Congress Must Stop SOX From Hurting the Little Guy

Excessive costs related to Sarbanes-Oxley (SOX) — specifically Section 404 — are well documented.

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Private sector and government reports, testimony at congressional hearings and even the findings of a special committee established by the Securities and Exchange Commission (SEC) examining SOX’s impact on small public companies point to an unruly law whose unintended consequences are damaging the growth and profitability of innovative small companies.

But will SOX’s regulatory excesses lead to compliance relief for small firms? That’s a fair question given the government’s grim track record of making changes to accommodate cost concerns expressed by business.

Some held out false hope that the SEC would fully adopt the widely supported recommendations of its Advisory Committee on Smaller Public Companies. But in outlining its “next steps” this week for SOX implementation, the SEC offered no exemptions for small public companies and announced that “ultimately all public companies will be required to comply with the internal control reporting requirements of Section 404.” Instead, they will offer better guidance to improve compliance and aim to make it more cost-effective.

Section 404 is the notorious piece of SOX, which, at the extraordinary expense of promising growth companies, is generating remarkable wealth for the accounting industry. It requires public firms to perform annual testing of internal controls and calls on management to evaluate whether these are adequate. Independent auditors are required to sign off on management’s assessment.

Compliance has been expensive and time-consuming for small firms with limited staff and cash. Various studies, for example, have found:

● Average compliance costs at $1 million
● Costs are 16 times greater for a company with market capitalization of $100 million or less versus a large company of $1 billion-$4.9 billion
● Legal and accounting work for an IPO costs nearly $2 million (up from $500,000 a few years ago)
● In 2005, only 56 venture-backed companies went public on U.S. exchanges – a healthy IPO market is double that number
● 75 community banks have filed to go private since the beginning of 2003
● 37 U.S. companies are currently listed on the AIM run by the London Stock Exchange – 19 of those have been listed within the past year
● An increasing number of firms are opting to stay private

Another Well-Intended Plan?

In its plan, the SEC doesn’t quite scold the accounting industry for using Section 404 to gouge business. However, they appear to incorporate steps that reign-in meandering audit activity, thus expenses, by including SEC inspections of the Public Company Accounting Oversight Board (PCAOB) on their inspections process of Section 404 audit work. The latter of which is intended to “improve Section 404 oversight” through more efficient and cost-effective audits.

If this all sounds like more bureaucracy being deployed to resolve inefficiencies in Section 404 compliance, that assessment may turn out to be quite accurate. After all, this is government.

SEC intentions are likely well intended, however. With respect to the SEC step that it will issue guidance to management “to assist in its performance of a top-down, risk-based assessment of internal control over financial reporting,” the Commission fully intends that it will be “scalable and responsive” to the individual circumstances of smaller public companies.

“As we go forward, we will consider the special concerns of all companies that fall under our jurisdiction – large, small, foreign and domestic,” said SEC Chairman Christopher Cox in announcing the series of actions on “getting it right” regarding Section 404 compliance.

Still, the SEC plan does not resemble what small public companies were seeking with respect to exemption relief, nor (at least not yet) the more direct and simple approach of scaling currently illogical and complex internal reporting requirements to the size and risk factors associated with smaller companies in the aggregate.

Will the SEC Plan Appease Congress?

Bipartisan concern over the impact of SOX has generated movement in the Congress to right-size Section 404 requirements for small public companies.

Senator Jim DeMint, R-S.C., and Rep. Tom Feeney, R-Fla., introduced the Competitive and Open Markets Protecting and Enhancing the Treatment of Entrepreneurs (COMPETE) Act concurrently in the Senate and House on May 17, the same day the SEC released its action plan. Rep. Gregory Meeks, D-N.Y., joined Rep. Feeney as a lead sponsor of the bill in the House.

COMPETE maintains core SOX accountability components — like increased transparency, prohibitions on conflicts of interest and enhanced internal controls — while providing flexibility for small and mid-size firms on Section 404 compliance. It directs the SEC to create an alternative system — standard guidelines — for companies that opt out of Section 404.

The bill requires the SEC to clarify the standard determining material weakness, and to release guidelines for measuring such terms as “reasonable,” “significant,” and “sufficient.” Internal auditors would be able to communicate and get advice from external auditors.

One of the goals of the bill’s authors was to spur the SEC to action. Now that the SEC has spoken, it remains to be seen whether Congress views their plans as substantive enough to back off.

Definitive Rules Desired by Small Companies

The SEC’s plan to improve Section 404 compliance is currently fraught with many unknowns. With words like “intends,” “yet to be determined,” and “consideration of possible alternatives” strewn throughout the action plan, it appears small business is not getting the certainty — or definitive relief — they desire. The only certainty is that small companies will be required to comply with the internal control reporting requirements of Section 404. Perhaps the process will be better, but there is no guarantee it will be less expensive.

Excessive costs are the crux of the issue for small business and for congressional reformers who want the U.S. to remain competitive.

“Sarbanes-Oxley was well intended but it is actually crippling businesses across America,” said Senator DeMint in introducing COMPETE. “America will never be the best place in the world to do business unless we stop penalizing companies through unnecessary regulation.”

Movement at the SEC and in Congress responding to small business concerns indeed is a positive development. While we can continue to hope for the best from the SEC, the COMPETE Act offers more clarity, certainty and flexibility for small firms. Congress should continue to press forward with this legislative remedy.

Karen Kerrigan is president & CEO of the Small Business & Entrepreneurship Council, a research and advocacy group based in Washington, D.C. that works to protect small business and promote entrepreneurship. She is also founder of Women Entrepreneurs, Inc., an association helping women business owners succeed through education, networking and advocacy. Kerrigan can be reached at

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