Risk & Compliance

SEC to Delay 404(b) for Small Companies

During the one-year delay, the commission will study the costs of compliance.
Stephen TaubFebruary 1, 2008

The Securities and Exchange Commission has voted unanimously to recommend a one-year delay of the date when small companies must comply with the auditor-attestation provision of the Sarbanes-Oxley Act so that it can complete a study on the costs of compliance with Section 404.

SEC chairman Christopher Cox had said in December that he planned to ask the other commissioners to back him on extending the exemption from Section 404(b) for companies with market capitalizations of less than $75 million.

For the cost study, the SEC will collect and analyze extensive “real-world” data from a broad array of companies currently complying with Section 404 under newly issued guidance for companies and auditors. That new guidance and the Public Company Accounting Oversight Board’s new auditing standard, AS5, were intended to reduce the costs of complying with Section 404.

Companies, especially small ones, have consistently complained that the costs to comply are unreasonably high. Most small companies vigorously dispute the SEC’s original assertion that compliance should cost them an average of $91,000. Consulting firm Lord & Benoit recently released a study pinpointing the average cost at $78,474, but many observers have dismissed that data as unrealistic as well, though the study did not take into account the costs of complying with Section 404(b).

Under the proposed extension, the Section 404(b) requirements would apply to smaller public companies beginning with fiscal years ending on or after December 15, 2009.

“The commission believes that strong investor protection and healthy capital formation go hand-in-hand,” said Cox. “The study will give us the opportunity to ensure that the investor protections of Section 404 are implemented in the way that Congress intended, and do not impose unnecessary or disproportionate burdens on smaller companies.”

Section 404 has two provisions: 404(a) requires company management to assess the effectiveness of the company’s internal controls over financial reporting, while 404(b) requires an auditor attestation on management’s assessment.

Larger companies, representing more than 95 percent of the market capitalization of U.S. equity securities markets, have been subject to both provisions since 2004, but with significantly higher costs than were projected when the SEC’s original rules implementing Sarbanes-Oxley were adopted, the commission noted.

All companies, including smaller ones, will file their first 404(a) reports using the commission’s guidance this year.

The SEC’s cost study will consist of two main parts: a Web-based survey of companies that are subject to Section 404, and in-depth interviews with companies, including those that are just now becoming compliant. Data will be gathered from a large cross-section of companies with an eye to analyzing what drives costs and how companies and investors derive benefits from those costs, the SEC explained. The SEC’s Office of Economic Analysis will lead the study with assistance from the Office of the Chief Accountant and Division of Corporation Finance.

The commission said it expects to complete the study by late summer or early fall, given that much of the key financial data will not be available to companies until March or April at the earliest.

There will be a 30-day comment period on the SEC’s proposal to delay compliance with 404(b) for small companies, after which it will vote again to make the delay final.

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