A group of U.S. senators and representatives introduced a bill on Wednesday that would exempt small companies from compliance with Sarbanes-Oxley Section 404, the controversial provision governing internal controls over financial reporting.
Under the bill, a company could opt out of the requirement to assess its internal controls and have its auditor attest to that assessment provided the company had a total market capitalization under $700 million, total product revenues under $125 million, or fewer than 1,500 shareholders. A company could also opt out if it had been a public issuer for less than a year or had never been required to file an annual report.
In a move of possibly sweeping implications for financial reporting, the bill would also change the standard of materiality for reporting controls weaknesses to 5 percent of net profits. Under current rules, controls weaknesses must be reported if there is “more than a remote likelihood” that a misstatement is “more than inconsequential” and will not be prevented or found. By drawing a bright line, the bill departs radically from the Securities and Exchange Commission’s reigning materiality guidance under Staff Accounting Bulletin No. 99, which specifically rules out the use of a percentage threshold to determine materiality.
Another provision of the bill would change auditor-independence rules “to allow prudent interaction between [independent auditors] and internal consultants.” The change is important because 404 “has created a hostile atmosphere between companies and their auditors,” Rep. Tom Feeney (R-Fla.), one of the bill’s framers, told CFO.com.
The bill also proposes a system of random 404 audits. After the first year in which a company’s auditors attest to and report on its controls assessments, the company would be subject to those requirements on a random basis. At least 10 percent of the issuers listed on each national securities exchange would receive a 404 audit each year; random selections would be administered by the exchanges themselves.
The random-audit system would “reduce 9 out of 10 cents in compliance costs but still have a chilling effect on any criminal or negligent” activity, Feeney said.
Called the Competitive and Open Markets that Protect and Enhance the Treatment of Entrepreneurs (COMPETE) Act, the bill was introduced by senators Jim DeMint (R-S.C.), Mel Martinez (R-Fla.), and John Ensign (R-Nev.) and representatives Feeney, Pete Sessions (R-Tex.), Candice Miller (R-Mich.), and Gregory Meeks (D-N.Y.).
Explaining the reason for the bill, Session’s press secretary, Gina Vaughn, said that “the problem is that corporate costs for Section 404 are [higher] than ever intended.” With more and more companies delisting or moving to foreign exchanges because of 404, she added, the provision is “driving capital out of the country.”
Asked if offering small companies the choice of whether or not to comply would hurt investors by making financial reporting less transparent, Feeney replied that investors could decide for themselves whether to place a premium on 404 compliance. “Some will only invest in companies that voluntarily comply,” he said, “other investors may come to another conclusion.”