Small Caps Kiss Compliance Exemptions Goodbye!

If you are the Chief Financial Officer or Controller at a small cap public company, or an SEC attorney, then Daszkal Bolton would like to bring to your attention a study recently released by the SEC that recommends that small cap companies be required to comply with the Internal Controls over Financial Reporting (ICFR) attestation requirements mandated by SOX Section 404(b).

Key Point: The SEC will not be waiving or changing the SOX 404(b) attestation requirement for publicly held companies whose market capitalization is between $75 and $250 million. The study concluded that costs of Section 404(b) compliance have declined and that financial reporting is more reliable when the auditor is involved with ICFR assessments. Importantly, the study found that investors generally view the auditor‘s attestation on ICFR as beneficial.

The study conducted by the SEC’s Office of the Chief Accountant was mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The main focus was to determine what, if any, steps should be taken to reduce the time investment and financial burden of compliance with SOX 404(b), while protecting corporate investors. The study was limited to companies with a market capitalization between $75 million and $250 million, and addresses the auditor attestation requirement with respect to an issuer’s internal control over financial reporting (ICFR) pursuant to Section 404(b). The study did not address management’s responsibility for reporting on the effectiveness their internal controls structure pursuant to Section 404(a) of the Sarbanes-Oxley Act. The study also included a review of whether the requirements to comply with Section 404(b) impact a company’s decision to list on U.S. exchanges.

Key Benefits

The historical data provided the SEC with the following information about the benefits of ICFR attestation:

• Increased Issue Recognition. Companies that used an outside audit firm to review their internal controls process and assessment discovered more issues than were identified through substantive testing alone.
• Disclosure Timing. Disclosures of material weaknesses under the Section 302 certification requirements were more likely to occur during the fourth quarter when auditors were on-site at the client’s office most frequently. Audit firms with experience in 404 audits also were more likely to catch critical issues than internal staff of the issuer.
• Increased Scrutiny of Deficiencies. The majority of internal control deficiencies that were classified by the auditor as a significant deficiency were initially assessed and classified by the company as less consequential.

Study Conclusions

Based on the information collected from existing 404(b) implementations and other research, the SEC drew the following four conclusions which were critical in arriving at their recommendation:

1. Reduced Cost of Compliance – The cost of compliance with Section 404(b), including both the aggregate costs and audit fees; have been on the decline since the PCAOB’s Auditing Standard No.5 reforms were issued in 2007. This means that the pool of remaining companies that have not been subject to ICFR audit will not be required to absorb significant fees from their independent audit firms for the internal controls audit, an issue that was of concern to many.
2. Exit Decisions – The study found that there was inconclusive information illustrating a clear link between the SOX 404(b) audit requirement and the decision of companies to “exit” the reporting requirements of the SEC.
3. Increased Accountability – Auditor involvement in ICFR has been directly linked to more timely, accurate and reliable disclosure of ICFR deficiencies. In addition, it was also found that the restatement rates for issuers with auditor involvement are significantly lower than those companies without such review.
4. Enhanced Investor Protection. The SEC found that the disclosure of internal control weaknesses was essential, relevant and meaningful information that investors should have access to when making short- and long- term investment decisions.

The SEC’s recommendations demonstrate their continued commitment to “balance” the reduced regulatory burdens on small business capital formation with the need to maintain investor protection. In this respect, the SEC supports the retention of 404(b) audit requirements as they currently stand but does not recommend an extension of this exemption to issuers whose market capitalization is between $75 and 250 million.

Contact Us

Small cap SEC registered companies will not receive any new compliance exemptions! CONTACT US NOW! It is critical that your company plan ahead to be in compliance with SOX reporting requirements. For additional information, please call Vicki Wright, CPA, at 561-367-1040, or click here to email Vicki. In a brief consultation she can address your questions and concerns, and identify the best way to proceed.