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SEC and PCAOB Chairs Testify on Section 404 Impact on Small Business

The Senate's Small Business Committee yesterday considered the impact of Sarbanes-Oxley Act section 404 on the smaller public companies that will have to submit their first management reports on internal controls for fiscal years ending after December 14, 2007. The first section 404 audit reports would be filed in March 2009, based on the latest extension granted by the SEC. Committee Chairman John Kerry (D-MA) and ranking member Olympia Snowe (R-ME) have asked for a further delay of an additional year from the time the SEC issues final guidance for management. SEC Chairman Christopher Cox, testifying before the Committee, noted that four years after the adoption of the Sarbanes-Oxley Act, over 6,000 public companies are still not required to provide the audited internal control reports required by section 404.

Cox noted that the SEC has delayed section 404 compliance for smaller companies because of the disproportionately higher costs they face compared to larger companies. The SEC and the PCAOB are working together to address the unique concerns of small businesses, he said. Cox added that the Sarbanes-Oxley Act and section 404 have corrected the most serious problems uncovered in the securities markets in recent years. Congress's focus on internal controls was not a mistake, he said. It was the right thing to do.

Cox stands by the SEC's previous statement that it will consider further postponing the section 404 audit report requirements if the additional guidance for management on the assessment of internal controls is not adopted in sufficient time to be used for the annual reports for 2007. However, he reported that the SEC intends to finish its work in the next few weeks in coordination with the PCAOB's work on its proposed auditing standard.

PCAOB Chairman Mark Olson advised that the Board is also in the final stages of replacing Auditing Standard No. 2 with a revised Standard No. 5. Small businesses constitute the largest segment of the entities affected by the PCAOB's audit standards, he said. The overwhelming majority of audit firms registered with the Board are small firms. Of the 1,700 firms registered with the PCAOB, about 1,000 are U.S. firms. Only about 125 of those firms have more than five public company clients. Over 450 firms registered even though they were not the auditor of record for a public company at the time.

Snowe asked about complaints that the SEC's proposed guidance and the PCAOB's proposed standard were not harmonized. Olson said that is exactly what they are trying to achieve with their revisions. The SEC's guidance for management should promote more efficiency since the audit standard will no longer be the de facto standard on which management must rely, he said. Olson believes a lot of the initial costs of section 404 were due to an overabundance of caution. The Board has since learned how to make the standard more effective and efficient, he said.

Cox agreed. He said one of the areas on which the respective staffs are focusing in the remaining weeks is the harmonization of terms. Some critics have said that the SEC's guidance is more principles-based, while the PCAOB's is more prescriptive. Cox said they are trying to harmonize their approaches. Otherwise, the more prescriptive approach becomes the de facto standard.

The Committee also heard from a second panel of small business representatives. Thomas Venables, the president and CEO of Benjamin Franklin Bancorp, Inc., said it is urgent that the SEC give small businesses one full year from the effective date of the guidance for management to prepare for compliance. He was alarmed that there was no mention of the SEC's intent to do so at its recent meeting. Their first reports are due in March, he said, so small businesses need to know the rules with which they are expected to comply.

Venables also proposed that the SEC update the shareholder thresholds that trigger registration under the 1934 Act. The level has not changed since 1964, he said. Given the number of investors in public companies today, he said the level should be raised to between 1,500 and 3,000 shareholders, rather than the current threshold of 500.

Jacquelyn Lumb