Accelerated Filer Amendments Weaken Investor Protections
On 12 March 2020, the Securities and Exchange Commission (SEC) adopted amendments to the accelerated filer and large accelerated filer definitions. According to the SEC, these amendments will reduce burdens and compliance costs for certain smaller issuers, thereby promoting capital formation while maintaining investor protections.
Respectfully, we disagree. The mission of the SEC is to “protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.” We do not believe, however, that the amendments will achieve that result. On the contrary, we believe they will weaken investor protections. CFA Institute supports preserving the previous accelerated filer definition.
The amendments allow certain smaller reporting companies[1] to qualify as nonaccelerated filers and thereby to be exempted from the Sarbanes-Oxley Act Section 404(b) requirement — that is, the need for auditor attestation of internal controls over financial reporting (ICFR).
The amendments significantly alter the level of assurance that investors obtain about the effectiveness of ICFR of the companies affected by the amendments. In a financial statement–only audit, the auditor obtains an understanding of internal control that is sufficient to assess the factors that affect the risks of material misstatement and to design further audit procedures. In an ICFR audit, however, the auditor’s objective is to express an opinion about the effectiveness of the company’s ICFR.
In our view, the requirement to eliminate the expression of an opinion on the audit of internal controls substantially lessens the auditors’ responsibilities to protect investors. Furthermore, the ICFR assessments by management are weakened by the fact that management knows such assessments will not be challenged by the auditors with the removal of the Section 404(b) requirement.
Investors are concerned that companies of this size are particularly prone to accounting issues. Indeed, the benefits of focusing on ICFR, including auditor attestation, are pronounced for smaller companies. Research has shown that the risk of a material restatement is higher at smaller companies. Since 2003, nonaccelerated US filers (companies with public float less than $75 million) have accounted for 62% of the total US financial statement restatements. The annual independent audit of ICFR, therefore, is essential as it highlights issues before they lead to material weaknesses and restatements. Because research has demonstrated the heightened need for attestation of internal controls, investors likely will price the loss of the internal controls audit in their equity risk premium. In other words, eliminating the attestation requirement may reduce the cash outflow associated with the audit of internal controls. This reduction, however, likely would be more than offset by a higher discount rate because of a rise in the equity risk premium required by investors when companies seek capital in the public market.
Please read our comment letter: https://www.cfainstitute.org/-/media/documents/comment-letter/2015-2019/20190822.ashx
[1] Companies with a public float of $75 million or more but less than $700 million, and with revenues of less than $100 million.
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