Coso Releases SOX Guidance: More Time for Small Firms

Small companies get additional time for SOX Compliance 

At the Securities and Exchange Commission's first public meeting presided over by its new chairman, Christopher Cox, the SEC unanimously voted to give smaller U.S. public companies an additional year to comply with the internal control reporting requirements of Sarbanes-Oxley Section 404. These requirements, which many small companies are complaining are too costly and difficult to comply with, mandate that companies assess and file reports with the SEC regarding the strength of their internal controls over financial reporting.

This is the second such grace period the SEC has granted to small companies. In March 2005, the Commission postponed the Section 404 deadline from July 15, 2005 to July 15, 2006 for non-accelerated filers - generally defined as companies with a market value of less than $75 million - and for foreign private issuers. The new extension gives all non-accelerated filers, including foreign private issuers who qualify as non-accelerated filers, until July 15, 2007 to implement the provisions of Section 404. However, foreign private issuers that are considered accelerated filers must still meet the July 15, 2006 deadline.

The extension of the compliance deadline follows the recommendation of the SEC's small-business advisory committee which, after examining the effects of SOX and securities laws on small companies, pushed for an additional year's delay for the internal control requirements. While the SEC acknowledged the particular hardships faced by small companies and aimed to lessen the burden of compliance on those companies with fewer resources, Cox explicitly noted that the Commission's decision to postpone the deadline "in no way reflects any desire to back away" from the full requirements of Sarbanes-Oxley.

COSO RELEASES SOX GUIDANCE FOR SMALL BUSINESSES
The Committee of Sponsoring Organizations (COSO) has released an exposure draft of its eagerly anticipated guidance for small companies on implementing SOX Section 404, "Guidance for Smaller Public Companies Reporting on Internal Control over Financial Reporting." The new guidance serves to supplement COSO's cardinal 1992 report, "Internal Control - Integrated Framework," by focusing on the unique needs and constraints faced by small companies when incorporating the Integrated Framework, particularly as part of compliance with the requirements of Section 404. Additionally, the release provides examples of how the internal control framework presented in the original report can be applied to smaller organizations in an efficient and effective manner.

In its new guidance, COSO outlines 26 fundamental principles that build on the five components of the exemplary internal control model provided in the Integrated Framework: control environment, risk assessment, control activities, information and communication, and monitoring. The report also lists practicable approaches smaller companies can use to integrate these principles into their own systems of internal controls. In the report, COSO acknowledges that internal control over financial reporting may be accomplished by choosing those approaches that are appropriate to the organization's circumstances and that help it effectively and efficiently meet its objectives for financial reporting.

The comment period for the exposure draft was scheduled to close on Dec. 31, 2005, and COSO's final guidance is expected in the first quarter of 2006. The full text of the proposed guidance can be found at COSO's Web site: www.ic.coso.org.

JUDGE RULES PRIVATE SUITS NOT ALLOWED UNDER SOX SECTION 304
A federal judge has ruled that only the SEC can bring action against top corporate executives under Section 304 of the Sarbanes-Oxley Act. Section 304 states the corporate executives can be forced to disgorge bonuses and personal profits gained in the wake of an alleged accounting scandal.

The ruling arises from a lawsuit filed by Ronald Jeffrey Neer against Stonepath Group Inc. regarding the restatement of several years' worth of Stonepath's financial statements. The suit alleged that the most recent restatement would reduce the company's reported revenue for 2001-2004 by $16.3 million, eliminating almost all of the company's previous earnings. According to the suit, Stonepath's top executives allegedly engaged in improper accounting practices while focusing the business efforts on acquiring companies in 2001, which ultimately resulted in the problematic restatements.

In his opinion on the case, U.S. District Court Judge Stewart Dalzell ruled that Congress intended Section 304 to be enforced only by the SEC and not by shareholders in private lawsuits (that is, derivative lawsuits). Although Section 304 is silent regarding the specifics of who can enforce its provisions, the judge ruled that implying the ability of shareholders to bring a cause of action under Section 304 would require "rewriting Congress' statute." He supported this decision by referring to Section 306 of the Act, which explicitly and purposefully allows shareholders to bring private lawsuits for enforcement of that section and contrasting this inclusion with the language of Section 304. Thus, the case was dismissed from the federal court, without prejudice,* as the remaining claims in the suit were state-law claims and should be heard at a state-level court. Source: Neer v. Pelino, No. 04-CV-04791-SD (E.D. Pa. Sept. 27, 2005)

SOX FEEDBACK
In a Wall Street Journal Online/Harris Interactive Personal Finance Poll of 2,061 U.S. adult investors, 55 percent of the respondents stated that current financial and accounting regulations governing publicly held companies still are too lenient. Among male investors aged 45 to 54, this number jumps to 77 percent. Further, only 25 percent of the investors polled believe that SOX has increased the transparency of financial information communicated by companies while 11 percent of the respondents felt the Act has actually decreased such transparency. The poll also revealed that nearly a third (30 percent) of the investors have reduced or divested their investment in a company due to poor corporate governance.

Another study conducted by RevenueRecognition.com found that Sarbanes-Oxley is having a noticeable impact on companies' revenue recognition policies. According to the survey, more than half (55 percent) of all public companies have changed revenue recognition policies as a result of SOX. Of those, 26 percent claim the change has been moderate or significant. Interestingly, a similar impact has been noticed by private companies, with 45 percent facing revenue recognition policy changes as a result of the Act, and more than 27 percent of those realizing moderate to significant modifications. However, while so many companies are altering their business policies and procedures to comply with SOX, only 14 percent of the public companies polled said their compliance processes related to Section 404 are highly efficient and require no further investment.

Conversely, 58 percent said their Section 404 compliance processes may require additional investment and 24 percent said further investment will be required. Four percent of the public companies admitted that their current processes are temporary fixes that will be replaced entirely.

Andi McNeal, CFE, CPA, is the accounting writer and editor for the research department of the Association of Certified Fraud Examiners.  

* Dismissal without prejudice gives the complainant the right to sue again on the same cause of action. Thus, Neer may again sue the corporation and/or its officers and directors in a lower court.  

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