Levitt on small firms and SOX

Former SEC chair Arthur Levitt writes today in the WSJ to oppose SOX exemptions for small public firms proposed in December by an SEC advisory committee.

This committee's proposal comes amid mounting evidence of the problems SOX is posing for smaller firms, which were discussed in detail in the advisory committee’s presentation linked above. In particular, because setting up an internal controls system involves a minimum cost regardless of the scale of the business, it's likely to cost small firms more per dollar of capitalization or revenues than larger firms. At the same time, internal controls disclosures are inherently less beneficial for small than for large companies. You don’t need elaborate control systems when your managers can watch what’s going on.

As discussed here recently, these problems are, among other things, reducing initial public offerings and causing smaller firms to go private, all of which negatively affects entrepreneurial activity.

Levitt says:

the small-business lobby is almost unrivaled in the fear it instills in policymakers. But political pressure often leads people down the path of least resistance and toward superficial, even counterproductive, fixes. Indeed, if these recommendations were implemented, they would make it more difficult for smaller companies to attract capital needed for growth and undermine confidence in the markets.

In other words, Levitt’s argument is that, despite the problems SOX causes for small firms, exempting them from SOX would be bad for them! That’s a pretty interesting argument. Funny that, as Levitt himself points out, they’re lobbying so hard for exemptions. Don’t they know what’s good for them?

Also, Levitt doesn’t mention evidence that investors seem to agree with the small business lobby that SOX is actually bad for smaller firms. For example, one study shows that share prices of smaller and less actively traded firms reacted less favorably to events that increased the likelihood of SOX’s passage. See Engel, Hayes & Wang, The Sarbanes-Oxley Act and Firms’ Going-Private Decisions.  Not that Levitt was ever big on evidence.

Nor does Levitt’s point about “confidence in the markets” make sense when viewed in terms of the total market rather than just the smaller firms. Although Levitt points out that smaller firms are 80% of public companies, he doesn’t mention that, as the SEC’s advisory committee pointed out, they’re only 7% by capitalization.

And Levitt’s disparagement of political pressure by the small business lobby is ironic in view of the legislative history of SOX, detailed by Roberta Romano. The SOX governance provisions were passed because of testimony by Levitt and fellow "policy entrepreneurs" in a chaotic closed-door atmosphere that excluded valuable inputs, including the small business lobby. A big problem with SOX is that small businesses, represented by the US Chamber of Commerce, were muscled out of the process. Now they’re trying to be heard.

Finally, Levitt’s recommendations for reform without total exemption won’t work because they don’t take into account the significant litigation risk that the internal controls disclosures pose both for the firms and for auditors.

If Levitt wants to be constructive, he might propose allowing small firms to opt out of SOX. That way they could have the benefits he thinks they get from SOX if they want them. And if they must be covered, against all logic in my view, the law could at least provide exemptions from civil and criminal liability.

Comments

[Some Guy]

Actually, this is a very consistent position Levitt has taken. He's a very strong support of small business and has held the view that Sarbanes-Oxley was good for small business for some time...

...that's why he granted Enron an exemption from the Investment Company Act in 1997, he intended all along to set the Sarbanes-Oxley train rolling by helping Enron run its accounting shell games.