Revised definition of smaller reporting company expected by fall of 2018

Revised definition of smaller reporting company expected by fall of 2018

The Securities and Exchange Commission (SEC) is planning to adopt a rule that revises the definition of “smaller reporting company” by the fall of 2018 and let more public companies submit regulatory filings with a lighter set of disclosures, according to the agency’s regulatory agenda, which was updated on May 9, 2018.

As part of the effort, the agency may also adopt a rule that exempts more companies from the auditor’s attestation requirement for internal controls over financial reporting (ICFR), according to Section 404(b) of the Sarbanes-Oxley Act of 2002. If the rule is adopted, it would represent one of the more significant accomplishments for the SEC under Chairman Jay Clayton, who is seeking a host of rule changes to reduce the compliance costs for public companies and encourage more companies to go public.

The rules would be based on a proposal issued in June 2016 in Release No. 33-10107, Amendments to Smaller Reporting Company Definition. If the SEC agrees to finalize the rules, companies with a public float up to $250 million would qualify as smaller reporting companies in the revised regulatory definition. The current small company threshold is $75 million, according to Rule 405 of the Securities Act of 1933.

The SEC did not propose to raise the public float threshold for when a company qualifies as an accelerated flier, which is currently set from $75 million to $700 million. Companies with public floats greater than $700 million are classified as large accelerated filers. However, the commission asked in Release No. 33-10107 whether the definition should be revised so that the number of companies exempt from Section 404(b) would be expanded. Currently, only non-accelerated filers with less than $75 million in public float are exempted.

During an April 26, 2018, House Financial Services Committee hearing, SEC Corporation Finance Director William Hinman said the SEC is “taking a fresh look” at expanding the Section 404(b) exemption.

The agency’s move comes amid a lobbying effort by business groups who say the auditor attestation rule is costly and does not offer much benefit to investors.

The “life science industry, as you mention, makes a fair point that this is costly for them,” Hinman said in response to a question by Rep. Trey Hollingsworth, a Republican from Indiana. “At the same time we want to protect investors. So, we want to have perhaps a more sophisticated test in this area. So, we wouldn’t look just at market cap. We also might look at revenues.”

Rep. Hollingsworth said many of the biotechnology companies that develop new drugs for a variety of diseases are in their early stage of operation and have a small staff even though their market cap is relatively large.

“One of the things I continue to hear from them is the cost of 404(b) compliance,” Hollingsworth said. “Companies are on the cutting edge of new technology, new biology, being able to finally cure diseases that ail millions of Americans but are spending more of the dollars that they have raised on compliance instead of the search for the cures.”

Hollingsworth added that companies with public floats between $75 million and $250 million spend an average of $840,000 a year on Section 404(b) compliance.

Hinmann responded that the suggestion by the life science industry to add a revenue test for Section 404(b) compliance is “a good idea.” According to the webpage for Release No. 33-10107, representatives of Biotechnology Innovation Organization (BIO) had four meetings with SEC officials in 2018.

Investor advocates and auditing firms would prefer the SEC to leave the current threshold alone.

“We believe Section 404(b) continues to be significant as it provides investors with reasonable assurance from the independent auditor that a company maintained effective internal control over financial reporting,” the Center for Audit Quality (CAQ) and the Council of Institutional Investors (CII) said in a joint comment letter in response to Release No. 33-10107. “This assurance is an important driver of confidence in the integrity of financial statements and in the fairness of our capital markets. A Government Accountability Office report found that companies exempted from Section 404(b) experience more financial restatements, as compared to nonexempt companies.”

For more information on this topic, or to learn how Baker Tilly SEC accounting specialists can help, contact our team.

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