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Proposed SOX 404(b) Changes Could Add to Investors’ Risks

House Financial Services committee members sit...Image via Wikipedia

There has been quite a bit of legislative and regulatory activity over the past few months regarding Sarbanes-Oxley Section 404(b), which requires public companies to have an independent auditor attest to management’s assertions on internal controls over financial reporting. I want to bring you up to date on recent developments and the AICPA’s position on the issue.

Currently, an exemption exists for issuers with a public float of less than $75 million, a provision enacted as part of the 2010 Dodd-Frank Act. These smaller issuers were never required by the Securities and Exchange Commission to comply with Section 404(b) since enactment of SOX. However, legislative, regulatory, business and economic influences are combining to apply pressure to extend the exemption to larger public companies, believing it would reduce reporting burdens and spur job growth. The AICPA has consistently urged implementation of Section 404(b) for all publicly held companies. It has led to improved financial reporting and greater transparency, and the AICPA believes all investors in public companies should have equal benefit of the same protections.

In September and November of 2011, the Center for Audit Quality, which is affiliated with the AICPA, joined with investor organizations including the Council of Institutional Investors and the CFA Institute, on letters to the House Financial Services Committee expressing concerns over exemptions from 404(b) and opposing the weakening of investor protections. It’s worth noting that in April 2011, the Securities and Exchange Commission Office of the Chief Accountant released a con­gressionally mandated study of Section 404(b) which found that compliance costs have declined and financial report­ing is more reliable when the auditor is involved with internal control over financial reporting assessments.

Still, in January the White House sent to Congress a set of proposals that includes creation of an “IPO on-ramp” for small, young companies. Again, a level of exemption from 404(b) is among the recommendations. So there is White House support for expanding exemptions from 404(b).

On Feb. 16, the House Financial Services Committee approved H.R. 3606, the “Reopening American Capital Markets to Emerging Growth Companies Act,” by a vote of 54-1. Like its companion bill in the Senate (S. 1933), H.R. 3606 would:

  • Establish a new category of public companies, to be called “emerging growth companies,” for those with less than $1 billion in annual revenues at the time they register with the SEC and less than $700 million in market capitalization after their IPOs.
  • Create a transitional “on-ramp” status for emerging growth companies to encourage them to go public. The transition period would last as many as five years, or until a company reached $1 billion in annual revenue or $700 million in market capitalization.
  • Exempt emerging growth companies from Section 404(b), among other regulations, during the transition period.

An amendment was offered during the bill’s markup. It would permanently exempt from Section 404(b) all companies with public floats of less than $1 billion. The amendment was withdrawn after the committee chairman promised it will be considered later this year.

I encourage you to keep an eye on these legislative measures. The AICPA will continue to serve as a resource to Congress and advocate for strong investor protections. I’m interested in hearing what you think of this important issue.

Barry C. Melancon, CPA, President and CEO, American Institute of CPAs.


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