Smaller Company SOX Delays May Be Coming to an End

The new chairman of the Securities and Exchange Commission plans to focus more of her attention and influence on disclosure, greater transparency and increased regulation for American businesses of all sizes.

Before her appointment as SEC chair was made, Mary Schapiro commented that the delays of Sarbanes Oxley Act’s Section 404 requirements for smaller companies may be coming to an end.  “Right now, we have a system where some issuers are complying with 404 and others are still exempt from it,” she said. “It’s time that we bring uniformity to the system so that investors know what to expect from companies, while being sensitive to the needs of small businesses.”

Section 404 of SOX requires management and the external auditor to report on the company’s internal controls over financial reporting.  The initial implementation timeline for Section 404 phased in the requirements depending upon the size of the entity.  Since then, there have been several delays for non-accelerated filers, those with less than $75 million in public float.  The most recent extension moved the outside auditor requirement to years ending after Dec. 15, 2009. 

Proponents of Section 404 feel that the process helped to restore investor confidence after the audit failures earlier this decade, which included Enron, WorldCom and several other well-known companies. More accurate and reliable financial statements are available to the public, and companies benefit from strengthened controls and better fraud prevention and detection. 

A three-year study performed by Lord & Benoit, LLC showed that a clean SOX opinion had a correlation with better–than-average market returns, while adverse opinions led to lackluster stock performance. 

Critics believe that these benefits do come at a significant cost.  They argue that SOX 404 for smaller companies is disproportionately more expensive because of the significant amount of fixed costs related to the required documentation and testing. 

The American Electronics Association report entitled Sarbanes-Oxley Section 404, The ‘Section’ of Unintended Consequences and Its Impact on Small Business revealed 2004 compliance costs of 2.55 percent of revenue for smaller companies (those with less than $100 million in revenue), while companies with revenues in excess of $5 billion spent only .06 percent of revenue.  In addition, the high cost of compliance and overly complex regulations have reduced the attractiveness of America’s capital markets, which stifle entrepreneurship and cause businesses to list on foreign exchanges. 

In light of the current political atmosphere and the public’s call for additional regulation over financial markets, the string of delays of SOX 404 compliance steps for smaller public companies will likely end this year, requiring the additional compliance requirements.  

To assist auditors with applying the provisions of Auditing Standard No. 5, the Public Company Accounting Oversight Board has issued, Staff Views – An Audit of Internal Control Over Financial Reporting That is Integrated With an Audit of Financial Statements: Guidance for Auditors of Smaller Public Companies.  This guidance, along with open communication with auditors may help to contain the implementation costs of SOX.