Growth Strategies

A Final Cry for Relief

One CFO says section 404 of Sarbanes-Oxley put a stressed out employee in the hospital. A teleconference Wednesday marks the last chance for small ...
Helen ShawApril 10, 2006

Will small companies catch a break on Sarbanes-Oxley reporting requirements? One way or another, they’ll find out soon.

On Wednesday, April 12, the SEC Advisory Committee on Smaller Public Companies will hold its last public teleconference to discuss whether the requirements of Section 404 of Sarbanes-Oxley should be scaled down, or in some cases, waived entirely for smaller companies. During the teleconference, the committee will discuss letters it received commenting on the draft of its final report, which is scheduled to be presented to the SEC on April 23.

This is also the last public meeting on the topic scheduled before the SEC’s May 10 roundtable on Section 404, which will be co-hosted by the SEC and the Public Company Accounting Oversight Board.

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The compliance costs of Section 404 of the Sarbanes-Oxley Act — which requires management and an independent accountant to assess internal controls over financial reporting annually — have been the cause of controversy, and much of the focus in recent months has been on the burden placed on smaller companies. The Advisory Committee on Smaller Public Companies, which was formed in March 2005, has already received many comments on its proposal to tailor those regulations to fit smaller companies. In the draft of its final report, the committee proposed to exempt certain companies from Section 404, specifically, micro-cap companies with less than $125 million in annual revenue and small-cap companies with less than $10 million in annual product revenue that adhere to certain other standards and codes of ethics.

Yet SEC chairman Christopher Cox may have dashed the hopes of many small business executives recently when he noted that small companies should not expect an exemption from 404. (See CFO.com’s recent reporting on Cox’s comments.) Former SEC chairmen William Donaldson, Arthur Levitt, and Richard Breeden also have publicly criticized the idea of exempting small companies from 404.

A majority of the comment letters encourage the committee’s consideration of eliminating the one-size-fits-all approach of Section 404. Most letters detail the financial and compliance burden that the internal controls provision has imposed upon small companies with limited staff and financial resources.

CFO Joseph Sutaris of The Wilber Corporation, a $115-million market cap bank holding company of Oneonta, New York, noted in a comment letter that the compliance effort has taken a “huge toll” on the company’s employees “in the form of stress so severe that it led to the hospitalization of at least one person.”

Other finance heads complained about the compliance cost to companies and shareholders. Paula Delaney, CFO at United Financial Corp. in Great Falls, Montana, calculated that the $100,000 in additional audit fees the company budgeted to complete its Sarbanes-Oxley testing represented a $.03 per share impact on the company’s earnings per share. For The Wilber Corporation, its 404-related expenses totaled $350,000 — about 4.5 percent of the company’s 2005 net income.

There have been recent reports that larger companies — who were required to comply with 404 last year — have seen increases in audit costs slow, or in some cases reverse. But that is little consolation for many companies. Last year, Geron, a biopharmaceutical company in Menlo Park, California, experienced a 10 percent increase in the hourly rate its auditors billed the company, according to a comment letter by David Greenwood, Geron’s finance chief. That’s far less than the 228 percent increase in hourly rate Geron saw from 2003 to 2004, but hardly an improvement.

Some companies requested that the committee consider the industry of a small company when ruling on Section 404. Jon Swets, CFO of Macatawa Bank Corporation in Holland, Michigan, noted that since the bank is already regulated by its state and the Federal Deposit Insurance Corporation, it already documents its internal controls in different ways for those regulators.

Another small-company finance chief urged a return to accounting basics. In a comment letter, Bob Krist, CFO of Endologix, a medical instruments developer based in Irvine, California, recalls that when he began his career, the focus was on the consistent application of basic accounting principles. “Applying these eight principles with a healthy dose of integrity, in my judgment, produced a better result than has thousands of rules, which unsuccessfully attempt to contemplate every possible circumstance,” wrote Krist. “This is not progress.”

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