By Jacquelyn Lumb
The PCAOB’s Office of Research and Analysis has issued a white paper on the characteristics of emerging growth companies (EGCs) to help inform the board in its rulemaking releases about the impact of applying new standards to their audits. The JOBS Act generally provides that new PCAOB standards will not apply to the audits of EGCs unless the SEC determines that this is necessary or appropriate in the public interest. When the board adopts a rule subject to this determination, it makes a recommendation to the SEC about whether the rule should apply to the audits of EGCs and submits information and analysis to assist the SEC in making its determination.
EGC eligibility. The information for the white paper was obtained from SEC filings and third-party vendors through November 15, 2016. To qualify as an EGC, a company must have less than $1 billion in annual revenues in its most recently completed fiscal year and must not have sold common equity securities on or before December 8, 2011 pursuant to a Securities Act registration statement.
The company retains its EGC status until the earliest of the first day of the fiscal year in which its annual gross revenues are $1 billion or more; the date on which it is deemed to be a large accelerated filer under the Exchange Act; the date on which it has issued more than $1 billion in non-convertible debt during the prior three-year period; or the last day of the fiscal year after the fifth anniversary of its first sale of common equity securities under an effective Securities Act registration statement.
The staff found that the overwhelming majority of registrants that ceased to qualify as EGCs did so because their annual revenue exceeded $1 billion or they became a large accelerated filer rather than as a result of issuing more than $1 billion in non-convertible debt.
EGC status. As of November 15, 2016, 1,951 registrants identified themselves as EGCs in at least one SEC filing and had filed audited financial statements with the SEC in the preceding 18 months. Of these, 742 had common equity securities listed on a U.S. national securities exchange. The number of EGC filers grew after the enactment of the JOBS Act but has recently stabilized, according to the white paper, while the number of inactive EGCs has grown.
The staff found that 465 companies that had previously identified as EGCs had ceased to be SEC registrants by either terminating their Exchange Act registration, having their registration revoked, or withdrawing their registration before effectiveness. The staff found that many EGC filers were not exchange-listed and had limited operations. About 50 percent of the non-listed filers had no revenue to report in their most recent filing with audited financial statements and 23 percent disclosed that they were shell companies. Approximately 51 percent of EGC filers had explanatory paragraphs in their auditor’s reports expressing substantial doubts about their ability to continue as a going concern.
Internal controls. Of the 1,262 EGCs that provided a management report on internal control over financial reporting in their most recent annual filing, approximately 47 percent reported material weaknesses. Thirteen percent of the exchange-listed filers reported material weaknesses. EGCs are not required to obtain auditor attestations on the effectiveness of their ICFR, but 2 percent voluntarily provided an auditor’s report on ICFR.
The staff plans to update this white paper semiannually based on the most recent data available as of May 15 and November 15 each year.