The debate over exempting small companies from the most onerous provisions of the Sarbanes-Oxley Act will reach new heights this week, as the Securities and Exchange Commission’s special committee considering the idea reviews Corporate America’s comments and finishes up its recommendations.
Wrapping up a 13-month effort, the SEC’s Advisory Committee on Smaller Public Company will hold a conference call tomorrow to discuss the more than 170 public comments submitted on the draft and decide if any changes will be made before the report is sent to the SEC on April 23.
Thyen
“We are very pleased with the interest shown and the thoughtful comments received,” James Thyen, co-chair of the committee and president and chief executive of Kimball International, told Compliance Week in an interview last week. “We heard from a variety of constituents. From the beginning of our work, the interest and engagement has been high.”
This week’s conference call will be available via dial-in or Webcast (see box at right for details). The committee then plans to meet once more on April 20 to finalize its report.
“We are very proud of the work accomplished by this committee in this brief period time,” Thyen said. “The SEC was correct to be concerned about the proportionality of cost and benefit for public companies based upon size,” which was a primary reason why it established the committee, he added. “Consumers are not interested in paying disproportionate costs for their products and services. The process needs to change to recognize that reality.”
One of the group’s numerous recommendations—to exempt the smallest companies from the requirements pertaining to management’s report on, and auditors’ attestations relating to, internal control over financial reporting, and to exempt some others from the auditor attestation requirement—ignited controversy, both among the committee’s own members and among the business community as a whole.
Three of the committee’s 21 members have expressed opposition to the proposed exemption, as have a number of high-profile public figures, including former Federal Reserve Chairman Paul Volcker, sitting SEC commissioners Roel Campos and Cynthia Glassman, and former SEC Chairman Arthur Levitt, among others.
Nearly four years after its passage, Corporate America is still grappling with the impact of the landmark law. Last September, acknowledging that difficulty, the SEC postponed for the third time the date by which non-accelerated filers must comply with Section 404, giving those companies until their first fiscal year ending on or after July 15, 2007 to comply.
The work of the committee, which was created by the SEC to examine the affect of federal securities laws on smaller public companies, has been closely watched, since the SEC has said it would give the panel’s advice significant weight. The SEC already acted on two previous recommendations made by the group last year. However, reports surfaced last week that SEC Chairman Christopher Cox told reporters at a conference in Washington that small companies won’t get an exemption from Section 404.
Glimpses Of Public Opinion
The contents of the flood of comment letters show tensions running high on the issue. Some opponents of the proposed exemption argue that easing the rules for smaller companies would harm investors and would create confusion, since different companies would be subject to different rules. Meanwhile, supporters of the exemption, including dozens of smaller public companies, say it will provide greatly needed relief from requirements that can overwhelm small businesses and can’t be successfully scaled for smaller firms.
SAMPLE COMMENTS
Below are excerpts of comments submitted to the Advisory Committee on Smaller Public Companies:
InterVideo Chief Compliance Officer, Director of Internal Audit, Romeo Dizon
...I am a strong proponent for laws related to requiring effective internal controls over financial reporting for all public companies; however, I believe that such laws or requirements should only be made at costs that will not significantly drain a company’s resources, financial and or human.
The cost of complying with SOX 404 on small companies is overwhelming. I currently hold the position of Chief Compliance Officer/Director of Internal Audit for a small publicly-traded software company. My company has incurred approximately 5% and 3% of total revenue and 40% and 84% of net income, in 2004 and 2005, respectively, on SOX 404-related consulting, accounting and audit fees in 2004 and 2005, respectively. These amounts are definitely not a chunk of change for a company our size.
In addition to the “hard” costs mentioned above, we have also incurred “soft” costs of approximately 8% and 13% of net income in 2004 and 2005, respectively. These “soft” costs represent the approximate total salaries and related costs of the applicable employees who spent time working on our company’s SOX 404 project for the two years mentioned above...
Ampco-Pittsburgh Vice President
Controller And Treasurer Dee Ann Johnson
...Under proposed guidance, “small-cap” companies would be exempt from the external audit requirements of Section 404 compliance under certain conditions, including annual revenues of less than $250 million. The magnitude of revenues, however, does not necessarily correlate with risk; accordingly, the revenue threshold should be excluded when determining a company’s §404 compliance requirements. It would also be difficult to find many companies that would benefit from the proposed guidance, as written, since the majority of companies with market caps between $128 million to $787 million would likely have revenues in excess of $250 million.
Additionally, despite the level of revenues, many companies, including Ampco, operate in highly-competitive markets with thin profit margins. In the initial year, our corporation spent close to $1 million in complying with the requirements of Sarbanes-Oxley (SOX). Although year 2 provided some relief, external costs exceeded $700,000. One should question the benefit of these additional costs. Ampco operates in a global market and none of our competitors in our principal business are U.S. publicly-held companies. They do not have the burden of SOX, financial or otherwise, that our corporation does...
Seneca Foods CEO
And President Kraig Kayser
I am the President and CEO of a food manufacturing company with a $100MM market capitalization and $850MM in annual revenues. The proposed rules do not take into account companies that may have top line revenues, but operate in very low margin business’. The float in our stock is just two million shares, and we trade at about $20 per share. I recognize that the committee is attempting to capture large companies that have fallen on hard times by putting in a revenue component but it does capture a small number of closely held companies with few shareholders, who nonetheless are subject to the punitive costs of complying with Section 404. I would recommend that the revenue piece be eliminated and but change the language to require companies whose market capitalization has FALLEN below $787MM be required to continue to comply- but companies whose market capitalization is CURRENTLY and has NEVER BEEN $787 million should be exempt from the Section 404 compliance efforts of SARBOX.
404 cost our company over $2MM last year, up from just $150,000 pre SARBOX. We are in the canned food business and our competitors are private or foreign, and not subject to these costs. It is punitive and non-competitive to force closely held micro-cap companies whose revenues are above $250MM to be required to comply. Size is of little consequence to the idea of protecting the shareholders with 404 when vast majority of the shares in our company are owned by the top 25 shareholders. Another alternative would be to look at float as opposed to revenues.
Source
Click Here To View All The Comments Submitted To The SEC's Advisory Committee on Smaller Public Companies
Many of the letters also offer some insight into an issue that’s been at the center of the 404 debate since some larger companies had to comply with the provision in 2004: the actual cost of 404 compliance. While not the only controversy surrounding 404, much of the discussion about the provision has focused on the cost-benefit. Since the 404 requirements took effect for certain issuers two years ago, numerous studies have been done on the costs of compliance, with varying results.
In their comments, several companies that have had to comply with Section 404 provided the SEC details on those costs. For example, InterVideo Inc., a provider of digital video and audio software with 2005 net income of $3.6 million, incurred SOX 404-related consulting, accounting and audit fees in 2004 of approximately 5 percent of total revenue and 40 percent of net income, and of 3 percent of total revenue and 84 percent of net income in 2005, according to Romeo Dizon, chief compliance officer and director of internal audit. Dizon noted that the company also incurred “soft” costs of about 8 percent and 13 percent of net income in 2004 and 2005, respectively, in total salaries and related costs of the employees who worked on its 404 project.
Others supported the exemption, but urged the committee to drop its proposed revenue requirement. Under the current proposal, “microcaps”—those companies with $125 million or less in annual revenue and market capitalizations of $128 million or less—would be exempt from all requirements of Section 404; while “small companies” with market caps between $128 million and $787 million annual and revenues of less than $250 million, would be exempt only from the external audit requirement.
While she offered accolades to the committee “for moving in the right direction,” Dee Ann Johnson, vice president, controller and treasurer at Ampco-Pittsburgh Corp., was among those who urged the group to drop the proposed revenue requirement. Ampco-Pittsburgh spent nearly $1 million to comply with SOX during the first year, according to Johnson. In Year Two, its external costs exceeded $700,000.
“The magnitude of revenues … does not necessarily correlate with risk,” Johnson wrote, noting that most companies with market caps between $128 million to $787 million would likely have revenues in excess of $250 million.
Kraig Kayser, president and chief executive officer of Seneca Foods Corp., also urged the committee to eliminate the revenue filter. Section 404 cost Seneca, a food manufacturing company with a $100 million market capitalization and $850 million in annual revenues, more than $2 million last year, according to Kayser.
“Size is of little consequence to the idea of protecting the shareholders with 404 when vast majority of the shares in our company are owned by the top 25 shareholders,” he wrote, adding that an alternative would be to look at float as opposed to revenues. “I recognize that the committee is attempting to capture large companies that have fallen on hard times by putting in a revenue component but it does capture a small number of closely held companies with few shareholders,” Kayser wrote.
While both sides make their cases both for and against the exemption, others have been debating whether or not the SEC even has the regulatory authority to exempt companies if it chooses to do so. In a letter to the SEC last month, Rep. Michael Oxley (R-Ohio), one of the bill’s architects, and Rep. Richard Baker (R-La.) said they believe that the Commission has the authority to act on the recommendation under Section 36(a) of the Exchange Act of 1934 and Section 3(a) of SOX. However, a group of law professors, led by Duke University’s James Cox, in a March 21 letter to the SEC, countered that “section 36(a) of the Securities Exchange Act, or for that matter section 3(a) of Sarbanes-Oxley, does not empower the SEC to exempt issuers from Section 404 of Sarbanes-Oxley.”
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