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JOBS Act Clears the Way for Small Companies

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Earlier this week, the House and Senate passed a bill aimed at easing the burden of going public for smaller companies. The bill gained widespread bipartisan support and is expected to be signed into law by President Obama soon.

The Jumpstart Our Business Startups Act, or simply the JOBS Act, achieves two major objectives: reducing cost and regulation for smaller companies seeking to go public and allowing for “crowdfunding” to solicit small investments, typically through the Internet. The legislation creates a new category of issuers with the Securities and Exchange Commission (SEC), called “emerging growth companies”—those with total annual gross revenues of less than $1 billion during the most recently completed fiscal year.

The new law scales back existing regulations in favor of allowing easier access to capital markets for smaller companies. Top among the reduced regulations is a decrease in auditing mandates. Currently, under Sarbanes-Oxley (SOX), public companies are required to pay an outside auditor to attest to an assessment of the company’s internal controls and procedures. The JOBS Act eliminates this requirement for the emerging growth company and will likely save small issuers millions of dollars in the process. Additionally, the emerging growth company will be required to show only two years of audited financial statements as opposed to three under the original SOX rule. Finally, in any registration statement to be filed with the SEC, an emerging growth company will not need to disclose financial data for any period before the earliest audited period presented in connection with its initial public offering.

The JOBS Act does not stop at SOX-era reductions; the new law also addresses the recent corporate governance provisions of Dodd-Frank. The act removes the need to hold say-on-pay and golden parachute votes on executive compensation.

Companies may only benefit from the emerging growth category for a limited time. There are four scenarios that will trigger a company’s exclusion from the emerging growth category. The first exclusion is triggered when the company’s annual gross revenues meet or exceed $1 billion. Alternatively, a company would be excluded after five years in the emerging growth category. The next and final two scenarios involve the company issuing over $1 billion in non-convertible debt or becoming a large accelerated filer.

In passing this law, Congress also took the opportunity to address some recent developments coming from the Public Company Accounting Oversight Board (PCAOB). Emerging growth companies will be exempt from any possible future rules requiring mandatory audit firm rotation or supplements to the auditor’s report in which an auditor would be required to provide additional information about the audit and the company’s financial statements, sometimes referred to the auditor’s discussion and analysis (AD&A). These limitations on the audit firm rotation and auditor’s reports are only speculative, as the PCAOB has only issued concept releases on the issues.

Opponents to the rule argue that the JOBS Act removes shareholder protections. Ann Yerger, of the Council for Institutional Investors (CII) said the act “will create greater risks for investors and ultimately could erode confidence in our capital markets.”

While NACD shares CII’s concerns, it supports the JOBS Act and sees it as a vehicle to reduce costly and burdensome regulations for small companies seeking access to the capital markets to grow their business. The benefits of this act, combined with well-functioning boards, outweigh the need for additional and costly shareholder protections. It is a board’s responsibility to protect shareholders by ensuring that the company is operating efficiently and ethically. While regulations can provide some measure of assurance, there is no replacement for a board when they have the right tools, education and shareholder input.

PCAOB Weighs Pros and Cons of Mandatory Audit Firm Rotation

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Earlier this week, the Public Company Accounting Oversight Board convened a public meeting to collect commentary on its concept release relating to auditor independence and audit firm rotation. The two-day meeting assembled nearly 50 experts in the fields of audit and accounting, including audit firm executives, audit committee chairs, former Securities and Exchange Commission members and investors. While the outcome is still uncertain, one thing is clear: The roundtable panelists view this issue very differently.

Those supporting mandatory audit firm rotation were primarily concerned with a perceived lack of independence in audit engagements. They contend that long-term audit engagements have the potential to weaken the auditor’s work performance. Under the current system, these critics argue, audit firms may try to please their clients in order to keep the engagement instead of remaining objective. As panelist Richard Kaplan, professor of law at the University of Illinois at Urbana-Champaign, put it, “Auditors are prone to bias their conclusions to best preserve the client relationship that pays their bills.” 

Panelists opposed to tenure limits for auditors dismiss this argument for lack of clear and convincing evidence. As Greg Jenkins, professor at Virginia Polytechnic Institute and State University, noted in his opening statement, “The academic findings on auditor rotation are mixed with no clear picture as to whether rotation is beneficial. Adding to this lack of clarity, is the increasing realization that the association between auditor tenure and audit quality is rather complex.” In other words, in the battle to improve audit quality, mandatory firm rotation is not a magic bullet.

Alex Mandl, chairman of the audit committee at Dell, shared the director’s perspective on behalf of the National Association of Corporate Directors. Mandl stressed that audit committees have dramatically improved their performance since the passage of Sarbanes-Oxley. While there is still room for improvement, mandatory audit firm rotation is not the appropriate method, he said. In her comments, Catherine Lego, chairman of the audit committee at SanDisk, suggested that audit quality improvement may lie in the education and training of directors. Greater audit committee engagement with the PCAOB and director education groups such as NACD, may be the most effective route in maintaining proper oversight of audit firms, she asserted.

NACD submitted a comment letter on this issue to the PCAOB in December. While NACD supports the PCAOB’s initiative to improve audit quality, NACD believes a term-limit system may be the wrong approach. This comment letter outlines five major issues with the proposal as drafted:

  • The board and audit committee are uniquely qualified to evaluate the work of an audit firm.
  • The board and audit committee have a statutory responsibility for the oversight of auditors. Mandatory audit firm rotation supplants this authority.
  • Audit firm rotation is unnecessary for objectivity, since there is already a requirement for mandatory audit partner rotation—as well as rules for auditor independence.
  • Developing an understanding of the company may take auditors years to develop and can require even more time to deliver the maximum benefits.
  • Mandatory audit firm rotation is disruptive and costly, particularly in special situations.

A formal proposal on this topic is still months away, if at all. NACD looks forward to engaging with the PCAOB, as well as the director community, on this important issue.

The Case for Routine Maintenance

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Every year, I have my annual physical at the worst time of the year—right after the holiday season and the Super Bowl. And right before I step on the scale, I make sure to empty my pockets and take off my shoes and watch to shred every ounce of extra weight so the true result won’t hurt so badly. While it’s not usually the time of my peak health, I make sure to schedule my physical every year at the same time so I can stay on top of potential health issues.

Much like with our bodies, our boardrooms can benefit from the same type of comprehensive, annual examination.

Just like our bodies can get sick, our boards can also struggle without attentive care to their needs, and it’s important to have independent experts who can conduct a thorough review of board performance. Directors should make it a priority to ensure that their boards are getting the proper maintenance and their fellow directors are providing the highest quality of service to their peers and to the company they’re overseeing.

Conducting routine board maintenance—aka a board “exam” —is an important step toward long-term boardroom health, and an independent third party is often well-positioned to prescribe strategies to bring boards up to par.  Healthy boards enable directors to fire on all cylinders with management, which ensures peak performance company-wide.

NACD’s Board Advisory Services is an example of an independent third party that is well-positioned to confidentially conduct board maintenance—with the expertise, confidentiality and analytically driven insights and knowledge to identify a board’s strengths and potential vulnerabilities. We know how to make the tough calls and provide the best strategic advice to strengthen boardroom performance—both as a cohesive whole and as a collection of individual directors. And we have the essential tools to dive deep into the issues today’s boards face—expert facilitators and the ability to analyze every board and director from a neutral standpoint.

In addition to independence, it’s important that any party evaluating your board be thorough and administer the right tests. Through personal interviews, as well as qualitative and quantitative evaluations, NACD can gather the necessary information, consolidate the data and look for key themes. By collaboratively establishing a talent matrix based on the current and future composition of your board, we can highlight the individual skills and attributes of board members and help identify the areas you should consider for effective succession planning. This quality, independent analysis is essential to a board looking to function at maximum efficiency.

Like your annual physical, a regular check up is a useful exercise to help your board prepare for a prosperous future, and the importance of using an independent third party to conduct recurring board maintenance cannot be overstated.