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SEC eases listing requirements

At the end of 2006, the
SEC published two
draft proposals. The first is designed to make it easier for US-listed companies
to comply with the financial reporting requirements of Sarbanes-Oxley’s
notorious section 404. The second makes it simpler for those firms already
listed on a US stock exchange to deregister if they find that access to North
American capital markets no longer meets their needs.

On the face of it, the moves could pose a challenge to the London Stock
Exchange, whose “lighter touch” regulatory regime has attracted listings from
some companies that might have been expected to choose New York. But LSE chief
executive Clara Furse probably won’t be losing too much sleep over the threat.

Michael Cole-Fontayn, London-based managing director of the Bank of New
York’s securities servicing ADR division, points out that most of those
companies that surprised markets by opting for London over New York are emerging
markets firms. “They found it more challenging to comply with the tougher US
regulations than the lighter touch approach in London,” he says. New emerging
market players may continue to choose London for a listing because many of their
specialist funds are managed here, he points out.

Focus on risk
The new Sarbox guidance means that FDs can focus efforts on those areas of
financial reporting where there may be a material risk. FDs will be able to
apply broad principles across the company rather than implement standard
controls everywhere – whether there’s much risk or not. Further, FDs don’t need
to take into consideration external audit standards when it comes to determining
how management evaluates the effectiveness of internal controls.

As Cole-Fontayn points out, the guidance broadly allows FDs to take into
account the complexity of their company when they identify those areas of the
company’s financial reporting that pose the largest risk of material
mis-statements. It also lets them obtain evidence about the operation of
controls and align its evaluation methods with its risk assessments, assess
whether any control deficiencies constitute a material weakness and, then,
decide what reasonable documentation is needed to support the methods and
procedures that management has developed to assess its internal controls.

“The proposed interpretive guidance should reduce uncertainty about what
constitutes a reasonable approach to management’s evaluation, while maintaining
a flexibility for companies that have already developed their own assessment
procedures and tools that serve the company and its investors well,” says John
White, director of the SEC’s division of corporate finance.

The CBI has
raised a qualified cheer for the changes. Director-general Richard Lambert,
says: “We welcome the fact that, in issuing the guidance, the SEC stressed that
internal controls should be led by senior management, not auditors, and sensibly
risk-based. We need to see the detail, but the language is right.”

Craig Scarr, a partner at Mazars, says: “It remains to be seen how well the
Big Four will interpret the requirements in favour of their clients. The
guidance will reduce the amount of work required, but companies that help
themselves through robust internal control testing throughout the year will
always be at an advantage.”

Bailing out
At least it is now easier for listed British (or other foreign) companies to
bail out if they don’t find the US market meets their needs. Insurance company
Royal & SunAlliance, which listed on the New York Stock Exchange in 1999,
was one of the higher profile UK firms exiting in 2006 under the old regime. It
cited the fact that it was no longer dependent on a US listing for raising
capital and the £10m annual costs of complying with SEC reporting and other
requirements, as reasons for quitting.

Under the old rules, an overseas private issuer in the US could only get out
of the Exchange Act registration and reporting regime if the class of its
securities had fewer than 300 record holders as US residents. The new rules
provide a benchmark based on trading volume – if the average daily trading
volume of the subject class of securities has been no greater than 5% of the
average daily trading volume of the same class of securities in the company’s
main trading market during a recent 12-month period.

But the 5% figure, as well as some of the technical detail involved in this
measure, could well be amended before the final version appears around the end
of March. However, with the SEC suddenly in listening (rather than
laying-down-the-law) mode, any amendments, based on comments from business,
could be even more helpful. Maybe there will be two cheers, after all.

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Philip Hammond