As If They Needed It

By Dan Edwards

On April 5, 2012, President Obama signed the JOBS Act into law with the hope of improving the economy by encouraging “emerging growth companies” to go public and list their stock on U.S. exchanges. The law, with the moniker “Jumpstart Our Business Startups,” carries far more punch than the plain vanilla wrapper it was sold in, particularly in regards to transparency and investor protection and how unintended consequences will affect management responsibility.

The package of legislation spends $447 million on tax cuts and benefits as well as public works. It also makes it easier for companies with revenues under $1 billion to receive money from individual investors, which is important to mining company start-ups because they rely so much on equity capital compared to debt in their early stages.

As Mark Lettes, Audit Committee Chairman of General Moly and former CFO of Apex Silver Mines, states, “Any regulation that makes it easier to raise capital is inherently good for business. It allows companies to minimize the cash spent on activities that do not relate to their mining operations.”

A Brief Summary

The JOBS Act is only applicable to companies that sell their common equity securities for the first time pursuant to an effective registration statement after December 8, 2012. For qualifying companies, it reduces the regulatory requirements that Congress and the President believe are keeping emerging growth companies from going public and, therefore, keeping them from accessing the capital they need to help their companies succeed. This should be good news for virtually everyone who wants access to public-market capital, as the vast majority of all companies, including those with mining operations, will receive the “emerging growth” designation.

For qualifying companies, the act will also reduce the financial burden of compliance with certain securities regulations.  Most notably are the changes in the requirements related to financial disclosures and accounting pronouncements, the reduction from three years of financial statements to two years for IPO filings, and the removal of the opinion on internal controls by independent auditors.

More Responsibility on Management, Boards

When government enacts laws that decrease investor protection measures from both governmental agencies and independent firms charged with protecting those investors, it increases the responsibility placed on management and boards of directors. For those who don’t execute their responsibilities, the JOBS Act clearly states that there are liability risks. 

Liability language exists in the act to hold virtually everyone who is involved in in the money-raising process personally responsible for ensuring investors have all the information necessary to adequately evaluate financial performance and assess the risks involved. In other words, directors, partners, principal executive officers, principal accounting officers and any other person occupying a similar status must sustain a burden of proof, allowing all investors to make an informed decision.

According to key findings in the statement of Lynn Turner before the Senate Committee on Banking, Housing, and Urban Affairs on March 6, 2012, history has taught us that since the implementation of SOX 404, restatements by companies that were under the requirements of section 404(b) decreased by 14 percent. Restatements by companies that were not rose by 40 percent.

Because responsibility for providing complete, timely, and accurate information rests so heavily on those involved in producing and disseminating that information, it is imperative that companies have a solid set of internal controls as well as systems in place to properly monitor and effectively evaluate them.

What Can You Do?

The good news is that companies will be able to focus their efforts and resources on those controls that mitigate the risks that are of greatest concern to them. Because auditors will not be required to opine on the design or operating effectiveness of the controls, companies will have greater flexibility with the types and number of controls they implement. This, however, also means that greater responsibility will be placed on managements to document and test their controls in order to prove that their companies have effective control environments.

As noted in the study that provided the key findings referred to above, one-third of larger companies and two-thirds of microcap companies that restated still claimed to have effective controls over financial reporting. Unfortunately, hiring individuals who have the requisite education and experience, who fit well into the organization’s culture, and who are “good” people does not equate to an adequate and effective system of internal controls.  Whether by accident or with fraudulent intent, inaccuracies will be recorded in accounting systems and reported in financial statements. Therefore, management and directors would serve their shareholders, creditors and themselves well to identify those areas that are most vulnerable to mistakes or fraud.

Having a robust internal controls system does not require exhaustive oversight by management or hiring an army of employees. I think many companies would be surprised at how easy and cost-effective it is to implement, maintain, and monitor a set of common sense controls that would mitigate the risks they identify.  A good set of entity-level  controls, such as background checks, whistleblower rules and budget-to-actual reviews, seeking vendor invoice approval, segregating the cash disbursement function, and limiting access to the accounting system  would go a long way towards preventing or detecting material mistakes or fraudulent activities.

Remember, at its core, the goal of internal controls is to protect those to whom management and directors have a legal and social responsibility.  But don’t forget, having a solid system of controls also protects those charged with that responsibility.

About the author

Dan Edwards, CPA, is a manager of business advisory services in the Denver office of Hein & Associates LLP, a full-service public accounting and advisory firm with additional offices in Houston, Dallas and Orange County. He specializes in technical GAAP and SEC advisory services, as well as SOX 404 implementation services, and also leads the firm’s mining practice area. Edwards can be reached at dedwards@heincpa.com or 303.298.9600.