The final report of the closely watched Advisory Committee on Smaller Public Companies is now in the hands of the Securities and Exchange Commission, which next must determine how to act on the group’s recommendations—including the controversial proposal to exempt small companies from complying with Section 404 of the Sarbanes-Oxley Act.
After 13 months, “It’s ‘pencils down’,” Herb Wander, the Committee’s co-chairman, told the group during its final meeting last Thursday morning.
Members had a chance to make comments at the meeting, during which the Committee approved its final recommendations. Among them was a provision to exempt small public companies from part or all of Section 404. Three of the Committee’s members opposed the exemption.
Schacht
One dissenter, Kurt Schacht of the CFA Centre for Financial Market Integrity, said the Committee acted “in haste to be visionary and to be … patriotic in solving the 404 problem. I think we’re making a couple of important mistakes in that haste. We’re seeking a quick fix.”
Still, several Committee members, including one who disagreed with the exemption proposal, maintained that the two sides weren’t that far apart. “We all agree costs [of 404] are disproportionate on smaller companies and that something must be done about that,” said Mark Jensen of Deloitte & Touche, who opposed the exemption. “The disagreement is on what the fix is. If you read the dissents, we agree that the basic issue is in the application of [Audit Standard 2] for smaller companies.”
Steven Bochner, a partner at law firm Wilson Sonsini Goodrich & Rosati who represented emerging growth companies, venture capital funds and lawyers working with those types of clients on the Committee, echoed that sentiment.
Bochner
“The differences are not that great between those dissenting and those who favor the recommendations,” he said. “We all agree that 404 is well-intended. The subtle disagreement is, do we fix the airplane in the air or do we ground it? Our report says we’ve got to ground it.”
33 Recommendations
The Committee’s final plan includes 33 recommendations in all. For the smallest of public companies (those with $125 million or less in annual revenue and market capitalizations of $128 million or less), Section 404 would be repealed entirely. Larger companies (with annual revenue up to $250 million and market caps from $128 million to $787 million) would only be exempt from Section 404’s external audit requirement. That first, microcap group would also need additional corporate governance controls to be exempt.
Dolan
Janet Dolan, chair of the subcommittee that drafted the contentious “exemption provision,” admitted she regrets introducing that phrase into debate over SOX. “The word has become a lightning rod,” she said. “What we’re recommending is a staged implementation. I urge [the SEC staff] not to get wrapped in that single word.” She added, “Postponing bringing 404 to small companies is an exemption by not acting.”
“We’re saying we’re not bringing in small companies [under 404] at this time,” Dolan said. “If you don’t do anything, you are exempting. We’re saying find a better fit for small companies.”
PROPORTIONAL REGULATION
The table below, "Recommendation on Scaled or Proportional Regulation for Smaller Public Companies," is excerpted from the discussion draft of the Final Report of the Advisory Committee on Smaller Public Companies to the U.S. Securities and Exchange Commission, published April 18, 2006:
Company Size
Market Cap. Cutoff
PercentOf Total U.S. Equity Market Capit.
Percent Of AllU.S. PublicCompanies
Microcap
$128.2 million
1%
52.6%
Smallcap
$128.2-$787.1 million
5%
25.9%
Smaller Public Cos.
$787.1 million
6%
78.5%
Larger Public Cos.
> $787.1 million
94%
21.5%
Discussion Draft: Final Report Of The Advisory Committee On Smaller Public Companies (April 18, 2006)
Even if the SEC decides against any exemptions—a distinct possibility, considering comments from Chairman Christopher Cox and Commissioner Roel Campos—small companies will still not need to comply with Section 404 until July 1, 2007. Large corporations have been complying with it since the start of 2005.
Dave Coolidge, chair of the capital formation subcommittee, urged the SEC staff to “pay attention to our international competitiveness as a capital market. When this Committee started, we saw indications of companies that were reluctant to go public in the U.S. because of 404. The evidence is growing that that reluctance remains and perhaps is increasing,” he said.
Prior to their vote, John White, who took the helm of the SEC’s Division of Corporation Finance in March, thanked the group and assured its members that the Commission would consider all of its recommendations with an open mind.
Calling the panel’s report “a thoughtful and comprehensive product,” White said, “I know you’ve worked tirelessly to meet your mandate.”
“All of us at SEC sincerely look forward to reading and studying the final report and recommendations. This will all be done with an open mind,” White told the group. The commissioners have no precise timeline for when they will act.
“I can’t predict how the Commission will ultimately respond to any individual recommendations, but, each recommendation will be given serious consideration,” White continued. “No final conclusions have been reached at this point.”
White also urged “all interested parties to actively contribute to the ongoing discussion of how small public companies fit within Sarbanes-Oxley and the securities laws in general.”
The final report of the SEC's Advisory Committee on Smaller Public Companies can be found in the box above, right.
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