Bracing for SOX 404 Small Business Exemption

Exempting smaller publicly-traded companies from the onerous 404 section of the Sarbanes Oxley (SOX) accounting reform
law, -- a prospect being pondered by the Securities and Exchange Commission (SEC) –may cause some CPA firms to reposition resources.

Charles Jones, a partner with the Marshall Jones & Co. CPA firm in Atlanta and operator of a 404 boutique practice, said that group is already planning to shift its focus from 404 compliance to helping smaller companies with their internal audits. Alyssa Martin, a risk assurance partner and leader of 404 services at the Weaver & Tidwell regional CPA
firm in Dallas, said her practice may move some people and resources to fraud prevention services and it may increase its services related to Statement of Auditing Standard 70, which applies to controls of information technology.

The SEC's Advisory Committee on Smaller Public Companies is scheduled, in April, to issue a final report on whether companies of under $125 million in market capitalization and under $125 million in annual revenue should be exempted from SOX’s 404 provision. This provision requires companies to establish and maintain internal controls for financial reporting and prepare annual reports of the control processes. A cottage industry has emerged for CPAs to offer 404 assistance services as third parties because companies’ auditors are prohibited from helping their audit clients in the 404 work, since that work is a non-audit service.

The committee favors exempting smaller companies because the costs of 404 compliance are disproportionately high for them –companies of under $100 million revenue would have to pay more than 2.5 percent of their total revenues to comply, versus one or two tenths of a percent of revenue cost for companies with over $1 billion in revenue. After receiving the full committee report in April, the SEC could opt to leave the 404 requirement in tact, eliminate it or reduce its scope for smaller companies.

The potential market for 404 services to smaller companies is vast. The SEC reports that 50 percent of all public companies have market caps of under $100 million.

Jones originally expected some significant volume for the 404 boutique, but now says that the work “was spotty at best” because the high costs of compliance prompted many smaller public companies to handle all the work on their own.

Martin noted that her practice had, over the past year, helped some 15 larger public companies meet their 404 requirements and was expecting work from the smaller companies to pick up in 2006 when those companies faced their first reporting deadlines. The SEC, last year, extended the deadline for meeting the first wave of 404 reporting requirements to July 15, 2006, for “non-accelerated filer” companies of under $700 million in market cap; this was the second such extension since SOX became law in 2002.

“We thought there might be some work from smaller companies in 2006, but with this (the SEC’s consideration of a 404 exemption for smaller companies), the sense of urgency won’t be there,” Martin said. Jones said the second extension was an indication that the sense of 404 urgency would never be there for smaller companies.

Leaders at JH Cohn, the super-regional firm in Roseland, N.J., say that an exemption for smaller companies would likewise prompt them to shift some resources they had set aside for 404 compliance services. But Anthony Zecca, partner in charge of consulting, noted that the firm’s 404 services have been directed mainly at larger companies.

“We knew all along this would be price sensitive market for the smaller companies,” he said. Cohn’s SOX compliance services business, in total, (404 and other provisions of the act) increased 50 percent over the past year, he added.

While some small companies have become more aware of the need for reporting system soundness as a result of the potential to be subject to 404, others have been ducking the issue hoping for an SEC exemption, according to the CPAs contacted for this story.

“Some smaller companies have seen the 404 regulation as a process improvement issue and have stepped forward while others are looking at the SEC’s considerations (for the exemption) and saying ‘Whoosh, We won’t have to do this,” said Martin.

However, Zecca and Martin both noted that, regardless of any 404 rule exemption, a separate SOX provision, 302, requires companies’ chief executive and chief financial officers to affirm in annual reports, that their companies’ reporting controls are sound.

Meanwhile, there’s growing concern that a 404 exemption for smaller companies could be a prelude to a wider movement of separate rules or “differential standards” for smaller versus larger companies. “We already have a steady onslaught of new regulations and this is big step toward creating a tapestry of so many rules that it will become an era when regulations drive marketing,” said Gale Crosley, a practice management consultant in Atlanta.

She said that if the SEC approves the exemption, CPA firms could conceivably start developing niche practices dedicated to different size company clients, much the way niche practices now focus exclusively on specific industries or practice specialties.

Peyton Burch, a CPA and chief operating officer of the Enterprise Resource Group technology consulting firm in Houston, agreed that practice niches for different size clients may evolve. “Different size companies have different resources and manpower levels and different risks so accountants’ marketing should respond accordingly. One company’s accounting department may include an entire accounts payable group, while another may have just two people in all of accounting, so you approach each very differently,” he said.

Allan D. Koltin, president of the Practice Development Institute practice management consulting firm in Chicago, said the SEC’s consideration on 404 could prompt accounting firms to market to lower-cap public companies in the same ways they reach out to non-public companies. That, among other things, could mean lower fees for the smaller public companies.

Koltin called the SEC’s consideration the first sign that “the pendulum is swinging the other way” in the federal government’s crackdown on financial reporting after the Enron scandal a few years ago.

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