September 20, 2005
Update: 24th Annual SEC Capital Formation Conference
Our Commentary on the conference from yesterday's meeting.
US Securities & Exchange Commission 24th Annual Government-Business Forum on Small Business Capital Formation
Holding this meeting in San Francisco, the SEC is trying to get input from various industry experts and investors to understand how to deal with the tricky issue of supporting small company innovation and growth while still serving the public’s needs for transparency and accountability.
It is no surprise that the Sarbanes-Oxley Section 404 has cost more than anyone ever thought. Per the SEC’s Commissioner, Paul Atkins, “Twenty times our original estimates of $98,000 per company”.
While this is costly to larger organizations, it can be catastrophic for smaller and startup companies. So the SEC has been holding a series of round tables around the United States since April of this year to hear from the public on these matters and to seek solutions.
Along with the Capital Formation Forum, the SEC Advisory Committee on Smaller Public Companies is having a meeting today as well. They seek to help the SEC understand how to possibly modify the Section 404 implementation so that smaller public companies can comply without drowning in “one size fits all” legislation.
After attending the initial meeting of the SEC Advisory Committee on Smaller Public Companies in April in Washington DC, the progression of ideas and definitions of the committee is impressive. Part of the problem in this thorny issue is: “What is a small public company?” Sounds simple but it really is not. What about market capitalization? With increases in natural resource prices, some companies have been thrust into larger valuations without any increase in staff. What about revenue? Some companies do not have revenue but have a great deal of spending going on which causes exposure to investors. Examples would be early stage mining companies or development stage drug companies. What about number of investors? Currently, employee option holders are added to the total number of shareholder, causing some private companies to be required to register as public companies. Many issues and paratmeters to consider.
It appears that the definition that is gaining ground is “total market capitalization” not just public float. This simplifies the calculation. This is the current definition that the SEC has used for determining if a company is an accelerated filer. The other part of this definition that is probably going to stick is making two classifications of smaller companies: 1) $100 - $700 million market capitalization as smaller companies and 2) Sub $100 million market cap as “microcap” companies.
The reason for the distinction is that currently all companies over $75 million in market capitalization (as of June 2004) headquartered in the US were considered Accelerated Filers for the Section 404 certification purposes. So two considerations from this change are important: 1) Some companies who are currently considered Accelerated Filers may become non-accelerated filers and 2) The requirements of “Smaller Public Companies” and “Microcaps” may differ.
The thinking is that companies of $700 million still do not have the resources of the largest public companies but should be subject to some more Section 404 requirements than the very smallest companies.
These breakpoints were arrived at as follows: 80% of US public companies provide only 6.4% of the US public market capitalization or less than $700 million. Approximately 50% of the US public companies account for only 1% of the US public company market capitalization or less than $100 million. Therefore, the exposure to the public for these smallest companies, from an exposure point of view is more limited and should be treated differently.
Testimony given by the public yesterday clearly favored maintaining the Section 404 legislation in place. This testimony was provided by securities lawyers and investment bankers in the Bay Area of San Francisco. Most of those testifying represented companies who mainly work with larger organizations. The smaller companies have the ear of the SEC and are getting help. No roll back in sight for the Accelerated Filers.
I posed a question to SEC Commissioner Paul Atkins on the delay. I asked if the size calculation was to apply to only US based companies or to all companies no matter where they were based. He wrote some notes and indicated that he had not considered that. I told him that Canadian companies are treated the same way as US companies on the exchanges. I wondered why size would the determinant and not location of headquarters, especially when dealing with Canadian GAAP is almost identical to US GAAP. He seemed favorable to considering size only. This only makes sense when it comes to exposure. The markets are equal opportunity so it seems market capitalization should not be subject to headquarters locations, especially when Canada is the question.
Those testifying and a summary of their position on SEC Guidelines and Section 404 is as follows:
Kenneth Hahn, Senior Vice President/CFO, Borland Corporation, Cupertino, CA: He believes that the largest cost from Section 404 has been the “over testing” of mundane transactions. This has increased cost without increasing benefit to shareholders. This is due to Audit firms being overly conservative from fear of reprisals.
Gerald Niesar, Partner, Niesar Curls Bartling LLP, San Francisco, CA: Supports a formal registration of unlicensed “finders” who raise money for smaller public companies but are not licensed. He proposed a less stringent and less expensive system to register these individuals.
Donald C Reinke, Partner, Reed Smith, Oakland, CA: He has experienced doing a public offering the London AIM (Alternative Markets) exchange. He said it does not involve approval by regulatory authorities but rather prospectuses are “vetted” by lawyers and accountants. He found the process less painful and 40% less costly. The AIM exchange has experienced very few bankruptcies. Many US companies are listing on AIM to access public markets and not comply with Sarbanes-Oxley.
Lynn E. Turner, Managing Director of Research, Glass, Lewis & Co: He was formerly with the SEC and was instrumental in getting Section 404 into the Sarbanes-Oxley legislation. He deeply believes in the legislation and has submitted a questionnaire to the SEC that he says could be used to help do low cost internal controls work for companies. He does not want to see the legislation rolled back for any size company.
Richard Ueltschy, Executive, Crowe, Chizek and Company LLC, Louisville, KY: As a non-Big Four audit firm, he indicated that he has seen much more competition in audit work in the Section 404 area. He indicated that those companies who do NOT use the Big Four Audit firms have begun to experience a 40% reduction in integrated audit costs for the second year. Those who have stayed with the Big Four have not experienced such reductions.
Ann Walker, Partner, Wilson, Sonsini, Goodrich & Rosati, Palo Alto, CA: She wants to see auditor attestation removed as a requirement for the smallest public companies because it is the big cost driver. She also wants the SEC to change the regulation for companies who issue options to employees and have more than 500 option holders not to have to register as a public company. She says these option holders are not shareholders and these compensatory options should not be dealt with in the same way as options issued for investment banks.
Chris Ailman, Chief Investment Officer, California State Teachers Retirement System, Sacramento, CA: He does not believe that there should be any roll back of Section 404. He believes that investor trust is too important. He says that his fund lost 15% of its value after Enron and thinks the costs of Section 404 are worth it. His fund only deals in larger companies due to their size, $135 Billion.
Irwin Federman, General Partner, US Venture Partners, Menlo Park, CA: He believes that Section 404 is like a fisherman with a net where the holes are too small. This legislation catches everything in it not just the bad guys. He thinks it has unintended costs and not much benefit. He also believes that the SEC needs to require hedge funds to register because there is a lot of abuse in that sector.
Bill Hambrecht, Founder, Chairman and CEO of W. R. Hambrecht, San Francisco, CA: He thinks the materiality level of PCAOB Audit Standard #2 is too high at 5%. He thinks you can hide a lot of fraud at that level. But he also thinks that the wrong emphasis has been placed on mundane transactions. He thinks revenue and inventory tell the story.
Jon Hickman, Vice President, Equity Research-Technology, MDB Capital Group LLC, Santa Monica, CA: He thinks the costs of Section 404 are too high and the benefits are not high enough.
Michael McConnell, Managing Director, Shamrock Capital Advisors, Burbank, CA: He likes Section 404 and the transparency it brings. He thinks the cost of capital is lowered. He deals with companies of all sizes. He thinks the investors’ voice has been lost until Sarbanes-Oxley.
Andrew Shapiro, President, Lawndale Capital Management, LLC, Mill Valley, CA: He thinks good governance is key. He likes the independence theme in Sarbanes-Oxley and thinks this is key. He would support a tiered system of Section 404 implementation for various sizes of companies so that they could comply more cost effectively.
Today, September 20th, the SEC Advisory Committee on Smaller Public Companies presents its recommendations to the SEC and the public for their consideration. As of yesterday, they are batting a thousand since SEC Commissioner pre-announced the delay was announced for Section 404 certification for another year for smaller public companies as well as a decision not to accelerate annual and quarterly reporting times for smaller public companies. This will be officially announced by the SEC tomorrow.
Wednesday the SEC will render its official details of delays in Section 404 and the acceleration of reporting deadlines for 10Q and 10K.
For ways to cut costs in your Sarbanes-Oxley reporting, see www.issuescentral.com and learn more about the Compliance Playbook(tm).
US Securities & Exchange Commission 24th Annual Government-Business Forum on Small Business Capital Formation
Holding this meeting in San Francisco, the SEC is trying to get input from various industry experts and investors to understand how to deal with the tricky issue of supporting small company innovation and growth while still serving the public’s needs for transparency and accountability.
It is no surprise that the Sarbanes-Oxley Section 404 has cost more than anyone ever thought. Per the SEC’s Commissioner, Paul Atkins, “Twenty times our original estimates of $98,000 per company”.
While this is costly to larger organizations, it can be catastrophic for smaller and startup companies. So the SEC has been holding a series of round tables around the United States since April of this year to hear from the public on these matters and to seek solutions.
Along with the Capital Formation Forum, the SEC Advisory Committee on Smaller Public Companies is having a meeting today as well. They seek to help the SEC understand how to possibly modify the Section 404 implementation so that smaller public companies can comply without drowning in “one size fits all” legislation.
After attending the initial meeting of the SEC Advisory Committee on Smaller Public Companies in April in Washington DC, the progression of ideas and definitions of the committee is impressive. Part of the problem in this thorny issue is: “What is a small public company?” Sounds simple but it really is not. What about market capitalization? With increases in natural resource prices, some companies have been thrust into larger valuations without any increase in staff. What about revenue? Some companies do not have revenue but have a great deal of spending going on which causes exposure to investors. Examples would be early stage mining companies or development stage drug companies. What about number of investors? Currently, employee option holders are added to the total number of shareholder, causing some private companies to be required to register as public companies. Many issues and paratmeters to consider.
It appears that the definition that is gaining ground is “total market capitalization” not just public float. This simplifies the calculation. This is the current definition that the SEC has used for determining if a company is an accelerated filer. The other part of this definition that is probably going to stick is making two classifications of smaller companies: 1) $100 - $700 million market capitalization as smaller companies and 2) Sub $100 million market cap as “microcap” companies.
The reason for the distinction is that currently all companies over $75 million in market capitalization (as of June 2004) headquartered in the US were considered Accelerated Filers for the Section 404 certification purposes. So two considerations from this change are important: 1) Some companies who are currently considered Accelerated Filers may become non-accelerated filers and 2) The requirements of “Smaller Public Companies” and “Microcaps” may differ.
The thinking is that companies of $700 million still do not have the resources of the largest public companies but should be subject to some more Section 404 requirements than the very smallest companies.
These breakpoints were arrived at as follows: 80% of US public companies provide only 6.4% of the US public market capitalization or less than $700 million. Approximately 50% of the US public companies account for only 1% of the US public company market capitalization or less than $100 million. Therefore, the exposure to the public for these smallest companies, from an exposure point of view is more limited and should be treated differently.
Testimony given by the public yesterday clearly favored maintaining the Section 404 legislation in place. This testimony was provided by securities lawyers and investment bankers in the Bay Area of San Francisco. Most of those testifying represented companies who mainly work with larger organizations. The smaller companies have the ear of the SEC and are getting help. No roll back in sight for the Accelerated Filers.
I posed a question to SEC Commissioner Paul Atkins on the delay. I asked if the size calculation was to apply to only US based companies or to all companies no matter where they were based. He wrote some notes and indicated that he had not considered that. I told him that Canadian companies are treated the same way as US companies on the exchanges. I wondered why size would the determinant and not location of headquarters, especially when dealing with Canadian GAAP is almost identical to US GAAP. He seemed favorable to considering size only. This only makes sense when it comes to exposure. The markets are equal opportunity so it seems market capitalization should not be subject to headquarters locations, especially when Canada is the question.
Those testifying and a summary of their position on SEC Guidelines and Section 404 is as follows:
Kenneth Hahn, Senior Vice President/CFO, Borland Corporation, Cupertino, CA: He believes that the largest cost from Section 404 has been the “over testing” of mundane transactions. This has increased cost without increasing benefit to shareholders. This is due to Audit firms being overly conservative from fear of reprisals.
Gerald Niesar, Partner, Niesar Curls Bartling LLP, San Francisco, CA: Supports a formal registration of unlicensed “finders” who raise money for smaller public companies but are not licensed. He proposed a less stringent and less expensive system to register these individuals.
Donald C Reinke, Partner, Reed Smith, Oakland, CA: He has experienced doing a public offering the London AIM (Alternative Markets) exchange. He said it does not involve approval by regulatory authorities but rather prospectuses are “vetted” by lawyers and accountants. He found the process less painful and 40% less costly. The AIM exchange has experienced very few bankruptcies. Many US companies are listing on AIM to access public markets and not comply with Sarbanes-Oxley.
Lynn E. Turner, Managing Director of Research, Glass, Lewis & Co: He was formerly with the SEC and was instrumental in getting Section 404 into the Sarbanes-Oxley legislation. He deeply believes in the legislation and has submitted a questionnaire to the SEC that he says could be used to help do low cost internal controls work for companies. He does not want to see the legislation rolled back for any size company.
Richard Ueltschy, Executive, Crowe, Chizek and Company LLC, Louisville, KY: As a non-Big Four audit firm, he indicated that he has seen much more competition in audit work in the Section 404 area. He indicated that those companies who do NOT use the Big Four Audit firms have begun to experience a 40% reduction in integrated audit costs for the second year. Those who have stayed with the Big Four have not experienced such reductions.
Ann Walker, Partner, Wilson, Sonsini, Goodrich & Rosati, Palo Alto, CA: She wants to see auditor attestation removed as a requirement for the smallest public companies because it is the big cost driver. She also wants the SEC to change the regulation for companies who issue options to employees and have more than 500 option holders not to have to register as a public company. She says these option holders are not shareholders and these compensatory options should not be dealt with in the same way as options issued for investment banks.
Chris Ailman, Chief Investment Officer, California State Teachers Retirement System, Sacramento, CA: He does not believe that there should be any roll back of Section 404. He believes that investor trust is too important. He says that his fund lost 15% of its value after Enron and thinks the costs of Section 404 are worth it. His fund only deals in larger companies due to their size, $135 Billion.
Irwin Federman, General Partner, US Venture Partners, Menlo Park, CA: He believes that Section 404 is like a fisherman with a net where the holes are too small. This legislation catches everything in it not just the bad guys. He thinks it has unintended costs and not much benefit. He also believes that the SEC needs to require hedge funds to register because there is a lot of abuse in that sector.
Bill Hambrecht, Founder, Chairman and CEO of W. R. Hambrecht, San Francisco, CA: He thinks the materiality level of PCAOB Audit Standard #2 is too high at 5%. He thinks you can hide a lot of fraud at that level. But he also thinks that the wrong emphasis has been placed on mundane transactions. He thinks revenue and inventory tell the story.
Jon Hickman, Vice President, Equity Research-Technology, MDB Capital Group LLC, Santa Monica, CA: He thinks the costs of Section 404 are too high and the benefits are not high enough.
Michael McConnell, Managing Director, Shamrock Capital Advisors, Burbank, CA: He likes Section 404 and the transparency it brings. He thinks the cost of capital is lowered. He deals with companies of all sizes. He thinks the investors’ voice has been lost until Sarbanes-Oxley.
Andrew Shapiro, President, Lawndale Capital Management, LLC, Mill Valley, CA: He thinks good governance is key. He likes the independence theme in Sarbanes-Oxley and thinks this is key. He would support a tiered system of Section 404 implementation for various sizes of companies so that they could comply more cost effectively.
Today, September 20th, the SEC Advisory Committee on Smaller Public Companies presents its recommendations to the SEC and the public for their consideration. As of yesterday, they are batting a thousand since SEC Commissioner pre-announced the delay was announced for Section 404 certification for another year for smaller public companies as well as a decision not to accelerate annual and quarterly reporting times for smaller public companies. This will be officially announced by the SEC tomorrow.
Wednesday the SEC will render its official details of delays in Section 404 and the acceleration of reporting deadlines for 10Q and 10K.
For ways to cut costs in your Sarbanes-Oxley reporting, see www.issuescentral.com and learn more about the Compliance Playbook(tm).
