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The AAO Weblog covers accounting issues and current events as they relate the practice of investment analysis.
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Oct
18
Written by:
Jack Ciesielski
10/18/2005 7:44 AM
SEC Commissioner Cynthia Glassman delivered a speech on October 7 as part of the Center for the Study of International Business Law Breakfast Roundtable Series at the Brooklyn Law School.
Her remarks were a fairly comprehensive update on the internationalization process going on in markets and in financial reporting. What struck me however, were her comments on Sarbanes-Oxley Section 404 reviews for small issuers:
"And finally, with respect to the recent additional delay for our smaller issuers, we realized, based in part upon a recommendation from the Commission's Advisory Committee on Smaller Public Companies, that these companies, foreign and domestic, face a greater challenge in implementing the internal control requirements. Smaller companies have fewer employees and resources, less formal and documented controls and procedures and, in many instances, lack a formal internal audit department. Given these additional hurdles facing smaller companies, as well as the pending consideration of a framework for internal controls for small companies and any future potential recommendations from our Advisory Committee, it seemed only fair and logical that we should delay the 404 compliance date for smaller companies... while we want them to continue to improve their preparedness, we should not cause them to continue to incur expenses unnecessarily in order to comply with new requirements that may change, and that is why the additional delay made sense."
Please help me: where does one go to register as an alien?
If the Food & Drug Administration was setting standards for food purity like the SEC is setting Section 404 compliance for small issuers, we'd have something like this:
"Five rat hairs per 10 pounds of flour is the standard we've set for large flour manufacturers. We understand that the human body can tolerate up to 20 rat hairs per 10 pounds of flour without ill effect, and that smaller flour millers can't get their quality level to 5 rat hairs per 10 pounds for another two years without significant costs. To keep them in business, we'll allow them 20 rat hairs per 10 pounds of flour while they phase in new quality controls..."
Just wouldn't fly, would it?
By accommodating the small issuer community, the SEC is creating a protected class - it's almost like granting diplomatic immunity to a segment of the capital market. That's a segment of the market that might take in a broad number of penny stocks - and many companies that might sop up valuable SEC enforcement resources for years to come. If internal controls are meant to prevent and detect waste, fraud and inefficiency, wouldn't it be prudent to have a little bit of "survival of the fittest?" This is capitalism, after all. If a company is so far behind the curve that it can't develop adequate internal controls within the last three and a half years, maybe it never will.
And there are possible unintended consequences of this initiative. Consider the airlines currently in Chapter 11 - and with market capitalizations and floats of less than $75 million, making them "small issuers." UAL has 61,000 employees and a market capitalization of $61 million; it had no opinion on its internal controls in 2004. There's ATA Holdings, with a market cap of $3.5 million and no 2004 internal control opinion. Northwest Airlines, with 58,000 employees, had a clean opinion on its internal controls in 2004, but with a current market cap of $53 million, it wouldn't be required to go through the cost of keeping on top of things under the anticipated "pardon." (The usual saw about the inadequate size of the company not permitting sufficient segregation of duties for internal control makes no sense for these kinds of firms - not with employees in the tens of thousands.) Delta has a market cap in excess of $75 million - for now.
Just an opinion, nothing more - but I believe that the coddling of small companies with delays and the crafting of special "frameworks" for their internal control evaluations does not serve the investing public well and will only create more bureaucracy and wasted resources - both for investors and at the SEC.
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Unexplored Obligations: Other Postretirement Benefits
Defined benefit pension plans take center stage in the pantheon of investors’ fears when it comes to worrying about liquidity effects or earnings distortions. Yet they rarely consider the cash demands and earnings distortions resulting from other postretirement benefit plans.
Since they’ve been required to measure - and display - a figure expressing the value of the promises made for providing employee health care benefits, managers have dealt vigorously with the obligations. Their growth has been held in check while pension obligations have grown ever higher. Yet even as they’ve become more controlled, other postretirement benefit plans are worth investor attention. As the benefit plans become less fearsome, the accounting principles involved have helped an increasing number of companies recognize phantom earnings - negative benefit costs - even while they’re putting cash into benefit payments under these plans. It’s better to be alert to such a trend early: firms may not always bring it to the attention of investors.
A recent edition of The Analyst’s Accounting Observer looks at the problematic reporting, with an eye focused on the "phantom income" results shown by 42 companies having negative OPEB costs. While the report is available only to paid subscribers, a condensed version is available for free upon request. To receive it, send an e-mail to Brenda Rappold at brappold@accountingobserver.com, with “OPEB Costs” in the subject line.
For information about subscribing to The Analyst’s Accounting Observer, click here.
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