Compliance Blog

Today we are going to give SOX 404 a break and focus on its Canadian cousin - Multilateral Instrument 52-109: Certification of Disclosure in Issuers' Annual and Interim Filings (MI 52-109).

The Canadian capital market is noteworthy for its decentralized approach to securities regulation (provincially run) and the strong market returns of the last few years.

The Canadian approach has been to take elements of SOX 302 (CEO/CFO Certifications) and SOX 404 (Internal Controls over Financial Reporting - ICFR) and combine them into MI 52-109 and then apply the rule across both TSX and TSX Venture filers.

The first phase of MI 52-109 associated with CEO/CFO certification of Disclosure Controls - Design and Evaluation has been in place for fiscal years ending on/after March 30, 2005.

The second phase of MI 52-109 associated with CEO/CFO certification of Internal Controls - Design is now kicking in for fiscal years on/after June 30, 2006. If our U.S. experience is any indication there are going to be lots of late nights in the coming months in Canada as ICFR teams rush to ensure that at least the Design portion of their ICFR projects is completed.

The third and proposed phase of MI 52-109 (click here to read - CSA Notice 52-313), commencing for fiscal years ending on/after December 31, 2007, will require all issuers to provide a Management Evaluation of Internal Controls and related CEO/CFO certification (similar to SOX 404) and detailed discussion within the MD&A with respect to ICFR evaluation process and results. However, as proposed this last phase will not require the dreaded auditor attestation from the "externals". So, on the one hand the issuer will save money with respect to external audit costs, but the issuer's board of directors takes on more responsibility and perhaps more liability with respect to errors made in the financial statements and "core" documents.

Stay tuned for upcoming Public and Industry input with respect to this third phase of MI 52-109 as it is anticipated that the various provincial securities regulators and the Canadian Securities Administrator (CSA) will be issuing an amended version of MI 52-109 after Labor Day.

It will be interesting to see if the CSA members attempt to include some form of "management guidance with respect to ICFR" as is being contemplated by the SEC to improve the clarity and efficiency of the SOX 404 process for issuers.

If you a Canadian-based issuer needing to either meet the requirements of MI 52-109 or SOX 404, please go to the website of our exclusive Canadian ICFR distributor, Thomson-Carswell, at www.compliancepartner.ca to learn more about their market leading MI 52-109/SOX 404 product - Compliance Partner(TM).

There has been much press in the U.S. as to how the Sarbanes-Oxley Act of 2002 is driving away IPOs. There has also been much glee in places like London where the AIM Exchange (Alternative Investment Market) has experienced a dramatic increase in listings as compared with U.S. markets such as NASDAQ.

Is the effort and cost associated with SOX really a detriment to the market and to investors?

A progressive Republican senator from California (imagine!), Senator Hiram Johnson, is reported to have said in 1917 around the time the US joined WWI was that " When war is declared, truth is the first casualty."

Methinks "truth" is lacking in the debate as to the perceived weakness in U.S. capital markets.

Some facts of interest to help move the debate forward are as follows:

1. Listings on AIM are indeed far higher than NASDAQ.
2. Legal costs and accounting costs are higher to list on U.S. markets than international markets.
3. IPO discounts (money left on the table) are generally higher on U.S. markets.
4. U.S. markets provide higher overall investor returns and greater share multiples than foreign markets.
5. Indeed the compliance requirements are stricter on U.S. exchanges than all other exchanges. Only the Canadian markets (TSX and TSX Venture) have compliance standards of comparable quality to the U.S. markets.

A very interesting study by an M&A boutique, Innovation Advisors, can be found here under the title- "Research Shows AIM Misses the Mark".

It appears to me that the following can be said on this debate as to U.S. market competitiveness:

1. The U.S. was an expensive market (fees, discounts) prior to SOX - not because of SOX. If you want to be the "Wal-Mart of IPOs" then lawyers, accountants and brokerage firms are going to have to reduce their fees.
2. Smaller and in many cases marginal firms are listing on AIM. It smells lots like a "pink sheet" market that is more geared to initial investors getting some money out than a long-term trading alternative.
3. Investors will make more money and companies will achieve greater market valuations on U.S. exchanges.
4. Some of the large foreign IPOs, particularly from China, never had any intention of listing on U.S. exchanges for both political and transparency (lack thereof) reasons.

You could actually argue that SOX is improving the quality of firms on U.S. markets and forcing marginal businesses to capital pools with lower standards.

There is no doubt that investors in the U.S. appear to be enjoying the benefits!

If your company must comply with SOX, then we can help you reduce the cost of compliance. Please visit www.issuescentral.com to learn more about the Compliance Playbook(TM). If you are a Canadian-based filer needing to comply with either SOX or MI 52-109 please visit the website of our exclusive Canadian distributor, Thomson-Carswell, at www.compliancepartner.ca to learn about Compliance Partner(TM).

Rumor has it that the SEC may wish to delay the required first year filing of SOX 404 (Management's Report and Assessment on Internal Control over Financial Reporting) reports for non-U.S. based SEC filers. Click here to read more.

It appears that Chairman COX and the SEC may be willing to consider some additional deadline extensions for smaller (non-accelerated) U.S. filers, as well as foreign filers, with respect to SOX 404 activity. Foreign filers were set to file their reports for all fiscal year-ends on/after July 31, 2006, whereas U.S. based non-accelerated filers were looking at revised filing deadlines for fiscal years beginning on/after December 15, 2006 (i.e. effectively Dec 31, 2007 years ends as for most filers).

So what is happening?

The SEC and PCAOB are looking at a number of initiatives at present including the PCAOB's revision of Audit Standard 2 (External Auditor's Standard with respect to Internal Control audit), as well as the SEC's recent initiative to solicit feedback on providing a "management version" of AS2.

Oh brother, how much more time do foreign filers and smaller filers need to get on with this! Haven't they had the benefit of watching the activities of the last 3 years with respect to larger filers? I guess that if a smaller filer and a foreign filer has already been providing certifications for SOX 302 (CEO/CFO Certifications) that cover elements of internal controls, then what is the real problem? Think about it. If you have signed a 302 certificate you would have done most of the work already, right? How could a CEO/CFO sign 302 without having done their own assessment over internal controls over financial reporting? I guess I don't get it.

If your company is a non-accelerated filer or a foreign filer needing to comply with SOX 404, you can learn more about a cost-effective and streamlined approach to achieving SOX 404 compliance, then go to www.issuescentral.com to learn about the Compliance Playbook(TM).

If you a Canadian-based filer needing to comply with SOX 404 or MI 52-109, please visit the website of our exclusive Canadian distributor, Thomson-Carswell, at www.compliancepartner.ca and learn more about Compliance Partner(TM).

Our organization's fearless (and opinionated) President gave the following interview back in March 2006 during a seminar entitled "The Impact of the Sarbanes-Oxley Act on the Canadian Insurance Industry".

Click here to read the interview published in the June 2006 issue of Canadian Underwriter. There is nothing to fear.

Time flies when you are head of the Securities & Exchange Commission (SEC). Christopher Cox, as the first Congressman ever appointed to head the SEC, has had an extremely busy year with a variety of initiatives including:

• Interactive data and XBRL initiatives
• Further review of the implementation of Internal Control Reporting provisions (SOX 404) and action to ensure that the PCAOB improves external auditor work with respect to internal control audits
• Protection of seniors from investment fraud
• Hedge fund regulation (oops!)
• Regulations NMS (National Market System) initiatives to provide a more level quotation and pricing "playing field"
• International initiatives to begin the march towards more global market rule harmonization (IFRS and U.S. GAAP)
• and lots more

We knew that William Donaldson, the previous head of the SEC, was going to be a hard act to follow. Cox has done a strong job in year one. The future is going to be very interesting for Mr. Cox. I wouldn't be surprised to hear his name being mentioned in 2007 as a potential Republican presidential candidate.

So, how would you grade the results associated with the Sarbanes-Oxley Act passed by President Bush on July 30, 2002?

It all depends on your perspective.

Here is how the grades might pan out depending on what type of stakeholder you are:

1. Investors - "B+" - SOX was created to help rebuild confidence in financial reporting and transparency. SOX has succeeded in this regard. Large investors such as Calpers are strong proponents of improved reporting and transparency. Investors in smaller companies don't like the costs of SOX 404 (Management's Report on Internal Controls) on smaller companies. Overall the stock markets are up significantly from July 2002. SOX is a contributing factor to the markets success as without SOX larger investors might have balked at financial information and assumed a larger risk premium and therefore greater cost of capital for all market participants. Investors like CEOs and CFOs to certify their companies' financial results and provide solid controls. It is all part of earning that big executive pay check.
2. Management teams of Publicly Traded Firms - "C-" - Management teams have long complained that they are spending too much time on compliance initiatives, and not enough on strategic management. While the furor has died down with larger filers, smaller filers continue to complain. Some management teams admit that financial reporting has improved, but don't feel that the cost justifies the benefits.
3. Public Accounting/Consulting Firms with SOX Consulting Practices - "A" - SOX has provided a service and revenue bonanza for firms providing SOX services, particularly those services associated with SOX 404. The demise of Enron and Arthur Andersen has created unprecedented wealth creation for public accounting firms and accounting grads.
4. U.S. Exchanges and U.S. Competitiveness Proponents - "C" - While it is acknowledged that investor confidence has been restored since its nadir in 2001/2002, it is widely felt that the U.S. markets are setting the compliance high bar too high and are thus losing new listings to exchanges such as LSE-AIM, Hong Kong, etc. Time will tell whether the "flexible compliance regimes" of these offshore markets will protect investor interest and market capitalization.
5. Foreign Markets - "A+" - Markets such as the LSE-AIM and others love SOX because they feel that is it driving many listings their way that otherwise might look at listing in the U.S.. Fewer rules and lower market access costs are attractive to many firms, but they tend to achieve lower market valuations in comparison to similar firms listed in the U.S.. Are shareholders okay with this? Perhaps theses listings will ultimately move on to U.S. exchanges to achieve higher market caps.

So, everyone has their perspective. In implementing SOX, the U.S. took a leadership position to ensure improved investor confidence. This mission is ongoing but stands in very good shape. The larger concern is now how to achieve cost-effective compliance and enhance competitiveness. No doubt this challenge can be met now that the market is resting on a strong controls and transparency foundation.

To help your firm achieve cost-effective SOX 404 compliance please go to www.issuescentral.com to learn more about the Compliance Playbook(TM).

If you are a Canadian-based filer, please go to our exclusive Canadian distributor's (Thomson-Carswell) website www.compliancepartner.ca to learn more about achieving SOX 404 or MI 52-109 compliance with Compliance Partner(TM).