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Advisory Committee Agrees on Definition of Smaller Public Company

The Advisory Committee on Smaller Public Companies yesterday voted to recommend to the SEC that it further delay, for another year, the compliance date for non-accelerated filers to comply with the internal control provisions over financial reporting. The Committee also agreed on a definition for smaller public companies that would include those that fall within the bottom 6% of total market capitalization, determined on an annual measurement date. Microcap companies would be those that fall within the bottom 1% of total market capitalization.

Janet Dolan, the CEO of Tennant Co., provided a status report for the subcommittee on internal control over financial reporting which focused on several major areas of concern. The subcommittee believes that the internal control provisions have fostered a climate of fear in the audit profession because of the perceived risk exposure. Among the major drivers of costs for small companies is the scarcity of resources, including the lack of internal staff or expertise to implement the section 404 provisions. The time pressure also has driven up costs. Emerging companies are burdened by having to comply with the internal control provisions while also struggling to meet the other obligations of a public company.

Dolan said the subcommittee will further consider auditors' risk aversion and liability, the tone at the top in the context of fraud prevention in the audit process and disclosure, the impact of revenue size and the obligations of the company versus the auditor. The subcommittee will also continue to review special needs of microcap companies and whether the internal control provisions are appropriate given the unique nature of their investors. Dolan said the subcommittee chose to table for now any consideration of the special needs of emerging companies until it completes its work in the other areas. The resolution of the other areas may reduce the special needs for emerging companies, she explained.

In recommending a further delay in the compliance with the internal control provisions by non-accelerated filers, Dolan said the subcommittee is currently assessing companies that have already complied with the provisions. It makes sense to hold off bringing small companies and foreign private issuers on board until the Advisory Committee has completed its work, she said. During the extended time frame, Dolan said that additional guidance, learning and best practices may develop.

After a unanimous vote to submit the subcommittee's recommendation to the Commission, Drew Connelly, president of IBA Capital Funding, asked whether the Committee could ask that it be fast-tracked, given the newly constituted Commission. Committee Co-chair Herbert Wander, a partner in the law firm Katten Muchin Zavis Rosenman, said that it could and that the SEC contemplated that some of the recommendations would be presented before the Committee concludes its mission.

Richard Jaffee, chairman of Oil-Dri Corp. of America, reported that the corporate governance and disclosure subcommittee is not ready to make recommendations yet, but its initial view is that the next phase-down date for accelerating the filing of Forms 10-K and 10-Q should not be implemented. The other subcommittees reported an initial agreement with this view. There is no measurable benefit to investors, Jaffee explained. Any major developments will be reported on Form 8-K to keep investors informed. The subcommittee also preliminarily decided against recommending that the SEC reduce the number of items reported on Form 8-K and against eliminating the loan prohibition in the Sarbanes-Oxley Act.

The size subcommittee's definition of smaller public company will guide each subcommittee's work. Alex Davern, chief financial officer of Nat'l. Instruments Corp., reviewed the research the subcommittee conducted in reaching its recommended definition, which was aided by the SEC's Office of Economic Analysis. Davern reported that the regulatory burden on large and small companies is not proportional. Audit fees for smaller companies are 30 to 40 times more expensive as a percentage of revenue than for large companies, and section 404 compliance is 50 times greater.

The Advisory Committee will next meet in San Francisco on September 19-20.