Stalling on Sarbox

The regulatory-reform bill passed by the House last week suggests that lawmakers will either exempt smaller companies from getting internal-controls audits or put off the decision for yet another year.

Rick Brounstein, CFO of microcap company NewCardio, hopes one day to be required to comply with the auditor-attestation requirement of the Sarbanes-Oxley Act, known as Section 404(b). Really, he does.

Presuming the time comes when NewCardio’s technology, which is designed to improve the accuracy of heart tests, goes to market and begins to collect significant revenue, the business could become more complicated, more global, and more needing of external checks on its internal controls over financial reporting, Brounstein says.

Until then, though, Brounstein doesn’t see a need to pay the extra auditing fee plus the additional man-hours to deal with the review process. He says complying with Section 404(b) would be an unnecessary expense, one that regulators have been unable to quantify for the smallest publicly traded companies since Sarbox was passed in 2002.

For the 2007 and 2008 reporting cycles, NewCardio reported it had effective internal controls. But doing the management report is easier “without having to write down all the stuff you do so that the auditor can see that you did [it],” says Brounstein. He couldn’t specify how much 404(b) would cost him, but he knows the added expense could affect next year’s budget.

At the moment, though, there’s a real possibility he won’t be required to comply. Promising it would be the last delay for companies with market capitalizations under $75 million, the Securities and Exchange Commission recently said those companies will have to provide 404(b) reports for 10-Ks filed for fiscal years ending after mid-June 2010. However, a key piece of legislation passed last week by the House of Representatives would give smaller companies yet another delay — or even a full exemption — from the requirement, as long as their market caps stay below a certain threshold.

The cluttered Wall Street Reform and Consumer Protection Act of 2009 carries several contradictions within its 1,279 pages. Despite the name, it would roll back the most onerous provision in the other major reform bill passed in this decade, Sarbanes-Oxley. The legislation simultaneously calls for another year-long delay for compliance, an exemption for the smallest of companies, and another study of the costs and benefits of full Sarbox compliance.

To be sure, the provisions could be tweaked or even deleted when the Senate puts its stamp on the legislation early next year. Still, political winds during the downturn could work in small businesses’ favor, according to Herbert Wander, a partner at law firm Katten Muchin Rosenman, who co-chaired the SEC’s Advisory Committee on Smaller Public Companies. “Everyone wants to get on the bandwagon to support small business,” he says. “It’s good for jobs and also good politically.” In 2006 Wander’s committee (of which Brounstein was also a member) recommended that, depending on revenue, some small-cap and microcap companies should be exempt from 404(b) unless regulators could come up with guidance tailored to their needs.

Earlier this year, an SEC study reported that the cost of Sarbox compliance has gone down over time. The commission concluded that larger companies — those that have had to fully comply with Section 404 — paid a mean total of $2.87 million when they first began following Sarbox, and expect to pay a mean of $2.03 million for their next internal-controls report. The commission figures the audits of their internal controls will cost a mean of $583,753 in fees.


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