Small and midsized CPA firms may have a lot at stake in the latest Congressional wrangling over the onerous 404 internal reporting provision in the Sarbanes-Oxley (SOX) accounting reform law. A government watchdog group’s finding that compliance with 404 has been far more expensive for public companies than originally expected has renewed debate over making compliance less rigorous for smaller companies.
“This report leads me to caution the Securities and Exchange Commission (SEC) against creating complex and cumbersome regulations that have the potential to place small businesses in a paralyzing state of regulatory limbo and damage their ability to create jobs,” U.S. Sen. Olympia Snowe, head of the Senate's Small Business Committee, told the Associated Press when asked about the study by the General Accountability Office (GAO).
THE GAO found that costs of compliance with 404 have been higher than anticipated for all companies, but especially so for smaller companies of under $75 million in market capitalization. It further found a “significant increase in public companies going private to avoid having to comply with the requirement,” noting that approximately 2 percent of all public companies privatized in 2004
The SEC has for years been grappling with how to apply 404 to small businesses in response to that sector’s cry that compliance costs are disproportionately high for them. Commission Chairman Christopher Cox has ruled out exempting small business from 404, but has noted that rule must be applied “in a cost-effective and investor-protected way.”
CPA firms, particularly small and midsized ones, may have a lot at stake in the issue as the GAO report indicates that they have been a main beneficiary of SOX’s application to smaller companies. The GAO found that mid-sized and small accounting firms conducted 30 percent of total public company audits in 2004, up from 22 percent in 2002, but the Big Four and other large firms continue to dominate the overall market, auditing 98 percent of U.S. publicly traded company sales or revenues.
Section 404’s requirement that companies file reports on the strength of their internal financial controls has provided a boon to smaller CPA firms because while the companies’ auditors are responsible for auditing the 404 reports, SOX restricts the non-audit services that they can provide their audit clients. And so they have called in smaller CPA firms and other third parties to provide some of the 404 preparation assistance.
In addition to third-party 404 work, smaller firms in recent years have gotten some of the smaller audit clients that large firms have had to shed in order to provide all the SOX-required services to their more lucrative larger clients.
Cox has rejected an SEC advisory committee’s recommendation earlier this year that smaller companies be exempted from 404. The GAO report does not recommend an exemption, and if anything it commends SOX, noting the regulators, investors, auditors and public companies themselves generally agree that SOX “has had a positive and significant impact on investor protection and confidence.”
However, the GAO report stresses that SOX has hurt some smaller companies’ ability to remain public, adding that its overall impact “remains unclear because the majority of smaller public companies have not fully implemented section 404.” To address concerns from smaller public companies, the SEC has several times extended their deadline for 404 compliance, with the latest extension to 2007, the GAO report notes.