Christopher Cox’s two months atop the Securities and Exchange Commission isn’t long enough to tell how his tenure will play out.
But it is enough time to get a sense of the key issues he plans to tackle: more protection on the accounting front for small companies, a closer look at the hedge fund industry and support for a controversial rule forcing publicly traded companies to treat stock options as expenses.
While Cox is expected to be a steady overseer of the financial markets, he’s also seen having a lighter regulatory hand than predecessor William Donaldson, who led the SEC for two years in the wake of accounting scandals at Enron Corp., among others. Donaldson raised the ire of publicly traded companies that thought he sided too much with investors at the expense of companies.
Cox, a Republican, resigned from his 48th district congressional seat that covers Newport Beach and Irvine, among other cities in Orange County, to become the nation’s top securities regulator in August.
He has the attention of small publicly traded companies with market values of less than $75 million. That crop of companies has been hard hit by one of the most onerous burdens of the Sarbanes-Oxley Act of 2002: Section 404.
Section 404 of Sarbanes-Oxley calls for all publicly traded companies to extensively document their internal accounting controls. While it’s not a killer for big publicly traded companies, Section 404 has proved costly for tiny companies struggling to eke out a profit.
“When it comes to smaller companies in particular, the commission is keenly sensitive to the differences in controls and procedures that are necessary for the protection of investors,” said Cox in a written response to questions from the Business Journal. “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 both 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.”
The accounting oversight board was created by Sarbanes-Oxley.
To the relief of small companies, the SEC under Cox recently delayed by a year the enforcement of Section 404 on them. The rule was set to go into effect this year.
“It’s a big deal for us,” said Marty Lynch, chief financial officer of Irvine-based Diedrich Coffee Inc., which has a market value of about $44 million. “It’s a tremendous cost for a company our size to get ready. It doubles our audit costs.”
Section 404 won’t be enforced for small companies until mid-2007.
“We spend a couple grand a year (for audits), and it’ll probably double once we are subject to Sarbanes-Oxley,” Lynch said. “It’ll take a quarter of a million dollars to gear up for it.”
Observers say that some public companies could benefit under Cox.
“Delaying the rules on internal controls (Section 404) is a big help,” said Tom Crane, managing partner with Rutan & Tucker LLP, a Costa Mesa-based firm that has a corporate securities practice.
Stock options expensing also is a key accounting issue for publicly traded companies.
As a lawmaker, Cox fought against investor groups who pushed for a rule that requires companies to count stock options as expenses. The rule stands to reduce earnings per share and possibly stock prices, particularly for technology companies that typically use options to lure workers.
The controversial rule was delayed by Cox predecessor Donaldson. The law is in effect for companies whose annual reporting period began after July 15.
For those whose annual period ends Dec. 31, they must comply by Jan. 1.
In the past, Cox proposed legislation that would have limited stock options expensing to the top five officers of a company.
“In a sense, (Cox’s proposal) diluted the standard that required expensing of stock options for all of management,” said Vivek Mande, director of the center for corporate reporting and governance at California State University, Fullerton.
But Cox said during his confirmation hearing that he wouldn’t fight the rule. And in statements made during the past few months, the chairman appeared to tow the SEC line, backing the controversial new rule.
“It doesn’t surprise me, because he’s no longer a politician and lawmaker,” said Mande, a former academic fellow with the SEC’s office of economic analyses in Washington, D.C. “He’s chairman of the SEC and he’s going to pursue the SEC’s agenda vigorously.”
Another hot button issue is hedge fund oversight.
Cox has signaled he’ll stand behind an SEC rule requiring hedge fund managers to register by Feb. 1 as “investment advisers” with the SEC.
Hedge funds, pools of investment capital catering mostly to wealthy investors, have come under closer scrutiny from federal regulators in recent years.
“I don’t expect any major technical difficulties for newly-registering hedge fund advisers,” Cox wrote to the Business Journal. “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.”
Secretive Investors
The murky, $1 trillion hedge fund industry has attracted plenty of attention of late. The SEC went after Bayou Management LLC, a Connecticut-based firm that collapsed after top officers allegedly took more than $450 million from investors. In late September, the officers pleaded guilty.
Donaldson pushed through the adoption of the hedge fund rule despite strong criticism from Federal Reserve Chairman Alan Greenspan and two Republican-appointed SEC commissioners who said the rule would do little to prevent fraud.
“The new legislation is not a positive or helpful thing,” said Charles “Chuck” Martin, who just launched Newport Beach hedge fund Mont Pelerin Capital LLC with plans to raise more than $200 million to invest. “The hedge fund industry is basically between sophisticated investors and top investment professionals. Like all industries, there are a few ‘bad apples,’ but registration will not prevent abuses.”
