Growth Strategies

Painful Memories: SEC Grilled on 404 Costs

Congress's new requests for "hard-dollar" figures on the costs of internal-controls compliance could scratch old scars at the commission.
David KatzJune 12, 2007

Under congressional pressure to ease the future burdens of small businesses in complying with Section 404 of the Sarbanes-Oxley Act, the Securities and Exchange Commission is being asked to return to an issue that’s likely to open old wounds: quantifying the costs to companies of complying with the Sarbox internal-controls provision.

On Monday, following up on testimony given the week before by SEC Chairman Christopher Cox, Representatives Nydia Velazquez and Steve Chabot, the chairwoman and ranking member of the House Committee on Small Businesses, respectively, wrote to Cox, asking him whether the commission has estimated the costs of implementing the SEC’s newly adopted revised rules under 404. Probing into the costs of proposed Accounting Standard No. 5, concerning controls assessment by independent auditors, the representatives asked Cox to provide answers to questions about the SEC’s methodology for estimating compliance costs by June 25.

Without supplying dollar figures, Cox said at the June 5 hearing that the SEC expects “the unduly high costs of implementing section 404 of the Act under the previous auditing standard will come down.” (Lacking specific guidance from the SEC, companies followed the stricter dictates of AS2, the current audit standard until AS5 is enacted.) The costs will decrease because companies “will be able to focus on the areas that present the greatest risk of material misstatements in the financials” and their managers will be able to exert judgment concerning which part of their compliance efforts to stress.

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But Velazquez, a New York Democrat, asked for more specifics about the expense. “The SEC stated last week that these new regulations will reduce small companies’ compliance costs,” she stated in a release issued on Tuesday. “But last week’s hearing provided no hard estimates—only promises.” In their letter, the representatives asked Cox to explain why, if the SEC hadn’t developed a cost estimate for its new, revised rules under 404, the commission hadn’t yet done so. They also asked if the SEC plans to publicly air cost estimates for AS5 implementation before the commissioners vote on final approval of the audit measure.

SEC spokesperson John Nester said that he couldn’t comment on the letter. Colleen Brennan, the PCAOB’s deputy director of public affairs, said: “We fully expect to meet the response date requested.”

In April, following testimony by Cox and PCAOB chairman Mark Olson at a hearing on Sarbox compliance of the Senate Small Business & Entrepreneurship Committee, Indiana Sen. Evan Bayh also pressed Cox for “hard data on the additional costs of compliance” generated by Sarbox 404, including cost-benefit information. Cox responded then that, “rather than trying to wing it,” he would like to ask the SEC’s office of the chief economist for such figures. As of Tuesday, however, “the chief economist’s office has not conducted its own analysis, and as yet none has been submitted to the committee,” Nester told

Congress’s new requests for “hard-dollar” figures on the costs of 404 compliance are likely to spawn painful memories for the SEC. In its 2003 statement of its final rules under 404, the SEC, using figures it developed under the Paperwork Reduction Act, estimated that the aggregate yearly costs of implementing 404 were around $1.24 billion–or $91,000 per company. Later ridiculed—one corporate executive asserted that it was too low by at least a factor of 100—the estimate became a rallying cry for small-business advocates bent on reforming the provision.

While companies with public equity of over $75 million have been complying with Sarbox 404 for three years, those with smaller public floats have yet to comply. After extending the deadlines a number of times, the SEC is now requiring that small companies adhere to the commission’s management guidance starting in 2008 and that the PCAOB’s audit standards be implemented in 2009. Cox has said that he expects that the SEC will approve AS5 in its final form this summer.

For their part, Velazquez and Senators John Kerry and Olympia Snowe, the chairman and ranking member, respectively, of the Senate small-business committee, have been pushing for even further delays on the implementation requirements of 404 for smaller companies. But more delays might open the SEC to legal liabilities for not acting on what a plaintiff might call the true intent of Congress under Sarbox: implementation of 404 for public companies small as well as large. The act itself makes no distinctions concerning company size.