Christopher Cox has had to walk a fine line since becoming Securities and Exchange Commission chairman in August, balancing lingering investor concerns over scandals with the corporate costs of complying with post-scandal regulations. The commission’s charge remains to protect investors, Cox said, but the cost of doing so has to be reasonable enough “so that the benefits of the new requirements can be achieved on a sustainable basis.”
Cox, who represented Newport Beach, Irvine and other areas in Congress before his appointment, talked with the Business Journal’s Pat Maio about Sarbanes-Oxley and other issues, including oversight of mutual and hedge funds.
Can the costs of Sarbanes-Oxley compliance be minimized?
I was in Congress when the Sarbanes-Oxley Act was passed. I served on the House-Senate conference committee that wrote the final version of the law. Our purpose was to address the egregious accounting scandals that had come to light at Enron, WorldCom and several other companies. There had been a serious deterioration in standards, and it was not limited to a handful of firms.
Section 404 of the act, which just went into effect this year for larger companies, requires a public report on the internal controls over financial reporting. There is no question that this process has tightened internal controls. That, in turn, has improved the quality of financial reporting, and directly benefited investors.
Those benefits, which are real, haven’t come cheaply. When it comes to smaller companies in particular, the Securities and Exchange Comm-ission is keenly sensitive to the differences in controls and procedures that are necessary for the protection of investors. Armed with the experience of the last three years’ implementation of Sarbanes-Oxley, the SEC and the Public Company Accounting Oversight Board are working to encourage companies and auditors to reduce unnecessary costs and other burdens, so that the benefits of the new requirements can be achieved on a sustainable basis.
Could you address the SEC’s proposed reporting deadlines, which require larger companies to file their quarterly and annual reports more quickly than smaller ones?
The intention of Congress and the SEC is to protect investors through regulation and enforcement, and to do so consistent with our responsibility to promote healthy capital markets. That means we must always take into account the cost to investors.
The commission has proposed shortening the period of time that the largest companies will have to file their annual and quarterly reports. The largest companies would file their annual reports within 60 days after the end of their fiscal years. Companies with floats between $75 million and $700 million would have 75 days, and smaller companies would continue to have 90 days as they do now. The shorter time period for larger companies reflects a realistic assessment of whether they can afford the extra costs and regulatory overhead, and whether within a much shorter time they can still produce financial information that is accurately prepared.
A recent Wall Street Journal article on the use of big fines to punish corporate wrongdoers seemed to indicate that you might argue against such fines. Is this the case?
Since I’ve been chairman of the commission, all of our votes,in more than 100 cases,have been unanimous. The clear policy I hope to establish when it comes to penalties is that they must serve at least one of three purposes: They must punish wrongdoers; deter future misconduct; or help compensate victims. Some fines can serve all three goals. In some of the cases that have come before the commission, we have increased the recommended penalties. In others, we have reduced them. Our unanimous objective is to impose penalties that are appropriate to the facts and circumstances of each case. With my colleagues, I am now working to establish objective principles to help guide us as we seek to determine the appropriate sanctions for wrongdoers. Congress has provided recent direction in this area as well. The SEC’s top priority is to protect investors, and it is critical that the fines we impose serve this goal.
The SEC’s advisory committee on smaller public companies is due to issue a report in April. What are you expecting from that?
We formed the Advisory Committee on Smaller Public Companies last year to examine the impact of the Sarbanes-Oxley Act, and other aspects of federal securities laws, on smaller public companies.
The SEC directed the committee to conduct its work with an over-arching view to protecting investors. Within that constraint, the committee is considering whether the costs imposed by the current securities regulatory system for smaller public companies are proportionate to the benefits. The committee also is focused on identifying ways to minimize costs and maximize benefits, and to facilitate capital formation by smaller companies.
Last month, the SEC acted on one of the committee’s initial recommendations: exempting smaller companies from compliance with some provisions for another year. The committee has indicated it will likely have additional recommendations in its next report, due in April. Those recommendations are expected to deal with where and how the SEC should draw lines between large and small companies. I look forward to reviewing those recommendations.
Some critical analysts sometimes don’t get to ask questions on corporate conference calls or are kept from meetings with top officers. Is this a big deal? How serious of an issue is this?
I share concerns regarding the potential impact that so-called “issuer retaliation” may have on the ability of investors to obtain objective research. The SEC is currently reviewing this matter.
Last year the industry developed voluntary guidelines that note companies must not discriminate among analysts on the basis of their prior research, opinions, recommendations earnings estimates, or research conclusions. The guidelines also make clear that in no circumstances should a company pressure an analyst to change a recommendation by threatening to withhold information or deny access to management.
Of course, many companies have limited resources and cannot be expected to grant every request for access to company management. But issuers must be fair and consistent in determining what level of access to company management should be provided to analysts. We are currently considering whether a new rulemaking is an appropriate response to retaliation against analysts by issuers.
How tough do you plan to press ahead with efforts to regulate hedge funds? Is it a top priority?
In December, the commission issued a new rule requiring hedge fund advisers to register with the SEC. The Commission’s action was designed to enhance the SEC’s ability to oversee and protect our nation’s securities markets.
Hedge funds have experienced tremendous growth in recent years. It’s estimated that hedge funds now hold approximately $1 trillion in assets, a nearly threefold increase in five years. In addition, there has been a trend toward retail interest in hedge funds, particularly investments by pension plans, and registered “fund of funds” with investment minimums as low as $25,000.
Hedge fund adviser registration, and the resulting prospect of SEC examination and oversight, will focus hedge fund advisers’ attention on the importance of their compliance obligations and fiduciary duties to investors.
It is worth noting that KL Group and Bayou Management, two hedge fund advisers involved in recent hedge fund problems, were not registered with the SEC, but would be required to register under our new rule.
The compliance date for the hedge fund adviser registration rule is Feb. 1. In addition to filing a registration document (which will be publicly available on the SEC’s Web site), hedge fund advisers must designate a chief compliance officer, adopt compliance policies and procedures and deliver a disclosure brochure to new clients.
I don’t expect any major technical difficulties for newly registering hedge fund advisers. Indeed, many hedge fund advisers already are registered with the SEC. This hasn’t hampered their growth, or impeded their ability to engage in legitimate investment techniques and strategies.
The General Accounting Office recently said the SEC had fewer examiners covering the mutual fund industry than it should. Do you support routine inspections of mutual funds or so-called “targeted examinations” linked to specific risks?
Limited government resources are best applied where they can do the most good. “Risk analysis” is the term for that practice, but it’s really common sense. The SEC’s mission is to protect investors, and that mission is best served when limited resources are strategically allocated. While it’s important for the SEC to monitor the entire universe of mutual funds as part of its mission to facilitate capital formation through oversight of the capital markets, it would be foolish to disregard our experience in our efforts to discover and deter wrongdoing. Mutual funds with long records of full, accurate, clear, plain-English disclosure are generally less likely to present risks of the sort the SEC works to reduce. Funds without track records, funds managed by personnel with problem records, or funds that describe themselves in language inaccessible to lay investors bear scrutiny.
Despite our emphasis on risk-based oversight, the commission will continue to collect reliable data on every fund, and impose sanctions for failures to comply with disclosure regulation. And we are reaching out to every fund in America to encourage their adoption of best practices. In November, the SEC will hold our first national conference for mutual fund chief compliance officers. Our previous efforts to assist chief compliance officers have been generally well received, and we anticipate that this new program will yield significant benefits for investors.
What are your plans to replace Paul Roye, the SEC’s former head of the unit that oversees mutual funds and hedge funds?
Our new director of the division of investment management will be an experienced professional who understands mutual funds and the information that shareholders need to wisely invest. I hope to make an announcement in the near future.
The SEC recently launched an investigation into allegations that Wall Street investors routinely pay medical researchers for confidential information about ongoing drug studies. A former colleague of yours in the Senate, Chuck Grassley, R-Iowa, wrote you to ask that the SEC and Justice Department investigate the matter. Where does this request now stand?
I can’t discuss specific cases or pending investigations. But I can share with you that the SEC has a longstanding interest in insider trading relating to drug development. We have worked closely with the Food and Drug Administration, which has related concerns with the integrity of the drug testing process. As a result of this collaboration, health professionals are becoming increasingly aware of the potential pitfalls of misusing confidential information from trials. In the past decade, the SEC has brought at least 11 insider trading cases for tipping and trading on the basis of confidential clinical trial information. We will continue our work to protect the integrity of the capital markets that support drug development, both for shareholders and for the millions of Americans who benefit from pharmaceutical advances.
