Smaller Companies May Soon See Relief From Section 404

Saturday, April 22, 2006

John Labate, http://

Abstracted from: Here's A Loophole That The Feds Would Create On Purpose

Treasury & Risk Management - February 2006, Pgs. 28-32

Taking a toll.
The one-size-fits-all requirements of the Sarbanes-Oxley Act's Section 404 takes the heftiest financial toll on the smaller companies charged with compliance. According to the American Electronics Association, Section 404 compliance absorbs an average of 2.55% of revenues for companies with less than $100 million in revenues, compared to 0.06% for companies with over $5 billion in revenues. Relief may be forthcoming, John Labate explains, under a new set of recommendations that the SEC might consider in 2006. In December 2005, an SEC subcommittee on internal controls suggested that external-audit requirements be eliminated for certain small companies and that the smallest issuers be exempt from all Section 404 requirements.

Moving toward reform.
Once the SEC's Advisory Committee on Smaller Public Companies issues its recommendations, expected in the spring of 2006, the debate over Section 404 reform for small and mid-sized companies will heat up, as regulators weigh the pros and cons of easing or lifting compliance requirements. Many in the business community see a desperate need for change to the current regulatory scheme, since it does not distinguish between companies based on size or complexity of operations. At the same time, notes the author, corporate governance experts and others oppose removing key provisions of Section 404 for small, publicly traded companies, which the observers believe require careful monitoring. Both camps must come together to hammer out a new set of reforms that will both reduce costs and maintain effective internal controls.

Section 404 no more, for some.
The chair of the internal-controls subcommittee is no stranger to the costs associated with Section 404. A former CEO and president of a $500 million manufacturer of industrial cleaning equipment, Janet Dolan experienced those costs first-hand when her company's external-audit fees jumped from $500,000 in 2003 to $1.4 million in 2004. While she has supported other types of recent corporate reform, including whistleblowing requirements and board independence, the one-size-fits-all nature of Section 404 does not appeal to her. Under her subcommittee's proposals, the author explains, companies with revenues below $125 million and a market capitalization under $125 million would be exempt from Section 404 (though subject to other certifications, audits, and corporate governance requirements). Companies with annual revenues above $250 million and market capitalizations of below $750 million would still have to comply with Section 404 but would not be required to seek an external audit of management's assertions.

No safe substitute for scrutiny.
Although some critics of the current proposals see today's regulations as flawed, they also point to the danger of exempting the smallest public companies from the tough regulatory standards designed to protect investors. Tight regulation is even more important for these companies, the author reports, because they escape the scrutiny of the analyst community and may be passed over by auditors for more lucrative assignments at larger firms. Other observers point out that the regulations do not address key issues such as what happens when a company restates its financials or commits fraud. While regulators and experts hash out the details of the Section 404 proposals, CFOs wait for cost-effective compliance techniques that will serve the interests of both companies and investors.

Abstracted from Treasury & Risk Management
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