The Securities and Exchange Commission announced Dec. 16 the creation of an advisory panel to examine the impact of The Sarbanes-Oxley Act and other securities laws on smaller public companies.
The move is part of an initiative to alleviate the regulatory burden on small issuers—one that has been gaining momentum in recent months at the Commission and industry standard setters. In September, for example, SEC Division of Corporation Finance Director Alan Beller stated that the Commission may be considering ways to ease the accounting and disclosure burdens of small public companies (see related coverage at right). One month later, the Commission issued an order that would grant certain small accelerated filers up to an additional 45 days to include in 10-Ks the required internal control reports as mandated by SOX Section 404. And last week, the Financial Accounting Standards Board finalized its stock option expensing rule, delaying the effective date for small-businesses to Dec. 15, 2005.
In addition, the SEC held a forum on small business capital formation in late September, and the new Public Company Accounting Oversight Board has begun a national series of roundtables aimed at small businesses and accounting firms with fewer than 20 issuer clients (details at right) .
Donaldson
In making the announcement, SEC Chairman William Donaldson said that Sarbanes-Oxley has been “an enormous benefit to America’s investors and markets,” but acknowledged that the time had come to review how the law has impacted smaller issuers. “Clearly there are costs associated with Sarbanes-Oxley,” he said in announcing the creation of the committee, acknowledging that the regulations don’t create exemptions for smaller entities. “The law makes no differentiation between large companies and smaller companies,” he said. “It’s sort of a one-suit-fits-all. That’s what we’re addressing.”
Tolbert
William Tolbert Jr., a former associate director of the SEC’s Division of Corporation Finance, told Compliance Week that the issue of small business compliance with Sarbanes-Oxley was a concern “at the outset,” but it was difficult—given the tremendous congressional support for the statute—for the SEC to justify treating smaller companies differently, at least initially.
“Now that things have calmed down a little bit I don’t think there’s a member of Congress who doesn’t think it’s a great idea,” said Tolbert, who is a partner in the Washington office of the law firm Jenner & Block.
The new advisory panel, which will be officially known as the SEC Committee on Smaller Public Companies, will look into four main areas:
404 Frameworks—The committee will review frameworks for internal control over financial reporting that are appropriate to smaller public companies. This marks a more active role for the Commission on the arena of frameworks; in recent months, the SEC had been urging third parties like COSO to spend the time to introduce unique frameworks for smaller issues. “I have encouraged the private sector to develop internal control guidance designed specifically to address their needs,” said Nicolaisen in a speech at an AICPA conference last week.
Governance Requirements—The committee would review corporate disclosure and reporting requirements for smaller public companies, as well as federally-imposed corporate governance requirements. This might include “differing regulatory requirements based on market capitalization, other measurements of size or market characteristics.”
Financial Reporting—The committee would review accounting standards and financial reporting requirements applicable to smaller public companies.
IPOs—The committee would also review the process, requirements and exemptions relating to offerings of securities by smaller companies, particularly public offerings.
The committee will be co-chaired by Katten Muchin Zavis Rosenman partner Herbert Wander, and Kimball International president and CEO James Thyen.
Impact Of SOX 404 Unknown
Thyen
According to Thyen, consumer products manufacturer Kimball International has found the benefits of Sarbanes-Oxley “to be substantial, and we have embraced it.” However, the new regulation has also “caused us to look at our cost choices differently. And it does have an impact on our global competitiveness,” Thyen said.
One of the hidden costs of Sarbanes-Oxley is what Thyen calls the “share of mind,” referring to the amount of time that executives in small companies spend on compliance with the law.
Donaldson echoed that concern. “The unestimable cost [of Sarbanes-Oxley] is the share of mind of the CEO that has to be diverted to not only resourcing compliance but also making the judgments that are so necessary,” said Donaldson. “That’s the kind of thing we want to try to get at.”
Donaldson and the two co-chairs of the new committee noted that, to date, there have been no reliable surveys about the benefits or costs of Sarbanes-Oxley; a claim that is not entirely accurate. In August, for example, Financial Executives International released its second survey on Sarbanes-Oxley, which surveyed 224 public companies with average revenues of $2.5 billion. The study pegged the total cost of "year one" compliance at $3.14 million, which was a 62 percent increase over its first study a similar survey FEI conducted in January, when the number was estimated to be $1.93 million. [Related studies are available from the box at right.]
Wander
Nevertheless, it’s clear that the impact of the internal control provisions of Sarbanes-Oxley will not be fully understood until companies’ annual reports are analyzed in early 2005. Fiscal year-end accelerated filers will be among the first to provide managements' assessment of internal control over financial reporting as required by Section 404 of Sarbanes-Oxley. Annual reports filed for fiscal years ending on or after Dec. 15, 2004 are due within 75 days; the SEC recently postponed an accelerated filing schedule that would have had those reports due within 60 days.
According to committee co-chair Wander, those first reports will provide the committee with critical data as to whether the new requirements need to be modified for smaller companies. “We know there [are] added cost burdens,” says Wander. “The real question is, ‘Are they disproportionate? Is it measurable?’”
Tolbert agrees that it will be interesting to see how the markets respond to information contained in the initial internal control filings—particularly for companies that don’t get a clean bill of health. “What’s everyone going to say?” he asks. "It's the ultimate reflection on how the operations are overseen by management."
Though a thorough SOX 404 impact study has not been performed, CFO Magazine—using data provided by Compliance Week—reported in September that the market reaction to internal control weakness and deficiency disclosures was highly irregular. Disclosures that accompanied other bad news—like earnings restatements—did negatively impact stock price; however, other companies actually witnessed stock increases after disclosing internal control problems. "The market does seem to have some sympathy for what companies are enduring," said the article. [The most recent Compliance Week analysis of internal control weakness and deficiency disclosures from November is at right.]
Define ‘Small,’ Please
Interestingly, the SEC chairman noted that one of the biggest challenges for the committee will be to examine the definition of a small company. That would be the third time in recent months that a size-related definition would be introduced to the market. In late October, the SEC created a definition of "Well Known Seasoned Issuers" as part of its securities offering reform. And in the recent delay of SOX 404 for some accelerated filers, affected small issuers were defined as those with less than a $700 million market cap.
“We have definitions here [at the SEC] that have to do with market capitalization," said Donaldson. “On the other hand, there are other measures having to do with sales, numbers of employees … and we’re looking to the committee to frame what is a small company.”
Wander agreed that the definition of size would be an important component of the committee’s work, noting that indicators like market cap or sales may be misleading. “It may well be that the size definition for small businesses should be raised considerably,” he said.
No matter how the term is ultimately defined, Donaldson clarified that the Commission’s examination of Sarbanes-Oxley would—at least for now—be limited to the affect on smaller companies. “There are no plans to go further than that but … we are hopeful that the information gathered here will help us make determinations about what should be done, if anything,” he said, noting that the SEC feels it has enough “leeway … to make adjustments” without involving Congress.
An additional nine to 19 members of the SEC Committee on Smaller Public Companies are expected to be named in the next few weeks, Donaldson said. The panel is slated to begin work in early 2005 and have a final report in 13 months, though interim reports are also anticipated.
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