Risk & Compliance

Why Leave 404 to Your Auditors?

At an SEC committee meeting on small businesses, one member suggests companies ought to be able to put the attestation of their internal controls o...
Marie LeoneApril 12, 2006

Perhaps much of the cost and burden of the Sarbanes-Oxley Act could be eliminated if a company’s auditors weren’t the only ones who could attest to its internal controls. That controversial idea was one of three new proposals discussed at a Securities and Exchange Commission committee meeting on Wednesday.

The meeting—a public teleconference of the SEC’s Advisory Committee on Smaller Public Companies—was the last public discussion of whether the requirements of Section 404 of Sarbanes-Oxley should be scaled down, or in some cases, waived entirely for smaller companies. The group is scheduled to submit its final report to the SEC on April 23.

Committee Co-chair Herbert Wander, a partner in the law firm of Katten Muchin Zavis Rosenman, stressed that the committee was not advocating any of the new recommendations, none of which were previously open to public comment, but said he believed that they “bear mentioning” in the final report.

The most controversial of those ideas was submitted by Ted Schlein, managing partner of Kleiner Perkins Caufield & Byers, a venture capital fund, who proposed rewriting 404 to allow companies to bid out attestation services. Currently, Section 404 mandates that a company’s audit firm perform an attestation that internal controls are working properly. Bidding the job out would keep the quality of attestations high, while “right sizing” the cost, said Schlein, who cited options valuation as a similar market in which small consultancies have “taken over” to produce quality results at the right price. In addition, he argued, the change would put companies and auditors on the “same side,” relieving the antagonistic relationship that had mushroomed since passage of Sarbox.

Wander said the proposal would “bridge the gap” between complete compliance with Section 404 for smaller companies, and a full exemption from a review of internal controls. The idea generated a lively discussion, prompting Wander to remind other members of the committee that none of the new recommendations had been vetted, and were simply ideas of note that should be included in the final report.

According to Wander, Rep. Tom Feeney (R- Fla.) also showed some support for removing the auditor restrictions, describing the idea as “interesting.” Furthermore, said Wander, to ensure that attestations were being conducted properly, and that companies were vigilant about upkeep of internal controls, other proponents of the idea suggested that random audits by a third-party—perhaps the stock exchanges—could be conducted, similar to Internal Revenue Service audit. That notion, too, sparked a lively conversation, causing Wander to reiterate his reminder that that the committee was not advocating the recommendation.

Another new suggestion came from Richard Jaffee, chairman of Oil-Dri Corp., who proposed that the SEC use “indexed numbers” to determine whether a company should be classified as “small” for Sarbox compliance purposes. Currently there is a market capitalization and product revenue ceiling that is used to classify companies. Wander commented that Jaffee’s proposal would prevent those numbers from getting “stale.”

Scott Royster, CFO of Radio One Inc., asked the committee to consider a private offering exemption for small companies that would allow them to continue to raise funds while their public registration is being processed. That would alleviate the problem of company’s running out of cash during the registration period. The concept was previously discussed in a 1990 SEC no-action letter, often referred to as the “Black Box Inc.” letter.

All three suggestions will be included in the committee’s final report to the SEC.

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