Although originally conceived as
legislation to regulate the financial industry,
the Dodd-Frank Act
has already touched public companies
and has the potential to affect private companies, too.
Smart companies will keep abreast
of the law’s on-going implementation
to deal proactively with any increased scrutiny.
A while ago, I spoke at a CFO conference hosted by a Big Four firm. My topic was the implications of the Dodd-Frank legislation 18 months after passage. It’s a monumental piece of reform legislation that was originally intended to apply only to financial institutions. But, the law is proving to have long tentacles – even with much of the implementation still to be done.
My presentation focused on how specific areas in the law’s initial implementation have already affected public companies in surprising ways. Public companies, private companies and auditing firms should pay attention to the law’s on-going rollout because implementation to-date demonstrates how regulatory activities can have far-reaching and unintended consequences that sometimes only become evident farther down the road. Certainly, the law has the potential to affect the actions of investors in public companies as well as the actions of private companies that want to become public.
In this newsletter, I’ll discuss some areas in which Dodd-Frank has already affected public companies, point out where there’s the possibility to impact private companies and offer a key takeaway on each topic. The areas are:
- Permanent deferral of 404(b) for small filers
- Whistleblower incentives
- Clawback policies
- Proxy access
Permanent deferral of 404(b) for small filers: Dodd-Frank has allowed smaller companies (under $75 million market float) a permanent exemption from Sarbanes-Oxley Act (SOA) provision 404(b) which requires outside audit of companies’ internal financial reporting controls. This is an obvious cost savings for smaller companies; however, management of these smaller companies must still attest to the compliance of their internal financial reporting controls and monthly bank reconciliations do not assure the required level of stringent review. The key takeaway: It’s in smaller companies’ interests to have their outside audit firm provide insight and feedback into their internal financial reporting controls at the time of the financial statement audit. Companies considering a public offering should engage trusted financial advisors to help put best practices in place early in the IPO cycle.
Whistleblower incentives: Under Dodd-Frank, the Securities and Exchange Commission (SEC) has established a program to provide both incentive awards and protection for whistleblowers. Accordingly, the SEC has put aside half a billion dollars for whistleblowers who report cases of fraud or malfeasance exceeding $1 million. This is a controversial provision because it has the potential to drive whistleblowers immediately to the SEC without using company channels. To maintain the ability to resolve issues internally, public companies must invest in a values-based, ethical culture underpinned by strong processes. Employees must understand the urgency of reporting any wrongdoing immediately. They must be confident that action will be taken quickly and they will be shielded. The key takeaway: This ruling has the potential to weaken the ability of businesses to handle wrongdoing themselves. Companies must communicate zero-tolerance for any impropriety at any level of the business and implement best practices to ensure quick and transparent resolution. It goes without saying that beyond Dodd-Frank or any oversight agency, all companies should consider an open, transparent, ethical environment part of their DNA.
Say-on-pay: The intent here is to extend shareholder engagement to include investor views on prospective executive compensation plans. To be sure, shareholder input is advisory and not binding. Nonetheless, under Dodd-Frank, larger public companies are now required to get shareholder views on executive compensation plans at least every three years. The requirement as it applies to smaller public companies is scheduled to be finalized by January 2013. The key takeaway: To meet this expansion in investor relations, companies need to beef up shareholder communications – especially with institutional investors. Sharing planned executive compensation changes before putting them out to vote will avoid unfavorable reaction and enable companies to keep control of their narrative.
Clawback policies: Under current proxy statement rules, public companies already have voluntary clawback processes that ensure payback of excess CEO and CFO bonuses in the event of a financial misstatement. Dodd-Frank expands the scope of these policies by requiring payback by all executives regardless of whether or not they were involved in the misconduct/misstatement. The SEC has been directed to write new rules that are expected to be finalized by June 2012. Of note here is that the blanket expansion connecting all executives receiving bonuses to any restatement means that some executives might be required to return bonuses earned for incentives not attached in any way to the misconduct or the restatement. The key takeaway: It’s obvious that these expanded rules will motivate executives to ensure their financial statements are right the first time. On the other hand, tolerance for errors is becoming lower while repercussions are rising.
Proxy access: Like say-on-pay, the intent here is greater shareholder involvement – in this instance by allowing qualified individual investors or groups of investors to nominate board directors. Because the Supreme Court has already rejected the SEC’s initial rules in this area, it’s not clear what the future holds. However, the key takeaway is that companies should expect that new rules and regulations will tilt toward shareholders having a greater voice in more areas of a company’s business.
In summary, the overall takeaway from everything I’ve discussed in this newsletter ties back to my October 2011 newsletter concerning proposed (and controversial) PCAOB changes. In that newsletter, I said it’s clear that oversight is not going to lessen any time soon. Given Dodd-Frank’s broad scope and ambitious agenda, my conclusion here is the same: Companies should expect increased scrutiny into how they conduct business and report results – along with new rules and regulations that will determine the look and form of compliance. When those new rules are issued, wise companies and their audit firms will be proactive and employ best practices to make effective adjustments.
At Blythe Global Advisors, we have the experience to help navigate new rules and to fill the gap in financial and accounting expertise without conflict of interest. We’d be honored to help you.
To discuss this important topic further
or if you’re looking for general accounting advice and counsel,
- Assisting companies preparing for initial public offering transactions, including preparation of historical financial statements in accordance with SEC reporting requirements.
- Assessing accounting for complex transactions, including variable interest entities, discontinued operations, goodwill/intangible asset impairment, income tax contingencies and derivatives.
- Assisting companies contemplating a sale, including conversion of cash basis financial information into proper financial statements prepared in accordance with generally accepted accounting principles (GAAP).
- Providing interim CFO, controller and SEC reporting staff augmentation.