A&A Update – Proposed Amendments to Sarbanes Oxley 404(b) Accelerated Filer Definition

On Thursday, May 9, 2019, the U.S. Securities and Exchange Commission (SEC) voted to issue a proposal that would provide significant relief to many public companies from the requirement that their auditors attest to management\’s financial controls in Section 404(b) of the Sarbanes-Oxley Act. The vote was not unanimous as Commissioner Robert Jackson, Jr. dissented. His dissent cites that the proposal was based on “data that’s over a decade old” and further states that he conducted his own analysis using current data and, “It’s clear that this proposal has no apparent basis in evidence.”  Jackson also cited the reasons why Congress initially passed the Sarbanes-Oxley Act (the accounting debacles at Enron and WorldCom cost American families more than $85 billion) by saying, “One problem at Enron and WorldCom was that corporate insiders were free to make decisions of enormous consequence without adequate controls to ensure those decisions were disclosed to investors.\”

The proposal was passed by vote of 3 to 1 and includes three primary changes:

• Exclude from the accelerated and large accelerated filer definitions an issuer that is eligible to be a smaller reporting company (SRC) and had no revenues or annual revenues of less than $100 million in the most recent fiscal year for which audited financial statements are available
• Increase the transition thresholds for accelerated and large accelerated filers becoming a non-accelerated filer from $50 million to $60 million and for exiting large accelerated filer status from $500 million to $560 million
• Add a revenue test to the transition thresholds for exiting both accelerated and large accelerated filer status

This proposal has been anticipated since the SEC published Release No. 33-10513, Amendments to Smaller Reporting Company Definition in June 2018 that raised the SRC threshold, which expanded the number of companies that were eligible to scale down some of the disclosures required for accelerated fillers under Regulations S-K and S-X.  That amendment increased the threshold to qualify as an SRC from $75 million to $250 million (based on public float) and from $50 million to $100 million (based on revenue).  However, the amendment passed in June 2018 did not make any changes to the accelerated filer and large accelerated filer thresholds, which drive the requirements for compliance with Section 404(b).

The amendments proposed on May 9, 2019, would revise the accelerated filer and large accelerated filer definitions in Rule 12b-2 of the Securities Exchange Act of 1934. Currently, accelerated filers are companies that have a public float of $75 million to $700 million and any public company that falls within or above this range is required to undergo an external audit of its internal controls over financial reporting (ICFR).  This proposal will exclude companies from the definitions of accelerated and large accelerated filers if they are SRCs and have annual revenues of less than $100 million in their most recent fiscal year (if the public float is under $700 million). This proposal essentially aligns the definition of an SRC with an accelerated filer as long as the registrant has under $100 million in revenue, and, as result, these companies will not be subject to Section 404(b).

Proponents of the proposal believe that the cost of compliance for smaller companies is not commensurate with the benefits received.  William Hinman, Director of the SEC’s Division of Corporation Finance stated, \”We believe that the proposal frees up resources for companies that may need them most,\” and \”The benefits of the ICFR auditor attestation requirement may be smaller for issuers with lower revenues because…they generally have less complex financials, and they may be less susceptible to risk of certain kinds of restatement misstatements such as those related to revenue recognition.\”

The following tables summarize the current and proposed threshold for both smaller reporting companies (SRCs) and accelerated filers.

Commissioner Hester Peirce expressed concern of the complexity that will arise from further confusion of the various reporting buckets that a registrant will now have to monitor by saying, \”This is adding complexity in this area, which requires us to do diagrams so that we can track that ourselves and see which companies fit into which bucket,” and “I am concerned that for a smaller company trying to figure out what it needs to do and which bucket it falls into, it\’s almost like they are going to have to get a Waze navigation system to figure out.\”

However, for financial institutions, relief is not so straightforward.  Banks must consider the additional factors related to the requirements of Section 36 of the Federal Deposit Insurance Act and Part 363 of the Federal Deposit Insurance Corporation\’s regulations, which state, “For each insured depository institution with total assets of $1 billion or more at the beginning of the institution\’s fiscal year, the independent public accountant who audits the institution\’s financial statements shall examine, attest to, and report separately on the assertion of management concerning the effectiveness of the institution\’s internal control structure and procedures for financial reporting.”  Under those rules, a bank is required to have an external audit of its ICFR if the beginning of year assets reported on its call report exceed $1 billion.  This threshold would require many financial institutions to continue to undergo an ICFR audit even if the requirements of Section 404(b) do not apply.