T
he Securities and Exchange Commission has again reassured smaller companies that they don’t need to do the same amount of work as their larger counterparts to assess and report on their internal controls under the SEC’s proposed management guidance for Section 404 of the Sarbanes-Oxley Act.
In remarks earlier this month at the SEC Speaks Conference, Zoe-Vonna Palmrose, the SEC’s deputy chief accountant for professional practice, gave an overview of the guidance—which was out for comment through Feb. 26—and described some ways non-accelerated filers could scale their approach to Section 404. Non-accelerated filers are slated to start providing management’s assessment regarding internal control over financial reporting in annual reports for fiscal years ending on or after Dec. 15, 2007.
“Meeting the requirements under Section 404 need not be a drain on company resources, especially those of smaller companies,” Palmrose said.
In evaluating the effectiveness of the controls that address financial reporting risks, Palmrose stressed that determining the evidence needed to support that assessment should consider the materiality of the financial-reporting element, its inherent risk of misstatement, and the risk that controls related to that element would fail to operate effectively to prevent or detect a material misstatement.
For example, she said, in lower risk areas, ongoing monitoring may provide sufficient evidence for the ICFR evaluation, and direct testing might not be necessary. In higher risk areas, however, Palmrose said the SEC would expect the evidence to include “some amount of direct testing, and cover a reasonable period of time, including the fiscal year-end.”
For smaller companies that have less complex internal control systems, Palmrose said the proposed guidance recognizes circumstances where management may be able to rely on its daily interactions and may need to create only limited documentation specifically for the evaluation of the operating effectiveness of the controls that address financial-reporting risk.
Dow
Robert Dow, a partner at the law firm Arnall Golden Gregory, says non-accelerated filers that have a “strong control environment but don’t have a lot of sophisticated accounting controls” stand to benefit the most from the SEC proposal. “Taken at face value, the proposal provides very useful relief for those companies,” says Dow. He expects the cost of compliance “will be much lower than it would have been for small companies under the current rules.”
Still, Dow and other observers stress that the true tension will be how outside auditors interpret the guidance from the SEC and Public Company Accounting Oversight Board.
Brounstein
“The real test is how this is going to be implemented,” says Rick Brounstein, executive vice president at Calypte Biomedical Corp. and director of the CFO Network. “Principles-based accounting relies on judgment, and today the auditors carry all the clout on what is acceptable.”
Likewise, Heather Badami, a partner at the law firm Bryan Cave, says managements “remain beholden to the auditors who, absent more specific guidance from the SEC and PCAOB, are likely to take the most conservative view in their remaining 404 audit.”
For example, she says, while the SEC proposal leaves “helpful room for varying levels of controls documentation,” no specific guidance or example exists of what documentation might be appropriate in a particular circumstance. ”That leaves management and the auditor to easily reach different conclusions—with a conservative auditor always having the upper hand,” Badami says.
Badami
While she calls the SEC proposal “a step in the right direction” in reducing the burden on smaller companies, Badami says it doesn’t address the heart of the issue: the “excessive amounts” spent by smaller companies on their auditors. “The auditor’s report on management’s assessment was redundant to begin with, and its elimination is not likely to significantly reduce those costs,” she says.
Brounstein says there may be “a little leeway” for non-accelerated filers since they don’t have to comply with the auditor-attestation requirement during their first year under 404, but adds: “I worry that the inherent conservative nature of an auditor, coupled with the fear of the PCAOB audit of the auditor, will continue to encourage over-auditing of the accelerated filers.”
CSA Seeks Comment On Plan For National Registration Rule
C
anadian securities regulators have published for comment proposed new rules that, if adopted, would replace the myriad rules of individual provincial securities acts, regulations, rules, and policy statements with one consolidated national rule.
Proposed National Instrument 31-103, Registration Requirements, marks the CSA’s first comprehensive national reformulation of the Canadian registration regime, according to a Feb. 20 legal advisory from the law firm Borden Ladner Gervais.
Understanding the proposals and “knowing how all the pieces fit together and how they will impact your business is vital,” the bulletin said. “The fact that registration requirements will be pulled together into one rule will have a largely positive impact on firms and individuals doing securities-related business in Canada.” The proposed new rules will, “to varying degrees, impact virtually every financial services firm doing business in Canada.”
The proposals cover the requirements for firms and individuals to be registered with the various securities commissions in Canada, as well as the regulation of referral arrangements and registrant-client relationships. Highlights of the proposals include:
a new concept of a “business trigger” for determining whether or not a firm must be registered, including clarification of its application to certain firms;
a new category of “exempt market dealers” and a simplified slate of registration categories;
a national system of mobility exemptions for registered Canadian advisers and exemptions for non-Canadian advisers and dealers doing business with specified clients in Canada; and
new requirements for individuals acting as the chief compliance officer or the “ultimate designated person” for a firm and an articulation of regulatory expectations for compliance systems for registrants.
The CSA anticipates the new rules would come into force some time in 2008, according to the alert. Comments on the new proposals are due by June 20, 2007.
$700 Million SEC Fee Cut Takes Effect
G
ood news for companies and investors: The SEC has slashed the fees public companies and other issuers pay for securities transactions and registrations. Fees to register securities were cut 71.3 percent, while fees on securities transactions were reduced by 50.2 percent.
The SEC adjusts the fees annually under the Investor and Capital Markets Fee Relief Act. The fee cuts for fiscal 2007 were held up because Congress hadn’t enacted the regular appropriations bill that includes the SEC, which triggers the rate changes. The agency requested special legislative relief to permit the fee cuts to go forward effective Feb. 20.
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