Compliance Blog

All ACSPC (Advisory Committee on Smaller Public Companies) meetings are lively, open and full of debate. But yesterday's meeting reached a crescendo between members of the Accounting profession and others on the committee.

Summary of Items that Affect Section 404 Filers:

1. New definitions for smaller public companies with elements of market cap and revenue filters
2. Recommendation for the smallest public companies (microcap) (less than $128 million and less than $10 million in revenue will not have to sign the 404 certification but will still have to document internal controls and will have no auditor attestation
3. Recommendation for next level of smaller public companies (small cap) (market cap between $128 million and $787 million with less than $250 million in revenue) will have to sign the 404 certification but would not have to have an auditor attestation.

The Committee is charged with several tasks around smaller public companies. Two of the most interest to the public are around the very definition of a smaller public company and what to do, if anything, for smaller public companies around the issue of Section 404.

There seems to be a fair bit of consensus around the proposed definitions:

1) Microcap companies would be defined as those companies representing the bottom 1% of market cap or at this time around $128 million or less
2) Smallcap companies would be defined as those companies with market capitalization between $128 to $787 million or the next 5% of the publicly traded companies
3) Smaller public companies would represent the bottom 6% of public companies with market cap of less than $787.

Note: These market cap numbers are approximate because they are % of market cap and will float.

An interesting note that was brought up was that at the end the fiscal year, the market cap of a company would be calculated to determine if they are Microcap etc for the next filing year for Section 404. In other words, if your market rose on December 31 (assuming this to be your year end) to say $130 million and this put you in the next category for Section 404 requirements, this would affect the next year not the current year. This was unclear from the proposed language.

Proposed Changes to Section 404 for Smaller Public Companies:

Recommendation 1: on Definitions: (From ACSPC Draft Dated February 14, 2006 - Pages 20-21)

Recommendation II.P.1:

Establish a new system of scaled or proportional securities regulation for smaller public companies using the following six determinants to define a “smaller public company”:

ƒ the total market capitalization of the company;
ƒ a measurement metric that facilitates scaling of regulation;
ƒ a measurement metric that is self-calibrating;
ƒ a standardized measurement and methodology for computing market capitalization;
ƒ a date for determining total market capitalization; and
ƒ clear and firm transition rules, i.e. small to large and large to small.

This new system would replace the SEC’s current scaling system for “small business issuers”
eligible to use Regulation S-B28 as well as the current scaling system based on “non-accelerated filer” but would provide eligibility for scaled regulation for companies based on their size relative to larger companies.

Recommendation III.P.1: Commentary:
The committee is recommending that Microcap companies be exempted from 404 certification requirements. The interesting twist to this is that in the language of Section 302 and Foreign Corrupt Practices Act of 1977/1978, companies must maintain internal controls over financial reporting. Further, microcap companies would still have to report material weaknesses so they will still have to document the controls and so some level of testing but they would not have to sign 404 certification and would have not auditor attestation.

Recommendation III.P.1: (From ACSPC Draft Dated February 14, 2006 - Pages 46-47)

Unless and until a framework for assessing internal control over financial reporting for microcap companies is developed that recognizes the characteristics and needs
of those companies, provide exemptive relief from Section 404 requirements to microcap companies with less than $125 million in annual revenue and to smallcap companies with less than $10 million in annual revenue that have or expand their corporate governance controls that include:

ƒ adherence to standards relating to audit committees in conformity with Rule
10A-3 under the Exchange Act; and
ƒ adoption of a code of ethics within the meaning of Item 406 of Regulation S-
K applicable to all directors, officers and employees and compliance with the
further obligations under Item 406(c) relating to the disclosure of the code of ethics.

In addition, as part of this recommendation, we recommend that the Commission confirm, and if necessary clarify, the application to all microcap companies, and indeed to all smallcap companies also, of the existing general legal requirements regarding internal controls, including the requirement that companies maintain a system of effective internal control over financial reporting, disclose modifications to internal control over financial reporting and their material consequences and apply CEO and CFO certifications to such disclosures.

Moreover, management should be required to report on any known material weaknesses. In this regard, the Proposed Statement on Auditing Standards of the AICPA, “Communications of Internal Control Related Matters Noted in an Audit,” if adopted by the AICPA and the PCAOB, would strengthen this disclosure requirement and provide some external auditor involvement in the internal control over financial reporting process.

Recommendation III.P.2: Commentary

In the recommendation for the Small Cap companies, they are really just trying to eliminate the auditor attestation requirement unless a different audit framework is developed. This recommendation is probably sensible for this level of company.

Recommendation III.P.2: (From ACSPC Draft Dated February 14, 2006 - Pages 50)

Unless and until a framework for assessing internal control over financial reporting for smallcap companies is developed that recognizes the characteristics and needs of those companies, provide exemptive relief from external auditor involvement in the Section 404 process to smallcap companies with less than $250 million but greater than $10 million in annual revenues, subject to their compliance with the same corporate governance standards as detailed in the recommendation above.

For the complete draft, click here.