Editors Note: Amalie L. Tuffin is a member of the Research Triangle Park law firm of Daniels Daniels & Verdonik, P.A.

RESEARCH TRIANGLE PARK, N.C. – The Sarbanes-Oxley Act of 2002 (SOX) was intended to provide protection for investors and to restore public confidence in our financial system after repeated corporate scandals at companies such as WorldCom and Enron. SOX Section 404 requires companies to adopt and maintain internal controls for financial reporting.

The costs of maintaining and assessing such internal controls can be quite high, especially on smaller public companies. Some studies have shown average compliance costs for such companies to be as high as 2.5 percent of revenues.

Many economists, commentators and others are deeply concerned that increased compliance costs are stifling the growth of smaller public companies, companies which pay a crucial role in fostering economic growth and innovation.

SEC Advisory Committee Proposed Significant Reforms

In part because of this concern, in 2005 the Securities and Exchange Commission (SEC) chartered the Advisory Committee on Smaller Public Companies. The Committee’s mission was to assess our securities laws as they apply to smaller public companies and to recommend changes. One of the topics the Committee was directed to address was internal controls, with a particular focus on the impact of SOX. In April 2006, the Committee issued its report and made a number of significant recommendations aimed at easing the burden on smaller companies of complying with Section 404’s internal control requirements. (These recommendations were discussed in detail in an LTW article available at http://localtechwire.com/printstory.cfm?u=13667.)

While the SEC has not endorsed the Committee’s recommendations — in fact, SEC Chairman Christopher Cox has publicly defended the Section 404 requirements — the SEC has acted in recent weeks to propose granting some additional relief to smaller public companies.

SEC Proposes Extending Compliance Deadlines

The SEC has proposed two different types of extensions to the deadlines by which smaller public companies (which the SEC refers to as non-accelerated filers) must comply with the internal control requirements of SOX Section 404. The first set of extensions applies to existing public companies. The SEC is proposing to extend the initial compliance date by which these companies must start providing a report by management assessing the effectiveness of the company’s internal control over financial reporting from fiscal years ending on or after July 15, 2007 to fiscal years ending on or after December 15, 2007.

Further, the SEC is proposing to extend the date by which these companies must begin to comply with the SOX Section 404(b) requirement to provide an auditor’s attestation report on internal control over financial reporting to the first annual report for a fiscal year ending on or after December 15, 2008. This would mean that smaller public companies would only be required to complete management’s portion of the internal control requirements in their first year of compliance.

The SEC expects that this graduated phase-in proposal will allow companies to save costs as well as make it easier to comply with additional reporting guidance the SEC and the Public Company Accounting Oversight Board (PCAOB) expect to issue before the new compliance deadline arrives. The SEC also left the door open to further extend the compliance deadlines in the event either the SEC or the PCAOB releases its additional guidance later than currently expected.

In addition to the deadline extensions proposed for existing public companies, the SEC has also proposed a transition period that will be applicable to newly public companies.

The SEC has proposed that such companies only be required to comply with Section 404 at the time that they file their second annual report after becoming public. The SEC indicated in its press release announcing the proposals that it is aware “of the fact that preparation of a newly public company’s first annual report can be a time and resource intensive process that may quickly follow an IPO or initial listing.” The SEC hopes the phase-in proposal will increase the overall efficiency and effectiveness with which such companies comply with their reporting and compliance obligations.

Additional Relief May Follow in the Future

As noted above, the SEC expressly noted that it may further extend the compliance deadlines if additional SEC and PCAOB guidance is not released in a timely fashion. The SEC also noted in its press release that both it and the PCAOB intend to take additional steps to improve the implementation of Section 404 for companies of all sizes.

Hopefully these additional steps will further ease the compliance burden on smaller public companies.

Daniels Daniels & Verdonik, P.A. has been serving the legal needs of entrepreneurial and high technology clients for more than 20 years. Amalie L. Tuffin concentrates her practice in the representation of entrepreneurial and technology-based businesses, focusing on corporate, taxation and securities matters. Questions or comments can be sent to atuffin@d2vlaw.com