______________________________________________________________________________

Study and Recommendations on Section 404(b)

of the Sarbanes-Oxley Act of 2002

For Issuers With Public Float Between $75 and $250 Million

______________________________________________________________________________

As Required by Section 989G(b)

of the Dodd-Frank Wall Street Reform

and Consumer Protection Act of 2010

This is a study by the Staff of the Office of the Chief Accountant

of the U.S. Securities and Exchange Commission.

The Commission has expressed no view regarding the analysis, findings,

or conclusions contained herein.

___________________________

April 2011

i

TABLE OF CONTENTS

Executive Summary....................................................................................................... 1

I. Introduction........................................................................................................ 10

A. Statutory Mandate, Approach, and Structure........................................... 10

1. Statutory Mandate....................................................................... 10

2. Approach to this Study................................................................ 11

3. Structure of this Study................................................................. 13

B. History of Commission Action and Other Developments....................... 14

1. Initial Commission Rule.............................................................. 15

2. First Extension of the Compliance Dates.................................... 15

3. Subsequent Extensions of the Compliance Dates......................... 16

4. ACSPC Report.............................................................................. 18

5. COSO Guidance.......................................................................... 19

6. Additional Extension of the Compliance Dates............................ 19

7. Transition Period for Newly Public Companies.......................... 21

8. PCAOB Auditing Standard No. 5................................................ 21

9. Commission Interpretive Release................................................. 22

10. Guide for Small Businesses on Section 404................................ 22

11. Further Extension of the Compliance Dates................................ 23

12. PCAOB Staff Views on Integrated Audits.................................. 23

13. SEC Staff Study on Section 404; Final Extension of the 

Compliance Date.......................................................................... 23

14. Section 404(c) of the Sarbanes-Oxley Act, as added by the 

Dodd-Frank Act........................................................................... 24

15. PCAOB Small Business Forums.................................................. 24

16. Tabular Summary of the Final Compliance Dates....................... 25

II. Analysis of the Issuers Subject to this Study.................................................... 26

A. Population Size Over Time....................................................................... 27

B. 2009 Illustrative Population...................................................................... 28

1. Size Information............................................................................ 30
ii

2. Industry Information..................................................................... 32

3. Geographic Information................................................................ 35

4. Audit Fees..................................................................................... 36

5. Restatements................................................................................. 39

6. Management ICFR Assessment.................................................... 41

7. Auditor Attestation on ICFR........................................................ 42

C. New Public Listings.................................................................................. 44

III. Analysis of the 2009 SEC Staff Study on Section 404..................................... 49

A. Costs of Section 404(b) Compliance and its Components by Size 

and Year Relative to the 2007 Reforms................................................... 51

B. Survey Participants‘ Perceptions of the Impact of the 2007 Reforms

on the Costs of Compliance...................................................................... 60

IV. Discussion of Public Comments......................................................................... 64

A. Request for Public Comment in Connection with this Study................... 65

1. Summary of Comments Received................................................. 67

2. Staff Analysis of Comments Received......................................... 76

B. Comments Received From Earlier Commission and

PCAOB Actions....................................................................................... 81

V. Summary of Prior Academic and Other Research on Section 404................ . 84

A. Benefits to Section 404 Compliance......................................................... 85

B. Costs of Section 404 Compliance............................................................. 87

1. Pre-2007 Reforms........................................................................ 88

2. Post-2007 Reforms....................................................................... 90

C. Behavior of Issuers in an Effort to Avoid Compliance............................ 91

1. Listing Trends............................................................................... 91

a. Going-Private and Going-Dark Transactions................... 91

b. Listing on Foreign Exchanges.......................................... 93

2. Managing Public Float................................................................. 95

D. Internal Control Deficiencies and Auditor Attestation............................ 96

1. Existence of Internal Control Deficiencies................................... 96
iii

2. Discovery and Disclosure of Internal Control Deficiencies......... 97

3. Financial Reporting Quality......................................................... 99

4. Cost of Debt and Equity Capital.................................................. 101

5. Individual Users‘ Decision Making.............................................102

E. Alternatives to the Requirements of Section 404.....................................104

VI. Conclusion and Recommendations.....................................................................107

A. Summary of Findings...............................................................................107

1. Analysis of the Issuers Subject to this Study...............................107

2. The 2009 Staff Study on Section 404...........................................108

3. Public Input..................................................................................109

4. Other Research on Section 404.....................................................110

B. Recommendations....................................................................................111

1. Maintain existing investor protections of Section 404(b)

for accelerated filers, which have been in place since

2004 for domestic issuers and 2007 for foreign private 

issuers...........................................................................................112

2. Encourage activities that have potential to further improve

both effectiveness and efficiency of Section 404(b) 

implementation.............................................................................112
1

Executive Summary

Under Section 989G(b) of the Dodd-Frank Wall Street Reform and Consumer Protection 

Act (the ―Dodd-Frank Act‖),

1

the Securities and Exchange Commission (―SEC‖ or 

―Commission‖) is required to conduct a study to determine how the Commission could reduce 

the burden of complying with Section 404(b) of the Sarbanes-Oxley Act of 20022(―Section 

404(b)‖) for companies whose market capitalization is between $75 and $250 million, while 

maintaining investor protections for such companies. Section 989G(b) also provides that the 

study must consider whether any methods of reducing the compliance burden or a complete 

exemption for such companies from Section 404(b) compliance would encourage companies to 

list on exchanges in the United States in their initial public offerings (―IPOs‖). 

This study addresses the auditor attestation requirement with respect to an issuer‘s

internal control over financial reporting (―ICFR‖) pursuant to Section 404(b) as required by 

Section 989G(b) of the Dodd-Frank Act. It does not address management‘s responsibility for 

reporting on the effectiveness of ICFR pursuant to Section 404(a) of the Sarbanes-Oxley Act. 

Although many of the academic and other studies surveyed relate to Section 404 in general and 

to Section 404(b) for all issuers, the research discussed in this study primarily focuses on 

findings related to accelerated filers. However, in conducting this study, the SEC Staff‘s

research and analysis considered certain existing information about Section 404 compliance 

beyond the specific areas of the study requirements as provided in the Dodd-Frank Act. This 

approach was used to develop findings and recommendations regarding Section 404(b) through 

the analysis of existing research, even though the purpose of the existing research may have been 

broader than the requirements of the current study. 

Broadly, the Staff gathered information for this study through: (1) a review of publiclyavailable information (including the 2009 SEC Staff study on Section 404, discussed in Section 

III of this study), focusing our data analysis on issuers that would be within the range called for 

by the study; (2) a review of prior academic and other research, including hundreds of studies 

and research papers with respect to Section 404; and (3) a request for public comment which 

included 23 specific areas of inquiry on how the Commission could reduce the burden of 

 

1

Pub. L. No. 111-203 (Jul. 21, 2010). 

2

15 U.S.C. 7201 et seq.
2

complying with Section 404(b) for issuers with $75-$250 million in public float, while 

maintaining investor protections for such issuers, and whether any methods of reducing the 

compliance burden or a complete exemption for such issuers from Section 404(b) would 

encourage issuers to list on U.S. exchanges in their IPOs.

The purpose of using these sources was to: (1) learn about the specific characteristics of 

the issuers in the range of the study, how they compare to other issuers reporting as accelerated 

filers and non-accelerated filers, and the benefits and current and historical costs of compliance 

with Section 404(b) and current investor protections relating to such issuers; and (2) facilitate the 

development of potential new ideas for reducing the compliance burden among such issuers, 

including the effects of such compliance burden reduction or complete exemption from Section 

404(b) to encourage companies to list IPOs in the United States.

Consideration of Prior Action by the Commission and Others

In performing this study, the Staff first considered actions taken by the Commission and 

others since the enactment of Section 404(b). The Staff performed this analysis to consider the 

effects of the significant steps that have already been taken to reduce the overall compliance 

burden on the population that is the subject of this study. Broadly, the timeline is as follows:

The Commission‘s initial implementing rule provided a phased-in approach to 

compliance;

In response to concerns from issuers (particularly non-accelerated filers) about 

compliance costs and management‘s preparedness, the Commission provided several 

extensions to the compliance dates; 

The Commission provided that Section 404 compliance is not required in an IPO and 

in the first annual report after an IPO;

In 2007, the Commission issued an interpretive release to provide guidance for 

management regarding its evaluation of internal controls and disclosure requirements; 

At approximately the same time that the Commission‘s interpretive release was 

issued, the Public Company Accounting Oversight Board (the ―PCAOB‖ or ―Board‖)

adopted Auditing Standard No. 5, An Audit of Internal Control Over Financial 
3

Reporting that is Integrated with an Audit of Financial Statements (―AS 5‖)

3

to 

address feedback from constituents about the costs of conducting an effective audit of 

internal controls, including feedback received from roundtables and other activities 

with the Commission; and

Additionally, in 2008 the Commission directed the Staff to conduct a study on 

Section 404, which was released in 2009 and forms part of the basis for the current 

study. 

Analysis of the Issuers Subject to this Study

After considering prior actions taken to reduce the compliance burden on all issuers 

subject to Section 404, the Staff analyzed the characteristics of issuers that are the subject of this 

study. The Staff performed this analysis to assist with the development of potential 

recommendations specific to any unique circumstances rather than to identify the exact listing of 

issuers as of any point in time that could be affected by any future actions resulting from the 

implementation of particular recommendations of the study. The characteristics analyzed 

included the following information about the issuers: (1) size in terms of assets and revenues; (2) 

industries; (3) locations; (4) audit fees and scalability; (5) restatement rates; and (6) reported 

material weaknesses in ICFR. The Staff also analyzed changes to the population of the issuers 

over time, noting that issuers frequently enter and exit this band of public float, such that the 

composition changes greatly from year to year. 

The Staff identified an illustrative population of issuers as of December 31, 2009 as a 

proxy for those in the studied range. The Staff observes that auditor attestation on ICFR has 

been required for accelerated filers since 2004 for domestic issuers and 2007 for foreign private 

issuers. The Staff‘s analysis reveals that the illustrative population is, in many important 

respects, significantly different from the population of all non-accelerated filers (the group of 

issuers permanently exempted from the requirements of Section 404(b) by the Dodd-Frank Act), 

particularly in relation to size (by revenue and assets), audit fees relative to size, restatement 

rates, and internal control issues discovered by management and auditors. Many of the 

characteristics point to similar financial reporting risks between the studied group of issuers and

 

3

PCAOB Release No. 2007-005A (Jun. 12, 2007), available at

http://pcaobus.org/Rules/Rulemaking/Docket%20021/2007-06-12_Release_No_2007-005A.pdf. On July 27, 2007, 

the Commission approved the issuance of this auditing standard. See Release No. 34-56152 (Jul. 27, 2007). 
4

issuers with larger public float that also must comply with Section 404(b). The Staff recognizes, 

as would be the case with establishing any numeric thresholds, that issuers at the lower end of 

the studied range within the illustrative population could be more likely to have characteristics 

more similar to non-accelerated filers (i.e., issuers that are just under or just over the $75 million 

threshold are likely to have similar characteristics to one another). This analysis suggests that 

there generally are not unique characteristics in the illustrative population that would suggest 

sufficient reasons for differentiating these filers from accelerated filers taken as a whole, 

including the requirement for an auditor attestation on ―ICFR‖ pursuant to Section 404(b). 

To understand whether any possible recommendations may encourage companies to list 

IPOs in the United States, the Staff analyzed the characteristics of global IPOs with respect to 

those likely to be in the range of issuers subject to this study. Although the U.S. IPO market 

over time has recovered from the 2007 levels, it has not reached the 1999 levels (i.e., we 

reviewed IPO activity over a range of years and noted that it was at a relatively low point during 

the financial crisis and has since recovered, but not to the peak for the range of years studied). 

The Staff‘s analysis shows that the United States has not lost U.S.-based companies filing IPOs 

to foreign markets for the range of issuers that would likely be in the $75-$250 million public 

float range after the IPO and that issuers filing IPOs in this range are not likely to remain in this 

range for an extended period of time. While U.S. markets‘ share of world-wide IPOs raising 

$75-$250 million has declined over the past five years, there is no conclusive evidence from the 

study linking the requirements of Section 404(b) to IPO activity. In addition, as noted above, the 

Commission has previously taken action to reduce the compliance burden for new issuers by not 

requiring the auditor attestation on ICFR for the IPO and the first annual report thereafter. 

Analysis of the 2009 SEC Staff Study on Section 404 

Once the Staff understood the characteristics of the studied group of issuers, it used the 

data from its 2009 Section 404 study to analyze the effects of prior efforts to reduce the Section 

404(b) compliance burden on such issuers. The Staff found that the 2007 reforms (broadly, the 

Commission‘s June 2007 interpretive release and the PCAOB‘s adoption of AS 5) had the 

intended effect of reducing the compliance burden and improving the implementation of Section 

404, including the requirements of Section 404(b) for the studied group of issuers. This 

information, in conjunction with the analysis of prior reforms and general information about the 

characteristics of the studied group of issuers, provided the Staff with a starting point to consider 
5

new public input, existing academic research, and other information to determine whether there 

are additional ways to further reduce the compliance burden of Section 404(b) while maintaining 

investor protections for such issuers.

Discussion of Public Comments 

To assist the Staff in considering possible recommendations, the Commission requested 

public input on 23 specific areas about how the Commission could reduce the burden of 

complying with Section 404(b) for the studied group of issuers, while maintaining investor 

protections for such issuers, and whether any methods of reducing the compliance burden or a 

complete exemption for such issuers from Section 404(b) would encourage issuers to list on U.S. 

exchanges in their IPOs. 

There were few suggestions provided from the public input that addressed techniques for 

further reducing the compliance burden while maintaining investor protections without providing 

a complete exemption. For example, the three industry groups that advocated an exemption from 

Section 404(b) for issuers in the studied market capitalization range did not provide other 

recommendations for reducing the compliance burden. The Staff considered this input as well as 

public input previously received on the compliance burden of Section 404(b) from past

Commission and PCAOB actions, but generally did not believe that those suggestions, beyond 

those previously implemented, were appropriate recommendations for the issuer group the Staff 

was required to study (e.g., forms of rotational or reduced testing and raising the threshold of 

what constitutes a material weakness). The Staff is also aware that there are continuing negative 

perceptions attributed to the Sarbanes-Oxley Act, including Section 404. 

 However, the Staff does believe that certain other suggestions from the public that 

involve Commission coordination and support for other groups will likely take into account both 

the compliance costs and effectiveness for all issuers, including those in the studied range. First, 

certain commenters recommended that the PCAOB publish additional observations about the 

implementation of the PCAOB‘s auditing standards related to Section 404(b), including 

comparing such implementation to the PCAOB‘s original intent. These commenters believed

that additional observations could assist auditors in performing more efficient and effective 

audits. The Staff supports recommending to the PCAOB that it continuously review inspection 

results and consider whether publishing observations is warranted to improve the effective and 

efficient application of its auditing standard. If such observations were published, they may 
6

contribute to a reduction in the compliance burden for issuers in the studied range and also 

provide auditors, issuers, investors, and others with important information about audit 

performance and quality.

Second, certain commenters recommended that the Commission actively participate and 

monitor the Committee of Sponsoring Organizations of the Treadway Commission (―COSO‖) 

update to its internal control framework. COSO announced plans to update its framework, which 

was originally released in 1992, in November of 2010. The stated aims of the update to the 1992 

framework do not explicitly address the compliance burden on issuers that use the COSO 

framework to evaluate ICFR, and it is not aimed at any particular size of issuer. However, the 

update is designed to describe how to evaluate internal controls in an environment that is more 

complex than it was when the original framework was developed. The Staff supports this 

recommendation, as the update may have implications on the compliance burden on issuers, 

including those in the studied range.

Summary of Prior Academic and Other Research on Section 404 

Finally, the Staff considered existing research on Section 404 to understand the trends in 

compliance costs and the existing investor protections provided by compliance with Section 

404(b), as well as to discern any additional ideas for reducing the compliance burden for issuers 

in the studied range. The research was useful to inform the Staff‘s broader consideration of how 

and if the compliance burden could be reduced for such issuers by examining, for example, 

compliance cost trends, listing trends, and individuals‘ decision making in lending and investing 

activities.

The academic and other research on Section 404:

Indicates that the cost of compliance with Section 404(b), including both total costs 

and audit fees, has declined since the 2007 reforms;

Does not provide conclusive evidence linking the enactment of Section 404(b) to 

decisions by issuers to exit the reporting requirements of the SEC, including ICFR 

reporting;

Indicates that auditor involvement in ICFR is positively correlated with more accurate 

and reliable disclosure of all ICFR deficiencies, and restatement rates for issuers with 

the auditor attestation is lower than that for issuers without this attestation; and
7

Indicates that disclosure of internal control weaknesses conveys relevant information 

to investors.

The Staff also considered and does not recommend an approach detailed in certain 

studies suggesting that the Commission allow an issuer to ―opt out‖ of Section 404(b) 

compliance. ―Opt out‖ approaches can provide a mechanism to allow an issuer options 

regarding compliance rather than a strict requirement. Under such an approach, so long as an 

investor was informed as to an issuer‘s decision to opt out or comply, an investor could consider 

this decision in allocating capital and otherwise making investment decisions. Although some 

suggest that allowing flexibility of this type could be beneficial, in the context of Section 404(b) 

the Staff considered the suggestion of an ―opt out‖ to be too similar to providing a full exemption 

given the Staff‘s view of the benefits of auditor involvement to reliable ICFR disclosures and 

reliable financial reporting. Academic literature also suggests it could incentivize insiders to 

exploit the information asymmetry between themselves and other investors about the incidence 

and severity of material weaknesses in ICFR.

Conclusion and Recommendations 

The information compiled for the study provided the Staff with an understanding that:

The costs of Section 404(b) have declined since the Commission first implemented 

the requirements of Section 404, particularly in response to the 2007 reforms;

Investors generally view the auditor‘s attestation on ICFR as beneficial;

Financial reporting is more reliable when the auditor is involved with ICFR 

assessments; and

There is not conclusive evidence linking the requirements of Section 404(b) to listing 

decisions of the studied range of issuers.
8

The Staff also received public input suggesting certain means to reduce the compliance 

burden that were previously considered by the Commission or the PCAOB and they determined 

not to adopt. The Staff considered this input but believes these suggestions would possibly be 

detrimental to effectiveness of audits of ICFR and, therefore, not maintain investor protections 

provided by Section 404(b). 

After considering the information gathered from internal and external sources, the Staff 

concludes the study with the following two recommendations:

1. Maintain existing investor protections of Section 404(b) for accelerated filers, 

which have been in place since 2004 for domestic issuers and 2007 for foreign

private issuers

The Staff believes that the existing investor protections for accelerated filers to comply 

with the auditor attestation provisions of Section 404(b) should be maintained (i.e., no new 

exemptions). There is strong evidence that the auditor‘s role in auditing the effectiveness of 

ICFR improves the reliability of internal control disclosures and financial reporting overall and is 

useful to investors. The Staff did not find any specific evidence that such potential savings 

would justify the loss of investor protections and benefits to issuers subject to the study, given 

the auditor‘s obligations to perform procedures to evaluate internal controls even when the 

auditor is not performing an integrated audit. Also, while the research regarding the reasons for 

listing decisions is inconclusive, the evidence does not suggest that granting an exemption to 

issuers that would expect to have $75-$250 million in public float following an IPO would, by 

itself, encourage companies in the United States or abroad to list their IPOs in the United States. 

The Staff acknowledges that the reasons a company may choose to undertake an IPO are varied 

and complex. The reasons are often specific to the company, with each company making the 

decision as to whether and where to go public based on its own situation and the market factors

present at the time. The costs associated with conducting an IPO and becoming a public 

company no doubt factor into the decisions and may be particularly challenging for smaller 

companies. The Staff appreciates that the costs and benefits of the regulatory actions that the 

Commission takes – and does not take – certainly can impact these decisions. At Chairman 

Schapiro‘s request, the Staff is taking a fresh look at several of the Commission‘s rules, beyond 

those related to Section 404(b), to develop ideas for the Commission about ways to reduce 

regulatory burdens on small business capital formation in a manner consistent with investor 
9

protection.4 However, the Dodd-Frank Act already exempted approximately 60% of reporting

issuers from Section 404(b), and the Staff does not recommend further extending this exemption.

2. Encourage activities that have potential to further improve both effectiveness and 

efficiency of Section 404(b) implementation

The Staff recommends that the PCAOB monitor its inspection results and consider 

publishing observations, beyond the observations previously published in September 2009, on 

the performance of audits conducted in accordance with AS 5. These observations could assist 

auditors in performing top-down, risk based audits of ICFR. These communications could 

include the lessons that can be learned from internal control deficiencies identified through 

PCAOB inspections.

The Staff is observing COSO‘s project to review and update its internal control 

framework, which is the most common framework used by management and the auditor alike in 

performing assessments of ICFR. The Staff believes that this project can contribute to effective 

and efficient audits by providing management and auditors with improved internal control 

guidance that reflects today‘s operating and regulatory environment and by allowing constituent 

groups to share information on improvements that can be made that enhance the ability to design, 

implement, and assess internal controls.

 

4

See Letter from Mary L. Schapiro, Chairman, U.S. Securities and Exchange Commission, to Congressman Darrell 

E. Issa, Chairman, Committee on Oversight and Government Reform, U.S. House of Representatives (Apr. 6, 2011), 

available at http://www.sec.gov/news/press/schapiro-issa-letter-040611.pdf.
10

I. Introduction

A. Statutory Mandate, Approach, and Structure

1. Statutory Mandate

Section 989G(b) of the Dodd-Frank Act directed the SEC to conduct a study with respect 

to the auditor attestation requirement under Section 404(b) for issuers whose market 

capitalization is between $75 and $250 million. Specifically, the Dodd-Frank Act provides:5

The Securities and Exchange Commission shall conduct a study to 

determine how the Commission could reduce the burden of complying 

with section 404(b) of the Sarbanes-Oxley Act of 2002 for companies 

whose market capitalization is between $75,000,000 and $250,000,000 for 

the relevant reporting period while maintaining investor protections for 

such companies. The study shall also consider whether any such methods 

of reducing the compliance burden or a complete exemption for such 

companies from compliance with such section would encourage 

companies to list on exchanges in the United States in their initial public 

offerings. Not later than 9 months after the date of the enactment of this 

subtitle, the Commission shall transmit a report of such study to Congress.

In addition, Section 989G(a) of the Dodd-Frank Act amended the Sarbanes-Oxley Act so that 

Section 404(b) does not apply with respect to ―any audit report prepared for an issuer that is 

neither a  ̳large accelerated filer‘ nor an  ̳accelerated filer‘ as those terms are defined in Rule 

12b-2 of the Commission.‖

6

Pursuant to Section 989I of the Dodd-Frank Act, the Government Accountability Office 

(―GAO‖) is required to conduct a study on the impact of the Section 404(b) amendments under 

the Dodd-Frank Act and to submit a report ―not later than 3 years after the date of enactment‖ of 

that Act (July 2013). The GAO study is to include an analysis of:7

(1) whether issuers that are exempt from such section 404(b) have 

fewer or more restatements of published accounting statements than 

issuers that are required to comply with such section 404(b);

(2) the cost of capital for issuers that are exempt from such section 

404(b) compared to the cost of capital for issuers that are required to 

comply with such section 404(b);

 

5

Supra note 1.

6

Id.

7

Id.
11

(3) whether there is any difference in the confidence of investors 

in the integrity of financial statements of issuers that comply with such 

section 404(b) and issuers that are exempt from compliance with such 

section 404(b);

(4) whether issuers that do not receive the attestation for internal 

controls required under such section 404(b) should be required to disclose 

the lack of such attestation to investors; and

(5) the costs and benefits to issuers that are exempt from such 

section 404(b) that voluntarily have obtained the attestation of an 

independent auditor. 

2. Approach to this Study

This study addresses the auditor attestation requirement with respect to an issuer‘s ICFR 

pursuant to Section 404(b) as required by Section 989G(b) of the Dodd-Frank Act. It does not 

address management‘s responsibilities pursuant to Section 404(a) of the Sarbanes-Oxley Act. 

Under the Commission‘s rules prescribed pursuant to Section 404(a) of the Sarbanes-Oxley Act, 

issuers, other than registered investment companies, are required to include in their annual 

reports a report of management on the issuer‘s ICFR that: (1) states management‘s responsibility 

for establishing and maintaining the internal control structure; and (2) includes management‘s 

assessment of the effectiveness of the ICFR. Section 404(b) requires the auditor to attest to, and 

report on, management‘s assessment.8 In light of the interrelationship between the requirements 

in Section 404(a) and Section 404(b), and to be complete in our efforts to identify potential 

methods of reducing the Section 404(b) compliance burden, the Staff‘s research and analysis

included consideration of certain existing information about Section 404 compliance more 

broadly, particularly where such information did not distinguish among the various requirements 

in Section 404. 

In order to fulfill the statutory mandate and produce this study, the Staff has assigned 

meaning to certain terms as described below:

For purposes of this study, the Staff generally uses public float as the measure of 

market capitalization.9 As the Commission described in its request for comment in 

connection with this study:10

 

8

See Exchange Act Rules 13a-15 and 15d-15 [17 CFR 13a-15 and 17 CFR 15d-15]. 

9 While the Staff believes that public float is the appropriate measure of market capitalization for the purposes of the 

study, an exact measure of public float as reported annually by issuers was not readily available for the dates the 

Staff analyzed. In Sections II and III, the Staff generally used free float capitalization, as determined by Thomson 
12

The Dodd-Frank Act does not define ―market capitalization‖ and it is not 

defined in Commission rules. For purposes of the study, we believe that 

public float is an appropriate measure of market capitalization. Public 

float, which is the aggregate worldwide market value of an issuer‘s voting 

and non-voting common equity held by its non-affiliates, is the measure 

used in Commission rules for determining ―accelerated filer‖ and ―large 

accelerated filer‖ status. The Commission has used public float 

historically in its actions to phase issuers into Section 404 compliance, and 

Section 404(c) of the Sarbanes-Oxley Act of 2002, as amended by Section 

989G(a) of the Dodd-Frank Act, provides that Section 404(b) shall not 

apply with respect to issuers that are neither an ―accelerated filer‖ nor a 

―large accelerated filer‖ pursuant to Commission rules, which are 

generally issuers with a public float below $75 million. We therefore 

believe it would be consistent to use public float between $75 million and 

$250 million to describe the group of issuers that are the subject of the 

study.

―Accelerated filer‖ means an issuer after it first meets the following conditions as of 

the end of its fiscal year:11

(i) The issuer had an aggregate worldwide market value of the voting and nonvoting common equity held by its non-affiliates of $75-$700 million as of the last 

business day of the issuer‘s most recently completed fiscal quarter;

(ii) The issuer has been subject to the requirements of Section 13(a) or 15(d) of 

the Exchange Act for at least twelve calendar months;

(iii) The issuer has filed at least one annual report pursuant to Section 13(a) or 

15(d) of the Exchange Act; and

(iv) The issuer is not eligible to use the requirements for smaller reporting 

companies in its annual and quarterly reports.

―Large accelerated filer‖ means an issuer that had an aggregate worldwide market 

value of the voting and non-voting common equity held by its non-affiliates of $700 

million or more as of the last business day of the issuer‘s most recently completed 

 

Datastream and defined as the market value of shares available to ordinary investors, as a proxy for public float, 

even though free float capitalization excludes some shares that may considered in calculating public float. See infra

note 52 regarding the use of free float capitalization as a proxy for public float. 

10 See Release No. 34-63108 (Oct. 14, 2010) (footnotes omitted).

11 See Exchange Act Rule 12b-2 [17 CFR 240.12b-2].
13

fiscal quarter and also meets the requirements of (ii) – (iv) listed above in the 

definition of accelerated filer.

12

The study uses the term ―non-accelerated filer‖ to refer to an issuer that does not meet 

the definition of either an ―accelerated filer‖ or a ―large accelerated filer,‖ which 

principally are issuers with a public float of less than $75 million.

The study uses the term ―illustrative population‖ to refer to the group of issuers 

identified for the analyses in Section II of this study. 

The methodologies used by the Staff to gather and analyze data for Sections II –V of this 

study are described in each of those sections. Broadly, the Staff gathered information for this study 

through: (1) a review of publicly-available information (including the prior Staff study on Section 

404), focusing our data analysis on issuers that would be within the range called for by the study; (2) 

a review of prior academic and other research, including hundreds of studies and research papers 

with respect to Section 404; and (3) a request for public comment which included 23 specific areas 

of inquiry on how the Commission could reduce the burden of complying with Section 404(b) for 

issuers with $75-$250 million in public float, while maintaining investor protections for such issuers, 

and whether any methods of reducing the compliance burden or a complete exemption for such 

issuers from Section 404(b) would encourage issuers to list on U.S. exchanges in their IPOs. 

3. Structure of this Study

This study is organized into the following sections:

Executive Summary – The Executive Summary provides an overview of the Staff‘s study 

and also recaps the Staff‘s recommendations.

Section I: Introduction – This section discusses the statutory mandate, approach, and 

structure of the study, and provides a history of Commission action and other 

developments related to Section 404.

Section II: Analysis of the Issuers Subject to this Study – This section analyzes 

demographic data for an illustrative population of issuers as a proxy for those in the 

studied range, including: size; industry; geographic location; audit fees; restatement data;

 

12 See id.
14

and past results of auditor and management assessments of internal controls over 

financial reporting. This section also includes data on new listings.

Section III: Analysis of the 2009 SEC Staff Study on Section 404 – This section analyzes 

the SEC Staff‘s 2009 study on Section 404, including further analysis of the data 

gathered in that study, focusing on findings related to issuers with $75-$250 million in 

public float.

Section IV: Discussion of Public Comments – This section discusses the public 

comments received from the Commission‘s October 2010 request for public comment in 

connection with this study, as well as comments received from earlier Commission and 

PCAOB actions with respect to Section 404.

Section V: Summary of Prior Academic and Other Research on Section 404 – This 

section summarizes the Staff‘s review of external studies and research reports on Section 

404, including research related to benefits and costs of compliance, internal control 

deficiencies, financial reporting quality, cost of debt and equity capital, individual users‘

decision making, and alternatives to existing auditor attestation.

Section VI: Conclusion and Recommendations – This section summarizes the Staff‘s 

findings and also provides the Staff‘s recommendations.

B. History of Commission Action and Other Developments

Since the enactment of the Sarbanes-Oxley Act, the Commission has taken several steps 

to reduce the burden for issuers to comply with the reporting and attestation requirements under 

Section 404. First, the Commission‘s initial implementing rule provided a phased-in approach to 

compliance. Then, in response to concerns from issuers (particularly non-accelerated filers) 

about compliance costs and management‘s preparedness, the Commission provided several 

extensions to the compliance dates discussed further below. In 2007, the Commission issued an 

interpretive release to provide guidance for management regarding its evaluation of ICFR and 

the related disclosure requirements. Additionally, in 2008, the Commission directed the Staff to 

conduct a study on Section 404. Each of these initiatives is described below, listed in 

chronological order along with related actions taken by the PCAOB and others. 
15

1. Initial Commission Rule

Section 404 of the Sarbanes-Oxley Act provided that the Commission prescribe rules 

requiring each Exchange Act annual report to include a report of management‘s assessment of 

the effectiveness of ICFR pursuant to Section 404(a) and an independent auditor‘s attestation to 

the effectiveness of those controls pursuant to Section 404(b). Consistent with Sections 404(a) 

and 404(b) of the Sarbanes-Oxley Act, on June 5, 2003, the Commission adopted initial 

amendments to its rules and forms requiring issuers, other than registered investment companies, 

to include in their annual reports filed with the Commission a report of management and an 

accompanying auditor‘s attestation report on the effectiveness of the issuer‘s ICFR.

13

 The 

Commission‘s release provided for a phase in of the compliance dates as follows:14 

Accelerated filers were to comply with the Section 404 requirements for their first 

fiscal year ending on or after June 15, 2004; and 

Issuers that were not accelerated filers as of June 15, 2004, including foreign private 

issuers that file annual reports on Form 20-F or Form 40-F, were to comply with the 

Section 404 requirements for their first fiscal year ending on or after April 15, 2005.

2. First Extension of the Compliance Dates

On February 24, 2004, the Commission extended the compliance dates as follows:15 

Accelerated filers were to comply with the Section 404 requirements for their first 

fiscal year ending on or after November 15, 2004; and

Non-accelerated filers and foreign private issuers that file annual reports on Form 20-

F or Form 40-F were to comply with the Section 404 requirements for their first fiscal 

year ending on or after July 15, 2005.

The Commission extended the compliance dates in light of the time and resources needed to 

properly implement the rules and to provide additional time for issuers and their auditors to 

implement a new auditing standard16 of the PCAOB, which set forth new standards for 

 

13 See Release No. 33-8238 (Jun. 5, 2003). 

14 Note that at the time of this release, there was no ―large accelerated filer‖ category in the Commission‘s rules. 

15 See Release No. 33-8392 (Feb. 24, 2004).

16 See PCAOB Rulemaking Docket Matter No. 008: Auditing Standard No. 2 – An Audit of Internal Control Over 

Financial Reporting Performed in Conjunction with an Audit of Financial Statements (―AS 2‖), available at
16

conducting an audit of ICFR performed in conjunction with an audit of the financial 

statements.17 

3. Subsequent Extensions of the Compliance Dates

In December 2004, the Commission announced that it was establishing the SEC Advisory 

Committee on Smaller Public Companies (―ACSPC‖) to assist the Commission in evaluating the 

current securities regulatory system relating to smaller public companies, including the rules 

relating to internal control reporting.18 In addition, the SEC Staff held roundtable discussions on 

April 13, 2005 and, jointly with the PCAOB, on May 10, 2006, to obtain input from the public 

about their experiences in implementing the Section 404 requirements in order to help develop 

policies to effectively and efficiently improve the reliability of financial statements.19 The 

roundtable participants included issuers, auditors, investors, representatives of the PCAOB, and 

other interested parties. In addition to these roundtables, SEC Staff also issued staff guidance on 

Section 404 compliance in January and May of 2005.20 As discussed below, the Commission 

provided further extensions to the compliance dates:

On March 2, 2005, the Commission extended the compliance date for non-accelerated 

filers and foreign private issuers that file annual reports on Form 20-F or Form 40-F 

to their first fiscal year ending on or after July 15, 2006.21 The Commission approved 

this extension in response to, among other things, the challenges that non-U.S. issuers 

 

http://pcaobus.org/Rules/Rulemaking/Pages/Docket008.aspx. Note that AS 2 is not discussed in detail because it 

was superseded by a new auditing standard of the PCAOB. See the discussion of AS 5 in Subsection B.8. of Section 

I of this study. 

17 See Release No. 33-8392 (Feb. 24, 2004).

18 See Release No. 33-8514 (Dec. 16, 2004).

19 See SEC Press Release 2005-13, Commission Announces Roundtable on Internal Control Reporting 

Requirements (Feb. 7, 2005), available at http://www.sec.gov/news/press/2005-13.htm; SEC Press Release 2005-

20, Commission Seeks Feedback and Announces Date of Roundtable on Implementation of Sarbanes-Oxley Internal 

Control Provisions (Feb. 22, 2005), available at http://www.sec.gov/news/press/2005-20.htm; SEC Press Release 

2006-22, Commission and PCAOB Announce Roundtable on Internal Control Reporting Requirements (Feb. 16, 

2006), available at http://www.sec.gov/news/press/2006-22.htm. 

20 See Office of the Chief Accountant, Division of Corporation Finance: Staff Statement on Management‘s Report 

on Internal Control Over Financial Reporting (May 16, 2005), and Division of Corporation Finance: Exemptive 

Order on Management‘s Report on Internal Control over Financial Reporting and Related Auditor Report; 

Frequently Asked Questions (Jan. 21, 2005), available at http://www.sec.gov/spotlight/soxcomp.htm. 

21 See Release No. 33-8545 (Mar. 2, 2005).
17

faced in complying with the ICFR requirements, including language, culture, and 

organization structures that are different than what is found typically in the United 

States.

22

 The Commission also noted that it was important to allow time for the 

ACSPC to consider the framework for ICFR applicable to smaller issuers, methods 

for management‘s assessment of the controls, and standards for auditing the 

controls.23 

On September 22, 2005, the Commission extended the compliance date for nonaccelerated filers to their first fiscal year ending on or after July 15, 2007.24

 This 

extension was consistent with an ACSPC interim recommendation to extend the 

compliance date while the ACSPC continued its evaluation of the impact of the ICFR 

requirements on smaller public companies. Also, COSO was continuing its efforts to 

develop guidance for smaller public companies.25 This extension also provided time 

for the Commission to review responses to its request for public comment on several 

questions about the application of the internal control reporting requirements,

including questions regarding the amount of time and expense that non-accelerated 

filers had incurred to prepare for compliance with the internal control reporting 

requirements.26

On August 9, 2006, the Commission extended the Section 404(b) compliance date for 

foreign private issuers that are accelerated filers and file annual reports on Form 20-F 

 

22 See id. 

23 See id.

24 See Release No. 33-8618 (Sept. 22, 2005).

25 COSO is a private-sector organization that provides frameworks and guidance on organizational governance, 

business ethics, internal control, enterprise risk management, fraud, and financial reporting. It was formed in 1985 

to sponsor the National Commission on Fraudulent Financial Reporting, an independent private-sector initiative 

which studied the causal factors that can lead to fraudulent financial reporting. In the adopting release for the initial 

rules implementing Section 404, the Commission noted that the rules require management to base its evaluation of 

the effectiveness of the company‘s internal controls on a suitable framework and, while the rules do not mandate use 

of a particular framework, the COSO framework satisfies the Commission‘s criteria and may be used for 

management‘s evaluation and disclosure requirements. See Release No. 33-8238 (Jun. 5, 2003).

26 See Release No. 33-8731 (Aug. 9, 2006).
18

or Form 40-F to their first fiscal year ending on or after July 15, 2007.27 The 

Commission extended the compliance date in order to provide foreign private issuers 

and their auditors an additional year to consider and adapt to actions by the 

Commission and the PCAOB to improve the implementation of the Section 404 

requirements.

28

 Also, the extension enabled management of this group of foreign 

private issuers to begin the process of reviewing and evaluating the effectiveness of 

ICFR prior to the initial ICFR audit. 

4. ACSPC Report

On April 23, 2006, the SEC‘s ACSPC issued its final report to the Commission 

including, among other things, the following recommendations:29

Unless and until a framework for assessing internal control over financial reporting 

for such companies is developed that recognizes their characteristics and needs, 

provide exemptive relief from Section 404 requirements to microcap companies with 

less than $125 million in annual revenue, and to smallcap companies with less than 

$10 million in annual product revenue, that have or add corporate governance 

controls that include:

o adherence to standards relating to audit committees in conformity with Rule 10A3 under the Exchange Act; and

o adoption of a code of ethics within the meaning of Item 406 of Regulation S-K 

applicable to all directors, officers and employees and disclosure of the code in 

connection with the company‘s obligations under Item 406(c) relating to the 

disclosure of the code of ethics.

In addition, as part of this recommendation, we recommend that the Commission

confirm, and if necessary clarify, the application to all microcap companies, and 

indeed to all smallcap companies also, of the existing general legal requirements 

regarding internal controls, including the requirement that companies maintain a 

system of effective internal control over financial reporting, disclose modifications to 

 

27 See Release No. 33-8730A (Aug. 9, 2006). Also on August 9, 2006, the Commission issued proposed rules to 

further extend the compliance date for non-accelerated filers to their first fiscal year ending on or after December 15, 

2007. See Release No. 33-8731 (Aug. 9, 2006). 

28 See SEC Press Release 2006-75 (May 17, 2006), SEC Announces Next Steps for Sarbanes-Oxley Implementation, 

available at http://www.sec.gov/news/press/2006/2006-75.htm, and PCAOB News Release (May 17, 2006), Board 

Announces Four-Point Plan to Improve Implementation of Internal Control Reporting Requirements, available at

http://www.pcaobus.org/News_and_Events/News/2006/05-17aspx. 

29 See Final Report of the Advisory Committee on Smaller Public Companies (Apr. 23, 2006), available at

http://www.sec.gov/info/smallbus/acspc/acspc-finalreport.pdf. The Co-Chairs of the ASCPC included a separate 

statement in the report, noting that their intent was to ―fix 404, not repeal it, so that it is both effective and efficient.‖ 

Id. at 124.
19

internal control over financial reporting and their material consequences, apply CEO 

and CFO certifications to such disclosures and have their management report on any 

known material weaknesses.

Unless and until a framework for assessing internal control over financial reporting 

for such companies is developed that recognizes their characteristics and needs, 

provide exemptive relief from external auditor involvement in the Section 404 

process to the following companies, subject to their compliance with the same 

corporate governance standards as detailed in the recommendation above:

o Smallcap companies with less than $250 million in annual revenues but more than 

$10 million in annual product revenue; and

o Microcap companies with between $125 and $250 million in annual revenue.

While we believe that the current costs of the requirement for an external audit of the 

effectiveness of internal control over financial reporting are disproportionate to the

benefits, and have therefore adopted [the recommendation] above, we also believe 

that if the Commission reaches a public policy conclusion that an audit is required, 

we recommend that changes be made to the requirements for implementing Section 

404‘s external auditor requirement to a cost-effective standard, which we call ―ASX,‖

providing for an external audit of the design and implementation of internal controls.

Provide, and request that COSO and the PCAOB provide, additional guidance to help 

facilitate the assessment and design of internal controls and make processes related to 

internal controls more cost-effective; also, assess if and when it would be advisable to

reevaluate and consider amending AS2.

5. COSO Guidance

Shortly after the release of the ACSPC report, COSO released a document entitled 

―Internal Control Over Financial Reporting – Guidance for Smaller Public Companies,‖ which 

provides guidance on how to apply the COSO internal control framework to smaller issuers and 

describes considerations related to designing and implementing cost-effective ICFR.30 The 

guidance also was intended to be useful to management in more efficiently evaluating ICFR in 

the context of guidance provided by regulators. 

6. Additional Extension of the Compliance Dates

Based on extensive analysis from investors, issuers, auditors, and others, the Commission 

on May 16, 2006 announced a series of actions to improve the implementation of the Section 404 

requirements, including: (1) issuing guidance for issuers; (2) working with the PCAOB on 

 

30 See Internal Control over Financial Reporting - Guidance for Smaller Public Companies, June 2006, available at

www.coso.org/ICFR-GuidanceforSPCs.htm.
20

revisions to its internal control auditing standard; and (3) conducting inspections of the 

PCAOB‘s efforts to improve Section 404 oversight.31 On July 11, 2006, the Commission issued 

a Concept Release to solicit public comment on providing additional guidance for management 

on its assessment of the effectiveness of ICFR.

32

 The release requested comment on a number of 

areas, including the level of public interest in any additional guidance and the appropriate scope 

for the guidance.33 On December 15, 2006, the Commission provided further relief to nonaccelerated filers by:34

Extending the Section 404(a) compliance date for non-accelerated filers to their first 

fiscal year ending on or after December 15, 2007; and

Extending the Section 404(b) compliance date for non-accelerated filers to their first 

fiscal year ending on or after December 15, 2008.

The Commission provided this extension in part because it would shortly be proposing 

interpretive guidance for management regarding its evaluation of ICFR and requesting public 

comment on the proposed guidance.35 This guidance was designed to increase the efficiency and 

cost-effectiveness of management‘s evaluation and to provide scalability and flexibility to 

issuers, particularly smaller issuers.

Additionally, the Commission held an open meeting on April 4, 2007 to discuss the 

PCAOB‘s proposed revised auditing standard on ICFR audits, described below, and to facilitate 

the alignment of the proposed revised standard with the Commission‘s related guidance.36 The 

open meeting was a continuation of the process announced by the Commission and the PCAOB 

 

31 See SEC Press Release 2006-75, supra note 28.

32 Release No. 34-54122 (Jul. 11, 2006).

33 See id. 

34 See Release No. 33-8760 (Dec. 15, 2006).

35 See Release No. 33-8762 (Dec. 20, 2006).

36 See SEC Press Release 2007-56 (Mar. 28, 2007), SEC Schedules Open Meeting to Discuss PCAOB‘s Proposed 

Auditing Standard and SEC‘s Proposed Management Guidance for Section 404 of Sarbanes-Oxley Act, available at

http://www.sec.gov/news/press/2007/2007-56.htm. 
21

in May 2006 to improve the reliability of issuers‘ financial statements while providing guidance 

to make the Section 404 process more efficient and cost-effective.37 

7. Transition Period for Newly Public Companies

On December 15, 2006, the Commission also amended its rules to reduce the burden on 

newly public companies by providing that such issuers do not need to comply with the Section 

404 requirements until the second annual report filed with the Commission.38 The Commission 

recognized that preparation of an issuer‘s first annual report is a comprehensive process 

involving compilation of information in response to many public disclosure requirements and 

that requiring a newly public company to comply with the Section 404 requirements during this 

same timeframe would impose an additional burden on these issuers.

39

 

8. PCAOB Auditing Standard No. 5

On June 12, 2007, the PCAOB issued AS 5 to address the costs in conducting an 

effective audit of internal controls, feedback from constituents, and participation in roundtables 

and other activities with the Commission. The Board further explained in the adopting release to 

AS 5 its rationale for issuing the new standard:

The Board issued [the AS 5 proposal] with the primary objectives of 

focusing auditors on the most important matters in the audit of internal 

control over financial reporting and eliminating procedures that the Board 

believes are unnecessary to an effective audit of internal control. The 

proposals were designed to both increase the likelihood that material 

weaknesses in companies‘ internal control will be found before they cause 

material misstatement of the financial statements and steer the auditor 

away from procedures that are not necessary to achieve the intended 

benefits. The Board also sought to make the internal control audit more 

clearly scalable for smaller and less complex public companies and to 

make the text of the standard easier to understand.40

The Board also stated that AS 5 aligned closely with guidance that the Commission had 

proposed in December 2006 (and adopted in June 2007, as described below) to help management 

 

37 See id.

38 See Release No. 33-8760 (Dec. 15, 2006).

39 See id.

40 PCAOB Release No. 2007-005A (Jun. 12, 2007), available at 

http://pcaobus.org/Rules/Rulemaking/Docket%20021/2007-06-12_Release_No_2007-005A.pdf. 
22

(not the auditor) evaluate internal controls for the purposes of its annual assessment.41 The 

PCAOB, while acknowledging fundamental differences in the evaluations performed by 

management and auditors, described its auditing standard as using a ―top down‖ approach, 

similar to that performed in financial statement audits and closely aligned to the concept 

described by the Commission in its guidance for management assessments of ICFR. AS 5 

contained provisions on scaling ICFR audits for smaller and less complex issuers, including 

consideration of how smaller issuers achieve control objectives and address risk of management 

override differently than larger issuers. 

9. Commission Interpretive Release

On June 20, 2007, the Commission issued an Interpretive Release entitled ―Commission 

Guidance Regarding Management‘s Report on Internal Control over Financial Reporting Under 

Section 13(a) and 15(d) of the Securities Exchange Act of 1934‖ (―Management Guidance‖), 

which described a ―top-down, risk based evaluation‖ as one way that registrants could satisfy the 

requirements of Rules 13a-15(c) and 15d-15(c).42 

Although the Management Guidance applies to all issuers, it specifically encourages

smaller issuers ―to take advantage of the flexibility and scalability to conduct an evaluation of 

ICFR that is both efficient and effective at identifying material weaknesses.‖

43

 The Commission 

further indicated that it believed ―principles-based guidance permits flexible and scalable 

evaluation approaches that will enable management of smaller public companies to evaluate and 

assess the effectiveness of ICFR without undue cost burdens.‖

44

 

10. Guide for Small Businesses on Section 404

In January 2008, the SEC Staff published a guide for small businesses to assist these 

issuers in understanding the steps necessary in connection with their initial evaluations of 

 

41 See id.

42 See Release No. 33-8810 (Jun. 20, 2007). The Management Guidance had been proposed by the Commission in 

December 2006. See Release No. 33-8762 (Dec. 20, 2006).

43 Release No. 33-8810 (Jun. 20, 2007).

44 Id. at 50. SEC Staff issued further guidance in the form of a ―Frequently Asked Questions‖ document in 

September 2007. See http://www.sec.gov/info/accountants/controlfaq.htm. 
23

internal controls.45 This publication also provided information on other sources of guidance to 

assist management in performing its assessment of internal controls. 

11. Further Extension of the Compliance Dates

On June 26, 2008, the Commission approved a further extension of the Section 404(b) 

compliance date for non-accelerated filers to fiscal years ending on or after December 15, 

2009.46 The extension was to allow time for the PCAOB to issue final staff guidance on auditing 

ICFR of smaller issuers and for the SEC Staff to undertake a study to help determine whether AS 

5, and the Commission‘s Management Guidance on evaluating ICFR, were facilitating more 

cost-effective ICFR evaluations and audits. 

12. PCAOB Staff Views on Integrated Audits

On January 23, 2009, the PCAOB issued its staff‘s views on integrated audits under AS 

5. The guidance was provided to assist auditors in designing and executing audit strategies that 

would achieve the objectives of AS 5. Specifically, the expressed purpose of this guidance was 

to ―help auditors apply the provisions of [AS 5] to audits of smaller, less complex public 

companies‖ and to provide ―direction to auditors on scaling the audit based on a company‘s size 

and complexity.‖

47

 The guidance discussed the selection of controls to test, testing the operating 

effectiveness of controls, evaluating entity-level controls, and determining the effect of entitylevel controls on other controls. The guidance also addressed, among other things, assessing the 

risk of management override, evaluating mitigating controls (including audit committee 

oversight and whistleblower programs), and evaluating segregation of duties. 

13. SEC Staff Study on Section 404; Final Extension of the Compliance 

Date

On October 2, 2009, the SEC Staff released its study on Section 404 (discussed in 

Section III of this study). Due to the proximity of the date of the Staff‘s study to the proposed 

 

45 See Sarbanes-Oxley Section 404 – A Guide for Small Business, available at

www.sec.gov/info/smallbus/404guide.pdf. 

46 Release No. 33-8934 (Jun. 26, 2008).

47 Staff Views - An Audit of Internal Control that is Integrated with an Audit of the Financial Statements: Guidance 

for Auditors of Smaller Public Companies (Jan. 23, 2009), available at

http://pcaobus.org/Standards/Auditing/Documents/AS5/Guidance.pdf. 
24

date that Section 404(b) compliance would have been required absent the further delay, on 

October 13, 2009, the Commission provided a final extension of the Section 404(b) compliance 

date for non-accelerated filers to fiscal years ending after June 15, 2010.48 In the release, the 

Commission noted that ―all steps necessary to implement the requirements of Section 404 of the 

Sarbanes-Oxley Act have been completed, and non-accelerated filers should work with their 

auditors to comply with Section 404(b) for annual reports for fiscal years ending on or after June 

15, 2010‖ and that the Commission ―does not expect to further defer the obligation of nonaccelerated filers to comply with Section 404(b).‖

49

14. Section 404(c) of the Sarbanes-Oxley Act, as added by the DoddFrank Act

On July 21, 2010, the Dodd-Frank Act was enacted and it added Section 404(c) to the 

Sarbanes-Oxley Act. Section 404(c) provides that Section 404(b) shall not apply with respect to 

any audit report prepared for an issuer that is neither a large accelerated filer nor an accelerated 

filer.

On September 15, 2010, the Commission amended its rules to conform them to the new 

Section 404(c).50 Prior to enactment of the Dodd-Frank Act, non-accelerated filers would have 

been required, under existing Commission rules, to include an auditor attestation report on ICFR

in the annual report filed with the Commission for fiscal years ending on or after June 15, 2010.

15. PCAOB Small Business Forums

Since 2004, the PCAOB has been holding forums throughout the year to share 

information about PCAOB activities with auditors operating in the small business community. 

Auditors working with small businesses have an opportunity to share their concerns with Board 

members and staff. At the forums, SEC staff provides updates on recent SEC activities and 

observations about common financial reporting issues facing smaller public companies. 

Feedback received from these forums is used to assist the PCAOB in understanding and 

considering the unique needs and challenges of the small business community. 

 

48 See Release No. 33-9072 (Oct. 13, 2009). 

49 Id.

50 See Release No. 33-9142 (Sept. 15, 2010).
25

16. Tabular Summary of the Final Compliance Dates

The following table summarizes the final compliance dates for issuers considering the 

actions described above and enactment of the Dodd-Frank Act. Note that accelerated filers with 

a public float between $75 and $250 million, which are the subject of this study, have been 

required to comply with Section 404(b) since 2004 (or for foreign private issuers, since 2007), 

and they have now benefited from the 2007 reforms (the Commission‘s Management Guidance 

and the PCAOB‘s AS 5) for several years. In contrast, non-accelerated filers have never been 

required to comply with Section 404(b).

Filer Status Management’s Report Auditor’s Attestation

U.S. Issuer

Large Accelerated 

Filer OR Accelerated 

Filer 

Annual reports for fiscal years 

ending on or after November 15, 

2004

Annual reports for fiscal years 

ending on or after November 15, 

2004

Non-accelerated Filer 

Annual reports for fiscal years 

ending on or after December 15, 

2007

Exempt as a result of the DoddFrank Act

Foreign 

Private Issuer

Large Accelerated 

Filer 

Annual reports for fiscal years 

ending on or after July 15, 2006

Annual reports for fiscal years 

ending on or after July 15, 2006

Accelerated Filer Annual reports for fiscal years 

ending on or after July 15, 2006

Annual reports for fiscal years 

ending on or after July 15, 2007

Non-accelerated Filer 

Annual reports for fiscal years 

ending on or after December 15, 

2007

Exempt as a result of the DoddFrank Act

U.S. Issuer or 

Foreign 

Private Issuer

IPO Second Annual Report Second Annual Report51

 

51 The auditor attestation is not required in any period where the issuer does not meet the definition of an accelerated 

filer or large accelerated filer.
26

II. Analysis of the Issuers Subject to this Study

The Staff analyzed certain characteristics of issuers in the studied range, including past 

costs of compliance with Section 404(b). Specifically, we identified an illustrative population of 

issuers as of December 31, 2009 as a proxy for those in the studied range. We then obtained and 

analyzed data about the issuers in the illustrative population, including: (1) size in terms of assets 

and revenues; (2) industries; (3) locations; (4) audit fees and scalability; (5) restatement rates;

and (6) reported material weaknesses in ICFR. In addition to conducting an analysis of the 

characteristics of the issuers in the 2009 illustrative population, we also separately conducted an 

analysis of how the composition of issuers within a $75-$250 million range changed from 2005-

2009. 

The purpose of these analyses were to assist with the development of potential 

recommendations specific to any unique circumstances of the issuers subject to this study, rather 

than to identify the exact listing of issuers as of any point in time that could be affected by any 

future actions resulting from the implementation of particular recommendations. The Staff also 

sought to understand the existing investor protections relating to these issuers, particularly those 

protections provided by Section 404(b). 

The findings of the analysis of the illustrative population demonstrates that the issuers in 

the studied range differ substantially from non-accelerated filers taken as a whole, which are 

already exempt from Section 404(b), in terms of the characteristics noted above. The Staff 

recognizes, as would be the case with establishing any numeric thresholds, that issuers at the 

lower end of the $75-$250 million range within the illustrative population could be more likely 

to have characteristics more similar to non-accelerated filers (i.e., issuers that are just under or 

just over the $75 million threshold are likely to have similar characteristics to one another). 

Importantly, however, the Staff‘s analysis of the population over time demonstrated that issuers 

frequently enter and exit this band of public float, such that the composition changes greatly 

from year to year. As discussed further in Section VI, based on the Staff‘s analysis, there 

generally do not appear to be unique characteristics in the illustrative population that would 

suggest sufficient reasons for differentiating them from accelerated filers taken as a whole, 

including with respect to compliance with Section 404(b).

To understand whether any possible recommendations may encourage companies to list 

IPOs in the United States, the Staff analyzed the characteristics of global IPOs with respect to 
27

those likely to be in the range of issuers subject to this study. The Staff‘s analysis shows that the 

United States has not lost U.S.-based companies filing IPOs to foreign markets for the range of 

issuers that would likely be in the range of issuers that are the subject of this study. In addition, 

U.S. markets have experienced a decline in overall share of the world-wide IPO market 

beginning in 2001. While this decline in market share could be attributed to, among other things, 

additional regulations imposed in U.S. markets after 2001, as discussed below, the study 

produced no conclusive evidence linking the requirements of Section 404(b) to IPO activity.

A. Population Size Over Time 

The number of issuers with public float between $75 and $250 million changes over time 

due to fluctuations in public float, new issuers entering the reporting system, and issuers exiting 

the reporting system. The table below shows the number of issuers at December 31 for 2005-

2009, with $75-$250 million of ―free float‖ capitalization as determined by Thomson 

Datastream.52 Within each year, the Staff then determined the number of those issuers that 

reported as accelerated filers and large accelerated filers during that period by ascertaining each 

issuer‘s self-reported filing status in its annual report.

53

 

52 Free float capitalization is defined by Thomson Datastream as the market value of shares available to ordinary 

(i.e., not strategic) investors. The Staff used free float capitalization as a proxy for public float because an exact 

measure of public float as reported annually by issuers was not available for the dates the Staff analyzed. Data on 

free float capitalization was available for all periods studied and was the measure used to define public float in the 

Staff‘s 2009 study described in Section III of this study. Free float capitalization excludes certain categories of 

shares that, if applicable, would be considered in calculating public float. However, in light of the use of free float 

capitalization as a proxy for public float, the Staff also analyzed the 2009 data using a proxy for public float that 

added back certain strategic holdings excluded from free float capitalization that were likely not held by the issuers‘ 

affiliates (the ―modified free float population‖). Such analysis of issuers in the modified free float population did 

not result in any materially different conclusions compared to the characteristics of the 2009 illustrative population 

as defined by free float capitalization. 

53 Sources: EDGAR and Audit Analytics. A proxy for the number of accelerated filers in the population is the 

number of issuers that filed an auditor attestation on ICFR, even though they may not have checked a filing status 

box on the Form 10-K. The population of issuers with an auditor attestation on ICFR includes a small number of 

non-accelerated filers that voluntarily obtained the attestation.

The larger number of issuers in the table that self-reported as large accelerated filers in 2008 may result from the 

fact that filing status is measured as of the issuer‘s most recently completed fiscal second quarter, and the 

measurement of public float for purposes of this analysis was as of December 31. In 2008, there was a broad and 

significant decline in equity markets, with the S&P 500 dropping 38.5% in that year, and dropping 29.4% from June 

30 (when a significant number of issuers measure their public float for determining filing status) to December 31. 

Source: Standard & Poor‘s. Large accelerated filers may also be in the illustrative population if free float 

capitalization is substantially different from actual public float as calculated for the issuer‘s most recently completed 

second quarter.
28

Year 2005 2006 2007 2008 2009

Issuers with free float capitalization of

$75-$250 million at December 31 1,016 1,010 1,096 911 967

Those reporting as accelerated filers ** * 634 827 708 766

Those reporting as large accelerated filers ** * 16 24 83 2

Those with auditor attestation on ICFR 756 735 867 826 818

* Data not available

** Filing status as self-reported by issuers in their annual reports. Issuers with public float of $75-$250 

million as of December 31 of a given year may not have been accelerated filers for that year if their public 

float as of the most recently completed second quarter was less than $75 million or more than $700 million. 

Further, newly public issuers are not considered accelerated filers until their second annual report.

Using this data, approximately 2,300 unique issuers had a free float capitalization 

between $75 and $250 million at December 31 for at least one of the years from 2005-2009.54 

However, only approximately 5% met the $75-$250 million float criterion for all five years.

55

 

Issuers entered and exited the list due to growth and contraction in public float, mergers, and 

securities registration termination (including for bankruptcy). Additionally, of the approximately 

2,300 issuers, approximately 40% appeared only once in the five-year period.56 

B. 2009 Illustrative Population

For purposes of analyzing the demographics of issuers that are the subject of this study, 

the Staff identified a population of issuers with a free float capitalization of $75-$250 million at 

December 31, 2009 as reported by Thomson Datastream.57 A reference point of December 31, 

2009 was chosen because this is the most recent year where full information about audit fees, 

management and auditor ICFR assessments, and other matters was available as of the writing of 

this study. The Staff analyzed these matters to ascertain the characteristics of the illustrative 

population and to compare such characteristics to those of all accelerated filers taken as a whole 

and to those of all non-accelerated filers taken as a whole that filed an annual report with the 

 

54 Source: Thomson Datastream.

55 Source: Thomson Datastream.

56 Source: Thomson Datastream. 

57 This includes any issuer with a fiscal year that ended in 2009, not just issuers with a fiscal year end of December 

31, 2009. In addition, because the Staff used free float capitalization from Thomson Datastream, the float amount 

could differ from the amount in the issuer‘s Form 10-K or 20-F filed with the Commission, which is calculated as of 

the last day of the issuer‘s most recently completed second quarter. See note 52 regarding why the Staff used free 

float capitalization as a proxy for those in the standard range for this portion of the study. 
29

Commission on Form 10-K or 20-F for fiscal years ending anytime in 2009. The Staff used such 

information to facilitate the development of potential recommendations for reducing the 

compliance burden among these issuers while maintaining investor protections. 

There were about 1,000 issuers in the 2009 illustrative population. Approximately 80%

of the issuers reported in EDGAR as accelerated filers in 2009 (and would have had to comply 

with Section 404(b) for that year), and approximately 20% reported in EDGAR as nonaccelerated filers in 2009 because the public float reported for the most recently completed 

second fiscal quarter may have been less than $75 million or the issuer may not have otherwise 

met the definition of an accelerated filer.

58

 Two issuers in the illustrative population reported as 

large accelerated filers in 2009.59

The Staff also evaluated the distribution of issuers overall by filing status. According to 

EDGAR, there were 9,092 unique issuers60 that filed annual reports with the Commission on 

Forms 10-K or 20-F for fiscal years ending anytime in 2009.

61

 Issuers that reported as nonaccelerated filers for 2009, which generally would be exempt from Section 404(b) if their filings 

 

58 For example, the issuer may have been reporting for less than one year. Pursuant to the Commission‘s rules 

implemented as a result of the Dodd-Frank Act, non-accelerated filers are now exempt from Section 404(b).

59 Such issuers would be part of the illustrative population if public float fell below $250 million from the most 

recently completed second quarter to December 31, 2009. Large accelerated filers may also be in the illustrative 

population if free float capitalization is substantially different from actual public float as calculated for the issuer‘s 

most recently completed second quarter.

60 The number of unique issuers excludes investment companies, asset backed securities issuers that file annual 

reports on Form 10-K but are not required to file audited financial statements or management‘s assessment of 

internal control over financial reporting, issuers that file annual reports on Form 10-K but are not required to file 

audited financial statements or management‘s assessment of internal control over financial reporting because they 

are considered inactive under Rule 3-11 of Regulation S-X [17 CFR 210.3-11], certain Canadian issuers that file 

annual reports on Form 40-F, guarantors that are issuers for purposes of the federal securities laws but for which 

there is not separate reporting under Rule 3-10 of Regulation S-X [17 CFR 210.3-10], and certain financial 

institutions that report to other regulators pursuant to Section 12(i) of the Exchange Act. The number of unique 

filers also excludes filers that were delinquent with their 2009 annual report as of January 4, 2011. 

61 About 3% of issuers with public float between $75-$250 million at December 31, 2009 did not file an annual 

report for a year ended in 2009, either because their year-end fell in the first week of 2010 (and the previous year 

end was in 2008), they were late in filing the report but were still required to file, or they registered securities in a 

time frame where an annual report was not required in 2009. For these issuers, the filing status from the annual 

report closest to 2009 was used, or the filing status was assumed to be that as indicated by the public float at 

December 31, 2009 for those with recent registration statements.
30

statuses did not change for 2010,62 made up 60.7% of all filers. The unique issuers reported the 

following statuses in the annual reports filed for 2009:

Comparing to the table above, the issuers in the illustrative population constitute approximately 

10% of all issuers that filed an annual report with the Commission on Forms 10-K or 20-F for 

fiscal years ending any time in 2009. The issuers in the illustrative population constituted 

approximately 40% of all accelerated filers and approximately 4% of all non-accelerated filers. 

The remainder of this Section II analyzes the illustrative population against all 

accelerated filers and non-accelerated filers. The primary purpose of this analysis is to compare 

the illustrative population to non-accelerated filers, and also to highlight the difference between 

all non-accelerated filers and all accelerated filers. However, because the illustrative population 

accounts for 40% of the all accelerated filers group, we do not base our findings on the analysis 

of differences between the illustrative population and all accelerated filers. 

1. Size Information

Figure 1 shows the percentage of issuers in the illustrative population, and all accelerated 

filers and all non-accelerated filers from the EDGAR population, within certain ranges of 

revenues.63 The illustrative population has a much lower percentage of issuers with less than $10 

million in revenue than the non-accelerated filer population in EDGAR taken as a whole. 

 

62 As discussed in more detail below, although non-accelerated filers generally are exempt from Section 404(b), 

some of these issuers comply voluntarily with Section 404(b) and include an auditor attestation on ICFR with their 

annual report filings to the Commission. 

63 Source: Audit Analytics. Issuers with no information reported to Audit Analytics for revenues are excluded, 

including foreign private issuers that do not report such information under Generally Accepted Accounting 

Principles in the United States (―U.S. GAAP‖). Issuers reporting no revenues are included; most of these are 

development stage companies. Ten million and $250 million were chosen for analysis, as these amounts of revenue 

were discussed as scaling thresholds for Section 404(b) in the final report of the ACSPC. We also used these 

amounts to present the assets of the illustrative population with those of accelerated filers and non-accelerated filers.

Large Accelerated Filer 1,670 18.4%

Accelerated Filer 1,875 20.6%

Non-Accelerated Filer 5,518 60.7%

Status Unknown or Not Indicated 29 0.3%

Total 9,092
31

Figure 1- Size of Selected Issuers by Revenue, 2009

Figure 2 shows the percentage of issuers in the illustrative population, and all accelerated 

filers and all non-accelerated filers from the EDGAR population, within certain ranges of total 

assets.64 The illustrative population has a much lower percentage of issuers with less than $10 

million in assets and a much higher proportion of issuers with more than $250 million in assets 

than the non-accelerated filer population taken as a whole. The revenue and asset information 

suggests the illustrative population is composed of a higher percentage of issuers with substantial 

assets than those in the population of all non-accelerated filers.

 

64 Source: Audit Analytics. Issuers with no information reported to Audit Analytics for assets are excluded, 

including foreign private issuers that do not report such information under U.S. GAAP.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

All Accelerated All NonAcceleratedIllustrative 

Population

>250,000,000

>10,000,000 and 

<250,000,000

< 10,000,000
32

Figure 2- Size of Select Issuers by Assets, 2009

2. Industry Information

Table 1 shows the industry classifications of the illustrative population and all accelerated 

filers and all non-accelerated filers from the EDGAR population. The industry classifications are 

derived from the reported SIC codes of registrants in EDGAR and mapped to the 49 industry 

categories devised by Fama and French.65

Issuers in the illustrative population represent almost all industries represented by other 

filer groups. Compared to all accelerated filers taken as a whole, issuers in the illustrative 

population were represented:

more frequently in the medical equipment, pharmaceutical product, business services, 

and communication industries; and 

 

65 E.F. Fama & K.R. French, Industry Costs of Equity, 43 J. FIN. ECON. 153 (1997). Using the Fama-French 

categorization results in a manageable number of industry descriptions for purposes of this study, compared to over 

440 unique SIC classifications used by issuers. The Fama-French classification system is used in many academic 

papers researching industry cost of equity and other industry topics in finance.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

All Accelerated All NonAcceleratedIllustrative 

Population

>250,000,000

>10,000,000 and 

<250,000,000

< 10,000,000
33

less frequently in the banking and trading industries, although the banking industry 

was the largest individual industry group for both the illustrative population and the 

group of all accelerated filers from the EDGAR population.

66

 

Because the group of accelerated filers is 40% comprised of the illustrative population, these 

differences, reported above, would be even more pronounced if the illustrative population were 

compared only to those accelerated filers not in the illustrative population.

Compared to all non-accelerated filers taken as a whole, issuers in the illustrative 

population were represented:

more frequently in the medical equipment, pharmaceutical product, banking and 

insurance industries; and 

less frequently in the entertainment, mining, real estate and trading (e.g., security and 

commodity brokering) industries.

While issuers in the illustrative population represent almost all industries represented by other 

filer groups, the Staff considered the effect of certain recommendations for reducing the 

compliance burden of Section 404(b) on financial institutions subject to the Federal Deposit 

Insurance Corporation Improvement Act of 1991 (―FDICIA‖),

67 and on pharmaceutical and 

medical product issuers that have $75-$250 million in free float capitalization but little or no 

reported revenue.

 

66 As discussed above, financial institutions that do not report to the Commission under Section 12(i) of the 

Exchange Act are not considered in the illustrative population nor in the entire population of accelerated filers or 

non-accelerated filers.

67 P.L. 102-242, 105 Stat. 2236. 
34

Table 1- Fama-French Industry Classification, 2009

 

N % N % N %

1 Agriculture 4 0.4% 11 0.6% 23 0.4% 35 0.4%

2 Food Products 12 1.2% 19 1.0% 69 1.3% 119 1.3%

3 Candy & Soda 1 0.1% 1 0.1% 7 0.1% 15 0.2%

4 Beer & Liquor - 0.0% 2 0.1% 20 0.4% 32 0.4%

5 Tobacco Products - 0.0% 1 0.1% 3 0.1% 9 0.1%

6 Recreation 4 0.4% 7 0.4% 36 0.7% 47 0.5%

7 Entertainment 8 0.8% 25 1.3% 121 2.2% 161 1.8%

8 Printing and Publishing 10 1.0% 13 0.7% 42 0.8% 66 0.7%

9 Consumer Goods 9 0.9% 20 1.1% 56 1.0% 94 1.0%

10 Apparel 6 0.6% 14 0.7% 40 0.7% 73 0.8%

11 Healthcare 16 1.7% 38 2.0% 61 1.1% 116 1.3%

12 Medical Equipment 43 4.4% 66 3.5% 156 2.8% 258 2.8%

13 Pharmaceutical Products 86 8.9% 135 7.2% 266 4.8% 466 5.1%

14 Chemicals 17 1.8% 23 1.2% 128 2.3% 186 2.0%

15 Rubber and Plastic Products 4 0.4% 12 0.6% 43 0.8% 60 0.7%

16 Textiles 1 0.1% 3 0.2% 11 0.2% 16 0.2%

17 Construction Materials 12 1.2% 21 1.1% 62 1.1% 108 1.2%

18 Construction 11 1.1% 22 1.2% 46 0.8% 90 1.0%

19 Steel Works Etc. 10 1.0% 20 1.1% 26 0.5% 74 0.8%

20 Fabricated Products 1 0.1% 5 0.3% 10 0.2% 18 0.2%

21 Machinery 25 2.6% 43 2.3% 86 1.6% 182 2.0%

22 Electrical Equipment 9 0.9% 27 1.4% 58 1.1% 103 1.1%

23 Automobiles and Trucks 15 1.6% 26 1.4% 45 0.8% 91 1.0%

24 Aircraft 3 0.3% 10 0.5% 17 0.3% 37 0.4%

25 Shipbuilding, Railroad Equipment 5 0.5% 4 0.2% 2 0.0% 9 0.1%

26 Defense 2 0.2% 4 0.2% 5 0.1% 12 0.1%

27 Precious Metals 11 1.1% 11 0.6% 102 1.8% 121 1.3%

28 Non-Metallic and Industrial Metal Mining 6 0.6% 18 1.0% 291 5.3% 329 3.6%

29 Coal 5 0.5% 7 0.4% 11 0.2% 29 0.3%

30 Petroleum and Natural Gas 46 4.8% 79 4.2% 295 5.3% 468 5.1%

31 Utilities 16 1.7% 35 1.9% 96 1.7% 234 2.6%

32 Communication 30 3.1% 42 2.2% 168 3.0% 289 3.2%

33 Personal Services 12 1.2% 33 1.8% 66 1.2% 115 1.3%

34 Business Services 73 7.5% 126 6.7% 480 8.7% 689 7.6%

35 Computers 13 1.3% 27 1.4% 60 1.1% 116 1.3%

36 Computer Software 51 5.3% 99 5.3% 262 4.7% 441 4.9%

37 Electronic Equipment 68 7.0% 120 6.4% 219 4.0% 437 4.8%

38 Measuring and Control Equipment 15 1.6% 32 1.7% 74 1.3% 130 1.4%

39 Business Supplies 5 0.5% 15 0.8% 22 0.4% 52 0.6%

40 Shipping Containers - 0.0% 2 0.1% 6 0.1% 17 0.2%

41 Transportation 32 3.3% 57 3.0% 74 1.3% 195 2.1%

42 Wholesale 27 2.8% 37 2.0% 160 2.9% 242 2.7%

43 Retail 34 3.5% 79 4.2% 165 3.0% 329 3.6%

44 Restaurants, Hotels, Motels 9 0.9% 27 1.4% 57 1.0% 106 1.2%

45 Banking 111 11.5% 236 12.6% 479 8.7% 822 9.0%

46 Insurance 26 2.7% 56 3.0% 67 1.2% 203 2.2%

47 Real Estate 9 0.9% 17 0.9% 235 4.3% 260 2.9%

48 Trading 50 5.2% 116 6.2% 548 9.9% 799 8.8%

49 Other 4 0.4% 16 0.9% 123 2.2% 154 1.7%

50 None Specified - 0.0% 16 0.9% 19 0.3% 38 0.4%

 967 1,875 5,518 9,092

Illustrative Population All Accelerated Filers All Non-Accelerated All Filers
35

3. Geographic Information

The Staff analyzed the geographic location of the illustrative population to ascertain if 

there were any particular characteristics that may be relevant to identifying potential methods for 

reducing the compliance burden. Approximately 90% of issuers in the illustrative population are 

based and incorporated in the United States and filed annual reports with the Commission on 

Form 10-K in 2009. This compares to approximately 80% of non-accelerated filers based and 

incorporated in the United States and approximately 90% of accelerated filers based and 

incorporated in the United States from the EDGAR population.

68

 

Only approximately 4% of the illustrative population filed their annual reports on Form 

20-F and therefore were considered foreign private issuers under the Exchange Act.

69

 In 

contrast, approximately 8% of accelerated filers and approximately 5.5% of non-accelerated 

filers were foreign private issuers in the EDGAR population.

Foreign private issuers filing on Form 20-F have the option to prepare their financial 

statements in accordance with U.S. GAAP, International Financial Reporting Standards as issued 

by the International Accounting Standards Board (―IFRS‖), or another basis of accounting (if 

accompanied by a reconciliation to U.S. GAAP).

70

 Nearly three-quarters of foreign private 

issuers in the illustrative population used U.S. GAAP in preparing their financial statements, 

compared to approximately 65% of foreign private issuers that were accelerated filers and 

approximately 50% of foreign private issuers that were non-accelerated filers in the EDGAR 

population.

71

The data demonstrate that issuers in the range contemplated by Section 989G(b) of the 

Dodd-Frank Act are predominantly U.S. issuers or issuers that otherwise file using U.S. GAAP. 

This indicates that any recommendation that would reduce the compliance burden on issuers that 

 

68 Source: EDGAR. The percentages exclude issuers based in the U.S. that are foreign private issuers.

69 Foreign private issuers are foreign issuers that do not have more than 50% of their outstanding voting securities 

directly or indirectly held by residents of the U.S. and either (1) the majority of their executives officers or directors 

are not U.S. citizens or residents, (2) more than 50% of their assets are located outside the U.S., or (3) their business 

is not administered principally in the U.S. See Exchange Act Rule 3b-4 [17 CFR 240.3b-4]. 

70 See Rule 4-01(a)(2) of Regulation S-X [17 CFR 210.4-01(a)(2)].

71 Source: EDGAR. 
36

file using U.S. GAAP (which includes U.S. issuers) would have an effect on the vast majority of 

the illustrative population. 

4. Audit Fees

Audit fees are one component of the total cost of compliance with Section 404(b). Audit 

fees comprise costs relating to the financial statement audit and to the auditor‘s attestation on 

ICFR. The Staff analyzed audit fees to assess the current compliance burden on issuers for the 

audit component of total Section 404(b) cost and to evaluate the trend in such fees over time, 

including since the 2007 reforms that were intended to reduce compliance burden. To analyze 

total audit fees, we separated the illustrative population into those reporting as non-accelerated 

filers and those reporting as accelerated filers, because the issuers that were accelerated filers 

were already subject to Section 404(b), while the non-accelerated filers were not. The audit fees 

of accelerated filers include fees relating to the auditor attestation under Section 404(b), while 

audit fees for non-accelerated filers do not include such fees unless the issuer voluntarily elected 

to have the auditor attestation.

The mean and median audit fees for issuers in the illustrative population that reported as 

non-accelerated filers were significantly higher than mean and median fees for all nonaccelerated filers from the EDGAR population. The mean and median audit fees for those in the 

illustrative population that reported as accelerated filers were lower than the mean and median 

fees for all accelerated filers from the EDGAR population. Because the group of accelerated 

filers is 40% comprised of the illustrative population, these differences, reported above, would be 

even more pronounced if the illustrative population were compared only to those accelerated 

filers not in the illustrative population.

These findings demonstrate that audit fees were positively correlated with float, as the 

population of all accelerated filers includes those issuers with public float greater than $250 

million. Figure 3 shows the mean and median audit fees for issuers in the illustrative population 

compared to other issuers with the same filing status from the EDGAR population.
37

Figure 3- Audit Fees of Select Issuers, 2009

Figures 4 and 5 show the mean and median audit fees as a percentage of revenues and 

assets, respectively, for issuers in the illustrative population and for all accelerated filers and all 

non-accelerated filers in the EDGAR population.

72

 As shown in Figures 4 and 5, the mean and 

median of audit fees as a percentage of revenue and of assets for accelerated filers in the 

illustrative population were similar to those of all accelerated filers (which, as noted above, 

includes a substantial portion of the illustrative population) and less than those of all nonaccelerated filers in the EDGAR population. This demonstrates that the scalability of audits for 

accelerated filers in the illustrative population is similar to that of all accelerated filers; that is,

those in the illustrative population incurred audit fees as a percentage of revenue and assets that 

were similar to the percentages incurred for all accelerated filers taken as a whole. The nonaccelerated filers in the illustrative population incurred similar fees as a percentage of revenues 

compared to all non-accelerated filers taken as a whole in the EDGAR population, but the issuers 

in the illustrative population and in the overall non-accelerated filer population are not required 

to comply with Section 404(b).

 

72 Source: Audit Analytics. In calculating the mean audit fees as a percentage of both revenue and assets, issuers in 

all categories with less than $100,000 in either revenue and assets are excluded. As a result, some of these issuers 

have audit fees as a percentage of revenue and assets that are over 100,000%. Such issuers are not excluded from 

the calculation of the medians.

$0 $400,000 $800,000 $1,200,000

$75-250 Non-Accelerated

$75-250 Accelerated

All Non Accelerated

All Accelerated

Median

Mean
38

Figure 4- Audit Fees of Select Issuers as Percentage of Revenue, 2009

Figure 5- Audit Fees of Select Issuers as Percentage of Assets, 2009

The Staff separately analyzed the mean and median audit fees for 2006-2009 of issuers 

identified in Section II.A. that reported as an accelerated filer or large accelerated filer. As 

shown in Figure 6, the overall trend from 2006-2009 is a modest increase in the mean and 

median audit fees. The increase could be caused by a number of factors, including general fee 

inflation, different characteristics of the issuers reporting in each of the periods, and changes in 

audit risk. As discussed above, the reduction in equity values across public markets in 2008 

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

% of revenue- mean

% of revenue- median

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

% of assets- mean

% of assets- median
39

resulted in many issuers dropping below $250 million in free float capitalization, although some 

of these issuers were large by other measures, such as assets or revenues. Many of these issuers

possess characteristics such as financial reporting complexity and geographical diversity that 

may have resulted in mean and median audit fees that were higher in 2008 compared to other 

years, as some of these issuers likely did not have $75-$250 million in free float capitalization 

before or after 2008.

Figure 6- Mean and Median Audit Fees for Accelerated Filers

and Large Accelerated Filers, 2006-2009

5. Restatements

The Staff analyzed restatement data to determine if the illustrative population has unique 

characteristics that indicate a particular need for the investor protections provided by Section 

404(b). To analyze restatement rates in the illustrative population, we separated it into those 

reporting as non-accelerated filers and those reporting as accelerated or large accelerated filers 

because the issuers that are accelerated filers are already subject to Section 404(b), while the 

non-accelerated filers are not. Figure 7 shows the restatement rates for restatement periods 

ending anytime in 2009 for issuers in the illustrative population and for all accelerated filers and 

all non-accelerated filers in the EDGAR population.73 The data show higher restatement rates in 

 

73 Source: Audit Analytics. The table counts incidents of restatement of 2009 periods by issuers, not by number of 

restatements. Issuers with multiple restatements of 2009 periods are only counted once. In addition, the 

$0

$200,000

$400,000

$600,000

$800,000

$1,000,000

$1,200,000

2006 2007 2008 2009

Mean

Median
40

the illustrative population. As noted previously, because both comparison groups contain the 

illustrative population, these differences would be even more pronounced if the illustrative 

population was removed from the comparison groups. This suggests that issuers in the 

illustrative population may benefit from the auditor focusing on ICFR to reduce such 

restatements.

Issuers with a requirement to have an auditor attestation on ICFR in 2009 (e.g., all 

accelerated filers in the EDGAR population and accelerated filers in the illustrative population) 

generally had a lower rate of restatement than issuers that did not have such a requirement. 

These findings suggest that Section 404(b) may contribute to valuable investor protections. 

Approximately 84% of the restatements in the illustrative population were caused by 

misapplication of GAAP, compared to approximately 81% for all accelerated filers and 

approximately 94% for all non-accelerated filers in the EDGAR population.

74

Figure 7- Restatement Rates for Select Issuers, 2009

 

restatements reported may have occurred after 2009. The data for this table is the number of restatements relating to 

2009 periods reported as of January 10, 2011. As discussed in note 52 above, the Staff also analyzed results using a 

modified free float population. For restatement rates, the Staff notes that the modified free float population did not 

result in a significantly different restatement rate for those reporting as accelerated filers, but would result in a 

reduction in the restatement rate for non-accelerated filers from approximately 11% as reported in Figure 7 to 

approximately 8%.

74 Source: Audit Analytics.

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

All Accelerated All NonAccelerated$75-250 

Accelerated

$75-250 NonAccelerated
41

6. Management ICFR Assessment

The Staff analyzed the management ICFR reports of issuers in the illustrative population 

to assess whether the nature of the material weaknesses in this population may be relevant to 

identifying potential methods for reducing the compliance burden. Of those in the illustrative

population with a management report on ICFR, approximately 7% reported ineffective ICFR.75 

For all accelerated filers in the EDGAR population with a management report on ICFR, 

approximately 4.5% reported ineffective ICFR. For all non-accelerated filers in the EDGAR 

population with a management report on ICFR, approximately 28% reported ineffective ICFR.76

Of those with ineffective ICFR as determined by management, Figure 8 below shows the 

percentages of material weaknesses by category. For 2009, all non-accelerated filers had

disproportionately more material weaknesses relating to segregation of duties and to ineffective 

audit committees than accelerated filers. For 2009, non-accelerated filers also had

disproportionately fewer material weaknesses relating to material year-end adjustments, account 

reconciliations, and non-routine transactions than accelerated filers. The relationship of the 

illustrative population to all non-accelerated filers in the EDGAR population yields similar 

differences. This suggests that the control environment for issuers in the illustrative population, 

which the auditor tests for operating effectiveness, was similar to that of accelerated filers taken 

as a whole in 2009. As to the larger proportion of non-accelerated filers with material

weaknesses related to segregation of duties, non-accelerated filers as a group tend to be more 

centralized and less complex than accelerated filers, but sometimes have less sophisticated 

governance and fewer personnel to which to assign duties. 

 

75 Source: Audit Analytics. The sample does not include restated management ICFR disclosures and excludes 

issuers that were required to file the management report but had not yet done so for 2009 as well as newly public 

issuers that were not yet required to provide a management report on ICFR.

76 The ineffective ICFR rate in management reports for the modified free float population was approximately 11%, 

compared to approximately 7% for the illustrative population.
42

Figure 8- Categories of Material Weaknesses Identified by Management, 2009

7. Auditor Attestation on ICFR

Of the issuers in the illustrative population, approximately 85% included an auditor 

attestation on ICFR for 2009.

77 This includes 60 non-accelerated filers that voluntarily included

such an attestation. Of those in the illustrative population with an ICFR report from their 

auditor, approximately 4% had ineffective ICFR as reported by the auditor before considering 

any restatement of the ICFR opinion.78 The rate is lower than the ineffective rate for 

management reports in the illustrative population given the illustrative population includes 

issuers that were not required to have an auditor‘s attestation and that more frequently have 

segregation of duties deficiencies that prevent management from asserting that the issuer has 

 

77 Source: Audit Analytics. The sample does not include restated ICFR opinions and excludes accelerated filers that 

were required to file the auditor‘s attestation but had not yet done so for 2009, as well as issuers with recent 

registration statements that do not need to file such reports.

78 The ineffective ICFR rate in auditor reports for the modified free float population was approximately 6%, 

compared to approximately 4% for the illustrative population.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Accelerated Filers Non-accelerated 

filers

Illustrative 

population

Segregations of duties/ design of 

controls (personnel)

Untimely or inadequate account 

reconciliations

Ineffective, non-existent or 

understaffed audit committee

Non-routine transaction control 

issues

Inadequate disclosure controls 

(timely, accuracy, complete)

Information technology, software, 

security & access issue

Accounting personnel resources, 

competency/training

Material and/or numerous auditor 

/YE adjustments

Accounting documentation, policy 

and/or procedures
43

effective ICFR. These issuers do not have an auditor‘s attestation on ICFR but are required to 

have a management assessment on ICFR.

For all accelerated filers in the EDGAR population, nearly 99% included an auditor 

attestation on ICFR, of which approximately 4.5% had ineffective ICFR. For non-accelerated 

filers in the EDGAR group, approximately 8.2% included an auditor report on ICFR, of which 

approximately 6% had ineffective ICFR according to their auditors.

The relatively low rate of ineffective ICFR in all three groups may suggest that an auditor 

attestation on ICFR contributes positively to the maintenance of effective controls and therefore 

provides a valuable investor protection. As noted previously, the non-accelerated filers were not 

required to comply with Section 404(b), but may have done so voluntarily.

Figure 9 below shows that the percentages of material weaknesses by category for issuers

in the illustrative population, all accelerated filers, and all non-accelerated filers complying 

voluntarily with Section 404(b). The percentage by category did not differ substantially among 

these groups. 

Figure 9- Categories of Material Weaknesses Identified by Auditor, 2009

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Accelerated Non-Accelerated Illustrative 

population

Inadequate disclosure controls 

(timely, accuracy, complete)

Non-routine transaction control 

issues

Information technology, software, 

security & access issue

Accounting personnel resources, 

competency/training

Material and/or numerous 

auditor/YE adjustments

Accounting documentation, policy 

and/or procedures

All other issues
44

C. New Public Listings

To understand whether any possible recommendations may encourage companies to list 

IPOs in the United States, the Staff analyzed the characteristics of global IPOs with respect to 

those likely to be in the range of issuers subject to this study. Although the U.S. IPO market 

over time has recovered from the 2007 levels, it has not reached the 1999 levels (i.e., we 

reviewed IPO activity over a range of years and noted that it was at a relatively low point during 

the financial crisis and has since recovered, but not to the peak for the range of years studied). 

The Staff‘s analysis shows that the United States has not lost U.S.-based companies filing IPOs 

to foreign markets for the range of issuers that would likely be in the $75-$250 million public 

float range after the IPO. However, the analysis does show that the U.S. markets‘ share of 

world-wide IPOs raising less than $250 million has declined over the past five years and further 

shows a dramatic decline in the number of smaller IPOs since 1999. There is no conclusive 

evidence from the study linking the requirements of Section 404(b) to IPO activity. The Staff 

notes that the Commission has previously taken action to reduce the compliance burden for new 

issuers by not requiring the auditor attestation on ICFR for the IPO and the first annual report 

thereafter and that the population of smaller issuers has been the subject of many of the reforms 

related to Section 404.

Figure 10 shows the number of IPOs in the United States and abroad that raised between 

$75 and $250 million from 1995-2010.79

 

79 Source: Thomson Reuters SDC Platinum. Figure 10 excludes the IPOs of investment funds, as these funds are not 

required, under existing SEC rules, to have an auditor attestation on ICFR, regardless of the fund‘s size. Figure 10 

also excludes IPOs for which the market location is not reported by Thomson. 
45

Figure 10- Number of new listings with proceeds of $75-$250 million, 1995-2010

Although an issuer that raises between $75 and $250 million in an IPO will not 

necessarily be an accelerated filer when the issuer assesses its Section 404(b) compliance 

requirements,80 this data provides useful information in determining the relative mix of markets81

where companies that have an IPO will potentially have a public float between $75 and $250 

million. Less than five U.S.-based companies that raised $75-$250 million listed in a foreign 

market in an IPO in each year from 2005-2010. This suggests that the United States has not lost

a significant amount of offerings in the United States that raise $75-$250 million to foreign 

jurisdictions due to Section 404(b), which was in effect for this entire period, or for any other 

reason.

Both U.S. and foreign markets saw a significant plunge in new listings in the $75-$250 

million range from 2007 to 2008, which coincided with the decline in equity markets worldwide 

in 2008 discussed above.82 In this size range, 130 foreign IPOs occurred in foreign markets in 

 

80 Measures of amounts raised in Figure 10 are not necessarily the same as what will be measured as public float 

when an issuer is required to determine filing status. Assuming no other market movements, IPO proceeds would be 

presumed to equal public float on the day of the offering if the remaining common equity held before the offering 

was retained by affiliates. Newly public issuers do not need to comply with Section 404(b) until they file their 

second annual report with the Commission (assuming they meet the definition of an accelerated filer at that time).

81 Markets include exchanges and over-the-counter bulletin board markets.

82 Without regard to the $75-$250 million range, the percentage of U.S. issuers choosing to list only on foreign 

exchanges increased from 8.6% in 2007 to 20% in 2008. See Letter from Congressman Darrell E. Issa, Chairman, 

Committee on Oversight and Government Reform, U.S. House of Representatives, to Mary L. Schapiro, Chairman, 

0

50

100

150

200

250

300

1995199619971998199920002001200220032004200520062007200820092010

U.S. Issuers, U.S. 

Markets

Foreign Issuers, 

Foreign Markets

Foreign Issuers, U.S. 

Markets

U.S. Issuers, Foreign 

Markets
46

2010, compared to 57 U.S. issuers that listed IPOs in U.S. markets in that year. Also in this size 

range, 30 foreign issuers listed IPOs in the United States in 2010. All jurisdictions saw increased 

listings since 2008 in this size range. Foreign listings in the United States have rebounded to 

levels of 2007, while foreign listings in foreign markets have increased since 2008 but are still 

significantly below 2007 levels.83 The table does, however, show that U.S. markets have 

experienced a decline in overall share of the world-wide IPO market beginning in 2001. 

Figures 11 and 12 show that the number of IPOs in U.S. markets with proceeds less than 

$75 and $50 million, respectively, has declined dramatically since 1999. While this data does 

not necessarily indicate that the issuer would be a non-accelerated filer when it first determines 

its filer status, it does indicate a decline in smaller IPOs for a population of issuers that has been 

the subject of many of the prior actions related to Section 404. This analysis is consistent with

the view that there is no conclusive evidence linking Section 404(b) to the reduction in IPOs 

among smaller companies, because such companies were never the subject of such 

requirements.

84

 

U.S. Securities and Exchange Commission (Mar. 22, 2011). This may not be due to compliance costs alone, 

however, as the evidence shows a decline in the relative liquidity of the U.S. market attributable primarily to an 

increase in the liquidity of equity markets in other countries. See M. Halling, M. Pagano, O. Randl & J. Zechner, 

Where is the Market? Evidence from Crosslistings in the U.S., REV. FIN. STUDIES 21, 725-61 (2008).

83 According to Thomson Reuters SDC Platinum, the total number of new listings on AIM (domestic and 

international) for companies with proceeds of $75-$250 million were 4, 24, 38, 11, 3, and 6 for 2005, 2006, 2007, 

2008, 2009, and 2010, respectively. 

84 The Staff recognizes that while the issuers in this range were never subject to Section 404(b), for most of the 

period between 2003 and 2010, the fact that compliance was simply deferred may have had an impact on eventual

compliance costs. However, as noted in Figures 11 and 12, the trend in U.S. IPOs in this range began to 

significantly decrease well before 2003, when the Commission adopted rules that would have subjected such issuers 

to Section 404(b) but for the repeated compliance deferrals. 
47

Figure 11- Number of new listings with proceeds of less than $75 million, 1995-2010

Figure 12- Number of new listings with proceeds of less than $50 million, 1995-2010

Figure 13 shows the number of IPOs in the United States and abroad that raised between 

$50 and $500 million from 1995-2010.85 There is a similar trend in listings for this group 

compared to those raising between $75 and $250 million discussed above. This illustrates that 

our findings concerning listings in foreign jurisdictions would not have been materially different 

by contemplating this wider range of proceeds.

 

85 Source: Thomson Reuters SDC Platinum.

0

100

200

300

400

500

600

700

800

1995199619971998199920002001200220032004200520062007200820092010

U.S. Issuers, U.S. 

Markets

Foreign Issuers, 

Foreign Markets

Foreign Issuers, U.S. 

Markets

U.S. Issuers, Foreign 

Markets

0

100

200

300

400

500

600

700

1995199619971998199920002001200220032004200520062007200820092010

U.S. Issuers, U.S. 

Markets

Foreign Issuers, 

Foreign Markets

Foreign Issuers, U.S. 

Markets

U.S. Issuers, Foreign 

Markets
48

Figure 13- Number of new listings with proceeds of $50-$500 million, 1995-2010

0

50

100

150

200

250

300

350

400

1995199619971998199920002001200220032004200520062007200820092010

U.S. Issuers, U.S. 

Markets

Foreign Issuers, 

Foreign Markets

Foreign Issuers, U.S. 

Markets

U.S. Issuers, Foreign 

Markets
49

III. Analysis of the 2009 SEC Staff Study on Section 404

This section of the study analyzes the data gathered from the SEC Staff‘s 2009 study on 

Section 404.86 The Staff believes that an assessment of the self-reported views about the costs of 

compliance under Section 404(b) and the impact of the 2007 reforms is useful in our broader 

evaluation of ways to reduce the burden costs of Section 404(b). Specifically, the Staff 

endeavored to understand the extent to which the 2007 reforms had the intended effect of 

improving the implementation of Section 404, including the requirements of Section 404(b). 

This information, in conjunction with the general information about the characteristics of issuers

in Section II, provided us with a starting point to consider new public input, existing academic 

research, and other information to determine whether there are additional ways to further reduce 

the compliance burden of Section 404(b) for the range of issuers identified in Section 989G(b)

while maintaining investor protections.

In connection with this current study, data from the 2009 study the Staff determined to be 

most relevant for this study were partitioned into four groups based on public float87 (< $75 

million, $75-$250 million, $250-$700 million, and > $700 million) and then primarily examined 

to analyze the reported cost under Section 404(b) to determine the impact of the 2007 reforms 

(the Commission‘s Management Guidance and the PCAOB‘s AS 5) on Section 404(b) 

compliance costs. We reanalyzed the data in this manner because the 2009 study did not analyze 

the population of accelerated filers that had a public float between $75 and $250 million 

 

86 See SEC Study of the Sarbanes-Oxley Act of 2002 Section 404 Internal Control over Financial Reporting 

Requirements, Office of Economic Analysis, September 2009, available at

http://www.sec.gov/news/studies/2009/sox-404_study.pdf. The 2009 study was based on web-based survey 

responses from 3,138 corporate executives. The study also involved separate, in-depth interviews of a sample of 30 

users of financial statements, including lenders, securities analysts, auditors, rating agencies, and other investors. 

The response rate to the web-based survey was 49% among all 404(b)-compliant companies and 55% among 

domestic 404(b)-compliant companies. Based on the survey data, the Staff determined that ―the costs of Section 404 

compliance decreased following the Commission‘s reforms introduced in 2007 and is expected to decrease further 

based on respondent‘s estimates for the fiscal year in progress at the time of the survey‖ and ―the survey participants 

perceive the reforms to have been a significant catalyst for these changes.‖ Id. at 96-7. In addition, from the 

perspective of the financial statement users involved, they generally regarded ICFR disclosures to be beneficial and 

indicated that Section 404(a) and Section 404(b) compliance has had a positive impact on their confidence in 

issuers‘ financial statements. 

87 Based on the 2009 study, size categories are determined by the issuer‘s market value of public float, which is 

―free float‖ capitalization as discussed in Section II (henceforth, ―public float‖), measured two quarters prior to the 

relevant fiscal year end date. SEC Study of the Sarbanes-Oxley Act of 2002 Section 404 Internal Control over 

Financial Reporting Requirements, supra note 86 at 3. The market value of the issuer‘s public float was reported by 

Thomson Financial Datastream six months prior to the fiscal year-end – the day used to assess accelerated filer 

status. Id. at 28.
50

separately from other accelerated filers. We separated the $75-$700 million group from the 2009 

study into two public float groups ($75-$250 million and $250-$700 million) to gain more 

insight about the population that is the subject of this study. We then reviewed issuers‘ views 

on:

the cost of Section 404(b) compliance and its components by size and year relative to 

the 2007 reforms; 

the cost of Section 404 compliance by total assets, size and years of Section 404(b) 

compliance experience;

the impact of the 2007 reforms on the costs of compliance; and

the impact of AS 5 on the amount of time required to complete Section 404(b) audits. 

As discussed in Section VI, the overall results based on the four public float groups

reveal that compliance costs typically increased as issuer size increases, decreased as issuers 

gained compliance experience, and decreased after the 2007 reforms. Across all size categories, 

including the $75-$250 million range, compliance costs decreased steadily following the 2007 

reforms. Issuers also reported important benefits associated with Section 404 compliance, 

including improvements in their internal control structure, financial reporting quality and ability 

to prevent and detect fraud. The results suggest that issuers have already significantly reduced 

the compliance costs burden of Section 404(b) and, as of the time of the 2009 survey, anticipate 

further reductions.

In addition, smaller (< $75 million) issuers in the survey, which generally provided less 

favorable responses about the costs of compliance and 2007 reforms, have subsequently been 

exempted from Section 404(b). The results further show that issuers with a public float of $75-

$250 million tended to be comparable with issuers with a public float of $250-$700 million, 

demonstrating that the $75-$250 million issuers more proportionately benefited from the reforms 

than the smaller (< $75 million) issuers that are now exempted. Therefore, in light of the 

extensive nature of the 2007 reforms, including new auditing standards that were aligned with 

the new Management Guidance for issuers, the Staff believes that to meaningfully further reduce 

the compliance burden of Section 404(b), any additional reforms beyond those implemented in 

2007 would have to be significant rather than marginal.88 However, any change of such 

 

88 See Section IV.B. of this study.
51

magnitude also would most likely adversely affect the investor protections provided by Section 

404(b). 

A. Costs of Section 404(b) Compliance and its Components by Size and Year 

Relative to the 2007 Reforms

Table 1 reveals mostly a downward trend in total Section 404 compliance costs that is 

independent of firm size.89 The declines in costs for Section 404(b)-related audit fees and 

outside vendor costs between pre- and post-2007 reform years were statistically significant for 

the medium ($75-$250 million and $250-$700 million) and large (>$700 million) issuers:

For issuers with public float between $75 and $250 million, the average decline in 

audit fees (-13%) and outside vendor costs (-21.2%) was significant at the 10% level 

and 5% level, respectively.90

For issuers with public float between $250 and $700 million, the average decline in 

audit fees (-24.2%) and outside vendor costs (-24.1%) was highly significant at the 

1% level.

For issuers with public float >$700 million, the average decline in audit fees (-19.5%) 

was significant at the 5% level while the decline in outside vendor costs (-31%) was 

highly significant at 1% level.

The drop in audit fees and outside vendor costs across time was not statistically 

significant for smaller (< $75 million) issuers, which are now exempt from Section 

404(b), and was mostly projected by these issuers themselves rather than realized.91 

Further details about the total costs of compliance and its component costs across the four 

public float groups are discussed below. Specifically, 

 

89 Table 1 reflects Table 9 in the 2009 study, partitioned into four groups based on public float (< $75 million, $75-

$250 million, $250-$700 million, and > $700 million). See SEC Study of the Sarbanes-Oxley Act of 2002 Section 

404 Internal Control over Financial Reporting Requirements, supra note 86 at 46.

90 A significance level ―.01‖ or 1% means that there is a 99% (1-.01=.99) chance of the findings being true. A 

significance level of ―.05‖ or 5% means that there is a 95% (1-.05=.95) chance of the findings being true. A 

significance level of ―.10‖ or 10% means that there is a 90% (1-.10=.90) chance of the findings being true.

91 As noted by the SEC Staff in the 2009 study, ―compared to the medium and larger filers, smaller companies tend 

to have less experience with Section 404(b) compliance at the time of the survey. This might explain why the 

difference in costs across time is not significant for smaller companies and underscores the importance of 

controlling for companies‘ compliance experience when drawing inferences about changes in the costs of 

compliance.‖ SEC Study of the Sarbanes-Oxley Act of 2002 Section 404 Internal Control over Financial Reporting 

Requirements, supra note 86 at 45.
52

The average total Section 404 compliance costs declined as follows:

o 10.3% for smaller (< $75 million) issuers;

o 7% and 7.4% for medium ($75-$250 million and $250-$700 million, 

respectively) issuers; and

o 20.9% for large (> $700 million) issuers.

Average Section 404(b) audit fees declined as follows:

o 16.6% for smaller (< $75 million) issuers;

o 13% and 24.2% for medium ($75-$250 million and $250-$700 million, 

respectively) issuers; and

o 19.5% for large (> $700 million) issuers.

Average outside vendor costs declined as follows:

o 25.9% for smaller (< $75 million) issuers;

o 21.2% and 24.1% for medium ($75-$250 million and $250-$700 million, 

respectively) issuers; and

o 31% for large (> $700 million) issuers. 

Following the 2007 reforms, there also was a decrease in average internal labor costs 

and average non labor costs across all size categorizes, but these results were mostly 

insignificant, except for non labor costs for large (> $700 million) issuers. 

Further analysis of the data in Table 1 also generally reveals a decline in the post-2007 

reform period in average Section 404(b) audit fees as a percentage of average total Section 404 

compliance costs:92

Pre-2007 reforms:

o 40.4% for smaller (< $75 million) issuers; and

o 29.2%-34.5% for medium ($75-$250 million and $250-$700 million) and 

large (> $700 million) issuers.

Post-2007 reforms:

o 37.5% for smaller (< $75 million) issuers; and

o 27.3%-28.2% for medium ($75-$250 million and $250-$700 million) and 

large (> $700 million) issuers.

 

92 The percentages are calculated by dividing the mean value of ―404(b) audit‖ costs by the mean value of ―Total 

Section 404‖ costs reported in Table 1. 
53

Table 1 – Cost of Section 404 compliance by size and year relative to 2007 reforms for Section 

404(b) companies

This table reports summary statistics for the total cost of Section 404 compliance and its components for 

Section 404(b) compliant issuers reported by Audit Analytics in the relevant fiscal year (Pre, Post, and 

Next). Pre includes firm-fiscal year observations pre-dating November 15, 2007; Post includes all 

completed firm-fiscal year observations post-dating November 15, 2007; and Next includes all firm 

observations referring to the fiscal years in progress at the time of the survey. The earliest completed 

fiscal year end is January 8, 2007 and the latest reported fee is for the fiscal year ending December 31, 

2009. In cases where issuers have two complete fiscal years in Pre (Post), we retain the fiscal year 

closest to the passage of the reform, i.e., the last (first) fiscal year prior to (following) the November 15, 

2007 date. This approach resulted in a reduction of the overall sample (firm-fiscal year observations) of 

less than 2% and it ensures that issuers are not double counted in any column. Panel A (B, C, D) is 

restricted to issuers with public float < $75 million ($75-$250 million, $250-$700 million, > $700 

million) in the relevant fiscal year. The public float is from DataStream and measured as of six months 

prior to the fiscal year end. The earliest public float data is from July 8, 2006 and the latest data is from 

June 30, 2009. When survey participants responded ―not applicable‖ for outside vendor costs or nonlabor costs, the responses were coded as zero. Responses of ―cannot estimate‖ were replaced with the 

mean of non-missing values conditional on the company assets. The last two columns report differences 

in means and medians. ***, **, and * indicate significance at a 1%, 5%, and 10% levels, respectively.

Pre Post Next Post-Pre

%

Post-Pre Next-Post

% 

Next-Post

Panel A: Public float < $75M

A. 404(b) audit Mean 310,613 259,004 171,784 -51,609 -16.6% -87,220** -33.7%**

Med 200,000 157,500 116,750 -42,500 -21.3% -40,750*** -25.9%***

N 63 99 162

B. Outside vendor Mean 194,429 144,093 98,555 -50,336 -25.9% -45,538** -31.6%**

Med 98,000 57,500 50,000 -40,500** -41.3%** -7,500 -13%

N 76 120 205

C. Internal labor Mean 327,145 317,846 283,698 -9,300 -2.8% -34,147 -10.7%

Med 121,000 145,200 121,000 24,200 20% -24,200 -16.7%

N 61 98 167

D. Non labor Mean 55,873 40,882 41,745 -14,991 -26.8% 863 2.1%

Med 12,500 10,000 5,000 -2,500 -20% -5,000 -50%

N 76 117 200

Total Section 404 

(A+B+C+D) Mean 769,266 690,219 581,176 -79,047 -10.3% -109,043 -15.8%

Med 579,277 439,460 365,900 -139,817 -24.1% -73,560 -16.7%

N 50 83 134
54

Table 1 – Cost of Section 404 compliance by size and year relative to 2007 reforms for Section 

404(b) companies (cont’d)

Pre Post Next Post-Pre

%

Post-Pre Next-Post

%

Next-Post

Panel B: Public float $75-$250M

A. 404(b) audit Mean 263,492 229,127 206,576 -34,365* -13%* -22,551 -9.8%

Med 180,000 147,834 147,000 -32,166** -17.9%** -834 -0.6%

N 364 398 365

B. Outside vendor Mean 189,701 149,432 97,174 -40,269** -21.2%** -52,258*** -35%***

Med 75,000 60,000 40,000 -15,000** -20%** -20,000*** -33.3%***

N 490 502 472

C. Internal labor Mean 429,642 397,460 388,806 -32,182 -7.5% -8,654 -2.2%

Med 242,000 217,800 211,750 -24,200 -10% -6,050 -2.8%

N 419 437 411

D. Non labor Mean 73,295 62,398 66,642 -10,897 -14.9% 4,244 6.8%

Med 20,000 13,750 12,500 -6,250* -31.3%* -1,250 -9.1%

N 485 492 461

Total Section 404 

(A+B+C+D) Mean 903,725 840,276 728,701 -63,449 -7% -111,575 -13.3%

Med 664,000 574,527 510,392 -89,473** -13.5%** -64,135 -11.2%

N 315 344 314

Panel C: Public float $250-$700M

A. 404(b) audit Mean 452,680 343,305 348,993 -109,375*** -24.2%*** 5,688 1.7%

Med 303,775 257,070 250,000 -46,705*** -15.4%*** -7,070 -2.8%

N 304 331 291

B. Outside vendor Mean 244,904 185,870 175,872 -59,034*** -24.1%*** -9,998 -5.4%

Med 100,000 80,000 75,000 -20,000* -20%* -5,000 -6.3%

N 448 469 430

C. Internal labor Mean 593,381 590,184 601,237 -3,197 -0.5% 11,053 1.9%

Med 360,000 342,733 326,700 -17,267 -4.8% -16,033 -4.7%

N 382 398 369

D. Non labor Mean 107,621 97,880 93,162 -9,741 -9.1% -4,718 -4.8%

Med 35,000 28,500 25,000 -6,500 -18.6% -3,500 -12.3%

N 447 464 424

Total Section 404 

(A+B+C+D) Mean 1,312,682 1,215,808 1,185,910 -96,874 -7.4% -28,898 -2.4%

Med 930,500 839,643 812,128 -90,857 -9.8% -27,515 -3.4%

N 272 288 258
55

Table 1 – Cost of Section 404 compliance by size and year relative to 2007 reforms for Section 

404(b) companies (cont’d)

Pre Post Next Post-Pre

%

Post-Pre Next-Post

%

Next-Post

Panel D: Public float >$700M

A. 404(b) audit Mean 1,400,443 1,127,325 1,045,150 -273,118** -19.5%** -82,175 -7.3%

Med 675,500 600,000 547,080 -75,500** -11.2%** -52,920 -8.8%

N 595 659 598

B. Outside vendor Mean 695,522 479,832 343,888 -215,689*** -31%*** -135,944*** -28.3%***

Med 195,740 123,000 90,000 -72,740*** -37.2%*** -33,000*** -28.8%***

N 871 959 869

C. Internal labor Mean 2,765,204 2,350,656 2,193,364 -414,548 -15% -157,292 -6.7%

Med 968,000 847,000 847,000 -121,000** -12.5%** 0 0%

N 728 820 746

D. Non labor Mean 248,771 208,307 194,585 -40,464** -16.3%** -13,722 -6.6%

Med 100,000 62,500 60,000 -37,500* -37.5%* -2,500 -4%

N 869 954 863

Total Section 404 

(A+B+C+D) Mean 5,041,707 3,986,121 3,585,743 -1,055,586** -20.9%** -400,378 -10%

Med 2,446,750 1,993,800 1,790,000 -452,950*** -18.5%*** -203,800* -10.2%*

N 524 591 533

Table 2 reports the summary statistics for survey participants‘ estimates of the percent of 

audit fees, outside vendor costs, and internal labor costs attributed to Section 404(b) 

compliance.93 Overall, the mean share of audit fees allocated to Section 404(b) was significantly 

lower post-2007 reforms, except for smaller (< $75 million) issuers that are now exempt from 

Section 404(b) compliance. However, all issuers projected a statistically significant decline in 

the percent of audit fees allocated to Section 404(b) beyond the first post-reform year. 

Regarding outside vendor costs, the mean share was only significantly lower post-2007 reforms 

for smaller (< $75 million) issuers and a subset of medium ($250-$700 million) issuers. Finally, 

the mean share for internal labor costs was not significantly different following the 2007 

reforms, regardless of size. Specifically,

The mean share of the total audit fees allocated to Section 404(b) compliance ranged 

from approximately 35.8% to 42.9% of the total compliance costs pre-2007 reforms 

and was inversely related to the issuer‘s size. During the first post-2007 reforms year, 

this share was significantly lower (at the 5% level) for issuers with public float 

 

93 Table 2 reflects Table 10 in the 2009 study, partitioned into four groups based on public float (< $75 million, $75-

$250 million, $250-$700 million, and > $700 million). See SEC Study of the Sarbanes-Oxley Act of 2002 Section 

404 Internal Control over Financial Reporting Requirements, supra note 86 at 49. Based on the 2009 study, the 

values in Table 2 are management estimates – given that it is an integrated audit, the percentage of audit fees 

relating to ICFR is not separately determined.
56

between $75 and $250 million, and highly significantly lower (at the 1% level) for 

issuers with public float between $250 and $700 million and issuers with public float 

greater than $700 million, while insignificantly lower for smaller (< $75 million) 

issuers. However, this share was projected to continue to decrease at a highly 

significant rate (at the 1% level) beyond the first post-reforms year, regardless of size, 

with both categories of medium issuers projecting roughly equal decreases. 

o 42.9% to 32.5% [< $75 million]

o 40.4% to 34.1% [$75-$250 million]

o 40.0% to 34.4% [$250-$700 million]

o 35.8% to 30.5% [> $700 million]

The mean share of outside vendor costs that was attributed to Section 404(b) 

compliance ranged from approximately 16.6% and 36.3% pre-2007 reforms. 

Although smaller (< $75 million) issuers allocated higher shares of outside vendor 

costs to Section 404(b) compliance, both the mean and median realized of these costs 

are significantly lower the first post-reforms year for both the smaller (< $75 million) 

issuers and a subset of medium ($250-$700 million) issuers. The mean share of 

outside vendor costs was mostly projected to continue to decrease beyond the first 

post-reforms year, regardless of size, with again both categories of medium issuers 

projecting roughly equal decreases. 

o 36.3% to 23.8% [< $75 million]

o 28.5% to 26.7% [$75-$250 million]

o 30.7% to 27.0% [$250-$700 million]

o 16.6% to 16% [> $700 million]

The mean share of internal labor costs attributed to Section 404(b) compliance ranged 

from approximately 24% to 40% pre-2007 reforms and, once again, this share was 

inversely related to size. However, it did not appear that this share for internal labor 

costs was significantly different following the 2007 reforms, regardless of size.

o 40.0% to 31.4% [< $75 million]

o 31.9% to 32.6% [$75-$250 million]

o 32.4% to 33.6% [$250-$700 million]

o 24.0% to 24.6% [> $700 million]
57

Table 2 – Percent allocation of cost components to Section 404(b) compliance by year relative to 

2007 reforms and size

Survey participants provided an estimate of the percent of total audit fees, outside vendor costs, and 

internal labor hours attributed to compliance with Section 404(b) requirements. This table reports the 

summary statistics for these allocations (in percentage terms) by issuer size and year relative to the 2007 

reforms. Panel A (B, C, D) is restricted to issuers with public float < $75 million ($75-$250 million, 

$250-$700 million, > $700 million) in the relevant fiscal year (Pre, Post, and Next). The public float is 

from DataStream and measured as of six months prior to the fiscal year end. The earliest public float data 

is from July 8, 2006 and the latest data is from June 30, 2009. Panel E includes all issuers. Pre includes 

firm-fiscal year observations pre-dating November 15, 2007; Post includes all completed firm-fiscal year 

observations post-dating November 15, 2007; and Next includes all firm observations referring to the 

fiscal years in progress at the time of the survey. The earliest completed fiscal year end is January 8, 

2007 and the latest reported fee is for the fiscal year ending December 31, 2009. In cases where issuers

have two complete fiscal years in Pre (Post), we retain the fiscal year closest to the passage of the reform, 

i.e., the last (first) fiscal year prior to (following) the November 15, 2007 date. This approach resulted in 

a reduction of the overall sample (firm-fiscal year observations) of less than 2% and it ensures that issuers

are not double counted in any column. When survey participants responded ―not applicable‖ for outside 

vendor costs or non-labor costs, the responses were coded as zero. Responses of ―cannot estimate‖ were 

replaced with the mean of non-missing values conditional on the company assets. The rows labeled PostPre (Next-Post, Next-Pre) report differences in means and medians. ***, **, and * indicate significance at 

a 1%, 5%, and 10% levels, respectively.

Percent of audit fees allocated 

to Section 404(b)

Percent of outside vendor costs 

allocated to 

Section 404(b)

Percent of internal labor 

costs allocated to 

Section 404(b)

Mean Median N Mean Median N Mean Median N

Panel A: < $75M

Pre 42.9 42.0 63 36.3 40.0 58 40.0 40.0 55

Post 40.5 40.0 99 27.2 20.0 89 36.8 35.0 95

Next 32.5 34.5 162 23.8 0.0 145 31.4 30.0 158

Post-Pre -2.4 -2.0 -9.1* -20.0** -3.2 -5.0

Next-Post -8.0*** -5.5*** -3.4 -20.0 -5.4 -5.0

Next-Pre -10.4*** -7.5*** -12.5*** -40.0*** -8.6** -10.0**

Panel B: $75-$250M

Pre 40.4 40.0 364 28.5 20.0 303 31.9 25.0 345

Post 37.9 35.0 398 29.6 25.0 319 32.8 30.0 361

Next 34.1 31.3 365 26.7 20.0 316 32.6 25.0 346

Post-Pre -2.5** -5.0** 1.1 5.0 0.9 5.0

Next-Post -3.9*** -3.7*** -2.9 -5.0** -0.1 -5.0

Next-Pre -6.4*** -8.7*** -1.8 0.0* 0.7 0.0

Panel C: $250-$700M

Pre 40.0 40.0 304 30.7 20.0 268 32.4 25.0 303

Post 36.3 35.0 331 25.9 10.0 303 31.8 25.0 328

Next 34.4 34.0 291 27.0 10.0 288 33.6 30.0 302

Post-Pre -3.7*** -5.0*** -4.8* -10.0** -0.6 0.0

Next-Post -1.9* -1.0* 1.1 0.0 1.8 5.0

Next-Pre -5.6*** -6.0*** -3.7 -10.0** 1.2 5.0
58

Table 2 – Percent allocation of cost components to Section 404(b) compliance by year relative to 

2007 reforms and size (cont’d)

Percent of audit fees allocated 

to Section 404(b)

Percent of outside vendor costs 

allocated to 

Section 404(b)

Percent of internal labor 

costs allocated to 

Section 404(b)

Mean Median N Mean Median N Mean Median N

Panel D: > $700M

Pre 35.8 35.0 595 16.6 0.0 510 24.0 20.0 603

Post 32.2 30.0 659 17.4 0.0 573 25.2 20.0 678

Next 30.5 30.0 598 16.0 0.0 530 24.6 20.0 614

Post-Pre -3.6*** -5.0*** 0.9 0.0 1.2 0.0

Next-Post -1.6** 0.0** -1.5 0.0** -0.6 0.0

Next-Pre -5.2*** -5.0*** -0.6 0.0** 0.6 0.0

Panel E: All issuers

Pre 38.3 38.8 1,326 24.1 10.0 1,139 28.7 25.0 1,306

Post 35.2 34.7 1,487 23.1 10.0 1,284 29.3 25.0 1,462

Next 32.5 31.0 1,416 22.0 0.0 1,279 29.2 25.0 1420

Post-Pre -3.2*** -4.1*** -0.9 0.0 0.6 0.0

Next-Post -2.7*** -3.7*** -1.1 -10.0*** -0.1 0.0

Next-Pre -5.9*** -7.8*** -2.1* -10.0*** 0.5 0.0

To determine if experience in Section 404 compliance can explain the reduction in costs 

documented in the previous tables, Table 3 reports total Section 404 compliance costs for issuers

sorted by public float and the number for years of compliance experience with Section 404(b).94

The results show that when focusing on issuers with more than one year of compliance 

experience, the total costs are significantly lower (at the 5% level) following the 2007 reforms 

among medium ($75-$250 million and $250-$700 million) issuers complying for the second time 

with Section 404(b). In addition, the total costs are significantly lower (at the 10% level) 

following the 2007 reforms for a subset of medium ($250-$700 million) issuers complying for 

the third time with Section 404(b) and highly significantly lower (at the 1%) level for large (> 

$700 million) issuers complying for the fourth time.

The data in Table 3 reveals no significant difference in the mean total cost of compliance 

as a fraction of assets between issuers with a public float of < $75 million and issuers with a 

public float of $75-$250 million. However, there was a statistically significant difference in the 

mean total cost of compliance as a fraction of assets between issuers with a public float of $75-

$250 million and issuers with a public float of $250-$700 million. 

 

94 Table 3 reflects Table 12 in the 2009 study, partitioned into four groups based on public float (< $75 million, $75-

$250 million, $250-$700 million, and > $700 million). See SEC Study of the Sarbanes-Oxley Act of 2002 Section 

404 Internal Control over Financial Reporting Requirements, supra note 86 at 53.
59

Table 3 shows that for Section 404(b) issuers, the total cost of compliance as a fraction of 

assets appears to decrease as the size of the issuer increases. In addition, for all size categorizes, 

scaled compliance costs typically decreased with the number of years of Section 404(b) 

compliance experience. In particular, a comparison of compliance costs over time (i.e., 4+ yrs –

1 yr) reveals a statistically significant reduction in compliance costs for medium ($75-$250 

million and $250-$700 million) issuers and large (> $700 million) issuers relative to small (< $75 

million) issuers. These reductions may be attributable to the absorption of start-up costs and 

other non-recurring fixed costs, as well as the 2007 reforms. Moreover, these results are 

consistent with the notion that experience with Section 404 compliance may explain some of the 

differences in compliance costs.

Table 3 – Total Section 404 compliance cost scaled by total assets, by size and years of Section 

404(b) compliance experience

This table reports mean total cost of compliance with Section 404 as a fraction of the issuer‘s total assets, 

measured at the end of the relevant fiscal year. In this table, issuers are segmented by their public float 

and by the number of years of experience complying with Section 404(b) in the relevant fiscal year. The 

unit of observation is a firm-fiscal year, the corresponding public float is downloaded from DataStream 

and measured as of six months prior to the fiscal year end, and Section 404(b) compliance status for the 

relevant year is from Audit Analytics. The earliest completed fiscal year end is January 8, 2007 and the 

latest reported fee is for the fiscal year ending December 31, 2009. The earliest public float data is from 

July 8, 2006 and the latest data is from June 30, 2009. When survey participants responded ―not 

applicable‖ for outside vendor costs or non-labor costs, the responses were coded as zero. Responses of 

―cannot estimate‖ were replaced with the mean of non-missing values conditional on the company assets. 

The row labeled 2yrs - 1yr [3yrs - 2yrs, 4yrs - 3yrs, 4yrs - 1yr] report differences in means between the 

corresponding subsamples. ***, **, and * indicate significance at a 1%, 5%, and 10% levels, 

respectively. 

Public Float

(1) (2) (3) (4)

stats <$75M (2)-(1)

$75M-

$250M

$250M-

$700M >$700M (3)-(2) (4)-(3)

1 year mean 0.70 0.77 0.58 0.14 0.07 -0.20* -0.44***

N 25 109 68 92

2 years mean 0.53 0.52 0.37 0.11 -0.00 -0.15* -0.27***

N 20 87 53 82

3 years mean 0.48 0.49 0.28 0.11 0.01 -0.21*** -0.17***

N 40 231 232 453

4+ years mean 0.64 0.41 0.25 0.08 -0.23 -0.16*** -0.17***

N 28 141 177 416

2yrs - 1yr -0.17 -0.25** -0.20** -0.03

3yrs - 2yrs -0.05 -0.04 -0.10* -0.00

4+yrs - 3yrs 0.17 -0.08 -0.02 -0.03***

4+yrs - 1yr -0.05 -0.36*** -0.32*** -0.06***
60

B. Survey Participants’ Perceptions of the Impact of the 2007 Reforms on the 

Costs of Compliance

In an optional section of the survey, participants characterized the impact of the 2007 

reforms on the costs of complying with Section 404 requirements. Table 4 reveals that on 

average, issuers perceive that the 2007 reforms helped reduce the cost of complying with Section 

404.

95

 Although this result holds true at a high level of statistical significance independent of the 

size of the issuer, large (> $700 million) issuers ascribe a larger impact to the reforms, while a 

subset of medium ($75-$250 million) issuers ascribe a smaller impact to the reforms. 

Table 4 – Impact of 2007 reforms on cost of compliance for Section 404(b) companies – (Optional 

Survey Section)

In an optional section of the survey, participants characterized the impact of the 2007 reforms on the costs 

of complying with Section 404 requirements. The response could vary between -1 and +1, where: -1

referred to ―a decrease,‖ 0 referred to ―little or no impact,‖ +1 referred to ―an increase.‖ Alternatively,

the response could be ―not sure‖ or ―not applicable.‖ This table is restricted to Section 404(b) issuers and 

reports summary statistics for the participants‘ responses to questions about the isolated and combined 

impact of the reforms on compliance costs. Issuers are segmented based on public float, measured as of 

2008. The column labeled Mean reports the mean response in the relevant sample. The row labeled (2)-

(1) [(3)-(1), (3)-(2), (4)-(1), (4)-(2), (4)-(3)] reports differences in mean responses across the relevant 

subsamples. ***, **, and * indicate significance at 1%, 5%, and 10% levels, respectively. 

decrease/none/increase

N -1 0 1 Mean

Impact of Management 

Guidance on total cost of 

compliance

< $75M (1) 40 47.5% 50.0% 2.5% -0.450***

$75M-$250M (2) 189 27.5% 66.1% 6.4% -0.212***

$250M-$700M (3) 187 33.2% 65.2% 1.6% -0.316***

>$700M (4) 364 45.3% 53.3% 1.4% -0.440***

(2) - (1) 0.238**

(3) - (1) 0.134

(3) - (2) -0.104*

(4) - (1) 0.010

(4) - (2) 0.228***

(4) - (3) -0.124***

Impact of Auditing Standard No. 

5 on total cost of compliance

< $75M (1) 41 48.8% 46.3% 4.9% -0.439***

$75M-$250M (2) 191 39.8% 52.4% 7.9% -0.319***

$250M-$700M (3) 191 56.0% 41.4% 2.6% -0.534***

>$700M (4) 373 66.5% 31.4% 2.1% -0.643***

 

95 Table 3 reflects Table 17 in the 2009 study, partitioned into four groups based on public float (< $75 million, $75-

$250 million, $250-$700 million, and > $700 million). See SEC Study of the Sarbanes-Oxley Act of 2002 Section 

404 Internal Control over Financial Reporting Requirements, supra note 86 at 70.
61

Table 4 – Impact of 2007 reforms on cost of compliance for Section 404(b) companies – (Optional 

Survey Section) (cont’d)

decrease/none/increase

N -1 0 1 Mean

(2) - (1) 0.120

(3) - (1) -0.095

(3) - (2) -0.215***

(4) - (1) -0.204**

(4) - (2) -0.324***

(4) - (3) -0.109**

Combined impact of 

Management Guidance and AS 5 

on total compliance cost

< $75M (1) 40 55.0% 40.0% 5.0% -0.500***

$75M-$250M (2) 192 41.2% 51.0% 7.8% -0.333***

$250M-$700M (3) 190 55.3% 42.6% 2.1% -0.532***

>$700M (4) 357 69.1% 29.6% 1.3% -0.677***

(2) - (1) 0.167

(3) - (1) -0.032

(3) - (2) -0.198***

(4) - (1) -0.177*

(4) - (2) -0.344***

(4) - (3) -0.146***

Finally, survey participants tended to provide a relatively favorable assessment of the 

impact of AS 5 in terms of the amount of time required for auditor attestation, and of the direct 

and indirect effects of Section 404 compliance on a number of factors, including the quality of 

the internal control structure and financial reporting and going-private decisions:

96

Approximately 60% of all respondents believe AS 5 reduced the time required for 

auditor attestation under Section 404(b); medium ($75-$700 million) and large (> 

$700 million) issuers perceived the time reduction to be greater than that perceived by 

smaller (< $75 million) issuers.97

Overall, some of the positive direct effects to Section 404 compliance ascribed by 

respondents included:

 

96 The findings are based on the results from Table 14 and Table 15 in the 2009 study. See SEC Study of the 

Sarbanes-Oxley Act of 2002 Section 404 Internal Control over Financial Reporting Requirements, supra note 86 at 

49, 64.

97 The findings are based on the results from Table 18 in the 2009 study. See id. at 72.
62

o improved quality of the internal control structure;

o improved confidence by the audit committee in the issuer‘s ICFR;

o improved quality of the issuer‘s financial reporting; and

o improved ability of the issuer to prevent and detect fraud. 

When assessing the indirect effects of Section 404 compliance, the majority of 

respondents perceived no effect on:

o the issuer‘s ability to raise capital;

o investors‘ confidence in the issuer;

o the liquidity of the issuer‘s common stock; or

o the issuer‘s overall value.

Nearly 40% of respondents claimed that they were more confident in the financial 

reports of other Section 404 compliant issuers, as opposed to only about one in four 

that found compliance to improve investors‘ confidence in their own company‘s 

reports. This discrepancy may imply that ―corporate insiders‘ representation of the 

benefits enjoyed by users of financial statements as a result of Section 404 

compliance may be downward biased.‖

98

The perceived net benefits of Section 404 compliance significantly increased with the 

size of the issuer. The average perceived net benefits of Section 404 compliance in 

the first fiscal year post-2007 reforms was higher relative to the prior year across all 

sizes of issuers, significantly so for medium ($75-$250 million and $250-$700 

million) issuers and large (> $700 million) issuers.

Net benefits were also expected to continue to be higher beyond the first post-reform 

year.

Although approximately 44% of respondents from U.S. issuers indicated that Section 

404 requirements prompted their companies to seriously or at least somewhat 

consider going private, this result was largely driven by smaller (< $75 million) 

issuers, which are now exempt from Section 404(b).99 Seventy percent of smaller (<

$75 million) issuers reported that their companies considered going private as a result 

 

98 See id. at 57. 

99 Id. 
63

of Section 404 requirements. Among foreign issuers, 26% of respondents reported 

their company had seriously considered delisting, while 25% report to have 

considered this option less seriously. Similar to the evidence for domestic issuers, 

this result primarily reflects the responses of smaller foreign issuers. The evidence 

implies that respondents from small issuers more frequently reported that their 

companies had considered delisting than did respondents from larger issuers.100 

 

100 Id. at 66.
64

IV. Discussion of Public Comments

Input from the public informed the Staff‘s analysis of potential ways to reduce the 

compliance burden for issuers with $75-$250 million in public float.101 In particular, the 

Commission solicited public input about the unique characteristics of these issuers and about 

how to reduce the compliance burden of complying with Section 404(b) and whether it would

encourage the listing of IPOs in the United States. The Staff also considered public input 

previously received on the compliance burden of Section 404(b) from other Commission and 

PCAOB actions described in Section I of this study. The Staff is also aware that there are 

continuing negative perceptions attributed to the Sarbanes-Oxley Act, including Section 404.102 

As discussed in Section VI of this study, there were few suggestions provided from the 

public input that addressed techniques for further reducing the compliance burden while 

maintaining investor protections without providing a complete exemption. For example, the 

three industry groups that advocated an exemption from Section 404(b) for issuers in the studied 

market capitalization range did not provide other recommendations for reducing the compliance 

burden. Several of the other suggestions short of an exemption were considered by either the 

Commission or the PCAOB in adopting the 2007 reforms, but were not adopted.

However, the Staff believes that certain other suggestions from the public to reduce 

compliance costs are likely to take into account both the compliance costs and effectiveness for 

all issuers, including those subject to this study. These relate to suggestions regarding the 

PCAOB potentially publishing additional observations on Section 404(b) implementation and the 

COSO‘s project to update its internal control framework. 

 

101 In addition to recommendations regarding the population of issuers with $75-$250 million in public float, several 

commenters made recommendations for disclosures for issuers that are already exempt from Section 404(b). One

commenter recommended that the Commission amend certain disclosure requirements for issuers that are exempt 

from the reporting requirements of Section 404(b), both by changing the front cover of Form 10-K and requiring 

more prominent disclosure within the form. Another commenter recommended that the auditor be required to state 

in its report that it did not audit the ICFR of issuers that are exempt from Section 404(b).

102 See, e.g., Whatever Happened to IPOs? WALL ST. J., Mar. 22, 2011. This editorial on initial public offerings 

stated that ―the 2002 Sarbanes-Oxley law...triggered billions of dollars in new compliance costs for public 

companies‖ including ―an external audit of... a company‘s financial practices, known as  ̳internal controls,‘ on top 

of the traditional audits of corporate financial statements...The question for companies now, as ever, is whether the 

benefits of going public are worth the costs. It‘s indisputable that America has raised those costs in recent years.‖ 
65

A. Request for Public Comment in Connection with this Study

On October 14, 2010, the Commission requested public comment in connection with this 

study.103 The request invited comments on the following topics:

(1) quantitative and qualitative information about the trends of internal and external 

costs of having an external auditor attest to management‘s assessment under Section 

404(b) for issuers with a public float between $75 million and $250 million from 

the first year of required compliance to the present; 

(2) current cost of auditor attestation under Section 404(b) in relation to overall cost of 

compliance with all of Section 404 (i.e., including management‘s assessment 

required by Section 404(a)) and changes to this relative cost over time; 

(3) characteristics of internal controls, management‘s evaluation process and corporate 

governance of subject issuers that distinguish them from other issuers; 

(4) unique audit planning and performance characteristics, if any, associated with 

subject issuers; 

(5) incremental effort for preparers and auditors to comply with the auditor attestation 

requirement of Section 404(b) for an integrated audit beyond the efforts that would 

already be incurred to comply with the requirements for a financial statement only 

audit, including the requirement to evaluate internal controls in connection with 

such an audit, for subject issuers; 

(6) whether and how initiatives of the Commission, such as the Commission Guidance 

Regarding Management‘s Report on Internal Control Over Financial Reporting 

Under Section 13(a) or 15(d) of the Securities Exchange Act of 1934, have reduced 

the burden of complying with Section 404(b) for subject issuers; 

(7) whether and how any aspects of Public Company Accounting Oversight Board 

(PCAOB) Auditing Standard No. 5,such as its focus on risk and materiality, 

scalability, tailoring of testing to risk, and extent of permitted use of the work of 

others, have reduced costs of compliance with Section 404(b) versus PCAOB 

Auditing Standard No. 2 for subject issuers; 

(8) whether and how other initiatives of the PCAOB, such as its staff guidance for 

auditors of smaller public companies, have reduced the burden of complying with 

Section 404(b) for subject issuers; 

(9) whether and how initiatives of the Committee of Sponsoring Organizations of the 

Treadway Commission (COSO), such as the June 2006 guidance for smaller public 

 

103 Release No. 34-63108 (Oct. 14, 2010).
66

companies on internal control over financial reporting, and the January 2009 

Guidance on Monitoring Internal Control Systems, have reduced the burden of 

complying with Section 404(b) for subject issuers; 

(10) whether and how initiatives of any other organization have reduced the burden of 

complying with Section 404(b) for subject issuers; 

(11) the possibility that guidance or rules issued by the Commission, PCAOB or others 

could further reduce the burden of complying with the auditor attestation 

requirement of Section 404(b), while maintaining investor protection, for subject 

issuers, and any specific recommendations concerning any such guidance or rules; 

(12) the impact on investor protection, investor confidence, and the cost of capital 

arising from the establishment and ongoing compliance with Section 404(b) by 

subject issuers, including in the context of initial public offerings; 

(13) the degree to which investor protection, investor confidence, and the cost of capital 

would increase or decrease, if any, as a function of each specific recommendation 

by which the Commission, the PCAOB, or others might reduce the burden of 

complying with Section 404(b) for subject issuers, while maintaining investor 

protection; 

(14) the impact of costs of complying with the auditor attestation requirement of Section 

404(b) on company decisions to list on exchanges in the United States versus 

foreign exchanges in initial public offerings for subject issuers after the offering; 

(15) the impact of costs of complying with Section 404(b) on company and investor 

decisions to engage in initial public offerings versus other financing alternatives for 

issuers whose public float is expected to be between $75 million and $250 million 

after the offering; 

(16) potential effect on the number of companies listing initial public offerings in the 

United States of a complete exemption from the internal control audit requirements 

for subject issuers, and the potential effect on listings for each specific 

recommendation for reducing the compliance burden of such requirements on 

subject issuers; 

(17) any qualitative differences between subject issuers that might list securities on a 

U.S. exchange in connection with their initial public offerings if the existing 

internal control audit requirement of Section 404(b) remains in effect and subject 

issuers that might list securities on a U.S. exchange in connection with their initial 

public offerings if subject issuers are completely exempt from the internal control 

audit requirements of Section 404(b), and any such qualitative differences that may 

arise from each specific recommendation for reducing the compliance burden of 

such requirements on subject issuers; 
67

(18) the potential effect of a complete exemption from Section 404(b) for subject issuers 

on matters such as: raising capital; engaging in mergers, acquisitions and similar 

corporate transactions; and attracting and retaining qualified independent directors; 

(19) whether and how the use of the auditor‘s attestation report on internal control over 

financial reporting for subject issuers differs from the use of the auditor‘s attestation 

report on internal control over financial reporting for issuers whose public float is 

greater than $250 million and the reason(s) for those differences; 

(20) quantitative and qualitative information about whether and how compliance with 

Section 404(b) has benefited investors and other users of financial statements of 

subject issuers; 

(21) whether and to what extent auditor attestation reports on internal control over 

financial reporting enhances confidence in management‘s assessment of the 

effectiveness of its internal control over financial reporting, improves the reliability 

of financial reporting and improves the prevention and detection of fraud and other 

misconduct for subject issuers; 

(22) any additional information for the Commission to consider to describe the 

illustrative population and how the Commission could reduce the burden of 

complying with Section 404(b) on that population; and 

(23) any other information commenters would like the Commission to consider in 

regards to the study. 

 

1. Summary of Comments Received

The Commission received a total of twelve comment letters.104 The following table 

shows the number of letters received by group:

Investor Groups105 2

Public Accounting Firms and Affiliated Organizations106 4

Industry Organizations

107 3

Individuals108 3

 

104 This number reflects comments received through April 21, 2011. Full text of these comment letters is available 

at http://www.sec.gov/comments/s7-29-10/s72910.shtml. In addition to these twelve letters, an additional comment 

letter (Stephen A. Boyko) was received, addressing subjects not related to the scope of this study.

105 See letters from Council of Institutional Investors (CII) and CFA Institute.

106 See letters from Center for Audit Quality (CAQ), Deloitte & Touche LLP (Deloitte), Ernst & Young LLP (E&Y), 

and Grant Thornton LLP (Grant Thornton).

107 See letters from Biotechnology Industry Organization (BIO), American Bankers Association, and Independent 

Community Bankers of America (ICBA).

108 See letters from Georg Merkl (Merkl), John L. Pierschbacher, and James Brady Vorhies (Vorhies).
68

Following is a summary of comments received, grouped by the subject of the comment. 

Whether some portion of issuers with public float greater than $75 million should be 

exempt from 404(b)

Six commenters109 (including all of the Investor Groups and Accounting Firms) stated 

that they did not support extending the 404(b) exemption to any issuers with public float greater 

than $75 million:

One commenter110 believes that any such exemption would have a ―negative effect on

both investors‘ ability to review and analyze potential investments in these 

companies, and that the exempted issuers themselves will be less rigorous in the 

design and application of ICFRs.‖ As a result, this commenter contends that

investors ―will pay with higher long-term capital costs than they would have 

otherwise had to pay.‖

Another commenter111 cited a recent study by COSO that analyzed financial 

statement fraud cases over the past 10 years,112 noted that ―companies committing 

fraud had median revenues and total assets just under $100 million,‖ and further 

noted that: 

In addition to the negative stock market reactions to news announcements 

about alleged fraud or fraud investigations, many fraud firms suffered longterm consequences, including bankruptcy, delisting by national exchanges, 

and material asset sales. Twenty-eight percent of fraud firms were bankrupt 

or liquidated within two years from the year in which the SEC issued the last 

[Accounting and Auditing Enforcement Release] related to the fraud, and 47 

percent were delisted from a national stock exchange. Material asset sales 

also affected about 62 percent of fraud companies. These rates of occurrence 

were significantly higher than the experiences of no-fraud firms during those 

years.

 

109 See letters from CFA Institute, CII, CAQ, E&Y, Deloitte, and Grant Thornton.

110 See letter from CFA Institute.

111 See letter from CII.

112 Committee of Sponsoring Organizations of the Treadway Commission, Fraudulent Financial Reporting 1998-

2007, An Analysis of U.S. Public Companies 4 (May 2010), available at 

http://www.coso.org/documents/COSOFRAUDSTUDY2010.pdf.
69

Another commenter,

113 commenting on the risk of fraud at smaller public companies, 

stated:

Further, research has shown that the incidents of material internal control 

deficiencies, financial statement restatements, and fraud are all more prevalent 

in smaller companies indicating that smaller companies have the greatest need 

for improvement in their internal control systems. Accordingly, we strongly 

believe that it is neither warranted nor prudent to eliminate compliance with 

Section 404(b) for subject issuers. Section 404 should be viewed as the 

underpinning of reliable financial reporting, rather than a compliance burden.

Four commenters114 suggested that extending the Section 404(b) exemption to issuers 

with a public float up to $250 million would be appropriate:

One commented115 that:

The overwhelming majority of [biotech] companies do not have revenue and 

are years away from putting a product on the market. An exemption from 

Section 404(b) for companies with public floats of $250 million or less would 

help these companies continue to grow during this rough economic climate.

Another commenter116 ―strongly favors‖ extending the exemption to public 

companies with public float between $75 and $250 million, noting that ―micro-cap 

and small-cap companies disproportionately share in the compliance burden and costs 

of Section 404, particularly the external audit costs of complying with Section 

404(b)‖ and the ―costs far outweigh the benefits.‖

Another commenter117 also supported extending the exemption, stating that although 

the costs of compliance have fallen, ―they are still unreasonably large, especially in 

relation to the size of these companies.‖

Another commenter118 did not advocate a complete exemption for issuers with market 

capitalization up to $250 million, but rather suggested that certain accelerated filers that did not 

 

113 See letter from Grant Thornton.

114 See letters from American Bankers Association, BIO, ICBA, and John L. Pierschbacher.

115 See letter from BIO.

116 See letter from ICBA.

117 See letter from American Bankers Association.

118 See letter from Merkl.
70

meet certain revenue thresholds (the dollar amount of which were not specifically identified by 

the commenter) should be exempt, as their market capitalizations are driven by investor 

expectations about the value of research projects for which there is no current revenue. This 

commenter stated ―the valuation implied by their market capitalizations and the investment 

decisions of investors are primarily based not on the financial statements, but on non-financial 

disclosures, such as the results of certain clinical trial milestones, certain FDA approvals or the 

granting of patent protection.‖

Cost of Compliance with Section 404(b) 

Four commenters119 expressed the view that there is a declining cost trend:

One commenter120 stated that:

[T]he PCAOB‘s internal control auditing standard, AS 5, as well as the additional 

guidance issued by the PCAOB, the SEC, the Committee of Sponsoring 

Organizations of the Treadway Commission (COSO), and other professional 

organizations have led to more efficient and effective Section 404 compliance 

processes for both issuers and auditors. Moreover, efficiencies in the effective 

implementation of Section 404 have been gained as a result of issuers and auditors 

becoming more experienced with assessing the design and operating effectiveness of 

ICFR. The combination of these factors has contributed to a general decline in costs 

associated with management‘s assessment and the external audit of ICFR.

Another commenter,121 referring to the cost trend, stated:

[S]tudies illustrate that the normal learning curve since the introduction of the 

Section 404 requirements, along with the reforms undertaken by the SEC and 

the PCAOB and the activities of other organization, such as COSO and the 

Center for Audit Quality, have had a significant impact on the effort 

associated with the ICFR audit, particularly at smaller public companies. 

While we note that there is limited data with respect to the particular subset of 

companies subject to the SEC‘s study, as well as for periods subsequent to 

2007, we believe that additional experience by both management and auditors 

with the SEC‘s management guidance, the requirements of AS No. 5 and the 

other tools available continue to drive improvements in the efficiency and 

effectiveness of the ICFR audit.

 

119 See letters from CAQ, Deloitte, E&Y, and Grant Thornton.

120 See letter from Deloitte.

121 See letter from E&Y.
71

However, another commenter122 noted that despite the recent guidance from the SEC, 

the PCAOB, COSO and others, ―studies continue to show that publicly held

companies pay an extraordinary amount to comply with SOX 404.‖ This commenter

cited a Financial Executives International study on Section 404 costs, noting that 

―while 404 auditor costs declined 5.4% from 2006 as the auditor scope of work 

narrowed, these costs were offset by a reported five percent increase in the average 

hourly audit rate charged by auditors.‖ Further, that commenter cited the 2009 SEC 

Staff study on costs of complying with Section 404 and stated:

[E]ven though the overall mean 404 compliance costs had dropped 19% from the preguidance cost, for smaller reporting companies, the drop was not as significant. In 

fact, the Study showed that for filers with public float lower than $75 million, the 

mean SOX 404 compliance cost following the issuance of SEC guidance was very 

high--$690,000 per year and the mean 404(b) audit cost was $259,004. From its 

study, the SEC generally concluded that smaller publicly held companies have higher 

Section 404 compliance costs as a fraction of their asset value.123 

Impact of investor protection, investor confidence, and the cost of capital arising from 

the establishment and ongoing compliance with Section 404(b) by subject issuers

Six commenters124 expressed the view that compliance with Section 404(b) has had a 

positive impact on investor protection and investor confidence. 

Regarding the impact on investor protection, for example, one commenter125 stated:

An auditor‘s involvement in the annual evaluation of the design and 

effectiveness of ICFR encourages additional accountability of individuals 

involved in financial reporting with respect to the design and maintenance of 

internal control, which enhances the quality and reliability of companies‘

financial reports. For example, as noted in the SEC‘s SOX study released in 

2009, Section 404(b) causes management to devote more resources to a 

disciplined financial reporting process in order to better understand financial 

reporting risks, implement controls to address those risks, and address control 

issues more timely...We believe that the discipline and accountability that the 

Section 404(b) attestation requirement fosters in an issuer‘s management is 

crucial in today‘s reporting environment given the complexity and pace of 

 

122 See letter from ICBA.

123 As previously noted, issuers with a public float less than $75 million are now exempt from Section 404(b). 

124 See letters from CFA Institute, CII, CAQ, Deloitte, E&Y, and Grant Thornton.

125 See letter from CAQ.
72

change in accounting standards and the increasing reliance on management‘s 

judgment in adopting and implementing those standards.

This commenter also stated ―there is no clear and compelling reason to roll back the 

current requirements given the potential reduction in benefits from auditor attestation 

on ICFR‖ and having another group of issuers that are not subject to Section 404(b) 

―will likely confuse investors and may undermine their confidence in financial 

reporting.‖ Also regarding the impact on investor confidence, this commenter cited a 

2007 Financial Executives International survey of representatives from issuers which 

found that as a result of compliance with Section 404, over 50% of issuers have 

increased confidence in the accuracy of financial reports and 56% have confidence 

that financial reports are more reliable.

Regarding the impact on investor confidence, one commenter126 expressed the view 

that: 

The decision about whether public companies should be required under the federal 

securities law to fully comply with Section 404(b) should be based on the views of 

the companies‘ shareowners rather than the companies‘ lobbyists. CII believes that 

this view is supported by a recent CAQ survey of investors that ―found that 65 

percent of respondents are concerned about the exemption from 404(b) for companies 

with less than $75 million in public float. More importantly, for purposes of the 

Study, the survey also found that 81 percent of investors are concerned about the 

possibility that Congress may extend the exemption to larger companies.

Five commenters127 expressed the view that compliance with Section 404(b) was a factor 

in a decreasing number of restatements since the implementation of 404(b):

One commenter128 cited a study by Audit Analytics that finds ―a review of SOX 404 

disclosures and subsequent restatements found that those companies that complied 

with the auditor attestation requirement of Section 404(b) had significantly lower 

rates of restatement.‖

This commenter also cited a study performed at the request of the Ohio Public 

Employees Retirement System, which found that ―the stock price of companies that 

 

126 See letter from CII.

127 See letters from CII, CAQ, Deloitte, E&Y, and Grant Thornton.

128 See letter from CII.
73

had restatements prior or subsequent to disclosure of internal control weaknesses 

underperformed market benchmarks by more than 10 percentage points.‖

Another commenter129 stated that, ―Eliminating compliance with Section 404(b) will 

reduce the willingness of subject issuers to invest any additional effort in evaluating 

the effectiveness of their internal controls systems, ultimately affecting the quality of 

financial reporting and investor confidence.‖

Another commenter130 questioned the impact of Section 404(b) on investor confidence. 

It stated that the benefits to investors of Section 404(b) ―are not clear‖ and that the SEC‘s own 

2009 study on Section 404 indicates that the benefits investors receive ―appear to be nominal‖

because ―the majority of respondents [to the survey of issuers] recognize no effect of Section 404 

compliance on the company‘s ability to raise capital, investor confidence in the company‘s 

financial reports, the company‘s overall firm value, and the liquidity of the company‘s stock.‖

131

 

This commenter also questioned the benefit of improving financial reporting quality by reducing 

restatements given the substantially higher costs.

Impact on public company listings

Concerning the impact of compliance on public company listings, one commenter132

stated:

Due to the current economic environment, we believe that it is not feasible to 

determine the effect Section 404(b) has had, or may continue to have, on the 

number of companies listing initial public offerings. It would seem that any 

intention to increase initial public offerings in the U.S., by reducing the initial 

requirements for auditor attestation would negate the original intent and spirit of 

Section 404. It is our belief that an auditor‘s report on the effectiveness of a 

subject issuer‘s internal control over financial reporting provides the same value 

to an investor in a non-accelerated filer as it does for an investor in an accelerated 

filer. We would also observe the impact on certain public exchanges when a 

significant economic downturn or financial reporting crises occurs. Such events 

often result in a debilitating impact on public listings on exchanges that are not 

grounded in sound, transparent, and robust financial reporting and governance 

 

129 See letter from Grant Thornton.

130 See letter from American Bankers Association.

131 The ―respondents‖ referred to in this quote are public companies themselves, indicating their perceptions of 

investor benefit. 

132 See letter from Grant Thornton.
74

standards. We believe that considering the impact on company shares, listings, 

and sustainability of those exchanges in challenging times is just as important as 

studying listings on exchanges with less restrictive reporting requirements in 

periods of economic growth.

Another commenter133 referred to the 2009 SEC study and stated the following 

concerning the impact of compliance on public company listings:

Overall, publicly held companies view the costs of Section 404 compliance as far 

outweighing the resulting benefits. The feeling was even more pronounced 

among smaller public companies. When asked if the costs of Section 404 

motivated their company to consider going private, among all firms, 16.8% 

answered that they were very seriously considering it and 27.4% said they were 

somewhat considering it. However, among smaller firms, 31.5% said they were 

seriously considering going private and 38.2% said they were somewhat 

considering it. Interestingly, when smaller foreign firms were asked if the costs 

of Section 404 motivated their company to consider delisting from U.S. 

exchanges, 46.2% said they were very seriously considering it and 30.8% said 

they were somewhat considering it.134

This commenter also noted that many publicly held community banks are having 

trouble raising capital due to the economic climate. The commenter stated that the costs 

of Section 404 compliance are a ―drain on the earnings‖ of these banks, making it more 

difficult for them to compete with private banks.135

Another commenter136 stated:

While transparency is paramount to promoting robust capital markets, costly 

regulatory rules without proper adjustments for smaller companies can take away 

already scarce financial resources that would otherwise be used for research and 

development. Scaling certain regulatory measures that provide for adequate 

transparency while minimizing the financial burden on small companies must be 

an achievable goal in today‘s economic climate. In 2010, the [biotech] industry 

has had 15 IPOs. However, the majority of these IPOs did not raise the amount 

that was originally filed.

 

133 See letter from ICBA.

134 As previously noted, issuers with a public float less than $75 million are now exempt from Section 404(b).

135 Id.

136 See letter from BIO.
75

Recommendations for further efficiencies in the Section 404(b) process

Five commenters137 offered recommendations for further efficiencies in the Section 

404(b) process (aside from recommending a full exemption from 404(b)). One commenter138

suggested that ―through the course of its work, the PCAOB is in a unique position where its 

inspection teams might identify efficient and effective audit approaches that could be vetted with 

its standards-setting staff with the objective of identifying ―best practices‖ for AS 5 audits.‖ It 

also suggested that, ―similar to how the PCAOB conducted forums with auditors and audit 

committees of smaller public companies across the country on the implementation of Section 

404...we recommend that the SEC explore the merits of working with the PCAOB to conduct 

similar events for subject issuers, audit committee representatives and auditors...‖

Consistent with that commenter‘s observation that the PCAOB is in a position to promote 

further efficiencies, another commented:

139

As a result of its inspections of 2007 audits, the PCAOB issued a report in 2009 

related to its observations on the first year implementation of AS No. 5. As that 

report was focused only on the first year of implementation of AS No. 5, we 

believe that the PCAOB should consider publishing observations on how the 

implementation in 2008 and 2009 has progressed relative to its expectations when 

AS No. 5 was issued. Such information might enable auditors to continue to 

adjust their ICFR procedures to further improve effectiveness and efficiency of 

the ICFR audit.

Two commenters140 suggested that the SEC ―actively participate [in] and monitor‖ the 

recently announced COSO project to review and update its Internal Control—Integrated 

Framework, to better inform the SEC Staff‘s Section 404(b) study. One of these commenters 

indicated that COSO internal control update could ―lead to additional efficiencies in the effective 

implementation of Section 404.‖

Other suggestions from commenters, short of a full exemption for issuers with $75-$250 

million in public float included:

 

137 See letters from CAQ, CFA Institute, E&Y, Merkl, and Vorhies. Certain respondents recommended disclosures 

for issuers that are already exempt from Section 404(b) and related audit report requirements for their auditors. See

letters from CFA Institute and Merkl.

138 See letter from CAQ.

139 See letter from E&Y.

140 See letters from CAQ and E&Y.
76

Allowing for the integration of management‘s ongoing monitoring process (―key 

controls self-assessment‖) and the processes used for Section 404(a) compliance, and 

then enable the independent auditors issuing reports under Section 404(b) to be able 

to place more reliance upon this integrated process.141 

Requiring an audit of the effectiveness of ICFR less frequently than every year.142

Requiring an opinion on only the effectiveness of the design of ICFR.143

Requiring more disclosures, such as those described in Item 304 of Regulation S-K 

when a CFO or other key accounting personnel leave an issuer when a reason for 

such departure was any disagreement over any matter of accounting principles or 

practices or financial statement disclosure.

144

2. Staff Analysis of Comments Received

The feedback from investor groups responding to the Staff‘s October 2010 request for 

comment strongly opposed any further exemption from Section 404(b). These groups cited the 

auditors‘ role in uncovering ICFR deficiencies and increased cost of capital for issuers without 

the auditor attestation. 

There were few suggestions provided from the public input that addressed techniques for 

further reducing, but not eliminating, the compliance burden while maintaining investor 

protections. The three industry groups that advocated an exemption from Section 404(b) for 

issuers in the studied market capitalization range did not provide recommendations for reducing 

the existing compliance burden without eliminating it altogether. In contrast, four commenters 

to the Commission‘s request for public comment, including the three industry groups, 

recommended that the Commission permanently exempt registrants in the studied market 

capitalization range from the provisions of Section 404(b), as Congress did for non-accelerated 

filers pursuant to the Dodd-Frank Act.145 One commenter stated that the benefits to investors of 

 

141 See letter from Vorhies.

142 See letter from Merkl.

143 See id.

144 See id. 

145 See letters from American Bankers Association, BIO, ICBA, and John L. Pierschbacher.
77

Section 404(b) compliance were ―not clear,‖ and ―appear to be nominal.‖

146

 These perspectives

appear to conflict with the evidence from the user interviews from the Staff‘s 2009 study, the 

comments received from investor groups for this study, and the academic research described in 

Section V, which suggests that investors receive valuable information from the auditor 

attestation on ICFR. Further, several of the commenters, in citing data from the Staff‘s 2009 

study, cited data relating to issuers with less than $75 million in public float, which are now 

exempt from Section 404(b).

Another commenter indicated that the implementation of Section 404(b) had ―gone 

awry.‖

147

 As discussed throughout this study, the implementation of reforms such as the 

Commission‘s management guidance and the PCAOB‘s AS 5 has reduced the compliance 

burden for issuers required to comply with Section 404(b). Another commenter supported a 

recommendation of the ACSPC, which recommended exempting issuers with up to $787 million 

of public float from the external auditor requirement of Section 404(b).148 The Staff notes that 

this suggestion was conditional on there not being a framework for assessing ICFR. The 

Commission released the management guidance in 2007, in part as a response to the ACSPC 

recommendations. The PCAOB released AS 5 in 2007 and COSO released its smaller company 

guidance as a response to other ACSPC recommendations.

Two industry groups representing the banking industry were among those that supported 

an exemption for issuers with up to $250 million in public float. Section 112 of the FDICIA 

added Section 36, ―Early Identification of Needed Improvements in Financial Management,‖ to 

the Federal Deposit Insurance Act (―FDI Act‖).149 Part 363 of the Federal Deposit Insurance 

Corporation‘s (―FDIC‖) regulations, which implements Section 36 of the FDI Act, requires 

insured depository institutions with $1 billion or more in total assets to have an assessment of 

ICFR by both management and their independent auditors, regardless of their filing status for 

purposes of Section 404.150 Part 363 requires independent public accountants to perform 

 

146 See letter from American Bankers Association.

147 See letter from BIO.

148 See letter from ICBA.

149 P.L. 81-797, 64 Stat. 873.

150 Part 363 was initially adopted by the FDIC‘s Board of Directors in 1993 and was most recently amended in June 

2009. See http://www.fdic.gov/news/news/financial/2009/fil09033.html.
78

financial statement audits and assessments of ICFR in accordance with the AICPA‘s generally 

accepted auditing standards and generally accepted standards for attestation engagements or the 

PCAOB‘s auditing standards, if applicable. The standards of the AICPA that do apply to such 

audits conform very closely to AS 5,151 suggesting an audit engagement of similar cost. 

Approximately 18% of the 111 banks in the 2009 illustrative population identified in Section II 

had less than $1 billion in total assets.152 Of these 20 banks, many were within $200 million of 

this threshold (e.g., 14 had more than $800 million in assets but less than $1 billion in assets).153 

To the extent the Part 363 requirement is similar in scope to the Section 404(b) requirement, this 

suggests an exemption from Section 404(b) would not reduce a bank‘s compliance burden if it 

had more than $1 billion in assets. However, to the extent an exemption from Section 404(b) 

would mean there was not public disclosure to investors of the results of the ICFR audit in an 

issuer‘s annual report, investor protections from the Section 404(b) requirement may not be 

maintained.

One commenter proposed having the auditor opine on the design, but not the operation, 

of ICFR.154 When it considered the 2007 reforms, the Commission explained that ―[t]o have a 

reasonable basis for its assessment of the effectiveness of ICFR, management must have 

sufficient evidence supporting the operating effectiveness of all aspects of its ICFR as of the date 

of its assessment.‖

155

 The Staff believes this reasoning also applies to the auditors‘ work because 

of the importance of the auditor in identifying material weaknesses.

The same commenter recommended requiring auditor attestation less than annually. The 

Staff notes that the PCAOB also considered but did not adopt provisions that would permit

rotational testing due to the potential negative impact on audit quality given that the auditor is 

 

151 AT Section 501, An Examination of an Entity‘s Internal Control Over Financial Reporting That Is Integrated 

With an Audit of Its Financial Statements, applies to examination of the design and operating effectiveness of an 

entity‘s internal control over financial reporting that is integrated with an audit of financial statements for entities 

that are not issuers. This standard, which is effective for periods ending after December 15, 2008, is similar to the 

standards for integrated audits for issuers described in the PCAOB‘s AS 5.

152 Source: Audit Analytics.

153 Source: Audit Analytics.

154 See letter from Merkl.

155 See Release No. 33-8810 (Jun. 20, 2007).
79

required by the Sarbanes Oxley Act to opine on ICFR every year, stating ―it is not possible to 

assess [a] control‘s operating effectiveness without performing some level of testing.‖

156

 

However, the PCAOB noted that the approach described in AS 5 allows the auditor to consider 

past testing and risk assessments that ―might permit the auditor to assess risk as lower than in the

initial year and, thus, might permit the auditor to reduce testing.‖

157

Requiring an opinion only on control design would still impose a cost on issuers, though 

less than that for a full integrated audit. However, investors would likely lose a key protection if 

the auditor‘s attestation only focused on design, as even properly designed controls that do not 

operate effectively will not prevent or detect a material misstatement. Auditors may also obtain 

information about the design of controls by testing their operating effectiveness. The Staff did 

not find any evidence from the work it performed that the cost savings of requiring the auditor to 

opine on only control design would justify the significant lost benefit. Furthermore, auditors 

may need to test the operating effectiveness of controls in many instances even when they are 

performing only a financial statement audit. 

Another commenter implied that a revenue threshold, in addition to the current public 

float threshold, may be appropriate for determining the issuers that are required to comply with 

Section 404(b).158 The Staff does not believe this would be an appropriate basis to distinguish 

Section 404(b) compliance because even issuers with little or no revenue may have other

significant financial reporting risks, such as risks related to valuation, classification, and 

recognition. The 2007 reforms, including AS 5, were designed in part to ensure that the auditor 

focuses on risks to reliable financial reporting. The Staff believes public float is a better measure 

for determining compliance because it relates to the public‘s financial exposure to the issuer. 

One commenter recommended that the Commission consider requiring more disclosures, 

such as those described in Item 304 of Regulation S-K when a CFO or other key accounting 

personnel leave an issuer when a reason for such departure was any disagreement over any 

matter of accounting principles or practices or financial statement disclosure.159 Although such 

 

156 PCAOB Release No. 2007-005A (Jun. 12, 2007), available at 

http://pcaobus.org/Rules/Rulemaking/Docket%20021/2007-06-12_Release_No_2007-005A.pdf.

157 Id.

158 See letter from Merkl.

159 See id.
80

disclosure might provide investors with more information about possible financial reporting and 

internal control issues at an issuer, such a rule would not likely change any compliance costs and 

would not impact the auditor‘s reporting under Section 404(b).

Another commenter recommended that the Commission enable issuers to use what the

commenter termed ―key control activity self-assessments‖ to evaluate ICFR, and for the 

Commission to instruct the PCAOB to change its auditing standards to enable audit firms to 

more easily rely on these assessments.160 The PCAOB stated in its adopting release to AS 5 that 

the standard focuses auditors ―on the most important matters in the audit of internal control over 

financial reporting‖ and eliminates procedures that the PCAOB believes are ―unnecessary to an 

effective audit of internal control.‖

161

 Further, AS 5 is designed to increase the likelihood that 

material weaknesses in internal control will be uncovered before they lead to a material 

misstatement of the financial statements, ―steer the auditor away‖ from unnecessary procedures, 

and make the audit of internal control ―more clearly scalable‖ for smaller, less complex 

issuers.162 AS 5 also allows the auditor to use the work of others (working under the direction of 

management or the audit committee) including, but not limited to, internal auditors, in order to 

obtain evidence about the design and operating effectiveness of controls. AS 5 thus permits the 

use of evaluation methods that meet its testing requirements. 

Several commenters made suggestions to reduce compliance costs that the Staff believes 

would take into account both the compliance costs and effectiveness for issuers subject to this 

study. First, three commenters recommended that the PCAOB publish additional observations 

about the implementation of AS 5, including comparing such implementation to the PCAOB‘s 

original intent.163 The PCAOB issued a similar document in 2009164 describing the 

implementation of AS 5 for the first year it was effective. These commenters believed that 

additional observations could assist auditors in performing efficient and effective audits. The 

 

160 See letter from Vorhies.

161 PCAOB Release No. 2007-005A (Jun. 12, 2007), available at 

http://pcaobus.org/Rules/Rulemaking/Docket%20021/2007-06-12_Release_No_2007-005A.pdf.

162 Id.

163 See letters from CAQ, E&Y, and Grant Thornton.

164 See http://pcaobus.org/Inspections/Documents/09-24_AS5_4010_Report.pdf.
81

Staff supports recommending to the PCAOB that it continuously review inspection results and 

monitor whether a Rule 4010165 report or other communication is warranted to improve the 

application of AS 5. If a 4010 report is issued, it may contribute to a reduction in the compliance 

burden for issuers subject to this study and also to provide auditors, issuers, investors, and others

with important information about audit performance and quality.

Second, several commenters recommended that the Commission actively participate in 

and monitor COSO‘s update to its Internal Control- Integrated Framework.166 COSO announced 

plans to update its framework, which was originally released in 1992, in November of 2010, 

describing the initiative as making ―the existing Framework and related evaluation tools more 

relevant in the increasingly complex business environment so that organizations worldwide can 

better design, implement, and assess internal control.‖

167

 The stated aims of the update to the 

1992 framework do not explicitly address the compliance burden on issuers that use the COSO 

framework to evaluate ICFR, and it is not aimed at any particular size issuer. The update will 

describe how to evaluate internal controls in an environment that is more complex than it was 

when the original framework was developed. The Staff supports this recommendation, as the

update may have implications on the compliance burden on issuers in the illustrative population.

B. Comments Received From Earlier Commission and PCAOB Actions

The Staff also considered comments received from past Commission and PCAOB actions 

related to the implementation of Section 404(b), beyond those previously implemented, that may 

affect the compliance burden. Such ideas included:

Increasing the extent to which evidence of operating effectiveness of controls can be 

obtained through the performance of walkthroughs;

 

165 PCAOB Rule 4010 permits the Board to publish summaries, compilations, or other general reports concerning 

the procedures, findings, and results of its various inspections provided that no such published report may identify 

the firm or firms to which criticisms of or defects in quality controls relate. In adopting Rule 4010, the PCAOB 

indicated that it would not customarily issue reports of positive trends and best practices but ―does not believe its 

rule needs to be changed to permit this type of report to be issued.‖ PCAOB Release No. 2003-019 (Oct. 7, 2003), 

available at http://pcaobus.org/Rules/Rulemaking/Docket%20006/Release2003-019.pdf.

166 See letters from CAQ, E&Y, and Grant Thornton.

167 http://www.coso.org/documents/COSOReleaseNov2010.pdf. As discussed above, the COSO framework is the 

internal control framework used by most registrants and auditors to evaluate ICFR under Section 404 of the 

Sarbanes-Oxley Act. 
82

Allowing the auditor to use the work of others, including management, beyond direct 

assistance in the conduct of walkthroughs; and

Changing the threshold for what constitutes a material weakness.

The Staff reviewed prior recommendations for reducing the Section 404(b) compliance 

burden related to the extent to which evidence of operating effectiveness of controls can be 

obtained through the performance of walkthroughs.

168

 The PCAOB previously considered these 

suggestions and implemented a risk-based approach. The PCAOB noted in its adopting release 

to AS 5 that it would not explicitly define situations in which walkthroughs alone could be 

accepted as evidence on the operating effectiveness of controls because such acceptance depends 

―on the risk associated with the control being tested, the specific procedures performed as part of 

the walkthroughs and the results of the procedures performed.‖

169

 Accordingly, the PCAOB 

included provisions in AS 5 that address this area.170 

The Staff also reviewed prior recommendations for reducing the Section 404(b) 

compliance burden related to using the work of others, such as the issuer‘s internal audit 

personnel and management. While AS 5 allows the auditor to use the work of such personnel in 

performing an audit of internal control in appropriate circumstances, it allows the auditor to use 

the work of others to achieve the objectives of a walkthrough only as direct assistance. Allowing 

the auditor to expand the use of the work of others in achieving the objectives of walkthroughs 

beyond direct assistance might reduce the compliance burden of Section 404(b) by reducing the 

time the auditor spends in performing walkthroughs; however, as the PCAOB noted in its 

adopting release to AS 5 ―allowing the use of the work of others to a greater extent ... would not 

provide the auditor with an adequate understanding of the relevant risks and the related 

controls.‖

171

 

Finally, the Staff reviewed prior comments regarding whether the definition of material 

weakness should have a greater threshold of probability that a material misstatement would 

 

168 A ―walkthrough‖ is a combination of inquiry, observation, evaluation of documents, and re-performance of a 

control, as evidence of the operating effectiveness of a control.

169 See PCAOB Release No. 2007-005A, supra note 161. 

170 See paragraph 49 of AS 5, including the related note, available at

http://pcaobus.org/Standards/Auditing/Pages/Auditing_Standard_5.aspx. 

171 Id.
83

result from the weakness. The comments were received when the Commission proposed 

amendments to its rules on management‘s report on ICFR. Certain commenters believed that 

raising the probability threshold would result in a reduced burden since a higher threshold would 

make it less likely that a deficiency would be a material weakness. The Commission declined to 

adopt a change to the definition of material weakness, noting that it was important for investors 

to be aware of any material weaknesses, and the evidence did not suggest that a higher threshold 

would reduce the compliance burden. The Commission stated that ―revisions that have the effect

of increasing the likelihood (that is, risk) of a material misstatement in a company‘s financial 

reports that can exist before being disclosed could give rise to questions about the meaning of a 

disclosure that ICFR is effective and whether the threshold for  ̳reasonable assurance‘ is being 

lowered.‖

172

 

 

172 See SEC Release 33-8809 (Jun. 20, 2007).
84

V. Summary of Prior Academic and Other Research on Section 404

The implementation of Section 404 of the Sarbanes-Oxley Act has generated debate since 

enactment in 2002. Some of this debate has centered on the efforts and attendant costs of 

complying with Section 404. This section of the study summarizes academic and other research 

in an effort to further assess the benefits and costs of compliance and to identify potential 

additional ways to reduce the cost burden of Section 404(b).173

Academic and other researchers have employed an array of methodological tools to 

evaluate the costs and benefits of compliance with Section 404 by primarily focusing on the 

following broad areas related to Section 404 compliance:

(1) benefits to compliance;

(2) costs of compliance;

(3) behavior of issuers in an effort to avoid being subject to the requirements;

(4) effects of internal control disclosures and auditor attestation; and

(5) alternatives to reduce the burden of compliance.

Although many of the academic and other studies surveyed relate to Section 404 in 

general and to Section 404(b) for all issuers, the research discussed in this study primarily 

focuses on findings related to accelerated filers. The research informed the Staff‘s broader 

consideration of how and if the burden of compliance with Section 404(b) could be reduced for 

such issuers by examining, for example, compliance cost trends, listing trends, and individuals‘

decision making in lending and investing activities. The Staff considered Section 404 overall 

and not just Section 404(b) in order to put the importance of the audit in the appropriate context 

(i.e., the ICFR disclosures required broadly by Section 404). This enabled us to consider a 

broader base of research from which to develop potential ideas to reduce the Section 404(b) 

compliance burden, particularly given the important past efforts by the Commission and the 

 

173 The research herein extends an earlier review of academic research on internal control reporting under the 

Sarbanes-Oxley Act. See A. Schneider, A. A. Gramling, D. R. Hermanson & Z. Ye, A Review of Academic 

Literature on Internal Control Reporting Under SOX, J. OF ACCT. LIT., Vol. 28, 1-46 (2009). It is not intended to be 

an exhaustive summary of all research pertaining to Section 404, but rather the research the Staff deemed most 

pertinent to the present study. The Staff acknowledges that the research discussed may have limitations and biases 

due to the scale and scope of analysis and other factors, such as the accuracy of measures and/or proxies used, 

omitted variables, and simultaneous event occurrences. As such, the research was evaluated for potential policy 

considerations rather than for evaluating for empirical accuracy or determinativeness. 
85

PCAOB to align management‘s requirements pursuant to Section 404(a) and the auditor‘s 

requirements pursuant to Section 404(b).

Similar to the Staff‘s analysis in prior Sections of this study, the academic and other 

research demonstrates that the costs of compliance with Section 404(b) have declined since the 

2007 reforms. The research also suggests that Section 404(b) generally did not affect decisions 

by issuers to exit the reporting requirements of the SEC. Academic research also shows that 

auditor involvement in ICFR promotes more accurate and reliable disclosure, and lower 

restatement rates. 

The literature includes some suggestions for potential reductions in the Section 404(b) 

compliance burden.

174

 However, these suggestions were already raised and either incorporated 

or determined not to adopt in connection with earlier actions by the Commission and the 

PCAOB. 

A. Benefits to Section 404 Compliance

Numerous research papers and studies address the benefits of compliance with Section 

404. Considering Sections 302175 and 404 of the Sarbanes-Oxley Act broadly, the research 

results suggest that unless the external auditor is involved in testing and reporting on the 

effectiveness of internal controls, as is the case under Section 404(b), the reliability of 

information about controls may be negatively affected.176 Auditor testing of accelerated filers‘

 

174 See, e.g., J. Grundfest & S. Bochner, Fixing 404, MICHIGAN L. REV., Vol 105, 1643-76 (2007). The authors 

proposed substantive fixes such as amending AS 2 to focus on risk thereby eliminating large costs, providing issuers 

with an efficient means of delisting from the market, providing a continued exemption for smaller issuers, and 

writing a separate set of rules only applicable in situations where the issuer is sufficiently small that the costs of 

compliance would likely exceed the benefits, even under an amended and more cost-effective AS 2 regime. Id. at 

1671-72.

175 Section 302 of the Sarbanes-Oxley Act requires an issuer‘s principal executive officer and principal financial 

officer to certify in each annual or quarterly report, among other things, that they are responsible for establishing and 

maintaining the issuer‘s internal controls, that the internal controls have been designed to ensure that material 

information relating to the issuer and its consolidated subsidiaries is made known to the certifying officers, that they 

have evaluated the effectiveness of the issuer‘s internal controls, and that they have disclosed their conclusions 

about such effectiveness in the report. 

176 See e.g., J. S. Hammersley, L.A. Myers & C. Shakespeare, Market Reactions to the Disclosure of Internal 

Control Weaknesses and to the Characteristics of those Weaknesses under Section 302 of the Sarbanes-Oxley Act of 

2002, REVIEW OF ACCT. STUDIES, Vol. 13(1), 141-65 (2008); J. C. Bedard & L. Graham, Detection and Severity 

Classifications of Sarbanes-Oxley Section 404 Internal Control Deficiencies, ACCT. REV., Vol. 86(3), (2011, 

forthcoming); J. C. Bedard, R. Hoitash & U. Hoitash, Evidence from the United States on the Effect on Auditor 

Involvement in Assessing Internal Control Over Financial Reporting, INT‘L J. OF AUDITING, Vol. 13 (2), 105-25 

(2009); D. R. Hermanson & Z. Ye, Why Do Some Accelerated Filers With SOX Section 404 Material Weaknesses 
86

controls has generally resulted in the disclosure of internal control deficiencies (―ICDs‖) that 

were not previously disclosed by management, and the external auditor attestation appears to 

have a positive impact on the informativeness of internal control disclosures and financial 

reporting quality.177

Studies also document that Section 404(a)-only issuers, comprised of mostly smaller 

issuers, have more material weaknesses, restatements, and incidences of fraudulent financial 

reporting as compared to most issuers that comply with Section 404(b). For example:

Section 404(a) and (b)-compliant issuers are less likely to issue materially misstated 

financial statements than issuers not subject to these requirements.

178

The rate of restatements surrounding a disclosure of effective ICFR was 46% higher 

among issuers that only filed Section 404(a) reports as compared to those that also 

filed auditor attestations under Section 404(b) during the cumulative four years of 

compliance with Section 404. Specifically, Section 404(b)-compliant issuers that 

reported effective ICFR experienced a financial restatement rate of 5.1%, while 

Section 404(a)-only issuers experienced a restatement rate of 7.4%.179

From 2003-2009, non-accelerated filers have accounted for approximately 65% of the 

total financial restatements compared to accelerated filers (3,979 restatements out of a 

total of 6,116).

180

 

Provide Early Warning Under Section 302? AUDITING: J. PRAC. & THEORY, Vol. 28(2), 247-71 (2009); T. 

Whitehouse, Internal Controls Audits Continue to Shine, COMPLIANCE WEEK, Nov. 16, 2010.

177 See id. 

178 See A. L. Nagy, Section 404 Compliance and Financial Reporting Quality, ACCT. HORIZONS, 24(3), 441-54 

(2010); Bedard, Hoitash & Hoitash, supra note 176 at 105.

179 See Audit Analytics, Restatements Disclosed by the Two Types of SOX 404 Issuers: (1) Auditor Attestations 

Filers and (2) Management-Only Report Filers, Nov. 4, 2009, available at

http://www.complianceweek.com/s/documents/AARestatements2.pdf. Audit Analytics also reported that if an 

auditor is involved in an ICFR assessment and there is a subsequent restatement, the public is immediately notified 

through disclosure that past financials cannot be relied upon. See Audit Analytics, New Research: SOX 404 ICFR 

Disclosures and Restatements, Dec. 4, 2009, available at http://www.auditanalytics.com/bulletins/2009-12-04-

bulletin.php.

180 See Audit Analytics, 2009 Financial Restatements: A Nine Year Comparison, Feb. 2010, available at

http://www.complianceweek.com/s/documents/AARestatements2010.pdf, at 18. 
87

Section 404(a)-only issuers had a higher adverse management report percentage rate 

(27.8%; 853 out of 3,066 annual reports), indicating that non-accelerated filers failed 

to maintain ICFR that were as reliable as accelerated filers‘ ICFR.181

A number of investors and stakeholder organizations opposed exempting smaller 

issuers from Section 404(b).182

B. Costs of Section 404 Compliance

Several academic studies that address the costs of complying with Section 404 have 

focused on audit fees. Some of these studies, using various measures of public float and market 

capitalization, suggest that there is a large burden on smaller issuers and that the benefits do not 

outweigh the costs, including limited value added from the Section 404(b) requirement for 

smaller firms.183

Earlier studies reveal a steep increase in audit fees and other costs borne by accelerated 

filers in the initial years of Section 404 implementation and varying audit fees in subsequent 

years, including significant declines in fees related to the Section 404(b) auditor attestation. 

More recent studies provide additional evidence of a significant decline in total average 

compliance costs, including auditor attestation fees, after the 2007 reforms. The decline in costs 

suggests that issuers and auditors are adapting to Section 404 and becoming more efficient at 

 

181 See Audit Analytics, SOX 404 Dashboard Year 6 Update, Oct. 2010, available at 

http://www.complianceweek.com/s/documents/AASOX404.pdf. Audit Analytics report that adding this population 

of 3,066 Section 404(a) reports to the 3,356 Section 404(b) reports, the adverse percentage of the total population of 

6,422 disclosures becomes 14.6%. Id. at 3. Audit Analytics stated: ―As of June in SOX 404 Year 6...the percentage 

of adverse Management-Only Assessments filed was the lowest, but this rate was about 10 times higher than the rate 

experienced by companies required to file Auditor Attestations. Id. at 1. See also, Council of Institutional Investors,

Glass, Lewis Finds Poor Internal Controls at Smaller Companies Hurt Investors, Council Governance Alert, Vol. 

14(48), Dec. 10, 2009, available at

http://www.cii.org/UserFiles/file/resource%20center/council%20governance%20alert/2009%20Archive/2009%20Al

ert%2048.pdf; E. R. Patterson & J. R. Smith, The Effects of Sarbanes-Oxley on Auditing and Internal Control 

Strength, ACCT. REV., Vol. 82(2), 427-55 (2007).

182 See CAQ, The Main Street Investor Survey, Key Findings, Sept. 2010, at 13, available at

http://www.thecaq.org/newsroom/pdfs/2010SummaryInvestorSurvey.pdf. See also, N.T. Hill, J.E. McEnroe & K.T. 

Stevens, A Comparison of CFOs‘ and CPAs‘ Perception of the Sarbanes-Oxley Act and the PCAOB, CPA J., Aug. 

2009, at 30-33; Protiviti, 2010 Sarbanes-Oxley Compliance Survey, Where U.S.-Listed Companies Stand: Reviewing 

Cost, Time, Effort and Processes, available at http://www.auditnet.org/articles/KL201010.pdf. 

183 See, e.g., P. Iliev, The Effect of SOX Section 404: Costs, Earnings Quality and Stock Prices, J. FIN., Vol. -

LXV(3), 1163-96 (2010); W. Kinney & M. Shepardson, Do Control Effectiveness Disclosures Require SOX 404(b) 

Internal Control Audits? A Natural Experiment With Small U.S. Public Companies, J. ACCT. RES., Vol. 49(2), 413-

48 (2011).
88

implementing and assessing ICFR, especially after the 2007 reforms. In addition, audit fees tend 

to decline as issuers gain more experience in the Section 404 compliance process. Below is 

more discussion of the academic research that was conducted before and after the 2007 reforms.

1. Pre-2007 Reforms

Academic researchers found the following with respect to the impact of Section 404 on 

audit fees prior to the 2007 reforms:

There was an overall audit fee increase during the initial years of Section 404 

compliance compared with those fees before the Section 404 requirements.

184

Issuers with Section 404 ICDs (material weakness, significant deficiency, or control 

deficiency) paid incrementally higher audit fees, especially for material weaknesses 

and for company-level internal control problems rather than account-specific internal 

control problems.185

Issuers that did not remediate previously disclosed internal control material 

weaknesses had higher audit fees compared to issuers that remediated such 

weaknesses.186

 

184 See, e.g., K. Raghunandan & D. V. Rama, SOX Section 404 Material Weakness Disclosures and Audit Fees, 

AUDITING: J. OF PRAC. & THEORY, Vol. 25(1), 99-114 (2006); R. Hoitash, U. Hoitash & J. Bedard, Internal Control 

Quality and Audit Pricing Under the Sarbanes-Oxley Act, AUDITING: J. OF PRAC. & THEORY, Vol. 27(1), 105-26 

(2008). See also, W. J. Carney, The Costs of Being Public After Sarbanes-Oxley: The Irony of  ̳Going Private‘, 

EMORY L.J., Vol. 55, 141-60, 148 (2006); O. Rezzy, Sarbanes-Oxley: Progressive Punishment for Regressive 

Victimization, HOUS. L. REV., Vol. 44(1), 95-129 (2007); L. Sneller & H. P. A. J. Langendijk, Sarbanes-Oxley 

Section 404 Costs of Compliance: A Case Study, CORP. GOVERNANCE: AN INT‘L REV., Vol. 15(2), 101-11 (2007); 

D. M. Fleming & R. N. Romanus, Auditor Industry Specialization and Audit Fees Surrounding Section 404 

Implementation, Working Paper, SAN DIEGO ST. U. & TEXAS TECH U., 2007, available at

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1012202; SEC Staff Study of the Sarbanes-Oxley Act of 2002 

Section 404 Internal Control over Financial Reporting Requirements, supra note 86.

185 See, e.g., Hoitash, Hoitash & Bedard, supra note 184; C. E. Hogan & M. S. Wilkins, Evidence on the Audit Risk 

Model: Do Auditors Increase Audit Fees in the Presence of Internal Control Deficiencies? CONTEMP. ACCT. RES., 

Vol. 25(1), 219-42 (2008); R. Elder, Y. Zhang, J. Zhou & N. Zhou, Internal Control Weaknesses and Client Risk 

Management, J. OF ACCT., AUDITING & FIN., Vol. 24(4), 543-79 (2009); V. Munsif, K. Raghunandan, D. V. Rama & 

M. Singhvi, Audit Fees after Remediation of Internal Control Weaknesses, ACCT. HORIZONS, Vol. 25(1), (2011), 

available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1687134. See also, D. Hay, W. R. Knechel & H. 

Ling, Evidence on the Impact of Internal Control and Corporate Governance on Audit Fees, INT‘L J. OF AUDITING, 

Vol. 12, 9-24 (2008).

186 See, e.g., Munsif, Raghunandan, Rama & Singhvi, supra note 185; S. M. Albring & M. J. Keane, The Effect of 

Internal Control Weaknesses and Their Remediation on Audit Fees, Working paper, SYRACUSE U. & PROVIDENCE 

COLL. (2009), available at

http://aaahq.org/meetings/AUD2010/EffectOfInternalControlWeaknessesAndRemediation.pdf, finding that audit 

fees remained high one, two, and three years following remediation, and firms that reported consecutive material 

weaknesses paid significantly higher audit fees than firms that remediated. See also, J. S. Hammersley, L. A. Myers 
89

Issuers that did remediate continued to pay higher audit fees in subsequent periods 

compared to issuers with clean Section 404 reports.187

Total compliance costs were higher with issuer size (i.e., larger issuers had larger 

Section 404-related costs but lower costs as a percentage of the issuer‘s assets), the 

presence of material internal control weaknesses, the installation costs of new 

computer systems and establishment of formal internal control policies, the 

involvement of auditors from the four largest audit firms, and corporate governance 

characteristics.

188

Total compliance costs were lower for issuers in regulated industries and issuers that 

raised new financing through the issuance of debt or equity.

189

For micro-audit offices (audit firms with fewer than 20 clients), audit fees were 

higher with Section 404 experience; however, fees were not higher for clients of 

larger-audit offices (the largest six audit firms) that had Section 404 experience 

(although fees were generally higher for these firms).

190

In general, the academic research on Section 404 costs demonstrates that issuers incurred 

significant audit fees in complying initially with the Section 404 requirements. Notwithstanding, 

numerous studies, surveys, and academic papers reveal a decline in total Section 404 compliance 

costs even before the 2007 reforms, including in audit fees.191 Additionally, one researcher 

 

& J. Zhou, The Failure to Remediate Previously-Disclosed Material Weaknesses in Internal Controls, Working 

paper, U. OF GEORGIA (2010), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1327470. The 

authors conjectured that non-remediating companies must do ―additional, more costly substantive testing to support 

their financial statement opinions in the presence of the continuing material weaknesses.‖ Id. at 12.

187See id.

188 See J. Krishnan, D. Rama & Y. Zhang, Costs to Comply with SOX Section 404, AUDITING: J. OF PRAC. &

THEORY, VOL. 27(1), 169-86 (2008). See also, H. Huang, K. Raghunandan & D. Rama, Audit Fees for Initial Audit 

Engagements Before and After SOX, AUDITING: J. OF PRAC. & THEORY, Vol. 28(1), 171-90 (2009); A. Ghosh & R. 

Pawlewicz, The Impact of Regulation on Auditor Fees: Evidence from the Sarbanes-Oxley Act, AUDITING: J. OF 

PRAC. & THEORY, Vol. 28(2), 171-97 (2009); Albring & Keane, supra note 186; Hay, Knechel & Ling, supra note 

185.

189 Krishnan, Rama & Zhang, supra note 188 at 169, 183. See also, Hay, Knechel & Ling, supra note 185.

190 See Bedard, Hoitash & Hoitash, supra note 176 at 108. 

191 See, e.g., B. P. Foster, W. Ornstein & T. Shastri, Audit Costs, Material Weaknesses Under SOX Section 404, 

MANAGERIAL AUDITING J., Vol. 22(7), 661-73 (2007); H. M. Roybark, Section 404 Reporting and Attestation 

Reports: A Descriptive Analysis of Attestation Reports Issued for ICFR During the First Two Years of Section 404 

Reporting, ICFAI U. J. OF AUDIT PRAC., Vol. V(3), 7-34 (2008); M. W. Maher & D. Weiss, Costs of Complying with 
90

noted that although the compliance cost of Section 404 was high, there were ―future long term 

benefits‖ because the incidence of fraud may be reduced and issuers may have a better ability to 

raise capital at a lower cost.

192

2. Post-2007 Reforms

The research suggests that Section 404(b) costs declined further following the adoption of 

AS 5.193 Similarly, the SEC Staff‘s 2009 study on Section 404 revealed that the 2007 reforms 

achieved their intended effect as reported compliance costs declined following the reforms and 

survey participants stated that the reforms were a contributing factor.194 Other research and 

surveys also revealed further declines in compliance costs after the 2007 reforms.

195

 

the SOX – Measurement, Variation, and Investors‘ Anticipation, Working paper, U. OF CAL.—DAVIS & TEL AVIV U.

(2010), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1699828; M. K. Aguilar, ―Year Two‖ SOX 

Audit Fees Down, COMPLIANCE WEEK, Apr. 4, 2006, available at http://www.complianceweek.com/article/2418/-

year-two- -404-audit-fees-down; R. Prentice, Sarbanes-Oxley: The Evidence Regarding the Impact of Section 404, 

CARDOZO L. REV., Vol. 29(2), 703-64 (2008); CRA International, Sarbanes-Oxley Section 404 Costs and 

Implementation Issues: Spring 2006 Survey Update, Apr. 17, 2006, available at

http://www.complianceweek.com/s/documents/cra_survey.pdf; Financial Executives International, FEI Survey:

Sarbanes-Oxley Compliance Costs are Dropping: Average Compliance Costs are $3.8 Million, Down 16% from 

Prior Year, Reductions About Half of What Were Anticipated, PRNewswire, Apr. 6, 2006, available at

http://fei.mediaroom.com/index.php?s=43&item=74; Financial Executives International, FEI Survey: Management 

Drives Sarbanes-Oxley Compliance Costs Down, but Auditors Fees Virtually Unchanged, May 16, 2007, available 

at http://www.financialexecutives.org/eweb/DynamicPage.aspx?site=_fei&webcode=ferf_404survey; Financial 

Executives International, FEI Audit Fee Survey Including Sarbanes-Oxley Section 404 Costs, Financial Executives 

Research Foundation, 1-17 (Apr. 2008); J. L. Orcutt, The Case Against Exempting Smaller Reporting Companies 

from Sarbanes-Oxley Section 404: Why Market-Based Solutions are Likely to Harm Ordinary Investors, FORDHAM 

J. OF CORP. & FIN. L., Vol. XIV, 325-414 (2009); C. Schelleman, R. Deumes & M. Finkeldei, SOX 404 Related 

Audit Fees and their Determinants, Working paper, U. MAASTRICHT & ERNST & YOUNG (2007); SEC – Roundtable 

Discussion of Second-Year Experience with Internal Control Reporting and Auditing Provisions, May 10, 2006, 

transcript available at http://www.sec.gov/spotlight/soxcomp/soxcomp-transcript.txt.

192 See Krishnan, Rama & Zhang, supra note 188 at 184. The authors supported the adoption of Section 404 by 

smaller issuers. See id.

193 See, e.g., R. M. Dey & M. W. Sullivan, What Will Non-Accelerated Filers Have to Pay for the Section 404 

Internal Control Audit? Working paper, ROCHESTER INST. OF TECH. & GEO. WASH. U. (2009), available at

http://www.fdewb.unimaas.nl/ISAR2009/02_15_Dey_Sullivan.pdf; Kinney & Shepardson, supra note 183. See 

also, Financial Executives International, FEI Audit Fee Survey Including Sarbanes-Oxley Section 404 Costs, supra 

note 191; R. Doogar, P. Sivadasan & I. Solomon, The Regulation of Public Company Auditing: Evidence from the 

Transition to AS 5, J. ACCT. RES., Vol. 48(4), 795-814 (2010).

194 See SEC Study of the Sarbanes-Oxley Act of 2002 Section 404 Internal Control over Financial Reporting 

Requirements, supra note 86 at 95.

195 See, e.g., Protiviti, supra note 182; T. Whitehouse, Exclusive Report: Audit Fees Continue to Plummet, 

COMPLIANCE WEEK, Aug. 24, 2010, available at http://www.complianceweek.com/exclusive-report-audit-feescontinue-to-plummet/article/186924.
91

C. Behavior of Issuers in an Effort to Avoid Compliance

1. Listing Trends

With respect to the portion of the study addressing the question of an impact on Section 

404(b) compliance on listing decisions, the Staff reviewed research on listing trends. 

a. Going-Private and Going-Dark Transactions

One aspect of listing trends relates to issuers that determine to exit the reporting system. 

Some academic literature on going-private transactions and going-dark transactions196 suggests

that the enactment of the Sarbanes-Oxley Act, including Section 404(b), has generally had 

relatively little or no effect on decisions to engage in these types of transactions.

197 However, 

there is reported evidence suggesting Sarbanes-Oxley Act compliance costs disproportionally

burdens smaller issuers, resulting in delisting activities.198 The findings also show that many 

going-private transactions resulted in surviving companies that remained subject to SEC 

reporting requirements or became SEC reporting companies within twelve months of the 

transaction.199 Specifically:

 

196 A going-private transaction generally involves the cash-out of all or a substantial portion of an issuer‘s shares so 

that the issuer can then deregister the shares under the Exchange Act. The transaction may involve, among other 

things, a merger, tender offer, or reverse split of the issuer‘s shares. A going-dark transaction is when an issuer 

voluntarily delists from a securities exchange(s) and subsequently deregisters its shares under the Exchange Act, to 

end its reporting obligations under the Exchange Act (assuming it is not subject to another reporting obligation).

197 See, e.g., C. Leuz, Was the Sarbanes-Oxley Act of 2002 Really this Costly? A Discussion of Evidence from Event 

Returns and Going-private Decisions, J. ACCT. & ECON., Vol. 44, 146-65 (2007); R. P. Bartlett, Going Private but 

Staying Public: Reexamining the Effect of Sarbanes-Oxley on Firms‘ Going-private Decisions, U. CHICAGO L. REV., 

Vol. 76, 7-44 (2009). See also, Iliev, supra note 183 at 1176; G. A. Karoyli, Discussion of A Lobbying Approach to 

Evaluating the Sarbanes-Oxley Act of 2002, J. ACCT. RES., Vol. 47(2), 585-95 (2009). 

198

 This research focuses on non-accelerated filers, which are now exempt from Section 404(b), and accelerated 

filers. See, e.g., S. Block, The Latest Movement to Going Private: An Empirical Study, J. APPLIED FIN., Vol. 14, 36-

44 (2004); E. Engel, R. Hayes & X. Zhang, The Sarbanes-Oxley Act and Firms Going Private Decisions, J. ACCT. &

ECON., Vol. 44, 116-45 (2007); E. Kamar, P. Karaca-Mandic & E. Talley, Sarbanes-Oxley‘s Effects on Small Firms: 

What is the Evidence, Working paper, U. S. CAL., RAND CORP. & U. CAL. BERKELEY (2007), available at 

http://ssrn.com/abstract=993198; D. Piotroski & S. Srinivasan, Regulation and Bonding: The Sarbanes-Oxley Act 

and the Flow of International Listings, J. ACCT. RES., Vol. 46(2), 383-425 (2008); E. Kamar, P. Karaca-Mandic & 

E. Talley, Going-Private Decisions and the Sarbanes-Oxley Act of 2002: A Cross-Country Analysis, J. L., ECON. &

ORG., Vol. 25(1), 107-33 (2009); X. Li, An Examination of the Impact of the Sarbanes-Oxley Act on Cross-Listed 

Foreign Private Issuers and the Legal Bonding Hypothesis, Working Paper, BOSTON COLL. (2011), available at 

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=952433. 

199 See Bartlett, supra note 197 at 29.
92

There are instances in which the Sarbanes-Oxley Act in general,

200 increased 

compliance costs, or Section 404 implementation was cited as a reason for delisting, 

especially for smaller, low performing (e.g., less liquid, slow growth), or high inside 

ownership issuers.

201

There was a sharp increase in the rate at which issuers have gone private since the 

enactment of the Sarbanes-Oxley Act. However, the rate at which such issuers 

remained Exchange Act reporting companies following a going-private transaction 

significantly increased between 2003 and 2006.202

There was an increase in the quarterly frequency of going-private activities from 1998 

to 2005203 and an increase in going-dark transactions in 2003 and 2004,204 which may 

be due to increased Sarbanes-Oxley costs, although several academic researchers 

argue that the link between the Sarbanes-Oxley Act and going-dark or going-private 

decisions in the United States is somewhat doubtful.205

There was no relative increase in the rate of acquisitions by private acquirers (going 

private) among U.S. issuers, and while there was an increase in the rate of going 

private transactions by small U.S. issuers in the first year after the Sarbanes-Oxley 

 

200 See S. Wolff & C. D. Long IV, Post-SOX Trends in Delistings and Deregistration, RICHMOND J. GLOBAL L. &

BUS., Vol. 9(1), 53-59 (2010).

201 See, e.g., L. A. Austen & D. Dickens, SOX Doomsday Predictions in Hindsight: Evidence from Delisting, 

CURRENT ISSUES IN AUDITING, Vol. I, A21-27 (2007); Engel, Hayes & Zhang, supra note 198; B. Hansen, G. 

Pownall & X. Wang, The Robustness of the Sarbanes-Oxley Effect on the U.S. Capital Market, REV. ACCT. STUD., 

Vol. 14(2-3), 404-39 (2009); C. Leuz, A. Triantis & T. Y. Wang, Why do Firms Go Dark? Causes and Economic 

Consequences of Voluntary SEC Deregistrations, J. ACCT. & ECON., Vol. 45, 181-208 (2008).

202 See Bartlett, supra note 197 at 10, 31. The author conjectures that these companies have elected to remain SEC 

reporting companies due to the use of high-yield debt financing. Id. at 10.

203 See, e.g., Engel, Hayes & Zhang, supra note 198; Carney, supra note 184; Block, supra note 198.

204 See Leuz, Triantis & Wang, supra note 201. See also, J. L. Coles, Disclosure Policy: A Discussion of Leuz, 

Traintis and Wang (2008) on ―Going Dark‖, J. ACCT. & ECON., Vol. 45, 209-20 (2008). 

205 See, e.g., Leuz, Triantis & Wang, supra note 201. Controlling insiders may have taken their companies dark for 

other reasons, such as to protect private control benefits and decrease outside scrutiny, especially when corporate 

governance and investor protection were deemed weak. Id. at 181. See also, Karoyli, supra note 197; Hansen, 

Pownall & Wang, supra note 201. Hansen, Pownall & Wang stated that: ―both general market conditions and firm 

fundamentals explain the delisting incidence and firms‘ delisting decisions; while SOX variables are positively 

associated with firms‘ delisting likelihood only when general market conditions are not included in the analyses.‖ 

Id. at 401. 
93

Act was enacted, there was no effect for acquisitions announced more than a year 

after the enactment of the Sarbanes-Oxley Act.206

Although an increasing number of foreign issuers exited the U.S. securities markets 

after the enactment of the Sarbanes-Oxley Act, the research suggests that these 

issuers had greater control by insiders rather than outside investors.

207

b. Listing on Foreign Exchanges

Another aspect of listing trends relates to issuers‘ decisions to list on foreign exchanges. 

Some research suggests that the decline in cross-listings may mostly be explained by changes in 

characteristics of the issuers, rather than changes in the benefits of cross-listing.

208

 The AIM 

market represents a distinct exception, with few delistings relative to the high rate of new listings 

in the period following the enactment of the Sarbanes-Oxley Act.

209

 More recent data on IPO 

activity on AIM shows that 102 companies raised £3.4 billion in the first half of 2007, 38 

companies raised £829.83 million in the first half of 2008, 3 companies raised £223 million in 

the first half of 2009, and 16 companies raised £350.6 million in the first half of 2010.210 

 

206 See E. Kamar, P. Karaca-Mandic & E. Talley, Going-Private Decisions and the Sarbanes-Oxley Act of 2002: A 

Cross-Country Analysis, J. L., ECON. & ORG., Vol. 25(1), 107-33 (2009).

207 See A. Marosi & N. Massoud, ―You Can Enter But You Cannot Leave...‖: U.S. Securities Markets and Foreign 

Firms, J. FIN., Vol. 63LXIII(5), 2477-506 (2008). See also, H. Huang, Sarbanes-Oxley Section 404 Compliance: 

Recent Changes in US-traded Foreign Firms‘ Internal Control Reporting, MANAGERIAL AUDITING J., Vol. 24(6), 

584-98 (2009).

208See C. Doidge, G. A. Karolyi & R. M. Stulz, Has New York Become Less Competitive than London in Global 

Markets? Evaluating Foreign Listing Choices Over Time, J. FIN. ECON., Vol. 91(3), 253-77 (2009). See also, C. 

Doidge, G. A. Karolyi & R. M. Stulz, Why do Foreign Firms Leave U.S. Equity Markets?, J. FIN., Vol. 65(4), 1507-

53 (2010); G. Gong, B. Ke & Y. Yu, Home Country Investor Protection, Ownership Structure and Cross-Listed 

Firms‘ Compliance With SOX-Mandated Internal Control Deficiency Disclosures, Working paper, PENN. ST. U.,

NANYANG TECH. U. & U. TEX. (2010), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1624186; 

Piotroski & Srinivasan, supra note 198. Among large foreign companies choosing between a U.S. exchange and the 

LSE‘s Main Market, listing preferences did not change following the enactment of the Sarbanes-Oxley Act, and the 

attractiveness of U.S. markets may have slightly increased. Id. at 410-11. Among smaller foreign companies 

eligible to choose between the Nasdaq and LSE‘s AIM, the likelihood of a U.S. listing declined following the 

enactment of the Sarbanes-Oxley Act, consistent with small, less profitable companies being unable to absorb the 

incremental costs associated with Sarbanes-Oxley Act compliance. Id. at 412.

209 The LSE‘s AIM experienced a nearly 775% increase in monthly listings over the forty-four month period 

following the enactment of the Sarbanes-Oxley Act, compared to the period before enactment of the Act. See

Piotroski & Srinivasan, supra note 198 at 399. 

210 http://www.londonstockexchange.com/statistics/new-issues-further-issues/new-issues-further-issues.htm.
94

Despite a strong post-2002 market growth, the U.S. IPO market remained ―cold‖ overall 

from 2001-2007, posting seven consecutive years with less than 200 IPOs being completed each 

year.

211

 Prior to 2001, the last time that less than 200 IPOs were completed in a year was 1990,

and only three times during that 11-year span were less than 300 IPOs completed.212 If 1999 and 

2000 are eliminated as bubble years, the aggregate proceeds raised by IPOs recovered in 2004 

and maintained that level through 2007, despite the drop in number of the number IPOs 

compared to the pre-2001 era.213 

A number of academics suggest that the net effect of Section 404 on smaller companies‘

IPOs is difficult to measure and may be due to other factors, such as the economic 

environment.214 One researcher found that between 2008-2009, the numbers of IPOs remained 

low, noting that this does not appear to be a result of the Sarbanes-Oxley Act.215 In addition, 

several studies demonstrate that ―foreign listing activity has slowed and foreign de-listing and 

deregistration activity has increased, but there is no consensus on how much influence the 

Sarbanes-Oxley Act has had‖ on these decisions.

216

Overall, although there is some reported evidence consistent with Sarbanes-Oxley Act

compliance cost disproportionally burdening small companies, the research on listing trends 

generally reveals that the enactment of Section 404(b) has not noticeably affected decisions by 

issuers to exit the reporting requirements of the SEC, including ICFR reporting, and therefore 

 

211 Orcutt, supra note 191 at 385. Orcutt stated that critics of Section 404 argue that ―the increase in costs imposed 

by SOX, and specifically by Section 404, is a significant reason for the failure of the U.S. IPO market to rebound for 

smaller companies.‖ Id. at 386. 

212 Id.

213 Id.

214 See Prentice, supra note 191; J. R. Ritter, Some Factoids About the 2008 IPO Market, Working paper, U. FLA.

(2009), available at http://bear.cba.ufl.edu/ritter/IPOs2008Factoids.pdf. 

215 J. R. Ritter, Some Factoids About the 2009 IPO Market, Working paper, U. FLA. (2010), available at 

http://bear.cba.ufl.edu/ritter/IPOs2009Factoids.pdf. The author noted that there were 21 IPOs in 2008 and 41 in 

2009, with aggregate proceeds of $22.76 billion and $13.17 billion, respectively. Id. at 2. 

216 See Karoyli, supra note 197 at 589. See also, C. Stoltenberg, K. A. Lacey, B. C. George & M. Cuthbert, A 

Comparative Analysis of Post-Sarbanes-Oxley Corporate Governance Developments in the US and European 

Union: The Impact of Tensions Created by Extraterritorial Application of Section 404, AM. J. COMP. L., Vol. 53(2),

457-91(2005).
95

evidence does not indicate that issuers‘ listing behavior would be significantly altered by 

reducing the cost of compliance or by granting further exemptions under Section 404(b). 

2. Managing Public Float

The research evidences that some issuers may attempt to avoid Section 404 costs by 

reducing or managing their public float in order to become or remain a non-accelerated filer.

217

 

Specifically, academic researchers found that:

Issuers with market capitalization between $60 and $90 million reduced their market 

values during the relevant time periods that determined Section 404 compliance by 

increasing insider purchases to impact the number of shares outstanding and using 

discretionary accruals218 to achieve stock price reduction.219

Some smaller issuers strived to remain below the $75 million non-accelerated filer 

threshold by reducing investments in property, plant, and equipment, intangibles, and 

acquisitions, increasing cash payouts to shareholders via ordinary and special 

dividends and share repurchases, reducing the number of shares held by nonaffiliates, making more ―bad news‖ disclosures, and reporting lower earnings.220

 

Cost savings from the avoidance of Section 404 compliance requirements motivated

some non-accelerated filers to underreport public float while the cost efficiency and 

flexibility of Form S-3 eligibility motivated other issuers to overreport public float.221

 

217 See Schneider, Gramling, Hermanson & Ye, supra note 173 at 29. 

218 The research proxies for discretionary accruals typically reflect management‘s choices; for example, in 

estimating allowance for doubtful accounts, warranty provisions, provisions for reorganization, layoffs, and 

restructuring, and contract completion costs. 

219 See M. E. Nondorf, Z. Singer & H. You, A Study of Firms Surrounding the Threshold of Sarbanes-Oxley Section 

404 Compliance, Working paper, U. CAL.–BERKELEY, MCGILL U. & HONG KONG U. (2011), available at

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1004965. 

220 See F. Gao, J. S. Wu & J. Zimmerman, Unintended Consequences of Granting Small Firms Exemptions From 

Securities Regulation: Evidence From the Sarbanes-Oxley Act, J. ACCT. RES., Vol. 47(2), 459-506 (2009). See also, 

R. M. Hayes, Discussion of  ̳Unintended Consequences of Granting Small Firms Exemptions from Securities 

Regulation: Evidence from the Sarbanes-Oxley Act‘, J. ACCT. RES., Vol. 47(2), 507-18 (2009).

221 See F. Gao, The Use of Discretion in Reporting Public Float, Working paper, U. ILLINOIS CHICAGO (2010), 

available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1549165. When non-accelerated filers became 

accelerated filers in a subsequent year, they were less likely to continue underreporting public float. Id. at 2. See 

also, Iliev, supra note 183 at 1177-80.
96

Overall, the research suggests that issuers may attempt to manage public float to remain 

or fall below a threshold for additional reporting; therefore, any further exemptions under

Section 404(b) could lead to such incentives by issuers that are larger (in terms of revenues and 

assets) than issuers with public float less than $75 million.

D. Internal Control Deficiencies and Auditor Attestation

A number of research papers study the association between ICDs and auditor attestation. 

The primary focus has been: the existence, discovery, and disclosure of ICDs; financial 

reporting quality; cost of debt and equity capital; and individual users‘ decision making.

222

 This 

research provides further insight into the investor protection function of existing Section 404(b) 

requirements that should be considered in evaluating any potential reductions in the burden, 

including a complete exemption.

1. Existence of Internal Control Deficiencies

The academic research shows that the existence of ICDs, especially material weaknesses, 

is associated with smaller, complex (e.g., rapidly growing, undergoing restructuring and/or 

mergers), riskier, and more financially-distressed issuers.

223 In addition, the expertise provided 

by stronger corporate governance and more qualified management teams, including the expertise 

of the audit committee, is associated with stronger internal controls.224 ICDs under Section 404 

most often relate to areas commonly found in accounting fraud cases or areas believed to be 

 

222 See Schneider, Gramling, Hermanson & Ye, supra note 173. 

223 See id. at 8. See also, W. Ge & S. McVay, The Disclosure of Material Weaknesses in Internal Control After the 

Sarbanes-Oxley Act, ACCT. HORIZONS, Vol. 19(3), 137-58 (2005); H. Ashbaugh-Skaife, D. W. Collins & W. R. 

Kinney, The Discovery and Reporting of Internal Control Deficiencies Prior to SOX-Mandated Audits, J. ACCT. &

ECON., Vol. 44(1/2), 166-92 (2007); J. Doyle, W. Ge & S. McVay, Determinants of Weaknesses in Internal Control 

Over Financial Reporting, J. ACCT. & ECON., Vol. 44(1/2), 193-223 (2007); M. Ogneva, K. R. Raghunandan & K. 

Subramanyam, Internal Control Weakness and Cost of Equity: Evidence From SOX 404 Disclosures, ACCT. REV., 

Vol. 82(5), 1255-97 (2007).

224 See Schneider, Gramling, Hermanson & Ye, supra note 173 at 4. See also, Y. Zhang, J. Zhou & N. Zhou, Audit 

Committee Quality, Auditor Independence, and Internal Control Weaknesses, J. ACCT. & PUB. POL‘Y, Vol. 26(3), 

300-27 (2007); G. V. Krishnan & G. Visvanathan, Reporting Internal Control Deficiencies in the Post-SarbanesOxley Era: The Role of Auditors and Corporate Governance, INT‘L J. AUDITING, Vol. 11(2), 73-90 (2007); U. 

Hoitash, R. Hoitash & J. C. Bedard, Corporate Governance and Internal Control over Financial Reporting: A 

Comparison of Regulatory Regimes, ACCT. REV., Vol. 84(3), 839-67 (2009); V. Naiker & D. Sharma, Former Audit 

Partners on the Audit Committee and Internal Control Deficiencies, ACCT. REV., Vol. 84(2), 559-87 (2009); C. Li, 

L. Sun & M. Ettredge, Financial Executive Qualifications, Financial Executive Turnover, and Adverse SOX 404 

Opinions, J. ACCT. & ECON., Vol. 50(1), 93-110 (2010).
97

higher risk, such as revenue recognition, income taxes, inventory, accounts receivable, and endof-period adjustments.

225

 

2. Discovery and Disclosure of Internal Control Deficiencies

Several academic studies highlight the importance of auditor involvement in the 

discovery and disclosure of ICDs. Section 404(b) has been described as essential to achieving 

the larger purpose of Section 404 to find weaknesses in ICFR and correct them.

226

 Because 

auditors‘ control tests detect many problems, regulations not requiring auditor involvement in 

control testing may be less effective in promoting accurate disclosure of deficiencies in ICFR as 

those that require auditor reporting.227 Specifically, the research revealed that:

More internal control weaknesses were discovered by the auditor (or auditor and 

client jointly) and by control tests rather than substantive tests.

228

Disclosures of material weaknesses under Section 302 were more likely in the fourth 

quarter when auditors were on-site at the client‘s office most frequently and when the 

audit firm or office had experience with Section 404 audits.229

The majority of ICDs that were classified by the auditor as a significant deficiency or 

a material weakness were initially classified by the issuer as less severe.230

 

225 See Schneider, Gramling, Hermanson & Ye, supra note 173 at 12. See also, H. M. Roybark, Section 404 

Reporting and Attestation Reports: A Descriptive Analysis of Attestation Reports Issued for ICFR During the First 

Two Years of Section 404 Reporting, ICFAI U. J. AUDIT PRAC., Vol. 5(3), 7-34 (2008); K. E. Scarborough & M. H. 

Taylor, Two Years and Counting, J. ACCT., Vol. 203(6), 74-80 (2007).

226 Bedard & Graham, supra note 176. Further, the authors conjecture that risk assessments in subsequent years may 

be less effective without detailed information on issuer controls derived through auditor detection and classification 

of control weaknesses.

227 Bedard & Graham, supra note 176. 

228 See Hammersley, Myers & Shakespeare, supra note 176 at 156. See also, Bedard & Graham, supra note 176. 

The authors found that auditors (or auditor and client jointly) detected 72.1% of all ICDs in their sample, mostly 

through control testing. Regarding detection method, 63.5% of all ICDs were detected by control tests, while only 

9.5% were detected by substantive tests. In addition, 60.6% of remediated (84.3% of material weakness, 89.9% of 

significant deficiencies, 74.7% of deficiencies) ICDs were identified by the auditor (or auditor and client jointly).

229 Bedard, Hoitash & Hoitash, supra note 176 at 120.

230 Bedard & Graham, supra note 176. The authors conjecture that of all ICDs detected in their sample, fewer than 

four percent were publicly reported as material weaknesses, demonstrating the importance of auditor involvement 

through Section 404(b).
98

Auditors‘ classifications of identified ICFR problems were influenced by 

management‘s assessment; however, increased documentation requirements mitigated 

management‘s influence231 and more experienced auditors were not persuaded by a 

favorable control assessment made by management.232

The detection of material weaknesses and significant deficiencies were more likely in 

issuers using consultants, having longer auditor testing periods, reporting their 

Section 404 process results to a level at the issuer independent of management, 

having less effective integration of information technology, and greater resources 

(issuer size).233

In addition, recent summaries of restatement data show a lower restatement rate for 

accelerated filers that are subject to Section 404(b) than non-accelerated filers that are not, which 

suggests that auditor attestation on ICFR is correlated with more reliable financial reporting.234

This trend corroborates the conclusion on the value of auditor involvement in the process. This 

issue is important because control testing required by Section 404 represents a shift from the 

predominately substantive audit approach.

235

 Researchers, using proprietary audit engagement 

teams‘ reports, have suggested that with a substantive audit approach, many control flaws that 

 

231 C. E. Earley, V. B. Hoffman & J. R. Joe, Reducing Management‘s Influence on Auditors‘ Judgments: An 

Experimental Investigation of SOX 404 Assessments, ACCT. REV., Vol. 83(6), 1461-85 (2008).

232 S. E. Kaplan, E. F. O‘Donnell & B. M. Arel, The Influence of Auditor Experience on the Persuasiveness of 

Information Provided by Management, AUDITING: J. OF PRAC. & THEORY, Vol. 27(1), 67-83 (2008). See also, J. 

Blaskovich & N.M. Mintchick, Management‘s Assessment of Internal Controls, External Consultants, and Audit 

Efficiency, Working paper, U. NEB. AT OMAHA & U. MO. AT ST. LOUIS (2007), available at

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=988194; A. A. Gramling, E. O‘Donnell & S. D. Vandervelde, 

Audit Partner Evaluation of Compensating Controls: A Focus on Design Effectiveness and Extent of Auditor 

Testing, AUDITING: J. OF PRAC. & THEORY, Vol. 29(2), 175-87 (2010); J. S. Hammersley, K. M. Johnstone & K. 

Kadous, How Do Audit Seniors Respond to Increased Salience of Fraud Cues? Working paper, U. GA., U. WIS.

MADISON & EMORY U. (2011), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1183172.

233 See id.

234 Audit Analytics, Restatements Disclosed by the Two Types of SOX 404 Issuers: (1) Auditor Attestations Filers 

and (2) Management-Only Report Filers, Nov. 2009, available at

http://www.complianceweek.com/s/documents/AARestatements2.pdf; Audit Analytics, SOX 404 Dashboard Year 6 

Update, Oct. 2010, available at http://www.auditanalytics.com/bulletins/2010-11-10-bulletin.php. 

235 A substantive audit approach consists of more substantive analytical procedures or test of details rather than 

internal control testing.

 
99

could affect current and future financial reporting quality will likely be missed by the auditor, 

and remain uncorrected.236

Overall, the research results show that ICDs, especially severe ICDs such as material 

weaknesses, are more likely to be discovered by external auditors and usually through control 

testing. Because auditors detect many ICDs not found by issuers and issuers tend to underclassify the severity of ICDs they detect, fewer ICDs would be remediated or publicly disclosed 

without auditor involvement. In addition, auditor attestation on ICFR results in lower 

restatements rates, suggesting more reliable financial reporting. 

3. Financial Reporting Quality

Although research on the relation between ICDs and earnings quality237 is somewhat 

mixed,

238 several of the recent academic studies suggest that the Section 404 internal control 

requirements result in improved earnings quality and suggest that Section 404 is meeting the 

objective of improving the overall quality of financial reporting. Strong internal controls provide 

a significant long-term benefit in improving the accuracy of financial reporting that leads to 

higher quality of information for investors.

239

 The research demonstrates that:

For internal control deficient issuers, earnings quality improves in the period that an 

internal control weakness is disclosed and for issuers reporting an effective internal 

control environment in their Section 404 report, earnings quality improves in the year 

of the first report.240

 

236 Bedard & Graham, supra note 176. The authors found that 81.5% of entity-level ICDs are detected by auditors 

through control tests, while only 15.1% are detected through substantive tests; account-specific ICDs were also more 

likely detected through control tests. Id. In contrast, other findings suggest that enhanced substantive procedures 

(by sourcing known misstatement as to cause) could be more effective in identifying at least one material weakness 

due to material and/or numerous audit/year-end adjustments. Kinney & Shepardson, supra note 183. However, due 

to limitations of publicly available data, Kinney & Shepardson‘s conclusion only relates to company-level reporting 

of effective or ineffective controls. See id.

237 Earnings quality refers to the reasonableness of earnings reported by companies, reflecting various underlying 

economic factors across companies.

238 Schneider, Gramling, Hermanson & Ye, supra note 173 at 16.

239 H. Ashbaugh-Skaife, D. W. Collins, W. R. Kinney & R. LaFond, The Effect of SOX Internal Control Deficiencies 

and Their Remediation on Accrual Quality, ACCT. REV., Vol. 83(1), 217-50 (2008).

240 J. Bedard, Sarbanes-Oxley Internal Control Requirements and Earnings Quality, Working paper, LAVAL U.

(2006), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=926271. See also, J. S. Hammersley, L. A. 

Myers & J. Zhou, The Failure to Remediate Previously Disclosed Material Weaknesses in Internal Controls, 
100

Issuers that were in compliance with the Section 404 auditor attestation requirements 

were less likely to issue materially misstated financial statements than noncompliant 

issuers.

241

Compared to Canadian companies listed on a U.S. exchange (not subject to Section 

404 in 2004 or 2005), issuers complying with Section 404 had a larger reduction in 

the magnitude of absolute abnormal accruals and a larger increase in the ability of 

earnings to predict future earnings and future cash flows.242

While one researcher found that Section 404 compliance led to lower discretionary 

accruals (i.e., discretionary earnings) for both domestic and foreign issuers,243 others 

found lower accrual quality for internal control weakness issuers, suggesting higher 

accounting risk.244

 

Working paper, U. GEORGIA, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1327470; AshbaughSkaife, Collins, Kinney & LaFond, supra note 239; H. Ashbaugh-Skaife, D. W. Collins, W. R. Kinney & R. 

LaFond, The Effect of SOX Internal Control Deficiencies on Firm Risk and Cost of Equity, J. ACCT. RES., Vol. 

47(1), 1-43 (2009); J. C. Bedard, R. Hoitash, U. Hoitash & K. Westermann, Material Weaknesses Remediation and 

Earnings Quality: A Detailed Examination, Working paper, BENTLEY U. & NORTHEASTERN U. (2009), available at

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1518544. 

241 See Nagy, supra note 178. See also, Whitehouse, supra note 176.

242 See Schneider, Gramling, Hermanson & Ye, supra note 173 at 16; Z. Singer & H. You, The Effect of Section 404 

of the Sarbanes-Oxley Act on Financial Reporting Quality, J. OF ACCT., AUDITING & FIN. (2011, forthcoming). 

243 Iliev, supra note 183 at 1167, 1192.

244 See Ogneva, Raghunandan & Subramanyam, supra note 223 at 1279. See also, J. T. Doyle, W. Ge & S. McVay. 

Accruals Quality and Internal Control over Financial Reporting, ACCT. REV., Vol. 82(5), 1141-70 (2007); K.C. 

Chan, B. Farrell & P. Lee, Earnings Management of Firms Reporting Material Internal Control Weaknesses under 

Section 404 of the Sarbanes-Oxley Act, AUDITING: J. OF PRAC. & THEORY, Vol. 27(2), 161-79 (2008); AshbaughSkaife, Collins, Kinney & LaFond, supra note 239; R. W. Epps & C. P. Guthrie, Sarbanes-Oxley 404 Material 

Weaknesses and Discretionary Accruals, ACCT. FORUM., Vol. 34(2), 67-75 (2010); B. W. Goh & D. Li, Internal 

Controls and Conditional Conservatism, ACCT. REV., 86(3) (2011, forthcoming). See also, C. Li & Q. Wang, SOX 

404 Assessments and Financial Reporting Errors, Working paper, U. PITTSBURGH & U. KANSAS (2006), available 

at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=926180; R. Nagarajan & P. Carey, Effectiveness of Internal 

Control Over Financial Reporting and Financial Statement Restatements: The Role of Management, Working paper, 

MONASH U. AUSTRALIA (2008).
101

4. Cost of Debt and Equity Capital

Several studies have documented evidence about the cost of debt and equity for issuers

with ICDs.

245

 The research demonstrates that ICD-disclosing firms have a higher cost of debt 

and, in some cases, a higher cost of equity than non-disclosing firms, and that cost of capital 

decreases after the issuer receives an unqualified Section 404(b) report. Specifically, researchers 

found that: 

Lenders‘ risk assessments and probabilities of extending lines of credit were 

negatively affected when an issuer had an adverse Section 404(b) report 

compared to a clean Section 404(b) report.246

Loan spread was higher for ICD borrowers than for non-ICD borrowers, 

borrowers with company-level ICDs rather than account-level ICDs paid higher 

loan rates, lenders imposed stricter nonprice terms (e.g., collateral requirements) 

on ICD borrowers (particularly for company-level ICDs), the number of 

participant lenders in each loan was smaller for ICDs borrowers, and lenders 

charged higher loan rates, were more likely to require collateral, and structure 

loans with fewer participant lenders for borrowers that failed to remediate, or 

exacerbate previously disclosed internal control weaknesses.247

 

245 See, e.g., Schneider, Gramling, Hermanson & Ye, supra note 173 at 19; A. Costello & R. Wittenberg-Moerman, 

The Impact of Financial Reporting Quality on Debt Contracting: Evidence From the Internal Control Weakness 

Reports, J. ACCT. RES., Vol. 49(1), 97-136 (2011); D. S. Dhaliwal, C. E. Hogan, R. Trezevant & M. S. Wilkins, 

Internal Control Disclosures, Monitoring, and the Cost of Debt, ACCT. REV. (forthcoming, 2011); A. Schneider & 

B. K. Church, The Effect of Auditors‘ Internal Control Opinions on Loan Decisions, J. OF ACCT. & PUB. POL‘Y, Vol. 

27(1), 1-18 (2008); J. Kim, B. Y. Song & L. Zhang, Internal Control Weakness and Bank Loan Contracting: 

Evidence from SOX Section 404 Disclosures, ACCT. REV. (forthcoming, 2011), available at

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1080479; Ogneva, Raghunandan & Subramanyam, supra note 

223.

246 See Schneider & Church, supra note 245. The authors suggest that an adverse Section 404(b) report ―weakens 

the importance assigned to the balance sheet and income statement in lending decisions and reduces lenders‘ 

confidence that financial statements are presented fairly in conformance with generally accepted accounting 

principles.‖ Id. at 1.

247 See Kim, Song & Zhang, supra note 245. But see Ogneva, Raghunandan & Subramanyam, supra note 223, 

finding that ―the higher cost of equity associated with ICW disappears after controlling for primitive firm 

characteristics and for analyst forecast bias.‖ Id. at 1255. Other researchers have documented evidence of an 

increase in cost of equity for issuers with Section 302 ICDs but not for issuers with Section 404 ICDs. See e.g., M. 

D. Beneish, M. B. Billings & L. D. Hodder, Internal Control Weaknesses and Information Uncertainty, ACCT. REV.,

Vol. 83(3), 665-703 (2008). 
102

In the year preceding the initial Section 404(b) report, issuers with adverse 

Section 404(b) reports had higher credit spreads and lower credit ratings

compared to issuers with clean Section 404(b) reports.248

When a borrower‘s financial statements contained a material internal control 

weakness, lenders were more likely to require collateral and they continued to 

distrust financial covenants even after the weakness was corrected.249

When issuers improved their internal control weaknesses and received an 

unqualified Section 404(b) report, their costs of equity capital decreased from 50 

to 150 basis points.250

Non-accelerated issuers voluntarily complying with Section 404(b) experience a 

lower cost of capital and a decline in the cost of equity and debt capital in the first 

year of compliance.251

5. Individual Users’ Decision Making

Researchers have examined individual decision making in controlled experiments to 

examine the effects of ICDs on individual users‘ decision making. In summary, the studies on 

individuals‘ judgments involving lending and investing activities imply that auditors‘ Section

404(b) reports make a difference in ―company risk assessments, probability of extending credit, 

stock price assessments, internal control strength evaluations, stock purchase recommendations, 

 

248 Dhaliwal, Hogan, Trezevant & Wilkins, supra note 245. See also, A. Ghosh & M. Lubberink, Timeliness and 

Mandated Disclosures on Internal Controls under Section 404, Working paper, CITY U. N.Y.– BARUCH COLL. &

LANCASTER U. AT LANCASTER (Paper presented at the 2006 American Accounting Association Annual Meeting); M. 

A. Elbannan, Quality of Internal Control over Financial Reporting, Corporate Governance and Credit Ratings, 

INT‘L J. DISCLOSURE & GOVERNANCE, Vol. 6(2), 127-49 (2009); M. Liu & M. Magnan, Financial Reporting Quality 

and Bond Issue, Working paper, CONCORDIA U. (2010), available at 

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1531955.

249 Costello & Wittenberg-Moerman, supra note 245.

250 Ashbaugh-Skaife, Collins, Kinney & LaFond, The Effect of SOX Internal Control Deficiencies on Firm Risk and

Cost of Equity, supra note 240. 

251C. A. Cassell, L. A. Myers & J. Zhou, The Effect of Voluntary Internal Control Audits on the Cost of Capital, 

Working paper, U. ARKANSAS & STATE U. N.Y. BINGHAMTON (2011), available at

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1734300.
103

and confidence in financial statements (current and future), as well as audit reports on them.‖

252

 

For example:

Loan officers‘ assessments of the risk of extending a line of credit and the probability 

of extending the line of credit were negatively affected when the issuer received an 

adverse Section 404(b) report as compared to a clean Section 404(b) report.253

Adverse Section 404(b) reports were significantly associated with investors assessing 

a higher risk of financial statement misstatement and future restatement, greater 

information asymmetry, lower financial statement transparency, higher risk premium 

and cost of capital, lower sustainability of earnings, and lower earnings

predictability.254

Investors adjust their investment risk assessments in response to material weakness 

disclosures.255

When material weakness disclosures include specific and detailed discussion of the 

pervasiveness of control weaknesses, investors increase assessments of investment 

risk for less pervasive weaknesses (affect individual accounts or classes of 

transactions) and decrease assessments of risk for more pervasive weaknesses 

(system-wide effects).256

Adverse Section 404(b) reports led to higher company risk assessments by investment 

analysts, as well as lower assessments of internal control strength, and higher

likelihoods of unfavorable stock recommendations.257

 

252 See Schneider, Gramling, Hermanson & Ye, supra note 173 at 24.

253 See Schneider & Church, supra note 245 at 1.

254 See T. J. Lopez, S. D. Vandervelde & Y. Wu, Investor Perceptions of an Auditor‘s Adverse Internal Control 

Opinion, J. OF ACCT. & PUB. POL‘Y, Vol. 28(3), 231-50 (2009).

255 See J. M. Rose, C. S. Norman & A. M. Rose, Perceptions of Investment Risk Associated with Material Control 

Weakness Pervasiveness and Disclosure Detail, ACCT. REV., Vol. 85(5), 1787-807 (2010). 

256 See id.

257 See Schneider, Gramling, Hermanson & Ye, supra note 173 at 23; S. W. Shelton & O.R. Whittington, The 

Influence of the Auditor‘s Report on Investors‘ Evaluations After the Sarbanes-Oxley Act, MANAGERIAL AUDITING 

J., Vol. 23(2), 142-60 (2008).
104

Equity analysts who were given Section 404(b) reports with entity-level weaknesses 

versus those given reports with account-specific weaknesses or no material 

weaknesses had lower confidence in internal control strength, the most recent year‘s 

audited and upcoming financial statements and audit reports on the financial 

statements.

258

E. Alternatives to the Requirements of Section 404

In response to arguments that Section 404 places substantial costs on issuers without 

sufficient commensurate benefits, some academic researchers have considered alternatives to the 

requirements to Section 404 and made other recommendations, including the following:259

Do not exempt smaller reporting companies from Section 404 because: (1) it would 

likely increase the information asymmetry between issuers and their investors; and 

(2) it would not provide significant value to issuers with strong ICFRs as ordinary 

investors could easily interpret the relief as a signal that policymakers do not consider 

ICFRs important for such issuers and therefore, would discount the lack of 

information.260 

Exempt all but the largest issuers from Section 404.

261

Other researchers conjectured that even without an ICFR audit, guidance in existing audit 

standards, in particular PCAOB Interim Standards AU 550, Other Information in Documents 

Containing Audited Financial Statements, already requires auditor actions that may cause 

management to disclose material weaknesses in internal control under either Section 302 or 

Section 404(a) of the Sarbanes-Oxley Act, and they concluded that:

 

258 See Schneider, Gramling, Hermanson & Ye, supra note 173 at 23-24; S. K. Asare & A. Wright, Equity Analysts‘ 

Reactions to Type of Control Deficiency and Likelihood Threshold in Adverse Control Reports, U. FLA. &

NORTHEASTERN U., Working paper (paper presented at the 2008 American Accounting Association Annual 

Meeting). See also, S. K. Asare & A. Wright, Evidence on the Factors that Medicate the Relationship between Type 

of Material Weakness and Investors‘ Financial Reporting Risk Assessments, Working paper, U. FLA. &

NORTHEASTERN U. (2011); L. Xu & A. P. Tang, Internal Control Material Weakness, Analysts‘ Accuracy and Bias, 

and Brokerage Reputation, Working paper, MORGAN ST. U. (2008); Ghosh & Lubberink, supra note 248.

259 Note that these alternatives were proffered prior to the Commission‘s final rule exempting issuers with public 

float of less than $75 million from Section 404(b).

260 See Orcutt, supra note 191 at 406-409.

261 See H. N. Butler & L. E. Ribstein, The Sarbanes-Oxley Debacle: What We‘ve Learned; How to Fix It, The 

American Enterprise Institute Press (2006), available at

http://www.aei.org/docLib/20060308_ButlerRibsteinSOXDraft313.pdf.
105

Unaudited management internal control reports and traditional financial audits may 

be a cost effective disclosure alternative for smaller issuers;262 and

Disclosure of an auditors‘ analysis of accounting mistakes in lieu of a Section 404(b) 

attestation might yield substantial disclosures at very low incremental cost for 

auditors and issuers.263

Some of the suggestions to reduce the burden were recommended before the 2007 

reforms and were implemented in those reforms.

264

 Additionally, the Dodd-Frank Act addressed 

an exemption for smaller issuers by exempting non-accelerated filers from Section 404(b) which, 

as noted in Section II, exempted approximately 60% of issuers that would have otherwise been 

subject to Section 404(b).

One alternative that has not been implemented is an ―opt out‖ of Section 404 compliance 

for smaller issuers.

265

 This would allow investors or management to decide if the cost of

compliance with Section 404, including the auditor attestation requirement in Section 404(b), 

exceeds the benefits. Potential investors would also have information about an issuer‘s decision 

on opting out (as opposed to today‘s requirement that is based primarily on public float) and 

could respond appropriately. 

A disadvantage of permitting voluntary exemption from Section 404(b) would be an 

increase to private control benefits for issuers where insiders and affiliates control shareholder 

voting. Insiders might be incentivized to exploit the information asymmetry between themselves 

and their investors about the incidence and severity of material weaknesses. The protections 

 

262 See Kinney & Shepardson, supra note 183. The authors suggested that ICDs might be identified without the cost 

of management‘s reports on ICFR and only a modest increase in financial audit work regarding the cause of known 

misstatements. 

263 See id. 

264 See Grundfest & Bochner, supra note 174.

265 See Orcutt, supra note 191. See also, M. R. Bloomberg & C. E. Schumer, Sustaining New York‘s and the US‘ 

Global Financial Services Leadership, The City of New York, Office of the Mayor, New York, NY & United States 

Senate, available at http://www.nyc.gov/html/om/pdf/ny_report_final.pdf; G. Hubbard, J. L. Thornton & H. S. 

Scott, Interim Report of the Committee on Capital Markets Regulation, Nov. 30, 2006, available at

http://www.capmktsreg.org/pdfs/11.30Committee_Interim_ReportREV2.pdf.
106

provided by Section 404(b) compliance may be even more important for investors when there is 

significant insider and affiliate control of voting.266

The frequent movement of issuers into and out of the studied range also reduces the 

usefulness of this recommendation – after opting out one year, an issuer may be required to 

comply in the following year due to changes in public float. Also, once effective controls are in 

place at the issuer, the auditor is more likely to continue to test them even if they are not issuing 

an auditor attestation under Section 404(b) during a particular year in order to rely on them for 

purposes of reducing substantive testing in the audit of the financial statements, particularly for 

issuers that are larger and more complex, as tends to be the case with accelerated filers. 

 

266 According to Thomson Datastream, 104 issuers in the illustrative population had public float shares of less than 

50% of the total voting shares outstanding. 
107

VI. Conclusion and Recommendations

A. Summary of Findings

1. Analysis of the Issuers Subject to this Study

Section II of this study, which summarizes the Staff‘s work to analyze the demographics 

of issuers that are the subject of this study, shows that the population represents a relatively small 

portion of issuers (approximately 10% of issuers over the past five years). The population is 

transient over time, with only about 5% of issuers appearing in the population all five years. 

Further, approximately 40% of issuers appeared in the population in only one of the five years. 

The Staff‘s analysis reveals that the illustrative population is in some important respects 

dissimilar to the population of all non-accelerated filers that are already exempt from Section 

404(b), particularly in relation to size (by revenue and assets), audit fees relative to size, 

restatement rates, and internal control issues discovered by management and auditors. Many of 

the characteristics point to similar financial reporting risks in the illustrative population 

compared to other issuers with larger public float that also must comply with Section 404(b). 

These facts suggest that there are not sufficiently unique characteristics in the illustrative 

population that would justify differentiating these filers from other accelerated filers, including 

the requirement for an auditor attestation on ICFR pursuant to Section 404(b), which has been 

required for these issuers since 2004 for domestic issuers and 2007 for foreign private issuers. 

Issuers in the illustrative population paid higher audit fees in absolute dollars in 2009 

than their smaller counterparts. However, this may be not only due to the auditor attestation 

requirement under Section 404(b), but in some cases also likely attributable to their size, 

complexity, and audit risk. Approximately 6% of non-accelerated filers in the illustrative 

population that voluntarily complied with Section 404(b) had ineffective ICFR in 2009, while 

approximately 28% of all non-accelerated filers in our EDGAR population had ineffective ICFR. 

Audit fees as a percentage of assets and revenues for accelerated filers in the illustrative 

population were similar to those of all accelerated filers in our EDGAR population and lower 

than those of non-accelerated filers. 

The Staff also analyzed the characteristics of global IPOs with respect to those likely to 

be in the range of issuers subject to this study. Although the U.S. IPO market over time has 

recovered from the 2007 levels, it has not reached the 1999 levels (i.e., we reviewed IPO activity 
108

over a range of years and noted that it was at a relatively low point during the financial crisis and 

has since recovered, but not to the peak for the range of years studied). The Staff‘s analysis 

shows that the United States has not lost U.S.-based companies filing IPOs to foreign markets for 

the range of issuers that would likely be in the $75-$250 million public float range after the IPO. 

While U.S. markets‘ share of world-wide IPOs raising $75-$250 million has declined over the 

past five years, there is no conclusive evidence from the study linking the requirements of 

Section 404(b) to IPO activity.

Section V demonstrates that the net effect of Section 404 on smaller companies‘ IPOs is 

difficult to measure and may be due to other factors, such as the economic environment. There 

is no consensus in the academic literature on how much influence the Sarbanes-Oxley Act in 

general or Section 404(b) in particular has had on decisions of where to list IPOs. In addition, 

with respect to IPOs, we note that the Commission has previously taken action to reduce the 

compliance burden for new issuers by not requiring the auditor attestation on ICFR for the IPO 

and the first annual report thereafter. 

2. The 2009 Staff Study on Section 404

Section III of this study, which includes additional analysis of the data collected for the 

Staff‘s 2009 study on Section 404, demonstrates that subsequent to the 2007 reforms there was a 

statistically significant decrease in Section 404(b) compliance costs (including audit fees) for 

issuers subject to this study. Respondents in the studied public float range tend to have a 

favorable view of Section 404(b) and believe that the 2007 reforms resulted in reduced cost 

burden as compared to non-accelerated filers, which are now exempt from Section 404(b).

In particular, there were statistically significant declines in Section 404(b) costs and 

outside vendor costs for the medium ($75-$250 million and $250-$700 million) and large (> 

$700 million) issuers. The survey participants‘ estimates of the mean share of audit fees 

allocated to Section 404(b) were also significantly lower post-2007 reforms, except for smaller 

(< $75 million) issuers that are now exempt from Section 404(b). However, all issuer size 

categories projected a statistically significant decline in the percent of audit fees allocated to 

Section 404(b) beyond the first post-reform year. For all issuer size categories, scaled

compliance costs typically decreased with the number of years of Section 404(b) compliance 

experience, especially for medium ($75-$250 million and $250-$700 million) and large (> $700 

million) issuers.
109

In an optional section of the survey, survey participants revealed that, on average, issuers 

perceived that the 2007 reforms helped reduce the costs of complying with Section 404. 

Regarding the impact of AS 5 on the amount of time required to complete the independent audit 

of ICFR, approximately 60% of all respondents believe AS 5 reduced the amount of time 

required for auditor attestation under Section 404(b). Medium ($75-$250 million and $250-$700 

million) and large (> $700 million) issuers perceived the impact of AS 5 in the year following 

the reform to be greater than that perceived by smaller (< $75 million) issuers, which are now 

exempt from Section 404(b).

Overall, the four public float analyses reveal that compliance costs typically vary with 

issuer size (increasing with size), compliance history (decreasing with increased compliance 

experience), and compliance regime (lower after the 2007 reforms). Across all size categories, 

including issuers with public float of $75-$250 million, compliance costs tended to decrease 

steadily beyond the post- 2007 reforms year. In addition, small (< $75 million) issuers in the 

survey that generally provided less favorable responses about the costs of compliance and 2007 

reforms have already been exempted. The results further show that issuers with a public float of 

$75-$250 million tended to be comparable with issuers with a public float of $250-$700 million, 

demonstrating that the $75-$250 million issuers more proportionately benefited from the reforms 

than did the smaller (< $75 million) issuers that are now exempted. Therefore, in light of the 

extensive nature of the 2007 reforms, including new auditing standards that were aligned with 

the new Management Guidance for issuers, the Staff believes that to meaningfully further reduce 

the compliance burden of Section 404(b), any additional reforms beyond those implemented in 

2007 would have to be significant rather than marginal. However, any change of such 

magnitude also would most likely adversely affect the investor protections provided by Section 

404(b). 

3. Public Input

Input from the public, as discussed in Section IV, also informed the Staff‘s 

recommendations. As demonstrated in Section II, most issuers subject to this study are already 

accelerated filers and are already subject to the Section 404(b) auditor attestation requirement. 

While the data suggests that issuers in the studied public float range are transient, issuers with 

public float in that range are more likely to have already incurred the initial cost of Section 

404(b) compliance, and the data derived from other sections of this study suggest that issuers that 
110

are currently complying with Section 404(b) have reduced the burden of compliance by focusing 

ICFR efforts on controls that are most important to reliable financial reporting. 

The feedback from investor groups responding to our October 2010 request for comment

strongly opposed any further exemption from Section 404(b). These groups cited the auditors‘

role in uncovering ICFR deficiencies and increased cost of capital for issuers without the auditor 

attestation. 

There were few suggestions provided from the public input that addressed techniques for 

further reducing, but not eliminating, the compliance burden while maintaining investor 

protections. Four commenters to the Commission‘s request for public comment, including the 

three industry groups, recommended that the Commission permanently exempt registrants in the 

studied market capitalization range from the provisions of Section 404(b), as Congress did for 

non-accelerated filers pursuant to the Dodd-Frank Act. 

The Staff also considered this input as well as public input previously received on the 

compliance burden of Section 404(b) from other Commission and PCAOB actions, but generally 

did not believe that those suggestions, beyond those previously implemented, were appropriate 

recommendations for the issuer group the Staff was required to study. However, the Staff 

believes that certain other suggestions from the public are likely to take into account both the 

compliance costs and effectiveness for all issuers, including those subject to this study. These 

relate to suggestions regarding the PCAOB potentially publishing additional observations on 

Section 404(b) implementation and the COSO‘s project to update its internal control framework. 

4. Other Research on Section 404

The academic and other research summarized in Section V of this study describes several 

trends that the Staff considered in forming its recommendations. Most importantly, the research 

demonstrates that the costs of compliance with Section 404(b), including both total costs and 

audit fees, have further declined since the 2007 reforms. Specifically, prior to additional 

guidance from the SEC or the PCAOB, compliance costs were declining over time as issuers and 

auditors gained more understanding and experience with the requirements, and issuers and 

auditors understood that they needed to modify their 404 assessments and audit processes in 

order to gain efficiencies. However, the 2007 reforms have resulted in significantly more cost 

savings for issuers, suggesting that some of the costs burden of Section 404 might have already 
111

been reduced. Further, the research also suggests that Section 404(b) generally did not affect 

decisions by issuers to exit the reporting requirements of the SEC, including ICFR reporting. 

Academic research also shows that auditor involvement in ICFR promotes more accurate 

and reliable disclosure of all ICFR deficiencies and that restatement rates for issuers with the 

auditor attestation are lower than the restatement rates for issuers without this attestation. 

Disclosure of internal control weaknesses conveys relevant information to investors, who can act 

on this information. Auditor involvement leads to the finding of more material weaknesses than 

with management‘s review alone, thus improving the quality of decision-useful information in 

the market. Further, auditors are more likely to classify ICDs as significant deficiencies or 

material weaknesses when management initially classifies them as less severe. 

Academic sources of information on Section 404(b) also discuss alternatives that might 

provide useful information to investors with less cost than the existing 404(b) requirements, 

many of which were implemented as part of the 2007 reforms. As discussed in Section V, one 

alternative that has not been implemented is a permitted ―opt out‖ of Section 404 compliance for 

smaller issuers. ―Opt out‖ approaches can provide a mechanism to allow an issuer options 

regarding compliance rather than a strict requirement. Under such an approach, so long as an 

investor was informed as to an issuer‘s decision to opt out or comply, an investor could consider 

this decision in allocating capital and otherwise making investment decisions. Although some 

suggest that allowing flexibility of this type could be beneficial, in the context of Section 404(b) 

the Staff considered the suggestion of an ―opt out‖ to be too similar to providing a full exemption 

given the Staff‘s view of the benefits of auditor involvement to reliable ICFR disclosures and 

reliable financial reporting. Further, it also could incentivize insiders to exploit the information 

asymmetry between themselves and other investors about the incidence and severity of material 

weaknesses in ICFR.

B. Recommendations

The work performed by the Staff reinforces our understanding that the costs of Section 

404(b) have declined since the Commission first implemented Section 404, particularly in 

response to the 2007 reforms, that investors generally view the auditor‘s attestation on ICFR as 

beneficial, and that financial reporting is more reliable when the auditor is involved with ICFR 

assessments. After considering the information gathered from internal and external sources, the 

Staff has the following specific recommendations:
112

1. Maintain existing investor protections of Section 404(b) for accelerated filers, which 

have been in place since 2004 for domestic issuers and 2007 for foreign private 

issuers

The Staff believes that the existing investor protections for accelerated filers to comply 

with the auditor attestation provisions of Section 404(b) should be maintained (i.e., no new

exemptions). There is strong evidence that the auditor‘s role in auditing the effectiveness of 

ICFR improves the reliability of internal control disclosures and financial reporting overall and is 

useful to investors. The Staff did not find any specific evidence that such potential savings 

would justify the loss of investor protections and benefits to issuers subject to the study, given 

the auditor‘s obligations to perform procedures to evaluate internal controls even when the 

auditor is not performing an integrated audit. Also, while the research regarding the reasons for 

listing decisions is inconclusive, the evidence does not suggest that granting an exemption to 

issuers that would expect to have $75-$250 million in public float following an IPO would, by 

itself, encourage companies in the United States or abroad to list their IPOs in the United States. 

The Staff acknowledges that the reasons a company may choose to undertake an IPO are varied 

and complex. The reasons are often specific to the company, with each company making the 

decision as to whether and where to go public based on its own situation and the market factors 

present at the time. The costs associated with conducting an IPO and becoming a public 

company no doubt factor into the decisions and may be particularly challenging for smaller 

companies. The Staff appreciates that the costs and benefits of the regulatory actions that the 

Commission takes – and does not take – certainly can impact these decisions. At Chairman 

Schapiro‘s request, the Staff is taking a fresh look at several of the Commission‘s rules, beyond 

those related to Section 404(b), to develop ideas for the Commission about ways to reduce 

regulatory burdens on small business capital formation in a manner consistent with investor 

protection.267 However, the Dodd-Frank Act already exempted approximately 60% of reporting

issuers from Section 404(b), and the Staff does not recommend further extending this exemption.

2. Encourage activities that have potential to further improve both effectiveness and 

efficiency of Section 404(b) implementation

The Staff recommends that the PCAOB monitor its inspection results and consider 

publishing observations, beyond the observations previously published in September 2009, on 

 

267 See Letter from Mary L. Schapiro, Chairman, U.S. Securities and Exchange Commission, supra note 4.
113

the performance of audits conducted in accordance with AS 5. These observations could assist 

auditors in performing top-down, risk based audits of ICFR. These communications could 

include the lessons that can be learned from internal control deficiencies identified through 

PCAOB inspections.

The Staff is observing COSO‘s project to review and update its internal control 

framework, which is the most common framework used by management and the auditor alike in 

performing assessments of ICFR. The Staff believes that this project can contribute to effective 

and efficient audits by providing management and auditors with improved internal control 

guidance that reflects today‘s operating and regulatory environment and by allowing constituent 

groups to share information on improvements that can be made that enhance the ability to design, 

implement, and assess internal controls.