Feb 1, 2006 (SmartPros) The Securities and Exchange Commission should not succumb to political pressure and allow smaller public companies to be exempt from 404 requirements of the Sarbanes-Oxley Act, said Arthur Levitt, former chairman of the SEC.
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Interestingly this is not the first heckle over section 404. In March 2005, the SEC further extended the compliance dates for non-accelerated filers and foreign private issuers over 404 by a year. Back then the commissions chief accountant Donald Nicolaisen stated that the extension was to provide enough time for issuers to objectively manage what he quoted was a hard look at internal controls. Alan Beller, the director of the division for corporation finance added that section 404 had the potential of improving the reliability of governance reporting and although it was a huge effort for some companies, it is those companies that should use the extension not to delay but improve the quality of their efforts.
So just under a year on and the section 404 debates still seem very much in play. For those not familiar with 404, we have paraphrased it below:
+ Section 404
Management Assessment of Internal Controls
(1) State the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting; and
(2) Contain an assessment, as of the end of the issuer's fiscal year, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting.
Section 404, 409, 302 are without doubt pieces of work or whole projects in their own right and simply cant be met through rulings or policies, but require the company to set about building a credible operational risk framework. This framework of course needs to be sensitive to measuring potential events that may affect the business and be representative of such a measurement in an ongoing fashion. No matter the size of the business there is going to be an expanse, where obviously some the largest companies will suffer the highest costs.
+ What the SEC is proposing & Levitts Issues
The SEC advisory committee on smaller public companies
recently recommended that public companies with a market
cap of less than $100 million and revenue of no more than
$125 million would be exempt completely from 404 requirements.
The former chairman of the SEC sees that it is smaller companies that are most likely to have control problems and yet least watched by analysts. He believes that by creating a different standard, small businesses are relegated to a second-class position which hinders their growth.
+ A Wider Issue releasing 404 culpability
From another perspective there are more pertinent concerns that strike me as worthy of consideration which orbit around discriminatory rule making. The most obvious of which is that such divisions leave gaps for exploitation.
A company of market capitalisation of $100 million could actually be quite a large organisation from a resource perspective however to avoid the rule the board may strategically divide the business up into entities that all fall below the threshold and thus escape Sarbanes & Oxley. Simply stating one set of laws under one condition and another set of mandates for a different class of business are also too loose and the SEC would have to define precise guidelines to close such loop holes, sadly this all complicates what is currently quite a tidy ruling.
A more obscure indisposition of discriminatory rule making is that it sets a president. 404 is applicable or not so because it is perceived difficult and expensive to achieve for small businesses. Now that is a platform for any business to argue for any compliance agenda when an industry is under stress. Then of course if 404 is such an enigmatic hurdle what about 409 and 302, should they be questioned as well. Its a slippery slope of erosion of values and each section of the act leans on other components for completeness. Take one component out and the overall act has a very different meaning. Finally on a point that few seemed to have raised; is where investor funds are pooled across a conglomerate of companies all falling under bar but when unified together are well past the mark, how are they to be treated.
What does seem evident is this remonstration of 404 seems to be a reactive one that needs further thought. Considering revenue in isolation of other business indicators is really unlikely to be a true representation of the risk a business contains and hence interferes with the potential a business has to meet the act.
