Despite Reforms, Small Businesses Still Reeling from Sarbox

Many entrepreneurs and small-company executives are unimpressed by the Securities and Exchange Commission’s recent attempt to ease the burden of Sarbanes-Oxley. Since it originated in 2002, the legislation has been especially hard on small public companies, which don’t have the spare resources to contend with Sarbox’s many tedious requirements.

The SEC tried to address this issue last month, when it approved guidance to reform Sarbox’s Section 404, which requires company management to assess its internal controls over financial reporting, and for external auditors to report on that assessment and on the controls. The new guidance limits the number of internal controls that companies are required to assess — now, management can select the controls that they think are most risky. And small companies with market caps less than $75 million don’t have to comply until January 2008, with external audits taking place the next year.

But small businesses remain concerned, believing that the internal-control deadline is still too soon and that their already limited funds will be drained by having to comply.

In an article that appeared in today’s Financial Times, Hal Scott, a professor at Harvard Law School, says small companies “may not be able to absorb such costs or remain solvent, let alone competitive,” and notes that they “may find themselves starved for venture capital.”

BIO, the biotech trade organization, has been working with a coalition that includes the National Venture Capital Association and the Advanced Medical Technology Association for the past few years to encourage the SEC to ease the Sarbox burden on emerging life sciences companies. The coalition contends that a one-size-fits-all approach to Section 404 hinders small life sciences companies’ ability to invest in R&D and gain access to capital.

But BIO CEO Jim Greenwood said in a statement last week that the current reforms provide only “marginal improvement.” Greenwood was especially bothered by the fact that the second part of the reforms — the one that specifies how auditors should proceed now that internal-control requirements have been adjusted — does not define “small company.” According to Greenwood, “Auditors are left without a clear tool to help them scale the audit properly. This lack of clear direction to auditors may lead them to seek more extensive audits in an effort to avoid criticism for being too lenient, potentially resulting in even more costs and burdens to small companies.”

It’s estimated that an external audit can run a company about $1 million, which, in the case of many emerging life sciences firms, instantly doubles their operating expenses. In its original letter to the SEC, the BIO coalition recommended that “small company” be defined as the bottom six percent (based on a quarterly average) of the total U.S. public market capitalization or by a revenue threshold set by the average revenues of companies at the bottom six percent of total market cap.

The SEC maintains that its recent reforms will be helpful. The agency’s chairman, Christopher Cox, tells the Times that the changes give “smaller companies the benefit of doing an initial assessment of their controls without the added burden and cost arising from an external audit.”

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