Access to capital is a good thing and necessary for ventures to become businesses and to expand. Pooling capital for many startups is difficult because they have no history of financial records to demonstrate the viability of their business plans, as well as credit standings to acquire loans or assets to secure them.
The Jumpstart Our Business Startups Act, which President Barack Obama signed this past Thursday, aims to open a door to capital for startups and other growing companies. That’s a good thing, but it also creates a slippery-slope double standard.
While it allows companies to initiate public offerings and sell stock to raise capital, as long as they don’t exceed a certain market capitalization or revenue thresholds, it exempts the same companies for five years from complying with Section 404 of the Sarbanes-Oxley Act of 2002, which requires outside audits of internal controls over financial reporting.
But wait, the Sarbanes-Oxley Act of 2002 was enacted to protect investors by requiring, among other highly ethical practices, that management of public companies assess the effectives of internal controls that impact financial statements. Smaller companies argue that complying with SOX 404 is cumbersome and not cost efficient.
Remember the Enron debacle in 2001 and the subsequent fall of its accounting firm Arthur Anderson. The use of special purpose entities, accounting loopholes, and inaccurate financial reporting enabled Enron to hide billions in debt. Its collapse and bankruptcy cost investors nearly $11 billion. It also led to legislation such as Sarbanes-Oxley.
The American Institute of Certified Public Accountants in a March 19 letter to the U.S. Senate urged lawmakers not to create a double standard for publicly traded companies. Here are some excerpts:
“The purpose of public company financial reporting is to provide investors and other users of public company financial statements with clear, objective, and transparent financial information….
“If public companies were not treated uniformly, investors would have great difficulty distinguishing between the differing accounting treatments, and in many cases, may be unable to do so at all. Consequently, they would be unable to compare accurately the financial condition of different public companies.”
Marketplace confusion is not a pretty picture. For the complete letter, go to www.aicpa.org/Advocacy/Issues/DownloadableDocuments/404b/3-19-12_Senate_Letter_re_accounting_and_auditing.pdf.
In addition, the creation of the double standard may have the opposite effect on raising capital. Assurance of accurate records can have a significant effect on the cost of capital at a company. Banks, for example, can offer better rates on loans if a company’s financial statements are audited because they know their risks are lowered.
Capital is good, but double standards in financial reporting control are a detriment. Something needs to be fixed to protect shareholders and stakeholders. For more on the Jumpstart Act and its impact on audit standards, go to www.aicpa.org/Advocacy/Issues/Pages/Section404bofSOX.aspx.