Remediation Center: 404 Exit Clause For Accelerated Filers

At the request of subscribers, Compliance Week has launched a Remediation Center, in which readers can submit questions—anonymously—to securities and accounting experts. Compliance Week's editors will review all questions and then submit them—confidentially, of course—to specialists who can address the issues. The questions and responses will then be reprinted in a future edition of Compliance Week. Below is one of the Q&As; ask your own questions by clicking here.

THE QUESTION

Anonymous —

The SEC last week adopted the rules for the exit from the accelerated filer status. First, does this exit clause apply to the SOX 404 requirements as well or is it only for the 60/75 day filing deadlines? Secondly, for which year is it applicable?

ANSWER

Karl Strait, McGuireWoods —

We will not know the answer to these questions for sure until the SEC posts the final rule release for the new accelerated filer "exit rules" announced on December 14, 2005 [see "Editor's Note, below].

However, based on the Staff's answer to Question 7 in the internal control over financial reporting FAQs (see box at right), an issuer would look to Exchange Act Rule 12b-2 to determine whether it is an "accelerated filer" for purposes of determining when it must comply with Items 308(a) and (b) of Regulations S-K and S-B. According to Question 7, if an issuer is not an "accelerated filer" as defined under Rule 12b-2, then the issuer would not be obligated to provide the disclosures required by Items 308(a) and (b) for internal control over financial reporting or the related certifications under Item 601.

Since the new definitions and reporting deadlines applicable to accelerated filers and large accelerated filers will apply to fiscal years ending on or after December 15, 2005, we would expect, for example, that a calendar-year issuer that would cease to be an accelerated filer as of December 31, 2005 because its public float fell below $50 million at the end of its most recently completed second quarter would exit accelerated filer status for its Form 10-K for the year ended December 31, 2005.

We would also expect that such an issuer would not be required to include the disclosures and certifications related to internal control over financial reporting in its 10-K (other than the disclosures required by Item 308(c) of Regulations S-K and S-B).

Non-accelerated filers (including foreign private issuers that are not accelerated filers) are not required to comply with the internal control disclosure requirements until their first fiscal year ending on or after July 15, 2007 (see Release No. 33-8618). Under the proposed "exit rules," an issuer that ceases to be an accelerated filer or a large accelerated filer would not become an accelerated filer or a large accelerated filer again unless it subsequently meets the applicable definition under Rule 12b-2.

All non-accelerated filers (and perhaps even some accelerated filers) should stay tuned for developments related to compliance with Section 404 of the Sarbanes-Oxley Act. According to a December 15, 2005 article in the The New York Times, the SEC's Advisory Committee on Smaller Public Companies has recommended that most companies with market capitalizations under $100 million be exempted totally from compliance with SOX Section 404 and that companies with market capitalizations of $100 million to $700 million not face audits of internal control. In addition, on October 26, 2005, the Committee of Sponsoring Organizations of the Treadway Commission (COSO) published for comment new guidance on the use of its framework to address the needs of smaller businesses in fulfilling the requirements of SOX Section 404.

Editor's Note: Shortly after Karl Strait answered this question, the SEC posted its final rule release for the changes to the definition of "accelerated filer" in Rule 12b-2. According to Strait, "The release does not change the substance of our response (i.e. that upon exiting accelerated filer status we believe that an issuer would no longer be required to include the disclosures and certifications related to internal control over financial reporting until the issuer's first fiscal year ending on or after July 15, 2007), but it does clarify that the rules governing exiting from accelerated and large accelerated filer status will be available beginning with fiscal years ending on or after December 15, 2005 (based on a public float calculation as of the last business day of the issuer's most recently completed second quarter)."

Compliance Week's Remediation Center is an information service only. Answers to questions should not be construed to be legal guidance. Consult with your auditors, internal counsel, and external counsel on all critical compliance and governance matters.

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