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Analysis of Section 404(b) of the Sarbanes-Oxley Act of 2002 for Non-Accelerated Filers

On October 13, 2009, the Securities and Exchange Commission (SEC) officially extended the date for non-accelerated filers to comply with Section 404(b) of the Sarbanes-Oxley Act of 2002 (SOX) until their fiscal years ending on or after June 15, 2010. Since the adoption of the rules implementing Section 404(b) on June 5, 2003, the time period for compliance by non-accelerated filers has been extended several times. It is widely believed that this extension, for six additional months, will be the last. Companies other than non-accelerated filers are already subject to Section 404 compliance. Although “non-accelerated” filers are not specifically defined, such filers include small business entities.

Among other things, Section 404(b) of SOX requires companies to include in their annual reports filed with the SEC, an accompanying auditor’s attestation report, on the effectiveness of the Company’s internal control over financial reporting. In other words, reporting companies must employ their auditor to audit and attest upon their financial internal control process, in addition to the financial statements themselves. One of the reasons that implementation has been delayed for non-accelerated filers, was the need for the SEC to provide guidance to both auditors and reporting companies as to how to structure internal controls, and what structure or structural deficiencies an auditor is to opine upon.

To assist companies and auditors in complying with the new rules, the SEC approved the issuance of PCAOB of Auditing Standard No. 5 providing guidance as to the Audit of Internal Controls Over Financial Reporting that is Integrated with an Audit of Financial Statements. In addition, the SEC has issued interpretative guidance to assist management of reporting companies in complying with the internal control evaluation and disclosure requirements. See Commission Guidance Regarding Management’s Report on Internal Control Over Financial Reporting under Section 13(a) or 15(d) of the Securities Exchange Act of 1934, Release No. 33-8810 dated June 20, 2007.

PCAOB of Auditing Standard No. 5 together with Release No. 33-8810 was intended by the SEC to make internal control over financial reporting audits and management evaluations of ICFR more cost-effective by being risk-based and scalable to a company’s size and complexity. Whether they meet these goals remains to be scene, however, many non-accelerated filers are finding the increased auditor expense alone to be cost prohibitive, let alone setting up the mandated infrastructure to avoid negative audit comments (for example, having only one officer responsible for financial reporting alone results in negative comments, regardless of the structure in place to ensure that the single officer properly records and reports all transactions).

The SEC has indicated that the last postponement for the Section 404(b) auditor attestation requirements for non-accelerated filers allowed time for the PCAOB to issue final staff guidance on auditing internal financial controls for smaller companies and for the SEC staff to evaluate whether their current guidance is the most cost-effective for smaller public companies. The PCAOB published staff guidance for auditors of smaller public companies on January 23, 2009 describing how auditors can apply the principles described in Auditing Standard No. 5 and providing approaches to particular issues that might arise in the audits of smaller, less complex public companies.

The SEC directed its staff to conduct a study in order to assess whether the SEC guidance and PCAOB guidance hare having the intended effect of facilitating more cost effective evaluations. The results of this study were made public on October 2, 2009. The most recent postponement is to allow smaller public companies and their auditors to digest and implement the results of these most recent studies and guidelines.

The SEC has made clear that they believe that all steps and guidance to implement Section 404(b) for non-accelerated filers has been completed and that auditors and small public companies should proceed forthwith to prepare to comply. That is, there will be no further delays. How these guidelines will be implemented and the additional cost to small public companies still causes great concern to those small companies that have been impacted by the recent economic downturn, which is the vast majority.

Attorney Laura Anthony is a Florida securities attorney and the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The Florida corporate and securities attorneys of Legal & Compliance offer specialized legal services to small and mid-size private and public (OTCBB) companies, entrepreneurs, and business professionals throughout the country. Contact us today for a FREE consultation!

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