Corporate Community Asks SEC for One-Year Extension for Small Companies to Comply with Sarbanes-Oxley 404 Internal Control Auditor Attestation

In a letter to SEC Chair Mary Schapiro, the Chamber of Commerce Center for Capital Markets Competitiveness urged the Commission to grant an additional one year extension for non-accelerated filers to comply with the auditor attestation provisions of Section 404 (b) of the Sarbanes-Oxley Act. Despite recent PCAOB guidance designed to help auditors scale their audits of smaller public companies, noted the Center, the preliminary cost assessments to comply with 404(b) have indicated that non-accelerated filers can expect a 50 to 100 percent increase in audit fees in 2009 if they are ultimately required to comply with Section 404(b) this year.

In the Center’s view, the initial costs assessments indicate that the current position on the learning curve is still far from the cost savings goal sought by the initial delay, thereby warranting a further extension. If no delay is granted, warned the Center, small companies will be faced with significantly increased compliance costs during an economic crisis in a period when there is already extreme difficulty for small business to access capital and credit markets.

In June of 2008, the SEC postponed for one year the date by which a non-accelerated filer must begin to include in its annual report an auditor attestation report on management’s assessment of internal control over financial reporting. Release No. 34-58028. As a result, non-accelerated filers were required to complete only management’s assessment of the effectiveness of the company’s internal controls in the first and second year of their compliance with Section 404. One reason the SEC extended the deadline was to give these companies time to consider the PCAOB’s guidance and incorporate such guidance in their planning and conduct of their internal control audits for 2009.

When it extended the deadline last year, the SEC also recognized that a non-accelerated filer that files only a management report on internal controls may be second-guessed as a result of separating the management and auditor reports. Management may conclude that the company’s internal controls are effective when the management report is filed without the auditor’s attestation report, but the company’s auditor may come to a contrary conclusion in its report filed in a subsequent year, and as a result, the company’s previous assessment may be called into question. To reduce the liability risk associated with such second-guessing, the SEC continued the temporary liability distinction and treated the management report of smaller companies as furnished rather than filed until such time as non-accelerated filers are required to comply with both sections of 404.

The cost/benefit study being conducted by the SEC Office of Economic Analysis (OEA) will be used to determine if Section 404(b) should be applicable to smaller public companies, noted the Center, and it is anticipated that the study results will be published this spring. In the absence of the finalization of these reports, reasoned the Center, the SEC should grant an additional one-year extension.

Due to limited economies of scale, said the Center, Section 404(b) disproportionately burdens smaller companies. This burden has been magnified during an extended period of time of frozen credit markets. The additional compliance costs may, in some instances, expend the funds that represent the margin of survival for small business during the economic crisis. Without immediate SEC action, noted the Center, the current state of rulemaking will exert additional downward pressure on earnings for small public companies and generate unnecessary costs that would likely be shifted to shareholders.

Buttressing the economies of scale argument, the Center observed that small companies do not have the staff to devote full-time attention to Section 404(b) compliance in the last half of the year. The work has to be spread out over a longer time period in order to meet the potential Section 404(b) compliance deadline in addition to the regular duties required to keep the company running. Moreover, companies are engaging audit firms earlier than normal to prepare for potential compliance with Section 404(b). Although it has been helpful to learn from the experience of larger filers and audit firms, acknowledged the Center, small companies will still have to expend a substantial amount of time and resources familiarizing themselves with the relevant processes and documentations.