SEC delays Sarbanes-Oxley requirements for small businesses

The Securities and Exchange Commission (SEC) has provided small businesses another 1-year delay to comply with Sarbanes-Oxley Section 404 requirements. Section 404 is the part of Sarbox that requires management to attest to the effectiveness of internal controls over financial reporting.

“This will help ease the burden on small firms and help encourage more small businesses to become public companies – while still ensuring transparency and honest accounting,” said Senator John Kerry (D-MA), chairman of the Senate Committee on Small Business and Entrepreneurship.

I see how this eases the regulatory burden on small entities, thereby indirectly encouraging small businesses to go public where they might otherwise not, but it remains to be seen how this “still ensures transparency and honest accounting”. How does not requiring companies to fully examine their systems of internal control and have management sign off on their effectiveness ensure anything?

It has been nearly five and a half years since Sarbanes-Oxley was implemented in the wake of the Enron meltdown and the delay applies to companies worth $75-million or less. When will smaller public companies be held to the same standard as larger ones?

Since the law was passed in 2002, the SEC has delayed compliance four times for small businesses. Currently, small companies … are expected to comply with the management guidance part of the law this year and the auditing section by 2009.

Legislators worked quickly to draft and pass Sarbanes-Oxley to protect investors in the aftermath of accounting scandals. Is it reasonable that it will be 7 years before it is in place for the smaller public companies in the US?

Accounting Standards

Inching towards international accounting standards in the US

In Canada, the Accounting Standards Board (AcSB) has already taken the first steps of convergence with international standards by outlining the plan under which publicly accountable enterprises will transition completely to IFRS. The change will occur over the next 5 years, and the Board expects the changeover process to be complete by fiscal years beginning in 2011, although it could still be pushed back if circumstances require it.

In the US, the SEC has recently proposed that foreign companies will not have to reconcile their IFRS financial statements to US GAAP:

If the current SEC proposal is approved, foreign companies registered with the SEC that use IFRS, which is published by the International Accounting Standards Board, wouldn’t have to provide a separate reconciliation report starting in 2009.

This is a great development and real progress towards convergence. Foreign companies will likely jump wholeheartedly on this proposal, as it will allow them to save significant costs. This means less work for the professionals, but so be it. The work is redundant and does not add value in the slightest. It is inefficient to have to present financials in two different sets of GAAP.

The SEC seeks comment on the proposal, in particular regarding the possible need for additional disclosure or information on areas where the two sets of GAAP don’t agree, and whether this might require too much knowledge on the part of users of the IFRS statements.

In particular:

Should issuers and auditors consider guidance related to materiality and quantification of financial misstatements?

This struck me, because if there are significant differences on these two very fundamental audit issues, perhaps convergence is farther off than I’d originally hoped.


BlackBerry maker getting the probe on options backdating

The Ontario Securities Commission has launched a probe of Research In Motion’s stock option practices. An OSC spokesperson said the review was launched in early October, which is not long after the company announced it would have to restate past financials because of its options accounting.

Another tech company is having difficulties with their options accounting. The reason is clear: the prevalence of stock options as compensation in cash-strapped startups.

RIM revealed Oct. 28 that the U.S. Securities and Exchange Commission had launched an “informal inquiry” into the way the company granted stock options. RIM did not disclose information about any similar OSC probe.

And the SEC had announced an investigation over a week earlier! Seems to me that the two major commissions in North America should have been communication between them.

This whole options backdating thing seems to me like it’s something you would intuitively know is against the rules, isn’t it?


Loading springs and dodging bullets

Two terms, “spring-loading” and “bullet-dodging” have reminded me of the tendency in business to put a positive spin on negative practices.

Spring-loading refers to the practice of granting options immediately before releasing good news that will likely increase the stock price, resulting in options that are not in the money technically when granted, but are, shortly thereafter.

Bullet-dodging refers to the practice of granting options immediately after releasing bad news that will likely decrease the stock price, resulting in options that avoid being further out of the money had they been granted before the news.

These practices are shady, dishonest, and similar to insider trading in that they take advantage of the difference in information that company insiders have compared to outsiders.

The use of options to motivate management and align their interests with that of shareholders is still relatively new, but it’s increasingly subject to manipulation that is unfair to ordinary investors.

Along with the ongoing SEC investigations into backdating of options, future investigations into spring-loading and bullet-dodging could turn up more violations of ethics in business.

The attractiveness of options continues to decline with every instance of abuse. As Jack Ciesielski points out:

What made them attractive in the first place was that they were “money for nothing” with little visibility into their disbursement.

Now that options are getting the publicity they deserve, and none of it positive, their use will stay in the spotlight until ethical use becomes the norm.

What do you think about the use of options as compensation? Is spring-loading and bullet-dodging really wrong, or am I up in arms about nothing?


Options backdating investigation not making the SEC any friends

Tech companies are the primary focus of the SEC’s recently announced and currently ongoing investigation into options dating irregularities, which makes sense given their proclivity for awarding stock options as part of compensation packages with employees.

An article in BusinessWeek documents what tech company executives have recently termed a “witch hunt”:

Many executives are surprised by the breadth of the government’s probe, which has resulted in SEC investigations into 80 companies and criminal indictments against former executives at Brocade Communications and Comverse Technology.

I think that speaks to the rampant abuse we’re going to see coming out into the open as a result of the probe. The SEC wouldn’t investigate unless they were reasonably certain there was wrongdoing to be found.

One tech company executive, Daniel Warmenhoven of Network Appliance, is interviewed for the article. The exec spoke out publicly because the company has just performed a comprehensive review of their options practices and deemed themselves in the clear.

“I thought the SEC’s role was to build investor confidence. What they’re doing right now is destroying it, and I don’t see the purpose.”

Applying a statute of limitations to this sort of white collar crime (let’s call it what it is) would send an even worse message to investors and their brittle confidence than all this pesky investigating.

Improving compliance with regulations and GAAP will do more to inspire confidence in the markets than sweeping all this under the rug.