Statement at Open Meeting on Proposed Amendments to Sarbanes Oxley 404(b) Accelerated Filer Definition
May 9, 2019
Thank you to the staff of the Divisions of Corporation Finance, Investment Management, and Economic and Risk Analysis and the Offices of General Counsel and Chief Accountant for your hard work on this proposal. It has been a long road for you, but I am happy to see the proposal before us today.
Almost one year ago, we adopted amendments to our definition of smaller reporting companies, or SRCs. I voted in favor of those amendments, but with reservations about their scope. Today, we will vote to propose further, related amendments, this time to our definition of accelerated filers, and again I will support the proposed amendments but with reservations about their scope.
Last year, our amendments expanded the pool of companies that qualify as SRCs and therefore are eligible for scaled disclosure. These changes were necessary and marginally beneficial, but failed to provide meaningful relief for smaller public companies. First, the amendments failed to offer newly qualified companies relief from the auditor attestation requirement of internal controls required by section 404(b) of Sarbanes-Oxley. Second, they introduced unnecessary complexity into the definition of SRC and accelerated filer.
Section 404 is intended to improve companies’ internal controls. Section 404(a) requires management to maintain adequate internal controls and to conduct an annual assessment of the effectiveness of those controls. Section 404(b) requires that an outside auditor attest to and report on the management’s 404(a) assessment. Since Sarbanes-Oxley’s passage in 2002, 404(b) has remained controversial due to the considerable expense it imposes on companies subject to its requirements.
Before last year’s amendments, any company that qualified as an SRC also was explicitly exempt from the requirements of 404(b). This structure provided not only the benefits of a reduced burden for SRCs, but also was simple to understand and for smaller companies to apply. When we, the Commission, created the SRC category in 2007, we justified its creation, in part, as a means of streamlining and simplifying the disclosure process for smaller companies. Regulatory compliance and disclosure costs often represent a greater proportion of a smaller company’s expenses than of its larger counterparts’ costs, because some of the expenses are relatively fixed regardless of a company’s size. Smaller companies also typically have few staff dedicated to disclosure and compliance issues, so simplification can be a considerable help to these companies.
Unfortunately, we undid our own work last year by breaking the link between SRCs and non-accelerated filers. A company may now qualify as both an SRC and an accelerated filer. Such a company enjoys the benefits of being an SRC, but nevertheless must submit the auditor attestation required by 404(b).
While last year’s amendments provided some relief in the form of scaled disclosure, they did not provide the much-desired relief from 404(b). Today, we consider offering 404(b) relief to a portion of the companies that newly qualify as SRCs following last year’s amendments. This proposal is a step in the right direction, which is why I intend to support the proposal. Yet, it still does not go far enough. The complexity remains; there still will be many SRCs that are also accelerated filers. The process of determining whether a company is an SRC and a non-accelerated filer, or an SRC and an accelerated filer, or outside of both categories is so complicated that even we at the SEC need diagrams to figure it out. The fact that we ourselves struggling to understand our own regime does not bode well for smaller companies trying to follow our rules without the benefit of a staff of seasoned securities attorneys.
I suspect that we also are missing the substantive mark. We are not proposing to exempt all SRCs from 404(b), and the SRCs that are not exempt will continue to receive auditor bills for 404(b). We currently lack the data to provide a clear picture of what the costs of 404(b) compliance are, especially for smaller companies. Our Division of Economic and Risk Analysis has assumed an increased cost of 25 percent for companies that must provide 404(b) attestations versus comparable companies that do not. Although I understand the Division’s rationale for using this number, given the dearth of current data that specifically targets this cost, it is difficult to know whether this number is correct. We have some anecdotal information suggesting it may be. At a small business roundtable the Office of the Small Business Advocate held here on Monday, for example, we heard from one CFO who estimated that his company’s audit costs could increase by 20 to 33 percent when they no longer qualified as an emerging growth company or EGC and therefore became subject to 404(b)’s attestation requirement. This specific experience—becoming newly subject to 404(b) due to the expiration of EGC status—is one that is especially relevant now as many companies that went public in the wake of the JOBS Act’s creation of the EGC category age out of that designation and face 404(b) requirements for the first time. I hope that those of you facing these costs will submit comments on our proposed rule and help to fill out the data in this area. It can be difficult for us to accurately parse the total costs that we see and allocate the correct portion specifically to 404(b).
Commissioner Jackson has mentioned an analysis that his staff performed using recent data. I have not yet received a copy of this study, but look forward to reviewing it with the comments we receive from the public.
I also hope to hear from commenters about the structure of the SRC and accelerated filer designations generally. Is the proposed structure too complex? Would it be better to realign the SRC and non-accelerated filer definitions by pegging both to the current SRC thresholds?
I am pleased that we are taking this step toward expanding the pool of companies exempt from 404(b) auditor attestations. I worry about the effect of this requirement on our public markets, in particular its effect on smaller companies deciding whether the costs of going public outweigh the benefits. In many instances, investors would rather see their money being used for something other than 404(b) compliance, such as research and development or hiring new employees. I look forward to hearing from those of you who will comment on the proposal, and hope that we will provide meaningful relief in the form of a final rule in the coming months.
 Hester M. Peirce, Commissioner, Securities and Exchange Commission, Statement at Open Meeting on Amendments to Smaller Reporting Company Definition, June 28, 2018, available at https://www.sec.gov/news/public-statement/peirce-statement-smaller-reporting-companies-062818.
 U.S. Securities and Exchange Commission, Release No. 33-8876, Dec. 19, 2007.
 Securities and Exchange Commission Small Business Roundtable, May 6, 2019, webcast archive available at https://www.sec.gov/news/upcoming-events/small-business-roundtable-050619.