(The news featured below is a selection from the news covered in the Federal Securities Law Reporter.)

Advisory Committee Adopts Preliminary Recommendations 

The Advisory Committee on Smaller Public Companies has approved preliminary recommendations to the SEC that will be included in a draft report. The committee will meet again in January 2006 to approve the version of the report that will be circulated for public comment. A final report will be approved in March 2006 for submission to the SEC. Among the committees' preliminary recommendations is that the SEC should exempt microcap companies from Sarbanes-Oxley Act Section 404, subject to enhanced corporate governance standards, and should exempt smaller public companies from the external audit requirements of Section 404.

The subcommittee's working definition of a microcap company is the lowest one percent of all U.S. public companies with a market capitalization in the $100 to $125 million range and revenues of no more than $125 million in their last fiscal year. Smaller public companies would be defined as those that are in the lowest six percent of U.S. public companies with a market capitalization between $700 million and $750 million and revenues of no more than $250 in the last fiscal year.

Janet Dolan, the chair of the internal controls subcommittee, explained that her group arrived at the decision to propose the exemption from Section 404 partly based on the disproportionate costs and burdens that Section 404 imposes on microcap and smaller public companies. The subcommittee also concluded that the risk of management override is significant in smaller companies so internal controls over financial reporting are not as effective in detecting or preventing fraud by senior executives.

The full committee adopted all of the subcommittees' recommendations, with some minority votes against, or abstentions, on specific items. One of the most widely debated items was a statement in the subcommittee's recommendation that "a question remains" as to whether the Public Company Accounting Oversight Board's Auditing Standard No. 2 is appropriate, even with the guidance that has been provided, and whether it is time to reevaluate or to amend the standard. A number of committee members were concerned that the statement would be interpreted as a recommendation to reopen Auditing Standard No. 2, which some of them opposed.

The committee members discussed a separation of the statement from the other recommendations, but some feared that by separating the statement, it would appear to be an even stronger recommendation. The members ultimately voted to retain the statement as part of the set of recommendations but to improve upon the language to ensure that it is not read as a recommendation to reopen Auditing Standard No. 2.

Another split vote occurred on the subcommittee's recommendation of an alternative standard if the SEC determines that some level of auditor reporting on smaller public company controls should be retained. The alternative standard would provide for an external audit of the design and implementation of internal controls but would not involve the testing of the operating effectiveness of the controls. Ms. Dolan explained that the subcommittee was so committed to providing relief for smaller public companies that it chose to give the SEC an option if it determines not to go with either of its first two recommendations.

The committee also approved a recommendation to ask the PCAOB to seek greater clarity and to encourage more cost-effectiveness in the application of Auditing Standard No. 2 and a recommendation that the SEC staff carefully analyze whether certain categories of issuers should be exempted from the Section 404 requirements, such as debt-only issuers, biotech companies or initial public offerings. The subcommittee did not have time to identify all of the special cases that may need relief, according to Ms. Dolan.

Kurt Schacht, the executive director of the CFA Centre for Financial Market Integrity and a member of the Section 404 subcommittee, cast the single dissenting vote in the drafting of the subcommittee recommendations. He explained that the exemptions would throw out the directives of Congress, the SEC and the PCAOB. Schacht also questioned whether the SEC has the authority to exempt companies from Section 404 and said the question should be resolved to prevent any legal challenges.

The corporate governance and disclosure subcommittee presented 10 recommendations, two of which are currently the subject of SEC actions. The SEC recently adopted amendments to the periodic report filing deadlines that will retain the current filing deadlines for non-accelerated filers.

The committee had been asked by the Section 404 subcommittee to consider enhanced corporate governance and disclosure standards for companies that would be subject to the Section 404 exemption under its proposal. The subcommittee referred to these enhancements as governance hygienics, and relate to audit committee independence, whistleblower procedures and the ability to hire consultants, as needed. The enhancements also would include disclosure about the exempt companies' internal control environment in place of the auditor attestation requirement.

The subcommittee also proposed a change in the ownership thresholds that trigger SEC reporting requirements, clarifying the Sarbanes-Oxley Act loan prohibition rule, changing the requirement for audited financial statements from three years to two, and providing for Internet delivery of a wide range of SEC filings similar to the SEC's proposal on proxy materials. The subcommittee also proposed more cost effective SEC forms, including wider availability of Form S-3 to cut down on duplicate disclosure, and the establishment of a task force to eliminate duplicative government filings. The problem is particularly pervasive in the banking industry, according to the group. The subcommittee also recommended that the SEC upgrade the EDGAR system.

The full committee took a separate vote on the subcommittee's recommendation that beneficial owners for purposes of Exchange Act Sections 12(g) and 15(d) exclude holders of unexercised options issued in compensatory transactions. Two members opposed the recommendation, but the full package of recommendations was approved by majority vote.

The accounting standards subcommittee also presented 10 recommendations. The subcommittee proposed that the Financial Accounting Standards Board permit microcap companies to apply the same effective dates as private companies for implementing new accounting standards. FASB should be encouraged to pursue objectives-based accounting standards, according to the members, and the standards should be simpler and easier to apply. The subcommittee recommended that the SEC adopt a de minimis provision in connection with the auditor independence rules and provide additional guidance on materiality with respect to previously issued financial statements.

The subcommittee echoed the corporate governance subcommittee's recommendation to require only two years of financial information rather than three. The subcommittee recommended a safe harbor from regulatory or legal actions where the accounting is well-intentioned and the appropriate process is followed.

The SEC and the PCAOB should promote competition among audit firms, and the PCAOB should consider continuing professional education requirements, under the recommendations. The PCAOB should determine if its May 2005 guidance is being appropriately applied, while the SEC should determine whether the structure of the Committee of Sponsoring Organization should be strengthened. Finally, the subcommittee said the SEC should provide more resources to assist smaller public companies with their reporting and legal requirements. The full committee voted unanimously to adopt the recommendations.

The vote on the capital formation subcommittee's recommendations was also unanimous. The recommendations included a new private offering exemption without prohibitions on general solicitation and advertising, a streamlined registration process for private placement broker-dealers, an easier process for going private and amendments to Rule 701.