A recent study by PricewaterhouseCoopers showed European stock exchanges for the first time in recent history outpacing their U.S. brethren when it came to initial public offerings (IPOs), in both volume and value. Whether or not the desertion can be attributed to the rigors of complying with Section 404 of the Sarbanes-Oxley Act, as critics charge, the Securities and Exchange Commission is clearly starting to take the threat seriously.
Last month the SEC proposed giving all newly public companies and foreign private issuers listing on a U.S. exchange a one-year reprieve on compliance with 404. In effect, IPOs and foreign private issuers would not have to comply with requirements for a management assessment of financial reporting internal controls or an auditor attestation confirming the assessment until the company files its second annual report with the SEC. "Giving new public companies an extra year after going public to comply with the internal control assertion and audit requirements will give them some breathing room," says R. Trent Gazzaway, managing partner of corporate governance at Grant Thornton LLP.
But Gazzaway stresses that this "transition period," as the SEC refers to it, is not a free pass. "It is important to note that companies that intend to go public must be prepared to issue complete and accurate financial statements coming out of the gate," he asserts. "They don't get an extra year to put good internal controls in place; they just get an extra year to complete the self-evaluation and independent audit." In other words, even if the SEC is willing to back off, the investment community is not necessarily as patient.
An important advocate of the IPO extension proposal is John W. White, director of the SEC's corporation finance division since March. Formerly a private-practice securities lawyer and 25-year partner at Cravath, Swaine & Moore LLP, White has taken part in numerous public financings and IPOs. Before joining the SEC, White had recommended an IPO proposal similar to the current one in a comment letter to the agency and moved to put the idea on the agenda soon after his appointment. "This is all about balance," says White. "How onerous do you want to make it for companies as they are going public or listing by imposing 404 at the same time? We want to make SarbOx more effective and efficient." As part of that effort, even bigger changes are expected from the SEC in the months ahead, including the agency's first guidance for management on how to conduct internal control assessments and a reworking of Auditing Standard No. 2 (AS2) by the Public Company Accounting Oversight Board (PCAOB). The extension may be especially attractive to newer non-U.S.-based companies, which must face both 404 and GAAP reconciliations, not to mention relatively high investment banking fees, when considering whether to list in the U.S.
But is the extra time enough of a break? "I speak to companies from such places as India and Israel that consider listing
in the U.S. or London or Luxembourg or elsewhere, and a one-year reprieve from 404 won't necessarily make the difference for all of them," says Edward S. Knight, executive vice president and general counsel of the Nasdaq Stock Market Inc. More important to many is whether there will be some relief from AS2, which has resulted in significantly more expensive and time-consuming external audits, as well as better guidance on what actually connotes a material internal control.
"They need to know they are going to find that the application of 404 is [being] done in a reasonable manner," Knight concludes. And right, it would be hard to get a group of 10 people to agree on what that means.