By:  Cydney Posner

This morning, the SEC Advisory Committee on Smaller Public Companies held a meeting to consider some changes to the Exposure Draft of the Committee's Final Report that was originally released for public comment on February 28, 2006. As you have probably heard, there has been significant debate regarding the Report's SOX 404 recommendations, both on the Committee itself and among Senator Sarbanes, Congressmen Oxley and Baker, SEC chairman COX and various of the Commissioners, several former SEC chairmen as well as a number of academics and others. (See my postings of 4/10/06, 4/4/06, 3/20/06, 3/2/06, 2/22/06, and 2/21/06.) Some of the Committee members took umbrage at what, in their view, has been a coordinated campaign in the press to "vilify" and prejudge the proposals, without taking into account the experience and judgment of the Committee members. Others stressed that many of the commentators have overemphasized SOX 404 and ignored the other important benefits of SOX, such as setting the tone at the top and the independence and renewed diligence of directors.

The Committee received 180 comment letters on its proposals, primarily from issuers and primarily in favor of the proposals. As expected, accounting firms were uniformly against the SOX 404 proposal, but recommended instead that implementation for smaller companies be deferred until the issue is resolved. It was also reported that, at the recent ABA meeting, former Corp Fin director, Alan Beller, recommended addressing the SOX 404 problem by reopening Auditing Standard No. 2, encouraging the private sector to devise best practices for smaller companies and addressing the fear generated among accountants by the prospect of PCAOB inspections. However, the Co-Chairs of the Committee committed to stand by their basic recommendations, reiterating their belief that the task originally set before the Committee was to be bold, independent and to think outside the box.

There were three suggested changes to the proposals as originally released:

  • To index the revenue thresholds in the definition of smallcap companies;
  • To expand the application of the Black Box no-action letter; and
  • To allow the attestation required by SOX 404 to be provided by certified consultants (as consultants have provided valuations for purposes of Section 409A) or others who are not auditors (with the goal of increasing competition) and/or to provide for a SOX 404 audit to be conducted on a random basis periodically by an external body, in a manner comparable to a periodic accreditation process.
Committee member Mark Jensen, from Deloitte & Touche, identified many problems with the proposals suggested in the last bullet point.  He thought that auditors of financial statements would not rely on someone else's audit of internal control because auditors needed to be comfortable with the internal controls for purposes of the financial audit. Therefore (apparently overlooking the practices that existed before SOX required any internal control audit), he thought the concept would result in duplication and would not diminish the cost of compliance. In response to comments that SOX 404 was driving many companies to register on overseas markets, he thought that it was important to conduct a serious public debate about whether SOX 404 has indeed caused the U.S. to "cross the line" on governance requirements or whether the migration to overseas markets, if any, is rather the result of globalization generally.

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