The regulator also concluded that smaller companies will have to pay a disproportionately higher amount to comply than larger firms. As a result, Brounstein says the SEC should next question whether 404(b) is actually helping investors in smaller companies or “taking too much out of their bottom line.”
The House bill calls on the SEC to do more studies on 404(b) compliance, including another cost-benefit analysis and a report that could lead to lawmakers deciding that small companies could have a “Sarbox lite” version to follow. There are scaled-down versions of other SEC regulations for “smaller reporting companies” — those with under $75 million in market cap — allowing them to disclose less information, such as in the Compensation Discussion and Analysis section of their proxy statements. The new study would explore whether the SEC should consider revenue as well as market cap when determining which companies have to comply with 404(b). The study would look at companies with public floats of less than $700 million and revenues under $250 million
The reform legislation’s definition of a smaller reporting company differs from the SEC’s. The discrepancy in numbers will likely be worked out in Congress, explains Howard Berkenblit, a partner at law firm Sullivan & Worcester, or it could raise the possibility that some companies that already fully comply with Sarbox (some of the so-called accelerated filers) could get a reprieve. Indeed, another provision in the bill asks the SEC and Comptroller General to see how the burden of 404(b) compliance could be reduced for companies with market caps of between $75 million and $250 million.
Considering revenue when deciding which companies should comply with Sarbox would help firms like Brounstein’s, whose market caps may skew the complexity of their operations. Development-stage companies may have ballooning stock prices because of market excitement over their products but may have little or no revenue. Alan Eisenberg, executive vice president of emerging companies and business development for the Biotechnology Industry Organization, praises the concept of a revenue threshold. Society, he says, “would rather see dollars go into the development of new therapies to alleviate and treat and cure diseases than go into paperwork or regulatory compliance.”
In its 2006 report, the SEC’s small-company advisory committee noted that auditors of smaller firms believe “the smaller the company, the less valuable the internal control audit is to the financial statement audit.” With larger companies, the auditors need to rely more on internal controls, since it’s impractical to test a large number of transactions for complex operations that are in multiple locations.
Not surprisingly, the consultancies and accounting firms that stand to gain from new business are deflecting the notion that 404(b) compliance is an unnecessary “burden” for small business. Critics of the reform legislation insist that the process gets easier over time, and say smaller businesses are especially in need of the scrutiny since they are inherently more risky, with fewer finance staffers in place to provide proper checks and balances. “If they’re going public, they should be following the same rules as everyone else,” says Guy Clarke, a consultant at accounting firm Sensiba San Filippo.
Still, these critics do see both sides and acknowledge there’s not an easy answer, particularly when a lot of small businesses have been struggling in the past 18 months. “It’s an interesting debate, whether you should exempt smaller companies from having their internal controls audited just because it’s expensive,” says Berkenblit.