-
Study of the Sarbanes-Oxley Act of 2002
Section 404
- Summary
of Recommendations
from the paper "Financial Regulatory Reform: A New
Foundation" by the US Department of the Treasury
-
The five key objectives of the US
Financial Regulatory Reform
-
The new acronyms: "Tier 1 FHC"
(Tier 1 Financial Holding Company) and
“nonbank”
banks.
Welcome to the May 2010 edition of
our newsletter.
OFFICE OF ECONOMIC
ANALYSIS
UNITED STATES SECURITIES AND EXCHANGE
COMMISSION (SEC)
Study of the Sarbanes-Oxley Act of 2002
Section 404
Internal Control over Financial Reporting
Requirements
Executive
Summary
The
Public Company Accounting Reform and Investor Protection Act,
otherwise known as the Sarbanes-Oxley Act (the “Act”), was enacted
in July 2002 after a series of high-profile corporate scandals
involving companies such as Enron and Worldcom.
Section
404(a) of the Act requires management to assess and report on the
effectiveness of internal control over financial reporting
(“ICFR”). Section 404(b) requires that an
independent auditor attest to management’s assessment of the
effectiveness of those internal controls.
Because
the cost of complying with the
requirements of Section 404 of the Act (“Section 404”) has been
generally viewed as being unexpectedly high,
efforts to reduce the costs while retaining the effectiveness of
compliance resulted in a series of reforms in 2007.
This
report presents an analysis of data from publicly traded companies
collected from an SEC-sponsored Web survey of financial executives
of companies with Section 404 experience conducted during December
2008 and January 2009.
The
analysis of the survey data is designed to inform the Commission
and other interested parties as to whether changes occurring since
2007 are having the intended effect of
facilitating more cost-effective internal controls evaluations and
audits, especially as they may apply to smaller reporting
companies.
The
findings of the analysis relating to efficiency include evidence
on the total and component compliance costs, the changes in costs
over time, and the factors that help to explain why costs are
lower or higher for some companies than for others.
These
findings include evidence of direct and indirect effects that
management ascribes to Section 404 compliance, including evidence
on intended benefits.
The
2007 reforms that are the focus of this inquiry include the SEC’s
June 2007 Management Guidance and its order approving the Public
Company Accounting Oversight Board’s (PCAOB)
Accounting Standard No. 5 (AS5)
(collectively referred to as the “2007
reforms”).
We are
primarily interested in whether and how
companies’ experience with Section 404(b) compliance changed
following the reforms, yet this report also presents evidence on
the implementation of both Section 404(a) and Section 404(b).
This
reflects the interrelationship between the two requirements.
The survey
was open to all reporting companies with relevant experience in
complying with Section 404, recognizing that only large
accelerated filers and accelerated filers are currently required
to comply with both Section 404(a) and Section 404(b) and, thus,
have information on the overall cost of compliance with these
sections.
These
experienced filers that responded to the survey tend to have
public float in excess of $75 million,
which is large compared to that of non-accelerated filers that are
not yet required to comply with Section 404(b).
The
evidence on the experiences of larger companies may be useful in
evaluating the extent to which additional improvements to the
implementation of Section 404(b) should be undertaken before it
becomes applicable to non-accelerated filers.
Notwithstanding, it is important to highlight that the analysis in
this report is not designed to provide compliance cost estimates
for companies that have yet to comply with the relevant
requirements of Section 404.
The
general conclusion from the analysis of survey data is that
compliance costs vary with company size
(increasing with size), compliance history (decreasing with
increased compliance experience), and compliance regime (lower
after the 2007 reforms).
Larger
companies tend to incur higher compliance costs in dollar terms
(“absolute cost”), while smaller companies
report higher costs as a fraction of asset value (“scaled cost”).
The
evidence suggests that companies bear some fixed start-up costs of
compliance that are not scalable. Some of these costs are
recurring fixed costs, while others are one-time start-up costs
borne in the first years of compliance that tend to dissipate over
time.
For
companies complying with both parts of Section 404, the cost of
complying with Section 404(b) is reportedly similar to the
incremental cost of complying with Section 404(a) alone.
The
resource requirements of Section 404(a) and Section 404(b)
compliance are quite different, however.
The
Section 404(a) cost is borne through increased internal labor and
outside vendor expenses, while the Section 404(b) cost is
experienced primarily through increased independent-auditor fees,
according to the survey evidence.
The
evidence also indicates that there is an economically and
statistically significant reduction in Section 404 compliance
costs following the 2007 reforms.
This
reduction is most pronounced among larger companies.
More than
half of survey participants (henceforth also referred to as
“respondents”) who answered explicit questions about the effects
of the 2007 reforms report that the reforms
led to a decrease in compliance costs, consistent with the
objectives of the reform and the reported cost reductions.
Nearly all
respondents indicated that they relied on the Management Guidance
and, of those, a majority found it to be useful.
As a
result of the Management Guidance, there has been a shift of
effort among smaller companies toward evaluating the effectiveness
of ICFR and away from the tasks of identifying risks to the
company’s financial reporting and identifying controls that
address identified risks.
These
respondents, however, had a less favorable
response to a question about the SEC’s responsiveness to concerns
about compliance costs.
The Web survey also included
questions about respondents’ perceptions of other potential
effects of Section 404 compliance, including potential beneficial
effects. Respondents ascribe some beneficial effects to Section
404 compliance.
In
particular, respondents were more likely to
report direct benefits of compliance with Section 404 rules (i.e.,
improvements directly related to a company’s financial reporting
process, such as the quality of the company’s ICFR), rather than
indirect benefits of compliance (i.e., improvements indirectly
related to a company’s financial reporting process, such as the
company’s ability to raise capital).
Respondents from larger companies and Section 404(b) companies
tend to regard Section 404 compliance more favorably than those
from their counterparts in almost every respect.
Before
turning to a more detailed outline of findings, it will be useful
to provide some background on the size and compliance categories
of the companies that are the subject of the study.
Throughout
the analysis, respondents are partitioned
based on the size of their company using the size thresholds that
parallel the SEC’s reporting thresholds.
Under SEC
regulations— typically—non-accelerated filers have public float of
less than $75 million; accelerated filers have public float
between $75 million and $700 million; and large accelerated filers
have public float of $700 million or more.
The
evidence on the costs and benefits of
Section 404(b) compliance is almost entirely from the last two
groups, which are termed “large” and “medium/mid-sized” companies
in this report, because “small” companies (with public float less
than $75 million) were typically not yet required to comply with
Section 404(b) at the time of the survey.
Following
previous research, in some instances, the analysis of smaller
companies focuses on those having a public float falling within a
band above and below the $75 million
threshold that distinguishes non-accelerated from accelerated
filers.
In
addition, to separate the effects of Section 404(a) compliance
from those of Section 404(b), when appropriate the analysis
partitions companies that were compliant with both Sections 404(a)
and 404(b) in the relevant fiscal year (henceforth “Section 404(b)
companies”) from those that are compliant with Section 404(a) only
(henceforth “Section 404(a)-only companies”).
A more
detailed presentation of findings as answers to the central
questions of the report follows:
Q1. How
does the cost of complying with Section 404 vary across companies,
and what factors influence a company’s compliance cost?
The
total cost of complying with Section 404 varies across companies
depending on
(1)
the company’s size,
(2)
whether the company is complying with Section 404(a) only or also
with Section 404(b),
(3) the
company’s experience in complying with Section 404(b), and
(4)
whether compliance occurred before or after the 2007 reforms.
Specifically, the absolute compliance cost
in dollar terms tends to increase
with company size (measured by public float), but the cost
scaled by asset value tends to decline as company size increases.
As one
would expect, total compliance costs are typically larger for
companies complying with Section 404(b) in addition to Section
404(a).
Longer
experience with Section 404(b) compliance, however, is associated
with a decrease in the typical reported costs (scaled by company
assets).
The cost
of compliance tends to be lower after the 2007 reforms than before
and this decrease is most pronounced among larger companies.
Q2. What is the observed trend in Section
404 compliance cost before and after the 2007 reforms?
The
Web survey collected response data on audit
fees, outside vendor fees, non-labor costs, and internal labor
hours.
These cost
components were aggregated using conservative assumptions in order
to obtain a dollar estimate of the total cost of compliance (see
Section IV.a).
The
evidence generally indicates that the typical total compliance
costs have decreased from the year prior compared to the one after
the 2007 reform and are expected to decrease further in the fiscal
year in progress at the time of the survey.
Among
Section 404(b) companies, the mean total
Section 404 compliance cost drops significantly from $2.87 million
pre-reform to $2.33 million post-reform, representing a 19 percent
decline in the total compliance cost.
The
compliance cost is expected to be lower still, with a mean cost of
$2.03 million, representing a combined decline of 29 percent.
When
reporting compliance costs by size category, the mean total
compliance cost decreases from $769,000 to $690,000 among filers
with public float lower than $75 million, but this difference is
not statistically significant.
The
reduction in compliance costs is more pronounced among the medium
and large companies that are already required to comply with
Section 404(b).
The
medians reveal similar patterns for the typical company in our
sample.8 The median total Section 404 compliance cost declines
significantly from $1.19 million pre-reform
to $1.04 million post-reform, a 13 percent decline.
The median
expected cost for the fiscal year in progress is lower still,
at $905,000, a combined decline of 24
percent relative to the pre-reform median cost.
For
non-accelerated filers, the median total compliance cost decreased
from $579,000 to $439,000, but, as with the
means, the difference for these companies is not statistically
significant.
When
analyzing first-time compliance costs before and after the 2007
reforms, the results are mixed and the mean decrease in total
costs is not statistically significant.
In
contrast, for companies in their second year of compliance with
Section 404(b), both the mean and median compliance costs are
significantly lower after the 2007 reforms than before.
Meanwhile, among Section 404(a)-only
companies, the mean total cost also decreased from $425,000
pre-reform to $336,000 post-reform, but the difference is not
statistically significant, and the median cost actually increased
from $111,000 to $162,000. Both the mean and the median, however,
are expected to decrease for the fiscal year in progress at the
time of the survey.
Q3. How do
the component costs of complying with Section 404 compare, and how
have they changed since the 2007 reforms?
For
Section 404(b) compliant companies, the largest cost component is
internal labor costs— which can comprise more than 50 percent of
the total compliance cost—followed by the estimated portion of
total audit fees attributed to ICFR (404(b) audit fees), outside
vendor fees, and non-labor cost.
In
general, every component cost declines after the reforms compared
to the year before, and is projected to decline further in the
fiscal year in progress.
The most
notable changes in the cost components between pre-reform and
post-reform are observed in the outside vendor fees and the
percent of the total audit fees attributable to ICFR.
The mean
outside vendor fee decreases by 29 percent from $438,000
pre-reform to $311,000. The median outside vendor fee decreases by
10 percent from $100,000 to $90,000.
Both
differences are statistically significant, and the outside vendor
fees are expected to decrease significantly to a mean cost of
$222,000 and median cost of $55,000 in the fiscal year in progress
at the time of the survey.
The mean
portion of the audit fee that respondents attributed to the ICFR
audit also decreases significantly by 21 percent
from $821,000 to $652,000.
This
decline is expected to continue.
Similarly,
the median audit fee decreases by 13 percent
from $358,000 to $311,000 and is expected to decrease to $275,000.
Q4. What are the benefits of complying
with Section 404, as reported by company executives, and how do
they compare against the costs of compliance?
The
survey asked the respondents to comment on the impact of Section
404 compliance on twelve characteristics relating to internal
governance and investor confidence, of which six were considered
direct effects of compliance and the remaining six indirect
effects of compliance.
The
respondents recognized Section 404 compliance as having a positive
impact on various dimensions of the financial reporting process,
but were less inclined to recognize these improvements as
affecting the companies’ dealings with other capital market
participants.
Furthermore, in an optional section of the
survey, respondents provided their assessment of the cost-benefit
trade-off of Section 404 compliance.
The
majority of respondents to this section perceive the trade-off to
be negative to varying degrees.
This
perceived trade-off is more favorable among larger companies and,
independently of size, improved following the 2007 reforms.
Among
the characteristics that are most widely reported benefiting from
Section 404 compliance is: the quality of
the respondent company’s internal control structure (73 percent),
the audit committee’s confidence in the company’s ICFR (71
percent), the quality of the company’s financial reporting (49
percent), the company’s ability to prevent and detect fraud (48
percent), and the respondent’s confidence in the financial reports
of other companies complying with Section 404 (40 percent).
The
majority of respondents recognize no effect
of Section 404 compliance on: the company’s ability to raise
capital, investor confidence in the company’s financial reports,
the company’s overall firm value, and the liquidity of the
company’s common stock.
Finally,
the perceived effect of Section 404 compliance on the efficiency
of the operating and financial reporting processes and the
timeliness of the company’s financial statement audit varies
widely: while a majority of respondents perceive no effect on
these dimensions, non-trivial portions of respondents recognize a
negative effect—that is, a reduction in the
efficiency of the operating and financial reporting processes
and/or the timeliness of financial statement audit.
In the
cross-section, larger companies were more likely to ascribe
positive direct and indirect effects to Section 404 compliance
than were smaller companies.
Q5. What are the reported benefits of
Section 404 compliance from the perspective of financial statement
users?
In
order to obtain a more complete picture of the effects of Section
404 implementation, staff members from the SEC’s Office of the
Chief Accountant conducted separate in-depth phone interviews of a
sample of 30 users of financial statements—including lenders,
securities analysts, credit rating agencies, and other investors.
Although
the sample is admittedly smaller than that
of issuers participating in the survey, the evidence gathered is
useful because it provides the perspective of financial statement
users on the effects of Section 404 compliance.
In
general, financial statement users regard ICFR disclosures to be
beneficial and indicated that Section 404(a) and Section 404(b)
compliance has had a positive impact on their confidence in the
companies’ financial reports.
The users
generally indicate that Section 404 compliance leads management to
better understand financial reporting risks, put in place
appropriate controls to address financial reporting risks, and
address internal control deficiencies in a more timely fashion
than in the absence of the disclosure requirement.
Although,
users offer divergent opinions regarding the extent to which
disclosures of material weakness affect their decision-making
process, most agree that severe weaknesses
that could take years to remediate are likely to negatively affect
their decision-making.
Users
tend not to perceive the benefits of Section 404 compliance to
vary with the size of the reporting company.
Instead,
many indicate that these benefits depend on a company’s complexity
and industry affiliation. At the same time, the users agree that
variations in compliance requirements based on complexity and/or
industry would likely be impractical.
Finally,
most users indicate that the benefits they
perceive from Section 404 compliance have not changed
substantially over time.
This is an
important finding since it indicates that the 2007 reforms, while
intended to reduce certain duplicative efforts in conducting the
evaluation of ICFR, did not at the same time change financial
statement users’ perception of the effectiveness of Section 404.
Regarding the Section 404(b) requirement, the general
consensus is that the auditor’s report on ICFR required under
Section 404(b) provides an incremental benefit beyond the
management’s report because many respondents perceive the audit
requirement to provide necessary discipline to the reporting
process.
Although
some users express the concern that ICFR evaluation may divert
management’s attention from other important areas of their
businesses, these respondents continued to believe that strong
ICFR is necessary and that financial statements need to be of high
quality and reliable.
Most
users interviewed indicate that the process of compliance with
Section 404 has become more efficient since the initial
implementation in 2004 due to:
(i) reduction in the level of documentation,
(ii)
improved communications between auditors and management,
(iii)
increased use of professional judgment in scoping and testing,
(iv) more
focus on higher risk areas, and
(v)
streamlining of audits subsequent to the first-time effort
required by Section 404 compliance.
Q6. In what ways have the Commission’s
2007 reforms affected the companies’ procedures of complying with
Section 404?
Nearly all respondents who completed an
optional section of the survey requesting feedback on management’s
Section 404(a) experience responded that they used Management
Guidance and found it to be useful.
Those who
responded indicate that both Management Guidance and Auditing
Standard No. 5 have helped reduce the total cost of compliance,
for companies in every size category.
The
respondents also indicate on average that
Auditing Standard No. 5 resulted in a small decrease in the time
it takes to complete the independent audit of ICFR.
The
perceived impact of AS5, however, varies
with the size of the company and its experience with Section
404(b) compliance.
Specifically, the perceived impact of AS5 on the time it takes to
complete the independent audit of ICFR is significantly smaller
among small filers and among companies with no previous experience
with Section 404(b) compliance.
When
asked to compare the changes in activities associated with
management’s evaluation of ICFR, the respondents indicate a slight
decrease on average from pre-reform to post-reform in the number
of risks subject to testing, the number of controls tested, but a
slight increase in the level of documentation, the use of
management’s interaction with controls as evidence, reliance on
evidence gained from self-assessment, and reliance on evidence
from direct testing.
Like much
of the previous results, the responses varied significantly
depending on the respondents’ size. While smaller companies
typically report an increase in every component, the changes
reported by medium and large filers are not homogenous.
Interestingly, however, the evidence
suggests that the compliance process across companies of different
size has become more homogenous following the 2007 reforms.
Finally,
the survey evidence indicates that companies are increasingly
structuring their evaluations of ICFR with the intent of allowing
the independent auditor to rely on their internal work, which is
consistent with one of the goals of the 2007 reforms through
Auditing Standard No. 5.
Some
caveats about the analysis of Web survey data on Section 404
implementation
There
are a number of caveats to consider when interpreting the evidence
presented in this study, some of which are due to the inherent
nature of survey data, while others are the result of the
particular context in which the Section 404 survey takes place.
First,
most, if not all, analyses of survey data are affected to various
degrees by the following potential
difficulties:
• Self-Selection Bias (i.e., Non-response
Bias):
Participation in survey research is generally voluntary.
The
process by which survey participants “select” to participate in a
survey can bias the inference based on survey data, if the
participants’ (self-) selection process is such that particular
segments of the population are systematically over- or
under-represented.
We conduct
extensive analyses to test for the presence and the potential
severity of the problem, particularly by investigating the extent
to which key characteristics of the sample of respondents to the
survey coincide or diverge from those of the list of companies
identified as the target population.
We find
that respondent companies are representative of the initial list
of public companies identified for this study, particularly among
Section 404(b) companies or within company size groups.
We also
find that the typical responses of voluntary
participants in the survey are not significantly different from
those of a randomly selected, stratified sample of companies that
were the target of follow-up efforts to induce their
participation.
Overall,
the evidence is consistent with the notion that the voluntary
nature of the participation introduces no bias in the responses,
at least relative to the separate treatment group where part of
the decision to participate is a result of the follow-up effort.
• Response Bias:
If there
are no penalties for misrepresentation and
survey participants have systematic incentives to be less than
fully truthful, inference based on survey data (or any other
self-reported information that meets those criteria) may not be
accurate.
A similar
problem arises when survey questions are designed to elicit the
participant’s subjective perceptions on a particular subject and
the participants’ views are systematically biased.
The
portion of survey data that we could independently verify (i.e.,
audit fees) indicates that the participants’ representations do
not deviate substantially from what is reported in official SEC
filings.
Aside from
this exercise, it is virtually impossible to
assess the extent to which the remaining survey data may not be
accurate.
The nature
of the survey questions varies, with some questions focusing on
quantifiable items (e.g., internal labor hours) and others on
directional perceptions (e.g., assessment of the effect of Section
404 on the quality of ICFR) and others still on
directional/ordinal perceptions (e.g., assessment of the effect of
AS5 on the amount of time it takes to complete the independent
audit under Section 404(b)).
The common
element, however, is that these data cannot
be independently verified, either because companies are do not
keep a separate record of the figures provided (e.g., costs) or
because the information provided is based on the respondents’
perceptions which by their very nature are not verifiable.
The analysis in this report provides a
characterization of companies’ experiences with Section 404
compliance that is based on survey participants’ representations
of their experiences.
Other
caveats are specific to the analysis
presented in this report, as they depend on the nature and timing
of the survey.
In
particular:
1.
The number of respondents from Section
404(b) companies that are non-accelerated filers and have usable
data is relatively small—approximately 100 companies versus over
1,600 accelerated filers in the most recently completed
fiscal year (see Table 9)—and there are reasons to believe the
experience of these companies may not extend to other
non-accelerated filers that are yet to comply with Section 404(b).
Specifically, non-accelerated Section 404(b) companies that
participated in the survey are either voluntary compliers or have
been required to comply in the past as accelerated filers and must
continue to do so because their float has not dropped below $50
million since.
To the
extent that these factors affect companies’ experience with
Section 404(b) compliance, one should be careful when
extrapolating the results to non-accelerated filers that are yet
to comply.
2.
Non-accelerated filers were required to
start complying with Section 404(a) at the end of 2007—after the
reforms.
Yet, a
number of non-accelerated filers responding to the survey reported
bearing Section 404 compliance costs prior to the reform.
These
respondents were contacted after the survey was closed to inquire
about the nature of the information provided.
These
respondents indicated that their company began complying with
Section 404 requirements prior to the Commission’s public
announcement that the compliance deadline had been extended and,
thus, they viewed the resulting pre-reform costs reported in the
survey as appropriately ascribed to Section 404(a) compliance.
The
analysis of non-accelerated filers’ experience prior to the
reforms should be interpreted with the caveat in mind that it may
not be representative of what the typical non-accelerated filer
would have experienced.
3.
The characteristics of the internal
governance structure and financial reporting process are likely to
be important determinants of the companies’ compliance
experiences, including costs and benefits and the nature of the
audit services they obtain under Section 404(b).
To the
extent that accelerated and non-accelerated filers display
significant differences in these dimensions, it may not be
appropriate to extrapolate the analysis of accelerated filers to
non-accelerated filers.
4.
All the cost figures presented in this
analysis are based on survey respondents’ characterization of the
resources devoted to Section 404 compliance. As such, the general
caveats above apply. Moreover, there are some aspects specific to
our analysis:
a. All
estimates presented in this report are based on non-audited
numbers based on the respondents’ perception provided in the
survey.
Moreover,
the nature of the estimates is limited by the scope of the survey.
b.
There are reasons to question the ability of respondents to
provide an accurate breakdown of audit fees into Section 404(b)
fees versus financial statement audit fees.
Auditors
interviewed by the SEC’s OCA staff highlight this difficulty on
the basis that, for Section 404(b) companies, the two audits are
integrated and audit firms do not typically provide a breakdown of
the fees.
Based on
conversations with issuers, however, it seems routine for them to
request and obtain audit fee quotes that account for the
incremental auditor’s work under Section 404(b) requirements
before the company begins complying with this section of the Act.
Thus, it
is possible that respondents’ attribution of audit fees to Section
404(b) may be inaccurate, to the extent that they are based on
quotes provided by auditors upon first-time compliance with this
section and that such a breakdown does not apply in subsequent
years of compliance
c. It is important to note that the
estimates of internal labor costs presented in this report are
based on an assumption about a reasonable hourly rate.
The rate
adopted for internal labor is $121 per hour, consistent with the
rate quoted as of September, 2008 for a junior accountant cited in
a report on salaries prepared by the
Securities Industry and Financial Markets Association (SIFMA),
to which the Commission frequently refers in its
rulemakings.
This is at
the low end of cost estimates that are provided in the SIFMA
report for accounting and related services,
and above the rate of $50/hour (or $100,000 for 2000 hours) that
is assumed in a series of Financial Executives International
(“FEI”) reports of survey findings relating to the costs of
compliance with Section 404 that date back to 2005.
Although
our assumed rate is within the range of reasonable estimates for
evaluating the overall costs of compliance, it is not intended for
use in estimating the cost to an individual company.
We have
provided information sufficient for determining how the internal
labor costs are affected by changes in the hourly rate—e.g.,
doubling (halving) the rate to $242 ($60.5) per hour doubles
(halves) the associated labor costs— and by changes in internal
labor hours, each of which may vary across companies.
d.
Coates (2007), among others, highlights that implementation of the
Sarbanes-Oxley Act “created new incentives
for firms to spend money on internal controls” even where
companies were required to invest such resources under the
previous regulatory regime.
This
observation is particularly relevant in the context of Section 404
implementation. In particular, Section 13(b)(2) of the Exchange
Act requires companies to maintain effective ICFR, while Section
404 requires management to report on the effectiveness of ICFR.
By this
reasoning, it is conceivable that Section 404 may have given
issuers incentives to spend more resources to meet the
requirements of the Exchange Act, causing companies to bear
“deferred maintenance” expenses to bring ICFR into compliance with
those requirements.
It is
possible that survey participants include these costs in their
assessment of the incremental costs due to Section 404 compliance.
Whether
this is the correct measure of the incremental costs of Section
404 compliance depends on the objective of the analysis.
For
example, issuers were required to be in compliance with Section
13(b)(2) of the Exchange Act prior to SOX, so the ICFR maintenance
costs might not seem pertinent.
From this
perspective, Section 404 cost estimates that include the ICFR
maintenance expenses overestimate the cost of compliance with
Section 404—by including more than just the cost of reviewing ICFR
and preparing the mandated disclosures.
Alternatively, if the argument above is correct, in the sense that
companies systematically shirk in complying with the Exchange Act
requirements absent SOX, then the incremental economic cost of
Section 404 compliance should include the aforementioned
maintenance expenses that would not be borne absent Section 404.
Similarly,
it is worth noting that a parallel logic applies to the benefits
of Section 404 compliance.
That is,
from an economic perspective, the incremental benefits of Section
404 include the improvements in ICFR resulting from the deferred
maintenance that would not have occurred absent the new disclosure
requirements of Section 404.
5.
Participants in the survey provided their
perceptions of the effects of Section 404 compliance, both on the
financial reporting process and their company’s interaction with
capital market participants. The following caveats should be kept
in mind for this part of the analysis:
a. The
assessment of the benefits is qualitative in nature, given the
intrinsic difficulty of quantifying the benefits of Section 404
compliance in monetary terms, and not directly comparable to the
cost estimates provided by the same respondents.
b. In
addition to lack of comparability with cost estimates, the
analysis of the survey responses about the benefits of compliance
may be subject to response bias.
In
particular, the response bias would seem to be especially relevant
when participants provide their assessment of how Section 404
compliance affects subjects outside the corporation (e.g.,
investors’ confidence in the company’s reports).
The
resulting analysis may be biased if the respondents’ perception or
their representation of those perceptions is biased.
With this
caveat in mind, the staff of the SEC’s
Office of the Chief Accountant (OCA) conducted in-depth interviews
with individuals representing a variety of external users of
financial statements to gather their views on the effects of
Section 404.
This
effort complements the analysis of the views expressed by the
companies participating in the survey, in combination providing a
broader and more complete assessment of the effects of Section 404
on capital market participants.
6. In
various parts of the survey, the
participants provided information about their experience with
Section 404 compliance over several years: the most recently
completed fiscal year; the fiscal year prior to that, and the
fiscal year in progress at the time of the survey.
While
responses referring to the participants’ past experience reflect
events that are certain, responses for the fiscal year in progress
at the time of the survey result in estimates and perceptions that
are intrinsically less precise, due to the inherent uncertainty
about future events.
SUMMARY OF RECOMMENDATIONS
From the paper "Financial Regulatory Reform: A New
Foundation" by the US Department of the Treasury, we read:
I. PROMOTE ROBUST SUPERVISION
AND REGULATION OF FINANCIAL FIRMS
A.
Create a Financial Services Oversight Council
1. We propose the creation
of a Financial Services Oversight Council
to facilitate information sharing and coordination,
identify emerging risks, advise the Federal Reserve on the
identification of firms whose failure could pose a threat to
financial stability due to their combination of size, leverage,
and interconnectedness (hereafter referred to as a Tier 1 FHC),
and provide a forum for resolving jurisdictional disputes
between regulators.
a. The membership of the
Council should include
(i) the Secretary of the
Treasury, who shall serve as the Chairman;
(ii) the Chairman of the Board
of Governors of the Federal Reserve System;
(iii) the Director of the
National Bank Supervisor;
(iv) the Director of the
Consumer Financial Protection Agency;
(v) the Chairman of the SEC;
(vi) the Chairman of the CFTC;
(vii) the Chairman of the
FDIC; and
(viii) the Director of the
Federal Housing Finance Agency (FHFA).
b. The Council should be
supported by a permanent, full-time expert staff at Treasury.
The staff should be responsible for providing the Council with
the information and resources it needs to fulfill its
responsibilities.
2. Our legislation will
propose to give the Council the authority to gather information
from any financial firm and the responsibility for referring
emerging risks to the attention of regulators with the authority
to respond.
B.
Implement Heightened Consolidated Supervision and Regulation of
All Large, Interconnected Financial Firms
1. Any financial firm
whose combination of size, leverage, and interconnectedness
could pose a threat to financial stability if it failed (Tier 1
FHC) should be subject to robust consolidated supervision and
regulation, regardless of whether the firm owns an insured
depository institution.
2. The Federal Reserve
Board should have the authority and accountability for
consolidated supervision and regulation of Tier 1 FHCs.
3. Our legislation will
propose criteria that the Federal Reserve must consider in
identifying Tier 1 FHCs.
4. The prudential
standards for Tier 1 FHCs – including capital, liquidity and
risk management standards – should be stricter and more
conservative than those applicable to other financial firms to
account for the greater risks that their potential failure would
impose on the financial system.
5. Consolidated
supervision of a Tier 1 FHC should extend to the parent company
and to all of its subsidiaries – regulated and unregulated, U.S.
and foreign.
Functionally regulated and
depository institution subsidiaries of a Tier 1 FHC should
continue to be supervised and regulated primarily by their
functional or bank regulator, as the case may be.
The constraints that the
Gramm-Leach-Bliley Act (GLB Act) introduced on the Federal
Reserve’s ability to require reports from, examine, or impose
higher prudential requirements or more stringent activity
restrictions on the functionally
regulated or depository
institution subsidiaries of FHCs should be removed.
6. Consolidated
supervision of a Tier 1 FHC should be macroprudential in focus.
That is, it should consider risk to the system as a whole.
7. The Federal Reserve, in
consultation with Treasury and external experts, should propose
recommendations by October 1, 2009 to better align its structure
and governance with its authorities and responsibilities.
C. Strengthen Capital and
Other Prudential Standards For All Banks and BHCs
1. Treasury will lead a
working group, with participation by federal financial
regulatory agencies and outside experts that will conduct a
fundamental reassessment of existing regulatory capital
requirements for banks and BHCs, including new Tier 1 FHCs.
The working group will issue a
report with its conclusions by December 31, 2009.
2. Treasury will lead a
working group, with participation by federal financial
regulatory agencies and outside experts, that will conduct a
fundamental reassessment of the supervision of banks and BHCs.
The working group will issue a
report with its conclusions by October 1, 2009.
3. Federal regulators
should issue standards and guidelines to better align executive
compensation practices of financial firms with long-term
shareholder value and to prevent compensation practices from
providing incentives that could threaten the safety and
soundness of supervised institutions.
In addition, we will support
legislation requiring all public companies to hold non-binding
shareholder resolutions on the compensation packages of senior
executive officers, as well as new requirements to make
compensation committees more independent.
4. Capital and management
requirements for FHC status should not be limited to the
subsidiary depository institution. All FHCs should be required
to meet the capital and management requirements on a
consolidated basis as well.
5. The accounting standard
setters (the FASB, the IASB, and the SEC) should review
accounting standards to determine how financial firms should be
required to employ more forward-looking loan loss provisioning
practices that incorporate a broader range of available credit
information.
Fair value accounting rules
also should be reviewed with the goal of identifying changes
that could provide users of financial reports with both fair
value information and greater transparency regarding the cash
flows management expects to receive by holding investments.
6. Firewalls between banks and their affiliates should be
strengthened to protect the federal safety net that supports
banks and to better prevent spread of the subsidy inherent in
the federal safety net to bank affiliates.
D.
Close Loopholes in Bank Regulation
1. We propose the creation
of a new federal government agency, the National Bank Supervisor
(NBS), to conduct prudential supervision and regulation of all
federally chartered depository institutions, and all federal
branches and
agencies of foreign banks.
2. We propose to eliminate
the federal thrift charter, but to preserve its interstate
branching rules and apply them to state and national banks.
3. All companies that
control an insured depository institution, however organized,
should be subject to robust consolidated supervision and
regulation at the federal level by the Federal Reserve and
should be subject to
the nonbanking activity restrictions of
the BHC Act.
The policy of separating
banking from commerce should be re-affirmed and strengthened.
We must close loopholes in the
BHC Act for thrift holding companies, industrial loan companies,
credit card banks, trust companies, and grandfathered
“nonbank” banks.
E.
Eliminate the SEC’s Programs for Consolidated Supervision
The SEC has ended its
Consolidated Supervised Entity Program, under which it had been
the holding company supervisor for companies such as Lehman
Brothers and Bear Stearns.
We propose also eliminating
the SEC’s Supervised Investment Bank Holding Company program.
Investment banking firms that
seek consolidated supervision by a U.S. regulator should be
subject to supervision and
regulation by the Federal Reserve.
F.
Require Hedge Funds and Other Private Pools of Capital to
Register
All
advisers to hedge funds (and other private pools of capital,
including private equity funds and venture capital funds) whose
assets under management exceed some modest threshold should be
required to register with the SEC under the
Investment
Advisers Act.
The advisers should be
required to report information on the funds they manage that is
sufficient to assess whether any fund poses a threat to
financial stability.
G.
Reduce the Susceptibility of Money Market Mutual Funds (MMFs) to
Runs
The SEC should move forward
with its plans to strengthen the regulatory framework around
MMFs to reduce the credit and liquidity risk profile of
individual MMFs and to make the MMF industry as a whole less
susceptible to
runs.
The President’s Working Group
on Financial Markets should prepare a report assessing whether
more fundamental changes are necessary to further reduce the MMF
industry’s susceptibility to runs, such as eliminating the
ability
of a MMF to use a stable net asset value or requiring
MMFs to obtain access to reliable emergency liquidity facilities
from private sources.
H.
Enhance Oversight of the Insurance Sector
Our legislation will
propose the establishment of the Office of National Insurance
within Treasury to gather information, develop expertise,
negotiate international agreements, and coordinate policy in the
insurance sector.
Treasury will support
proposals to modernize and improve our system of insurance
regulation in accordance with six principles outlined in the
body of the report.
I.
Determine the Future Role of the Government Sponsored
Enterprises (GSEs)
Treasury and the
Department of Housing and Urban Development, in consultation
with other government agencies, will engage in a wide-ranging
initiative to develop recommendations on the future of Fannie
Mae and Freddie Mac, and the Federal Home Loan Bank system.
We need to maintain the
continued stability and strength of the GSEs during these
difficult financial times.
We will report to the
Congress and the American public at the time of the President’s
2011 Budget release.
II. ESTABLISH COMPREHENSIVE
REGULATION OF FINANCIAL MARKETS
A.
Strengthen Supervision and Regulation of Securitization Markets
1. Federal banking
agencies should promulgate regulations that require originators
or sponsors to retain an economic interest in a material portion
of the credit risk of securitized credit exposures.
2. Regulators should
promulgate additional regulations to align compensation of
market participants with longer term performance of the
underlying loans.
3. The SEC should continue
its efforts to increase the transparency and standardization of
securitization markets and be given clear authority to require
robust reporting by issuers of asset backed securities (ABS).
4. The SEC should continue
its efforts to strengthen the regulation of credit rating
agencies, including measures to promote robust policies and
procedures that manage and disclose conflicts of interest,
differentiate between structured and other products, and
otherwise strengthen the integrity of the ratings process.
5. Regulators should
reduce their use of credit ratings in regulations and
supervisory practices, wherever possible.
B.
Create Comprehensive Regulation of All OTC Derivatives,
Including Credit Default Swaps (CDS)
All OTC derivatives
markets, including CDS markets, should be subject to
comprehensive regulation that addresses relevant public policy
objectives:
(1) preventing activities in
those markets from posing risk to the financial system;
(2) promoting the efficiency
and transparency of those markets;
(3) preventing market
manipulation, fraud, and other market abuses; and
(4) ensuring that OTC
derivatives are not marketed inappropriately to unsophisticated
parties.
C. Harmonize Futures and
Securities Regulation
The CFTC and the SEC
should make recommendations to Congress for changes to statutes
and regulations that would harmonize regulation of futures and
securities.
D.
Strengthen Oversight of Systemically Important Payment,
Clearing, and Settlement Systems and Related Activities
We propose that the
Federal Reserve have the responsibility and authority to conduct
oversight of systemically important payment, clearing and
settlement systems, and activities of financial firms.
E.
Strengthen Settlement Capabilities and Liquidity Resources of
Systemically Important Payment, Clearing, and Settlement Systems
We propose that the
Federal Reserve have authority to provide systemically important
payment, clearing, and settlement systems access to Reserve Bank
accounts, financial services, and the discount window.
III.
PROTECT CONSUMERS AND INVESTORS FROM FINANCIAL ABUSE
A. Create a New Consumer Financial
Protection Agency
1. We propose to create a
single primary federal consumer protection supervisor to protect
consumers of credit, savings, payment, and other consumer
financial products and services, and to regulate providers of
such products and services.
2. The CFPA should have
broad jurisdiction to protect consumers in consumer financial
products and services such as credit, savings, and payment
products.
3. The CFPA should be an
independent agency with stable, robust funding.
4. The CFPA should have
sole rule-making authority for consumer financial protection
statutes, as well as the ability to fill gaps through
rule-making.
5. The CFPA should have
supervisory and enforcement authority and jurisdiction over all
persons covered by the statutes that it implements, including
both insured depositories and the range of other firms not
previously subject to comprehensive federal supervision, and it
should work with the Department of Justice to enforce the
statutes under its jurisdiction in federal court.
6. The CFPA should pursue
measures to promote effective regulation, including conducting
periodic reviews of regulations, an outside advisory council,
and coordination with the Council.
7. The CFPA’s strong rules
would serve as a floor, not a ceiling.
The states should have the
ability to adopt and enforce stricter laws for institutions of
all types, regardless of charter, and to enforce federal law
concurrently with respect to institutions of all types, also
regardless of charter.
8. The CFPA should
coordinate enforcement efforts with the states.
9. The
CFPA should have a wide variety of tools to enable it to perform
its functions effectively.
10. The Federal Trade
Commission should also be given better tools and additional
resources to protect consumers.
B.
Reform Consumer Protection
1. Transparency. We
propose a new proactive approach to disclosure.
The CFPA will be authorized to
require that all disclosures and other communications with
consumers be reasonable: balanced in their presentation of
benefits, and clear and conspicuous in their identification of
costs, penalties, and risks.
2. Simplicity. We propose that
the regulator be authorized to define standards for “plain
vanilla” products that are simpler and have straightforward
pricing.
The CFPA should be authorized
to require all providers and intermediaries to offer these
products prominently, alongside whatever other lawful products
they choose to offer.
3. Fairness. Where efforts
to improve transparency and simplicity prove inadequate to
prevent unfair treatment and abuse, we propose that the CFPA be
authorized to place tailored restrictions on product terms and
provider
practices, if the benefits outweigh the costs.
Moreover, we propose to
authorize the Agency to impose appropriate duties of care on
financial intermediaries.
4. Access. The Agency
should enforce fair lending laws and the Community Reinvestment
Act and otherwise seek to ensure that underserved consumers and
communities have access to prudent financial services, lending,
and
investment.
C.
Strengthen Investor Protection
1. The SEC should be given
expanded authority to promote transparency in investor
disclosures.
2. The SEC should be given
new tools to increase fairness for investors by establishing a
fiduciary duty for broker-dealers offering investment advice and
harmonizing the regulation of investment advisers and
broker-dealers.
3. Financial firms and
public companies should be accountable to their clients and
investors by expanding protections for whistleblowers, expanding
sanctions available for enforcement, and requiring non-binding
shareholder votes on executive pay plans.
4. Under the leadership of
the Financial Services Oversight Council, we propose the
establishment of a Financial Consumer Coordinating Council with
a broad membership of federal and state consumer protection
agencies, and a
permanent role for the SEC’s Investor
Advisory Committee.
5. Promote retirement
security for all Americans by strengthening employment based and
private retirement plans and encouraging adequate savings.
IV.
PROVIDE THE GOVERNMENT WITH THE TOOLS IT NEEDS TO MANAGE
FINANCIAL CRISES
A.
Create a Resolution Regime for Failing BHCs, Including Tier 1
FHCs
We recommend the creation
of a resolution regime to avoid the disorderly resolution of
failing BHCs, including Tier 1 FHCs, if a disorderly resolution
would have serious adverse effects on the financial system or
the economy.
The regime would supplement
(rather than replace) and be modeled on to the existing
resolution regime for insured depository institutions under the
Federal Deposit Insurance Act.
B.
Amend the Federal Reserve’s Emergency Lending Authority
We will propose legislation to
amend Section 13(3) of the Federal Reserve Act to require the
prior written approval of the Secretary of the Treasury for any
extensions of credit by the Federal Reserve to individuals,
partnerships, or
corporations in “unusual and exigent
circumstances.”
V.
RAISE INTERNATIONAL REGULATORY STANDARDS AND IMPROVE
INTERNATIONAL COOPERATION
A. Strengthen the
International Capital Framework
We recommend that the
Basel Committee on Banking Supervision (BCBS) continue to modify
and improve Basel II by refining the risk weights applicable to
the trading book and securitized products, introducing a
supplemental leverage
ratio, and improving the definition of
capital by the end of 2009.
We also urge the BCBS to
complete an in-depth review of the Basel II framework to
mitigate its procyclical effects.
B.
Improve the Oversight of Global Financial Markets
We urge national authorities
to promote the standardization and improved oversight of credit
derivative and other OTC derivative markets, in particular
through the use of central counterparties, along the lines of
the G-20 commitment,
and to advance these goals through
international coordination and cooperation.
C.
Enhance Supervision of Internationally Active Financial Firms
We recommend that the
Financial Stability Board (FSB) and national authorities
implement G-20 commitments to strengthen arrangements for
international cooperation on supervision of global financial
firms through establishment and
continued operational
development of supervisory colleges.
D.
Reform Crisis Prevention and Management Authorities and
Procedures
We recommend that the BCBS
expedite its work to improve cross-border resolution of global
financial firms and develop recommendations by the end of 2009.
We further urge national authorities to improve
information-sharing arrangements and implement the FSB
principles for cross-border crisis management.
E.
Strengthen the Financial Stability Board
We recommend that the FSB
complete its restructuring and institutionalize its new mandate
to promote global financial stability by September 2009.
F.
Strengthen Prudential Regulations
We recommend that the BCBS
take steps to improve liquidity risk management standards for
financial firms and that the FSB work with the Bank for
International Settlements (BIS) and standard setters to develop
macroprudential tools.
G.
Expand the Scope of Regulation
1. Determine the
appropriate Tier 1 FHC definition and application of
requirements for foreign financial firms.
2.
We urge national authorities to implement by the end of 2009 the
G-20 commitment to require hedge funds or their managers to
register and disclose appropriate information necessary to
assess the systemic risk they pose individually or collectively
H.
Introduce Better Compensation Practices
In line with G-20
commitments, we urge each national authority to put guidelines
in place to align compensation with long-term shareholder value
and to promote compensation structures do not provide incentives
for excessive risk taking.
We recommend that the BCBS
expediently integrate the FSB principles on compensation into
its risk management guidance by the end of 2009.
I. Promote Stronger
Standards in the Prudential Regulation, Money
Laundering/Terrorist Financing, and Tax Information Exchange
Areas
1. We urge the FSB to
expeditiously establish and coordinate peer reviews to assess
compliance and implementation of international regulatory
standards, with priority attention on the international
cooperation elements of prudential
regulatory standards.
2. The United States will
work to implement the updated International Cooperation Review
Group (ICRG) peer review process and work with partners in the
Financial Action Task Force (FATF) to address jurisdictions not
complying with international anti-money laundering/terrorist
financing (AML/CFT) standards.
J.
Improve Accounting Standards
1. We recommend that the
accounting standard setters clarify and make consistent the
application of fair value accounting standards, including the
impairment of financial instruments, by the end of 2009.
2. We recommend that the
accounting standard setters improve accounting standards for
loan loss provisioning by the end of 2009 that would make it
more forward looking, as long as the transparency of financial
statements is
not compromised.
3. We recommend that the
accounting standard setters make substantial progress by the end
of 2009 toward development of a single set of high quality
global accounting standards.
K.
Tighten Oversight of Credit Rating Agencies
We urge national
authorities to enhance their regulatory regimes to effectively
oversee credit rating agencies (CRAs), consistent with
international standards and the G-20 Leaders’ recommendations.
The five key objectives of the US
Financial Regulatory Reform
From the paper "Financial Regulatory Reform: A New
Foundation" by the US Department of the Treasury, we read:
(1) Promote robust supervision and
regulation of financial firms.
Financial institutions that are
critical to market functioning should be subject to strong
oversight.
No financial firm that poses a
significant risk to the financial system should be unregulated
or weakly regulated.
We need clear accountability in
financial oversight and supervision.
We propose:
• A new
Financial Services Oversight Council of financial regulators to identify emerging systemic
risks and improve interagency cooperation.
•
New authority for the Federal Reserve to supervise all
firms that could pose a threat to financial stability, even
those that do not own banks.
• Stronger capital and other
prudential standards for all financial firms, and even higher
standards for large, interconnected firms.
• A new
National Bank Supervisor
to supervise all federally chartered banks.
• Elimination of the federal
thrift charter and other loopholes that allowed some depository
institutions to avoid bank holding company regulation by the
Federal Reserve.
• The registration of advisers of hedge funds and other
private pools of capital with the SEC.
(2) Establish comprehensive supervision of
financial markets.
Our major financial markets must
be strong enough to withstand both system-wide stress and the
failure of
one or more large institutions.
We propose:
•
Enhanced regulation of securitization markets, including new requirements for market transparency,
stronger regulation of credit rating agencies, and a requirement
that issuers and originators retain a financial interest in
securitized loans.
• Comprehensive regulation of all
over-the-counter derivatives.
• New authority for the Federal Reserve
to oversee payment, clearing, and settlement systems.
(3) Protect consumers and investors from
financial abuse.
To rebuild trust in our markets,
we need strong and consistent regulation and supervision of
consumer financial
services and investment markets.
We should base this oversight not
on speculation or abstract models, but on actual data about how
people make financial decisions.
We must promote transparency,
simplicity, fairness, accountability, and access.
We propose:
• A new Consumer Financial Protection Agency to protect consumers across the financial sector from
unfair, deceptive, and abusive practices.
• Stronger regulations to improve the
transparency, fairness, and appropriateness of consumer and
investor products and services.
• A level playing field and higher standards for
providers of consumer financial products and services, whether
or not they are part of a bank.
(4)
Provide the government with the tools it needs to manage
financial crises.
We need to be sure that the
government has the tools it needs to manage crises, if and when
they arise, so that we are not left with untenable choices
between bailouts and financial collapse.
We propose:
• A new regime to resolve
nonbank financial institutions whose failure could have serious systemic effects.
• Revisions to the
Federal Reserve’s emergency lending authority to improve accountability.
(5) Raise international regulatory standards
and improve international cooperation.
The challenges we face are
not just American challenges, they are global
challenges.
So, as we work to set high
regulatory standards here in the United States, we must ask the
world to do the same.
We propose:
• International reforms to support our efforts at home, including
strengthening the capital framework; improving oversight of
global financial markets; coordinating supervision of
internationally active firms; and enhancing crisis management
tools.
In addition to substantive reforms of the
authorities and practices of regulation and supervision, the
proposals contained in this report entail a significant
restructuring of our regulatory system.
We propose the creation of a
Financial Services Oversight Council,
chaired by Treasury and including the heads of the
principal federal financial regulators as members.
We also propose the creation of
two new agencies.
We propose the creation of the
Consumer Financial Protection Agency, which will be an independent entity dedicated to
consumer protection in credit, savings, and payments markets.
We also propose the creation of the
National Bank Supervisor,
which will be a single agency with separate status in
Treasury with responsibility for federally chartered depository
institutions.
To promote national coordination in the insurance
sector, we propose the creation of an
Office of National Insurance within Treasury.
Under our proposal,
the Federal Reserve and the Federal Deposit Insurance
Corporation (FDIC) would maintain their respective roles
in the supervision and regulation of statechartered
banks, and the National Credit Union Administration (NCUA) would
maintain its authorities with regard to credit unions.
The Securities and Exchange Commission (SEC) and Commodity
Futures Trading Commission (CFTC) would maintain their current
responsibilities and authorities as market regulators, though we propose to harmonize the statutory and
regulatory frameworks for futures and securities
The new acronyms: "Tier 1 FHC" (Tier
1 Financial Holding Company) and "nonbank" banks
From the paper "Financial Regulatory Reform: A New
Foundation" by the US Department of the Treasury, we read:
Tier 1 FHCs =
firms whose failure could pose a threat to financial
stability due to their combination of size, leverage, and
interconnectedness.
"We propose the creation of a Financial
Services Oversight Council to facilitate information sharing and
coordination, identify emerging risks, advise the Federal
Reserve on the identification of firms whose failure could pose a
threat to financial stability
due to their combination of size, leverage, and
interconnectedness (hereafter referred to as a
Tier 1 FHC), and provide a forum for resolving jurisdictional
disputes between regulators."
Nonbank
Banks = When Congress amended the definition of “bank” in the
BHC Act in 1987, it grandfathered a number of companies that
controlled depository institutions that became a “bank” solely
as a result of the 1987 amendments.
As a
result, the holding companies of
these so-called “nonbank banks” are not treated as BHCs for
purposes of the BHC Act.
Although few of these companies remain today, there is no
economic justification for allowing these companies to continue
to escape the activity restrictions and consolidated supervision
and regulation requirements of the BHC Act.
Under
our plan, holding companies of “nonbank banks” would become
BHCs.
Over the
past two years, the financial
system has been threatened by the failure or near failure of
some of the largest and most interconnected financial firms.
Our
current system already has strong procedures and expertise for
handling the failure of banks, but
when a bank holding
company or other nonbank financial firm is in severe distress,
there are currently only two options: obtain outside capital or
file for bankruptcy.
During most economic climates,
these are suitable options that will not impact greater
financial stability.
However, in stressed conditions it may prove difficult for
distressed institutions to raise sufficient private capital.
Thus, if
a large, interconnected bank holding company or other nonbank
financial firm nears failure during a financial crisis, there
are only two untenable options: obtain emergency funding from
the US government as in the case of AIG, or file for bankruptcy
as in the case of Lehman Brothers.
Neither
of these options is acceptable for managing the resolution of
the firm efficiently and effectively in a manner that limits the
systemic risk with the least cost to the taxpayer.
We
propose a new authority, modeled on
the existing authority of the FDIC, that should allow the
government to address the potential failure of a bank holding
company or other nonbank financial firm when the stability of
the financial system is at risk.
In
order to improve accountability in the use of other crisis
tools, we also propose that the Federal Reserve Board receive
prior written approval from the Secretary of the Treasury for
emergency lending under its “unusual and exigent circumstances”
authority.
A new regime to resolve nonbank financial
institutions whose failure could have serious systemic effects.
Dear
Potential, New or Sitting Member of the Board,
You
have the duty to prudently represent the interests of the
shareholders.
You have to understand the needs and desires
of employees, customers and regulators.
You have to do your
best to understand the risks in your organization, and to exercise
oversight.
Year after year, you have to do more, and you
have more responsibilities.
Our Mission: To help you make
informed business decisions in good faith.
Our International
Association provides networking, training, certification, alerts and
updates you can use.
Best Regards,
George
Lekatis
President of the International Association of Potential,
New and Sitting Members of the Board of Directors (IAMBD)
General
Manager, Compliance LLC
1200 G Street NW Suite 800, Washington DC
20005, USA
Tel: (202) 449-9750
Email: lekatis@members-of-the-board-association.com
Web:
www.members-of-the-board-association.com
HQ: 1220 N. Market Street
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Tel: (302) 342-8828
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