Risk & Compliance

Small-Company Execs Sound Off on 404

Next month's SEC roundtable on Sarbox's internal control provisions could be dominated by gripes from small caps.
Marie LeoneApril 5, 2006

The participant list is still a work in progress. Judging by the comment letters on the Securities and Exchange Commission’s website, however, the SEC’s upcoming Section 404 roundtable will feature a great deal of heated talk about how hard and costly it is for small companies to comply with the internal-controls provision of the Sarbanes-Oxley Act.

Currently, 21 comment letters concerning companies’ second-year experiences in complying with the provision with are posted on the SEC site. Of those, about half specifically call for some type of small-company exemption from Section 404 as a way to ease the high costs if compliance. In one letter, Hamp Haucke, a vice president at Timco Aviation Services, complains that the company spent more on Sarbox compliance in 2005 than it earned in net income. At Timco, which has a market capitalization of under $83 million, “it appears likely that 2006 will be a repeat performance, ” he writes.

The cost crunch was also felt by MainSource Financial Group, an Indiana-based bank with 60 offices around the state and $97 million in revenues. In his comment letter, Robert Hoptry, the bank’s chairman, noted that the company spent more than $1 million on Sarbox compliance. The act has “collectively robbed investors in smaller companies of several times more profit than all of the losses incurred by so very few dishonest corporate executives,” he added.

Similar criticism can be found in comment letters submitted to the SEC’s Advisory Committee on Smaller Public Companies. Recently, the committee voted 18 to 1 in favor of an exposure draft that would exempt companies with a market capitalization below $700 million from Section 404 requirements. In addition, the proposal recommends that most companies with a market cap below $100 million be exempted from Sarbox entirely.

Because the exposure draft needs final approval from SEC commissioners, however, enacting it may be a problem. On Monday, while speaking at a Stanford Law School forum, SEC Chairman Christopher Cox said that small companies should not necessarily expect an exemption from Section 404. “Our emphasis is on making 404 work and implementing it in a cost-effective and investor-protected way, rather than simply waiving it,” Cox said, according to published reports.

On May 10, the SEC and the Public Company Accounting Oversight Board will sponsor the roundtable to discuss second-year experiences with Section 404 of the Sarbanes-Oxley Act. Section 404 covers public corporations’ internal control over financial reporting and auditor certification of those controls.

Roundtable participants will include representatives from public companies and audit firms, investors, and other interested parties likely consultants and academics, according to the SEC. The list of invited guests scheduled to give testimony is usually released no more than two weeks before the event.

The SEC’s Advisory Committee on Smaller Public Companies will hold a public conference on April 12 to discuss the committee’s proposal to exempt smaller companies from regulations. Four CFOs sit on the 21-member committee: Patrick Barry of Bluefly Inc., Richard Brounstein of Calypte Biomedical Corp., Alex Davern of National Instrument Corp., and Scott Royster of Radio One Inc.