SEC’s Efforts at Further Regulation Dealt a Blow

25 Jul
By: Daniel W. Rumsey

Hope for Smaller Reporting Companies?

A federal appeals court last Friday struck down the SEC’s “proxy access rule”, which was designed to give significant shareholders access to corporate proxy statements, making it easier to oust corporate directors.  To qualify, shareholders must have owned at least 3% of a corporation’s stock – a high threshold for a Fortune 500 company, but a relatively easy threshold to overcome in the case of smaller reporting companies.  Had the court ruled in favor of the SEC, smaller reporting companies would have been burdened with yet another regulation that disproportionately impacts these companies, which are widely held out as providing the greatest hope our country has to create jobs in a stagnating economy.  

Smaller reporting companies are currently in the thick of complying with the new requirement that public companies file their financial statements in a new computer readable format, or XBRL – a requirement that arguably provides little perceptible benefit to the investing public in the case of smaller reporting companies, yet in most cases at least doubles their filing costs.  These companies are rarely followed by the analyst community, who are likely going to be the heaviest users of the new computer readable data.  The financial and related burdens proposed by XBRL are only going to get worse when companies are required to detail “tag” their financial statement footnotes in year-two of compliance.

XBRL is in addition to a wide range of new regulations mandated under the Dodd-Frank Act that are going to impact smaller reporting companies beginning in 2012.  These new regulations will impact executive compensation and related disclosure, and corporate governance.  And, beginning with annual meetings that occur on or after January 21, 2013, smaller reporting companies will be required to provide shareholders with the ability to weight in on executive compensation – the so-called “say-on-pay” requirement.

The SEC is hopefully carefully weighing the impact on smaller reporting companies of proposed new rules mandated by Dodd-Frank, as well as considering whether such rules truly have a perceptible benefit to the investing public.  In the case of “say-on-pay”, the rule is arguably intended to address perceived compensation abuses at companies with substantially greater market capitalizations than $75.0 million, the threshold below which a company is considered a smaller reporting company.  Yet, “say-on-pay” will disproportionately affect smaller reporting companies that may lack the human and financial resources to affectively respond to the new rule.  With the court’s Friday ruling striking down the proxy access rule, the SEC is on notice that proposed rules that fail to consider the economic affects of such rules will face a difficult challenge in the courts.

Notwithstanding Dodd-Franks’ rule making mandate, Congress permitted the SEC to exempt one or more classes of companies from compliance with new rules adopted under the Act.   The most likely class of issuer that may be exempted from these new disclosure requirements would be smaller reporting companies.  Let’s hope that the SEC carefully considers its power to exempt.  Congress itself did so when it provided smaller reporting companies with relief from the auditor attestation requirement imposed by the Sarbanes-Oxley Act, and the courts have done so recently in striking down the proxy access rule.  In so doing, the court ruled that the SEC acted “arbitrarily and capriciously for having failed once again…adequately to assess the economic effects of a new rule.”  It even went further by slapping the wrist of the SEC for “inconsistently and opportunistically” citing the economic costs and benefits in support of the rules.

The recent actions by the courts and Congress provide hope that the disproportionate costs imposed on smaller reporting companies will receive even more weight by the SEC in considering new rule making initiatives. While it may be asking too much, perhaps certain existing rules impacting smaller reporting companies that provide little if any perceptible benefit to the investing public can be revisited – such as the soon-to-be mandated XBRL detail tagging requirement.  These rules disproportionately burden smaller reporting companies at a time when the economy needs such companies to return to their traditional role of being the engine of our country’s economic growth.

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