The Securities and Exchange Commission may postpone the implementation of Section 404 of the Sarbanes-Oxley Act for certain companies.
Nicolaisen
Donald Nicolaisen, the Commission's chief accountant, confirmed the regulator is considering a delay, possibly for smaller companies that are having difficulty meeting the deadline, which is currently for all filers above $75 million in market capitalization whose fiscal year ends after Nov. 15.
"We do hear of a number of instances of companies that are running out of resources or started too late," says Nicolaisen. "If it looks like a large number of companies won t be able to comply, we will consider whether there is some relief we can make available to limited segments of our registrant community."
One of the possibilities is a postponement, he confirmed.
He won't specify exactly when the SEC will make a definitive decision or what kinds of companies would be affected. "We're just not there yet," he stresses. "We're still monitoring the situation." Nicolaisen has been asked to take a look at the issue from many fronts, including the companies themselves, the accounting firms and the legal community. "Everyone," he adds.
Small Companies Only
The Commission, of course, is not wild about further delaying implementation of 404 given that it has already twice postponed the start date.
Nicolaisen does point out that most of the companies that could receive some sort of relief would be smaller companies. He believes the largest companies are in pretty good shape, or have the additional resources to throw at the situation.
Why are smaller companies having trouble meeting the SEC's deadline? Nicolaisen believes it's partly due to resource constraints. "The firms are clearly resourced-constrained and it is difficult to add additional professionals at this time. The additional work and focus on internal controls is important, but at the same time the firms still need to perform a quality audit of the financial statements."
Section 404 also is costing companies a bundle. The average company is expected to shell out more than $3 million this year just to comply with Section 404, 62 percent more than they expected, according to a recent survey by Financial Executives International. It said the tab will probably come in at more than $8 million for companies whose revenues exceed $5 billion (see survey coverage at right).
Of course, a number of the companies that are currently scrambling to comply with 404 may simply have gotten started much later than they should have, Nicolaisen concedes.
Fitzwilliam
Grant Fitzwilliam, managing director of Answerthink, a strategic business and technology consulting firm, says another reason for the delays is due to the fact that the Public Company Accounting Oversight Board, which oversees the auditors, didn't provide official 404 guidance to the accounting firms until the end of the first quarter of 2004. As a result, auditors didn't provide more specific guidance to their clients until the beginning of the third quarter, which didn't leave companies with much time to meet their auditors' expectations. "It's going to be a close call for many companies," he asserts.
He also believes that companies spent so much time concentrating on their finance functions, thus overlooking their IT operations and the role they play in documenting internal controls. "IT is not usually a control-conscious operation," Fitzwilliam adds.
Define "Small"; Higher Risks?
Fitzwilliam believes companies below $500 million have had an especially tough time, due in part to the fact that their heavily strained auditors are paying more attention to their larger clients. "The auditors are over-sold, so they are dictating the time line for their clients," he adds. "So, if at the last minute remediation is required, companies won't have enough time to fix it, and it could cause an adverse opinion."
In fact, he says he just started helping two clients in the past two weeks with their IT operations. He expects to finish in mid-December, but he warns, "If the auditor finds a problem, it will be an issue."
There are other important issues at stake for companies that don't meet their deadline. In a report to clients last week, Bear Stearns said it believes that investors ordinarily should demand a higher risk premium when investing in a company that has ineffective or deficient internal controls.
"Ineffective internal controls over financial reporting do not necessarily mean that there are accounting irregularities, but it does heighten the probability that they may exist," it added in the report. "In the long run, as these deficiencies are corrected, we expect increased investor confidence and lower cost of capital "to outweigh the higher costs of Section 404 compliance.
If the SEC does not delay implementation, what else can it do to provide relief for companies that haven't met the deadline? Nicolaisen could slightly alter the schedule, creating gradations of deadlines based on the size of the companies. For example, he could stick with the Nov. 15 deadline, but give companies extra time in 2005 to meet the requirements of 404.
Katz
Another possibility is that he exempts parts of the rule or staggers certain provisions. But this would be impractical. "It's a comprehensive effort to go through," stresses David Katz of Wachtell, Lipton, Rosen & Katz.
Garris
"I doubt he would go as far as exempt certain companies from it," adds Dennis Garris, partner with Alston & Bird. "I wonder if he just threw it out just to say that's not the only option but really didn't have an answer."
For his part, Nicolaisen says, "The biggest concern is we don't know with precision the number of companies who may not complete their 404 work. Therefore, it's responsible for us to monitor the situation."
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