Accounting & Auditing

On April 22, 2011, the U.S. Securities and Exchange Commission (SEC) released a special study on the implementation of Section 404(b) of the Sarbanes-Oxley Act of 2002 (SOX)—the auditor’s report on internal control over financial reporting (ICFR)—with respect to smaller issuers, specifically accelerated filers with market capitalization between $75 million and $250 million. 

The study, Study and Recommendations on Section 404(b) of the Sarbanes-Oxley Act of 2002 For Issuers With Public Float Between $75 and $250 Million, was required by Section 989G(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. It concludes the existing investor protections for accelerated filers to comply with Section 404(b)’s auditor attestation provisions should be maintained, i.e., no new exemptions.

The SEC staff makes two recommendations at the end of the study, as quoted below:

1. Maintain existing investor protections of Section 404(b) for accelerated filers, which have been in place since 2004 for domestic issuers and 2007 for foreign private issuers

   “The Staff believes that the existing investor protections for accelerated filers to comply with the auditor attestation provisions of Section 404(b) should be maintained (i.e., no new exemptions). There is strong evidence that the auditor's role in auditing the effectiveness of ICFR improves the reliability of internal control disclosures and financial reporting overall and is useful to investors. The Staff did not find any specific evidence that such potential savings would justify the loss of investor protections and benefits to issuers subject to the study, given the auditor's obligations to perform procedures to evaluate internal controls even when the auditor is not performing an integrated audit. Also, while the research regarding the reasons for listing decisions is inconclusive, the evidence does not suggest that granting an exemption to issuers that would expect to have $75-$250 million in public float following an IPO would, by itself, encourage companies in the United States or abroad to list their IPOs in the United States. The Staff acknowledges that the reasons a company may choose to undertake an IPO are varied and complex. The reasons are often specific to the company, with each company making the decision as to whether and where to go public based on its own situation and the market factors present at the time. The costs associated with conducting an IPO and becoming a public company no doubt factor into the decisions and may be particularly challenging for smaller companies. The Staff appreciates that the costs and benefits of the regulatory actions that the Commission takes – and does not take – certainly can impact these decisions. At Chairman Schapiro's request, the Staff is taking a fresh look at several of the Commission's rules, beyond those related to Section 404(b), to develop ideas for the Commission about ways to reduce regulatory burdens on small business capital formation in a manner consistent with investor protection. However, the Dodd-Frank Act already exempted approximately 60% of reporting issuers from Section 404(b), and the Staff does not recommend further extending this exemption.”

2. Encourage activities that have potential to further improve both effectiveness and efficiency of Section 404(b) implementation

   “The Staff recommends that the PCAOB monitor its inspection results and consider publishing observations, beyond the observations previously published in September 2009, on the performance of audits conducted in accordance with AS 5. These observations could assist auditors in performing top-down, risk based audits of ICFR. These communications could include the lessons that can be learned from internal control deficiencies identified through PCAOB inspections.

   The Staff is observing COSO's project to review and update its internal control framework, which is the most common framework used by management and the auditor alike in performing assessments of ICFR. The Staff believes that this project can contribute to effective and efficient audits by providing management and auditors with improved internal control guidance that reflects today's operating and regulatory environment and by allowing constituent groups to share information on improvements that can be made that enhance the ability to design, implement, and assess internal controls.”

The entire study is available on the SEC website. For more information, contact your BKD advisor.