S.E.C. Revises Its Standards for Corporate Audits




By Eric Dash

The Securities and Exchange Commission approved new guidelines yesterday that try to balance the need for tighter financial controls with the cost of complying with them. It said the new procedures will make it less costly for smaller companies to assess the state of their internal financial controls.

The new standards call for public companies to focus on the areas most prone to potential fraud, streamlining an auditing process that many have called excessive and burdensome.

While big public companies had previously adhered to more rigorous standards, the unanimous vote by the commission’s five members paves the way for this more relaxed set of guidelines to be imposed on the smaller companies that make up the vast majority of American businesses, those with a market value of less than $75 million.

Small companies will have to adhere to the new guidelines starting on Dec. 15 for the 2007 calendar year. The commission had previously delayed the effective date amid complaints that complying with the rules would be too costly for small companies.

The S.E.C. also introduced six rule proposals yesterday aimed at making it easier for small businesses to raise capital.

Federal regulators have been under pressure from business groups and lawmakers to ease the requirements of the internal controls provision of the Sarbanes-Oxley Act of 2002, which was introduced after the Enron and WorldCom scandals.

Section 404, which requires public companies to assess the controls they have put in place in order to certify that their reports are reliable, was intended to discourage fraud and financial manipulation. Its critics, however, say its stringent requirements impose unnecessary costs on small companies and have caused United States financial markets to lose ground.

Congress left it up to regulators to determine how thoroughly auditors had to conduct their exams.

The commission’s action yesterday was the culmination of a fierce lobbying battle between accounting firms, which have reaped huge profits from the tighter standards, and an influential coalition of small public companies, which has called for relief for years.

The regulator of auditors, the Public Company Accounting Oversight Board, is expected to vote today on new rules for auditors, which reflect a similar emphasis on end results over process.

The S.E.C.’s new guidelines largely resemble those it proposed late last year, accounting experts say. They call on corporate managers to use a “top down” approach to identify the areas where fraud or errors are most likely and a “risk based” approach that allows room to avoid unnecessary testing. This contrasts with a more prescriptive approach that auditors had employed.

Among the most concrete changes is that the S.E.C. will now require a company to get an outside auditor’s formal opinion on whether its financial controls are working. Previously, companies were required to have outside auditors evaluate the quality of the assessment process as well. Accounting experts said this could lower a typical audit’s cost by 10 to 20 percent.

Among the rule proposals on the raising of capital, the S.E.C. has recommended changing its Rule 144 in a move that would allow investors in PIPEs — private investments in public equity — and other restricted securities to sell their positions six months earlier.

Currently, those investors must hold the securities for at least a year. Those who are shorting the stock — betting its price will fall — will still have to hold it for a year.

The S.E.C. also proposed expanding the number of small companies that would qualify for less stringent disclosure requirements and be able to take advantage of so-called shelf registration. While both areas are prone to abuse, regulators are seeking a balance between making it easier for small companies to raise capital and ensuring investor protection.

The commission will solicit comments on the proposals over the next 60 days.