Will Time Help?: SOX 404 Compliance

September 21, 2005 marked the first open meeting of the Securities & Exchange Commission (SEC) under its new Chairman Christopher Cox.
More importantly, at that meeting the SEC approved a one year extension
for compliance with Sarbanes Oxley (SOX) section 404 for
non-accelerated filers.  [1]  The
Commission also proposed creating new categories for large accelerated
filers, who would be the only category subject to the initial phase-in
period and would make it easier for some companies to move from
accelerated to non-accelerated filer status. [2]

Section 404 of SOX requires companies to perform an audit of internal controls.  One
of the most controversial sections of the act, under the current rules
accelerated filers must include in its annual report an audit by
independent auditors and a report by management that cover the
company’s internal controls over financial reporting. [3]  For
accelerated filers the first internal control reports must be included
for the first year ending on or after November 15, 2004.  Prior
to the September 21 meeting non-accelerated filers and foreign issuers
were required to file internal control reports for the first year
ending on or after July 15, 2006. [4]  The announced extension changes that date to July 15, 2007. [5]


companies have complained of the increased audit costs resulting from
the regulation and the burden that it places on the company.  Even
for companies with pre-existing internal controls, the process of
documentation and the inclusion of an additional section in the annual
report is tedious, time consuming and expensive. [6] The SEC has
admitted that many large companies had difficulty meeting their
deadline. [7] Adding to the problem is that non guidance has been
issued by the SEC sub-committee for section 404 small business
compliance.  Thus, although the implementation
date has been extended twice before, small companies continue to
express concern about their ability to meet the deadline. 


makes this extension different is that the added 15 months may affect
the decisions of small companies contemplating going public.  Furthermore, it allows current small public companies to pursue exit strategies such as going dark or going private. [8]  In
such a scenario a company with under 300 shareholders (500 if the
company has less than $10 million in assets for the prior 3 years) can
suspend its reporting obligation by filing a form with the SEC.  Companies
with over the maximum shareholders may pursue transactions such as a
leveraged buy-out, a tender offer, or a reverse stock split in order to
take advantage of the non-reporting requirement.  However, the process is longer, more expensive and subject to more scrutiny by the SEC.  [9]  Nevertheless
the extension may provide enough time for small businesses to complete
the necessary steps before the new effective date of section 404. 


extending the deadline for small companies, the SEC has proposed the
creation of a third category of issuer, large accelerated filers.  [10]
These companies would be those with a public float over $700 Million,
subject to the SEC reporting requirements for over a year, has filed at
least one annual report and is not eligible to use the small business
forms (10-KSB and 10-QSB).  [11] An accelerated filer would be a company with a pubic float between $75 and $700 Million.  All
who do not fit into these first two categories would be non-accelerated
filers. [12] Such a change may help smooth the transition of section
404 implementation as many current accelerated filers may be
reclassified as non-accelerated filers.  This
reclassification would give companies extra time to file their
quarterly and annual reports required by section 404 which may help
alleviate the burden.


idea that has been proposed, though not by the SEC, is that the
creation of three issuer categories could allow an out for smaller
companies who are most affected by the regulation.  Under this plan, large accelerated and accelerated filers would be subject to the current rules.  However, smaller companies, with public floats under $75 million, would be exempt from the section 404 regulations.  Such a change would solve the compliance problem for the vast majority of small public companies.  However, it would not do much to help mid-sized companies who would really feel the crunch.  Where
as a large company can spend a few million on internal control audits,
audit costs can quickly become a large percent of mid-sized companies

The SEC has set a 30-day period for comments and it is likely that the SEC will act on the proposals shortly thereafter.  Until
then companies have few more answers than before, but with the benefit
of time, they may have more options available to them and maybe there’s
still hope that Section 404 won’t be the undoing of many mid-small
public companies simply due to its burden and cost.



Press Release, Securities and Exchange Commission, SEC Votes to Propose
Changes in Filing Deadlines and Accelerated Filer Definition; Postpone
404 Compliance Date for Nonaccelerated Filers; Propose Issuing Section
28(e) Interpretive Guidance 2005-134, available at

[2] Id.

[3] Sarbanes-Oxley, 17 C.F.R. §210.

[4] Id.

[5] Press Release, Securities and Exchange Commission, supra note 1.

[6] Stephen Taub & Dave Cook, PCAOB, SEC: 404 Costs Too High, CFO.com, May 17, 2005, http://www.cfo.com/article.cfm/3982049?f=TIF071805

[7] Id.

[8] See Marc Morgenstern & Peter Nealis, Going Private: A Reasoned Response to Sarbanes-Oxley?, http://www.sec.gov/info/smallbus/pnealis.pdf.

[9] Id.

[10]  Revisions
to Accelerated Filer Definition and Accelerated Deadlines for Filing
Periodic Reports Release No. 33-8617 (proposed Sept. 22, 2005) available at

[11] Id.

[12] Id.