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Advisory Committee on Smaller Public Companies Considers Recent Views

The SEC's Advisory Committee on Smaller Public Companies yesterday held a teleconference meeting to discuss events and comments since its last meeting and the release of the discussion draft of its final report. The committee's final meeting is April 20 at which it will adopt a final report to submit to the Commission. While some have questioned whether the committee should alter its course of action in response to press reports of opposition to its draft recommendations, Co-chair Herbert Wander reminded the committee that its mandate was to be bold, to think outside the box and to be independent. He believes the committee's recommendations are well-founded. It is up to the SEC whether to implement them or not, he said.

Wander noted that the committee continues to receive new information as the sunset on its charter approaches. A few new ideas were discussed for inclusion in the final report, which will be accompanied by a note that the information requires further study but merits consideration.

Wander said it has become clear that sides have been taken on the committee's draft recommendations. While SEC Chairman Christopher Cox has been reported as saying that exemptions from Sarbanes-Oxley Act section 404 are not in order for smaller companies, Wander believes he will be receptive to the report once it is submitted. Four commissioners have reportedly spoken against the exemptions, but Wander noted that only Commissioner Roel Campos has outlined his preferred approach to section 404 for smaller public companies.

Wander reported that former Corporation Finance Director Alan Beller spoke at the spring meeting of the American Bar Association's section of business law where he expressed his view that the private sector should develop best practices for smaller public companies to follow in satisfying the internal control requirements. According to Wander, Beller also said that he would definitely reopen the PCAOB's Auditing Standard No. 2 for further review. Beller reportedly believes that the inspections conducted by the PCAOB create too much of a fear factor and should be carefully tailored to avoid that result. Wander said that Beller did not support either of the extreme sides of the section 404 debate, but believes that section 404 should be right-sized for smaller companies. Until that is accomplished, smaller public companies should be exempted from the provision, he said.

Wander also addressed an opinion piece and a letter written by former SEC Chairman Arthur Levitt in which he said that he was not in favor of section 404 exemptions. Levitt acknowledged the problems it poses for smaller public companies and the need to nurture small businesses for job creation and innovation, Wander noted. He only differs on the solutions. Wander also cited remarks by former Chairman William Donaldson in which he said that the issue needs further study, and by former Chairman David Ruder expressing his belief that the SEC will provide some relief for small companies.

One development since the committee last met is that the Canadian authorities decided not to add an external auditor attestation of internal controls to its requirements. Wander said that would be noted in the committee's report. On the Congressional front, Wander referred to a hearing on April 5 by Rep. Candice Miller (R-MI) in which a bipartisan group took an active stand in favor of right-sizing section 404. Wander added that Minority Leader Nancy Pelosi (D-CA) has also spoken in favor of providing relief for small companies.

The committee has received over 180 letters in response to the draft recommendations, most of which are from issuers. About 14 are from professional organizations. The Big Eight accounting firms also submitted comments. Wander said he was disappointed by the lack of comments by professional investors, but suggested that the letter by the National Venture Association may be a proxy for some of the institutional investors' views. Companies generally are in favor of the committee's principal recommendation on section 404, while the accounting firms are not. The accounting firms generally favor one standard and the retention of Auditing Standard No. 2. They support a right-size scalable approach rather than exemptive relief, Wander explained. He said the groups may not be as far apart in viewpoints as some may think.

A number of commenters did not support a formal standard setting role for the Committee of Sponsoring Organizations. Wander said that view may create a real policy issue in determining who will right-size section 404.

Wander believes the committee's proposed safe harbor to protect well-intentioned preparers from regulatory or legal action is a critical start to addressing concerns about the choice of appropriate accounting treatments. He reported that there was a lot of support for the idea of field-testing or beta testing internal control procedures for smaller public companies before implementing final standards.

Among the new ideas that were presented for inclusion in the final report was a recommendation to index the numbers for defining smaller public companies so that they do not become stale over time. Another suggestion was to expand upon the SEC's position taken in the Black Box Inc. no-action letter (June 26, 1990). The letter addresses the private offering exemption and integration issues. A third suggestion was that the internal control attestation be expanded beyond auditors to include other certified consultants.

With respect to the latter recommendation, Wander noted that the statute says that the auditing firm must do both the audit and the attestation, but the committee is arguing that the SEC has the exemptive authority to require otherwise. Some may believe the proposal is antagonistic to the concept of an integrated audit, Wander added, but it provides a means to bridge the gap between no external review and the current attestation requirement. The idea needs a lot of fleshing out, he said, but merits a mention in the report without advocating for its implementation.

Mark Jensen, with Deloitte & Touche, said that having someone other than the auditor attest to the internal controls would be duplicative and would increase costs. He has a lot of difficulty with that approach, he said. With respect to another idea that was floated, to have random periodic audits by a regulator, would cost the same whether companies are audited in any given year or not. They would still have to be in compliance, he said. Jensen expressed concern about the lack of an opportunity for accounting firms and others to comment on these ideas.

The committee members were hoping to see the GAO report on many of these same issues before voting on their final report. The report must first be submitted to Congress which then must approve its release. Given that Congress is in recess for two weeks, it does not appear likely that the GAO report will be available before the committee's final vote on April 20.