By Soyoung Ho
The SEC is full steam ahead on its controversial plans to exempt more categories of companies from auditor attestation of management’s financials required by Section 404(b) of the Sarbanes-Oxley Act of 2002 despite strong opposition by several large investor groups.
The market regulator is planning to adopt a May 2019 proposal in Release No. 34-85814, Amendments to the Accelerated Filer and Larger Accelerated Filer Definitions , by April 2020, according to the latest rulemaking agenda.
The SEC has historically taken two or more years to adopt a controversial rule. However, the SEC under Chairman Jay Clayton has accelerated its rulemaking effort, especially on rules that reduce compliance burdens for companies.
The SEC’s move comes as businesses for several years have complained that Section 404(b) is costly but offers little benefit to investors. They argue that many companies are reluctant to go public partly because of heavy compliance burdens, and the commission under Clayton’s leadership has been sympathetic to their arguments. He has mainly followed business-friendly policies that President Donald Trump has instituted.
However, investor protection advocates believe that auditor attestation of internal control over financial reporting (ICFR) makes it less likely that management will manipulate the company’s financials. Moreover, studies have shown that a strong emphasis on internal controls has substantially reduced the risk of material misstatement. Congress passed Sarbanes-Oxley in response to scandals at Enron, WorldCom, and others that cost investors $85 billion.
If the SEC decides to adopt the proposed rule, it will benefit low revenue companies even if the funds raised in the public stock markets are not small. Today, companies with less than $75 million in public float are exempted from Section 404(b) . Public float is the value of a company’s common stock that is publicly traded. Currently, accelerated filers are companies that have a public float of $75 million to $700 million. Large accelerated filers have more than $700 million in public float.
In particular, the proposal would exclude smaller reporting companies (SRCs) that have annual revenues of less than $100 million. SRCs have less than $250 million in public float. A company with no public float or with a public float of less than $700 million also qualify as an SRC if it had annual revenues of less than $100 million during its most recently completed fiscal year. Previously companies could provide scaled disclosure if they had no public float and less than $50 million in annual revenues.
The SEC estimated that 539 companies would be exempted.
Businesses that have been pushing for further exemptions applauded the SEC’s effort.
The U.S. Chamber of Commerce said the costs can be disproportionately expensive and regressive.
In a comment letter, the U.S. Chamber said it “has long been concerned that a decline in public companies has created fewer opportunities for American families and businesses.”
The Biotechnology Innovation Organization (BIO) said that biotech investors spend time learning about a company’s science, the diseases it is treating, and other factors that will determine the company’s success or failure.
“Our investors expect these companies to dedicate the capital they invest toward our innovation, hiring scientists, and continuing to move through the clinical trial process,” BIO wrote. “The information gained by investors from Section 404(b) compliance does not address what investors are most concerned about, and only serves to divert funds from the company’s progress in bringing their product candidate(s) to market.”
But investor protection advocates in comment letters questioned whether the regulator has done the homework to justify its plans. They disputed the agency’s assessment that the benefits will outweigh the costs of increased exemptions.
“Because research demonstrates the heightened need for attestation of internal controls, investors are likely to price the loss of the internal controls audit in their equity risk premium,” the CFA Institute wrote to the SEC. “In other words, eliminating the attestation requirement may reduce the cash outflow associated with the audit of internal controls, but it is likely to be more than offset by a higher discount rate because of a rise in the equity risk premium required by investors when companies seek capital in the public market.”
This article originally appeared in the November 22, 2019 edition of Accounting & Compliance Alert, available on Checkpoint.
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