What the Beltway Has in Store

It’s been a few years now since fraud at companies like Enron, WorldCom, and Adelphia sent regulators into frenzied search for corporations that were cooking the books or raiding the cookie jar. Five years on and the centerpiece legislation, Sarbanes-Oxley, is still being debated in Washington. It’s not clear yet if the pendulum is swinging back toward a more-measured approach, but regulators still have a slew of unfinished business. Over the next 12 months look for important developments, or in some cases, a lack of movement from the SEC and Congress on auditing, litigation, and 404. Oh, and they might still have more to say about compensation, too.
  

At the top of the list is addressing what some see as the over-regulation from SOX. To determine what changes are needed, if any, a debate continues over how well the legislation has served companies and their investors and if the benefits justify the price. “In most respects, [it] has been working very well. The dynamic at corporate boards has changed fundamentally and for the better,” says Michael Emen, vice president of listing qualifications at Nasdaq. That does not mean that Emen opposes changes to SOX:  “Good regulation is good for business, but the costs and benefits of regulation need to be kept in balance.”

Small companies pay 11 times what large companies do as a percentage of revenues on SOX implementation, Emen points out. A rollback of the requirement for smaller companies to adopt 404 tops the lists of many who desire changes to the legislation. Emen is concerned that SOX compliance may be scaring some foreign companies from listing on U.S. exchanges. According to Ernst & Young, in 2005 only one of the 24 largest IPOs in the world was from within the U.S.; the statistics last year were not much better.

Scott McLucas, the director of governmental affairs at KPMG, doesn’t see much movement on the 404 front. “The Democratic Congress is less sympathetic to making changes and I think peoples’ expectations have been scaled back a bit,” he says. McLucas expects non-accelerated filers to get another deferral on 404, while regulators haggle over the permanent requirement for smaller companies. Still on the table is an exemption for companies with a market cap of under $700 million. McLucas says that this is now seen as “a bridge too far.”

Patrick McGurn, executive vice president and special counsel at Institutional Shareholder Services, agrees that a rollback on 404 for smaller companies looks unlikely. “If you view things in terms of markets, and I always tend to, sell your SOX 404 stock now because we’re not going to see any changes.  It’s going to be implemented on schedule now.” In fact, McGurn doesn’t expect much change in the regulatory environment at all: “I think that the pendulum isn’t swinging.  It’s stuck hanging straight down right now.  And you’re not going to see a lot of new activity out of the SEC.”   

While gridlock might be the descriptive word for Congress and the SEC, in July the Supreme Court issued an important decision on the class action front. It ruled in Tellabs v. Makor to leave in tact an important aspect of the Private Securities Litigation Reform Act that was being questioned in the case. It reaffirmed a higher legal standard for what’s required to bring a case to trial.  In the eight-to-one decision issued by Justice Ruth Bader Ginsberg, the Court ruled that there must be cogent and compelling evidence of intent in order to bring a lawsuit. It continues a recent trend on the High Court toward pro-business rulings. “There’s some hope that this may be the beginning of a change in the climate,” says McLucas.

Also in July, Federal Judge Lewis Kaplan sent a case against KPMG partners back to the lower court, ruling that it was a violation of due process to prohibit KPMG from paying its employees attorneys’ fees. “I think that’s huge. I would say it’s also a good sign that due process could be working again,” says Laura Unger, a director at Ambac Financial Group and CA Inc., and a former SEC commissioner.

Proxy Access
Another issue that could get some attention from regulators is proxy access as a follow-up to majority voting. “This was a hot topic during the proxy season this year with strong support being given to resolutions at United Health and Hewlett-Packard,” says McGurn. “We’re expecting the SEC, following up on the proxy roundtables it held, to come up with some proposal related to ballot access.”

A compromise is on the table where the SEC would cut back on some of the predatory shareholder resolutions that end up showing up on ballots, according to McGurn, in exchange for some limited form of ballot access. “I don’t expect that rule-making activity to result in anything substantive, but it probably means that the ballot access issue stays on corporate ballots next year,” he says.