Insurance and Economy and Government and Small Business

Smaller banks seeking relief: Legislation takes on costly regulatory costs

May 15, 2006

German American Bancorp in Jasper has spent more than $1 million the past two years complying with the stringent accounting provisions of the Sarbanes-Oxley Act.

The cost alone is reason enough for the community bank's president and CEO, Mark Schroeder, to support a measure exempting smaller public companies such as his from Section 404 of the act. He even traveled to Washington, D.C., May 3 to testify in front of the U.S. House of Representatives Small Business Committee.

"Ultimately, this isn't a cost that can be passed on to customers; it comes straight off the bottom line," he said. "This is just another layer of regulatory burden that doesn't add value."

Section 404 requires public corporations to assess their internal accounting controls to ensure their financial reporting is accurate-and requires accounting firms to vouch for those controls.

Public companies have devoted thousands of employee hours and millions of dollars to comply with the additional safeguards passed in the wake of financial scandals at Enron Corp. and MCI WorldCom.

But a Securities and Exchange Commission advisory committee is recommending that small public companies, including banks, be relieved of Section 404's regulatory oversight.

Specifically, the proposal would exclude public companies with a market value of less than $128.2 million. Moreover, public companies with a market value of less than $787.1 million would be partially exempt, meaning expensive external audits by outside accounting firms no longer would be necessary.

SEC approval would mark a huge shift in the current rules, in which public companies with a market value of less than $75 million are the only ones free of oversight.

The Independent Community Bankers of America-a Washington, D.C., trade association with 5,000 members, 700 of which are publicly owned-is among the groups urging the SEC to adopt the committee's recommendations. A ruling could come in June.

"Section 404 is very costly and increases the overall burden on the community banks," said Chris Cole, the ICBA's regulatory counsel. "It diverts resources."

The additional oversight of Sarbanes-Oxley has led 75 community banks to shed their public-company status in favor of private ownership, which impedes their ability to raise capital and lend money, Cole said.

Supporters of reform say the regulations are unnecessary and especially arduous for smaller firms with fewer resources than large corporations.

Besides the cost, proponents argue the Federal Deposit Insurance Corp. already regulates banks. The FDIC Improvement Act of 1991, much like Section 404, requires financial institutions to undergo internal audits and have accounting firms attest to their accuracy.

Monroe Bancorp in Bloomington spent nearly $600,000 on audit and compliance costs last year, said Carol Ball, vice president and senior auditor. The requirements put more stress on smaller companies, both financially and on their personnel, she said, because Section 404 makes no distinction between large and small firms.

"While we believe that documentation and testing of internal controls over financial reporting is important," Ball said, "we don't believe smaller companies contain the complexities of large, multifaceted companies."

Proponents for change further argue that those receiving a full or partial exemption make up only 6 percent of the total U.S. equity market, but account for 78 percent of all public companies, according to the SEC's Office of Economic Analysis.

Lincoln Bancorp in Plainfield has yet to comply with Section 404, because it fell under the $75 million threshold last year. But it looks as though that won't happen again, unless the SEC grants relief to the smaller companies, said Brad Davis, the bank's vice president and chief accounting officer.

"If there were a terrible fraud at Lincoln Bank, it's not going to affect the economy the way it did with Enron," he said. "The smaller companies don't present the biggest risk."

A Government Accountability Office report released May 8 supports the advisory panel's recommendation. Its report came two days before a roundtable meeting hosted by the SEC and the Public Company Accounting Oversight Board.

Not everyone favors the proposed changes, however. The American Institute of Certified Public Accountants, whose larger members perform external-audit duties for public companies, is among the opponents.

Instead of excluding smaller public companies from oversight, it suggests the SEC develop a pilot program that would serve as a field test and lead to the development of compliance tools specifically for those types of companies.

"Most of our members who audit public companies believe that protections provided by Section 404 should be afforded to investors in all public companies regardless of size," the AICPA wrote. "Anything short of this outcome would diminish such protection."

Investor protection for smaller companies should be strengthened rather than weakened, the AICPA further argued. The association cited a study from San Francisco-based Glass Lewis & Co., an investment research and advisory firm, indicating the smallest public companies have the highest risk of restatement.

The ICBA, meanwhile, is doing its best to rally support.

"We are trying to generate as much congressional support as possible to sway their minds, if they have any doubts," Cole said. "I'm cautiously optimistic."

Federal legislation tackling the issue has been introduced as well. Known as the Communities First Act, the bill before the House Financial Services Committee would exempt banks with up to $5 billion in assets from Section 404's requirements.
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