Section 404: Companies Feel Impact of Compliance

Section 404: Companies Feel Impact of Compliance

By Stephanie R. Myers

Small public companies have been hit especially hard by the Section 404 requirement of the Sarbanes-Oxley Act, according to CPAs recently interviewed.

“We expect the problems will be severe, due to their lack of resources and personnel,” said Jeffrey Brinn, founder of TheSECRules.com, which assists small public companies in complying with regulations passed down by the Securities and Exchange Commission.

Section 404 of the landmark corporate reform law mandates that, as part of their annual report, management of SEC registrants must issue a report on the effectiveness of the companies’ internal controls over financial reporting. CPA firms that audit these companies’ financial statements must attest to the management’s assessment of the internal controls.

For accelerated filers, the deadline for compliance with Section 404 was Nov. 15, 2004, while the deadline for nonaccelerated filers, companies with less than $75 million in public equity, is July 15, 2006, recently extended one year by the SEC.

For small and large companies, the financial and time considerations that go into fulfilling this specific requirement are considerable.

George Victor, of Holtz Rubenstein Reminick LLP, chair of the Society’s SEC Practice Committee, said that smaller public companies will find compliance especially difficult.

“The larger firms were quicker to retain consulting help, because they had to comply sooner as a result of the regulations,” Victor said. “The small firms had additional time, and they tended to delay hiring consultants to help them comply with the regulations.”

Companies cannot use their auditors to perform Section 404 consulting work, and many have turned to legal counsel, other CPA firms and outside professionals for assistance in meeting the provision’s obligations.

The challenge in compliance sometimes lies in managing the time of executives with the company, said Douglas Beck, of Lev Pharmaceuticals, Inc.

“I have worked with companies that needed to hire outside consultants to implement Sarbanes-Oxley,” Beck said. “It was time-consuming and expensive. However, the executives found out more about their own company than ever before.”

Beck also noted that the financial considerations of fulfilling a requirement are sometimes misjudged by companies.

“The initial budget for the consultants and auditors needed to be raised by two to three times because no one knew the magnitude and the in-depth details that needed to be done for Sarbanes-Oxley,” Beck said.

John M. Haslbauer, from PKF CPAs, said that while his company does not have any registrants other than small business entities, they have done some consulting with accelerated filers to help them in complying with Section 404. He said that the requirements are “quite a drain” on registrants and their finances.

“One CEO stated that he thought they were in the real estate business but now thinks they are in the compliance business,” Haslbauer said. “In this particular company, most of their finance people are dealing with the 404 requirements and not with their ongoing business. All of this is compounded by the additional cost that needs to be incurred.”

Some firms have created groups to address the new SEC regulations. Michele Amato, partner in charge of Raich Ende Malter & Co. LLP’s new SEC Practice Group, said the firm has hired more people to comply with Section 404 and has begun a marketing campaign to promote it. The smaller registrants, she said, were the ones that contacted the company.

Amato said the price of compliance has been high.

“The overall cost of compliance has negatively impacted the bottom lines of registrants to a much larger extent than perhaps anyone anticipated,” Amato said. “Some smaller companies are barely profitable, if at all, so another regulatory burden is the last thing their investors need. Ideally, Section 404 should make the investors more comfortable, but at what cost?”