On March 12, the SEC voted (by a vote of three to one, with Commissioner Allison Lee dissenting) to approve amendments to the accelerated filer and large accelerated filer definitions to provide a narrow carve-out for companies that qualify as smaller reporting companies (SRCs) and reported less than $100 million in annual revenues in the most recent fiscal year for which audited financial statements were available. Most significantly, under the final amendments, companies qualifying for the carve-out will no longer be subject to the SOX 404(b) requirement to have an auditor attestation report on internal control over financial reporting (ICFR), a requirement that applies to accelerated and large accelerated filers. In adopting these amendments, the SEC said that the amendments will “more appropriately tailor the types of issuers that are included in the definitions, thereby reducing unnecessary burdens and compliance costs for certain smaller issuers while maintaining investor protections. The amendments are consistent with the Commission’s and Congress’s historical practice of providing scaled disclosure and other accommodations to reduce unnecessary burdens for new and smaller issuers.” The new rules will become effective 30 days after publication in the Federal Register.

The issue of whether—and how—to address the “accelerated filer” definition has been steeped in controversy for several years. But not, as the designation “accelerated filer” might suggest, because a revision of the definition would allow a new tranche of companies to prepare and file their periodic reports on a more relaxed schedule; that result has been largely disregarded as inconsequential. Rather, the controversy arises out of the potential exemption of these companies from the obligation to obtain a SOX 404(b) auditor attestation on ICFR, a requirement that is viewed as critical investor protection by its advocates, but is anathema to many supporters of deregulation.

Background

In June 2018, the SEC approved amendments that raised the cap for status as a “smaller reporting company” from “less than $75 million” in public float to “less than $250 million.” The amendments also designated as SRCs companies with less than $100 million in annual revenues if they also had either no public float or a public float of less than $700 million. These changes, however, disturbed the previous alignment between the categories of “smaller reporting company” and “non-accelerated filer,” with the result that some companies are now categorized as both SRCs and accelerated filers (or, surprisingly, even large accelerated filers). Many commenters on the proposal took the opportunity to recommend that the SEC increase the public float threshold in the accelerated filer definition to be commensurate with the cap in the new SRC definition, arguing that the costs associated with SOX 404(b) were burdensome and “divert capital from core business needs.”

Although the SEC elected not to raise the accelerated filer threshold at that time, notwithstanding the admitted additional regulatory complexity, Chair Clayton did direct the staff to formulate recommendations “for possible additional changes to the ‘accelerated filer’ definition that, if adopted, would have the effect of reducing the number of companies that qualify as accelerated filers in order to promote capital formation by reducing compliance costs for those companies, while maintaining appropriate investor protections.” As a result, it was widely expected that the SEC would harmonize these filer categories and simply propose to raise the threshold for “accelerated filer” status to align with the SRC cap, as had been recommended by various advisory groups.

But the SEC opted for a scalpel instead of a buzz saw, crafting instead a narrowly tailored carve-out that attempts to thread the needle with regard to the SOX 404(b) controversy, an approach the SEC viewed as analogous to other past approaches that opted for scaled disclosure. However, the resulting framework proposed for determining filer categories and requirements adds another layer of complexity to the current labyrinth, including some rather head-spinning new transition provisions. Notably, commenters on the proposal were predictably split, expressing mixed views on the effect of the proposal on capital formation, decisions to go public and the effect on investor protection. That mix of views was largely reflected in the opinions of the Commissioners discussed below.

Current Rules

Currently, under Rule 12b-2, to be an accelerated filer, a company must have:

  • an aggregate worldwide public float of $75 million or more, but less than $700 million, as of the last business day of the company’s most recently completed second fiscal quarter;
  • been subject to the Exchange Act reporting requirements for at least twelve calendar months; and
  • filed at least one annual report.

A large accelerated filer must have an aggregate worldwide public float of $700 million or more, as of the last business day of its most recently completed second fiscal quarter, and also satisfy the second and third conditions above.

Under the current rules, an accelerated filer can also be an SRC if it has a public float of $75 million or more, but less than $250 million, regardless of annual revenues; or a public float of more than $250 million, but less than $100 million in annual revenues.

Changes to the accelerated filer definition

Under SOX 404(c), companies that are neither large accelerated filers nor accelerated filers are exempt from the auditor attestation requirement for ICFR. The new amendments exclude from the definitions of “accelerated filer” and “large accelerated filer” in Rule 12b-2 any issuer that is eligible to be an SRC and had annual revenues of less than $100 million in the most recent fiscal year for which audited financial statements are available. More specifically, the new amendments add a new fourth condition to the definitions of accelerated and large accelerated filer: that the company not be eligible to be an SRC under the revenue test (in paragraphs (2) or (3)(iii)(B), as applicable) of the “smaller reporting company” definition in Rule 12b-2. (By referring to the paragraphs, the SEC intended to add flexibility in the event the thresholds change in the future.) Although not addressed in this post, the final amendments also exclude business development companies from the definitions under similar circumstances.

SEC rationale for the amendments

The SEC generally believes that including low-revenue issuers in the accelerated and large accelerated filer definitions may involve greater costs and relatively lower benefits, as compared to other issuers, largely because “low-revenue issuers may, on average, be less susceptible to the risk of certain types of restatements, such as those related to revenue recognition.” In addition, the SEC estimates that a company that is no longer subject to the SOX 404(b) requirement would save approximately $210,000 a year, which the SEC viewed as a “meaningful cost savings for many of the affected issuers.” The SEC believes that the costs of the attestation requirement may be disproportionately burdensome for low-revenue SRCs because they “include fixed costs that are not scalable for smaller issuers.”

SideBar

In one example cited by a critic of SOX 404(b), the cost of the controls audit for one small public biotech with fewer than 60 employees and a public float of $85 million added 1% to the company’s burn rate. (See this PubCo post.)

In addition, with regard to electing to go public, the SEC observed that, over the last 20 years, the number of public companies listed on major exchanges has decreased by about 40%, but the decline has been concentrated among smaller companies, those with market caps below $700 million (65% decline) and those with revenues under $100 million (60% decline). According to the SEC, the cost reduction could be a positive factor encouraging companies to go public.

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The proposed changes to the accelerated filer definition reignited the debate that has been ongoing among the Commissioners and in the public sphere about the reasons for the decline in recent years in the number of IPOs and public companies: is the decline attributable primarily to regulatory burden or is it attributable to any of a variety of other reasons, such as the substantial availability of capital in the private markets, the greater maturity expected of IPO candidates, the proliferation of opportunities for liquidity for investors and employees through secondary trading in the private markets, changes to the Exchange Act registration threshold that permit companies to stay private longer or concerns regarding hedge-fund activists that impose short-term pressure for quarterly results.

Many critics of SOX 404(b) have argued that it is a significant contributor to the type of regulatory overload that has deterred companies from conducting IPOs: the attestation audit is just too time-consuming and expensive for many smaller companies. In his statement, Chair Jay Clayton contended that Congress’s retrospective review of SOX in the JOBS Act, which exempted emerging growth companies for five years, has proven to be correct over time: “Providing up to a five-year on-ramp that included an exemption from Section 404(b) for EGCs to join the public markets incentivized more companies to join our public markets and provided public market investors with more investment opportunities. And, importantly, investors have made it clear that this is approach is appropriate.” Commissioner Lee, on the other hand, was not at all convinced that the proposed amendments would encourage more IPOs. She argued that the reasons provided for the rule changes–reducing costs for low-revenue issuers and promoting capital formation—are questionable and not supported by evidence. There “just isn’t evidence,” she contended, to support the idea that companies will be encouraged to go public if they will be relieved “of modest additional costs for auditor attestation.”

Finally, in light of the other protections available, such as the management assessment of ICFR, the aspects of ICFR review that are included in financial statement audits, and the auditors’ requirement to communicate significant deficiencies and material weaknesses in ICFR to management and others, the SEC believes that “the amendments are not likely to have a significant effect on the overall ability of investors in the affected issuers to make informed investment decisions.” Notably, the SEC believes that recently settled actions for failure to maintain effective ICFR could have a deterrent effect.

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In January 2019, the SEC announced settled charges against four public companies for failing to remediate internal control weaknesses—for years! We’re talking seven to ten years. The companies seemed to be under the misimpression that, as long as they disclosed the material weaknesses, they were in the clear. But they learned the hard way that that was not the case. According to Melissa Hodgman, an Associate Director in Enforcement, “Companies cannot hide behind disclosures as a way to meet their ICFR obligations. Disclosure of material weaknesses is not enough without meaningful remediation. We are committed to holding corporations accountable for failing to timely remediate material weaknesses.” (See this PubCo post.)

Although the SEC acknowledges that the amendments “may be associated with some adverse effects on the effectiveness of ICFR and the reliability of financial statements for the affected issuers,” the SEC points to “evidence that suggests that these effects and their impact on investor protection are likely to be mitigated in the case of the affected issuers as compared to other accelerated filers.” According to the SEC, there are probably fewer benefits of the attestation for low-revenue SRCs than for other issuers. The economic analysis indicated that 10% to 20% of restatements and about 60% of financial disclosure fraud cases relate to improper revenue recognition, a problem to which low-revenue SRCs may be less susceptible. In addition, low-revenue companies have, on average, the SEC maintained, restatement rates “three to nine percentage points lower than those for higher-revenue issuers. Moreover, certain low-revenue SRCs likely have less complex financial systems and controls and, therefore, may be less likely than other issuers to fail to detect and disclose material weaknesses in the absence of an ICFR auditor attestation.” Finally, the SEC believes that the financial statements of low-revenue SRCS “may be less critical to assessing their valuation” relative to “their future prospects.”

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Advocates of SOX 404(b), however, have emphasized that internal controls are the backbone of the financial statements, and some auditors view the attestation as more important than the audit itself. According to Audit Analytics, the percentage of adverse internal control auditor attestations decreased from 15.7% in 2004 to 5.3% in 2015. In its 2015 Financial Restatements Report, Audit Analytics “found that after the implementation of SOX there was a massive increase in financial restatements that peaked at 1,851 in 2006. That number declined significantly to just 737 in 2015.” In addition, it “found that the financial impact on net income has also declined. Restatements of $3 billion to $6 billion were made in each year between 2002 and 2006. Since 2008 only one year had a restatement that has impacted net income by more than $1 billion.” Its 2018 Financial Restatements Report showed that total restatements dropped for four consecutive years to an 18-year low. Moreover, there were 171 restatements filed by accelerated filers and 229 by non-accelerated filers. An EY report showed a similar result: following the effectiveness of the SOX attestation requirement, from 2005 to 2016, the number of financial restatements declined by 90%, and the aggregate amount of net income involved in restatements declined from $6 billion to $1 billion. Likewise, advocates contend, a GAO study found that companies exempt from controls audits had more restatements, while another study showed that companies that had controls audits had higher valuation premiums and lower cost of debt. Advocates also note that the cost of the attestation audit has declined over time, particularly incremental costs as part of an integrated audit.

As reported here, in 2019, MarketWatch enlisted Audit Analytics to identify public companies with revenue under $100 million “that received a negative opinion from their auditors on their internal controls over financial reporting. Audit Analytics counted 176 companies that received adverse opinions on their internal controls since 2014. That represents 70% of all adverse internal control opinions issued for all public companies and 16.5% of the opinions issued for companies with less than $100 million in revenue that were required to do so.”

Similarly, the WSJ cited a 2017 academic study that “estimated that 20% of exempted firms had ineffective internal controls from 2007 to 2014. During that same period, just 11% of them actually disclosed such a weakness. They also found that 41% of exempted firms provided insufficient information to identify the causes of the weaknesses in their internal controls, compared with just 7% for firms that were complying with the Sarbanes-Oxley rules. According to the study, the smallest companies not currently exempt from required internal-controls audits would have paid an additional $73,165 a year in audit fees. The SEC estimated that annual costs related to outside audits are higher, around $225,000 per company.”

Relationships among the categories of filers

Although many were hoping for complete alignment of the SRC and non-accelerated filer categories, the SEC elected not to take that leap, in the belief that it would have resulted in greater costs and risks of adverse impact on the reliability of the financial statements of higher-revenue companies. The SEC’s table below illustrates the relationships among the filer categories under the final amendments:

Relationships between SRCs and Non-Accelerated and Accelerated Filers under the Final Amendments
Status Public Float Annual Revenues
SRC and Non-Accelerated Filer Less than $75 million N/A
$75 million to less than $700 million Less than $100 million
SRC and Accelerated Filer $75 million to less than $250 million $100 million or more
Accelerated Filer (not SRC) $250 million to less than $700 million $100 million or more
Large Accelerated Filer (not SRC) $700 million or more N/A

Effect of the final amendments

As noted above, a company subject to the carve-out, in addition to being exempt from obtaining an auditor attestation and report on management’s assessment of ICFR, would no longer be required to file its periodic reports in accordance with the accelerated filer timeframes, nor would it have to provide disclosure regarding unresolved staff comments on periodic reports or whether it made its filings available on its website. Because the SEC elected to pursue a more tailored approach that distinguishes among SRCs, companies with public floats between $75 million and $250 million will still be subject to all of the accelerated filer requirements unless their revenues were under the $100 million revenue cap.

A foreign private issuer is not qualified for status as an SRC or to comply with the requirements for SRCs unless it uses the forms and rules designated for domestic issuers and provides financial statements prepared in accordance with U.S. GAAP. Accordingly, “an FPI would be excluded from the accelerated and large accelerated filer definitions if it qualifies as an SRC under the SRC revenue test in Exchange Act Rule 12b-2.”

The amendments will also add a check box to the cover pages of annual reports on Forms 10-K, 20-F, and 40-F to indicate whether an ICFR auditor attestation is included in the filing. As required under inline XBRL, companies will also be required to tag this cover page check box. Commissioner Hester Peirce remarked that the new check box will make it easy for investors to decide whether they want to invest in companies that have chosen not to devote resources to internal controls audits.

Revisions to the transition provisions under the final amendments

The final amendments also revise the transition provisions applicable to companies exiting accelerated and large accelerated filer status. This structure is designed to avoid situations in which companies enter and exit non-accelerated filer status due to small fluctuations in their public float or revenues. Under current rules, an accelerated filer will not become a non-accelerated filer unless it determines at the end of a fiscal year that its public float had fallen below $50 million on the last business day of its most recently completed second fiscal quarter. Similarly, a large accelerated filer will lose its status as a large accelerated filer if its public float has fallen below $500 million on the same date, becoming an accelerated filer if its public float is at $50 million or more, and a non-accelerated filer if its public float falls below $50 million.

To align the SRC, accelerated filer and large accelerated filer transition thresholds, the final amendments increase from $50 million to $60 million the public float transition thresholds for accelerated and large accelerated filers to become non-accelerated filers and increase the threshold for exiting large accelerated filer status from $500 million to $560 million. These new public float transition thresholds represent 80% of the corresponding initial thresholds, consistent with the approach taken for the transition thresholds for SRC eligibility.

The SEC’s table below shows these changes:

Final Amendments to the Public Float Transition Thresholds

 

Initial Public Float Determination Resulting Filer Status Subsequent Public Float Determination Resulting Filer Status
$700 million or more Large Accelerated Filer $560 million or more Large Accelerated Filer
Less than $560 million but $60 million or more Accelerated Filer
Less than $60 million Non-Accelerated Filer
Less than $700 million but $75 million or more Accelerated Filer Less than $700 million but $60 million or more Accelerated Filer
Less than $60 million Non-Accelerated Filer

 

In addition, the final amendments add more complexity with a new revenue test as part of the transition thresholds for exiting both accelerated and large accelerated filer status. As amended, a company that is already an accelerated filer would remain an accelerated filer unless either its public float falls below $60 million or it becomes eligible to be an SRC under the revenue test in paragraphs (2) or (3)(iii)(B), as applicable, of the SRC definition.

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Note that paragraph (2) of the SRC definition states that a company qualifies as an SRC if its annual revenues are less than $100 million and it has no public float or a public float of less than $700 million. Paragraph (3)(iii)(B) states, among other things, that a company that initially determines it does not qualify as an SRC because it had annual revenues of $100 million or more cannot become an SRC until its annual revenues fall below $80 million. A company that is initially applying the SRC definition or previously qualified as an SRC would apply paragraph (2) of the SRC definition. Once the company determines that it does not qualify for SRC status, it would apply paragraph (3)(iii)(B) of the SRC definition at its next annual determination.

In essence, as the proposing release explained, under the amendments, “an accelerated filer would remain an accelerated filer until its public float falls below $60 million or its annual revenues fall below the applicable revenue threshold ($80 million or $100 million), at which point it would become a non-accelerated filer.”

Similarly, a large accelerated filer would become an accelerated filer at the end of its fiscal year if its public float fell to $60 million or more but less than $560 million as of the last business day of its most recently completed second fiscal quarter and its annual revenues were not below the applicable revenue threshold ($80 million or $100 million). A large accelerated filer would become a non-accelerated filer if its public float fell below $60 million as of the last business day of its most recently completed second fiscal quarter or its annual revenues fell below the applicable revenue threshold ($80 million or $100 million).

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One exception to this requirement is that an issuer that was a large accelerated filer with public float that had fallen below $700 million (but remained $560 million or more) but became eligible to be an SRC under the SRC revenue test in the first year the SRC amendments became effective would become a non-accelerated filer even though its public float remained at or above $560 million.

Below are two (highly enjoyable) examples the SEC provides in the adopting release to illustrate the application of the transition provisions:

“Under the final amendments, an accelerated filer with revenues of $100 million or more that is eligible to be an SRC based on the public float test contained in paragraphs (1) and (3)(iii)(A) of the SRC definition can transition to non-accelerated filer status in a subsequent year if it has revenues of less than $100 million. For example, an issuer with a December 31 fiscal year end that did not exceed the public float threshold in the prior year and that has a public float, as of June 30, 2020, of $230 million and annual revenues for the fiscal year ended December 31, 2019 of $101 million will be eligible to be an SRC under the public float test; however, because the issuer would not be eligible to be an SRC under the SRC revenue test, it will be an accelerated filer (assuming the other conditions [required for accelerated filers] are also met). At the next determination date (June 30, 2021), if its public float, as of June 30, 2020, remains at $230 million and its annual revenues for the fiscal year ended December 31, 2019 are less than $100 million, the issuer will be eligible to be an SRC under the SRC revenue test (in addition to the public float test) and thus it will become a non-accelerated filer.

“On the other hand, an issuer with a December 31 fiscal year end that has a public float, as of June 30, 2020, of $400 million and annual revenues for the fiscal year ended December 31, 2019 of $101 million will not be eligible to be an SRC under either the public float test or the SRC revenue test and will be an accelerated filer (assuming the other conditions [required for accelerated filers] also are met). At the next determination date (June 30, 2021), if its public float, as of June 30, 2021, remains at $400 million, that issuer will not be eligible to be an SRC under the SRC revenue test unless its annual revenues for the fiscal year ended December 31, 2020 are less than $80 million, at which point it will be eligible to be an SRC under the SRC revenue test and to become a non-accelerated filer.”

Transition

The final amendments will become effective 30 days after publication in the Federal Register and will apply to annual reports due on or after the effective date. Accordingly, even if the annual report is for a fiscal year ending before the effective date, the company may determine its status as a non-accelerated, accelerated or large accelerated filer based on the final amendments: e.g., a March 31 FYE company with a 10-K due after the effective date may apply the final amendments to determine its filing status even though its FYE precedes the effective date; if it determines it is eligible to be a non-accelerated filer, it will not be required to provide an ICFR auditor attestation for its annual report due and submitted after the effective date and may comply with the more relaxed filing deadlines and other accommodations for non-accelerated filers.

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In 2011, the SEC’s Office of Chief Accountant examined the costs of the attestation requirement and reported to the SEC that there was no “specific evidence that [any savings from rolling back 404(b)] would justify the loss of investor protections.” In a similar vein, commenters on the proposal raised concerns that, “rather than targeting issuers where there may be relatively fewer benefits of the ICFR auditor attestation requirement, the amendments will remove this requirement for exactly those issuers where the benefits may be greatest.” For example, they contended that “investors react more strongly to news of restatements or material weaknesses in ICFR…at small or low-revenue issuers.” At the time of the proposal, former Commissioner Robert Jackson criticized the proposal on that basis, and commissioned his office to study “how investors react to news of an internal control failure in two groups of companies: those that would receive a rollback of 404(b) under today’s proposals and those who would not. The evidence is striking. The data show we are proposing today to roll back 404(b) for exactly the group of companies where investors care about the benefits of auditor attestation most.” As part of its economic analysis, however, the SEC conducted additional analyses and did “not find any evidence that investors react more negatively to restatements or to auditors reporting material weaknesses in ICFR at low-revenue issuers than at higher-revenue issuers.”

Commenters also contended that the cost of the amendments would significantly outweigh the benefits and that the proposal did not adequately consider the risk of fraud, which could be particularly high for low-revenue companies. The SEC conducted supplemental analyses and did not find support for those contentions. In particular, the SEC analyzed the fraud risk and

“did not find evidence based on the available data that low-revenue issuers that, like the affected issuers, are not within five years of their IPO (‘seasoned’ issuers), are more highly represented in the set of seasoned issuers associated with financial misconduct or financial reporting fraud than they are in the overall population of seasoned issuers. We also estimated the extent to which expanding the exemption from the ICFR auditor attestation requirement could affect the likelihood of the affected issuers engaging in such activities and include a quantification of the associated costs of this risk in our overall assessment of the potential costs of the amendments. Overall, this supplemental analysis does not cause us to change our primary conclusions regarding the potential effects of the amendments.”

Commissioners’ views on the final amendments

While the SEC did not hold an open meeting to vote on adoption of the final amendments, some of the Commissioners did post statements. As noted above, the split of views among the commenters was also reflected in the views of the Commissioners:

Clayton. In his statement (which was replete with his own graphics), Chair Clayton viewed the amendments as “a much needed recalibration of three categories of reporting companies—smaller reporting company, accelerated filer and large accelerated filer.” Considering the amendments with a broader perspective allowed him to “enthusiastically support” adoption. First, he argued, Congress had already determined that smaller issuers and EGCs should be exempt from SOX 404(b) and, as noted above, that approach had already proven to be correct. The amendments extend the SOX 404(b) relief to only a “subset of companies—small, former EGCs,” which are “a particular focus” of his. Second, ICFR and the interaction between SOX 404(a) and 404(b) processes has evolved and “financial reporting, ICFR and the audit process have become more systematized and integrated.” Third, the vast majority of public companies will not be affected; smaller, low-revenue companies that will benefit from the rule represent in the aggregate less than 1% of total market cap—slightly over 500 companies—for which “the cost of unnecessary regulation is most acute.” Finally, Clayton has not heard investors in foreign companies complain about the absence of an auditor attestation for those companies. While they may express concerns about the control environment in general, U.S. companies differ in that they are subject to a “multi-faceted regulatory structure” that he believes provides for an effective control environment. For example, even in the absence of 404(b) attestation requirement, these companies will “still be required to have their principal executive and financial officers certify that, among other things, they are responsible for establishing and maintaining ICFR and have evaluated and reported on the effectiveness of the company’s disclosure controls and procedures, will continue to be subject to a financial statement audit by an independent auditor who is required to consider ICFR in the performance of that audit and will still be subject to the independent audit committee and other requirements of Sarbanes-Oxley.”

Peirce. Ideally, Commissioner Peirce would have made SOX 404(b) entirely optional for all companies, based on market demand. That not being possible, given the Congressional imperative, she was “disappointed” that the SEC had “not fully re-aligned the SRC and non-accelerated filer definitions.” Nevertheless, she was pleased that at least some companies would benefit from the new rule, particularly biotechs that would have more funds to invest in R&D—maybe even a new vaccine for a virus. She was concerned, however, given the overlap between financial audits and internal controls audits, that “auditors accustomed to being compensated handsomely for internal controls audits may have a financial incentive to increase certain assessments under the financial statement audit for these newly exempt issuers,” in effect, shifting costs by folding “a back-door internal controls audit into their financial statement audits.” Ultimately, though, in her view, the final rule was “a balanced one.”

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You might recall that in her previous statement regarding the proposal, Peirce indicated that, while she supported the proposal, she had reservations about its scope. Although she viewed the proposal as “a step in the right direction,” she did not believe that it went “far enough….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.” The resulting complexity in the definitions, she said, required a navigation tool to comply. (Taking into account the rather byzantine transition provisions, she may have a point!)

Lee. Commissioner Lee, who dissented on the vote, opened her statement, with something between a protest and a lament: “in the face of extensive objection from investors, we strip away a layer of investor protection for financial reporting…. Eliminating the auditor attestation removes a critical gatekeeping function that we know works to improve the reliability of financial reporting for investors. And we sacrifice this important protection for an admittedly modest cost reduction for issuers that could well be negated by an increased cost of capital.” Although some advocated going even further by excluding all SRCs from the accelerated filer definition, “a balanced approach means more than just declining to go as far as we could. When the changes we do choose to make are, time and again, opposed by investors, that should give us pause.” While she acknowledged that there were “valid concerns on both sides of the policy choice,” she expressed concern that investors’ views had not been given adequate consideration—on this proposal as well as a number of other recent actions, such as the proxy guidance issued last August (see this PubCo post), proposed changes to the shareholder proposal submission thresholds last November (see this PubCo post), and the accredited investor proposal last December (see this PubCo post), among others. “There must be a limit,” she said, “to the number of times we can credibly assert to investors that we act in their best interests by making policy choices they directly oppose.”

In her view, the elimination of the SOX auditor attestation requirement for low-revenue SRCs rolls back an important protection that SOX put in place following major accounting scandals. The amended rule reduces the role of the auditor as gatekeeper in protecting those controls—“the first line of defense in detecting and preventing material errors or fraud in financial reporting.” Although auditors still review internal controls as part of their audits, she contends that there is “a significant difference between that review and an opinion from auditors as to the adequacy of internal controls. Attestations are designed to, and do, heighten and focus the attention of those in a position to ensure efficiency and compliance. Attestations increase accountability and they work. It’s a kind of ‘buck stops here’ approach that is lost under the new rule.” She also questioned as counterintuitive a suggestion in the economic analysis “that the market reacts positively to the disclosure of ineffective internal controls at low-revenue issuers. Respectfully, such a result, at a minimum, deserves deeper scrutiny. Unfortunately, it will be too late for us to consider public comment on this point, or any of the other substantial new analysis in the release.”

In addition, she questioned whether the modest cost savings that might be realized would necessarily be ploughed back into the business. Instead, any savings “may well be diminished or even negated by an increase in the cost of capital for issuers that do not have auditor attestations….Thus, while the benefit to public markets of the rollback is unclear, its effect is not. There will be less information for investors about the quality of internal controls, less detection of ineffective internal controls, and less accountability for management regarding its assessment of internal controls.”