The SEC plans to finalize a rule in the fall of 2018 to revise the regulatory definition of “smaller reporting company” and let more companies submit filings with fewer disclosures.
The market regulator’s timing for the final rule appeared in the latest update to its rulemaking agenda.
The rules, if adopted, would come about two years after the SEC in June 2016 proposed to allow companies with a public float up to $250 million to qualify as smaller reporting companies in Release No. 33-10107, Amendments to Smaller Reporting Company Definition. The current threshold is $75 million.
In 2015, about 32 percent of companies registered with the SEC had less than $75 million in public float, compared to 42 percent when the smaller reporting company definition was set in 2007, according to Release No. 33-10107. If the $250 million threshold is adopted, 42 percent of public companies will qualify as smaller reporting companies and be eligible for a number of exemptions from Regulation S-K and Regulation S-X. Reg S-K lays out the disclosure requirements for registration statements and annual and quarterly reports while Reg S-X sets the form and content of financial statements in SEC filings.
Small companies are exempt from Reg S-K’s requirement to prepare stock performance graphs, ratios of earnings to fixed charges, and compensation committee reports. Small companies can provide executive compensation data for three named executive officers instead of the five executives that large companies have to report. They also need to include two years of comparison in the management’s discussion and analysis (MD&A) section of a regulatory filing instead of three. Small companies need to provide only two years of income and cash flow statements, instead of three, under Reg S-X.
The SEC’s Advisory Committee on Small and Emerging Companies, which had recommended the increased market value threshold, welcomed the proposal. However, it was disappointed that more companies will not be exempt from the auditor attestation of management’s internal controls as required by Section 404(b) of the Sarbanes-Oxley Act of 2002. Currently, companies with public floats of less than $75 million, or “nonaccelerated filers,” are exempted.
Public companies often complain about the costs of complying with Section 404(b), and the small company panel recommended that the SEC change the definition of “accelerated filers,” which are companies with a market value between $75 million and $700 million. The advisory committee recommended raising the threshold to $250 million, and businesses also backed the increase in comment letters to the SEC.
But in 2011, the SEC said in Study and Recommendations on Section 404(b) of the Sarbanes-Oxley Act of 2002 for Issuers With Public Float Between $75 and $250 Million that it “found no specific evidence that any potential savings from exempting” more companies from Section 404(b) “would justify the loss of investor protections and benefits to registrants from such an exemption.” The SEC said accelerated filers that were subject to Section 404(b) requirements generally had a lower restatement rate than those not subject to the auditor attestation.
However, since the staff’s study, academic research has shown mixed findings, according to Release No. 33-10107. While the SEC is not proposing to raise the accelerated filer threshold or modify Section 404(b) requirements, Release No. 33-10107 said that the SEC is seeking opinions about revising the range for accelerated filers.
Participants in the SEC Government-Business Forum on Small Business Capital Formation in 2016 also recommended that the commission change the definition of smaller reporting company and nonaccelerated filer to include companies with less than $250 million in public float.
While SEC Chairman Jay Clayton has not said he plans to exempt more companies from Section 404(b), he has said his priorities include finding ways to encourage more companies to go and stay public at a time when the number of initial public offerings (IPOs) has significantly declined. Businesses and their lobbying groups have largely blamed the reporting rules for public companies for the slow pace of IPOs and have sought more exemptions from SEC disclosure rules or scaled-down versions of them for small companies. The auditor attestation requirements for internal controls are among the rules that are most frequently criticized.
However, auditors and investor advocates oppose widening the exemptions because such a move would be a “detriment” to investors and capital markets.
Sarbanes-Oxley included the requirements to verify the effectiveness of the internal controls over financial reporting to prevent a repeat of the accounting scandals at Enron and WorldCom.
“Complying with Section 404(b) has a benefit for issuers,” Cynthia Fornelli, executive director of the Center for Audit Quality, and Jeffrey Mahoney, general counsel for the Council of Institutional Investors, wrote in a joint comment letter to the SEC. “Academic research has demonstrated that the cost of capital for companies that voluntarily comply with Section 404(b) is lower than peer companies and has decreased for public companies since enactment of the Sarbanes-Oxley Act, especially for smaller companies.”
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