controversial proposals allows for a company to recapture incentive compensation paid in past years to an executive if the company is forced to issue a financial restatement. Frank noted that if just three Republican members of the Financial Services Committee agreed, there would be enough support to force committee consideration of the bill. Not a single Republican member of the committee has come forward to do so.

Republicans steered clear of Frank on pretty much everything. In the 2005-06 Congress, Frank introduced 32 bills and resolutions, according to Thomas, the online congressional research service. None of them was passed by any committee, which may not be surprising, particularly given Republican control of the House. Besides the bill on executive pay, the only other legislation Frank introduced that was relevant to financial executives had to do with extending the Terrorism Risk Insurance Act (TRIA).

Financial Services Committee Chairman Rep. Mike Oxley, who has now retired, included very little of Frank’s bill in the measure the House eventually passed. In December 2005, Congress adopted a very different Senate bill that extended the TRIA program for two years, meaning Frank will have another shot in this session at influencing the terrorism insurance program. Late in January this year, Frank announced that he expects the House to vote to extend the program by April, and that he favors making it permanent.

It’s worth noting that Frank, through his wit, intellect and passion, can on occasion get things done. In 2006, he managed to convince Chairman Oxley and many of the other GOP stalwarts on Financial Services to allocate some of the profits earned by housing juggernauts Freddie Mac and Fannie Mae to public interest groups who advocate for public housing.

Some of the more conservative Republicans on the committee heatedly opposed Frank’s amendment to the Federal Housing Finance Reform Act, which passed the House but never got through the Senate. Still, Frank’s amendment passed the committee by a vote of 16-6.

Rep. Tom Feeney (R-Fla.) was one of the recalcitrants. He was amazed at Frank’s chutzpah. Feeney and his band of conservatives looked at Frank’s gambit as a thinly disguised effort to funnel money to groups such as ACORN (Association of Community Organizations for Reform Now), a nonprofit housing group with an active political arm, which is seen as an appendage to the Democratic Party.

But Frank convinced Oxley to sign on to ostensible “firewall” language in the housing bill that disallowed any spending of what was expected to be a $500 million honey pot for political uses. “Could you imagine if I had proposed an amendment to give $500 million to the National Rifle Association and said they could not use it to educate school kids on guns?” Feeney asks. “What do you think Barney Frank would have said?”

But Feeney was as amazed as he was appalled. “He hoodwinked everyone on the committee,” he says. “And while I was the loser, I admire a successful manipulator.”

As committee chairman, Frank could become an intimidator, too. The chairman’s sharp wit can draw blood, making some colleagues hesitant to challenge him. “While he knows how to make a point, you might be a little bit hesitant to engage him in debate,” states former Rep. John LaFalce, who worked with Frank for many years on the Financial Services Committee and retired at the end of 2004 as the panel’s top Democrat. “His wit can be a double-edged sword. But, it far more often works in his favor than not.”

What will definitely work in his favor is his influence with the House Democratic leadership. House Speaker Rep. Nancy Pelosi (D-Calif.) greatly enhanced his public stature when she shot down Rep. John Dingell (D-Mich.), the incoming chairman of the Energy & Commerce Committee; Dingell had floated a trial balloon right after the November election advertising his intention to take back jurisdiction for the SEC from Frank’s Financial Services Committee.

SEC jurisdiction had been in Energy & Commerce for many years prior to 2002, when Republicans made a switch as a sop to Rep. Oxley. But Dingell’s suggestion obviously fell on deaf ears, despite the fact that Frank had supported Rep. Steny Hoyer (D-Md.) for majority leader over Rep. John Murtha (D-Pa.), Pelosi’s chosen candidate. But Frank paid no price for that challenge to Pelosi, which, in his normal fashion, he made loud and clear.

Maintaining his prominent place in the House Democratic firmament, however, mitigates, to some extent, Frank’s ability as a legislator to channel organized labor legends like Samuel Gompers. That’s because the congressman receives hundreds of thousands of dollars each two-year election cycle from corporate political action committees (PACs). This was true despite the fact that he has either nominal or, as was the case in 2006, no one challenging him for his congressional seat.

During the 2005-06 cycle, JP Morgan Chase & Co. was Frank’s biggest contributor, chipping in with $13,500. Ernst & Young was at number three with $10,000. Right behind Ernst was the Securities Industry Association, UBS AG and the Bond Market Association. Labor unions gave him money, too, but considerably less.

In addition, Frank raked in heavy contributions from business people in his district and outside it. John J. Brennan, chairman of the Vanguard Group, tossed him $1,000, as did Aryeh Bourkoff, managing director of UBS Securities. In total, Frank raised $1.56 million in 2005-06, $721,000 from PACs, $818,000 from individuals. He was a half-million dollars in front of the next-closest House colleague in the Massachusetts delegation.

One might wonder why Frank needs to solicit, or even accept, business PAC contributions when his seat is as safe as Tom Brady’s job as quarterback of the New England Patriots. If he is not spending that money on campaign advertising and consultants, what is he doing with all that money? Well, he is using it to support Democrats running for House seats.

In 2006, Frank contributed $326,000 to the Democratic Congressional Campaign Committee, which was run by Nancy Pelosi. Frank contributed more to the DCCC than any other House committee chairman, and almost as much as Rep. Steny Hoyer, the House majority leader. Frank even out-donated Pelosi.

With Democrats in power, and his hands on the traffic light controls for the first time in his career, Frank can ill afford to jeopardize either his leverage with the leadership or the flood of campaign contributions from business groups which, in part, allow him to make a big splash with House Democrats. And besides the contributions, Frank also needs from business some legislative cooperation if he is to make good on his “grand design” agenda. So, he cannot be seen to be in labor’s vest, much less their pocket.

With that, business groups are waiting to see whether the new Financial Services Committee chairman will continue to show maturation in the form of compromise on issues such executive compensation.

Says J.P. Morgan Chase’s Lazio: “It’s impossible not to see why Barney would be concerned about executive compensation. But the challenge for him is to develop a compelling legislative response — one that doesn’t damage competitiveness and still creates incentives for restraint that would be applauded by shareholder advocates. To be comfortable, public companies will want the Frank bill to acknowledge the limited information which shareholders have on which to base their views on compensation, as well as to have it apply only to key management positions, not non-management employees who may be highly compensated.”

Frank also may have to take a position on a Sarbanes-Oxley reform bill. Two members of the committee, Rep. Gregory Meeks (D-N.Y) and Florida’s Rep. Feeney, plan to introduce a revised version of their COMPETE Act, which would make significant changes to Sarbanes-Oxley Section 404. That section has occasioned a much-debated SEC rule, as well as Auditing Standard 2, which deals with attestation on the corporate controls report, from the PCAOB.

Both the SEC and PCAOB proposed changes to their rules last December, and the agencies have been mulling over comments from the business community on whether those changes go far enough. The Meeks-Feeney bill goes beyond those December changes. If high-tech groups decide to push the bill, as they did when its first iteration was introduced in 2006, Speaker Pelosi, whose “Innovation Agenda” includes support for a Sarbanes-Oxley fix, may push Frank in a direction he has said he does not want to go.

No one herds Barney Frank, of course, not even Nancy Pelosi. He doesn’t necessarily listen to his staff, either. David Eppstein, director of state affairs for the National Association of Professional Insurance Agents, says during his years as a Republican staffer on the Financial Services Committee, the Democratic staff could never commit to a deal on behalf of Frank.

Even labor groups cannot always count on his allegiance. “We are looking forward to working with Chairman Frank, even though we know we won’t agree with everything he says, and he won’t agree with everything we say,” says Damon Silvers, assistant general counsel for the AFL-CIO.

Told that some people might be surprised to hear him say that, given Frank’s stratospheric AFL-CIO rating, Silvers laughs. “Chairman Frank doesn’t agree with anything anybody says,” he answers. “He is an independent thinker.”

Indeed, in an era in which politicians are criticized for being overly beholden to PACs, Frank has sometimes not just bitten the hand that feeds him, he has chewed on it. It is a neat trick, but those corporate PAC contributions, in truth, reflect the desire of business interests to at least keep Frank’s door open.

It is a considerably weightier door now, though. In this new Congress, business groups hope that once Frank makes a decision on an issue, and slams the door closed, they won’t still have their fingers on the jamb.