Sarbanes-Oxley Act: Consideration of Key Principles Needed in Addressing Implementation for Smaller Public Companies
Published: 2006-04-13T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Congress passed the Sarbanes-Oxley Act to help protect investors and restore investor confidence. While the act has generally been recognized as important and necessary, some concerns have been expressed about the cost for small businesses. In this report, GAO (1) analyzes the impact of the Sarbanes-Oxley Act on smaller public companies, particularly in terms of compliance costs; (2) describes responses of the Securities and Exchange Commission (SEC) and Public Company Accounting Oversight Board (PCAOB) to concerns raised by smaller public companies; and (3) analyzes smaller public companies' access to auditing services and the extent to which the share of public companies audited by mid-sized and small accounting firms has changed since the act was passed.
section_title: What GAO Found
paragraphs: Regulators, public companies, audit firms, and investors generally agree that the Sarbanes-Oxley Act of 2002 has had a positive and significant impact on investor protection and confidence. However, for smaller public companies (defined in this report as $700 million or less in market capitalization), the cost of compliance has been disproportionately higher (as a percentage of revenues) than for large public companies, particularly with respect to the internal control reporting provisions in section 404 and related audit fees. Smaller public companies noted that resource limitations and questions regarding the application of existing internal control over financial reporting guidance to smaller public companies contributed to challenges they face in implementing section 404. The costs associated with complying with the act, along with other market factors, may be encouraging some companies to become private. The companies going private were small by any measure and represented 2 percent of public companies in 2004. The full impact of the act on smaller public companies remains unclear because the majority of smaller public companies have not fully implemented section 404. To address concerns from smaller public companies, SEC extended the section 404 deadline for smaller companies with less than $75 million in market capitalization, with the latest extension to 2007. Additionally, SEC and PCAOB issued guidance intended to make the section 404 compliance process more economical, efficient, and effective. SEC also encouraged the Committee of Sponsoring Organizations of the Treadway Commission (COSO), to develop guidance for smaller public companies in implementing internal control over financial reporting in a cost-effective manner. COSO's guidance had not been finalized as of March 2006. SEC also formed an advisory committee to examine, among other things, the impact of the act on smaller public companies. The committee plans to issue a report in April 2006 that will recommend, in effect, a tiered approach with certain smaller public companies partially or fully exempt from section 404, "unless and until" a framework for assessing internal control over financial reporting is developed that recognizes the characteristics and needs of smaller public companies. As SEC considers these recommendations, it is essential that the overriding purpose of the Sarbanes-Oxley Act--investor protection--is preserved and that SEC assess available guidance to determine if additional supplemental or clarifying guidance for smaller public companies is needed. Smaller public companies have been able to obtain access to needed audit services and many moved from the largest accounting firms to mid-sized and small firms. The reasons for these changes range from audit cost and service concerns cited by companies to client profitability and risk concerns cited by accounting firms, including capacity constraints and assessments of client risk. Overall, mid-sized and small accounting firms conducted 30 percent of total public company audits in 2004--up from 22 percent in 2002. However, large accounting firms continue to dominate the overall market, auditing 98 percent of U.S. publicly traded company sales or revenues.

section_title: Letter
paragraphs: In response to numerous corporate failures arising from corporate  mismanagement and fraud, Congress passed the Sarbanes-Oxley Act of  2002. Generally recognized as one of the most significant market reforms  since the passage of the securities legislation of the 1930s, the act is  intended to help protect investors and restore investor confidence by  improving the accuracy, reliability, and transparency of corporate  financial reporting and disclosures, and reinforce the importance of  corporate ethical standards. Public and investor confidence in the fairness  of financial reporting and corporate ethics is critical to the effective  functioning of our capital markets. The act’s requirements apply to all  public companies regardless of size and the public accounting firms that  audit them.
The act established the Public Company Accounting Oversight Board  (PCAOB) as a private-sector non-profit organization to oversee the audits  of public companies that are subject to securities laws. PCAOB, which is  subject to oversight by the Securities and Exchange Commission (SEC), is  responsible for establishing related auditing, quality control, ethics, and  auditor independence standards. The act also addresses auditor  independence and the relationship between auditors and the public  companies they audit. The act requires public companies to assess the  effectiveness of their internal control over financial reporting and for their  external auditors to report on management’s assessment and the  effectiveness of internal controls. The act also contains provisions  intended to make chief executive officers (CEO) and chief financial  officers (CFO) more accountable, improve the oversight role of boards of  directors and audit committees, and provide whistleblower protection.  Finally, the act expanded the SEC’s oversight powers and mandated new  and expanded criminal penalties for securities fraud and other corporate  violations.
For the purposes of this report, we use the term smaller public company to refer to  a  company with a market capitalization of $700 million or less unless otherwise noted. We  use the term large accounting firms to refer to the top four U.S. accounting firms in terms  of total revenue in fiscal year 2004—Deloitte & Touche LLP, Ernst & Young LLP,  PricewaterhouseCoopers LLP, and KPMG LLP; mid-sized firms to refer to the four next  largest U.S. firms—Grant Thornton LLP, BDO Seidman LLP, Crowe Chizek & Company  LLC, and McGladrey & Pullen LLP; and small firms to refer to all other accounting firms in  the United States., which consist of regional and local firms. changes to determine costs of compliance. Similarly, we constructed a  database of public companies that went private using SEC filings and  press releases retrieved from Lexis-Nexis, an online periodical database.  To obtain information on smaller public companies’ experiences with  Sarbanes-Oxley Act compliance, we also conducted a survey of companies  with market capitalization of $700 million or less and annual revenues of  $100 million or less that, as of August 11, 2005, reported to SEC that they  had complied with the act’s internal control-related requirements. One  hundred fifty-eight of 591 companies completed the survey, for an overall  response rate of 27 percent. Additionally, we held discussions with  representatives of SEC, the Small Business Administration (SBA), PCAOB,  smaller public companies, the Committee of Sponsoring Organizations of  the Treadway Commission (COSO), financial service providers, rating  agencies, institutional investors, trade groups, accounting firms, and other  market participants.
Because SEC has extended the date by which registered public companies  with less than $75 million in public float (known as non-accelerated filers)  had to comply with the act’s internal control-related provisions (section  404) to their first fiscal year ending on or after July 15, 2007, we could not  analyze the impact of the internal control provisions of the act for a  significant number of smaller public companies (SEC estimates that non- accelerated filers represent about 60 percent of all registered public  companies). Thus, to gain some insight into the potential impact these  provisions may have on smaller public companies, we analyzed public data  and other information related to the experiences of public companies that  have fully implemented the act’s provisions. To determine the act’s impact  on smaller privately held companies, we interviewed officials about state  requirements comparable to key Sarbanes-Oxley provisions and  representatives of smaller private companies and financial institutions  about capital access requirements. We also analyzed data on companies’  initial public offering (IPO) and secondary public offering (SPO) from SEC  filings. To assess changes in the domestic public company audit market,  we used public data—for 2002 and 2004—on public companies and their  external accounting firms to determine how the number and mix of  domestic public company audit clients had changed for firms other than  the large accounting firms. As requested by your staff, we addressed nine  specific questions contained in your request letter.
Appendix I contains a more complete description of our scope and  methodology, including a cross-sectional comparison between the nine  specific questions contained in the request letter and the four objectives of  this report. We conducted our work in California, Connecticut, Georgia,  Maryland, New Jersey, New York, Virginia, and Washington, D.C., from  November 2004 through March 2006 in accordance with generally  accepted government auditing standards.
subsections: section_title: Background
paragraphs: Responding to corporate failures and fraud that resulted in substantial  financial losses to institutional and individual investors, Congress passed  the Sarbanes-Oxley Act in 2002. As shown in table 1, the act contains  provisions affecting the corporate governance, auditing, and financial  reporting of public companies, including provisions intended to deter and  punish corporate accounting fraud and corruption.
The Sarbanes-Oxley Act generally applies to those companies required to  file reports with SEC under the Securities Exchange Act of 1934 and does  not differentiate between small and large businesses. The definition of  small varies among agencies, but SEC generally calls companies that had  less than $75 million in public float non-accelerated filers. Accelerated  filers are required by SEC regulations to file their annual and quarterly  reports to SEC on an accelerated basis compared to non-accelerated filers.  As of 2005, SEC estimated that about 60 percent —5,971 companies—of all  registered public companies were non-accelerated filers. SEC recently  further differentiated smaller companies from what it calls “well-known  seasoned issuers”—those largest companies ($700 million or more in  public float) with the most active market following, institutional  ownership, and analyst coverage.
Title I of the act establishes PCAOB as a private-sector nonprofit  organization to oversee the audits of public companies that are subject to  the securities laws. PCAOB is subject to SEC oversight. The act gives  PCAOB four primary areas of responsibility:  registration of accounting firms that audit public companies in the U.S.  securities markets;  inspections of registered accounting firms;    establishment of auditing, quality control, and ethics standards for  registered accounting firms; and investigation and discipline of registered accounting firms for violations of  law or professional standards.
Title II of the act addresses auditor independence. It prohibits the  registered external auditor of a public company from providing certain  nonaudit services to that public company audit client. Title II also specifies  communication that is required between auditors and the public  company’s audit committee (or board of directors) and requires periodic  rotation of the audit partners managing a public company’s audits.
Titles III and IV of the act focus on corporate responsibility and enhanced  financial disclosures. Title III addresses listed company audit committees,  including responsibilities and independence, and corporate  responsibilities for financial reports, including certifications by corporate  officers in annual and quarterly reports, among other provisions. Title IV  addresses disclosures in financial reporting and transactions involving  management and principal stockholders and other provisions such as  internal control over financial reporting. More specifically, section 404 of  the act establishes requirements for companies to publicly report on  management’s responsibility for establishing and maintaining an adequate  internal control structure, including controls over financial reporting and  the results of management’s assessment of the effectiveness of internal  control over financial reporting. Section 404 also requires the firms that  serve as external auditors for public companies to attest to the assessment  made by the companies’ management, and report on the results of their  attestation and whether they agree with management’s assessment of the  company’s internal control over financial reporting.
SEC and PCAOB have issued regulations, standards, and guidance to  implement the Sarbanes-Oxley Act. For instance, both SEC regulations  and PCAOB’s Auditing Standard Number 2, “An Audit of Internal Control  Over Financial Reporting Performed in Conjunction with an Audit of  Financial Statements” state that management is required to base its  assessment of the effectiveness of the company’s internal control over  financial reporting on a suitable, recognized control framework  established by a body of experts that followed due process procedures,  including the broad distribution of the framework for public comment.  Both the SEC guidance and PCAOB’s auditing standard cite the COSO  principles as providing a suitable framework for purposes of section 404  compliance. In 1992, COSO issued its “Internal Control—Integrated  Framework” (the COSO Framework) to help businesses and other entities  assess and enhance their internal control. Since that time, the COSO  framework has been recognized by regulatory standards setters and others  as a comprehensive framework for evaluating internal control, including  internal control over financial reporting. The COSO framework includes a  common definition of internal control and criteria against which  companies could evaluate the effectiveness of their internal control  systems.  The framework consists of five interrelated components:  control environment, risk assessment, control activities, information and  communication, and monitoring. While SEC and PCAOB do not mandate  the use of any particular framework, PCAOB states that the framework  used by a company should have elements that encompass the five COSO  components on internal control.
Internal control generally serves as a first line of defense in safeguarding  assets and preventing and detecting errors and fraud. Internal control is  defined as a process, effected by an entity’s board of directors,  management, and other personnel, designed to provide reasonable  assurance regarding the achievement of the following objectives: (1)  effectiveness and efficiency of operations; (2) reliability of financial  reporting; and (3) compliance with laws and regulations. Internal control  over financial reporting is further defined in the SEC regulations  implementing section 404. These regulations define internal control over  financial reporting as providing reasonable assurance regarding the  reliability of financial reporting and the preparation of financial  statements, including those policies and procedures that    pertain to the maintenance of records that, in reasonable detail, accurately  and fairly reflect the transactions and dispositions of the assets of the  company;   provide reasonable assurance that transactions are recorded as necessary  to permit preparation of financial statements in conformity with generally  accepted accounting principles, and that receipts and expenditures of the  company are being made only in accordance with authorizations of  management and directors of the company; and   provide reasonable assurance regarding prevention or timely detection of  unauthorized acquisition, use, or disposition of the company’s assets that  could have a material effect on the financial statements.
PCAOB’s Auditing Standard No. 2 reiterates this definition of internal  control over financial reporting. Internal control is not a new requirement  for public companies. In December 1977, as a result of corporate  falsification of records and improper accounting, Congress enacted the  Foreign Corrupt Practices Act (FCPA). The FCPA’s internal accounting  control requirements were intended to prevent fraudulent financial  reporting, among other things. The FCPA required companies to: (1) make  and keep books, records, and accounts that in reasonable detail accurately  and fairly reflect the transactions and dispositions of assets and (2)  develop and maintain a system of internal accounting controls sufficient to  provide reasonable assurance over the recording and executing of  transactions, the preparation of financial statements in accordance with  standards, and maintaining accountability for assets.
section_title: Smaller Public Companies Have Incurred Disproportionately Higher Audit Costs in Implementing the Act, but Impact on Access to Capital Remains Unclear
paragraphs: Based on our analysis, costs associated with implementing the Sarbanes- Oxley Act—particularly those costs associated with the internal control  provisions in section 404—were disproportionately higher (as a  percentage of revenues) for smaller public companies. In complying with  the act, smaller companies noted that they incurred higher audit fees and  other costs, such as hiring more staff or paying for outside consultants, to  comply with the act’s provisions. Further, resource and expertise  limitations that characterize many smaller companies as well as their  general lack of familiarity or experience with formal internal control  frameworks contributed to the challenges and increased costs they faced  during section 404 implementation. Along with other market factors, the  act may have encouraged a relatively small number of smaller public  companies to go private, foregoing sources of funding that were  potentially more diversified and may be less expensive for many of these  companies. However, the ultimate impact of the Sarbanes-Oxley Act on  smaller public companies’ access to capital remains unclear because of the  limited time that the act has been in effect and the large number of smaller  public companies that have not yet fully implemented the act’s internal  control provisions.
subsections: section_title: Smaller Public Companies Incurred Disproportionately Higher Audit Costs
paragraphs: Our analysis indicates that audit fees have increased considerably since  the passage of the act, particularly for those smaller public companies that  have fully implemented the act. Both smaller and larger public companies  have identified the internal control provisions in section 404 as the most  costly to implement. However, audit fees may have also increased because  of the current environment surrounding public company audits including,  among other things, the new regulatory oversight of audit firms, new  requirements related to audit documentation, and legal risk. Figure 1  contains data reported by public companies on audit fees paid to external  auditors before and after the section 404 provisions became effective for  accelerated filers in 2004. Based on this data, we found that (1) audit fees  already were disproportionately greater as a percentage of revenues for  smaller public companies in 2003 and (2) the disparity in smaller and  larger public companies’ audit fees as a percentage of revenues increased  for those companies that implemented section 404 in 2004. For example,  of the companies that reported implementing section 404, public  companies with market capitalization of $75 million or less paid a median  $1.14 in audit fees for every $100 of revenues compared to $0.13 in audit  fees for public companies with market capitalization greater than $1  billion. Among public companies with market capitalization of $75  million or less (2,263 in total), the 66 companies that implemented section  404 paid a median $0.35 more per $100 in revenues compared to those that  had not implemented section 404. However, using publicly reported audit  fees as an indicator of the act’s compliance costs has some limitations.  First, the audit fees reported by companies that complied with section 404  should include fees for both the internal control audit and the financial  statement audit. As a result, we could not isolate the audit fees associated  with section 404. Second, the fees paid to the external auditor do not  include other costs companies incurred to comply with section 404  requirements, such as testing and documenting internal controls and fees  paid to external consultants. While the spread between what smallest and  largest public companies that implemented section 404 paid as a  percentage of revenue increased between 2003 and 2004, we also noted  that, as a percentage of revenue, the relative disproportionality between  the audit fees paid by smaller public companies and the largest public  companies remained roughly the same between 2003 and 2004. However,  unlike audit fees, these costs are not separately reported and, therefore,  are difficult to analyze and measure.
section_title: Smaller Public Companies Incurred Other Costs in Complying with the Act
paragraphs: According to executives of smaller public companies that we contacted,  smaller companies incurred substantial costs in addition to the fees they  paid to their external auditors to comply with section 404 and other  provisions of the act. For example, 128 of the 158 smaller public  companies that responded to our survey (81 percent of respondents) had  hired a separate accounting firm or consultant to assist them in meeting  section 404 requirements. Services provided included assistance with  developing methodologies to comply with section 404, documenting and  testing internal controls, and helping management assess the effectiveness  of internal controls and remediate identified internal control weaknesses.  These smaller companies reported paying fees to external consultants for  the period leading up to their first section 404 report that ranged from  $3,000 to more than $1.4 million. Many also reported costs related to  training and hiring of new or temporary staff to implement the act’s  requirements. Additionally, some of the smaller companies that responded  to our survey reported that their CFOs and accounting staff spent as much  as 90 percent of their time for the period leading up to their first section  404 report on Sarbanes-Oxley Act compliance-related issues. Finally, many  of the smaller public companies incurred missed “opportunity costs” to  comply with the act that were significant. For example, nearly half (47  percent) of the companies that responded to our survey reported deferring  or canceling operational improvements and more than one-third (39  percent) indicated that they deferred or cancelled information technology  investments.
While most companies, including the majority of the smaller public  companies that responded to our survey and that we interviewed, cited  section 404 as the most difficult provision to implement, smaller public  companies reported challenges in complying with other Sarbanes-Oxley  Act provisions as well. Nearly 69 percent of the smaller public companies  that responded to our survey said that the act’s auditor independence  requirements had decreased the amount of advice that they received from  their external auditor on accounting- and tax-related matters. About half  the companies that responded to our survey indicated that they incurred  additional expenses by hiring outside counsel for assistance in complying  with various requirements of the act. Examples mentioned included legal  assistance with drafting charters for board committees, drafting a code of  ethics, establishing whistleblower protection, and reviewing CEO and CFO  certification requirements. About 13 percent of the smaller public  companies reported incurring costs to appoint a financial expert to serve  on the audit committee, and about 6 percent reported incurring costs to  appoint other independent members to serve on the audit committee.  While these types of costs were consistent with those reported for larger  companies, the impact on smaller public companies was likely greater  given their more limited revenues and resources.
section_title: Smaller Companies Have Different Characteristics Than Larger Companies, Some of Which Contributed to Higher Implementation Costs
paragraphs: While public companies—both large and small—have been required to  establish and maintain internal accounting controls since the Foreign  Corrupt Practices Act of 1977, most public companies and their external  auditors generally had limited practical experience in implementing and  using a structured framework for internal control over financial reporting  as envisioned by the implementing regulations for section 404. Our  survey of smaller public companies and our discussions with external  auditors indicated that the internal control framework—that is the COSO  framework—referred to in SEC’s regulations and PCAOB’s standards  implementing section 404 was not widely used by public companies,  especially smaller companies, prior to the Sarbanes-Oxley Act.
Many companies documented their internal controls for the first time as  part of their first year implementation efforts to comply with section 404.  As a result, many companies probably underestimated the time and  resources necessary to comply with section 404, partly because of their  lack of experience or familiarity with the framework. These challenges  were undoubtedly compounded in companies that needed to make  significant improvements in their internal control systems to make up for  deferred maintenance of those systems. While this was largely true for  both larger and smaller companies, regulators (SEC and PCAOB), public  accounting firms, and others have indicated that smaller public companies  often face particular challenges in implementing effective internal control  over financial reporting.
Resource limitations make it more difficult for smaller public companies  to achieve economies of scale, segregate duties and responsibilities, and  hire qualified accounting personnel to prepare and report financial  information. Smaller companies are inherently less able to take advantage  of economies of scale because they face higher fixed per unit costs than  larger companies with more resources and employees. Implementing the  functions required to segregate transaction duties in a smaller company  absorbs a larger percentage of the company’s revenues or assets than in a  larger company. About 60 percent of the smaller public companies that  responded to our survey said that it was difficult to implement effective  segregation of duties. Several executives told us that it was difficult to  segregate duties due to limited resources. According to COSO’s draft  guidance for smaller public companies, smaller companies can develop  and implement compensating controls when resource constraints  compromise the ability to segregate duties. The American Institute of  Certified Public Accountants noted that smaller public companies often do  not have the internal audit functions referred to in COSO’s internal  framework guidance. Other executives commented that it was difficult to  achieve effective internal control over financial reporting because they  lacked expertise within their internal accounting staff. For example,  according to an executive from a company that reported a material  weakness in its section 404 report, the financial accounting standards for  stock options were too complex for his staff and it was easier to have its  auditor fix the mistakes and cite the company for a material weakness in  internal control over financial reporting. Two other executives told us that  their auditors cited their companies with material weaknesses in internal  controls over financial reporting for not having appropriate internal  accounting staff; to remediate this weakness, the companies had to hire  additional staff.
According to COSO, however, some of the unique characteristics of  smaller companies create opportunities to more efficiently achieve  effective internal control over financial reporting and more efficiently  evaluate internal control which can facilitate compliance with section 404.  These opportunities can result from more centralized management  oversight of the business, and greater exposure and transparency with the  senior levels of the company that often exist in a smaller company. For  instance, management’s hands-on approach in smaller companies can  create opportunities for less formal and less expensive communications  and control procedures without decreasing their quality. To the extent that  smaller companies have less complex product lines and processes, and/or  centralized geographic concentrations in operations, the process of  achieving and evaluating effective internal control over financial reporting  could be simplified.
According to SEC, another characteristic of smaller public companies is  that they tend to be much more closely held than larger public companies;  insiders such as founders, directors, and executive officers hold a high  percentage of shares in the companies. Further, CFOs of smaller public  companies frequently play a more integrated operational role than their  larger company counterparts. According to a recommendation by  participants at the September 2005 Government-Business Forum on Small  Business Capital Formation hosted by SEC, these types of shareholders  are classic insiders who do not need significant SEC protection.  According to SEC’s Office of Economic Analysis, among public companies  with a market capitalization of $125 million or less, insiders own on  average approximately 30 percent of the company’s shares. Although the  “insider” shareholders owners may not have the same need for significant  investor SEC protection as investors in broadly held companies, minority  shareholders who are not insiders may have a need for such protection.
section_title: Complexity, Scope, and Timing of PCAOB Guidance also Appeared to Influence Cost of Section 404 Implementation
paragraphs: Accounting firms and public companies also have noted that the scope,  complexity, and timing of PCAOB’s Auditing Standard No. 2 contributed to  the challenges and higher costs in the first year of implementation of  section 404. PCAOB’s Auditing Standard No. 2 establishes new audit  requirements and governs both the auditor’s assessment of controls and its  attestation to management’s report. PCAOB first issued an exposure draft  of the standard for comment by interested parties on October 7, 2003. The  Board received 194 comment letters from a variety of interested parties,  including auditors, investors, internal auditors, public companies,  regulators, and others. Due to the time needed to draft the standard,  evaluate the comment letters, and finalize the standard, PCAOB did not  issue the final standard until March 2004—more than 8 months after SEC  issued its final regulations on section 404 and part way into the initial year  of implementation for accelerated filers. SEC, which under the act is  responsible for approving standards issued by PCAOB, did not approve  Auditing Standard No. 2 until June 17, 2004. As a result of both timing and  unfamiliarity with PCAOB’s Auditing Standard No. 2, auditors were not  prepared to integrate the internal control over financial reporting  attestation and financial audits in the first year of implementation as  envisioned by Auditing Standard No. 2.
Furthermore, according to PCAOB, auditors were not always consistent in  their interpretation and application of Auditing Standard No. 2. In  PCAOB’s report on the initial implementation of Auditing Standard No. 2,  the Board found that both auditors and public companies faced enormous  challenges in the first year of implementation arising from the limited time  frames for implementing the new requirements; a shortage of staff with  prior training and experience in designing, evaluating, and testing controls;  and related strains on available resources. The Board found that some  audits performed under these circumstances were not as effective or  efficient as they should have been. Auditing firms and a number of public  companies have stated that they expect subsequent years’ compliance  costs for section 404 to decrease.
section_title: Costs Associated with the Sarbanes-Oxley Act May Have Impacted the Decision of Some Smaller Public Companies to Go Private, but Other Factors also Influenced Decision to Go Private
paragraphs: Since the passage of the act in July 2002, the number of companies going  private (that is, ceasing to report to SEC by voluntarily deregistering their  common stock) increased significantly. As shown in figure 2, the number  of public companies that went private has increased significantly from 143  in 2001 to 245 in 2004, with the greatest increase occurring during 2003.  However, the 245 companies represented 2 percent of public companies as  of January 31, 2004. Based on the trends observed in 2003 and 2004 and  the 80 companies that went private in the first quarter of 2005, we project  that the number of companies going private will have risen more than 87  percent, from the 143 in 2001 to a projected 267 through the end of 2005.  Our analysis also indicated that companies going private during this entire  period were disproportionately small by any measure (market  capitalization, revenue, or assets).
The costs associated with public company status were most often cited as  a reason for going private (see table 2). While there are many reasons for a  company deregistering—including the inability to benefit from its public  company status—the percentage of deregistered companies citing the  direct cost associated with maintaining public company status grew from  12 percent in 1998 to 62 percent during the first quarter of 2005. These  costs include the accounting, legal, and administrative costs associated  with compliance with SEC’s reporting requirements as well as other  expenses such as those related to managing shareholder accounts. The  number of companies citing indirect costs, such as the time and resources  needed to comply with securities regulations, also has increased since the  passage of the Sarbanes-Oxley Act. In 2002, 64 companies that went  private cited cost as one of the reasons for the decision; however, that  number increased to 143 and 130 companies in 2003 and 2004,  respectively. Many of the companies mentioned both the direct and  indirect costs associated with maintaining their public company status.  Over half of the companies that cited costs mentioned the Sarbanes-Oxley  Act specifically (roughly 58 percent in 2004 and 2005 and 41 percent in  2003). For smaller public companies, the costs of complying with  securities laws likely required a greater portion of their revenues, and cost  considerations (indirect and direct) were the leading reasons for  companies exiting the public market, even prior to the enactment of the  Sarbanes-Oxley Act.
Further, the benefits of public company status historically appeared to  have been disproportionately smaller for smaller companies, companies  with limited need for external funding, and companies whose public  shares were traded infrequently or in low volume at low prices. As a  result, issues unrelated to the Sarbanes-Oxley Act, such as market and  liquidity issues and the benefits of being private, are also major reasons for  companies going private. From 1999 to 2004, more companies cited market  and liquidity issues than the indirect costs associated with maintaining  their public company status. Companies in this category cited a wide  variety of issues related to the company’s publicly traded stock such as a  lack of analyst coverage and investor interest, poor stock market  performance, limited liquidity (trading volume), and inability to use the  secondary market to raise additional capital. Smaller companies also  have cited advantages of private status such as greater flexibility, freedom  from the short-term pressures of Wall Street, belief that the markets had  consistently undervalued the company, and the ability to avoid disclosures  of information that might benefit their competitors (see app. II).
Companies that elect to go private reduce the number of financing options  available to them and must rely on other sources of funding. In aggregate,  equity is cheaper when it is supplied by public sources, net of any costs of  regulatory compliance. However, in some circumstances, private equity or  bank lending may be preferable alternatives to the public market.  Statistics suggest bank loans are the primary source of funding for U.S.  companies that rely on external financing. Some companies with  insufficient market liquidity had little opportunity for follow-on stock  offerings and going private would not have fundamentally altered the way  they raised capital. We found that almost 25 percent of the companies that  deregistered from 2003 through the end of the first quarter of 2005 were  not trading on any market at all (see fig. 3). Approximately 37 percent of  the companies that went private during this period were traded on the  Over-the-Counter Bulletin Board (OTCBB); the general liquidity of this  market is significantly less than major markets traded on the NASDAQ  Stock Market, Inc. (NASDAQ) or the New York Stock Exchange (NYSE).  Additionally, 14 percent were traded in the Pink Sheets and, therefore,  were most likely closely held and traded sporadically, if at all. Pink Sheets  LLC is not registered with SEC, has no minimum listing standards, does  not require quoted companies to provide detailed information to its  investors, and is regarded as high-risk by many investors. As a result,  trading on the Pink Sheets may produce negative reputational effects that  can further reduce liquidity and the market value of the company’s stock,  thereby increasing the cost of equity capital.
section_title: It Is Too Soon to Determine How Sarbanes- Oxley Affected Access to Capital for Smaller Public Companies
paragraphs: As previously discussed, a large number of smaller public companies have  not fully implemented all the requirements of the Sarbanes-Oxley Act,  notably non-accelerated filers (public companies with less than $75 million  in public float). As a result, it is unlikely that the act has affected access to  the capital markets for these companies. Moreover, the limited time that  the act’s provisions have been in force would limit any impact on access to  capital, even for the companies that have implemented section 404. For  instance, more than 80 percent of the smaller public companies that  responded to our survey indicated that the act has had no effect or that  they had no basis to judge the effect of the act on their ability to raise  equity or debt financing or on their cost of capital.
There are indications that the Sarbanes–Oxley Act at a minimum has  contributed to some smaller companies rethinking the costs and benefits  of public company status. For example, more than 20 percent of the  smaller companies that responded to our survey also stated that the act  encouraged them to consider going private or deregistering. In contrast, a  number of the smaller public companies that responded to our survey  cited positive effects associated with the implementation of the act,  notably positive impacts on audit committee involvement (60 percent),  company awareness of internal controls (64 percent), and documentation  of business processes (67 percent).
section_title: SEC and PCAOB Have Been Addressing Smaller Company Concerns Associated with the Implementation of Section 404
paragraphs: SEC and PCAOB have taken actions to address smaller public company  concerns about implementation of Sarbanes-Oxley Act provisions,  particularly section 404, by giving smaller companies more time to comply,  issuing or refining guidance, increasing communication and education  opportunities, and establishing an advisory committee on smaller public  companies. In particular, SEC has extended deadlines for complying with  section 404 requirements several times since issuing its final rule in 2003  (see table 3). In its final rulemaking on section 404 requirements, SEC  stated that it was sensitive to concerns that many smaller public  companies would experience difficulty in evaluating their internal control  over financial reporting because these companies might not have as formal  or well-structured a system of internal control over financial reporting as  larger companies. In November 2004, SEC granted “smaller” accelerated  filers an additional 45 days to file their reports on internal control over  financial reporting out of concern that these companies were not in a  position to meet the original deadline. SEC granted non-accelerated filers  two additional extensions in March 2005 and September 2005, with the  latter extension giving non-accelerated filers until their first fiscal year  after July 2007 before having to report under section 404. SEC also  considered the particular challenges facing smaller companies when  granting these extensions. Further, SEC noted that there were other small  business initiatives underway that could improve the effectiveness of non- accelerated company filers’ implementation of the section 404 reporting  requirements.
While SEC’s final rule serves as basic guidance for public company  implementation of section 404 requirements, PCAOB’s Auditing Standard  Number 2 provides the auditing standards and requirements for an audit of  the financial statements and internal control over financial reporting, as  part of an integrated audit. It is a comprehensive document that addresses  the work required by the external auditor to audit internal control over  financial reporting, the relationship of that work to the audit of the  financial statements, and the auditor’s attestation on management’s  assessment of the effectiveness of internal control over financial reporting.  The standard requires technical knowledge and professional expertise to  effectively implement.
While both SEC regulations and the PCAOB standard refer to COSO’s  internal control framework, many companies were unfamiliar with or did  not use this framework, despite the fact that public companies have been  required by law to have implemented a system of internal accounting  controls since 1977. According to SEC, smaller public companies and their  auditors had expressed concern that the COSO internal control framework  was designed primarily for larger public companies and smaller companies  lacked sufficient guidance on how they could use COSO’s internal control  framework, resulting in disproportionate section 404 implementation  costs. As a result, SEC staff asked COSO to develop additional guidance to  assist smaller public companies in implementing COSO’s internal control  framework in a small business environment. In October 2005, COSO issued  a draft of the guidance for public comment, and anticipated issuing final  guidance for smaller public companies in early 2006. The draft guidance  outlined 26 principles for achieving effective internal control over financial  reporting and provides examples on how companies can implement them.  The draft guidance states that the fundamental concepts of good internal  control over financial reporting are the same whether the company is large  or small. At the same time, the draft guidance points out differences in  approaches used by smaller companies versus their larger counterparts to  achieve effective internal control over financial reporting and discusses  the unique challenges faced by smaller companies. While intended to  provide additional clarity to smaller companies for implementing an  internal control framework, the guidance has received mixed reviews with  some questioning whether it will significantly change the disproportionate  cost and other burdens for smaller public companies associated with  section 404 compliance.
In December 2004, SEC announced its intention to establish its Advisory  Committee on Smaller Public Companies to assess the current regulatory  system for smaller companies under the securities laws, including the  impact of the Sarbanes-Oxley Act. In addition to granting companies more  time to meet the act’s requirements, SEC has been considering how its  section 404 guidance and overall approach to implementation might be  revised. SEC chartered the advisory committee on March 23, 2005. The  committee plans to issue its final report to SEC by April 2006.
On March 3, 2006, the committee published an exposure draft of its final  report for public comment that contained 32 recommendations related to  securities regulation for smaller public companies. Due to the number of  recommendations, the advisory committee refers to its 14 highest priority  recommendations as “primary recommendations.” One of its primary  recommendations is an overarching recommendation calling for a “scaled”  approach to securities regulation, whereby smaller public companies are  stratified into two groups, “microcap” and “smallcap” companies. Under  this recommendation, microcap companies would consist of companies  whose common stock in the aggregate make up the lowest 1 percent of  U.S. equity market capitalization. The advisory committee estimates, based  on data from SEC’s Office of Economic Analysis, that the microcap  category would include public companies whose individual market  capitalization is less than $128 million, approximately 53 percent of all U.S.  public companies. For the smallcap category, the advisory committee  estimates that the category would include public companies whose  individual market capitalization is less than $787 million and greater than  $128 million, and would encompass an additional 26 percent of U.S. public  companies and an additional 5 percent of U.S. market capitalization.  Taken together, the categories of microcap and smallcap companies, as  defined by the advisory committee draft recommendations, would include  approximately 79 percent of all U.S. public companies and 6 percent of  market capitalization, according to the advisory committee’s analysis of  SEC data. The recommendation calling for a scaled approach for securities  regulation based on company size was also incorporated into the  committee’s preliminary recommendations related to internal control over  financial reporting.
While acknowledging that some have questioned whether smaller public  companies’ problems with section 404 have been overstated, the advisory  committee concluded that section 404, as currently structured, “represents  a clear problem for smaller public companies and their investors, one for  which relief is urgently needed.” In part, the advisory committee based  its conclusion on a belief that smaller public company compliance with  section 404 has resulted in disproportionate costs and less certain  benefits.
The advisory committee’s primary recommendations related to internal  control over financial reporting address regulatory relief from section 404  for a subset of the microcap and smallcap categories described above by  the inclusion of revenue criteria. Specifically, the committee’s  preliminary recommendations are that:    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 all of the  requirements of section 404 of the Sarbanes-Oxley Act to microcap  companies with less than $125 million in annual revenue and to smallcap  companies with less than $10 million in annual product revenue.
Unless and until a framework for assessing internal control over financial  reporting for smallcap companies is developed that recognizes the  characteristics and needs of those companies, provide exemptive relief  from section 404(b) of the act—the external auditor involvement in the  section 404 process—to smallcap companies with less than $250 million  but greater than $10 million in annual product revenues and microcap  companies with between $125 million and $250 million in annual revenues.
By including the revenue criteria, the committee’s recommendations  regarding section 404 cover a subset of the public companies included  within its microcap and smallcap definitions. The committee estimated  that, after applying the revenue criteria, 4,641 “microcap” public  companies (approximately 49 percent of 9,428 public companies identified  in data developed for the advisory committee by SEC’s Office on  Economic Analysis) may potentially qualify for full exemption from  section 404 and another 1,957 “smallcap” public companies  (approximately 21 percent of the SEC-identified public companies)—a  total of 70 percent of SEC-identified public companies—may potentially  qualify for exemption from the external audit requirement of section  404(b). It is likely that a number of public companies that would qualify  for exemptive relief under the committee’s recommendations have  probably already complied with both sections of 404(a) and (b), based on  their status as accelerated filers.
If adopted, these recommendations would effectively establish a “tiered  approach” for compliance with section 404, “unless and until” a framework  for assessing internal control over financial reporting is developed for  microcap and smallcap companies. Under the tiered approach, larger  public companies that do not meet the committee’s size criteria for  exemption would continue to be required to comply with both section  404(a)—management’s assessment of and reporting on internal control  over financial reporting—and section 404(b)—the external auditors’  attestation on management’s assessment and the effectiveness of the  company’s internal control. “Smallcap” public companies that meet the  revenue criteria would be exempt from complying with section 404(b), but  the companies would still be required to comply with section 404(a).  “Microcap” and some “smallcap”companies that meet the revenue criteria  would be entirely exempt from both section 404(a) and (b). The  committee’s two primary recommendations related to regulatory relief  from section 404 for smaller public companies also include additional  requirements that affected public companies apply additional corporate  governance provisions and report publicly on known material internal  control weaknesses.
In its next primary recommendation on internal control over financial  reporting, which is premised on the adoption of the recommendation for  microcap companies described above, the committee acknowledged that  SEC might conclude, as a matter of public policy, that an audit  requirement is necessary for smallcap companies. In that case, the  committee recommended SEC provide for the external auditor to perform  an audit of only the design and implementation of internal control over  financial reporting, which by its nature would be more limited than the  audit of the effectiveness of internal control over financial reporting  required by section 404(b) and PCAOB’s Auditing Standard No. 2, and that  PCAOB develop a new auditing standard for such an engagement. While  this recommendation is based on the view that having the external auditor  perform a review of the design and implementation of internal control  over financial reporting would be more cost-effective than the work  otherwise required under Auditing Standard No. 2, the committee’s report  does not address the extent to which costs for such a review would be  lower than that required under Auditing Standard No. 2 and whether the  lower costs would be worth the reduced assurances provided by reduced  scope of the external auditors’ work on internal control over financial  reporting.
While not specifically focused on small business issues, SEC also  conducted a public “roundtable” in April 2005 that gave public companies,  accounting firms, and others an opportunity to provide feedback to SEC  and PCAOB on what went well and what did not during the first year of  section 404 implementation. GAO also participated in this roundtable.  Following the roundtable, the SEC and PCAOB Chairmen noted the  importance of section 404 requirements but acknowledged that initial  implementation costs had been higher than expected and noted the need  to improve the cost-benefit equation for small and mid-sized companies.  Both agencies issued additional guidance in May 2005 based on findings  from the roundtable. PCAOB’s guidance clarified that auditors (1) should  integrate their audits of internal control over financial reporting with their  audits of the client’s financial statements, (2) exercise judgment and tailor  their audit plans to best meet the risks faced by their clients rather than  relying on standardized “checklists,” (3) use a top-down approach  beginning with company-level controls and use the risk assessment  required by the standard, (4) take advantage of the work of others, and (5)  engage in direct and timely communication with their audit clients, among  other matters. Guidance by SEC and its staff emphasized the need for  reasonable assurance, risk-based assessments, better communication  between the auditor and client, and clarified what should be in material  weakness disclosures. Representatives of the smaller public companies  that we interviewed indicated that the additional guidance that SEC and  PCAOB issued was helpful. SEC and PCAOB plan to hold a second  roundtable in May 2006 to discuss companies’ second year experiences  with implementing section 404. Both chairs of SEC and PCAOB have said  that they would consider additional guidance if necessary.
On November 30, 2005, PCAOB also issued a report on the initial  implementation of its auditing standard on internal control over financial  reporting. The report included observations by PCAOB—based in  significant part, but not exclusively, on its inspections of public  accounting firms, which in the 2005 cycle included a review of a limited  selection of audits of internal control over financial reporting—on why the  internal control audits were not as efficient or effective as the standard  intended. PCAOB also amplified the previously issued guidance of May  2005, discussing how auditors could achieve more effective and efficient  implementation of the standard.
Further, PCAOB has held a series of forums nationwide to educate the  small business community on the PCAOB inspections process and the new  auditing standards. The goal of the forums was to provide small  accounting firms and smaller public companies an opportunity to discuss  PCAOB-related issues with Board members and staff. PCAOB also  established a Standing Advisory Group to advise PCAOB on standard- setting priorities and policy implications of existing and proposed  standards. The Standing Advisory Group has considered ways to improve  the application of its internal control over financial reporting  requirements—Auditing Standard No. 2—with respect to audits of smaller  public companies.
Finally, both SEC and PCAOB have acknowledged the challenges that  smaller public companies faced and continue to face in implementing  section 404 and have begun to address those challenges. SEC also has  emphasized that smaller companies need to focus on the quality of their  internal control over financial reporting. Data provided by SEC’s Office of  Economic Analysis and other studies have pointed to the increased level  of restatements as an indicator that the Sarbanes-Oxley Act—section 404  in particular—has gotten companies to identify and correct weaknesses  that led to financial reporting misstatements in prior fiscal years. For  example, according to recent research conducted by Glass, Lewis and Co.,  the restatement rate for smaller public companies was more than twice  the rate for the largest public companies (9 percent for companies with  revenues of less than $500 million and 4 percent for companies with more  than $10 billion). SEC staff also noted that smaller public companies had  a disproportionately higher rate of material weaknesses in internal control  over financial reporting during the first year of implementing section 404.  Our discussions with accounting firms confirmed that smaller public  companies have had a higher rate of reported material weaknesses in  internal control over financial reporting than larger public companies.
A major challenge in considering any regulatory relief from section 404 is  that the overriding purpose of the Sarbanes-Oxley Act is investor  protection. Investor confidence in the integrity and reliability of financial  reporting is a critical element for the efficient functioning of our capital  markets. The purpose of internal control over financial reporting is to  provide reasonable assurance over the integrity and reliability of the  financial statements and related disclosures. Market reactions to financial  misstatements illustrate the importance of accurate financial reporting,  regardless of a company’s size.
Given the anticipated regulatory changes, particularly those relating to  section 404’s internal control reporting requirements, smaller public  companies may be limiting or not taking definitive actions to improve  internal control over financial reporting based on a perception that they  could become exempt from section 404. Further, PCAOB officials noted  that such a perception may have limited smaller business involvement in  PCAOB forums.
section_title: Sarbanes-Oxley Act Requirements Minimally Affected Smaller Private Companies, Except for Those Seeking to Enter the Public Market
paragraphs: While the act does not impose new requirements on privately held  companies, companies choosing to go public realistically must spend  additional time and funds in order to demonstrate their ability to comply  with the act, section 404 in particular, to attract investors. This may have  been a contributing factor in the reduction of the number of initial public  offerings (IPO) issued by small companies since 2002. However, other  factors—stock market performance and changes in listing standards— likely also have affected the number of IPOs. While a number of states  proposed legislation with provisions similar to the Sarbanes-Oxley Act,  three states actually enacted legislation requiring private companies or  nonprofit organizations to adopt requirements similar to certain Sarbanes- Oxley Act provisions. Finally, some privately held companies have been  adopting the act’s enhanced governance practices because these  companies believe these practices make good business sense.
subsections: section_title: Sarbanes-Oxley May Have Affected IPO Activity; however, Other Important Factors also Influence Entry into the Public Market and Access to Capital
paragraphs: Small businesses that are not public companies typically rely on a variety  of sources to finance their operations, including personal savings, credit  cards, and collateralized bank loans. In addition, small businesses can use  private equity capital sources such as venture capital funds—private  partnerships that provide private equity financing to early- and later-stage  high-growth small businesses—to fund their growth. Small businesses may  also issue equity shares to other types of investors to finance further  growth. These shares may be sold through private placements where  shares are sold directly to investors (direct placement) or through a public  offering where the shares are sold through an underwriter (going public).  In addition, some small companies issue equities that trade on smaller  markets such as the Pink Sheets. For those private companies desiring to  enter the public market, the IPO process has always been recognized as a  time-consuming and expensive endeavor.
However, venture capitalists and private company officials told us that, as  a result of the act and other market factors, many private companies have  been spending additional time, effort, and money to convince investors  that they can meet the requirements of the act. For example, investors  have become more cautious and demanding of the private companies in  which they invest. Consequently, private companies have hired auditors  and additional staff to make substantial changes to their financial system  and data-reporting capabilities, document internal controls and processes,  and review or change accounting procedures.
According to venture capitalists and private company officials with whom  we spoke, a private company’s ability to meet the Sarbanes-Oxley Act’s  requirements can significantly decrease some of the investment risk  associated with becoming a public company. For example, both groups  told us that companies with well-documented internal control and  governance policies were more attractive and able to secure investor  funding at a much lower cost. Moreover, they noted that underwriters  expected private companies to consider and comply with the act well in  advance of going public. If a private company were unable to meet the  act’s requirements, venture capitalists would want the company to show  evidence of a plan for becoming compliant as soon as the company  became public. If not, venture capitalists noted that they would be less  likely to invest in such a company and look elsewhere for investment  opportunities.
These new expectations may have served to increase the expenses  associated with the IPO process through changes in the professional fees  charged by auditors and potentially other costs as well. Specifically, we  found that there has been a disproportionate increase for the smallest  companies when IPO expenses were viewed as a percentage of revenue.  As shown in table 4, the direct expenses (excluding underwriting fees)  associated with the IPO represented a significant portion of a small  company’s revenues, relative to larger companies, from 1998 through the  second quarter of 2005. These expenses have increased disproportionably  since 2002 for small companies going public—especially for the smallest of  these companies ($25 million or less in revenues). While Sarbanes-Oxley  Act requirements could explain some of this increase, legal, exchange  listing, printing, and other fees unrelated to the act could also account for  this increase. Moreover, other market factors also could explain the  increase in IPO expenses paid to auditors.
In addition to the requirements of the Sarbanes-Oxley Act and the general  increase in direct expenses, other important factors likely have influenced  IPO activity. To illustrate, the downward trend in IPOs occurred before the  passage of the Sarbanes-Oxley Act in mid-2002. It is widely acknowledged  that IPO filings and pricings tend to be closely associated with stock  market performance. As shown in figure 4, companies generally issued  (priced) significantly more IPOs when stock market valuations were  higher.
Companies with smaller reported revenues now make up a smaller share  of the IPO market. The number of IPOs by companies with revenues of $25  million or less decreased substantially, from 70 percent of all IPOs in 1999  to about 48 percent in 2004 and 31 percent during the first two quarters of  2005. Venture capitalists told us that, on average, a private company had to  demonstrate at least 6 quarters of profitability before it could go public  and hire an auditor to carry it through the IPO process. According to the  venture capitalists, an increasing number of small and mid-sized private  companies have been pursuing mergers and acquisitions as a means of  growing without going through the IPO process, which now typically costs  more than a merger or acquisition.
section_title: Potential Spillover Effects of the Sarbanes-Oxley Act on Private Companies Have Been Minimal
paragraphs: While the Sarbanes-Oxley Act has increased corporate governance and  accountability awareness throughout business and investor communities,  our research and discussions with representatives of financial institutions  suggest that financiers are not requiring privately held companies to meet  Sarbanes-Oxley Act requirements as a condition to obtaining access to  capital or other financial services. For example, the representatives said  they emphasize utilization of credit scoring to make decisions and may  make lending decisions using “personal guarantees” in lieu of audited  financial statements and reported cash flow on financial statements for the  smallest private companies. For larger private companies, the  representatives stated that they require audited financial statements and  cash flow information, but that their lending requirements existed well  before the Sarbanes-Oxley Act and have not changed as a result of its  passage. Overall, they noted that they do not believe that the act has  affected the way financial institutions and lenders conduct business with  private companies. They also noted that financial institutions and lenders  have always enjoyed the freedom to obtain virtually any information about  a potential borrower and to inquire about the company’s financial  reporting process and corporate governance practices. For example, if it  were considered necessary to help determine a company’s ability repay a  debt, a lender could ask the company to provide copies of any corporate  governance guidelines, business ethics policies, and key committee  charters that the company had adopted.
Immediately following the act’s passage, several states proposed  legislation to enact corporate governance and financial reporting reforms  for private companies and nonprofit organizations. Specifically, several  state legislatures proposed instituting requirements similar to those in the  Sarbanes-Oxley Act for privately held state-registered companies.  Subsequently, three states—Illinois, Texas, and California—passed  legislation that mandates corporate governance and accountability  requirements that resemble certain provisions of the Sarbanes-Oxley Act.  For example, Illinois passed legislation in 2004 that requires enhanced  disclosures for certain nonpublic companies and additional licensing  requirements for certified public accountants and, in 2003, Texas passed  legislation that imposes strict ethics and disclosure requirements for  outside financial advisors and service providers, public or private, that  provide financial services to the state government. On September 29, 2004,  California adopted the Nonprofit Integrity Act of 2004, becoming the first  state in the nation to require nonprofit organizations to meet requirements  that resemble some provisions of the Sarbanes-Oxley Act. For instance,  nonprofits with gross revenues of $2 million or more operating within the  state of California currently are required to have independent auditors  and, in the case of charitable corporations, audit committees. Further, two  other states—Nevada and Washington—have passed legislation that  require accounting firms to retain work papers for 7 years for audits of  both public and private companies. Furthermore, based on our research  and discussions with representatives from the National Association of  State Boards of Accountancy, we found that some state boards made  changes to regulations that focus on key governance and accountability  issues similar to those mandated by the Sarbanes-Oxley Act. For example,  New Jersey adopted enhanced peer review requirements and Tennessee  instituted additional work paper retention requirements for certified  public accountants.
Based on our discussions with private equity providers and private  company officials, it appears that some privately held companies  increasingly have incorporated certain elements of the Sarbanes-Oxley Act  into their governance and internal control policies. Specifically, they have  adopted practices such as CEO/CFO financial statement certification,  appointment of independent directors, corporate codes of ethics,  whistleblower procedures, and approval of nonaudit services by the board.  According to these officials, some private companies have reported  receiving pressure from board members, auditors, attorneys, and investors  to implement certain “best practice” policies and guidelines, modeled after  the requirements of the act. They noted that the act has raised the bar for  what constitutes best practices in corporate governance and for  expectations regarding internal control. Additionally, the officials told us  that some private companies may have chosen to voluntarily adopt certain  practices that resemble Sarbanes-Oxley Act provisions to satisfy external  auditors and legal counsel looking for comparable assurances to reduce  risk, increase confidence, and improve credibility with many stakeholders.  Based on our research, we found that many of the aspects of corporate  governance reform currently being adopted by private companies were  those relatively inexpensive to implement, but information on the specific  costs associated with adopting these provisions was not available.
section_title: Smaller Companies Appear to Have Been Able to Obtain Needed Auditor Services, Although the Overall Audit Market Remained Highly Concentrated
paragraphs: Since the enactment of the Sarbanes-Oxley Act, smaller public companies  have been able to obtain needed auditor services; however, auditor  changes suggest smaller companies have moved from using the services of  a large accounting firm to using services of mid-sized and small firms.  Some of this activity has resulted from the resignation of large accounting  firms from providing audit services to small public companies. Reasons for  these changes range from audit cost and service concerns cited by  companies to client profitability and risk concerns cited by accounting  firms, including capacity constraints and assessments of client risk. In  recent years, public accounting firms have been categorized into three  categories—the largest firms, “second tier” firms (mid-sized), and regional  and local firms (small).  From 2002 to 2004, 1,006 companies reported  auditor changes involving a departure from a large accounting firm. Over  two-thirds of these companies reported switching to a mid-sized or small  accounting firm. Most of the companies that switched to a mid-sized or  small accounting firm were smaller public companies with market  capitalization or revenues of $250 million or less. Overall, mid-sized and  small accounting firms conducted 30 percent of the total number of public  company audits in 2004—up from 22 percent in 2002. Despite client gains  for mid-sized and small firms, the overall market for audit services  remained highly concentrated, with mid-sized and smaller firms auditing  just 2 percent of total U.S. publicly traded company revenue. In the long  run, mid-sized and small accounting firms could increase opportunities to  enhance their recognition and acceptance among capital market  participants as a result of the gains in public companies audited and  operating under PCAOB’s registration and inspection process.
subsections: section_title: Smaller Companies Found It Harder to Keep or Obtain the Services of a Large Accounting Firm, but Overall Access to Audit Services Appeared Unaffected
paragraphs: Our limited review did not find evidence to suggest that the Sarbanes- Oxley Act has made it more difficult for smaller public companies to  obtain needed audit services, but did suggest that smaller public  companies may have found it harder to retain a large accounting firm as a  result of increased demand for auditing services, largely due to the  implementation of section 404 and other requirements of the act, and the  capacity limitations of the large accounting firms. Of the 2,819 auditor  changes from 2003 through 2004 that we identified using Audit Analytics  data, 79 percent were made by companies that represented the smallest of  publicly listed companies (companies with $75 million or less in market  capitalization or revenue). Although fewer mid-sized and small  accounting firms conducted public company audits in 2004 because some  firms did not register with PCAOB or merged with other firms, the market  appears to have absorbed these changes effectively, with other firms  taking on these clients.
section_title: Recent Auditor Changes Resulted in Small Accounting Firms Gaining Clients
paragraphs: Our analysis showed that 1,006 of the 2,819 changes, or 36 percent,  involved departures from a large accounting firm. Of the 1,006 auditor  changes, less than one-third (311 or 31 percent) resulted in the public  company moving to another large accounting firm, and slightly under two- thirds (651 or 65 percent) retained a mid-sized or small accounting firm  (see table 5).
Over the same period, mid-sized and small accounting firms lost fewer  public company clients to the large accounting firms; as a result, mid-sized  and small firms experienced a net increase of 510 public company  clients—a net gain of 161 and 349 companies for mid-sized and smaller  firms, respectively. Because we had no data on companies’ selection  processes, we could not determine whether mid-sized and small firms  competed for these clients with other large accounting firms or if they  received these clients by default with no competition from the other large  accounting firms. According to Who Audits America, small and mid-sized  accounting firms increased their percentage public company audit from 22  percent in 2002 to 27 percent in 2003, and by 2004 they audited 30 percent  of all U.S. publicly traded companies. Small and mid-sized firms audited  over 38 percent of all public clients in 2004 according to Audit Analytics  data, which include, in addition to publicly traded companies, other SEC  reporting companies including foreign registered entities, registered funds  and trusts, and registered public companies that are not publicly traded.
The majority of the clients the mid-sized and small firms gained were  smaller companies with market capitalization or revenues averaging  $200 million or less. As shown in table 5 and figure 5, the companies  leaving a large accounting firm and retaining another large firm tended to  be very large—with average market capitalization (or revenue) of more  than $1 billion. However, the average market capitalization (or revenue) of  companies leaving a large accounting firm and retaining a mid-sized  accounting firm was less than $175 million and the capitalization (or  revenue) of companies retaining a small firm was significantly smaller— less than $53 million. Similarly, companies leaving smaller and mid-sized  firms that retained a large accounting firm tended to be much larger than  those that retained another mid-sized or small firm.
section_title: Reasons for Auditor Changes May Have Included Costs Related to the Act and Risk Assessments
paragraphs: While the reasons for the movement of smaller public companies to mid- sized and small accounting firms may be somewhat speculative at this  point, the Sarbanes-Oxley Act may have contributed to this shift. Some  smaller companies may have preferred a large firm because of the  perception that large accounting firms—by virtue of their reputation or  perceived skills—can help attract investors and improve access to  capital. Workload demands placed on the large firms by larger public  companies, which represent the overwhelming majority of their clients,  have increased with section 404 and other Sarbanes-Oxley Act  implementing regulations. The resulting increases in workload and audit  fees appear to have constrained smaller companies’ access to large  accounting firms—either because smaller companies were unable to  afford a large accounting firm or because large accounting firms resigned  from smaller clients. According to Audit Analytics, the largest accounting  firms resigned from three times as many clients in 2004 as in 2001, and  three-quarters of those were companies with revenues of less than $100  million.
Beyond resignations by large accounting firms in response to increased  demand for audit services, the act may have caused large accounting firms  to reevaluate the risk in their aggregate client portfolios by increasing the  responsibilities and liability of auditors, leading them to shed smaller  public companies. According to the large accounting firms with whom we  spoke, they did not have enough resources to retain all of their clients  after the Sarbanes-Oxley Act and cited risk as a significant factor in  choosing which clients to keep. Moreover, the largest audit firms could  be applying stricter profitability guidelines in selecting their clients,  eliminating those engagements where profit margins are smaller.
While former clients of large accounting firms may represent opportunities  for mid-sized and small accounting firms, they also represent some risks.  For example, we found that a disproportionate percentage of the  companies that left a large accounting firm for a small firm had accounting  or risk issues. Overall, about 69 percent of the companies that left a large  accounting firm switched to a mid-sized or small accounting firm.  However, 92 percent of the companies that received a going concern  qualification went to a mid-sized or small accounting firm. In addition,  about 81 percent of the companies with at least one accounting issue  (such as restatement, reportable condition, scope limitation, management  found to be unreliable, audit opinion concerns, illegal acts, or SEC  investigation) went from a large to a mid-sized or small accounting firm. In  contrast, 63 percent of the companies with no going concern qualification  or any additional “risk” issues went to mid-sized and small firms. We also  found that, if a large accounting firm resigned as the auditor of record, the  company was more likely to switch to a mid-sized or small accounting  firm. Roughly 85 percent of the smallest companies that were dropped by  one of the largest accounting firms retained a smaller audit firm.
section_title: Mid-sized and Small Accounting Firms Continued to Operate in a Highly Concentrated Market
paragraphs: Although mid-sized and small accounting firms gained clients in 2003 and  2004, they continued to operate in a market dominated by large accounting  firms. The market for audit services in 2004 changed little from the market  we described in our 2003 report. For example, mid-sized and small  accounting firms increased their share of all public company revenues by 1  percentage point in 2002–2004. The market for audit services remained  highly concentrated—a tight oligopoly, where in 2004 the four largest  firms audited 98 percent of the market and the remaining firms audited 2  percent—and the potential market power was significant.
The market for smaller public company audits was much more  competitive than the overall and large public company market. As shown  in figure 6, while the market for audit services for large company clients  remained dominated by large accounting firms, the market for the smallest  public company clients appeared to indicate healthy competition. Mid- sized and small firms audited 59 percent of all public company clients with  revenues of $25 million or less, 45 percent of all clients with revenues  greater than $25 million up to $50 million, and 32 percent of all clients with  revenues greater than $50 million up to $100 million. When these revenue  categories were combined, the large accounting firms combined with the  mid-sized firms audited 75 percent of companies with revenues of $100  million or less, while the small firms audited the remaining 25 percent. As  noted in our 2003 report, as companies expanded operations around the  world, the large audit firms globally expanded through mergers in order to  provide service to their international clients.
More recently, mid-sized and small accounting firms gained more large  clients. In 2004, these accounting firms audited approximately 3 percent of  the companies with revenues greater than $500 million, up from 2 percent  in 2002. However, as shown in table 5, the average revenue of the clients  lost to the largest accounting firms was $1.1 billion while the average  revenue of the client gained from the largest accounting firms was $138.8  million. Overall, mid-sized and small accounting firms conducted 30  percent of the total number of public company audits in 2004—up from 22  percent in 2002. While these companies make up just 2 percent of total  public company revenue, they are a large segment of the market of  publicly traded clients.
section_title: Sarbanes-Oxley Act May Impact the Continuing Competitive Challenges Faced by Mid-Sized and Small Accounting Firms
paragraphs: According to some experts, competitive challenges related to the ability of  mid-sized and small firms to compete for public companies such as  capacity, expertise, recognition, and litigation risks may have been  strengthened since the passage of the Sarbanes-Oxley Act. For example,  in a recent American Assembly report, a number of industry professionals  indicated that large accounting firms’ facility with new requirements was  seen as increasingly important as audits have become more complex and  time-consuming and the financial consequences of noncompliance more  severe.
Additionally, even though some experts believe that large accounting  firms’ regulatory competence has been overstated, a perception may exist  among many large and some small U.S. companies as well as other market  influencers and stakeholders that only the large accounting firms can  provide the required auditing services necessary to meet the requirements  of the act. For example, the venture capital industry representatives that  we spoke with stated that this perception has been especially prevalent for  companies issuing IPOs. As shown in figure 7, companies large and small  tended to use large accounting firms for IPOs.
Over the long run, the Sarbanes-Oxley Act could ease some of these  challenges. For example, mid-sized and small accounting firms have  continued to confront the perceptions of capital market participants that  only large firms have the skills and resources necessary to perform public  company audits. These perceptions have constrained firms from obtaining  or retaining many clients that the firms believed were within their capacity  to audit. However, the increase in public company audits performed by  mid-sized and small accounting firms has given these firms additional  opportunities to enhance their recognition and acceptance among more  public companies and capital market participants. Also, as smaller public  companies begin complying with section 404 in 2007, small accounting  firms will gain additional experience with the implementation of the act.  Taking on additional clients will provide an important growth opportunity.  Effectively matching company size and needs with accounting firm size  and capabilities could allow smaller public companies to find the best  combination of quality, service value, and reach.
In addition, the PCAOB registration and inspection process and the  establishment of attestation, quality control, and ethics standards to be  used by registered public accounting firms in the preparation and issuance  of audit reports could provide increased assurance of the quality of small  accounting firm audits. Similarly, as more information will become  available through PCAOB’s ongoing inspection program, small accounting  firms could establish a “track record,” allowing for additional  opportunities for recognition and acceptance among analysts, investment  bankers, investors, and public companies.
section_title: Conclusions
paragraphs: The Sarbanes-Oxley Act was a watershed event—strengthening disclosure  and internal control requirements for financial reporting, establishing new  auditor independence standards, and introducing new corporate  governance requirements. Regulators, public companies, audit firms, and  investors generally have acknowledged that many of the act’s provisions  have had a positive and significant impact on investor protection and  confidence. Yet, for smaller public companies and companies of all sizes  that have complied with the various provisions of the Sarbanes-Oxley Act,  compliance costs have been higher than anticipated—with the higher cost  being associated with the internal control over financial reporting  requirements of section 404.
There is widespread agreement that several factors contributed to the  costs of implementing section 404 for both larger and smaller public  companies. Few public companies or their audit firms had prior direct  experience with evaluating and reporting on the effectiveness of internal  control over financial reporting or with implementing the COSO internal  control framework, particularly in a small business environment. This was  despite previous requirements, dating back to 1977, that public companies  implement a system of internal accounting controls. The first year costs  were exacerbated because many companies were documenting their  internal control over financial reporting for the first time and remediating  poor or nonexistent internal controls as part of their first-year  implementation efforts to comply with section 404, both of which could be  viewed as a positive impact of the act. In addition, the nature, timing, and  extent of available guidance on establishing and assessing internal control  over financial reporting made it more difficult for most public companies  and audit firms to efficiently and effectively implement the requirements  of section 404. As a result, management’s implementation and assessment  efforts were largely driven by PCAOB’s Auditing Standard No. 2, as  guidance at a similar level of detail was not available for management’s  implementation and assessment process. These factors, in conjunction  with the changed environment and expectations resulting from the act,  contributed to a considerable amount of “learning curve” activities and  inefficiencies during the initial year of implementation. Auditing firms and  a number of public companies have stated that they expect subsequent  years’ compliance costs for section 404 to decrease. This is not  unexpected given the significance and nature of the changes and a  preexisting environment that did not place enough emphasis on effective  internal control over financial reporting.
Consistent with the findings of the Small Business Administration on the  impact of regulations generally on smaller public companies, it is  reasonable to conclude that smaller public companies face  disproportionately greater costs, as a percentage of revenues, than larger  companies in meeting the requirements of the act. While facing the same  basic requirements, smaller public companies generally have more limited  resources, fewer shareholders, and generally less complex structures and  operations. Again, this is to be expected given the economies of scale and  differing levels of corporate infrastructure and resources. However, some  of the unique characteristics of smaller companies can create  opportunities to efficiently achieve effective internal control over financial  reporting. Those characteristics include more centralized management  oversight of the business, more involvement of top management in the  business operations, simpler operations, and limited geographic locations.
The ultimate impact of the Sarbanes-Oxley Act on the majority of smaller  public companies remains unclear because the time frame to comply with  section 404 of the act was extended until fiscal years ending after July  2007 for the approximately 5,971 public companies with less than   $75 million in public float. Recognizing the challenges that smaller public  companies have faced in meeting the requirements of the act, particularly  section 404, SEC formed an advisory committee on smaller public  companies to analyze the impact of the act and other securities laws on  smaller public companies. The advisory committee has issued an exposure  draft of its final reporting stating that certain smaller public companies  need relief from section 404, “unless and until” a framework for assessing  internal control over financial reporting is developed that recognizes the  characteristics and needs of smaller public companies. The exposure draft  contains specific recommendations that would essentially result in a  “tiered approach” for compliance with section 404 requirements, where  larger public companies would continue to be required to fully comply  with all requirements of section 404, while smaller public companies  consisting of “microcap” and “smallcap” companies would be granted  differing levels of exemptions until an adequate framework was in place.
We have two specific concerns regarding the advisory committee’s  recommendations. First, the recommendations propose relief “unless and  until a framework for assessing internal control over financial reporting”  for smaller companies is developed that “recognizes the characteristics  and needs of those companies.” While the recommendations hinge on the  need for a framework that recognizes smaller public company  characteristics and needs of smaller public companies, they do not  address what needs to be done to establish such a framework or how such  a framework should take into consideration the characteristics and needs  of smaller public companies. Many, if not most, of the significant problems  and challenges encountered by large and small companies in implementing  section 404 related to problems with implementation, rather than the  internal control framework itself. In addition to having a useful internal  control framework, appropriate implementation of a framework by public  companies must be based on risk, facts and circumstances, and  professional judgment. We believe that sufficient guidance covering both  the internal control framework and the means by which it can be  effectively implemented is essential to enable large and small public  companies to implement a framework which would enable effective and  efficient assessment and reporting on the effectiveness of internal control  over financial reporting.
Our second concern relates to the ambiguity surrounding the conditional  nature of the “unless and until” provisions of the recommendations and its  potential impact on a large number of companies that would likely qualify  for the proposed exemptions. If resolution of small public company  concerns about a framework and its implementation results in an  extended period of exemption, then large numbers of public companies  would potentially be exempted for additional periods from complying with  this important investor protection component of the act. The categories of  microcap and smallcap companies, as defined by the advisory committee  recommendations, cover 79 percent of U.S. public companies and   6 percent of the U.S. equity market capitalization when combined.  Although the categories of microcap and smallcap have been further  refined by the advisory committee through the addition of a revenue size  filter for purposes of its primary recommendations on section 404, it  appears that a large number of companies, up to 70 percent of all U.S.  public companies, would be potentially exempted. Specifically, the  committee estimates that, after applying the revenue criteria, 4,641 “micro  cap” public companies (approximately 49 percent of 9,428 public  companies identified in data developed for the advisory committee by  SEC’s Office on Economic Analysis) may potentially qualify for the  proposed full exemption from section 404 and another 1,957 “smallcap”  public companies (approximately 21 percent of the identified public  companies) may potentially qualify for the proposed exemption from the  external audit requirement of section 404(b). These estimates do not  include those public companies trading on the Pink Sheets that would be  covered by the Advisory Committee’s preliminary recommendations. In  addition, it is likely that a number of public companies qualifying for  exemptive relief under the committee’s recommendations are likely to  have already complied with both sections of 404(a) and (b) of the act  under the current category of accelerated filers.
Also, regarding the committee’s third primary internal control  recommendation calling for a review of the design and implementation of  internal control if SEC concludes, as a matter of public policy, that the  external auditor’s involvement is required, it is not clear from the  committee’s report the extent to which, particularly in the present  environment, such a review would result in lower costs than those being  associated with the implementation of PCAOB’s Auditing Standard No. 2.  Any lower costs that might result must be considered in light of the  reduced independent assurances on the effectiveness of internal control  over financial reporting that would result and the potential for confusion  on the part of users of the public company’s financial statements and audit  reports.
Until sufficient guidance is available for smaller public companies, some  interim regulatory relief on a limited scale may be appropriate. However,  given the number of public companies that would potentially qualify for  relief under the recommendations being considered, we believe that a  significant reduction in scope of the proposed relief needs to occur to  preserve the overriding investor protection purpose of the Sarbanes-Oxley  Act. The purpose of internal control over financial reporting is to provide  reasonable assurance over the integrity and reliability of the financial  statements and related disclosures. Public and investor confidence in the  fairness of financial reporting is critical to the effective functioning of our  capital markets. Market reactions to financial statement misstatements  illustrate the importance of accurate financial reporting, regardless of a  company’s size. SEC staff and others have pointed to the increased level of  restatements as an indicator that the Sarbanes-Oxley Act—section 404 in  particular—has prompted companies to identify and correct weaknesses  that led to financial reporting misstatements in prior fiscal years.
Indicators also show that in some respects, smaller companies have a  higher risk profile for investors. For instance, smaller public companies  have higher rates of restatements generally and showed a  disproportionately higher rate of reported material weakness in internal  control over financial reporting during the initial year of section 404  implementation. Over time, having the effective internal control over  financial reporting envisioned by the act can reduce some aspects of the  higher risk profile of smaller public companies.
When SEC receives and considers the final recommendations of SEC’s  small business advisory committee, it is essential that SEC consider key  principles, under the umbrella principle of investor protection, when  deciding whether or to what extent to provide smaller public companies  with alternatives to full implementation of the section 404 requirements.  These principles include (1) assuring that smaller public companies have  sufficient useful guidance to implement, assess, and report on internal  controls over financial reporting to meet the requirements of section 404,  (2) if additional relief is considered appropriate, conducting further  analysis of small public company characteristics to significantly reduce  the scope of companies that would qualify for any type of additional relief  while working to ensure that the Sarbanes-Oxley Act’s goal of investor  protection is being met, and (3) acting expeditiously such that smaller  public companies are encouraged to continue improving their internal  control over financial reporting.
First, it is critical that SEC carefully assess the available guidance,  including that being developed by COSO, to determine whether it is  sufficient or whether additional action needs to be taken, such as issuing  supplemental or clarifying guidance to smaller public companies to help  them meet the requirements of section 404. Our analysis of available  research and discussions with smaller public companies and audit firms  indicate that public companies and external auditors have had limited  practical experience with implementing internal control frameworks in a  smaller company environment and that additional guidance is needed.  Moreover, it is critical that SEC coordinate its actions with PCAOB, which  is responsible for establishing standards for the external auditor’s internal  control attestations, to ensure that external auditors are using standards  and guidance on section 404 compliance that are consistent with guidance  for public companies and that they are doing so in an effective and  efficient manner. As SEC considers the need for additional  implementation guidance, it will be important that the guidance and  related PCAOB audit standards be consistent and compatible. Also, it will  be important for the PCAOB to continue to identify ways in which auditors  can achieve more economical, effective, and efficient implementation of  audit-related standards and guidance.
Second, as SEC considers whether and to what extent it might be  appropriate to provide additional interim relief to some categories of  smaller public companies, it will be important to balance the needs of the  investing public with the concerns expressed by small businesses. In doing  so, it is important to determine whether there are unique characteristics,  in addition to size, that could influence the extent that some regulatory  accommodation might be appropriate in order to arrive at a targeted and  limited category of companies being provided with potential exemptions.  For example, if these companies were closely held or have a higher rate of  insider investors, regulatory relief may raise less of an investor protection  concern. These investors may be more knowledgeable about company  operations and receive fewer benefits from section 404’s enhanced  disclosures. For companies that are widely traded, regulatory relief would  raise more concerns about investor protection and relief would appear  less appropriate. Furthermore, although the “insider” shareholder owners  may not have the same need for investor protection as investors in broadly  held companies, minority shareholders who are not insiders may need  such protection. For other purposes, certain provisions of SEC’s securities  regulations and the Employee Retirement Income Security Act of 1974  regulations condition different types of relief, in part, on the nature and/or  the financial sophistication of the investor, and SEC may wish to consider  whether such approaches would help serve to balance the concerns of  small businesses against the needs of investors. The criteria and  characteristics used should be linked to the investor protection goals of  the Sarbanes-Oxley Act and be geared toward limiting the numbers of  companies that would be eligible based on those investor protection goals.  In addition, the advisory committee’s preliminary recommendations to  exempt “smaller public companies” from the external audit requirements  of section 404 would include a number of companies that have already  complied with section 404, and SEC needs to carefully consider whether it  is appropriate to provide regulatory relief on this basis.
Finally, we believe that SEC has an obligation to resolve section 404  implementation requirements for smaller public companies in a way that  creates incentives for smaller public companies to take actions to improve  their internal control over financial reporting. Rather than delaying  implementation, which would likely result in smaller public companies  anticipating future extensions or relief, SEC’s resolution of these issues  would provide needed clarity and certainty over the scope and timing of  smaller companies’ compliance with section 404 and provide incentives to  smaller public companies to begin the process of implementing section  404.
section_title: Recommendations
paragraphs: In light of concerns raised by the SEC Advisory Committee on Smaller  Public Companies and others regarding the ability of smaller public  companies to effectively implement section 404, we recommend that the  Chairman of SEC    assess the guidance available, with an emphasis on implementation  guidance for management’s assessment of internal control over financial  reporting, to determine whether the current guidance is sufficient and  whether additional action is needed, such as issuing supplemental or  clarifying guidance to help smaller public companies meet the  requirements of section 404, and   coordinate with PCAOB to (1) help ensure that section 404-related audit  standards and guidance are consistent with any additional guidance  applicable to management’s assessment of internal control and (2) identify  additional ways in which auditors’ can achieve more economical, effective,  and efficient implementation of the standards and guidance related to  internal control over financial reporting.
If, in evaluating the recommendations of its advisory committee, SEC  determines that additional relief is appropriate beyond the current July  2007 compliance date for non-accelerated filers, we recommend that the  Chairman of SEC analyze and consider, in addition to size, the unique  characteristics of smaller public companies and the knowledge base,  educational background, and sophistication of their investors in  determining categories of companies for which additional relief may be  appropriate to ensure that the objectives of investor protection are  adequately met and any relief is targeted and limited.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to the Chairman, SEC, and the Acting  Chairman, PCAOB, for their review and comment. We received written  comments from SEC and PCAOB that are summarized below and  reprinted in appendixes III and IV. SEC agreed that the Sarbanes-Oxley  Act has had a positive impact on investor protection and confidence, and  that smaller public companies face particular challenges in implementing  certain provisions of the act, notably section 404. SEC stated that our  recommendations should provide a useful framework for consideration of  its advisory committee’s final recommendations. PCAOB stated that it is  committed to working with SEC on our recommendations and that it is  essential to maintain the overriding purpose of the Sarbanes-Oxley Act of  investor protection while seeking to make its implementation as efficient  and effective as possible. Both SEC and PCAOB provided technical  comments that were incorporated into the report as appropriate.
As we agreed with your office, unless you publicly announce the contents  of this report earlier, we plan no further distribution of it until 30 days  from the date of this letter.  At that time, we will send copies of this report  to interested congressional committees and subcommittees; the Chairman,  SEC; the Acting Chairman, PCAOB; and the Administrator, SBA. We will  make copies available to others upon request. In addition, the report will  be available at no charge on the GAO Web site at http://www.gao.gov.
If you have any questions concerning this report, please contact William B.  Shear at (202) 512-8678 or shearw@gao.gov, or Jeanette M. Franzel at  (202) 512-9471 or franzelj@gao.gov. Contact points for our Office of  Congressional Relations and Public Affairs may be found on the last page  of this report. See appendix V for a list of other staff who contributed to  the report.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: Our reporting objectives were to (1) analyze the impact of the Sarbanes- Oxley Act on smaller public companies in terms of costs of compliance  and access to capital; (2) describe the Securities and Exchange  Commission’s (SEC) and Public Company Accounting Oversight Board’s  (PCAOB) efforts related to the implementation of the act and their  responses to concerns raised by smaller public companies and the  accounting firms that audit them; (3) analyze the impact of the act on  smaller privately held companies, including costs, ability to access public  markets, and the extent to which states and capital markets have imposed  similar requirements on smaller privately held companies; and (4) analyze  smaller companies’ access to auditing services and the extent to which the  share of public companies audited by small accounting firms has changed  since the enactment of the Sarbanes-Oxley Act.
In arriving at our report objectives, we incorporated nine specific  questions contained in your request letter. See table 6 for a cross-sectional  comparison of the nine specific questions contained in your letter, the four  report objectives, and our findings.
To address our four objectives, we reviewed and analyzed information  from a variety of sources, including the legislative history of the act,  relevant regulatory pronouncements and related public comment letters,  and available research studies and papers. We also interviewed officials at  SEC, PCAOB, and the Small Business Administration (SBA). In addition,  we held discussions with the chief financial officers (CFO) of smaller  public and private companies, representatives of relevant trade  associations, accounting firms, market participants, and experts.
subsections: section_title: Impact of Sarbanes-Oxley Act on Smaller Public Companies
paragraphs: We could not analyze the impact of the act on many smaller public  companies because SEC has extended the date by which public registrants  with less than $75 million public float (known as “non-accelerated” filers)  must comply with Section 404 of the act to their first fiscal year ending on  or after July 15, 2007. According to SEC, non-accelerated filers represent  about 60 percent of all registered public companies and about 1 percent of  total available market capitalization. As a result, we analyzed public data  and other information related to the experiences of public companies that  have fully implemented the act’s provisions. We also compared the  information from companies that had implemented the act with  information from smaller companies that took the SEC extension to gain  some insight into the potential impact of these provisions on the non- accelerated filers.
subsections: section_title: Audit Fees and Auditor Changes
paragraphs: Audit Analytics, an on-line market intelligence service maintained by Ives  Group, Incorporated provides, among other things, a database of audit  fees by company back to 2000 along with demographic and financial  information. Using this database, we analyzed changes in the audit fees  companies have paid by various size categories. Audit Analytics also  provides a comprehensive listing of all reported auditor changes, which  includes data on the date of change, departing auditor, engaged auditor,  whether the change was a dismissal or resignation, whether there was a  going concern flag or other accounting issues, and whether a fee dispute  or fee reduction occurred. Using this database, we identified 2,819 auditor  changes from 2003 through 2004.
We performed several checks to verify the reliability of the Audit Analytics  data. For example, we crosschecked random samples from each of the  Audit Analytics databases with SEC proxy and annual filings and other  publicly available information. While we determined that these data were  sufficiently reliable for the purpose of presenting trends in audit fees and  auditor changes, the descriptive statistics on audit fees contained in the  report should be viewed in light of a number of data challenges. First, the  Audit Analytics audit fee database does not include fees for companies  who did not disclose audit fees paid to their independent auditor in an  SEC filing. Second, some companies included in the database—especially  small companies—did not report complete financial data. We handled  missing data by dropping companies with incomplete financial data from  any analysis involving the use of such data. Therefore, it should be noted  that we are not dealing with the entire population included in the Audit  Analytics database but rather a large subset. Because of these issues, the  results should be viewed as estimates of audit fees based on a large  sample rather than precise estimates of all fees charged over the entire  population. It should also be noted that SEC found issues with the data on  market capitalization (used largely in our discussion of auditor changes  and companies going private) which are being addressed by Audit  Analytics.
section_title: Deregistrations
paragraphs: To determine the number of companies that have deregistered before and  after the implementation of the Sarbanes-Oxley Act, we obtained and  analyzed data filed with SEC. From 1998 through April 24, 2005, over  15,000 companies filed SEC Form 15 (Certification and Notice of  Termination of Registration). First, we analyzed all the companies to  determine whether the company was deregistering its common stock to  continue to operate as a privately held company. During this step, we  eliminated companies that filed the Form 15 as a result of acquisitions,  mergers that were not “going private” transactions liquidations,  reorganizations, or bankruptcy filings or re-emergences. We also  eliminated duplicate filings and filings by foreign registrants. For the  remaining companies, we reviewed their SEC filings and press releases  and other press articles to determine their reasons for deregistration. We  grouped the reasons into seven categories for our final analysis.
We took a number of steps to ensure the reliability of the database,  including testing of random samples of the coded data, 100 percent  verification of certain areas of the database, and various other quality  control measures. For the initial coding, we found the error rates to be 0.6  percent or lower for all years except 2001 and 1998. Because the initial  error rate exceeded 1.5 percent for these 2 years, we performed 100  percent verification and corrected any errors. However, because the error  rate for the remaining years was positive, it is unlikely that we captured  every company going private in 1998–2005. We also excluded all  companies with one or zero holders of record unless that company also  filed a Schedule 13E-3 (Going private transaction by certain issuers) with  SEC. In doing so, we may have missed some companies going private.  However, an outside study found only 12 companies that filed a Form 15  but did not file a Schedule 13E-3 from 1998 through 2003. Additionally,  our analysis of the companies that listed more than one holder of record  on the Form 15 should have picked up some of these types of firms. As a  result, this limitation is minor in the context of this report and does not  alter the trends also found by a number of research reports.
section_title: Survey of Public Company Views on Implementing the Sarbanes-Oxley Act
paragraphs: To obtain information about public companies’ views on implementing  Sarbanes-Oxley Act requirements, we conducted a Web-based survey of  companies with market capitalization of $700 million or less and annual  revenues of $100 million or less that reported to SEC that they had  complied with the act’s requirements related to internal control over  financial reporting. To develop and test our questionnaire, we interviewed  officials at 14 smaller public companies. We then pretested drafts of our  questionnaire with 10 companies and then discussed their answers and  experiences with our social science survey specialists. The pretests were  conducted in person and by telephone with company executives in  Virginia, Maryland, New York, Connecticut, California, Georgia, and  Illinois.
To identify the smaller public companies eligible to participate in the  survey, we analyzed company SEC filings from the Audit Analytics  database. Our survey universe consisted of 591 companies that met the  following five criteria: (1) $700 million or less in market capitalization as  of the end of the company’s 2004 fiscal year; (2) $100 million or less in  revenues as of the end of the company’s 2004 fiscal year end; (3)  completed section 404 requirements by filing related reports of  management and the company’s external auditor as of August 11, 2005; (4)  were not foreign companies; and (5) were not investment vehicles such as  mutual funds and shell companies. Of the 591, we could not reach 168  within the survey period because we were not able to obtain e-mail  addresses for the CFO or other executive. We began our Web-based survey  on September 21, 2005, and included all useable responses as of November  1, 2005. We sent follow-up e-mails on three occasions to remind  respondents to complete the survey. One hundred fifty-eight companies  completed the survey for an overall response rate of 27 percent. Only one  respondent indicated that his company was a non-accelerated filer.
The low response rate raised concerns that the views of 158 respondents  might not be representative of all smaller public company experiences  with the Sarbanes-Oxley Act. While we could not test this possibility for  our primary questions (whether the act places a disproportionate burden  on smaller companies or compromises their ability to raise capital), we did  conduct an analysis to determine whether our sample differed from the  population of 591 in company assets, revenue, and market capitalization  and type (based on the North American Industrial Classification System  code). We found no evidence of substantial non-response bias based on  these characteristics. However, because of the low response rate we still  could not assume that the views of the 158 respondents were  representative of the views of other smaller public companies on  implementing Sarbanes-Oxley Act requirements. Therefore, we do not  consider these data to be a probability sample of all smaller public  companies.
In addition to potential non-response bias, the practical difficulties of  conducting any survey may introduce other non-sampling errors. For  example, difference in how a particular question is interpreted or the  sources of information available to respondents may introduce errors. We  took steps to minimize such non-sampling errors in both the data  collection and data analysis stages. We examined the survey results and  performed computer analyses to identify inconsistencies and other  indications of error. A second independent analyst checked all the  computer analyses. Further, we used GAO’s Questionnaire Programming  Language (QPL) system to create and process the Web-based survey. This  system facilitates the creation of the instrument, controls access, and  ensures data quality. It also automatically generates code for reading the  data into SAS (statistical analysis software). This tool is commonly used  for GAO studies.
We used QPL to automate some processes, but also used analysts to code  the open-ended questions and then had a second, independent analyst  review them. (The survey contained both open- and close-ended  questions.) We entered a set of possible phrases, called tags, which we  identified for each question into QPL. When the analysts reviewed the text  responses, they assign the tags that best reflect the meaning of what the  respondent has written. The system then compares the tags assigned by  the independent reviewers. Multiple tags may be assigned to a single  response; thus, it is possible for reviewers to agree on some tags and not  on others. Although it is possible to have reviewers resolve their  differences until agreement is found, for this survey we only considered  tags that were selected by all reviewers on the first pass. Tags assigned by  only one reviewer were dropped. This process allowed a quantitative  analysis of open comments made by respondents. Finally, we verified all  data processing on the survey in house and found it to be accurate.
section_title: SEC and PCAOB Efforts to Address Smaller Company Concerns
paragraphs: To address our second objective describing SEC’s and PCAOB’s efforts  related to the implementation of the act and their responses to concerns  raised by smaller public companies and the accounting firms that audit  them, we interviewed SEC and PCAOB staff on the rulemaking and  standard setting processes. We also interviewed public company  executives, representatives of relevant trade associations, and market  participants for their reaction to the agencies’ rules, guidance, and other  public announcements.
During the course of our review, both SEC and PCAOB held forums and  other open meetings to allow a public discourse on the act’s impact on  public companies, accounting firms, investors, and other market  participants. We attended most of these forums and open meetings and  reviewed submitted comments. Specifically, from November 2004 to  February 2006, we attended either in person or through a Web cast the  following: SEC’s Advisory Committee on Smaller Public Companies open  meetings; SEC’s Roundtable on Implementation of Internal Control  Reporting Provisions; SEC’s Government-Business Forum on Small  Business Capital Formation; PCAOB’s Standing Advisory Group Meetings;  and PCAOB’s forums on auditing in the small business environment. We  reviewed the guidance that SEC and PCAOB separately issued on May 16,  2005, as a result of comments received at SEC’s section 404 roundtable.
section_title: Impact of Act on Smaller Privately Held Companies
paragraphs: To determine the act’s impact on smaller privately held companies, we  analyzed available research and studies. We also interviewed officials of  the National Association of State Boards of Accountancy in states that  required or were considering requiring privately held companies to comply  with corporate accountability, governance, and financial reporting  measures comparable to key provisions in the Sarbanes-Oxley Act.
Further, we analyzed data and interviewed officials on whether lenders,  financial institutions, private equity providers, or others were imposing the  act’s requirements on privately held companies as a condition of obtaining  capital or financial services. Finally, we interviewed officials and analyzed  available data on whether, as a result of the act, privately held companies  were voluntarily adopting key provisions of the act as best practices or  whether they had faced challenges in trying to reach the public markets.
To assess the impact of the act on privately held companies trying to reach  the public markets, we obtained a sample from SEC’s Electronic Data  Gathering, Analysis, and Retrieval (EDGAR) system, a database that  includes companies’ initial public offering (IPO) and secondary public  offering (SPO) filings. Our sample contained registration statements,  pricings and applications for withdrawal filed with SEC from 1998 through  July 2005. We performed various analyses of IPO and SPO activity prior to  and after enactment of Sarbanes-Oxley, including analyses of the sizes of  companies coming and returning to the market, types and amounts of IPO  expenses, and the reasons cited by companies for withdrawing their IPO  filing. We analyzed IPO expenses as a percentage of revenue and offering  amount for companies in various size categories to determine whether the  differences between the groups changed over time and whether the  differences were statistically significant when controlling for other  determining factors.
SEC’s EDGAR database is considered the definitive source for information  on IPOs since all companies issuing securities that list on the major  exchanges and the OTCBB, as well as those that meet certain criteria  listing on the Pink Sheets, must register the securities with SEC.  Nevertheless, we crosschecked the descriptive statistics retrieved from  EDGAR with NASDAQ’s IPO data. However, there was no financial data  available on several companies, while others failed to provide information  to complete all of the fields. In cases where revenue was left blank,  individual filings were reviewed and actual revenue, 9-month revenue or  pro-forma data was used to determine the size of the company. In cases  were this data was not available we dropped these companies from any  analysis involving the use of such data. Additionally, there can be  significant lag between the dates a company initially files for an IPO with  SEC and when the stock of the company is finally priced (begins trading).  Because we had data on IPO filings during the last 2 months of 1997, we  were able to include those companies that priced IPOs over the 1998-2005  period that initially filed for an IPO during that time. However, any IPOs  that were priced during this time but had an initial filing that occurred  prior to November 1, 1997, are not included. For this reason the number of  priced IPOs for 1998 (and to an even lesser extent 1999) may understate  somewhat the actual numbers of companies coming to the public market  during that year. This limitation is insignificant in the context of this  report.
section_title: Company Access to Auditing Services and Changes in Share of Public Companies That Small Firms Audit
paragraphs: To assess changes in the domestic public company audit market, we used  public data—for 2002 and 2004—on public companies and their external  accounting firm to determine how the number and mix of domestic public  company audit clients had changed for firms other than the large  accounting firms. To be consistent with our 2003 study of the structure of  the audit market, we used the Who Audits America database, a directory  of public companies with detailed information for each company,  including the auditor of record. Only domestic public companies traded on  the major exchanges or over-the-counter with available financial data were  included in our analysis of audit market concentration and the results do  not include a number of clients of the smallest audit firms. Users of our  2003 study will also note that we used the term “sales” when referring to  auditor concentration but use the term “revenue” in this report. Although  Who Audits America refers to sales, our conversations with the provider  of the data, confirmed that although the terms can be used  interchangeably, “revenue” is a better term than “sales” in accurately  describing the contents of the database.
To verify the reliability of these data sources, we performed several  checks to test the completeness and accuracy of the data. Previously GAO  crosschecked random samples of the Who Audits America database with  SEC proxy filings and other publicly available information. Descriptive  statistics calculated using the database were also compared with similar  statistics from published research. Moreover, academics who worked with  GAO in the past also compared random samples from Compustat, Dow- Jones Disclosure, and Who Audits America and found no discrepancies.  We also crosschecked the results with estimates obtained using Audit  Analytics’ audit opinion database. The results were not significantly  different and confirm the finding outlined in the body of the report.  However, because of the lag in updating some of the financial information  and the omission of a number of small public clients, the results should be  viewed as estimates useful for describing the market for audit services.
We conducted our work in California, Connecticut, Georgia, Maryland,  New Jersey, New York, Virginia, and Washington, D.C., from November  2004 through March 2006 in accordance with generally accepted  government auditing standards.
section_title: Appendix II: Additional Details about GAO’s Analysis of Companies Going Private
paragraphs: A number of research studies and anecdotal evidence suggest that a  significant number of small companies have gone private as a result of  costs associated with the increased disclosure and internal control  requirements introduced by the Sarbanes-Oxley Act of 2002. To provide a  better understanding of companies going private, we analyzed Form 15s  filed by companies, related Securities and Exchange Commission (SEC)  filings and press releases to determine the total number of companies  exiting the public market and the reasons for the change in corporate  structure. See appendix I for our scope and methodology. This appendix  provides additional information on the construction of our database and  descriptive statistics.
subsections: section_title: Our Database Included Firms That “Went Dark” as Well as Firms That Completely Exited the Public Market
paragraphs: Although there is no consensus on the term “going private,” we started  with the description used in the “Fast Answers” section of SEC’s Web site:  a company “goes private” when it reduces the number of its shareholders  to fewer than 300 (or 500 in some instances) and is no longer required to  file reports with SEC. To reduce the number of holders of record, a  company can undertake a number of transactions including tender offers,  reverse stock splits, and cash-out mergers. In many cases, the company  already meets the requirement for deregistration and therefore the  registrant need only file a Form 15 (which notifies SEC of a company’s  intent to deregister) with SEC to meet this description of “going private.”  As a result, we use the terms “going private” and “deregistering”  interchangeably. However, not all companies that deregister completely  exit the public markets; some elect to continue trading on the less  regulated Pink Sheets. Companies that deregister their shares with SEC  but continue public trading on the Pink Sheets are often considered as  having “gone dark” rather than private in the academic literature.  However, our final “going private” numbers include companies that no  longer trade on any exchange and those that continue to trade on the less  regulated Pink Sheets (“went dark”). It should be noted that SEC does not  have rules that define “going dark” and the term is used here as it is used  in academic research.
The companies contained in our database include only those companies  that deregistered common stock, were no longer subject to SEC filing  requirements, and were headquartered in the United States. Moreover, the  database excludes most cases where the company was acquired by, or  merged into another company; filed for, or was emerging from,  bankruptcy; or was undergoing or planning liquidation. We also excluded a  significant number of companies that filed for an initial public offering and  subsequently filed a Form 15 within a year; filed no annual or quarterly  financials between the first filing with SEC and the Form 15; or filed as a  result of reorganization where the company remained a public registrant.  Based on the information contained on the Form 15, we were able to  exclude four types of filers: (1) companies that deregistered securities  other than their common stock; (2) companies that continued to be  subject to public reporting requirements; (3) companies that were  headquartered in a foreign country; and (4) companies for which a Form  15 could not be retrieved electronically.
In addition to SEC filings, we used press releases located through Lexis- Nexis to investigate whether the companies experienced any of the  disqualifying conditions (bankruptcy, merger, acquisition, liquidation,  etc.). Companies that were merged into, or were acquired by, another  company were only included if the transaction was initiated by an affiliate  of the company (either the company filed a Schedule 13E-3 with SEC or  our analysis found evidence of a “going private” transaction in the case of  Over-the-Counter Bulletin Board (OTCBB) and Pink Sheet-quoted  companies). Moreover, if the transaction resulted in the company  becoming a subsidiary of another publicly traded company or a foreign  entity, or if the transaction met any of the other disqualifying conditions,  that company was excluded from our final numbers.
Each Form 15 also contained the number of holders of record. We  excluded all companies with one or zero holders of record unless that  company also filed a Schedule 13E-3 with SEC. A test of a random sample  of 200 of these companies found that merging, bankrupt, and liquidating  firms typically reported one or zero as the number of holders of record.  Because there may have been some companies that went private by way of  merger that did not file a Schedule 13E-3, our database may have excluded  some companies going private as a result of using this qualifier. However,  this limitation is minor in the context of this report (see app. I for  additional information on data reliability). In total, these exclusions left us  with 1,093 U.S. companies going private from 1998 through the first  quarter of 2005 out of the 15,462 Form 15 filings initially provided to us by  SEC.
section_title: Consistent with Outside Studies, We Found That the Number of Companies That Went Private Increased Significantly from 2001 through 2004
paragraphs: The number of public companies going private increased significantly  from 143 in 2001 to 245 in 2004 (see fig. 8). Based on the number of  companies going private during the first quarter of 2005, we project that  the number of companies going private will increase, to 267 companies by  the end of 2005. While these numbers constitute a small percentage of the  total number of public companies, the trends we identified suggest that  more small companies are reconsidering the cost and benefits of  remaining public and raising capital on domestic public equity markets. As  figure 8 shows, the number of companies going private increased  significantly, whether or not we excluded the types of companies  explicitly considered as speculative investments by SEC—blank check and  shell companies. Overall, these companies, identified as such by Standard  Industry Classification code, represent 17 percent of the companies going  private in 2004 but just 2.5 percent of the companies going private during  the first quarter 2005 and 8.4 percent of the overall sample.
A number of research reports have also found that the number of  companies exiting the public market has increased since 2002. Although  there are differences in the search methodologies and types of companies  included, each study found similar trends and reached similar conclusions  (see fig. 9). For example, in Leuz et al. (2004) the number of companies  going dark or private increased from 144 to 313 between 2002 and 2003.  Moreover the authors found that the bulk of the increase was made up of  companies that continued trading on the Pink Sheets after deregistration.  Engel et al. (2004), which was based on a smaller subset of deregistering  companies, found a statistically significant increase in the rate at which  companies went private. Marosi and Massoud (2004) excluded all merger- related transactions and found that the number of companies going dark  increased from 71 in 2002 to 127 in 2003.
section_title: We Grouped Reasons for Company Decisions to Go Private into Seven Categories
paragraphs: In analyzing company decisions, we used various sources to determine  why the companies included in our database deregistered their common  stock. Because companies did not always disclose the reasons for their  decision in an SEC filing, we also searched press releases and newswire  announcements using the Lexis-Nexis search engine. We then used the  reasons given in the various filings and other media to construct seven  broad categories, summarized in table 7. Because companies often gave  multiple reasons for the decision to deregister (go private) and it was  difficult to tell which were the most important, we allowed up to six  reasons for each company included in our database. For example,  Westerbeke Corporation went private in 2004 and cited the following  reasons for the decision: “a small public float,” inability to use its stock as  currency for acquisitions, benefits the company would receive as private  entity such as “greater flexibility,” the ability to make “decisions that  negatively affect quarterly earnings in the short run,” and the costs and  time devoted by employees and management “resulting from the adoption  of the Sarbanes-Oxley Act of 2002.” This company is included in our  database with following coded reasons for going private: (1)  market/liquidity issues; (2) private company benefits; (3) direct costs; and  (4) indirect costs.
section_title: More Companies Have Cited Costs as Reasons for Going Private Since 2002
paragraphs: Although companies go private for a variety of reasons, in recent years,  more companies cited the direct costs of maintaining public company  status as at least one of the reasons for going private. As shown in figure  10, the number of companies citing costs as at least one reason for going  private increased from 64 in 2002 to 143 and 130 in 2003 and 2004.  However, the percentage of companies citing cost as the only reason for  exiting the market has increased significantly in recent years. While only  21 cited costs and no other reason in 2003 (15 percent of the total citing  cost), 43 did so in 2004 (33 percent of the total citing cost). During the first  quarter of 2005, nearly 50 percent of the companies mentioning cost, cited  costs as the only reason for going private.
section_title: Companies Going Private Typically Were among the Smallest of Publicly Traded Companies
paragraphs: By any measure (market capitalization, revenue or assets), the companies  that went private over the 2004–2005 period represent some of the  smallest companies in the public arena (see figs. 11 and 12). Because these  companies were on average very small, they enjoyed limited analyst  coverage and limited market liquidity—one of the primary benefits cited  for going or remaining public. The median market capitalization and  revenue for these companies was less than $15 million.
Figure 12 also illustrates that companies going private were  disproportionately small, which reflected that the net benefits from being  public likely were smallest for small firms and the costs of complying with  securities laws likely required a higher proportion of a smaller company’s  revenue. For example, 84 percent of the companies that went private in  2004 and 2005 had revenues of $100 million or less and nearly 69 percent  had revenues of $25 million or less. We also found that a significant  portion of these companies—12.5 percent of those that went private in  2004–2005—had not filed quarterly or annual financial statements with  SEC in more than 2 years; therefore, we did not have access to recent  financial information.
section_title: Appendix III: Comments from the Securities and Exchange Commission
section_title: Appendix IV: Comments from the Public Company Accounting Oversight Board
section_title: Appendix V: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts GAO Contacts
section_title: Acknowledgments
paragraphs: In addition to those named above, Harry Medina and John Reilly, Assistant  Directors; E. Brandon Booth; Michelle E. Bowsky; Carolyn M. Boyce; Tania  L. Calhoun; Martha Chow; Bonnie Derby; Barbara El Osta; Lawrance L.  Evans Jr.; Gabrielle M. Fagan; Cynthia L. Grant; Maxine L. Hattery; Wilfred  B. Holloway; Kevin L. Jackson; May M. Lee; Kimberly A. McGatlin; Marc W.  Molino; Karen V. O’Conor; Eric E. Petersen; David M. Pittman; Robert F.  Pollard; Carl M. Ramirez; Philip D. Reiff; Barbara M. Roesmann; Jeremy S.  Schwartz; and Carrie Watkins also made key contributions to this report.