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Congress Approves Small Company Exemption from SOX Section 404 (b)

15 Jul 2010

The House and Senate have passed sweeping financial reform legislation which includes a provision that permanently exempts non accelerated filers (companies with public float less than $75 million) from complying with Section 404 (b) of the Sarbanes Oxley Act. Section 404 (b) requires public companies to provide an attestation report from its external auditors regarding management's assessment of internal controls over financial reporting.

On October 13, 2009, the Securities and Exchange Commission (SEC) issued a final rule, Internal Control over Financial Reporting in Exchange Act Periodic Reports of Non-Accelerated Filers, requiring all non-accelerated filers to comply with Section 404(b) beginning with their annual reports for fiscal years ending on or after June 15, 2010. Following suit, the House of Representatives passed financial reform legislation in December 2009 exempting small public reporting companies (non accelerated filers) from Sarbanes Oxley Section 404 (b). The original Senate version passed in May 2010 did not contain a similar provision. A Conference Committee composed of senior members from the House and Senate convened to draft legislation acceptable to both Houses of Congress and in June 2010, the Senate conferees agreed to adopt the House 404 (b) exemption for small companies. The exemption contained in the House-Senate bill will effectively negate the SEC's final rule and provide a permanent exemption from the auditor attestation requirement for eligible smaller companies. The President is expected to sign the bill into law during the week of July 19th.

Despite support of small companies, venture capitalists and banking organizations who have cited the high costs of SOX compliance, the 404 (b) exemption has been opposed by the SEC, the AICPA and the Council of Institutional Investors, which believe that the Sarbanes Oxley requirements promote financial reporting reliability and thereby increase investor confidence.

Comment:
This legislation does not impact Sarbanes Oxley Act Section 404(a), which requires management to perform an annual review of the effectiveness of its internal control structure. This section requires management to review its internal control structure, and disclose in its Annual Report on Form 10-K that it has made its evaluation and its conclusions as to whether controls were effective as of the date of the evaluation. If management identifies any material weaknesses in internal control, those continue to require disclosure.

Additionally, the Sarbanes Oxley requirements contained in Section 302 (requiring CEO and CFO certification that they have reviewed the financial information in the filing, that the financial information and reports are fairly presented and do not contain any untrue statements of material fact, that the responsibility for designing disclosure controls and procedures and internal control over financial reporting rests with the certifying officers, and that the certifying officers have evaluated the effectiveness of the disclosure controls, have disclosed changes in disclosure controls and have performed a review of the internal control structure and disclosed significant deficiencies or material weaknesses in design or operation of internal controls over financial reporting as well as any instances of fraud related to those involved with internal controls over financial reporting to the Board and to the external auditors) and Section 906 (CEO and CFO certification of compliance with the Securities and Exchange Act and that the information contained in the periodic reports fairly presents the financial condition and results of operations of the issuer) are unaffected by the above exemption and will continue to apply.

DLA will continue to monitor legislative and regulatory changes and will report on further developments and their implications.