Ask FERF about ... SEC Advisory Committee on Smaller Public Companies recommendations.

• Author: de Mesa Graziano, Cheryl
• Position: Resources - Financial Executives Research Foundation

In its final public meeting on April 20, 2006, the Securities and Exchange Commission (SEC) Advisory Committee on Smaller Public Companies issued its Final Report. Chartered on March 23, 2005, the 21-member committee was formed to assess the current regulatory system for smaller public companies and make recommendations for changes. The committee was directed to consider the applicability of four areas, including the impact of the Sarbanes-Oxley Act of 2002: internal control frameworks, including management's assessment methods and auditing standards; corporate governance and disclosure requirements; accounting standards and financial reporting requirements; and the public-offering process.

The committee made 32 recommendations, assigning each to one of two tiers, to indicate priority. The first primary recommendation is to establish a new system of scaled securities regulation for smaller public companies. Microcap companies, which represent 1 percent of the U.S. equity market, would be defined as those with a market capitalization of less than $128.2 million. Companies with a market cap of $128.2 to $787.1 million (5 percent of the U.S. market) would be considered smallcap.

The measurement of market cap would be self-calibrating and based on a standardized methodology. The new system would provide for clear and firm rules for companies that transition from being a small to a large one and vice versa. The committee believes that the scaled system should be established before the SEC examines whether or not individual regulations should be scaled back.

The most-publicized item relates to recommendations that call for exemptions from Sarbanes-Oxley Section 404 requirements. Microcaps with less than $125 million in annual revenue and smallcaps with less than $10 million in product revenue would be exempt from Section 404 as long as they adhere to the Securities and Exchange Act of 1934 audit committee standards and adopt a code of ethics to comply with Item 406 of Regulation S-K. Relief from external auditor involvement with 404 would also be provided for microcaps with annual revenue between $125 and $250 million and smallcaps with $250 million or less in annual revenues and $10 million or more in annual product revenues.

Based on data from the SEC's Office of Economic Analysis, more than 6,000 companies would receive breaks based on these exemptions. However, should the SEC continue the 404 audit requirement, the committee recommends a more...