An important meeting of the Securities and Exchange Commission’s Advisory Committee on Smaller Public Companies last week did little but bring tensions around the Sarbanes-Oxley Act into sharper relief, even as the debate heats up still more with the release of the committee’s proposed recommendations.
The panel was formed last year to examine the effect of SOX and other securities regulations on small companies, but businesses of all sizes have followed the committee’s doings closely since the SEC says it will give significant weight to the group’s conclusions.
The committee released a draft of its much-anticipated report for public comment just prior to its meeting Feb. 21. A revised draft that reflects changes made following that meeting is expected to be posted shortly (see box at right).
While the group’s 165-page draft document includes 32 recommendations in all, one predominates: exempting the smallest companies (those with $125 million or less in annual revenue and market capitalizations of $128 million or less) from the requirements of Section 404 entirely, and a larger pool of companies (those with annual revenue up to $250 million and market caps from $128 million to $787 million) from Section 404’s external audit requirement. That first, microcap group would also need additional corporate governance controls specified by the committee to be exempt.
404 Lite
Discussion at last week’s meeting demonstrated that the committee’s 21 members are divided on whether to recommend an exemption. Most strongly favor exempting some companies, contending that the costs of compliance with Section 404 vastly outweigh the benefits to small companies. Others—including Kurt Schacht, executive director of the CFA Centre for Financial Market Integrity; John Veihmeyer, deputy chairman of KPMG; and Mark Jensen, national director of Venture Capital Services for Deloitte & Touche—have raised concerns about the exemption proposal.
Schacht
Schacht noted that there’s “a lot of confusion on what’s meant by ‘better implementation’ of Section 404,” which the group has discussed as an alternative to exemption. “We should be clearer in our recommendation that there is some flexibility as to what better implementation means,” he said. “I think we left open whether a better implementation means a redefined [Audit Standard 2] or simply more specific direction to small companies … on rightsizing SOX.”
Jensen argued for deferral rather than an exemption. The Big 4 accounting firms, he said, oppose a “404 lite approach” fearing that multiple standards would be difficult to maintain and confuse investors. Instead, the firms will argue for continued delay of Section 404 until “more guidance can be made available and there’s more implementation experience obtained,” he said. “This approach would allow smaller companies more time to get it right and would allow all of the user groups to come together on it,” Jensen said. He also questioned whether the SEC has the authority to make such exemptions.
The SEC has already delayed implementation of Section 404’s audit requirements until 2007 for small companies, largely at the suggestion of the advisory committee last summer.
Veihmeyer agreed that a decision now on a permanent exemption is premature.
“Until we look at things like monitoring controls in a smaller company, as well as a number of other very specific points that are unique to smaller companies, and try and assess whether or not 404 is scalable for both management and their auditors to attest to the system of internal controls, I think we’re doing a disservice to leap to a permanent exemption of those companies,” he said.
Defer, Defer, Defer
Dolan
Janet Dolan, chair of the internal controls subcommittee that recommended the exemption and a former chief executive officer of Tennant Co., promptly shot back: “We’ve spent several months here trying to get everyone who’s testified to tell us how we can right-size this for small companies, and no one has been able to do it yet … I hear what people say, ‘Let’s just defer, defer, defer,’ but deferring often means just the status quo.”
What the business community needs, she said, is specific detail from the SEC about what is required to comply with Section 404. “The more the SEC could do right now to absolutely paint the picture of what is really expected of companies would save everybody a lot of time and effort trying to keep aiming at a moving target,” she said. Dolan suggested that the committee give the SEC an outline of the kind of language it could use to instruct companies on exactly what is required of them under the law.
Davern
Alex Davern, chief financial officer of National Instruments Corp., accused the Big 4 of “flip-flopping on this issue for a second time” and insisted the panel act. “We can no longer afford to stick our heads in the sand and hope this issue will go away. It is vitally important for the competitiveness of small American business that we take action and we take action now,” he said.
Goelzer
Meanwhile, Daniel Goelzer, an observer to the advisory group and a member of the Public Company Accounting Oversight Board, said that PCAOB won’t take a position on the group’s recommendations. The PCAOB considers the matter a policy issue in the SEC’s hands, he said, while the PCAOB’s job is to implement “an effective and efficient auditing standard for whatever level of companies the SEC and the Congress say should be filing these reports.”
As far the possibility of an “ASX”—an alternative auditing standard where the auditor would report on the design and implementation of controls rather than on their operating effectiveness—Goelzer said the board believes such a standard “could be developed.” “It has roots in the existing attestation literature,” he said, adding that “whether it’s desirable or not from a policy standout is a little bit out of our bailiwick.”
Several prominent public figures, including former SEC Chairman Arthur Levitt; former Federal Reserve Chairman Paul Volcker; John Bogle, the former chairman of Vanguard Group Inc.; John Biggs, former TIAA-CREF chairman and CEO; and former U.S. Comptroller General Charles Bowsher, have all publicly come out against an exemption. And in recent public remarks, SEC Commissioner Roel Campos indicated that he too opposes an exemption (see box at right).
While published estimates, including those provided in the group’s own report, have said that the proposal as currently written would exempt 80 percent of U.S. public companies from the internal-controls requirements, members of the group last week noted that the figure is lower when companies that trade on the pink sheets are taken into account.
Jensen said that the number of companies that would be exempted under the current recommendations is “largely misunderstood.” Noting that many registrants aren’t filing 404 reports now and “wouldn’t even if it did go effective,” he said, in reality the population that would be exempt “is much smaller than many people might think.”
The committee plans to hold a teleconference on April 12. A full meeting is scheduled for April 20, at which point the group is expected to have finished its report for submission to the SEC.
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