The Trump Administration wants to exempt more companies from audits of internal control over financial reporting by raising the exemption threshold from $75 million to $250 million in market cap, and by doubling the time a newly public company is shielded from compliance obligations to 10 years.
So says a Treasury Department report released Friday afternoon. The 220-page document examines how the Trump Administration might overhaul regulation of the capital markets, and comes with a raft of proposals—including multiple ideas about rolling back Sarbanes-Oxley compliance, especially for smaller public companies.
For compliance officers, the three most significant proposals are:
- More companies exempt from audits of internal financial control. Section 404(b) of SOX requires an annual outside audit of internal control over financial reporting. Companies with market cap below $75 million are exempt. The Trump Administration proposes raising that exemption ceiling to $250 million in market cap.
- Doubling the lifespan of Emerging Growth Companies. Congress created a new class of public filers in 2012, “emerging growth companies,” that are exempt from numerous corporate governance and compliance rules for the first five years of their lives. The Trump Administration wants to double that period to 10 years.
- Ending “social disclosure rules” required under the Dodd-Frank Act. The Dodd-Frank Act imposed several required disclosures such as the Conflict Minerals Rule, the CEO Pay Ratio Rule, and the Mine Safety Rule. The Trump Administration says these rules are not material to making investment decisions; so they should either be repealed, or reassigned away from the Securities and Exchange Commission to other agencies such as the Labor, Energy, or Commerce departments.
The report contains much more beyond those ideas. It has a section calling for the SEC and the Commodities and Futures Trading Commission to do more rigorous cost-benefit analyses before new rulemaking; and for both agencies to be more thoughtful about publishing guidance outside normal rulemaking paths (that is, in speeches, no-action letters, and so forth).
Anyone working at broker-dealer firms will also want to give this report a close read, since it has several sections about equity market structure and self-regulatory organizations like stock exchanges.
For corporate ethics and compliance officers, however, the most important points are the three flagged above: more companies exempt from SOX, more companies exempt from other governance rules, and an end to the social disclosure rules in Dodd-Frank. That’s the proposal.
Now consider what the Treasury Department report doesn’t do…
Doesn’t Prove Its Point on SOX
The Trump Administration and Republicans in Congress like to note that the number of publicly traded companies on U.S. markets has declined by more than half since 1996. That fact is true.
It’s also true that most of that decline happened before Sarbanes-Oxley took effect. We had a total of nearly 8,000 public registrants in 1997, which fell to 5,000 by 2004, the first year companies had to comply with SOX. We have since fallen to 4,000 today. That’s all on Page 21 of the Treasury Department report.
What actually has happened in the last 20 years? First, the dot-com bubble imploded by 2000 and wiped out a flock of companies that never should have been public in the first place. Then came the recession of 2002, and the financial crisis and Great Recession of 2008. Both events spurred the Fed to cut interest rates, which led to M&A takeover booms—which took two companies on the U.S. markets and combined them into one.
The plain truth is, thanks to outsourcing and abundant private capital, more and more companies don’t need to go public. They don’t need huge sums of capital to make gigantic equipment expenditures and hire 200,000 people. The Treasury report ducks the tough questions about larger macro-economic forces driving down the number of IPOs. Straight from the text:
The number of IPOs and amounts raised varies over time, and it is challenging to identify specific causal factors that contribute to decisions on whether to go public. However, increased disclosure and other regulatory burdens may influence a decision to obtain funding in the private markets for a company that might have previously sought to raise capital in the public markets.
In other words, “We don’t really know what the problem is, but SOX might be part of it, and since weakening SOX is something we can do, that’s the plan.”
Meanwhile, as we’ve noted before, SOX achieves its original goal of making financial statements more reliable. U.S. markets today have two-thirds fewer restatements, that involve fewer issues, that restate fewer dollars, across fewer restated periods; and those restatements are filed in fewer days. Strong internal control over financial reporting also reduces the risk of fraud by senior managers, and leads to lower costs of capital when a firm goes to the markets for financing.
You can say SOX is clumsy and tedious; it is. You can say SOX compliance needs to be streamlined; it does. But you can’t say SOX doesn’t work.
Next in SOX Compliance
An appendix to the report matches Treasury Department recommendations to specific regulators that might bring about those changes. Tellingly, the report ties expanded exemptions from Section 404(b) to potential action from the Securities and Exchange Commission rather than Congress.
Let’s not forget, Republicans in the House already have passed the Financial Choice 2.0 Act, a toy box of right-wing regulatory repeal ideas—including a proposal to exempt all companies with market capitalization up to $500 million from Section 404(b), and then index that threshold to inflation moving forward.
Clearly the Trump Administration is look for something—anything, really—that it can actually accomplish. Rolling back Section 404(b) protections is a key item on conservatives’ wish, and leaning on the SEC to raise the exemption threshold is a much safer bet than waiting for Congress. Lord only knows when the Senate might consider the House’s Financial Choice legislation, if at all.
At the SEC, chairman Jay Clayton has made no secret of his desire to pry open the IPO window, and his subtext is always that relaxing compliance with Section 404(b) is the way to do that. So don’t be surprised if we see him move on that idea, by exercising the SEC’s authority to grant exemptive relief from various rules. (The SEC is meeting this week, coincidentally, to talk about simplifying disclosure.)
Repealing the social disclosures under Dodd-Frank are a different matter. They are required by law, so only Congress can abolish them outright. But the SEC could postpone compliance with the rules indefinitely; ease compliance requirements (as the SEC just did with the CEO Pay Ratio Rule); or just not take enforcement against companies that ignore compliance.
And doubling the potential lifespan of an Emerging Growth Company from five years to 10—that’s an act of Congress.
Remember: This Is Not News
None of these ideas should surprise compliance professionals who have been paying attention. They are all standard talking points for the Trump Administration and Republicans generally. The main theme of the talking points is that if we embrace these ideas, more companies will go public on U.S. markets, and economic Shangri-La will ensue.
These talking points are also deceptively framed and incomplete. At best, some Trump Administration ideas might generate marginally more IPO activity, even as they foist more risk upon Mr. and Mrs. 401(k) trying to save for retirement. Much more likely, they won’t make any difference to anyone other than Wall Street wheeler dealers—among whose number, until this year, were Treasury Secretary Steven Mnuchin, SEC chairman Clayton, and President Trump himself. Guys like them will still get rich off these proposals.
Whether anyone else will get rich, or even merely get wealthy and stay wealthy, is a very open question.