New Jobs Act Does Not Reduce Management Liability

By | April 9, 2012

Any U.S. corporate executives who think they can use the Jobs Act’s relaxed rules for public listing to cut corners on accounting and disclosure may want to think again.

The Act, signed into law by President Barack Obama last Thursday, may allow smaller companies new to the markets to reduce their financial regulation, and it removes the requirement for an expensive internal audit. It does not protect CEOs and CFOs from being sued by regulators and investors for fraud.

So-called emerging growth companies – those with less than $1 billion in revenue – will be exempt from an outside audit of internal controls for up to five years. Yet senior management must continue to hold its accounting systems to the same standards introduced in 2002 under Sarbanes Oxley. The corporate reform law, passed after the Enron scandal, was designed to ensure that companies’ internal controls were in order.

“Management is still reviewing internal controls, testing them, and giving a report in their 10-K, even if the auditor won’t have to attest to it,” said Rick Kline, a partner at Goodwin Procter in Menlo Park, California, who specializes in capital markets transactions. “Management understands they have liability.”

Despite the loosening of some provisions, “this isn’t the Wild West,” said Brian Margolis, a corporate partner at Orrick, Herrington & Sutcliffe in New York. “Management that uses this for carte blanche to not have internal controls is really missing the boat.”

Lawyers say it is not yet clear whether risk for company executives will increase under the Jobs Act. Companies that neglect bookkeeping will face regulatory action and investor lawsuits. If management is not viewed as trustworthy, market valuations stand to be punished.

“The moment you fall from following best practices … you’ll be viewed as something less than premium, and that is going to impact your stock price,” said Payam Zamani, chief executive of online marketer The company is considering a public offering after withdrawing plans for one earlier this year.

Some investors say they will be scrutinizing companies even more closely. Without an independent audit, the risk of management’s failing to find a material weakness – a deficiency in financial reporting that may lead a company to misstate its numbers – could increase.

“If anything, I might be more demanding (now) because there is more room for companies to hide problems,” said Yoni Jacobs, chief investment strategist at New York-based investment management firm Chart Prophet Capital. “You have to be extra diligent.”

Some companies will invariably let procedures fall by the way. Even the rigorous disclosure and audit rules required by Sarbanes Oxley didn’t prevent a series of recent accounting scandals that have tainted the image of Chinese companies listed in North America. Trading halts, de-listings, lawsuits and regulatory probes in both the United States and Canada have followed.

Earlier this week Chicago-based Groupon was sued by shareholders. When the coupon website went public in November, it misled them, the suit alleges, about its financial performance and concealed weak internal controls under the current disclosure rules.

Groupon management deceived investors – so the suit says – despite backing from top tier Silicon Valley venture firms, as well as IPO underwriters Goldman Sachs, Morgan Stanley and Credit Suisse.

“You can regulate as much as you want, but if someone wants to commit fraud, they’ll do it,” said Scott Saks, a corporate partner at Paul Hastings in New York. “If companies want to get around regulations, they’ll find a way.”

(Edited by Martin Howell and Prudence Crowther)

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