Auditors, Clients Square Off over 404 Exemption

Public companies, accounting firms fired their parting shots to the SEC's small-business committee; professional investors were conspicuously silent.
Marie LeoneApril 21, 2006

A widening schism between auditors and their clients was apparent on Wednesday during a public teleconference of the Securities and Exchange Commission’s Advisory Committee on Smaller Public Companies. In general, said committee co-chairman Herbert Wander, clients favor exempting smaller companies from complying with certain provisions of Sarbanes-Oxley, while auditors oppose such an exemption.

Wander, a partner at law firm Katten Muchin Zavis Rosenmann, and his 20 fellow committee members are scheduled to pass along their final report to the SEC on April 23 (on a Sunday, strangely: perhaps after brunch). The report’s key recommendation is that companies with a market capitalization less than $128 million, and with annual revenues less than $10 million should be granted an exemption from part or all of Section 404, the internal-controls provision of Sarbanes-Oxley.

During the teleconference, Wander summarized some 180 comment letters sent to the SEC regarding the committee’s exposure draft of the final report. Most were from public companies; a dozen or so came from professional groups and trade organizations. Seven came from major accounting firms — PricewaterhouseCoopers, Deloitte & Touche, Ernst & Young, KPMG, Grant Thornton, McGladrey and Pullen, and BDO Seidman — all of them submitted April 3, the last day for comments to be filed.

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Their comments, similar in theme, protested the contention of the exposure draft that “internal controls are less relevant and beneficial to small companies than to large companies,” in the words of the Deloitte letter. The accounting firms also railed against the number of companies that would be exempted. The letter from PwC noted that under the conditions of the exposure draft, 80 percent of public companies would not be required to obtain an auditor’s opinion of the effectiveness of their internal controls over financial reporting — a central provision of Section 404.

The firms supported developing one audit standard, such as the Public Company Accounting Oversight Board’s AS2, and generally maintained that “right sizing” Section 404, even if it means giving small companies a compliance deferral, is better than an outright exemption.

In their letters, executives of public companies also spoke with one voice, bemoaning compliance costs that far outweigh the benefits. Alexander Lagerborg, president and CEO of Across America Real Estate, wrote that even with the advisory committee’s recommended exemptions, Section 404 would still apply to “over 90 percent of the equity market capitalization” and therefore “the spirit of Section 404 will not be diminished as important reforms to rebuild investor confidence.”

Amid the volleys of comment letters fired off by companies and auditors, letters from institutional investors were largely missing in action. Wander called this poor turnout “disappointing” and suggested that perhaps the lack of opinion was itself a message. He also posited that the committee may want to consider a letter from the National Venture Capital Assn., which agreed with the committee’s key recommendation on exempting smaller companies, as a proxy for the opinion of all professional investors.

The committee’s final report will be discussed at the SEC’s roundtable, scheduled for May 10, on second-year experiences of implementing the reporting and auditing requirements of Section 404.