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One More Year
On March 2, 2005, the Securities and Exchange Commission granted non-accelerated filers — companies with a public float of $75 million or less — and foreign private issuers filing annual reports on Form 20-F or 40-F a 1-year extension for compliance with SEC rules adopted under Section 404 of the Sarbanes-Oxley Act (SOX) of 2002. The rules require companies to:
- include in their annual reports a report by management on the company's internal control over financial reporting and an attestation as to the same by the company's independent auditor (Items 308(a) and (b) under Regulations S-K and S-B);
- evaluate, as of the end of each fiscal period, any change in internal control over financial reporting that occurred during the period that has materially affected, or is reasonably likely to materially affect, the company's internal control over financial reporting (Exchange Act Rules 13a-15d or 15d-15(d)); and
- include certain representations regarding internal control over financial reporting in the certificates by the company's principal executive and financial officers that are filed with its annual and quarterly reports (Exchange Act Rules 13a-14(a) and 15d-14(a)).
Under the terms of the extension, a company that is a non-accelerated filer or foreign private issuer must begin to comply with the requirements listed above for its first fiscal year ending on or after July 15, 2006. For a company with a Dec. 31 fiscal year end, this would require that management's report and the auditors' attestation be included in the company's Annual Report on Form 10-K or 10-KSB for the fiscal year ended Dec. 31, 2006, which would be filed in March 2007. Unlike the management/auditor reports and officer certifications, the evaluation of changes in internal control over financial reporting would need to be included in the first periodic report after the first annual report including management's report — in the example above, the Quarterly Report on Form 10-Q or Form 10-QSB for the first quarter of 2007.
Factors Prompting the Extension
The SEC's extension is attributable in part to feedback from small companies and their advisers, indicting that Section 404 places a disproportionate burden on these companies that is not offset by a corresponding benefit to the company or to the investing public. Under Section 404, a $10 billion company and a $10 million company are both currently governed by the same internal control framework and auditing standards. Costs of complying with these rules can be substantial, and companies with small revenue bases are less able to absorb these costs. A report issued in February 2005 by the American Electronics Association stated that Section 404 expenses are significantly greater as a percentage of revenue for small companies than they are for larger ones. Based on data from a Financial Executives International Study, the report stated that Section 404 compliance costs represented less than 1% of revenue for companies with over $100 million in revenue, as compared with more than 2.5% for companies with under $100 million in revenues.
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