Amendments to the Accelerated Filer and Large Filer Definitions

Daniel Taylor is Associate Professor of Accounting at The Wharton School at the University of Pennsylvania. This post is based on a comment letter to the SEC’s Amendments to the SOX 404(b) Accelerated Filer Definition from Professor Taylor; Mary Barth, the Joan E. Horngren Professor of Accounting, Emerita at the Stanford University Graduate School of Business; Wayne Landsman, the KPMG Distinguished Professor of Accounting at the Kenan-Flagler Intranet at the University of North Carolina; and Joe Schroeder, Associate Professor at the Indiana University Kelley School of Business.

We appreciate the opportunity to comment on the Securities and Exchange Commission’s (the “Commission”) proposed Amendments to the Accelerated Filer and Large Accelerated Filer Definitions. Herein we provide comments and analysis relating primarily to the Request for Comments in Sections II.E and III.D of the proposed Amendments (“Proposal”). Our comments relate to the provisions of the Proposal that would eliminate internal control audits required under Section 404(b) of the Sarbanes-Oxley Act for companies with annual revenue less than $100 million.

Part I of this letter provides comment on the central premise of the Proposal. The Commission’s total estimated benefit to companies—$210,000 in cost savings from foregoing internal control audits—is economically small and amounts to less than 0.1% of the average affected company’s equity market value. In contrast, we interpret the evidence in the Proposal as suggesting that the elimination of internal control audits is likely to result in significantly weaker internal controls over the financial reporting system and significantly greater levels of accounting restatements (i.e., poorer financial reporting quality). Thus, the $210,000 cost savings needs to be weighed against the potentially large social costs created by weaker internal controls and elevated levels of accounting restatements.

Part II of this letter comments on various aspects of the Commission’s economic analysis. We believe the analysis is incomplete for three reasons. First, the analysis quantifies the cost of internal control audits, but does not attempt to quantify the benefits of such audits. Second, the analysis focuses on the rate of restatements among affected companies and does not consider the magnitude of the restatements. A preliminary analysis of restatements announced in 2018 shows that 11 companies that the Commission proposes to exempt from internal controls audits restated over $65 million in net income and these restatements destroyed more than $294 million in shareholder wealth. This destruction in wealth, caused by only a handful of restatements, dwarfs the Proposal’s total cost savings of $75 million across all 358 affected companies.

Third, the Commission’s analysis does not seek to analyze the historical rate of fraud or SEC Accounting and Enforcement Actions within the set of affected companies. As of 2018, several affected companies had equity market values in excess of $500 million. In companies of this size, even one or two additional frauds resulting from the elimination of internal control audits would adversely affect not only the company’s investors, but also all of its stakeholders (e.g., employees, retirees, customers, and suppliers), and would have ripple effects throughout the US economy.

Although it might be socially desirable to encourage investment, and research and development, we believe there are ways to do so without sacrificing oversight.

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The Comment Letter is available here.

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