Hensarling bill would broaden Sarbanes-Oxley 404(b) exemptions

House Financial Services Committee Chairman Jeb Hensarling is proposing to exempt a broad swath of small-cap companies from the auditor attestation requirements in Section 404(b) of the Sarbanes-Oxley Act of 2002.

The provision, which would retool existing exemptions to the requirement, is set to be included in an updated version of Hensarling’s far-reaching Financial Choice Act, according to a recent memo circulated by the Texas Republican.

The auditor attestation requirement is widely seen as one of the most expensive corporate accounting reforms in the 2002 law, mandating that an outside auditor review and report on management’s assessment of internal controls over financial reporting (ICFR).

Today, exemptions to Section 404(b) are governed by a company’s public float. So-called non-accelerated filers, the companies with public floats of less than $75 million, are exempt from Section 404(b).

Hensarling, in the original iteration of the Choice Act in 2016, proposed expanding the exemption to include companies with up to $250 million in market capitalization, as well as banks with up to $1 billion in assets. And in a memo last month outlining updates to the bill for the current congress, Hensarling indicated he plans to double that proposed market cap threshold, to $500 million.

The new Choice Act language is part of a broader debate over the proper scope of Section 404(b) among both lawmakers and regulators, although the debate has historically revolved around public float and not market capitalization.

Large corporations, stock exchanges and industry trade groups have voiced support for broadening the exemptions, while the audit profession and investor groups back keeping the current threshold.

In comment letters last year to the SEC’s proposal in Release No. 33-10107, Amendments to Smaller Company Reporting Definition, a group of industry commenters that included the New York Stock Exchange pushed the commission to raise the ceiling to qualify for the exemption to $250 million in public float from $75 million.

“Section 404(b) is often the most burdensome requirement from a cost perspective, and reforming the accelerated filer definition would provide small companies a great deal of relief,” the NYSE wrote in its July 25, 2016, comment letter.

Deloitte & Touche LLP and BDO USA LLP, in comment letters on the same proposal, opposed the change. They were joined by the Center for Audit Quality (CAQ), an affiliate of the AICPA, and the Council of Institutional Investors (CII), a trade group representing pension funds, who warned that expanding the Section 404(b) exemption would harm investors.

“We believe Section 404(b) continues to be significant as it provides investors with reasonable assurance from the independent auditor that a company maintained effective internal control over financial reporting,” the CAQ and CII wrote in a joint August 30 comment letter. “This assurance is an important driver of confidence in the integrity of financial statements and in the fairness of our capital markets.”

A 2011 SEC staff report, entitled Study and Recommendations on Section 404(b) of the Sarbanes-Oxley Act of 2002 for Issuers With Public Float Between $75 and $250 Million, concluded that “registrants with public floats between $75 million and $250 million did not have sufficiently unique characteristics that would justify differentiating this population of registrants from other accelerated filers with respect to the Section 404 auditor attestation requirements.”

The SEC, in its proposal in Release No. 33-10107, opted against changing the accelerated filer threshold, citing the findings of the 2011 study.

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