(The news featured below is a selection from the news covered in the Federal Securities Report Letter, which is distributed to subscribers of the Federal Securities Law Reports.)

PCAOB Proposes Tiered Funding Formula to Support Board Activities

The new public company accounting oversight board, or PCAOB, has proposed rules to establish the accounting support fee required under the Sarbanes-Oxley Act to fund the board's activities. Section 109 of the act provides that funds to cover the board's annual budget are to be collected from public companies, with the amount due from such companies referred to as the board's accounting support fee.

The PCAOB proposal calls for a four-tiered classification system with investment companies in a separate category. In addition, the board proposes to prohibit an accounting firm from signing an unqualified audit opinion with respect to the financial statements of a company that owes any past-due share of the accounting support fee. The proposed funding system rules will not take effect until approved by the SEC.

The rules would separate issuers into four classes. The first class is meant to capture public companies with market capitalizations greater than $25 million. The second class would consist of investment companies and business development companies with market capitalizations of greater than $250 million. The board decided to treat investment companies as a separate class because the audits of investment companies are not as complex as those of operating companies. In addition, these companies are basically vehicles for holding the shares of other companies, who may themselves have already been assessed an accounting support fee. The third class consists of issuers that, in general, have a basis not to file audited financial statements with the SEC or to file modified financial statements. These entities could include asset-backed issuers, unit investment trusts, and small business investment companies. The fourth class will be composed of companies with average, monthly market capitalizations of $25 million or less, including those that have only debt outstanding, and investment companies with average, monthly market capitalizations of $250 million or less.

The proposed rules go on to set forth what share of the accounting support fee is to be allocated to each of the four classes. Each company in the first two classes will be allocated an amount equal to the accounting support fee, multiplied by a fraction. The numerator of the fraction will be the company's average, monthly market capitalization during the preceding calendar year. The denominator will be the sum of the average, monthly market capitalizations of all issuers in the first and second classes.

For purposes of this allocation, however, the market capitalization of an investment company will be ten percent of the investment company's average, monthly market capitalization. For investment companies that are not traded on a national securities exchange or quoted on Nasdaq, the figure used will be net asset value. This reduction is meant to reflect that investment company audits are relatively less complex than audits of public companies. Finally, all issuers in the third and fourth classes will be allocated a share of zero.

¨ PCAOB Release No. 2003-02 will be published in a forthcoming report.