Accelerated Filer and Large Accelerated Filer Definitions, 17178-17242 [2020-05546]

Download as PDF 17178 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 229, 230, 240, and 249 [Release No. 34–88365; File No. S7–06–19] RIN 3235–AM41 Accelerated Filer and Large Accelerated Filer Definitions Securities and Exchange Commission. ACTION: Final rule. lotter on DSKBCFDHB2PROD with RULES2 AGENCY: SUMMARY: The Securities and Exchange Commission (‘‘Commission’’) is adopting amendments to the accelerated filer and large accelerated filer definitions to more appropriately tailor the types of issuers that are included in the categories of accelerated and large accelerated filers and promote capital formation, preserve capital, and reduce unnecessary burdens for certain smaller issuers while maintaining investor protections. The amendments exclude from the accelerated and large accelerated filer definitions an issuer that is eligible to be a smaller reporting company and that had annual revenues of less than $100 million in the most recent fiscal year for which audited financial statements are available. The amendments also include a specific provision excluding business development companies from the accelerated and large accelerated filer definitions in analogous circumstances. In addition, the amendments increase the transition thresholds for accelerated and large accelerated filers becoming non-accelerated filers from $50 million to $60 million, and for exiting large accelerated filer status from $500 million to $560 million. Further, the amendments add a revenue test to the transition thresholds for exiting from both accelerated and large accelerated filer status. Finally, the amendments add a check box to the cover pages of Forms 10–K, 20–F, and 40–F to indicate whether an internal control over financial reporting (‘‘ICFR’’) auditor attestation is included in the filing. As a result of the amendments, certain lowrevenue issuers will remain obligated, among other things, to establish and maintain ICFR and have management assess the effectiveness of ICFR, but they will not be required to have their management’s assessment of the effectiveness of ICFR attested to, and reported on, by an independent auditor. DATES: This final rule is effective April 27, 2020. FOR FURTHER INFORMATION CONTACT: John Fieldsend, Special Counsel, in the Division of Corporation Finance, at VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 (202) 551–3430, and Brian Johnson, Assistant Director, in the Division of Investment Management, at (202) 551– 6792, U.S. Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549–3628. SUPPLEMENTARY INFORMATION: We are amending 17 CFR 229.10(f) (‘‘Item 10(f)’’) under Regulation S–K; 1 17 CFR 230.405 (‘‘Rule 405’’) under the Securities Act of 1933; 2 and 17 CFR 12b–2 (‘‘Rule 12b–2’’), 17 CFR 249.220f (‘‘Form 20–F’’), 17 CFR 249.240f (‘‘Form 40–F’’), and 17 CFR 249.310 (‘‘Form 10– K’’) under the Securities Exchange Act of 1934 (‘‘Exchange Act’’).3 Table of Contents I. Introduction II. Discussion of the Final Amendments A. Background B. Amendments to Exclude Low-Revenue SRCs From the Accelerated and Large Accelerated Filer Definitions 1. Proposed Amendments 2. Comments on the Proposed Amendments a. Comments on Using Revenue for Determining Accelerated and Large Accelerated Filer Status b. Comments on the Proposed Amendments’ Effect on Capital Formation and the Number of Public Issuers c. Comments on the Proposed Amendments’ Effect on Investor Protection d. Comments on the Disproportionate Costs and Benefits of the ICFR Auditor Attestation Requirement to Small and Low-Revenue Companies e. Comments on the Relationship Between Non-Accelerated Filers and SRCs f. Other Comments 3. Final Amendments a. Using Revenue for Determining Accelerated and Large Accelerated Filer Status b. Effect on Capital Formation and the Number of Public Companies c. Effect on Investor Protection d. Disproportionate Costs and Benefits of the ICFR Auditor Attestation for Small and Low-Revenue Companies e. Relationship Between Non-Accelerated Filers and SRCs f. Effect on Business Development Companies g. Effect on Foreign Private Issuers h. Requiring ICFR Auditor Attestation Less Frequently Than Annually i. Check Box Indicating Whether an ICFR Auditor Attestation Is Included in a Filing C. Amendments To Increase the Public Float Transition Thresholds From $50 million to $60 million and $500 million to $560 million and To Add the SRC Revenue Test to the Transition Threshold 1 15 U.S.C. 229.10 through 229.1305. U.S.C. 77a et seq. 3 15 U.S.C. 78a et seq. 2 15 PO 00000 Frm 00002 Fmt 4701 Sfmt 4700 1. Proposed Amendments 2. Comments 3. Final Amendments D. Transition Issues III. Other Matters IV. Economic Analysis A. Introduction B. Baseline 1. Regulatory Baseline 2. Characteristics of Accelerated Filer Population 3. Timing of Filings 4. Internal Controls and Restatements C. Discussion of Economic Effects 1. Affected Issuers 2. Potential Benefits of Expanding the Exemption From the ICFR Auditor Attestation Requirement for Affected Issuers a. Evidence on Possible Indirect Costs of the ICFR Auditor Attestation Requirement b. Evidence on Net Costs of the ICFR Auditor Attestation Requirement i. Studies Involving Avoidance Behavior ii. Studies Based on Comparative Analysis or Market Reactions iii. Other Evidence on Net Costs c. Potential Reduction in Audit Fees d. Additional Potential Compliance Cost Savings e. Implications of the Cost Savings 3. Potential Costs of Expanding the Exemption From the ICFR Auditor Attestation Requirement for Affected Issuers a. Broad Considerations and Evidence Regarding the Effects of ICFR Auditor Attestations on Financial Reporting b. Estimated Effects on ICFR, the Reliability of Financial Statements, and Potential Fraud i. Effects on the Prevalence of Ineffective ICFR ii. Effects on the Detection and Disclosure of Material Weaknesses in ICFR iii. Effects on Restatements iv. Effects on Fraudulent Financial Reporting v. Timing of the Effects c. Implications for Investor DecisionMaking d. Potential Economic Costs of Effects on ICFR, the Reliability of Financial Statements, and Potential Fraud i. Computation of Monetized Estimates of Costs ii. Discussion of Economic Costs 4. Potential Benefits and Costs Related to Other Aspects of the Amendments a. Filing Deadlines b. Disclosures Required of Accelerated Filers c. Transition Thresholds d. Disclosure 5. Alternatives to the Amendments a. Exclude All SRCs From Accelerated Filer Category b. Include or Exclude Certain Issuer Types c. Alternative Threshold V. Paperwork Reduction Act A. Summary of the Collections of Information B. Burden and Cost Estimates Related to the Final Amendments 1. ICFR Auditor Attestation Requirement E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations 2. Filing Deadlines, Disclosure Regarding Filing Availability, and Unresolved Staff Comments 3. Check Box Disclosure 4. Total Burden Reduction VI. Regulatory Flexibility Act Analysis A. Need for, and Objectives of, the Final Amendments B. Significant Issues Raised by Public Comments C. Small Entities Subject to the Amendments D. Projected Reporting, Recordkeeping, and Other Compliance Requirements E. Agency Action To Minimize Effect on Small Entities Statutory Authority and Text of Rule Amendments lotter on DSKBCFDHB2PROD with RULES2 I. Introduction On May 9, 2019, we proposed amendments 4 to the ‘‘accelerated filer’’ and ‘‘large accelerated filer’’ definitions in Rule 12b–2.5 We proposed these amendments to promote capital formation for certain smaller issuers while maintaining investor protections by more appropriately tailoring the types of issuers that are included in the categories of accelerated and large accelerated filers and revising the transition thresholds for accelerated and large accelerated filers. Specifically, we proposed to exclude from the accelerated and large accelerated filer definitions an issuer that is eligible to be a smaller reporting company (‘‘SRC’’) 6 and that has annual revenue of less than $100 million in the most recent fiscal year for which audited financial statements are available (‘‘SRC revenue test’’), with the effect that such an issuer would not need to satisfy the requirements applicable to an accelerated or large accelerated filer. We also proposed to increase the public float transition threshold for accelerated and large accelerated filers to become a non-accelerated filer from $50 million to $60 million, and to increase the exit threshold in the large accelerated filer transition provision from $500 million to $560 million in public float. Finally, we proposed to add a revenue test to the transition thresholds for exiting both accelerated and large accelerated filer status. We received over 60 comment letters on the proposal, including over 40 unique letters and approximately 20 4 Amendments to the Accelerated and Large Accelerated Filer Definitions, Release No. 34–85814 (May 9, 2019) [84 FR 24876 (May 29, 2019)] (‘‘Proposing Release’’). 5 Although Rule 12b–2 defines the terms ‘‘accelerated filer’’ and ‘‘large accelerated filer,’’ it does not define the term ‘‘non-accelerated filer.’’ If an issuer does not meet the definition of accelerated filer or large accelerated filer, it is considered a nonaccelerated filer. 6 See Item 10(f), Rule 405, and Rule 12b–2 (defining SRC). VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 letters that were substantially similar. Many of the commenters generally supported the proposed amendments 7 while other commenters generally opposed them or suggested the need for further empirical study.8 In addition, the SEC’s Small Business Capital Formation Advisory Committee 7 See, e.g., letters from Adamas Pharmaceuticals, Inc. (July 19, 2019) (‘‘Adamas’’); Advanced Medical Technology Association Accel (July 26, 2019) (‘‘AdvaMed’’); Aequor, Inc. (July 18, 2019) (‘‘Aequor’’); Ardelyx, Inc. (July 18, 2019) (‘‘Ardelyx’’); American Securities Association (July 29, 2019) (‘‘ASA’’); Biotechnology Innovation Organization (July 29, 2019) (‘‘BIO’’); Broadmark Capital (July 29, 2019) (‘‘Broadmark’’); California Life Sciences Association (Jun. 10, 2019) (‘‘CLSA’’); Catalyst Biosciences, Inc. (July 29, 2019) (‘‘Catalyst’’); Cerecor Inc. (July 3, 2019) (‘‘Cerecor’’); Chiasma, Inc. (July 11, 2019) (‘‘Chiasma’’); Coalition of Four Small Businesses and their Investors (July 24, 2019) (‘‘AdvaMed et al.’’); Concert Pharmaceuticals, Inc. (July 1, 2019) (‘‘Concert’’); Corvus Pharmaceuticals, Inc. (July 19, 2019) (‘‘Corvus’’); Council of State Bioscience Associations (July 25, 2019) (‘‘CSBA’’); CSB Bancorp, Inc. (July 26, 2019) (‘‘CSB’’); CymaBay Therapeutics, Inc. (July 24, 2019) (‘‘CymaBay’’); Dare´ Bioscience, Inc. (July 10, 2019) (‘‘Dare´’’); Darian B. Andersen, General Counsel, PC (Jun. 5, 2019) (‘‘Andersen’’); Equillium, Inc. (July 22, 2019) (‘‘Equillium’’); Evoke Pharma, Inc. (July 17, 2019) (‘‘Evoke’’); Gritstone Oncology Inc. (July 24, 2019) (‘‘Gritstone’’); Guaranty Federal Bancshares, Inc. (July 23, 2019) (‘‘Guaranty’’); Independent Community Bankers of America (July 24, 2019) (‘‘ICBA’’); Kezar Life Sciences, Inc. (July 17, 2019) (‘‘Kezar’’); Kyle Carver (May 25, 2019) (‘‘Carver’’); Marinus Pharmaceuticals, Inc. (July 17, 2019) (‘‘Marinus’’); Millendo Therapeutics, Inc. (July 29, 2019) (‘‘Millendo’’); MSB Financial Corp. (July 19, 2019) (‘‘MSB’’); Nasdaq, Inc. (July 29, 2019) (‘‘Nasdaq’’); Organovo, Inc. (July 18, 2019) (‘‘Organovo’’); Pieris Pharmaceuticals, Inc. (July 11, 2019) (‘‘Pieris’’); Revance Therapeutics, Inc. (July 22, 2019) (‘‘Revance’’); SI–BONE, Inc. (July 19, 2019) (‘‘SI–BONE’’); South Carolina Bankers Association (July 26, 2019) (‘‘SCBA’’); Summit State Bank (May 28, 2019) (‘‘Summit’’); Sutro Biopharma, Inc. (July 8, 2019) (‘‘Sutro’’); Syros Pharmaceuticals, Inc. (July 22, 2019) (‘‘Syros’’); Teligent, Inc. (July 23, 2019) (‘‘Teligent’’); Terra Tech Corp. (May 29, 2019) (‘‘Terra Tech’’); The Bank of South Carolina (July 26, 2019) (‘‘BSC’’); U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness (July 29, 2019) (‘‘Chamber’’); Xenon Pharmaceuticals Inc. (Jun. 19, 2019) (‘‘Xenon’’); and Zynerba Pharmaceuticals, Inc. (July 8, 2019) (‘‘Zynerba’’). 8 See, e.g., letters from BDO USA, LLP (July 29, 2019) (‘‘BDO’’); Better Markets, Inc. (July 29, 2019) (‘‘Better Markets’’); Center for Audit Quality (July 29, 2019) (‘‘CAQ’’); CFA Institute, in consultation with its Corporate Disclosure Policy Council (Aug. 22, 2019) (‘‘CFA Inst.’’); Colleen Honigsberg, Associate Professor of Law, Stanford Law School, et al. (July 22, 2019) (‘‘Prof. Honigsberg et al.’’); Consumer Federation of America (July 29, 2019) (‘‘CFA’’); Council of Institutional Investors (July 25, 2019) (‘‘CII’’); Crowe LLP (July 29, 2019) (‘‘Crowe’’); Deloitte & Touche LLP (July 26, 2019) (‘‘Deloitte’’); Grant Thornton LLP (July 17, 2019) (‘‘Grant Thornton’’); John Hassell, Indiana University (May 19, 2019) (‘‘Prof. Hassell’’); Mary Barth, Stanford University, Wayne Landsman, University of North Carolina, Joseph Schroeder, Indiana University, and Daniel Taylor, University of Pennsylvania (July 11, 2019) (‘‘Prof. Barth et al.’’); RSM US LLP (July 29, 2019) (‘‘RSM’’); and Weili Ge, University of Washington; Allison Koester, Georgetown University; and Sarah McVay, University of Washington (July 26, 2019) (‘‘Prof. Ge et al.’’). PO 00000 Frm 00003 Fmt 4701 Sfmt 4700 17179 (‘‘SBCFAC’’) adopted a recommendation supporting the proposed amendments,9 and the 2019 SEC Government-Business Forum on Small Business Capital Formation (‘‘SEC Small Business Forum’’) provided a recommendation on the accelerated filer definition.10 After taking into consideration these recommendations and the public comments, we are adopting the amendments substantially as proposed. The final amendments are consistent with our historical practice of providing scaled disclosure and other accommodations for smaller issuers and with recent actions by Congress to reduce unnecessary burdens on new and smaller issuers.11 II. Discussion of the Final Amendments A. Background In June 2018, the Commission adopted amendments 12 to the SRC 9 See U.S. Sec. and Exch. Comm’n Small Bus. Capital Formation Advisory Comm., Recommendation on the Commission’s Proposal to Amend the Accelerated and Large Accelerated Filer Definitions (Aug. 23, 2019) (‘‘SBCFAC Recommendations’’), available at https:// www.sec.gov/spotlight/sbcfac/recommendationsrule-3-05-and-accelerated-filer-definition.pdf. Although it supported the proposed amendments, the SBCFAC stated that it ‘‘would welcome the Commission to explore additional further amendments’’ to the accelerated and large accelerated filer definitions and recommended exploring raising the revenue threshold to be a nonaccelerated filer to one higher than $100 million, basing the revenue test for an issuer to qualify as a non-accelerated filer on a three-year rolling average instead of basing it on the revenue in the most recent fiscal year, and looking at whether all SRCs should be non-accelerated filers. 10 See U.S. Sec. and Exch. Comm’n Gov’t-Bus. Forum on Small Bus. Capital Formation, Report on the 38th Annual Government-Business Forum on Small Business Capital Formation (Aug. 14, 2019) (‘‘SEC Small Business Forum’’), available at https:// www.sec.gov/files/small-business-forum-report2019.pdf. The SEC Small Business Forum recommended aligning the definition of nonaccelerated filer with the definition of SRC to include issuers with a public float less than $250 million or with annual revenues less than $100 million (and either no public float or a public float less than $700 million). 11 For example, Title I of the Jumpstart Our Business Startups Act of 2012 (‘‘JOBS Act’’) amended Section 404(b) of the Sarbanes-Oxley Act (‘‘SOX’’), 15 U.S.C. 7262(b), which relates to an issuer’s ICFR to exempt emerging growth companies (‘‘EGCs’’) from the requirement of SOX Section 404(b). In particular, SOX Section 404(b) requires that an issuer’s independent auditor attest to, and report on, management’s assessment of the effectiveness of the issuer’s ICFR (‘‘ICFR auditor attestation’’). See Public Law 112–106, Sec. 103, 126 Stat. 306 (2012). In addition, Section 72002 of the Fixing America’s Surface Transportation Act of 2015 requires the Commission to revise Regulation S–K to further scale or eliminate requirements to reduce the burden on EGCs, accelerated filers, SRCs, and other smaller issuers, while still providing all material information to investors. See Public Law 114–94, 129 Stat. 1312 (2015). 12 See Smaller Reporting Company Definition, Release No. 33–10513 (June 28, 2018) [83 FR 31992 (July 10, 2018)] (‘‘SRC Adopting Release’’). E:\FR\FM\26MRR2.SGM 26MRR2 17180 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations definition 13 to expand the number of issuers that qualify for scaled disclosure accommodations. The amended SRC definition allows an issuer to use either a public float 14 test or the SRC revenue test to determine whether it is an SRC. The amendments increased the threshold in the public float test for an issuer to initially qualify as an SRC from less than $75 million to less than $250 million.15 The Commission also expanded the revenue test to include issuers with annual revenues 16 of less than $100 million if they have no public float or a public float of less than $700 million.17 The Commission intended the amendments to promote capital formation for smaller issuers by reducing compliance costs for the newly eligible SRCs while maintaining appropriate investor protections.18 In conjunction with these amendments, the Commission also revised the accelerated filer and large accelerated filer definitions in Rule 12b–2 to remove the condition that, for an issuer to be an accelerated filer or a large accelerated filer, it must not be eligible to use the SRC accommodations.19 One result of these amendments is that some issuers now are categorized as both SRCs and accelerated or large accelerated filers.20 These issuers have some, but not all, of the benefits of scaled regulation. In particular, issuers that are categorized as both SRCs and accelerated or large accelerated filers must comply with the earlier filing deadlines required of accelerated and large accelerated filers for annual and quarterly reports and the requirement of SOX Section 404(b).21 B. Amendments To Exclude LowRevenue SRCs From the Accelerated and Large Accelerated Filer Definitions Rule 12b–2, an issuer must satisfy three conditions to be an accelerated filer or large accelerated filer.24 We proposed to Prior to the SRC amendments, the SRC category of filers generally did not overlap with either the accelerated or large accelerated filer categories.22 Now, however, as illustrated in Figure 1 of this section, because the public float tests in the SRC and accelerated filer definitions partially overlap, and the accelerated and large accelerated filer definitions no longer specifically exclude an issuer that is eligible to be an SRC, an issuer meeting the accelerated filer definition will be both an SRC and an accelerated filer 23 if it has: • A public float of $75 million or more, but less than $250 million, regardless of annual revenues; or • Less than $100 million in annual revenues, and a public float of $250 million or more, but less than $700 million. 1. Proposed Amendments 13 See note 6 above. float is defined in paragraph (3)(i)(A) of the SRC definition in Rule 12b–2, which states that public float is measured as of the last business day of the issuer’s most recently completed second fiscal quarter and computed by multiplying the aggregate worldwide number of shares of its voting and non-voting common equity held by nonaffiliates by the price at which the common equity was last sold, or the average of the bid and asked prices of common equity, in the principal market for the common equity. See also Item 10(f) (2)(i)(A) and Rule 405. An entity with no public float because, for example, it has equity securities outstanding but is not trading in any public trading market would not be able to qualify on the basis of a public float test alone. That entity must look to the SRC revenue test to determine whether it qualifies as an SRC. 15 To avoid situations where an issuer frequently enters and exits SRC status, each test includes two thresholds—one for initially determining whether an issuer qualifies as an SRC and a subsequent transition threshold that is lower for issuers that did not initially qualify as an SRC, or that no longer qualify as an SRC because they exceeded the initial thresholds. lotter on DSKBCFDHB2PROD with RULES2 14 Public VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 16 Annual revenues are measured as of the most recently completed fiscal year for which audited financial statements are available. See Item 10(f)(2)(i)(B), Rule 405, and Rule 12b–2. 17 See Item 10(f)(1), Rule 405, and Rule 12b–2. The prior revenue test included issuers with no public float and annual revenues of less than $50 million. See SRC Adopting Release, note 12 above, at 31995. The lower transition thresholds under the revenue test for an issuer that did not initially qualify as an SRC, or that no longer qualifies as an SRC because it exceeded the initial thresholds, were revised from less than $40 million of annual revenues and no public float to less than $80 million of annual revenues and either no public float or a public float of less than $560 million. See Item 10(f)(2)(iii)(B), Rule 405, and Rule 12b–2. 18 SRC Adopting Release, note 12 above, at 31992. 19 This amendment, among other things, preserved the existing thresholds in those definitions and did not change the number of issuers subject to the ICFR auditor attestation requirement. 20 Although rare, under our existing rules, some issuers that meet the large accelerated filer definition may be eligible to be an SRC because of the expanded revenue test in the SRC definition. PO 00000 Frm 00004 Fmt 4701 Sfmt 4700 See Proposing Release, note 4 above, at 24877, n. 25. As discussed below, in Section II.B.3., we are adopting the proposed amendment to the ‘‘large accelerated filer’’ definition so that an issuer that is eligible to be an SRC under the SRC revenue test would not also qualify as a large accelerated filer. 21 15 U.S.C. 7262(b). 22 See SRC Adopting Release, note 12 above, at 32001. 23 The thresholds provided below are based on the initial thresholds of each definition; however, due to the transition provisions of the accelerated and large accelerated filer definitions, additional issuers may also be both an SRC and an accelerated or large accelerated filer. 24 The three existing conditions for qualifying as an accelerated filer are that an issuer: (1) Had an aggregate worldwide public float of $75 million or more, but less than $700 million, as of the last business day of the issuer’s most recently completed second fiscal quarter; (2) has been subject to the requirements of 15 U.S.C. 78m (Exchange Act Section 13(a)) or 15 U.S.C. 78o(d) (Exchange Act Section 15(d)) for a period of at least twelve calendar months; and (3) has filed at least E:\FR\FM\26MRR2.SGM 26MRR2 ER26MR20.000</GPH> Under the existing accelerated filer and large accelerated filer definitions in Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 add a new condition to the definitions of accelerated filer and large accelerated filer that would exclude from those definitions an issuer that is eligible to be an SRC and that meets the SRC revenue test. The most notable effect of the proposed amendments 25 would be that an issuer that is eligible to be an SRC and that meets the SRC revenue test would not be subject to the requirement of SOX Section 404(b) that an issuer’s independent auditor must attest to, and report on, management’s assessment of the effectiveness of the issuer’s ICFR.26 The final amendments do not change an auditor’s role in a financial statement audit.27 SOX Section 404(a) 28 requires almost all issuers, including SRCs, that file reports pursuant to Exchange Act Section 13(a) or 15(d) 29 to establish and maintain ICFR and have their management assess the effectiveness of their ICFR.30 SOX Section 404(b) subjects certain issuers not otherwise exempted to the ICFR auditor attestation requirement.31 The most significant exemption from the ICFR auditor attestation requirement is the exemption provided to EGCs pursuant to Title I of the JOBS Act (‘‘JOBS Act Exemption’’). Generally, an EGC is a company that has total annual gross revenues of less than $1.07 billion during its most recently completed fiscal year end and that has one annual report pursuant to those sections. For a large accelerated filer, conditions (2) and (3) are the same, but condition (1) is that an issuer had an aggregate worldwide public float of $700 million or more, as of the last business day of the issuer’s most recently completed second fiscal quarter. Also, as discussed in note 20 above, some issuers that meet the ‘‘large accelerated filer’’ definition may be eligible to be an SRC. 25 The issuer also would not have to abide by the filing deadlines of an accelerated or large accelerated filer, provide the disclosure required by Item 1B of Form 10–K and Item 4A of Form 20– F about unresolved staff comments on its periodic and/or current reports, or provide the disclosure required by Item 101(e)(4) of Regulation S–K about whether it makes filings available on or through its internet website. See 17 CFR 229.101(e)(4). 26 See 17 CFR 240.13a–15(f) and 17 CFR 240.15d– 15(f) (defining ICFR). 27 See letter from Deloitte (suggesting that the Commission explain how an auditor’s role in a financial statement audit will change as a result of the amendments). 28 15 U.S.C. 7262(a). 29 See 17 CFR 240.13a–15 and 17 CFR 240.15d– 15. 30 Investment companies registered under Section 8 of the Investment Company Act of 1940, 15 U.S.C 80a–8, are specifically exempted from SOX Section 404 by SOX Section 405, 15 U.S.C. 7263. Notwithstanding the exemption pursuant to SOX Section 405, these registered investment companies are subject to other requirements regarding internal controls. See Proposing Release, note 4 above, at 24879, n. 44. 31 For example, SOX Section 404(c) exempts from Section 404(b) any issuer that is neither a large accelerated filer nor an accelerated filer. See 15 U.S.C. 7262(c). VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 not sold common equity securities under a registration statement.32 The JOBS Act Exemption provides EGCs with a five-year exemption from the ICFR auditor attestation requirement. We estimate that the JOBS Act Exemption applies to issuers with an aggregate market capitalization of about $585 billion, compared to about $95 billion in aggregate for the issuers that are newly exempt from the ICFR auditor attestation requirement under the amendments.33 2. Comments on the Proposed Amendments Many commenters supported the portion of the proposed amendments that would exclude an issuer that is eligible to be an SRC and that meets the SRC revenue test from the accelerated and large accelerated filer definitions.34 Other commenters opposed the proposed amendments or suggested the need for further analysis.35 Commenters’ views on different aspects of the proposal, as well as its effects, are discussed topically, below. a. Comments on Using Revenue for Determining Accelerated and Large Accelerated Filer Status A number of commenters stated explicitly that they supported using revenue as a measure to determine 32 See 15 U.S.C. 77(b)(a)(19). 33 These estimates are based on staff analysis of data on market values from Compustat for annual reports in calendar year 2018. See note 298 below for details on the identification of the population of different filer types. See note 336 below for details on the identification of the population of affected issuers. Out of the 1,430 issuers who qualified as EGCs in 2018, 1,097 are also nonaccelerated filers. The remaining EGCs are still exempt from the ICFR auditor attestation requirement solely due to the JOBS Act Exemption, and those issuers are significantly larger in terms of aggregate market capitalization (approximately $145 billion) than the issuers newly exempted under the amendments (approximately $95 billion). This estimate excludes 41 EGCs with an aggregate of approximately $20 billion in market capitalization for which we are unable to determine non-accelerated filer status, the majority of which are Canadian issuers filing on Form 40–F. 34 See, e.g., letters from Adamas, AdvaMed, AdvaMed et al., Aequor, Andersen, Ardelyx, Ardelyx’s slides from its presentation to the SBCFAC Meeting (Aug. 13, 2019) (‘‘Ardelyx Presentation’’), ASA, BIO, Broadmark, BSC, Carver, Catalyst, Cerecor, Chamber, Chiasma, CLSA, Concert, Corvus, CSB, CSBA, CymaBay, Dare´, Equillium, Evoke, Gritstone, Guaranty, ICBA, Institute of Management Accountants’ Financial Reporting and Small Business Committees (July 16, 2019) (‘‘IMA’’), Kezar, Marinus, Millendo, MSB, National Association of Manufacturers (July 26, 2019) (‘‘NAM’’), Nasdaq, Organovo, Pieris, Revance, SCBA, SI–BONE, Summit, Sutro, Syros, Teligent, Terra Tech, Xenon, and Zynerba. 35 See, e.g., letters from BDO, Better Markets, CAQ, CFA, CFA Inst., CII, Crowe, Deloitte, Grant Thornton, Prof. Barth et al., Prof. Ge et al., Prof. Hassell, Prof. Honigsberg et al., and RSM. PO 00000 Frm 00005 Fmt 4701 Sfmt 4700 17181 whether an issuer should be subject to the ICFR auditor attestation requirement.36 These commenters suggested that using a revenue measurement is preferable to using a public float measurement 37 because public float is often affected by industry or economic trends not specific to any particular issuer,38 and that revenue is more predictable,39 a better indicator of an issuer’s complexity,40 and a better indicator of an issuer’s ability to absorb the burdens of the ICFR auditor attestation requirement.41 Other commenters questioned whether revenue is an appropriate measure for determining whether an issuer should be a non-accelerated filer in all cases.42 One commenter asserted that lowrevenue companies may have less sophisticated or experienced accounting functions and some aspects of their business may be associated with accounting complexities.43 This commenter also suggested that issuers may recognize revenue in ways that could result in them frequently transitioning in and out of nonaccelerated filer status.44 Another commenter indicated that an issuer could have a relatively low amount of revenue but still have a large market capitalization and thus ‘‘greater investor exposure.’’ 45 b. Comments on the Proposed Amendments’ Effect on Capital Formation and the Number of Public Issuers Commenters expressed mixed views on the effect that the proposed amendments would have on capital formation, the cost of capital, and the decisions of companies as to whether to enter the public capital markets. Some commenters agreed with the view expressed in the Proposing Release that, by expanding the JOBS Act Exemption, the proposed amendments would enhance capital formation or allow affected issuers to preserve capital 46 while also maintaining investor 36 See, e.g., letters from BIO, Broadmark, Chamber, Concert, Corvus, and MSB. 37 See, e.g., letters from Broadmark, Chamber, Concert, Corvus, and MSB. 38 See letter from MSB. 39 See letter from Broadmark. 40 See, e.g., letters from Concert and Corvus. 41 See letter from Broadmark. 42 See letter from Ernst & Young LLP (July 29, 2019) (‘‘EY’’), Grant Thornton, and National Association of State Boards of Accountancy (July 23, 2019) (‘‘NASBA’’). 43 See letter from EY. 44 Id. 45 See letter from Grant Thornton. 46 See, e.g., letters from Andersen, CLSA, Concert, ICBA, and NASBA. E:\FR\FM\26MRR2.SGM 26MRR2 17182 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations protection.47 One commenter, questioning the benefits, if any, of the ICFR auditor attestation requirement, asserted that there is no correlation between a smaller issuer’s compliance with the ICFR auditor attestation requirement and stronger markets in general.48 Additionally, some commenters suggested that eliminating the ICFR auditor attestation requirement would encourage certain companies to enter the public markets.49 Conversely, other commenters asserted that the proposed amendments would not enhance capital formation, and some indicated they could even reduce capital formation.50 Two of these commenters expressed the view that eliminating the ICFR auditor attestation requirement could increase the cost of capital for certain issuers because investors would require a premium to invest in issuers due to the heightened risk of ineffective internal controls.51 In addition, some commenters maintained that the ICFR auditor attestation requirement does not prevent companies from entering the public markets.52 For example, one commenter suggested that the Proposing Release’s statement about the significant decline in the number of issuers listed on major exchanges implied that the cost of compliance with the ICFR auditor attestation requirement has contributed materially to that decline.53 This commenter and some others asserted that the decline can be attributed to many other factors.54 Some commenters stated that confidence in the U.S. capital market system, likely stems, at least in part, from financial reporting safeguards, including the ICFR auditor attestation requirement, and contended that the proposed amendments would thereby reduce investor confidence in issuers’ financial reporting.55 Several commenters indicated that the ICFR auditor attestation requirement is not necessary because issuers are permitted to voluntarily obtain an ICFR 47 See, e.g., letters from ICBA and NASBA. letter from BIO. e.g., letters from AdvaMed, AdvaMed et al., Broadmark, Cerecor, and ICBA. 50 See, e.g., letters from Better Markets, CII, CFA, CFA Inst., and Prof. Ge et al. 51 See letters from Better Markets and CFA. 52 See, e.g., letters from CFA, CFA Inst., CII, and Crowe. 53 See letter from CFA. 54 See, e.g., letters from CII, CFA, CFA Inst., and Crowe. Other factors commenters cited include the expansion of exemptions to registration that increase companies’ ability to raise funds privately, see, e.g., letters from CFA, CII, and Crowe; corporate consolidations, see, e.g., letters from CFA and CII; market conditions, see letter from CFA; and the general regulatory environment, see letter from Crowe. 55 See, e.g., letters from CAQ and CII. 48 See lotter on DSKBCFDHB2PROD with RULES2 49 See, VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 auditor attestation if they believe it is in their interest to do so.56 Some instances in which commenters suggested that issuers may choose to voluntarily obtain an ICFR auditor attestation include when their investors demand it,57 when not obtaining it would have a negative impact on investment analysts’ coverage,58 or when issuers otherwise deem it a good use of their capital resources.59 In this regard, one commenter suggested clarifying that it is the authority and responsibility of the issuer’s audit committee to determine whether the issuer should voluntarily obtain an ICFR auditor attestation.60 c. Comments on the Proposed Amendments’ Effect on Investor Protection Commenters’ views as to the effect of the proposed amendments on investor protection were also mixed. Many commenters asserted that, even if the ICFR auditor attestation requirement did not apply, other existing requirements would provide investors in these issuers with sufficient protection.61 Commenters cited a number of these other requirements, including SOX Section 404(a); 62 Nasdaq’s listing standards, surveillance, and enforcement; 63 the required management certifications; 64 and the obligation of an independent auditor to consider ICFR when conducting a financial statement audit.65 For example, several commenters noted that, when conducting a financial statement audit, the auditor is required to obtain an understanding of each component of ICFR,66 which a few of these commenters asserted would provide investors with sufficient protection absent the ICFR auditor attestation requirement.67 Other commenters noted that the requirement that an auditor communicate to the 56 See, e.g., letters from ASA, BIO, Broadmark, Chamber, Guaranty, and Nasdaq. 57 See, e.g., letters from BIO and Guaranty. 58 See letter from Guaranty. 59 Id. 60 See letter from EY. 61 See, e.g., letters from ASA, Broadmark, BSC, Carver, Cerecor, Guaranty, ICBA, MSB, NAM, Nasdaq, Pieris, SCBA, and Xenon. 62 See, e.g., letters from ASA, Broadmark, Carver, ICBA, MSB, Nasdaq, and Xenon. 63 See letter from Nasdaq. 64 See 17 CFR 229.601(31)(i), 17 CFR 240.13a– 14(a), and 17 CFR 240.15d–14(a). See, e.g., letters from MSB, Nasdaq, and Xenon. 65 See, e.g., letters from ASA, Carver, Cerecor, MSB, NAM, and Xenon. 66 See, e.g., letters from ASA, CAQ, CFA Inst., Crowe, EY, Grant Thornton, Guaranty, NASBA, Nasdaq, PricewaterhouseCoopers LLP (July 25, 2019) (‘‘PWC’’), and RSM. 67 See, e.g., letters from ASA, Guaranty, and Nasdaq. PO 00000 Frm 00006 Fmt 4701 Sfmt 4700 issuer’s management and its audit committee any significant deficiencies or material weaknesses related to ICFR in a financial statement audit would provide a certain level of protection for investors in the affected issuers.68 Some commenters expressed a view that the ICFR auditor attestation requirement is not important or material to investors generally.69 A few of these commenters asserted that investors rarely ask an issuer that is exempt from the ICFR auditor attestation requirement to voluntarily obtain such an attestation.70 One commenter 71 cited a study 72 that found no statistically significant market response on average to disclosures of material weaknesses in disclosure controls, which suggests, according to the commenter, that investors do not significantly change their long-term value assessment of an issuer based on these disclosures. In addition to these broader points, several commenters in the banking sector pointed out that community banks and bank holding companies are subject to extensive supervision and regulation by federal and state banking regulators, which they stated would protect investors in this industry even if the affected issuers were not subject to the ICFR auditor attestation requirement.73 Conversely, other commenters asserted that the ICFR auditor attestation requirement is an important investor protection and that eliminating it would undermine such protection.74 68 See letter from Nasdaq. e.g., letters from Adamas; Ardelyx; Ardelyx Presentation, ASA, BIO, Carver, Catalyst, Chiasma, Corvus, CymaBay, Equillium, Evoke, Gritstone, Kezar, Marinus, Millendo, Organovo, Pieris, Revance, SI–BONE, Syros, Teligent, and Zynerba. Some of these commenters and others asserted that the ICFR auditor attestation requirement is not material for, or important to, investors based on the results of a study and their own experience. See, e.g., letters from Adamas, Ardelyx, Catalyst, Chiasma, Corvus, CymaBay, Equillium, Evoke, Gritstone, Kezar, Marinus, Millendo, Organovo, Pieris, Revance, SI–BONE, Syros, Teligent, and Zynerba (citing Craig Lewis and Joshua White, Science or Compliance: Will Section 404(b) Compliance impede Innovation by Emerging Growth Companies in the Biotech Industry, (Feb. 2019) (‘‘BIO Study’’), available at https://www.bio.org/sites/default/files/BIO_EGC_ White_Paper_02_11_2019_FINAL.pdf). 70 See, e.g., letters from Ardelyx Presentation and BIO. 71 See letter from BIO. 72 Jacqueline Hammersley, Linda Myers, and Catherina Shakespeare, Market Reactions to the Disclosure of Internal Control Weaknesses and to the Characteristics of those Weaknesses under Section 302 of the Sarbanes Oxley Act of 2002 (Mar. 2008), available at https://papers.ssrn.com/sol3/ papers.cfm?abstract_id=979538. 73 See, e.g., letters from BSC, Guaranty, ICBA, and SCBA. 74 See, e.g., letters from Better Markets, Grant Thornton, and Prof. Barth et al. 69 See, E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations One commenter disputed the contention in the Proposing Release that eliminating the ICFR auditor attestation requirement for low-revenue issuers would not significantly affect the ability of investors to make informed investment decisions.75 Some commenters stated that the ICFR auditor attestation requirement increases investor confidence generally 76 and that investors view the requirement as beneficial.77 Some commenters asserted that the SOX Section 404(a) requirement would not provide investors in low-revenue SRCs with sufficient protection if they were not also subject to the ICFR auditor attestation requirement 78 because, as one commenter stated, the ICFR auditor attestation requirement acts as an effective check on SOX Section 404(a).79 Another commenter asserted that management’s assessment is weakened when management knows that it will not be challenged by an ICFR auditor attestation.80 A third commenter claimed that investors would place undue reliance on management’s report when not accompanied by an ICFR auditor attestation.81 A few commenters noted that a financial statement audit does not provide the same level of assurance as an integrated audit 82 because a financial statement audit’s objective is different from that of an integrated audit as it relates to ICFR.83 Therefore, some commenters asserted that, without the ICFR auditor attestation requirement, the requirement for auditors to obtain an understanding of each component of ICFR when conducting a financial statement audit would not provide sufficient investor protection.84 Similarly, other commenters suggested that some testing of ICFR conducted as part of a financial statement audit would not provide sufficient investor protection.85 One commenter asserted 75 See letter from Prof. Barth et al. e.g., letters from Better Markets, CAQ, CFA Inst., and EY. 77 See, e.g., letters from CII, CFA Inst., and EY. 78 See, e.g., letters from Better Markets, CFA Inst., Crowe, Grant Thornton, and Prof. Barth et al. 79 See letter from Better Markets. 80 See letter from CFA Inst. 81 See letter from Grant Thornton. 82 See, e.g., letters from CFA Inst., Crowe, and EY. 83 See, e.g., letters from CAQ, CFA Inst., and RSM (noting that a financial statement audit’s objective is for the auditor to obtain an understanding of the issuer’s ICFR that is sufficient to assess the factors that affect the risks of material misstatement and to design further audit procedures, whereas an integrated audit’s objective is to test and express an opinion on the effectiveness of the issuer’s ICFR). 84 See, e.g., letters from CAQ, CFA Inst. Crowe, EY, and RSM. 85 See, e.g., letters from EY, Grant Thornton, and NASBA. lotter on DSKBCFDHB2PROD with RULES2 76 See, VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 that the control testing performed by a financial statement auditor would not be as extensive as testing performed in an ICFR auditor attestation and that it is more difficult for a financial statement auditor to challenge the design of ICFR.86 Another commenter noted that, despite the requirement that a financial statement auditor communicate any significant deficiencies or material weaknesses related to ICFR to the issuer’s management and its audit committee, a financial statement audit is not designed to identify such significant deficiencies or material weaknesses.87 Some commenters indicated that the ICFR auditor attestation requirement promotes effective ICFR and more accurate disclosures related to ICFR,88 including the likelihood and timeliness of disclosing ineffective ICFR.89 Also, a number of commenters noted that, as discussed in the Proposing Release, effective ICFR, generally, and the ICFR auditor attestation requirement, more specifically, enhances transparency; 90 increases the quality and reliability of issuers’ financial statements,91 corporate governance,92 audits,93 and analyst forecasts; 94 and reduces the number of issuers’ restatements, misstatements,95 the instances of fraud,96 and occurrences of insider trading.97 A few commenters expressed concern about the effect that the amendments could have on the reliability of key performance indicators and other measures. One commenter indicated that investors in certain issuers that would become non-accelerated filers under the amendments rely on key performance indicators that are derived from their financial statements, such as backlog, sales orders, and number of customers, and asserted that eliminating the ICFR auditor attestation requirement could reduce the reliability of those indicators.98 Another commenter noted that investors in those issuers rely on 86 See Frm 00007 d. Comments on the Disproportionate Costs and Benefits of the ICFR Auditor Attestation Requirement to Small and Low-Revenue Companies A number of commenters stated that the ICFR auditor attestation requirement is quite costly.100 One of these commenters indicated that the ICFR auditor attestation requirement ‘‘is the most costly aspect of being an [a]ccelerated [f]iler.’’ 101 Several commenters asserted more specifically that the ICFR auditor attestation requirement is disproportionally costly to small and/or low-revenue issuers.102 Some of these commenters indicated that the reason for the disproportionate costs is that there are fixed costs associated with the ICFR auditor attestation requirement that are not scalable for smaller issuers.103 Other commenters stated that the benefits of the ICFR auditor attestation requirement do not outweigh the costs,104 including the costs associated with ICFR auditor attestation fees,105 issuer personnel time,106 and outside consultants.107 Some commenters asserted that eliminating the ICFR auditor attestation requirement would not substantially reduce costs to issuers.108 A few of these commenters noted that ICFR auditor attestations have become less expensive and more effective because auditors are more experienced in conducting them.109 Some commenters stated that potential compliance cost reductions may be negated if there is a loss of investor confidence and protection,110 if ICFR deficiencies go undetected,111 if there is an increase in restatements and misstatements,112 or if there are higher letter from CAQ. e.g., letters from BIO, Broadmark, Carver, Guaranty, ICBA, MSB, Summit, and Syros. 101 Letter from Guaranty. 102 See, e.g., letters from AdvaMed et al., Andersen, BIO, Broadmark, Chamber, CLSA, CSB, Guaranty, and NAM. 103 See, e.g., letters from Broadmark and Guaranty. 104 See, e.g., letters from ICBA, MSB, and Syros. 105 See, e.g., letters from MSB and Summit. 106 See, e.g., letters from Carver, MSB, and Summit. 107 See, e.g., letters from MSB and Summit. 108 See, e.g., letters from BDO, Better Markets, CFA, CFA Inst., EY, Grant Thornton, and RSM. 109 See, e.g., letters from CFA Inst. and Deloitte. 110 See, e.g., letters from Better Markets and CII. 111 See letter from CFA Inst. 112 See, e.g., letters from BDO, CFA, and CFA Inst. 100 See, 88 See, e.g., letters from Better Markets, CFA, CII, Crowe, Grant Thornton, Prof. Barth et al., and PWC. 89 See, e.g., letters from Better Markets, CFA, Crowe, and Prof. Barth et al. 90 See letter from EY. 91 See, e.g., letters from Better Markets, CAQ, CFA, CII, Deloitte, EY, Grant Thornton, Prof. Barth et al., PWC, and RSM. 92 See letter from Deloitte. 93 See letter from CAQ. 94 See letter from CFA. 95 See, e.g., letters from CAQ, CFA, CFA Inst., Crowe, Deloitte, EY, Grant Thornton, and Prof. Barth et al. 96 See, e.g., letters from Better Markets and Deloitte. 97 See letter from CFA. 98 See letter from NASBA. PO 00000 non-GAAP financial measures, key performance indicators, and other disclosures and stated that the Commission may wish to consider auditor involvement with that information to address potential risks related to completeness and accuracy.99 99 See letter from EY. 87 Id. Fmt 4701 Sfmt 4700 17183 E:\FR\FM\26MRR2.SGM 26MRR2 17184 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations costs of capital.113 Additionally, some commenters stated that any cost reductions would vary widely among issuers 114 and would be hard to quantify.115 Other commenters asserted that the benefits of the ICFR auditor attestation requirement are not as great for lowrevenue and smaller issuers as they are for other issuers.116 These commenters expressed the view that the issuers that would be exempt from the ICFR auditor attestation requirement under the proposed amendments are less likely to have ineffective ICFR than other issuers. One commenter cited a study that concluded that biotech EGCs are less likely to have ineffective ICFR than other issuers.117 Another commenter noted that ineffective ICFR is less of a concern for banking issuers because of the ‘‘federal and state regulatory oversight and internal control audits of community banks.’’ 118 Conversely, a number of other commenters contended that the benefits of the ICFR auditor attestation requirement are greater for low-revenue and smaller issuers than for other issuers.119 Some of the commenters discussed how those issuers are more likely to have ineffective ICFR.120 Commissioner Robert J. Jackson Jr.’s dissent from the Proposing Release (‘‘Commissioner Jackson’s Statement’’) 121 asserted that investors care most about ICFR auditor attestations at those issuers that would not be subject to the ICFR auditor attestation requirement under the proposed amendments, and that high113 See, lotter on DSKBCFDHB2PROD with RULES2 114 See, e.g., letters from CFA and CFA Inst. e.g., letters from EY, Grant Thornton, and PWC. 115 See, e.g., letters from Grant Thornton, PWC, and RSM. 116 See, e.g., letters from BIO and Guaranty. 117 See letter from BIO (citing the BIO Study). Note that the BIO Study investigates only the incremental effect of being in the category of biotech EGCs after accounting for the association of ineffective ICFR with the other characteristics of these issuers (such as their size and return on assets). It is unclear from the study whether these issuers have a higher or lower rate of ineffective ICFR on average, when considering all of their characteristics. 118 See letter from Guaranty. 119 See, e.g., letters from Better Markets, CAQ, CFA, CFA Inst., CII, Crowe, EY, Grant Thornton, IMA, NASBA, Prof. Barth et al., Prof. Hassell, and RSM. 120 See, e.g., letters from Better Markets, CAQ, CFA, CII, Grant Thornton, IMA, NASBA, Prof. Barth et al., and Prof. Hassell. 121 Commissioner Robert J. Jackson Jr., Statement on Proposed Amendments to Sarbanes Oxley 404(b) Accelerated Filer Definition (May 9, 2019), available at https://www.sec.gov/news/public-statement/ jackson-statement-proposed-amendmentsaccelerated-filer-definition. A few commenters cited Commissioner Jackson’s Statement. See, e.g., letters from CFA, CFA Inst., and CII. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 growth companies, which potentially would include some of the affected issuers, are those in which the risk and consequences of fraud are the greatest.122 Some commenters referred to statistics cited in the Proposing Release to argue that issuers not subject to the ICFR auditor attestation requirement have higher levels of ineffective ICFR compared with issuers subject to that requirement.123 Additionally, commenters observed that some low-revenue issuers or smaller companies may still have complex financial statements that require sophisticated accounting.124 Finally, some commenters maintained that the risks of fraud 125 and financial statement restatements or misstatements 126 are greater for the issuers that would not be subject to the ICFR auditor attestation requirement under the proposed amendments than they are for other issuers. Other commenters cited research that concludes that, since 2003, nonaccelerated U.S. filers accounted for 62 percent of the total U.S. financial statement restatements.127 Some commenters contended that issuers that would not be subject to the ICFR auditor attestation requirement under the proposed amendments have fewer resources and personnel,128 which could result in increased misstatements,129 unidentified material weaknesses,130 and ineffective ICFR.131 e. Comments on the Relationship Between Non-Accelerated Filers and SRCs A number of commenters discussed the relationship between the non122 We address Commissioner Jackson’s Statement in the Economic Analysis. See Section IV.C.3.c. below. 123 Commenters cited the statistics in the Proposing Release, note 4 above, that over 40 percent of non-accelerated filers that are not subject to the ICFR auditor attestation requirement have ineffective ICFR, compared to less than approximately nine and five percent of accelerated and large accelerated filers, respectively. As noted in the Proposing Release, note 4 above, over 68 percent of non-accelerated filers have reported two consecutive years of ineffective ICFR and over 38 percent have reported four consecutive years of ineffective ICFR in their annual reports. See, e.g., letters from Better Markets and Grant Thornton. 124 See, e.g., letters from BDO and RSM. 125 See, e.g., letters from Better Markets, CFA, CII, and Prof. Barth et al. 126 See, e.g., letters from Better Markets, CAQ, EY, Grant Thornton, IMA, Prof. Barth et al., and RSM. 127 See, e.g., letters from CAQ and CFA Inst. 128 See, e.g., letters from CAQ, Crowe, EY, and Grant Thornton. 129 See, e.g., letter from Crowe. 130 See, e.g., letter from EY. 131 See, e.g., letters from CAQ and Grant Thornton. PO 00000 Frm 00008 Fmt 4701 Sfmt 4700 accelerated filer and SRC definitions.132 Some commenters noted the current relationship is incongruent, which results in complexity.133 Several commenters indicated that the proposed amendments would reduce some of this complexity by more closely aligning the definitions.134 In contrast, other commenters asserted that the proposed amendments would increase the complexity of determining filer status.135 While supporting the proposed amendments, some commenters recommended that the final amendments completely align the SRC and non-accelerated filer definitions.136 Additionally, one commenter recommended further extending the relief from the ICFR auditor attestation requirement to issuers with a public float that exceeds $700 million if their annual revenues are less than $100 million.137 f. Other Comments We received a variety of other comments on the Proposing Release. Some commenters noted that it is difficult for investors to easily determine whether an issuer’s filing includes an ICFR auditor attestation.138 These commenters suggested requiring issuers to disclose whether they are exempt from the ICFR auditor attestation requirement 139 and/or have voluntarily obtained an ICFR auditor attestation 140 either on a filing’s cover page,141 such as with a check box,142 or in management’s report on ICFR.143 Two commenters recommended that the Commission engage in a postimplementation review of the impact of the final amendments,144 with one of these commenters recommending that 132 See, e.g., letters from ASA, BDO, BIO, Broadmark, CFA, CFA Inst., Chamber, EY, Grant Thornton, Guaranty, KPMG LLP (July 29, 2019) (‘‘KPMG’’), NAM, Nasdaq, PWC, and RSM. 133 See, e.g., letters from BDO, BIO, Broadmark, CFA, and Nasdaq. 134 See, e.g., letters from BIO, Grant Thornton, KPMG, and Nasdaq. 135 See, e.g., letters from BDO, CFA Inst., EY, PWC, and RSM. See also SBCFAC Meeting Transcript (Aug. 13, 2019), available at https:// www.sec.gov/info/smallbus/acsec/sbcfac-transcript081319.pdf. 136 See, e.g., letters from ASA, Guaranty, NAM, and Nasdaq. 137 See letter from Corvus. 138 See, e.g., letters from CAQ, CFA Inst., and Grant Thornton. 139 See, e.g., letters from CFA Inst., CII, and Grant Thornton. 140 See, e.g., letters from CFA Inst. and KPMG. 141 See, e.g., letters from CAQ, CFA Inst., CII, and Grant Thornton. 142 See, e.g., letters from CAQ and Grant Thornton. 143 See letter from Grant Thornton. 144 See letters from IMA and PWC. E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations the final amendments require a review of the impact of the changes on the affected registrants five years after adoption of the amendments.145 Some commenters requested that we allow sufficient time and notice for auditors and issuers to prepare for compliance with the final amendments,146 whereas other commenters noted that some issuers may be subject to the ICFR auditor attestation requirement for only a short time 147 and requested the Commission adopt final amendments quickly.148 One commenter asserted that the measurement date for nonaccelerated filer status and the timing of the start of the auditor’s attestation of ICFR is burdensome to small biotech registrants.149 Additionally, although we did not propose amendments to the accelerated and large accelerated filer definitions that would specifically address foreign private issuers (‘‘FPI’’) or business development companies (‘‘BDC’’), we solicited comment on these points and a few commenters requested we do so.150 One commenter asserted that there should be no disparity between an FPI that presents its financial statements in accordance with International Financial Reporting Standards (‘‘IFRS’’) and a domestic issuer or FPI that presents its financial statements in accordance with U.S. GAAP.151 The commenter noted that an FPI that presents its financial statements in accordance with IFRS cannot be an SRC, so such an FPI cannot rely on the proposed amendments. Another commenter recommended that the Commission extend the benefits of nonaccelerated filer status to BDCs if they have total investment income of less than $80 million in their most recently completed fiscal year for which audited financial statements are available and have either no public float or public float of less than $700 million.152 The commenter stated that allowing BDCs to qualify as non-accelerated filers under this modified SRC revenue test would reduce regulatory asymmetry between BDCs and operating companies, consistent with recent congressional mandates to allow BDCs to use the same offering rules as operating companies. The commenter also suggested that allowing smaller BDCs to benefit from non-accelerated filer status would ease regulatory costs and burdens, which could encourage more BDCs to enter public markets, creating greater access to capital for small operating companies 17185 and expanding investment opportunities for retail investors.153 3. Final Amendments After considering the comments, we are adopting the final amendments substantially as proposed. The final amendments add a new condition to the accelerated and large accelerated filer definitions in Rule 12b–2 that excludes an issuer that is eligible to be an SRC and that had annual revenues of less than $100 million in the most recent fiscal year for which audited financial statements are available. The amendments also allow BDCs to qualify for this exclusion if they meet the requirements of the SRC revenue test using their annual investment income as the measure of annual revenue, although BDCs would continue to be ineligible to be SRCs.154 The final amendments are consistent with our historical practice of providing scaled disclosure and other accommodations for smaller issuers 155 and with recent actions by Congress to reduce burdens on new and smaller issuers.156 The table below summarizes the conditions required to be considered an accelerated and large accelerated filer under the final amendments to Rule 12b–2. TABLE 1—ACCELERATED FILER AND LARGE ACCELERATED FILER CONDITIONS UNDER THE FINAL AMENDMENTS Final accelerated filer conditions Final large accelerated filer conditions The issuer has a public float of $75 million or more, but less than $700 million, as of the last business day of the issuer’s most recently completed second fiscal quarter. The issuer has been subject to the requirements of Exchange Act Section 13(a) or 15(d) for a period of at least twelve calendar months. The issuer has filed at least one annual report pursuant Exchange Act Section 13(a) or 15(d) ... The issuer is not eligible to use the requirements for SRCs under the revenue test in paragraph (2) or (3)(iii)(B), as applicable, of the ‘‘smaller reporting company’’ definition in Rule 12b–2 or, in the case of a BDC, does not meet the requirements of the revenue test in those paragraphs using annual investment income as the measure of its annual revenues. Below we discuss specific aspects of the final amendments about which we received significant public comment and our response to those comments. In 145 See letter from IMA. e.g., letters from BDO, CAQ, Crowe, EY, KPMG, PWC, and RSM. 147 See, e.g., letters from Concert, MSB, Nasdaq, and Xenon. 148 See, e.g., letters from MSB and Summit. 149 See letter from Corvus. Public float for both SRC status and accelerated and large accelerated filer status is measured on the last business day of the issuer’s most recently completed second fiscal quarter, and revenue for purposes of determining SRC status is measured based on annual revenues for the most recent fiscal year completed before the last business day of the second fiscal quarter. Therefore, an issuer will be aware of any change in SRC status or accelerated or large accelerated filer status as of that date. Although an issuer that lotter on DSKBCFDHB2PROD with RULES2 146 See, VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 The issuer has a public float of $700 million or more, as of the last business day of the issuer’s most recently completed second fiscal quarter. Same. Same. Same. many cases, our responses reflect analysis and data that is more comprehensively presented in the Economic Analysis.157 determines it will no longer be eligible to be an SRC is permitted to continue to use the SRC accommodations for the Form 10–K for the year in which it fails the measurement test, an issuer that becomes an accelerated or large accelerated filer on that same measurement date would be required to include the ICFR auditor attestation in that Form 10–K. See Rule 12b–2, Item 10(f)(2)(i)(C), and Rule 405. Although the transition provisions apply differently, the measurement dates for SRC status and accelerated and large accelerated filer status each provide an issuer with at least six months to prepare for a change in its status, and we continue to believe that this is an adequate amount of time to prepare for the transition. 150 See, e.g., letters from Dorsey & Whitney LLP (Aug. 16, 2019) (‘‘Dorsey & Whitney’’) and Proskauer Rose LLP (July 26, 2019) (‘‘Proskauer’’). PO 00000 Frm 00009 Fmt 4701 Sfmt 4700 151 See 152 See letter from Dorsey & Whitney. letter from Proskauer. 153 Id. 154 See Section II.B.3.f. below. e.g., Smaller Reporting Company Regulatory Relief and Simplification, Release No. 33–8876 (Dec. 19, 2007) [73 FR 934 (Jan. 4, 2008)]; Smaller Reporting Company Regulatory Relief and Simplification, Release No. 33–8876 (Dec. 19, 2007) [73 FR 934 (Jan. 4, 2008)] (‘‘2007 SRC Adopting Release’’); and SRC Adopting Release, note 12 above. 156 See note 11 above. 157 See Section IV. below. 155 See, E:\FR\FM\26MRR2.SGM 26MRR2 17186 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations a. Using Revenue for Determining Accelerated and Large Accelerated Filer Status As discussed above,158 several commenters supported the use of revenue in the proposal, providing a variety of reasons that a revenue measurement is preferable to using a public float measurement.159 Others, however, questioned whether revenue is an appropriate measure for determining whether an issuer should be considered a non-accelerated filer.160 One of these commenters asserted that low-revenue issuers may have less sophisticated or experienced accounting functions and some aspects of their business may be associated with accounting complexities.161 Also, the commenter suggested that these issuers may recognize revenue in ways that could result in them frequently transitioning in and out of non-accelerated filer status.162 As we discuss in more detail below,163 we continue to believe, as a general matter, that there may be greater costs and relatively lower benefits to including low-revenue issuers, as compared to other issuers, in the accelerated and large accelerated filer definitions. While we recognize that the circumstances of individual issuers and their accounting systems and processes may vary, we believe that low-revenue issuers may, on average, be less susceptible to the risk of certain types of restatements, such as those related to revenue recognition.164 We also note that the revisions to the transition thresholds included in the final amendments may help minimize the risk of frequent reclassifications of issuer status.165 For these reasons, we continue to believe that revenue is an appropriate measure for determining whether an issuer should be considered a non-accelerated filer. b. Effect on Capital Formation and the Number of Public Companies Under the final amendments, an issuer that is eligible to be an SRC and that meets the SRC revenue test will not be required to comply with accelerated or large accelerated filer requirements and, thereby, will not be subject to the ICFR auditor attestation requirement. 158 See Section II.A.2.a. above. e.g., letters from Broadmark, Chamber, Concert, Corvus, and MSB. 160 See, e.g., letters from EY and Grant Thornton, and NASBA. 161 See letter from EY. 162 Id. 163 See Sections II.B.3.d. and Section IV.C.2.d. below. 164 See Section IV.C.3. below. 165 See Section II.C. below. lotter on DSKBCFDHB2PROD with RULES2 159 See, VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 Not subjecting these affected issuers to the ICFR auditor attestation requirement should reduce their compliance costs. As discussed in the Economic Analysis,166 we estimate that, consistent with the proposal, an issuer no longer subject to the ICFR auditor attestation requirement would save approximately $210,000 per year comprised of approximately $110,000 per year reduction in audit fees and an additional reduction in non-audit costs of approximately $100,000. Some commenters stated that eliminating the ICFR auditor attestation requirement would enhance capital formation or allow those issuers to preserve capital.167 We note, however, that a number of other commenters asserted that these cost savings would be small,168 and may not help capital formation.169 As we discuss in the Economic Analysis,170 we continue to believe that the expected savings are likely to represent a meaningful cost savings for many of the affected issuers and, therefore, may have a positive effect on capital preservation and formation. Although the average annual cost savings may represent a small percentage of the average affected issuer’s revenues and market capitalization, we believe those savings may be meaningful given that affected issuers have, on average, negative net income and negative net cash flows from operations.171 More generally, lowrevenue issuers are likely to face financing constraints because they do not have access to internally generated capital.172 Therefore, the average savings of $210,000 per year for these issuers may be put to productive use 173 such as developing the company.174 166 See Section IV.C.2.b. below. e.g., letters from Andersen, CLSA, Concert, ICBA, and NASBA. 168 See letters from CFA, CFA Inst., CII, and Prof. Barth et al. 169 See note 50 above. 170 See Section IV.C.2.d. below. 171 See note 362 below. 172 This information is based on staff analysis of data from Compustat. See Section IV.C.2.d. below. 173 For example, in a survey of issuers in the biotech industry, among 11 biotech EGCs that responded to a question regarding how an extension of the exemption from the ICFR auditor attestation requirement would affect them given the costs associated with the requirement, eight out of the 11 issuers indicated that they expected a positive impact on investments in research and development and six out of the 11 issuers indicated that they expected a positive impact on hiring employees. See BIO Study, note 423 above. 174 See, e.g., letters from Adamas, Aequor, Andersen, Ardelyx, Catalyst, Chiasma, CLSA, Concert, Corvus, CymaBay, Dare´, Evoke, Equillium, Gritstone, ICBA, Kezar, Marinus, Millendo, NASBA, Organovo, Pieris, Revance, SI–BONE, Sutro, Syros, Teligent, and Zynerba. As we noted in the Proposing Release,175 the affected issuers are a type of smaller issuer whose representation in public markets has decreased relative to the years before SOX. Over the past two decades, the number of issuers listed on major exchanges has decreased by about 40 percent,176 but the decline has been concentrated among smaller size issuers. For example, the number of listed issuers with a market capitalization below $700 million has decreased by about 65 percent,177 and the number of issuers with less than $100 million in revenue has decreased by about 60 percent.178 Although factors other than the ICFR auditor attestation requirement may have contributed to the decline,179 we believe that the described cost reductions associated with the final amendments could be a positive factor in encouraging additional small companies to register their securities offerings or a class of their securities, which would provide an increased level of transparency and investor protection with respect to those companies.180 c. Effect on Investor Protection We continue to believe that the amendments are not likely to have a significant effect on the overall ability of investors in the affected issuers to make informed investment decisions and note that many commenters agreed with this assessment.181 As discussed in greater detail in the Proposing Release,182 issuers have a number of other obligations that we believe will provide sufficient protections for investors in the affected issuers and allow investors in those issuers to make informed investment decisions. These responsibilities derive from the Foreign Corrupt Practices Act (‘‘FCPA’’) 167 See, PO 00000 Frm 00010 Fmt 4701 Sfmt 4700 175 See Section III.C.1. of the Proposing Release, note 4 above. Staff extracted information regarding whether issuers reported having securities registered under Section 12(b) of the Exchange Act from the cover page of annual report filings using a computer program supplemented with hand collection. See note 336 below for details on the identification of the population of affected issuers. 176 This estimate is based on staff analysis of data from the Center for Research in Security Prices database for December 1998 versus December 2018. The estimate excludes RICs and issuers of ADRs. 177 Id. 178 This estimate is based on staff analysis of data from Standard & Poor’s Compustat and Center for Research in Security Prices databases for fiscal year 1998 versus fiscal year 2017. The estimate excludes RICs and issuers of ADRs. 179 See note 54 above. 180 See, e.g., letters from AdvaMed, AdvaMed et al., Broadmark, Cerecor, and ICBA. 181 See note 61 to 68 above and accompanying text. 182 See Section II.B. of the Proposing Release, note 4 above. E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 requirements with respect to internal accounting controls 183 as well as a number of different changes to financial reporting that were introduced by SOX.184 For example, although a nonaccelerated filer that is eligible to be an SRC and that meets the SRC revenue test will not be subject to the ICFR auditor attestation requirement, it will remain subject to the SOX Section 404(a) requirement to state in its annual report the responsibility of management for establishing and maintaining an adequate control structure and procedures for financial reporting, and for that report to contain an assessment of the effectiveness of that structure and its procedures. In addition, affected issuers are required to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions are recorded as necessary to permit the preparation of financial statements in conformity with GAAP.185 Also, the principal executive and financial officers of certain issuers are required to certify that, among other things, they are responsible for establishing and maintaining ICFR, have designed disclosure controls and procedures to ensure material information relating to the issuer and its consolidated subsidiaries is made known to such officers by others within those entities, and have evaluated and reported on the effectiveness of the issuer’s disclosure controls and procedures.186 Furthermore, the issuers that are subject to the final amendments will remain subject to a financial statement audit by an independent auditor, which will help maintain appropriate investor protections. Even without an ICFR auditor attestation requirement, an independent auditor is required to consider ICFR in the performance of a financial statement audit.187 We acknowledge, as stated by some commenters,188 that the objective of a 183 The FCPA added Section 13(b)(2)(B) to the Exchange Act, 15 U.S.C 78m(b)(2)(B) (referring to ‘‘internal accounting controls’’ rather than ICFR). 184 See, e.g., SOX Sections 302, 15 U.S.C. 7241, and 404(a) and related rules. See 17 CFR 229.308, 17 CFR 240.13a–15, 17 CFR 240.15d–15, Form 20– F, Form 40–F, 17 CFR 270.30a–2, and 17 CFR 270.30a–3. 185 15 U.S.C. 78m(b)(2)(B). 186 See 17 CFR 240.13a–14 or 17 CFR 240.15d– 14 (requiring certification) and 17 CFR 229.601(b)(31) (prescribing certification content). These rules were adopted pursuant to SOX Section 302. See 15 U.S.C. 7241. 187 See Public Company Accounting Oversight Board (‘‘PCAOB’’) Accounting Standard (‘‘AS’’) 2110, Identifying and Assessing Risks of Material Misstatement, paragraphs .18 through .40 (‘‘PCAOB AS 2110’’), paragraphs .18 through .40. 188 See note 83 above. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 financial statement audit and the level of control testing performed is different from an ICFR audit. However, we believe that the requirements of a financial statement audit, among other requirements, provide some additional protections and that, for low-revenue SRCs, this and the other protections and factors associated with these issuers described above sufficiently mitigate the risk that the final amendments will adversely affect the ability of investors to make informed investment decisions.189 For example, the auditor in a financial statement audit is required to identify and assess the risks of material misstatements, which is similar to the risk assessment evaluation required in an ICFR auditor attestation. Additionally, the auditor engaged in a financial statement audit often may test the operating effectiveness of certain internal controls even if not performing an integrated audit to reduce the extent of substantive testing required to issue an opinion on the financial statements. Moreover, even if an auditor decides not to rely on internal controls to reduce the extent of substantive testing, the auditor may still identify internal control deficiencies during such substantive testing in a financial statement audit. Under PCAOB standards, the evaluation and communication of significant deficiencies and material weaknesses in ICFR to management and the issuer’s audit committee is required in both a financial statement audit and an ICFR auditor attestation.190 The evaluation of the severity of a control deficiency identified by the auditor is the same for a financial statement audit and an ICFR auditor attestation. Further, a financial statement auditor has the responsibility to review management’s disclosure for any misstatement of facts, such as a statement that ICFR is effective when there is a known material weakness.191 Therefore, we continue to believe significant deficiencies and material weaknesses that an ICFR auditor attestation may uncover also may be uncovered as a part of the financial statement audit of a lowrevenue SRC. As discussed above,192 because of these requirements, a number of commenters agreed that an auditor of 189 See Section IV.C.3.b. below (stating that, in the Proposing Release, note 4 above, we noted that lowrevenue issuers may be less likely than other issuers to fail to detect and disclose material weaknesses in the absence of an ICFR auditor attestation, perhaps because they have less complex financial systems and controls). 190 See Section II.C. of the Proposing Release, note 4 above. 191 Id. 192 See notes 61 to 68 above and accompanying text. PO 00000 Frm 00011 Fmt 4701 Sfmt 4700 17187 the financial statements of a lowrevenue issuer that would be exempt from the ICFR auditor attestation requirement under the final amendments would still be required to consider ICFR and therefore this process would provide sufficient investor protection. Other developments may serve to reinforce these existing investor protections. In 2010, the PCAOB adopted enhanced auditing standards related to the auditor’s assessment of, and response to, risk that, in part, clarify and augment the extent to which internal controls are to be considered in a financial statement audit.193 In particular, these risk assessment standards require auditors in both an integrated and financial statement audit to evaluate the design of certain controls.194 The PCAOB has expressed concern about the number and significance of deficiencies in auditing firm compliance with these risk assessment auditing standards, but it has also noted promising improvements in their application.195 Additionally, recent settled charges against four public companies for failing to maintain effective ICFR for seven to 10 consecutive annual reporting periods 196 may have a deterrent effect on issuers failing to remediate material weaknesses, which could reduce the overall rate of persistence of material weaknesses in ICFR. Also, if management elects to obtain and use automated controls testing and process automation,197 this may result in 193 See Auditing Standards Related to the Auditor’s Assessment of and Response to Risk and Related Amendments to PCAOB Standards, PCAOB Release No. 2010–004 (Aug. 5, 2010) (‘‘PCAOB Release No. 2010–004’’). See also Public Company Accounting Oversight Board; Order Approving Proposed Rules on Auditing Standards Related to the Auditor’s Assessment of and Response to Risk and Related Amendments to PCAOB Standards, Release No. 34–63606, File No. PCAOB 2010–01 (Dec. 23, 2010) [75 FR 82417 (Dec. 30, 2010)] (‘‘PCAOB Release No. 2010–01’’). These auditing standards are discussed in further detail in the Economic Analysis. See Section IV.B.1. below. 194 See AS 2110, paragraphs .18 through .40, note 187 above. 195 See Inspection Observations Related to PCAOB ‘‘Risk Assessment’’ Auditing Standards (No. 8 through No.15), PCAOB Release No. 2015– 007 i through iii (Oct. 15, 2015) (‘‘PCAOB Release No. 2015–007’’). 196 See SEC Charges Four Public Companies with Longstanding ICFR Failures, press release (Jan. 29,2019) (‘‘SEC Press Release’’), available at https:// www.sec.gov/news/press-release/2019-6. 197 See, e.g., Kevin Moffitt, Andrea Rozario, & Miklos Vasarhelyi (2018), Robotic Process Automation for Auditing, Journal of Emerging Technologies, 15(1) Acct. 1 (‘‘Robotic Process Automation’’) (describing how, for example, a robotic process automation program can be ‘‘set up to automatically match purchase orders, invoices, and shipping documents [and] can check that the E:\FR\FM\26MRR2.SGM Continued 26MRR2 17188 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 improvements in ICFR regardless of the ICFR auditor attestation requirement if their increased application results in more robust financial reporting with fewer opportunities for ICFR deficiencies and/or in an increase by management in their testing and related improvements of controls. In Section IV.C.3.b.5, we note, as an example, that issuers may have made investments in systems, procedures, or training to explain how control improvements may persist for certain affected issuers. Finally, we note that auditors have had many years of experience with the 2010 risk assessment standards, and therefore auditors may be more likely to test ICFR, even if an ICFR auditor attestation is not required, as a means of enhancing auditing efficiency.198 We recognize that some commenters disagreed with this assessment and asserted that investor protections other than the ICFR auditor attestation requirement would not be sufficient because, among other reasons, a financial statement audit has a different objective than an integrated audit,199 testing of ICFR in a financial statement audit is not as extensive,200 it is more difficult for a financial statement auditor to challenge the design of ICFR,201 and a financial statement audit is not designed to identify significant ICFR deficiencies or material weaknesses.202 As discussed in the Economic Analysis, we acknowledge that the amendments may be associated with some adverse effects on the effectiveness of ICFR and the reliability of financial statements for the affected issuers.203 However, the Proposing Release presented evidence that suggests that these effects and their impact on investor protection are likely to be mitigated in the case of the affected issuers as compared to other accelerated filers. The Economic Analysis provides further related price and quantity on each of the documents match [to] help auditors validate the effectiveness of preventive internal controls . . . .’’). 198 See Study and Recommendations on Section 404(b) of the Sarbanes-Oxley Act of 2002 For Issuers With Public Float Between $75 and $250 Million at 106 (Apr. 2011) (‘‘2011 SEC Staff Study’’), available at https://www.sec.gov/news/studies/ 2011/404bfloat-study.pdf (stating that ‘‘. . . once effective controls are in place at the issuer, the auditor is more likely to continue to test them even if [it is] not issuing an auditor attestation during a particular year in order to rely on them for purposes of reducing substantive testing in the audit of the financial statements, particularly for issuers that are larger and more complex’’). 199 See, e.g., letters from CAQ, CFA Inst., and RSM. 200 See letter from EY. 201 Id. 202 Id. 203 See Section IV.A. below. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 analysis in response to commenter feedback and does not find evidence that leads us to alter this view.204 One commenter indicated that a lowrevenue issuer could have a large market capitalization and thus ‘‘greater investor exposure.’’ 205 As discussed in the Economic Analysis,206 we agree that, as capitalization increases, there is more investor capital at risk. We note, however, that relative to higher-revenue issuers, on average, risk among these issuers is likely more associated with their future prospects than their current financial statements.207 Therefore, exempting low-revenue issuers from the ICFR auditor attestation requirement is less likely to affect investor protections with respect to those issuers. One commenter noted its concern that certain issuers that would no longer be subject to the ICFR auditor attestation requirement are conducting large initial public offerings (‘‘IPOs’’) based on key performance indicators that are derived from financial systems, and that eliminating the ICFR auditor attestation requirement could result in potentially less robust internal controls and unreliable data.208 To the extent the commenter is primarily concerned with the information available to investors at the time of an IPO, we note that the affected issuers that would be newly exempt from the ICFR auditor attestation requirement are generally more mature firms that are not within five years of their IPO. Also, we believe the risk for those low-revenue issuers for which key performance indicators are material to investors and that are derived from financial systems is mitigated by the requirement to maintain, evaluate, and disclose effectiveness of disclosure controls and procedures 209 on a quarterly basis.210 Key performance indicators or non-GAAP measures disclosed within a report filed or submitted to the Commission generally are within the scope of disclosure controls and procedures. The financial systems from which an issuer derives 204 Id. 205 See letter from Grant Thornton. Section IV.C.3.d. below. 207 Also, the affected parties are limited to issuers with no more than $700 million in public float. Further, as discussed in Section IV.C.3.d below, we estimate that in aggregate the affected issuers that will be newly exempt from all ICFR auditor attestation requirements represent 0.2 percent of the total equity market capitalization of issuers. 208 See letter from NASBA. 209 Although there is substantial overlap between an issuer’s disclosure controls and procedures and ICFR, there are elements of each that are not subsumed by the other. See 17 CFR 240.13a–15 and 17 CFR 240.15d–15. 210 See 17 CFR 240.13a–14 and 17 CFR 240.15d– 14. the key performance indicator or nonGAAP measure would normally be included in ICFR and, therefore, within the scope of management’s assessments as well. Further, the Commission recently issued disclosure guidance on key performance indicators and metrics and reminded issuers of the importance of effective controls and procedures when disclosing material key performance indicators or metrics that are derived from their own information.211 d. Disproportionate Costs and Benefits of the ICFR Auditor Attestation for Small and Low-Revenue Companies Not only is the ICFR auditor attestation requirement costly in general, as discussed above, a number of commenters asserted that the ICFR auditor attestation requirement is disproportionally costly to small and low-revenue issuers.212 We agree that the costs of the ICFR auditor attestation requirement may be particularly burdensome for these issuers because they include fixed costs that are not scalable for smaller issuers, as also noted by several commenters.213 Further, low-revenue issuers have limited access to internally generated capital, and so the costs may more directly impact their ability to spend on investments or hiring.214 We therefore expect that reducing these costs would have a more beneficial impact on small and low-revenue issuers than it would for other issuers. Some commenters similarly expressed the view that the amendments would enhance these issuers’ ability to preserve capital without significantly affecting the ability of investors to make informed investment decisions based on the financial reporting of those issuers.215 As discussed above, other commenters claimed that eliminating the ICFR auditor attestation requirement would not substantially reduce costs to issuers 216 and that there would be other negative impacts of this change.217 We acknowledge that the magnitude of these cost savings likely will vary among issuers depending upon their 206 See PO 00000 Frm 00012 Fmt 4701 Sfmt 4700 211 See Commission Guidance on Management’s Discussion and Analysis of Financial Condition and Results of Operations, Release No. 34–88094 (Jan. 30, 2020). 212 See note 102 above and accompanying text. 213 See letters from ASA, Broadmark, Chamber, and Guaranty. 214 See, e.g., letters from Dare ´ , Summit and Xenon. 215 See letters from Andersen, CLSA, Concert, ICBA, and NASBA. 216 See note 108 above and accompanying text. 217 See notes 110 to 113 above and accompanying text. E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations particular facts and circumstances 218 and, as some commenters asserted,219 ICFR auditor attestations have become less expensive over time because auditors are more experienced in conducting them. However, based on the comments received and our own analysis of available data,220 we believe the cost reductions from not being subject to the ICFR auditor attestation requirement could be substantial for affected issuers. We believe the benefits of the ICFR auditor attestation requirement likely are fewer for low-revenue SRCs than for other issuers, an assessment supported by some commenters.221 As a result, obtaining the ICFR auditor attestation is likely, on average, to be less meaningful for these issuers, and not obtaining one should have less of an impact on investor protection than for other types of issuers. First, we note that lowrevenue SRCs may be less susceptible to the risk of certain kinds of misstatements, such as those related to revenue recognition. As discuss in the Economic Analysis,222 10 to 20 percent of restatements and about 60 percent of financial disclosure fraud cases in recent times have been associated with improper revenue recognition,223 which is less of a risk, for example, for issuers that currently have little to no revenue. Second, as we noted in Table 14 of the Proposing Release,224 issuers with revenues of less than $100 million have, on average, restatement rates that are three to nine percentage points lower than those for higher-revenue issuers. Moreover, certain low-revenue SRCs likely have less complex financial systems and controls and, therefore, may be less likely than other issuers to fail to detect and disclose material weaknesses in the absence of an ICFR auditor attestation. Third, we believe that those issuers’ financial statements may be less critical to assessing their valuation given, for example, the relative importance of their future prospects. We recognize that other commenters disagreed and asserted that benefits of the ICFR auditor attestation requirement are greater for lower-revenue and smaller issuers than for other issuers.225 We carefully considered these comments and, as discussed in the Economic Analysis, investigated the claims by conducting supplemental analysis, but we did not find evidence that led us to alter our views.226 e. Relationship Between NonAccelerated Filers and SRCs Under the final amendments, some, but not all, SRCs would become nonaccelerated filers. We are not adopting an alternative suggested by some commenters of fully aligning the SRC and non-accelerated filer definitions. As we note in the Economic Analysis,227 although full alignment of the two definitions could provide several benefits, including greater regulatory simplicity, reducing any frictions or confusion associated with issuers’ 17189 determination of their filer status or reporting regime, and expanding the number of issuers that qualify as nonaccelerated filers, fully aligning the two definitions also could result in costs that are greater than those for the amendments we are adopting. For example, the mitigating factors associated with exempting low-revenue issuers, such as a potential lower susceptibility to the risks of certain kinds of misstatements and a greater role of future prospects relative to current financial statements in driving market valuations for these issuers as compared to other issuers,228 may not be present or may be more limited, for other types of SRCs. As a result, fully aligning the SRC and non-accelerated filer thresholds could have adverse effects on the reliability of the financial statements of the issuers with higher revenues and the ability of investors to make informed investment decisions about those issuers.229 Therefore, we do not believe it would be appropriate at this time to increase the public float threshold for nonaccelerated filers to align that definition with the SRC definition. Additionally, we note that many non-accelerated filers remain eligible for the JOBS Act Exemption for their first five years as a public company. The table below summarizes the relationships between SRCs and non-accelerated and accelerated filers under the final amendments. TABLE 2—RELATIONSHIPS BETWEEN SRCS AND NON-ACCELERATED, ACCELERATED, AND LARGE ACCELERATED FILERS UNDER THE FINAL AMENDMENTS Relationships between SRCs and non-accelerated, accelerated, and large accelerated filers under the final amendments Status Public float SRC and Non-Accelerated Filer .................................... Less than $75 million .................................................... $75 million to less than $700 million ............................. $75 million to less than $250 million ............................. $250 million to less than $700 million ........................... $700 million or more ..................................................... lotter on DSKBCFDHB2PROD with RULES2 SRC and Accelerated Filer ............................................ Accelerated Filer (not SRC) ........................................... Large Accelerated Filer (not SRC) ................................ f. Effect on Business Development Companies In a change from the proposal, the final amendments also exclude BDCs from the accelerated and large accelerated filer definitions under circumstances that are analogous to the exclusions for other issuers under the amendments. The amendments include a specific provision applicable to BDCs, 218 See, e.g., letters from EY, Grant Thornton, and PWC. 219 See, e.g., letters from CFA Inst. and Deloitte. 220 See Section IV.C.2.d. 221 See notes 116 to 118 above and accompanying text. 222 See Section IV.C.3. below. 223 See Audit Analytics, 2017 Financial Restatements: A Seventeen Year Comparison, (May 2018), and Committee of Sponsoring Organizations of the Treadway Commission, (‘‘COSO’’), Fraudulent Financial Reporting 1998–2007: An Analysis of U.S. Public Companies (2010).) (‘‘COSO 2010 Fraud Study’’), available at https:// www.coso.org/documents/COSO-Fraud-Study-2010001.pdf. 224 See Section III.C.4.b. of the Proposing Release, note 4 above. 225 See notes 119 to 124 above and accompanying text. 226 See Section IV.C.3.a. below. 227 See Section IV.C.5.a. below. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 PO 00000 Frm 00013 Fmt 4701 Sfmt 4700 Annual revenues N/A. Less than $100 million. $100 million or more. $100 million or more. N/A. because BDCs are not eligible to be SRCs and to provide a definition of ‘‘revenue’’ for BDCs to use for this purpose.230 Specifically, a BDC will be excluded from the accelerated and large 228 See Section IV.C.3. below. 229 Id. 230 Although a BDC is considered to be eligible to use the requirements for SRCs under the revenue test in paragraph (2) or (3)(iii)(B) of the ‘‘smaller reporting company’’ definition in Rule 12b–2 for purposes of the amended accelerated filer and large accelerated filer definitions, BDCs will continue to be ineligible to be SRCs under the final amendments. E:\FR\FM\26MRR2.SGM 26MRR2 17190 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 accelerated filer definitions in Rule 12b–2 if the BDC: (1) Has a public float of $75 million or more, but less than $700 million; and (2) has investment income of less than $100 million.231 The amendments to Rule 12b–2 provide that, for this purpose, a BDC’s revenue is the BDC’s investment income, as defined in Rule 6–07.1 of Regulation S–X.232 BDCs are subject to the same transition provisions for accelerated filer and large accelerated status that apply to other issuers under the amendments, except that the amendments’ BDC-specific ‘‘revenue’’ definition will apply to these transition provisions as well.233 Although the Commission did not propose to exclude BDCs from the accelerated and large accelerated filer definitions using the SRC revenue test, the Commission did solicit comment on such an approach and discussed the relative costs and benefits of this alternative in the Proposing Release.234 In response, one commenter urged that we adopt such an approach, stating that, among other reasons, the policy reasons that support providing regulatory relief to smaller reporting companies should apply equally to smaller BDCs.235 This commenter suggested that the Commission expand the proposed amendment to the definition of accelerated filer and large accelerated filer to exclude BDCs with total investment income of less than $80 million in the most recently completed fiscal year for which audited financial statements are available and either no public float or public float of less than $700 million. Although we observed in the Proposing Release that the SRC revenue test would not be meaningful for BDCs because BDCs prepare financial statements under Article 6 of Regulation S–X and generally do not report revenue, the final amendments’ definition of ‘‘revenue’’ for purposes of the BDC-specific provisions incorporate information that BDCs report in their financial statements. A BDC’s investment income includes income from dividends, interest on securities, and other income.236 We recognize, as 231 See paragraphs (1)(iv), (2)(iv), and (4) of the amended definitions of accelerated filer and large accelerated filer in Rule 12b–2. Consistent with the current definitions of these terms, a BDC with public float of less than $75 million is already a non-accelerated filer, regardless of the amount of its annual investment income. 232 See 17 CFR 210.6–07.1. 233 See Section II.C. below (discussing the amended transition provisions more generally). 234 See Sections II.C., II.E., and III.C.6. of the Proposing Release, note 4 above. 235 See letter from Proskauer. 236 A BDC’s annual investment income is equivalent to annual revenues solely for purposes VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 stated in the Proposing Release, that investors in BDCs generally may place greater significance on the financial reporting of BDCs relative to lowrevenue non-investment company issuers and BDC financial statements will continue to be audited by an independent auditor. As the commenter supporting this approach observed, however, the policy considerations supporting the final amendments generally apply to BDCs.237 Moreover, BDCs that are excluded from the accelerated and large accelerated filer definitions will remain obligated, among other things, to establish and maintain internal control over financial reporting and have management assess the effectiveness of internal control over financial reporting. The final amendments also are consistent with other rulemaking initiatives in which we have sought to provide BDCs parity with other reporting companies in appropriate circumstances.238 g. Effect on Foreign Private Issuers Under the proposed amendments, an FPI would be excluded from the accelerated and large accelerated filer definitions if it qualifies as an SRC 239 under the SRC revenue test in Exchange Act Rule 12b–2. One commenter asserted that the final amendments should permit an FPI that presents its financial statements using IFRS to qualify for the exemption based on the low-revenue test.240 We note that foreign issuers that qualify as FPIs or SRCs are permitted to avail themselves of special accommodations unique to each reporting regime, but must select one reporting regime or the other. The final amendments provide an exemption from the ICFR auditor attestation requirement for low-revenue SRCs. of the accelerated filer and large accelerated filer definitions. These amendments do not affect the meaning of ‘‘revenue’’ or ‘‘investment income’’ in other Commission rules or provisions of the securities laws. 237 See letter from Proskauer. 238 See Securities Offering Reform for Closed-End Investment Companies, Release No. 33427 (Mar. 20, 2019) [84 FR 14448 (Apr. 10, 2019)]. 239 See 2007 SRC Adopting Release, note 155 above, Section II, and Acceptance From Foreign Private Issuers of Financial Statements Prepared in Accordance with International Financial Reporting Standards without Reconciliation to U.S. GAAP, Release No. 33–8879 (Dec. 21, 2007) [73 FR 985 (Jan. 4, 2008)], Section III.E.4. (stating that an FPI is not an SRC unless it makes its filings on forms available to U.S. domestic issuers and otherwise qualifies to use the SRC scaled disclosure accommodations). We are adding instructions to the SRC definitions in Item 10(f), Rule 405, and Rule 12b–2 clarifying our position that an FPI is not eligible to use the requirements for SRCs unless it uses the forms and rules designated for domestic issuers and provides financial statements prepared in accordance with U.S. GAAP. 240 See letter from Dorsey & Whitney. PO 00000 Frm 00014 Fmt 4701 Sfmt 4700 Issuers that qualify as FPIs and elect to use the FPI reporting regime have other accommodations available to them, such as the ability to disclose material changes in their ICFR and effectiveness of disclosure controls and procedures on an annual basis, as compared to the quarterly basis required of U.S. issuers, including SRCs.241 h. Requiring ICFR Auditor Attestation Less Frequently Than Annually The final amendments do not revise our rules to require an ICFR auditor attestation requirement less frequently than annually. Issuers that are accelerated or large accelerated filers will be required to obtain an ICFR auditor attestation every year, unless they qualify as EGCs, as under our current rules. We did not propose to revise this requirement, but requested comment on this matter, and every commenter that discussed the subject 242 asserted that issuers that are subject to the ICFR auditor attestation requirement should obtain one annually. A few of these commenters asserted that requiring the ICFR auditor attestation only once every three years would not decrease costs significantly because auditors consider prior year audit results when planning and performing the current year audit, so performing an audit of ICFR every three years would reduce efficiencies gained from performing audits annually and add complexity and costs.243 Also, one commenter indicated that auditors in many instances may continue to test internal controls in the financial statement audit, which potentially limits any resulting cost reduction.244 i. Check Box Indicating Whether an ICFR Auditor Attestation Is Included in a Filing Although we did not propose a requirement that issuers report whether they have obtained an ICFR auditor attestation, we requested comment on whether we should do so. As discussed above,245 some commenters recommended that the final rule include a requirement for an issuer to prominently disclose in its filing whether an ICFR auditor attestation is included. This type of disclosure was also recommended by the Government Accountability Office (‘‘GAO’’) in a 241 See Rule 13a–15(d), Rule 15d–15(d), Item 15(d) of Form 20–F, and General Instruction B(6)(e) of Form 40–F. 242 See, e.g., letters from Crowe, KPMG, and NASBA. 243 See, e.g., letters from Crowe and KPMG. 244 See letter from KPMG. 245 See notes 138 to 143 above and the accompanying text. E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 2013 study of internal controls requirements.246 No commenters opposed such a requirement. Disclosure of the ICFR auditor attestation is currently required within the auditor’s report on the financial statements and management’s annual report on ICFR.247 After reviewing these comments, we are persuaded to add a check box to the cover pages of Forms 10–K, 20–F, and 40–F to indicate whether an ICFR auditor attestation is included in the filing because we agree that more prominent and easily accessible disclosure of this information would be useful to investors and market participants while imposing only minimal burdens on issuers. Under the new rule, issuers will be required to include the check box on their cover pages in any annual report filed on or after the final amendments’ effective date. Once issuers are required to tag the cover page disclosure data using Inline eXtensible Business Reporting Language (‘‘Inline XBRL’’), they will also be required to tag this cover page check box disclosure in Inline XBRL because Item 406 of Regulation S–T (‘‘Item 406’’),248 Item 601(b)(104),249 paragraph 104 to ‘‘Instructions as to Exhibits’’ of Form 20–F, and paragraph B.17 under the ‘‘General Instructions’’ of Form 40–F require those issuers to tag every data point on the cover pages of Form 10–K, Form 20–F, and Form 40–F.250 We do not expect the incremental compliance burden associated with tagging the additional cover page information to be significant, given that registrants already are being required on a phased-in basis to tag other cover page information as well as information in their financial statements.251 246 See U.S. Gov’t Accountability Office, GAO– 13–582, Internal Controls: SEC Should Consider Requiring Companies to Disclose Whether They Obtained an Auditor Attestation (July 2013) (‘‘2013 GAO Study’’). 247 See Item 308 of Regulation S–K and PCAOB AS 3101. 248 17 CFR 232.406. 249 17 CFR 229.601(b)(4). 250 Item 406 mandates that companies required to tag their financial statements in Inline XBRL must also tag their cover page data in Inline XBRL. Operating companies are required to tag their financial statements in Inline XBRL on a phase-in basis. See Inline XBRL Filing of Tagged Data, Release No. 33–10514 (June 28, 2018) [83 FR 40846 (July 10, 2018)] and 17 CFR 232.405. 251 Electronic Data Gathering, Analysis and Retrieval System (‘‘EDGAR’’) filers that are required by Item 406 to provide cover page Inline XBRL data tagging will be required to tag the ICFR data element only after a revised Document Entity Identifier taxonomy has been posted to SEC.gov and the Commission has adopted a new EDGAR Filer Manual that reflects appropriate changes to the submission of Forms 10–K, 20–F and 40–F. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 C. Amendments To Increase the Public Float Transition Thresholds From $50 Million to $60 Million and $500 Million to $560 Million and To Add the SRC Revenue Test to the Transition Threshold 1. Proposed Amendments An issuer initially becomes an accelerated filer after it first meets certain conditions as of the end of its fiscal year, including that it had a public float of $75 million or more but less than $700 million as of the last business day of its most recently completed second fiscal quarter. An issuer initially becomes a large accelerated filer in a similar manner, including that it had a public float of $700 million or more as of the last business day of its most recently completed second fiscal quarter. Once the issuer becomes an accelerated filer, it will not become a non-accelerated filer unless it determines at the end of a fiscal year that its public float had fallen below $50 million on the last business day of its most recently completed second fiscal quarter. Similarly, a large accelerated filer will remain one unless its public float had fallen below $500 million on the last business day of its most recently completed second fiscal quarter. If the large accelerated filer’s public float falls below $500 million but is $50 million or more, it becomes an accelerated filer. Alternatively, if the issuer’s public float falls below $50 million, it becomes a non-accelerated filer.252 The purpose of these transition thresholds is to avoid 252 For example, under the rules prior to these amendments, if an issuer that is a non-accelerated filer determines at the end of its fiscal year that it had a public float of $75 million or more, but less than $700 million, on the last business day of its most recently completed second fiscal quarter, it will become an accelerated filer. On the last business day of its next fiscal year, the issuer must re-determine its public float to re-evaluate its filer status. If the accelerated filer’s public float fell to $70 million on the last business day of its most recently completed second fiscal quarter, it would remain an accelerated filer because its public float did not fall below the $50 million transition threshold. Alternatively, if the issuer’s public float fell to $49 million, it would then become a nonaccelerated filer because its newly determined public float is below $50 million. As another example, an issuer that has not been a large accelerated filer but had a public float of $700 million or more on the last business day of its most recently completed second fiscal quarter would then become a large accelerated filer at the end of its fiscal year. If, on the last business day of its subsequently completed second fiscal quarter, the issuer’s public float fell to $600 million, it would remain a large accelerated filer because its public float did not fall below $500 million. If, however, the issuer’s public float fell to $490 million at the end of its most recently completed second fiscal quarter, it would become an accelerated filer at the end of the fiscal year because its public float fell below $500 million. Similarly, if the issuer’s public float fell to $49 million, the issuer would become a non-accelerated filer. PO 00000 Frm 00015 Fmt 4701 Sfmt 4700 17191 situations in which an issuer frequently enters and exits accelerated and large accelerated filer status due to small fluctuations in its public float. In the SRC Adopting Release,253 we amended the SRC rules so that the SRC transition thresholds were set at 80 percent of the corresponding initial qualification thresholds. In the Proposing Release, we proposed to revise the accelerated and large accelerated filer transition thresholds to be 80 percent of the corresponding initial qualification thresholds to align the transition thresholds across the SRC, accelerated filer, and large accelerated filer definitions. Additionally, we indicated that revising these thresholds would limit the cases in which an issuer could be both an accelerated filer and an SRC or a large accelerated filer and an SRC, thereby reducing regulatory complexity. We proposed to revise the transition threshold for becoming a nonaccelerated filer from $50 million to $60 million and the transition threshold for leaving the large accelerated filer status from $500 million to $560 million. We also proposed to add the SRC revenue test to the public float transition thresholds for accelerated and large accelerated filers. If the SRC revenue test were not added to the accelerated filer and large accelerated filer transition provisions, an issuer’s annual revenues would never factor into determining whether an accelerated filer could become a non-accelerated filer, or whether a large accelerated filer could become an accelerated or nonaccelerated filer. We proposed that an issuer that is already an accelerated filer would remain one unless either its public float falls below $60 million or it becomes eligible to use the SRC accommodations under the revenue test in paragraph (2) or (3)(iii)(B) of the SRC definition,254 as applicable.255 Therefore, under the proposed amendments, an accelerated filer would remain an accelerated filer until its public float falls below $60 million or its annual revenues fall below the 253 See note 12 above. (2) of the SRC definition states that an issuer qualifies as an SRC if its annual revenues are less than $100 million and it has no public float or a public float of less than $700 million. Paragraph (3)(iii)(B) of the SRC definition states, among other things, that an issuer that initially determines it does not qualify as an SRC because its annual revenues are $100 million or more cannot become an SRC until its annual revenues fall below $80 million. 255 An issuer that is initially applying the SRC definition or previously qualified as an SRC would apply paragraph (2) of the SRC definition. Once an issuer determines that it does not qualify for SRC status, it would apply paragraph (3)(iii)(B) of the SRC definition at its next annual determination. 254 Paragraph E:\FR\FM\26MRR2.SGM 26MRR2 17192 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations applicable revenue threshold ($80 million or $100 million), at which point it would become a non-accelerated filer. Similarly, we proposed conforming amendments to the large accelerated filer transition provisions for when an issuer that is already a large accelerated filer transitions to either accelerated or non-accelerated filer status. To transition out of large accelerated filer status at the end of the issuer’s fiscal year, an issuer would need to have a public float below $560 million as of the last business day of its most recently completed second fiscal quarter or meet the revenue test in paragraph (2) or (3)(iii)(B), as applicable, of the SRC definition. A large accelerated filer would become an accelerated filer at the end of its fiscal year if its public float fell to $60 million or more but less than $560 million as of the last business day of its most recently completed second fiscal quarter and its annual revenues are not below the applicable revenue threshold ($80 million or $100 million). The large accelerated filer would become a non-accelerated filer if its public float fell below $60 million as of the last business day of its most recently completed second fiscal quarter or its annual revenues fell below the applicable revenue threshold ($80 million or $100 million).256 2. Comments We received very few comments regarding the proposed changes to the transition thresholds. The commenters who discussed the proposed amendments to increase the public float transition thresholds supported them.257 One commenter also suggested that the Commission consider indexing the thresholds to inflation in a manner similar to the indexing that applies to the EGC definition.258 Only two commenters addressed the proposed amendments to add the SRC revenue test to the transition thresholds, and these commenters supported that proposal.259 3. Final Amendments After considering the comments, we are adopting the final amendments as proposed. As discussed in greater detail in the Economic Analysis,260 transition thresholds in Rule 12b–2 are lower than entry thresholds to keep issuers from frequently needing to reclassify their filer status. The frequent reclassifications that would result without the transition thresholds may cause confusion for issuers and investors as to the issuer’s status. Also, such frequent reclassifications may increase issuers’ costs because they would frequently need to revise their disclosure schedules and continually consider the impact of whether they are subject to the ICFR auditor attestation requirement from one year to the next, and may increase investors’ incremental costs of evaluating the reliability of the issuer’s financial disclosures. Therefore, we believe a transition threshold is appropriate. However, we recognize that providing a transition threshold results in some issuers remaining in their filer status even though their public float or revenues are below that filer status’s entry threshold. The final amendments revise the public float transition threshold for accelerated and large accelerated filers to become a non-accelerated filer from $50 million to $60 million and revise the public float transition threshold for a large accelerated filer to lose its large accelerated filer status from $500 million to $560 million. Prior to the final amendments, the public float threshold for an accelerated and large accelerated filer to become a nonaccelerated filer was $50 million and the public float transition threshold for a large accelerated filer to lose its large accelerated filer status was $500 million. We believe these threshold amounts are too low and result in more issuers than intended being classified as an accelerated or large accelerated filer. However, we believe there should be some transition threshold so as to avoid some volatility. The amendments would make the public float transition thresholds 80 percent of the initial thresholds, which is consistent with the percentage used in the transition thresholds for SRC eligibility. We believe this approach appropriately balances the risk of frequent reclassifications resulting from a higher percentage threshold against the risk of delaying appropriate transitions due to a lower threshold. The table below summarizes how an issuer’s filer status will change based on its subsequent public float determination. TABLE 3—SUBSEQUENT DETERMINATION OF FILER STATUS BASED ON PUBLIC FLOAT UNDER FINAL AMENDMENTS lotter on DSKBCFDHB2PROD with RULES2 Final amendments to the public float thresholds Initial public float determination Resulting filer status Subsequent public float determination $700 million or more ...................... Large Accelerated Filer ................ Less than $700 million but $75 million or more. Accelerated Filer ........................... $560 million or more ..................... Less than $560 million but $60 million or more. Less than $60 million ................... Less than $700 million but $60 million or more. Less than $60 million ................... 256 One exception to this requirement is that an issuer that was a large accelerated filer whose public float had fallen below $700 million (but remained $560 million or more) but became eligible to be an SRC under the SRC revenue test in the first year the SRC amendments became effective would become a non-accelerated filer even though its VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 public float remained at or above $560 million. See SRC Adopting Release, note 12 above, at n. 31 (‘‘For purposes of the first fiscal year ending after effectiveness of the amendments, a registrant will qualify as a SRC if it meets one of the initial qualification thresholds in the revised definition as of the date it is required to measure its public float PO 00000 Frm 00016 Fmt 4701 Sfmt 4700 Resulting filer status Large Accelerated Filer. Accelerated Filer. Non-Accelerated Filer. Accelerated Filer. Non-Accelerated Filer. or revenues (the ‘measurement date’), even if such registrant previously did not qualify as a SRC.’’). 257 See, e.g., letters from CLSA, Nasdaq, and RSM. 258 See letter from RSM. 259 See letters from CLSA and Nasdaq. 260 See Section IV.C.4.c below. E:\FR\FM\26MRR2.SGM 26MRR2 lotter on DSKBCFDHB2PROD with RULES2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations The final amendments also add the SRC revenue test to the transition threshold for accelerated and large accelerated filers. As we noted in the Proposing Release, if we do not add the SRC revenue test to the accelerated filer and large accelerated filer transition provisions, an issuer’s annual revenues would never factor into determining whether an accelerated filer could become a non-accelerated filer, or whether a large accelerated filer could become an accelerated or nonaccelerated filer. We note that one commenter stated that the manner in which issuers may recognize revenue could cause them to frequently lose and gain non-accelerated filer status.261 We believe that providing transition thresholds should mitigate any such concern. Under the final amendments, an accelerated filer with revenues of $100 million or more that is eligible to be an SRC based on the public float test contained in paragraphs (1) and (3)(iii)(A) of the SRC definition can transition to non-accelerated filer status in a subsequent year if it has revenues of less than $100 million. For example, an issuer with a December 31 fiscal year end that did not exceed the public float threshold in the prior year and that has a public float, as of June 30, 2020, of $230 million and annual revenues for the fiscal year ended December 31, 2019 of $101 million will be eligible to be an SRC under the public float test; however, because the issuer would not be eligible to be an SRC under the SRC revenue test, it will be an accelerated filer (assuming the other conditions described in Table 1 are also met). At the next determination date (June 30, 2021), if its public float, as of June 30, 2020, remains at $230 million and its annual revenues for the fiscal year ended December 31, 2019 are less than $100 million, the issuer will be eligible to be an SRC under the SRC revenue test (in addition to the public float test) and thus it will become a non-accelerated filer. On the other hand, an issuer with a December 31 fiscal year end that has a public float, as of June 30, 2020, of $400 million and annual revenues for the fiscal year ended December 31, 2019 of $101 million will not be eligible to be an SRC under either the public float test or the SRC revenue test and will be an accelerated filer (assuming the other conditions described in Table 1 also are met). At the next determination date (June 30, 2021), if its public float, as of June 30, 2021, remains at $400 million, that issuer will not be eligible to be an 261 See letter from EY. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 SRC under the SRC revenue test unless its annual revenues for the fiscal year ended December 31, 2020 are less than $80 million, at which point it will be eligible to be an SRC under the SRC revenue test and to become a nonaccelerated filer. D. Transition Issues The final amendments will become effective 30 days after they are published in the Federal Register. The final amendments will apply to an annual report filing due on or after the effective date. Even if that annual report is for a fiscal year ending before the effective date, the issuer may apply the final amendments to determine its status as a non-accelerated, accelerated, or large accelerated filer. For example, an issuer that has a March 31, 2020 fiscal year end and that is due to file its annual report after the effective date of the amendments may apply the final amendments to determine its filing status even though its fiscal year end date precedes the effective date. An issuer that determines it is eligible to be a non-accelerated filer under the final amendments will not be subject to the ICFR auditor attestation requirement for its annual report due and submitted after the effective date of the amendments and may comply with the filing deadlines that apply, and other accommodations available, to nonaccelerated filers. III. Other Matters If any of the provisions of these amendments, or the application of these provisions to any person or circumstance, is held to be invalid, such invalidity shall not affect other provisions or application of such provisions to other persons or circumstances that can be given effect without the invalid provision or application. Pursuant to the Congressional Review Act,262 the Office of Information and Regulatory Affairs has designated these amendments as not ‘‘a major rule,’’ as defined by 5 U.S.C. 804(2). IV. Economic Analysis We are mindful of the costs and benefits of the amendments. The discussion below addresses the economic effects of the amendments, including their anticipated costs and benefits, as well as the likely effects of the amendments on efficiency, competition, and capital formation.263 262 5 U.S.C. 801 et seq. 2(b), 15 U.S.C. 77b(b), and Section 3(f) of the Exchange Act, 15 U.S.C. 78c(f), directs the Commission, when engaging in rulemaking where it is required to consider or determine whether an 263 Section PO 00000 Frm 00017 Fmt 4701 Sfmt 4700 17193 We also analyze the potential costs and benefits of reasonable alternatives to the amendments. Where practicable, we have attempted to quantify the economic effects of the amendments; however, in certain cases, we are unable to do so because either the necessary data are unavailable or certain effects are not quantifiable. In these cases, we provide a qualitative assessment of the likely economic effects. A. Introduction As discussed above, we are adopting amendments to the definitions of ‘‘accelerated filer’’ and ‘‘large accelerated filer’’ that will generally extend non-accelerated filer status to issuers with up to $700 million in public float if they are eligible to be SRCs and their revenues are less than $100 million. As non-accelerated filers, among other things, these issuers will not be required to obtain an ICFR auditor attestation pursuant to SOX Section 404(b). The amendments are intended to reduce compliance costs for these issuers while maintaining investor protections by more appropriately tailoring the types of issuers that are included in the categories of accelerated and large accelerated filers. In the Proposing Release, we presented evidence that the imposition of the ICFR auditor attestation requirement has been associated with benefits to issuers and investors, such as reduced rates of ineffective ICFR and more reliable financial statements.264 However, as explained in the Proposing Release, the affected issuers may find the costs of this requirement to be particularly burdensome given certain fixed costs that may not scale with size. Importantly, because these issuers have limited access to internally-generated capital, savings on compliance costs may be more likely to be applied to additional investment, research, or hiring. We acknowledged, in the Proposing Release, that exempting these lowrevenue issuers from the ICFR auditor attestation requirement may result in adverse effects such as an increased prevalence of ineffective ICFR and action is necessary or appropriate in the public interest, to consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation. Further, Section 23(a)(2) of the Exchange Act, 15 U.S.C. 78w(a)(2), requires the Commission, when making rules under the Exchange Act, to consider the impact that the rules would have on competition, and prohibits the Commission from adopting any rule that would impose a burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act. 264 See Section III.C.4.a. of the Proposing Release, note 4 above,. See also Section IV.C.3.a. below. E:\FR\FM\26MRR2.SGM 26MRR2 17194 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations restatements, and we estimated the potential effects on the rates of such issues among the affected issuers. At the same time, we provided evidence in support of two mitigating factors specific to the affected issuers.265 First, we documented that low-revenue issuers have relatively low rates of restatement, which could mean that the affected issuers may, on average, be less susceptible to the risk of certain kinds of misstatements. Next, we provided evidence that the market value of the low-revenue issuers was not as associated with contemporary financial statements as for higher-revenue issuers, which could imply that their valuations are driven to a greater degree by their future prospects. Commenters raised a number of concerns with our analysis and conclusions in the Proposing Release. We carefully reviewed all of the comments received and in a few instances, conducted supplemental analysis in response to the issues and questions raised by those comments. Overall, based on our analysis of the available evidence and data, our primary conclusions have not substantively changed. While we address the comments in detail in the body of the Economic Analysis below, we highlight certain of our findings in relation to some commenter concerns here. One concern raised by commenters is that rather than targeting issuers where there may be relatively fewer benefits of the ICFR auditor attestation requirement, the amendments will remove this requirement for exactly those issuers where the benefits may be greatest.266 These commenters supported this assertion by, for example, claiming that investors react more strongly to news of restatements or material weaknesses in ICFR—and thus care more about the benefits of an ICFR auditor attestation—at small or lowrevenue issuers as compared to other issuers.267 In response to these comments, we have conducted additional analyses of the investor response to ICFR disclosures and restatement announcements. We do not find any evidence that investors react more negatively to restatements or to auditors reporting material weaknesses in ICFR at low-revenue issuers than at higher-revenue issuers. Further, based on the suggestions of a commenter,268 we have refined our analysis of the extent to which financial statement variables are associated with the valuation of different types of issuers. We continue to find that financial statement variables explain a greater amount of the variation in stock prices and returns for higher-revenue issuers than for low-revenue issuers, even when we focus on more seasoned issuers similar to those that would be affected by the amendments or when we expand the set of variables that we consider. Overall, our analysis does not provide support for the assertion that investors care more about the information produced by the ICFR auditor attestation requirement at low-revenue issuers than at other issuers. A few commenters asserted that the costs of the amendments will significantly outweigh any benefits.269 We have conducted supplemental analysis and quantification of the potential costs of the amendments and do not find evidence to support the views of these commenters. We carefully considered the cost estimates provided by commenters and found them useful in refining our own analysis. However, we found some of these estimates to be overstated. For example, some estimates applied costs associated with a small fraction of issuers to all of the affected issuers or implicitly compared aggregate estimates of costs over multiple years to the estimated savings for a single year.270 Others identified investor harms that occurred despite the ICFR auditor attestation requirement being in place, which may demonstrate the limitations of the ICFR auditor attestation requirement rather than informing us of the risks of removing the requirement.271 Some commenters stated that the Proposing Release did not provide sufficient quantification of the costs of the amendments.272 In response to those comments, as additional context for our consideration of the possible effects of the final amendments, we conducted supplemental analysis of the expected frequency, type, and magnitude of potential adverse effects. We consider 268 See letter from Crowe. e.g., letters from Better Markets and Prof. Barth et al. 270 See letter from Prof. Barth et al. (with respect to quantified benefits of ICFR audit for the average company). 271 See letters from Better Markets and Prof. Barth et al. (with respect to estimates of income and stock market impact of restatements). 272 See, e.g., letters from Better Markets, CFA Inst., CII, Prof. Barth et al., and Prof. Ge et al. lotter on DSKBCFDHB2PROD with RULES2 269 See, 265 We also noted in the Proposing Release, note 4 above, that issuers exempted from this requirement may choose to voluntarily obtain an ICFR auditor attestation if investors demand it or the issuers otherwise deem it, from their perspective, to be the best use of their resources. 266 See, e.g., letters from CFA, CFA Inst., and CII. See also Commissioner Jackson’s Statement. 267 Id. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 PO 00000 Frm 00018 Fmt 4701 Sfmt 4700 effects resulting from potential misreporting about the effectiveness of ICFR as well as those driven by potential changes in the actual effectiveness of ICFR. Where possible, we estimate dollar costs as well as dollar transfers across shareholders, which represent costs to some shareholders and benefits to other shareholders. We note that these cost estimates do not fully adjust for the mitigating factors that we find to be associated with low-revenue issuers and may therefore be inflated. Also, we caution against attempts to overinterpret the relation between our quantitative estimates of monetized benefits and monetized costs because we are not able to place dollar values on all of the potential costs and benefits of the amendments. Several commenters argued that the expected cost savings are too small to be economically meaningful,273 and that the amendments are unlikely to have capital formation benefits.274 We acknowledge that, while the amendments could be a positive factor in the decision of additional companies to enter public markets, it may not be the decisive factor, and the direct impact of the amendments on the number of public companies may be limited to the extent that companies may be more focused on other factors associated with the decision to go public. However, we continue to believe that the expected savings is likely, in many cases, to represent a meaningful cost savings for the affected issuers.275 In particular, while the average annual cost savings may represent a small percentage of the average affected issuers’ revenues and market capitalizations, it is still likely to be meaningful given that the net income and operating cash flows of the affected issuers are typically negative.276 These savings may thus have beneficial economic effects on net capital formation through the productive use of 273 See, e.g., letters from CFA, CFA Inst., CII, and Prof. Barth et al. 274 See, e.g., letters from Better Markets, CII, CFA, CFA Inst., and Prof. Ge et al. 275 One commenter requested that we replicate, with recent data, the analysis in a previous study that found a ‘‘bunching’’ of firms below the public float threshold for entering accelerated filer status, in order to explore whether the costs of the ICFR auditor attestation requirement remain as high as previously documented. See letter from Prof. Honigsberg, et al. See also Commissioner Jackson’s Statement. As discussed in more detail below, we provide this analysis and find that there may be some such ‘‘bunching,’’ but we note that our conclusion that the cost savings may be meaningful to the affected issuers does not rely on this analysis or the related study. 276 See note 362 below. E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations this preserved capital towards, for example, new investments. Some commenters indicated that the Proposing Release did not adequately consider the risk of fraud,277 or that the risks of fraudulent financial reporting may be particularly high for lowrevenue issuers.278 We acknowledge the argument that incentives to engage in misconduct could be different for lowrevenue issuers and, in response to these comments, we conducted supplemental analysis concerning the risk of fraud. In particular, we conducted an analysis to investigate this risk and did not find evidence based on the available data that low-revenue issuers that, like the affected issuers, are not within five years of their IPO (‘‘seasoned’’ issuers), are more highly represented in the set of seasoned issuers associated with financial misconduct or financial reporting fraud than they are in the overall population of seasoned issuers.We also estimated the extent to which expanding the exemption from the ICFR auditor attestation requirement could affect the likelihood of the affected issuers engaging in such activities and include a quantification of the associated costs of this risk in our overall assessment of the potential costs of the amendments. Overall, this supplemental analysis does not cause us to change our primary conclusions regarding the potential effects of the amendments. The economic analysis also considers other changes associated with the amendments. For example, the affected issuers will be permitted an additional 15 days and five days, respectively, after the end of each period to file their annual and quarterly reports, relative to the deadlines that apply to accelerated filers.279 The amendments also revise the transition provisions for accelerated and large accelerated filer status, including increasing the public float thresholds to exit accelerated and large accelerated filer status from $50 million and $500 million in public float to $60 million and $560 million in public float. Additionally, the amendments introduce a new check-box disclosure on the cover page of annual reports on Forms 10–K, 20–F, and 40–F to indicate lotter on DSKBCFDHB2PROD with RULES2 277 See, e.g., letters from CFA Inst., CII, and Prof. Barth et al. 278 See, e.g., letter from CFA, CFA Inst., CII and Prof. Barth et al. 279 Non-accelerated filers also are not required to provide disclosure required by Item 1B of Form 10– K and Item 4A of Form 20–F about unresolved staff comments on their periodic and/or current reports or disclosure required by Item 101(e)(4) of Regulation S–K about whether they make filings available on or through their internet websites. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 whether an ICFR auditor attestation is included in the filing. The discussion that follows examines the potential benefits and costs of the amendments in detail. As part of our analysis, we consider both the comments received on the Proposing Release and the likelihood that the effects of the ICFR auditor attestation have changed over time with changes in auditing standards and other market conditions. B. Baseline To assess the economic impact of the amendments, we are using as our baseline the current state of the market under the existing definition of ‘‘accelerated filer.’’ This section discusses the current regulatory requirements and market practices. It also provides statistics characterizing accelerated filers, the timing of filings, disclosures about ineffective ICFR, and restatement rates under the baseline. 1. Regulatory Baseline Our baseline includes existing statutes and Commission rules that govern the responsibilities of issuers with respect to financial reporting, as well as PCAOB auditing standards and market standards related to the implementation of these responsibilities. In particular, accelerated and large accelerated filers are subject to accelerated filing deadlines for their periodic reports relative to nonaccelerated filers. These deadlines are summarized in Table 4 below. All registrants can file Form 12b–25 (‘‘Form NT’’) to avail themselves of an additional 15 calendar days to file an annual report, or an additional five calendar days to file a quarterly report, and still have their report deemed to have been timely filed. TABLE 4—FILING DEADLINES FOR PERIODIC REPORTS Category of filer Calendar days after period end Annual Non-Accelerated Filer ................... Accelerated Filer ... Large Accelerated Filer ................... Quarterly 90 75 45 40 60 40 The Proposing Release discusses in detail the issuer and auditor responsibilities with respect to disclosure controls and procedures and ICFR for issuers of different filer PO 00000 Frm 00019 Fmt 4701 Sfmt 4700 17195 types.280 These responsibilities derive from the FCPA requirements with respect to internal accounting controls as well as a number of different changes to financial reporting that were introduced by SOX. In particular, all issuers 281 are required to devise and maintain an adequate system of internal accounting controls 282 and to have their corporate officers assess the effectiveness of the issuer’s disclosure controls and procedures 283 and disclose the conclusions of their assessments, typically on a quarterly basis.284 In addition, all issuers are required to have their corporate officers certify in each of their periodic reports that the information in the report fairly presents, in all material respects, the issuer’s financial condition and results of operations.285 All issuers other than RICs and asset-backed securities (‘‘ABS’’) issuers 286 are also required to include management’s assessment of the effectiveness of their ICFR in their annual reports.287 Further, all issuers are required to have the financial statements in their annual reports examined and reported on by an independent auditor, who, even if not engaged to provide an ICFR auditor attestation, is responsible for considering ICFR in the performance of the financial statement audit.288 Also, an auditor engaged in a financial statement only audit may test the operating effectiveness of some internal controls in order to reduce the extent of substantive testing performed in the audit. Importantly, all of these responsibilities with respect to financial reporting and ICFR apply equally to 280 See Sections II.B. and III.B.1. of the Proposing Release, note 4 above. 281 Specifically, the requirements apply to all issuers that file reports pursuant to Section 13(a) or 15(d) of the Exchange Act. 282 See Section 13(b)(2)(B) of the Exchange Act. 283 See note 209 above. 284 See note 210 above. 285 See 17 CFR 240.13a–14(b) and 17 CFR 240.15d–14(b). 286 See 17 CFR 240.13a–15 and 17 CFR 240.15d– 15. A newly public issuer is also not required to provide a SOX Section 404(a) management report on ICFR until its second annual report filed with the Commission. See Instructions to Item 308 of Regulation S–K. 287 See Management’s Report on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports, Release No. 33–8238 (June 5, 2003) [68 FR 36635 (June 18, 2003)]. These evaluations of ICFR, as well as any associated ICFR auditor attestations, should be based on a suitable, recognized control framework. The most widely used framework for this purpose is the one set forth in a report of the Committee of Sponsoring Organizations of the Treadway Commission (‘‘COSO’’). 288 See PCAOB AS 2110, note 187 above. See also the discussion below in this section about this auditing standard. E:\FR\FM\26MRR2.SGM 26MRR2 17196 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations non-accelerated as well as accelerated and large accelerated filers. Finally, all issuers listed on national exchanges are required to have an audit committee that is composed solely of independent directors and is directly responsible for the appointment, compensation, retention and oversight of the issuer’s independent auditors.289 The amendments do not change any of these requirements, including the requirements of a financial statement audit. Beyond these requirements, accelerated filers and large accelerated filers other than EGCs, RICs, and ABS issuers are required under SOX Section 404(b) and related rules to include an ICFR auditor attestation in their annual reports. In addition, certain banks, even if they are non-accelerated filers, are required under Federal Deposit Insurance Corporation (‘‘FDIC’’) rules to have their auditor attest to, and report on, management’s assessment of the effectiveness of the bank’s ICFR (the ‘‘FDIC auditor attestation requirement’’).290 One commenter raised questions about the nature of the FDIC auditor attestation requirement and how it compares to the ICFR auditor attestation requirement.291 For banks that are subject to the ICFR auditor attestation requirement, the FDIC regulations require ICFR attestation engagements to be performed according to the same standards as the ICFR auditor attestation requirement under SOX Section 404(b) (i.e., AS 2201,292 as discussed below).293 For other banks, the FDIC allows ICFR attestations to be performed either according to AS 2201 or according to the American Institute of Certified Public Accountants (‘‘AICPA’’) attestation standard.294 In 2015, the Auditing Standards Board of the AICPA issued Statement on Auditing Standards (‘‘SAS’’) No. 130, revising their attestation standard with the intention of adhering as closely as possible to AS 2201 while aligning with their generally accepted auditing standards and avoiding unintended consequences in practice.295 The FDIC also requires that the attestation reports be made available for public inspection (at the bank’s main and branch offices or, alternatively, by mail to anyone who requests it).296 Per Section IV.B.4 below, material weaknesses reported in SOX Section 404(a) reports and the corresponding SOX Section 404(b) reports typically mirror each other, so material weaknesses identified by the FDIC auditor attestation may also become publicly known via corresponding SOX Section 404(a) management reports. Finally, we note that FDIC and Federal Reserve examiners may also independently review and assess the adequacy of ICFR of banks. Some issuers that are not required to comply with SOX Section 404(b) voluntarily obtain an ICFR auditor attestation.297 Estimates of the number of issuers of each filer type are provided in Table 5 below.298 TABLE 5—FILER STATUS FOR ISSUERS FILING ANNUAL REPORTS IN 2018 Nonaccelerated * Accelerated Large accelerated FPI ............................................................................................................................................... EGC ............................................................................................................................................. 265 1,097 137 333 264 0 Total ...................................................................................................................................... 3,900 1,416 2,266 lotter on DSKBCFDHB2PROD with RULES2 * The estimated number of non-accelerated filers includes approximately 621 ABS issuers, which are not required to comply with SOX Section 404. Staff estimates that very few, if any, ABS issuers are accelerated or large accelerated filers. ABS issuers are identified as issuers that made distributions reported via Form 10–D. 289 See 17 CFR 240.10A–3. In the absence of an ICFR auditor attestation requirement, we note that the audit committee is responsible for approving whether to voluntarily obtain an ICFR auditor attestation, and would be alerted by the auditor engaged in a financial statement only audit if the auditor becomes aware of a significant deficiency or material weakness in ICFR. 290 Part 363 of the FDIC regulations requires that the auditor of an insured depository institution with consolidated total assets of $1 billion or more (as of the beginning of the fiscal year) examine, attest to, and report separately on the assertion of management concerning the effectiveness of the institution’s internal control structure and procedures for financial reporting. 291 See letter from CFA Inst. 292 See AS 2201, An Audit of Internal Control Over Financial Reporting That Is Integrated with An Audit of Financial Statements (‘‘AS 2201’’). 293 See Section 18A of Appendix A to Part 363 of the FDIC regulations. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 294 Id. 295 See Executive Summary to SAS 130 (October 2015), available at https://www.aicpa.org/Research/ Standards/AuditAttest/DownloadableDocuments/ SAS_130_Summary.pdf. 296 See Section 363.4 of Part 363 of the FDIC regulations. 297 Up to about seven percent of exempt issuers voluntarily provided an ICFR auditor attestation from 2005 through 2011. See 2013 GAO Study, note 246 above. We find similar results when examining data for non-accelerated filers and EGCs in calendar years 2014 through 2018 from Ives Group Audit Analytics to identify, among issuers of these types that have a SOX Section 404(a) management report, how many also have an ICFR auditor attestation report available in the database. See note 298 below regarding the identification of filer types. 298 The estimates in this table are based on staff analysis of self-identified filer status for issuers filing annual reports on Forms 10–K, 20–F, or 40– F in calendar year 2018, excluding any such filings PO 00000 Frm 00020 Fmt 4701 Sfmt 4700 that pertain to fiscal years prior to 2017. Staff extracted filer status from filings using a computer program supplemented with hand collection and compared the results for robustness with data from XBRL filings, Ives Group Audit Analytics, and Calcbench. FPIs represent those filing on Forms 20– F or 40–F and do not include FPIs that choose to file on Form 10–K. EGC issuers are identified by using data from Ives Group Audit Analytics and/or by using a computer program to search issuer filings, including filings other than annual reports, for a statement regarding EGC status. The estimates generally exclude RICs because these issuers do not file on the annual report types considered. This table also excludes 143 issuers, mostly Canadian MJDS issuers filing on Form 40–F (which does not require disclosure of filer status or public float), for which filer type is unavailable. E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations Audits of ICFR and the associated ICFR auditor attestation reports are made in accordance with AS 2201,299 previously known as Auditing Standard Number 5 (‘‘AS No. 5’’).300 This standard, which replaced Auditing Standard Number 2 (‘‘AS No. 2’’) in 2007, was intended to focus auditors on the most important matters in the audit of ICFR and eliminate procedures that the PCAOB believed were unnecessary to an effective audit of ICFR.301 Among other things, the 2007 standard facilitates the scaling of the evaluation of ICFR for smaller, less complex issuers by, for example, encouraging auditors to use top-down risk-based approaches and to use the work of others in the attestation process.302 It was accompanied by Commission guidance similarly facilitating the scaling of SOX Section 404(a) management evaluations of ICFR.303 The adoption of AS 2201 in 2007 has been found to have lowered audit fees.304 However, several studies have provided evidence that, at least initially, after the adoption of AS 2201, the quality of ICFR of issuers subject to the ICFR auditor attestation requirement decreased relative to that of other issuers.305 Around 2010, PCAOB 299 See note 292 above. No. 5 was renumbered as AS 2201, note 292 above, effective Dec. 31, 2016. See Reorganization of PCAOB Auditing Standards and Related Amendments to PCAOB Standards and Rules, PCAOB Release No. 2015–002 (Mar. 31, 2015). 301 See Auditing Standard No. 5, An Audit of Internal Control Over Financial Reporting That Is Integrated with An Audit of Financial Statements, and Related Independence Rule and Conforming Amendments, PCAOB Release No. 2007–005A (June 12, 2007). See also Public Company Accounting Oversight Board; Order Approving Proposed Auditing Standard No. 5, An Audit of Internal Control Over Financial Reporting that is Integrated with an Audit of Financial Statements, a Related Independence Rule, and Conforming Amendments, Release No. 34–56152, File No. PCAOB 2007–02 (July 27, 2007) [72 FR 42141 (Aug. 1, 2007)]. 302 Id. 303 See Commission Guidance Regarding Management’s Report on Internal Control Over Financial Reporting Under Section 13(a) or 15(d) of the Securities Exchange Act of 1934, Release No. 33–8810 (June 20, 2007) [72 FR 35323 (June 27, 2007)]. See also Amendments to Rules Regarding Management’s Report on Internal Control Over Financial Reporting, Release No. 33–8810 (June 20, 2007) [72 FR 35309 (June 27, 2007)]. 304 See, e.g., Study of the Sarbanes-Oxley Act of 2002 Section 404 Internal Control over Financial Reporting Requirements (Sept. 2009) (‘‘2009 SEC Staff Study’’), available at https://www.sec.gov/ news/studies/2009/sox-404_study.pdf; Rajib Doogar, Padmakumar Sivadasan, & Ira Solomon, 48(4) J. of Acct. Res. 795 (2010). 305 See, e.g., Joseph Schroeder & Marcy Shepardson, Do SOX 404 Control Audits and Management Assessments Improve Overall Internal Control System Quality?, 91(5) Acct. Rev. 1513 (2016) (‘‘Schroeder and Shepardson 2016 Study’’); Lori Bhaskar, Joseph Schroeder, & Marcy Shepardson, Integration of Internal Control and lotter on DSKBCFDHB2PROD with RULES2 300 AS VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 inspections of auditors began to include a heightened focus on whether auditing firms had obtained sufficient evidence to support their opinions on the effectiveness of ICFR.306 There is some evidence that these inspections have led to an improvement in the reliability of ICFR auditor attestations,307 but also concerns that audit fees also increased around the same time.308 In 2010, the PCAOB adopted enhanced auditing standards related to the auditor’s assessment of and response to risk.309 The enhanced risk assessment standards have likely reduced, to some extent, the degree of difference between a financial statement only audit and an integrated audit (which includes an audit of ICFR) because the standards clarify and augment the extent to which internal controls are to be considered even in a financial statement only audit. In particular, the risk assessment standards applying to both types of audits require auditors, in either case, to evaluate the design of certain controls, including whether the controls are implemented.310 Based on the results of inspections in the several years after the adoption of the new risk assessment auditing standards, the PCAOB expressed concern about the number and significance of deficiencies in auditing firm compliance with these standards, but also noted promising improvements in the application of these standards.311 While the risk assessment standards may reduce the degree of difference Financial Statement Audits: Are Two Audits Better than One? Acct. Rev. (forthcoming 2018) (‘‘Bhaskar et al. 2018 Study’’), available at https:// aaajournals.org/doi/abs/10.2308/accr-52197. See Section IV.C.3.a. and notes 464 and 474 below for more information on these studies. 306 See Jeanette Franzel, Board Member, PCAOB, Speech by PCAOB board member at the American Accounting Association Annual Meeting, Current Issues, Trends, and Open Questions in Audits of Internal Control over Financial Reporting (2015), available at https://pcaobus.org/News/Speech/ Pages/08102015_Franzel.aspx. 307 See Mark Defond & Clive Lennox, Do PCAOB Inspections Improve the Quality of Internal Control Audits?, 55(3) J. OF ACCT. RES. 591 (2017) (‘‘Defond and Lennox 2017 Study’’). 308 See, e.g., Tammy Whitehouse, Audit Inspections: Improvement? Maybe. Costs? Yes, Compliance Week (April 14, 2015), available at https://www.complianceweek.com/news/newsarticle/audit-inspections-improvement-maybecosts-yes#.W5LW7mlpCEd; and Jennifer McCallen, Roy Schmardebeck, Jonathan Shipman, & Robert Whited, Have the Costs and Benefits of SOX Section 404(b) Compliance Changed Over Time?, Working Paper (Nov. 2019), available at https:// papers.ssrn.com/sol3/papers.cfm?abstract_ id=3420787 (‘‘McCallen et al. 2019 study’’). 309 See PCAOB Release No. 2010–004 and PCAOB Release No. 2010–01, note 193 above. 310 See AS 2110, paragraphs .18–.40, note 187 above. 311 See PCAOB Release No. 2015–007, note 195 above. PO 00000 Frm 00021 Fmt 4701 Sfmt 4700 17197 between a financial statement only audit and an integrated audit, there remain important differences in the requirements of these audits as they relate to controls. For example, in an integrated audit, but not a financial statement only audit, the auditor is required to identify likely sources of misstatements in considering the evaluation of ICFR.312 Also, the extent of the procedures necessary to obtain the required understanding of controls generally will be greater in an integrated audit due to the different objectives of such an audit as compared to a financial statement only audit.313 The Commission recently settled charges against four public companies for failing to maintain effective ICFR for seven to 10 consecutive annual reporting periods.314 These enforcement cases may have a deterrent effect among issuers failing to remediate material weaknesses, which might reduce the overall rate of persistence of material weaknesses in ICFR. We also note that there have been some recent changes in accounting and auditing that are part of our baseline and could increase the uncertainty of our analysis due to their effects on factors such as audit fees, restatements, and ICFR. For example, three new reporting standards have been issued recently by FASB, on the topics of revenue recognition, leases, and credit losses, which could temporarily increase audit fees as issuers and auditors adjust to the new standards.315 Recent changes in technology, such as the potential for management to use automated controls testing and process automation,316 may result in improvements in ICFR regardless of the ICFR auditor attestation requirement if their increased application results in more robust financial reporting processes with fewer opportunities for deficiencies and/or in an increase by 312 See PCAOB Release No. 2010–004, note 309 above, at 7 and A10–41. As discussed above, even in a financial statement only audit, if the auditor becomes aware of a significant deficiency or material weakness in ICFR, it is required to inform management and the audit committee of this finding and has the responsibility to review management’s disclosure for any misstatement of facts, such as a statement that ICFR is effective when there is a known material weakness. See notes 190 to 191 above and the accompanying text. 313 See Proposed Auditing Standards Related to the Auditor’s Assessment of and Response to Risk and Conforming Amendments to PCAOB Standards, PCAOB Release No. 2008–006 A9–8 (Oct. 21, 2008). 314 See SEC Press Release, note 196 above. 315 Information on these and other FASB Accounting Standards updates is available at https://www.fasb.org/jsp/FASB/Page/ SectionPage&cid=1176156316498. 316 See, e.g., Robotic Process Automation, note 197 above. E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations management in control testing and related improvements. Such automation could also reduce audit fees, including the costs of an audit of ICFR, but at least one report suggests that the uptake of these technologies has been slow.317 Finally, auditors have had many years of experience with integrated audits, as well as risk assessment standards that require the consideration of ICFR even in the absence of an ICFR auditor attestation. This experience may affect their execution of financial statement only audits of issuers for whom the ICFR auditor attestation requirement is eliminated. For example, given their experience, auditors may be more likely to detect control deficiencies or to increase their auditing efficiency by reducing substantive testing in favor of testing some related controls even when BILLING CODE 8011–01–C The distribution of public float among accelerated filers is skewed towards lower levels of float, but higher levels of float are also significantly represented. Figure 3 321 presents the distribution of revenues across those accelerated filers that have less than $1 billion in revenues. While the full population of accelerated filers has revenues of up to over $20 billion, about 90 percent of accelerated filers have less than $1 billion in revenues. We restrict the figure to this subset in order to more clearly display the distribution in this range. 317 See, e.g., Protiviti survey results, Benchmarking SOX Costs, Hours and Controls (2018) (‘‘Protiviti 2018 Report’’). 318 2011 SEC Staff Study, note 198 above, (stating that ‘‘. . . once effective controls are in place at the issuer, the auditor is more likely to continue to test them even if [it is] not issuing an auditor attestation during a particular year in order to rely on them for purposes of reducing substantive testing in the audit of the financial statements, particularly for issuers that are larger and more complex’’). 319 The estimates in the figure are based on staff analysis of data from XBRL filings. See note 298 above for details on the identification of the population of accelerated filers. 320 Because of the accelerated filer transition provisions, some accelerated filers have float below $75 million. The public float of these issuers would previously have exceeded $75 million, causing them to enter accelerated filer status, but has not dropped below the $50 million public float level required to exit accelerated filer status. 321 The estimates of revenues are based on staff analysis of data from XBRL filings, Compustat, and Calcbench. The revenue data used is from the last fiscal year prior to the annual report in calendar year 2018, because the SRC revenue test is based on the prior year’s revenues. See note 298 above for details on the identification of the population of accelerated filers. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 PO 00000 Frm 00022 Fmt 4701 Sfmt 4700 an ICFR auditor attestation is not required.318 2. Characteristics of Accelerated Filer Population Per Table 5, there were approximately 1,400 accelerated filers in total in 2018. Figure 2 319 presents the distribution of public float across these issuers.320 BILLING CODE 8011–01–P E:\FR\FM\26MRR2.SGM 26MRR2 ER26MR20.001</GPH> lotter on DSKBCFDHB2PROD with RULES2 17198 17199 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations The distribution of revenues for accelerated filers is heavily skewed towards lower levels of revenue, with roughly three-quarters of accelerated filers having revenues of less than $500 million and more than a third having revenues of less than $100 million. Other than a clustering of issuers with zero or near zero revenues, there are no obvious breaks in the distribution. While a large range of industries are represented among accelerated filers, a small number of industries account for the majority of these issuers. The ‘‘Banking’’ industry accounts for about 14.1 percent of accelerated filers, followed by ‘‘Pharmaceutical Products’’ (13.9 percent) ‘‘Financial Trading’’ (8.0 percent), ‘‘Business Services’’ (5.7 percent), ‘‘Petroleum and Natural Gas’’ (4.8 percent), ‘‘Computer Software’’ (4.4 percent), ‘‘Retail’’ (4.4 percent), ‘‘Transportation’’ (4.2 percent), and ‘‘Electronic Equipment’’ (4.1 percent).322 3. Timing of Filings As discussed above, non-accelerated, accelerated, and large accelerated filers face different filing deadlines for their periodic reports. In Table 6, we present the timing in recent years of annual report filings by these different groups of issuers relative to their corresponding deadlines.323 TABLE 6—FILING TIMING FOR ANNUAL REPORTS IN YEARS 2014 THROUGH 2018, BY FILER STATUS 322 These estimates are based on staff analysis of data including SIC codes from XBRL filings and Ives Group Audit Analytics, using the Fama-French 49-industry classification system. See https:// mba.tuck.dartmouth.edu/pages/faculty/ken.french/ Data_Library/det_49_ind_port.html. See note 298 above for details on identification of population of accelerated filers. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 Accelerated 90 days ............. 101 days ........... 75 days ............. 70 days ............. 60 days. 56 days. 72% 44% 28% 13% 91% .................. 63% .................. 9% .................... 5% .................... 94%. 61%. 6%. 4%. 323 The estimates in this table are based on staff analysis of EDGAR filings. These statistics include all annual reports on Forms 10–K, 20–F, and 40– F filed in calendar years 2014 through 2018 other than amendments. If multiple annual reports (excluding amendments) are filed in the same calendar year, the analysis considers only the latest such filing. Given the effect of weekends and PO 00000 Frm 00023 Fmt 4701 Sfmt 4700 .................. .................. .................. .................. holidays, filings are considered to be on time if within two calendar days after the original deadline. The ‘‘5 days early’’ and ‘‘over 15 days after’’ categories are similarly adjusted to account for the possible effect of weekends and holidays. See note 298 above for details on the identification of filer type. E:\FR\FM\26MRR2.SGM 26MRR2 ER26MR20.002</GPH> lotter on DSKBCFDHB2PROD with RULES2 Annual report filing deadline ............................................................................................... Average days to file ............................................................................................................ Percentage filed: By deadline .................................................................................................................. Over 5 days early ........................................................................................................ After deadline .............................................................................................................. Over 15 days after deadline ........................................................................................ Large accelerated Non-accelerated 17200 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations Table 6 documents that accelerated and large accelerated filers file their annual reports, on average, four or five days before the applicable deadline. Nine percent and six percent, respectively, of accelerated and large accelerated filers submit their annual reports after the initial deadline, with roughly half of these filers surpassing the 15-day grace period that is obtained by filing Form NT. Non-accelerated filers are less likely to meet their initial deadline or extended deadline, with the average non-accelerated filer submitting its annual report 11 days after the initial deadline and 13 percent of nonaccelerated filers filing after the 15-day grace period obtained by filing Form NT. 4. Internal Controls and Restatements We next consider the current rates of ineffective ICFR and restatements 324 among issuers that are accelerated filers under the baseline relative to other filer types. The data for all years of the analysis has been updated relative to the analysis in the Proposing Release.325 Throughout our analysis, we use the term restatement to refer to a restatement that is associated with some type of misstatement. As discussed above, non-accelerated filers and EGCs are statutorily exempted from the ICFR auditor attestation requirement. Table 7 presents the percentage of issuers reporting ineffective ICFR in recent years by filer type.326 TABLE 7—PERCENTAGE OF ISSUERS REPORTING INEFFECTIVE ICFR Nonaccelerated (%) Ineffective ICFR year reported in lotter on DSKBCFDHB2PROD with RULES2 Management Report: 2014 ...................................................................................................................................... 2015 ...................................................................................................................................... 2016 ...................................................................................................................................... 2017 ...................................................................................................................................... 2018 ...................................................................................................................................... Average/year ................................................................................................................. Auditor Attestation: 2014 ...................................................................................................................................... 2015 ...................................................................................................................................... 2016 ...................................................................................................................................... 2017 ...................................................................................................................................... 2018 ...................................................................................................................................... Average/year ................................................................................................................. Accelerated (%) Large accelerated (%) 40.1 41.2 38.3 40.2 40.3 40.0 7.8 9.2 9.5 9.2 8.9 8.9 3.2 3.8 4.6 5.0 3.8 4.1 n/a n/a n/a n/a n/a n/a 8.0 9.1 9.0 9.4 8.7 8.8 3.3 3.8 4.6 4.9 3.8 4.1 Based on management’s SOX Section 404(a) reports on ICFR from recent years, on average, about nine percent of accelerated filers reported at least one material weakness in ICFR in a given year.327 This represents a moderately higher rate than that among large accelerated filers, approximately four percent, on average, of which reported ineffective ICFR,328 and a substantially lower rate than that among nonaccelerated filers, more than a third of which reported ineffective ICFR each year.329 For issuers subject to the ICFR auditor attestation requirement, the rates of ineffective ICFR reported by management and by auditors are similar.330 This may not be surprising, as management will be made aware of any material weaknesses discovered by the auditor and vice versa. We next consider the persistence of material weaknesses across these issuer categories. Table 8 331 presents the percentage of issuers that reported two, three, or four consecutive years of ineffective ICFR culminating in 2018, by filer type.332 324 Unless otherwise specified, statistics and analysis regarding restatements are not restricted to those restatements requiring Form 8–K Item 4.02 disclosure. 325 Previous years of data may be revised due to, for example, newly disclosed restatements that reflect misstatements in these earlier years, restated internal control reports that relate to previous fiscal years, previously incomplete data that was later populated, or other updates or database changes. 326 The estimates in this table are based on staff analysis of Ives Group Audit Analytics data. ICFR effectiveness is based on the last amended management or auditor attestation report for the fiscal year. Percentages are computed out of all issuers of a given filer type with the specified type of report available in the Ives Group Audit Analytics database. See note 298 above for details on the identification of filer type. 327 Per the second column of the first panel of Table 7, the rate of ineffective ICFR among accelerated filers has ranged from 7.8 to 9.5 percent for the years 2014 through 2018, for an average per year of 8.9 percent. 328 Per the third column of the first panel of Table 7, the rate of ineffective ICFR among large accelerated filers has ranged from 3.2 to 5.0 percent for the years 2014 through 2018, for an average per year of 4.1 percent. 329 Per the first column of the first panel of Table 7, the rate of ineffective ICFR among nonaccelerated filers has ranged from 38.3 to 41.2 percent for the years 2014 through 2018, for an average per year of 40.0 percent. 330 Per the second column of Table 7, the average rate of ineffective ICFR for accelerated filers across years 2014 through 2018 was 8.9 percent as reported in management reports and 8.8 percent as reported in auditor reports. Similarly, per the third column of Table 7, the average rate of ineffective ICFR for large accelerated filers across years 2014 through 2018 was 4.1 percent as reported in management reports and 4.1 percent as reported in auditor reports. 331 The estimates in this table are based on staff analysis of Ives Group Audit Analytics data. ICFR effectiveness is based on the last amended management report for the fiscal year. Percentages in the first panel are computed out of all issuers of a given filer type in 2018 with SOX Section 404(a) management reports available in Ives Group Audit Analytics database, while percentages in the second panel are computed out of issuers of a given filer type reporting ineffective ICFR in their SOX Section 404(a) management report for 2018. See fourth row of Table 7 and note 298 above for details on the identification of filer type. 332 One commenter noted that the Proposing Release, note 4 above, indicated that over 68 percent of non-accelerated filers have reported two consecutive years of ineffective ICFR and over 38 percent have reported four consecutive years of ineffective ICFR in their annual reports. See letter from Better Markets. To clarify, we note that these statistics, like those reported in the second panel of Table 8 below, reflect percentages out of the issuers in each category that maintained ineffective ICFR in the last year of the analysis, not percentages of all issuers in each category. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 PO 00000 Frm 00024 Fmt 4701 Sfmt 4700 E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations 17201 TABLE 8—PERCENTAGE OF ISSUERS REPORTING CONSECUTIVE YEARS OF INEFFECTIVE ICFR IN MANAGEMENT REPORT, BY 2018 FILER STATUS Nonaccelerated (%) Ineffective ICFR years Issuers with persistent ineffective ICFR/All issuers: 2017–2018 (at least 2 years) ............................................................................................... 2016–2018 (at least 3 years) ............................................................................................... 2015–2018 (4 years) ............................................................................................................ Issuers with persistent ineffective ICFR/Issuers with 2018 ineffective ICFR: 2017–2018 (at least 2 years) ............................................................................................... 2016–2018 (at least 3 years) ............................................................................................... 2015–2018 (4 years) ............................................................................................................ The first panel of Table 8 is intended to demonstrate the overall rate of persistently ineffective ICFR among issuers of different types, while the second panel is intended to demonstrate the degree of persistence of ineffective ICFR among the subset of issuers of each type that report ineffective ICFR in 2018. Compared to non-accelerated filers, we find that a smaller percentage of accelerated and large accelerated filers report material weaknesses that persist for multiple years, with about one percent of accelerated filers and about 0.3 percent of large accelerated filers reporting ineffective ICFR for four consecutive years (per the third row of the table), representing about 11 percent of the accelerated filers and about seven percent of the large accelerated filers that reported ineffective ICFR in 2018 (per the last row of the table). A larger percentage of non-accelerated filers persistently report material weaknesses, with about 16 percent of these issuers (per the third row of the table), or about 40 percent of those reporting ineffective ICFR in 2018 (per the last row of the table), having reported material weaknesses for four consecutive years. As discussed above, it is possible that recent Commission enforcement actions might lead to a reduction in the persistence of material weaknesses in Accelerated (%) Large accelerated (%) 28.4 20.8 16.1 3.5 2.0 1.0 1.4 0.5 0.3 70.4 51.6 39.9 39.2 22.4 11.3 36.4 14.1 7.2 ICFR to the extent that they change issuers’ awareness of the risks of longstanding ICFR failures. Table 9 presents the rate of restatements among each of these filer types, excluding EGCs, and for EGCs separately. For each year, we consider the percentage of issuers that eventually restated the financial statements for that year. The reporting lag before restatements are filed results in a lower observed rate in the later years of our sample, particularly for 2017 (and even more so for 2018, which we do not report for this reason), as issuers may yet restate their results from recent years.333 TABLE 9—PERCENTAGE OF ISSUERS ISSUING RESTATEMENTS BY YEAR OF RESTATED DATA Nonaccelerated (ex. EGCs) (%) Restated Total Restatements: 2014 .......................................................................................................... 2015 .......................................................................................................... 2016 .......................................................................................................... 2017 .......................................................................................................... Average/year ..................................................................................... 8–K Item 4.02 Restatements: 2014 .......................................................................................................... 2015 .......................................................................................................... 2016 .......................................................................................................... 2017 .......................................................................................................... Average/year ..................................................................................... lotter on DSKBCFDHB2PROD with RULES2 The first panel of Table 9 presents the percentage of issuers that make at least one restatement, of any type, while the second panel presents those that make at least one restatement requiring Form 8–K Item 4.02 disclosure. The latter type of restatement (‘‘Item 4.02 333 The estimates in this table are based on staff analysis of Ives Group Audit Analytics data. Percentages are computed out of all issuers of a given filer type with a SOX Section 404(a) management report available in the Ives Group Audit Analytics database. Accelerated and nonaccelerated categories exclude EGCs that are in these filer categories. See note 298 above for details on the identification of filer type. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 Frm 00025 Fmt 4701 Sfmt 4700 Large accelerated (%) EGC (%) 10.9 9.2 6.8 6.9 8.5 11.9 12.5 9.6 7.5 10.4 14.5 12.7 8.9 6.3 10.6 17.7 16.0 9.3 8.3 12.8 3.9 3.1 2.4 2.3 2.9 3.6 3.6 2.7 2.0 2.9 2.4 1.8 1.3 0.7 1.6 5.0 4.7 3.0 3.1 3.9 restatements’’) reflects material misstatements, while other restatements deal with misstatements that are considered immaterial. We find that EGCs, which are not subject to the ICFR auditor attestation requirement and generally are also younger issuers than those in the other groups, restate their financial statements at higher rates than other issuers, whether we consider all restatements or only Item 4.02 restatements. For non-accelerated filers, which also are not subject to the ICFR auditor attestation requirement, we find that the percentage of issuers reporting PO 00000 Accelerated (ex. EGCs) (%) Item 4.02 restatements is similar to, and the rate of all restatements slightly lower than, that for accelerated filers who are subject to the ICFR auditor attestation requirement. We note that there is a greater proportion of lowrevenue issuers in the non-accelerated filer category than in other categories, and that, in the Proposing Release, we found such issuers to have lower rates of restatement than other issuers.334 When, in the Proposing Release, we 334 See Table 14 in the Proposing Release, note 4 above. E:\FR\FM\26MRR2.SGM 26MRR2 17202 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations separately considered issuers with revenues below $100 million, we found that the accelerated filers in this category are less likely to restate their financial statements than nonaccelerated filers in the same revenue category.335 C. Discussion of Economic Effects The costs and benefits of the amendments, including impacts on efficiency, competition, and capital formation, are discussed below. We first address the population and characteristics of issuers that will newly qualify as non-accelerated filers under the amendments, and then introduce certain categories of issuers that are used for comparison purposes. We next discuss the anticipated costs and benefits associated with the proposed change in applicability of the ICFR auditor attestation requirement. Following this discussion, we consider the costs and benefits associated with the proposed changes with respect to filing deadlines, exit thresholds, and other required disclosures. Finally, we consider the relative benefits and costs of the principal reasonable alternatives to the amendments. 1. Affected Issuers We estimate that the amendments will result in 527 additional issuers being classified as non-accelerated filers, and therefore no longer subject to the filing deadlines and ICFR auditor attestation requirement applicable to accelerated filers.336 Of these, an estimated 154 issuers are EGCs and are thereby already exempt from the ICFR auditor lotter on DSKBCFDHB2PROD with RULES2 335 Id. 336 The number of affected issuers is based on staff estimates of: (i) The number of accelerated filers in 2018 that have prior fiscal year revenues of less than $100 million and are eligible to be SRCs (i.e., excluding ABS issuers, RICs, BDCs, subsidiaries of non-SRCs, and FPIs filing on foreign forms or using IFRS) or are BDCs with prior year investment income of less than $100 million; (ii) the number of large accelerated filers in 2018 that have a public float of less than $560 million and prior fiscal year revenues of less than $100 million and are eligible to be SRCs; and (iii) the number of accelerated filers in 2018 that have a public float of at least $50 million but less than $60 million. The estimate of the number of affected issuers does not include large accelerated filers that have a public float of at least $560 million but less than $700 million even though such issuers could become non-accelerated filers under the amendments if they became eligible to be SRCs under the SRC revenue test in the first year the SRC amendments became effective due to the limited horizon of this accommodation. See note 252 above (describing the accommodation provided in the SRC Adopting Release). Revenue data is sourced from XBRL filings, Compustat, and Calcbench. Public float data is from XBRL. See note 298 above for details on the identification of the population of accelerated and large accelerated filers and other filer types. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 attestation requirement.337 Among the total 527 affected issuers, an estimated 492 issuers are accelerated filers (or large accelerated filers that have public float of less than $560 million) that will be newly classified as non-accelerated filers because they have annual revenues of less than $100 million and are eligible to be SRCs.338 An additional 28 issuers are BDCs that will be newly classified as non-accelerated filers because they are currently accelerated filers (and therefore have public float of less than $700 million) and have annual investment income of less than $100 million.339 The remaining seven affected issuers are accelerated filers that will be newly classified as nonaccelerated filers despite having revenues of at least $100 million because they have a public float of at least $50 million but less than $60 million.340 Our estimate of the number of affected issuers excludes issuers for which we were unable to determine filer classification or revenues, which could represent up to approximately an additional 30 affected issuers. Our estimate of the number of affected issuers does not include any FPIs. We estimate that there are no FPIs that file on domestic forms and present their financial statements pursuant to U.S. GAAP, and that also meet the required thresholds and other qualifications to be an affected issuer under the amendments. However, there are an estimated 31 FPIs that file on foreign forms, but otherwise meet the required thresholds and other qualifications. There are also FPIs filing on foreign forms for which we were unable to determine filer classification or revenues, which could represent up to approximately an additional 90 FPIs that file on foreign forms but that may meet the required thresholds and other qualifications.341 While we do not include these issuers in our counts of the number of affected issuers,342 some of these 30 to 120 additional issuers might choose to file on domestic forms using U.S. GAAP in order to benefit 337 Id. 338 Id. 339 Id. 340 Id. 341 The majority of these potential additional issuers are Canadian MJDS filers that are not required to disclose filer type or public float. See note 298 above. 342 In the Proposing Release, note 4 above, we included FPIs that file on foreign forms, but otherwise meet the required thresholds and other qualifications, in the number of affected issuers. While these issuers could become subject to the amendments by changing their reporting regime, it is difficult to predict how many would do so and therefore, to be conservative, we do not include them in the number of affected issuers in this release. PO 00000 Frm 00026 Fmt 4701 Sfmt 4700 from the amendments if these benefits, together with other benefits of such a choice (such as the ability to rely on the scaled disclosure accommodations available to SRCs) outweigh the costs of changing their disclosure regime. However, many factors are involved in the choice of a reporting regime, and it is difficult to predict how many of these issuers are likely to change their reporting practices due to the amendments. As noted above, the total number of affected issuers includes an estimated 154 EGCs (including 152 EGCs with annual revenues or, in the case of BDCs, investment income of less than $100 million and two EGCs that will be affected because they have a public float of at least $50 million but less than $60 million).343 It also includes an estimated 78 banks with $1 billion or more in total assets that are not EGCs.344 The estimated 154 EGCs are not required to comply with the ICFR auditor attestation requirement under SOX Section 404(b). We estimate that the remaining 373 affected issuers will, including 21 BDCs, be newly exempt from this requirement.345 Two commenters provided estimates of 382 affected issuers and 385 affected issuers, respectively, as the number of issuers that would be newly exempt from the ICFR auditor attestation requirement under the proposal.346 While these estimates are largely consistent with our estimate, we note that the commenters’ estimates apply some simplifications and use different underlying data sources than our estimate.347 343 See note 336 above. are identified as issuers with SIC codes of 6020 (commercial banks), 6021 (national commercial banks), 6022 (state commercial banks), 6029 (NEC commercial banks), 6035 (savings institutions, federally-chartered) or 6036 (savings institutions, not federally-chartered). 345 Of these 373 issuers, 368 had less than $100 million in revenues (or, in the case of BDCs, investment income) in their last fiscal year, while the remaining five would be affected despite having greater revenues because of the revised transition provisions (i.e., because their public float is at least $50 million but less than $60 million). 346 See letters from CFA Inst. and Prof. Barth et al. See also letter from Nasdaq, estimating that at least 399 Nasdaq-listed companies may be affected by the amendments. 347 For example, neither commenter excludes from its estimate issuers that are not eligible to be SRCs or adjusts for the effect of the revised transition thresholds as described in note 336 above and note 151 of the Proposing Release, note 4 above. The letter from CFA Inst. appears to rely on a footnote in the Proposing Release that, while citing to the correct definitions of EGC in our rules, incorrectly stated that an EGC is an issuer that has total annual gross revenues of ‘‘less than $1.07 million’’ during its most recently completed fiscal year (rather than the correct threshold of ‘‘less than $1.07 billion’’) and did not identify the other requirements to be an EGC (such as not having reached the last day of the fiscal year following the 344 Banks E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations Of the 373 issuers that will be newly exempt from the ICFR auditor attestation requirement, we estimate that the 78 banks identified above will be subject to the FDIC auditor attestation requirement,348 while the remaining 295 issuers will not be subject to any such auditor attestation requirement.349 For the banks that will lotter on DSKBCFDHB2PROD with RULES2 fifth anniversary of the date of the first sale of common equity securities of the issuer under an effective Securities Act registration statement as an EGC). See footnote 47 of the Proposing Release, note 4 above. The estimate in the letter from CFA Inst. also excluded all 10–K filers with the SIC code 6200 (‘‘Security & Commodity Brokers, Dealers, Exchanges & Services’’), which we do not believe is appropriate. While the letter correctly indicates that the ICFR auditor attestation requirement does not apply to audits of brokers and dealers performed pursuant to SEC Rule 17a–5, these audits apply to the reports required by Rule 17a–5, which are distinct from a Form 10–K filing. Issuers filing Form 10–Ks that have a subsidiary that is a broker or dealer are not treated differently from other issuers with respect to the ICFR auditor attestation requirement. 348 If these banks are no longer subject to the SOX Section 404(b) auditor attestation requirement, their auditors may follow the AICPA’s auditing standards in lieu of the PCAOB’s auditing standards for the FDIC auditor attestation. See Section 18A of Appendix A to FDIC Rule 363 and the AICPA’s AU–C Section 940. See also Section III.B.1. above. 349 Of these 274 issuers, 269 are accelerated filers (or large accelerated filers that have public float of less than $560 million) that will be newly classified as non-accelerated filers because they have annual revenues of less than $100 million and are eligible to be SRCs, while the remaining five will be newly classified as non-accelerated filers despite having revenues of at least $100 million because they have VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 be newly exempt from the ICFR auditor attestation requirement but will remain subject to the FDIC auditor attestation requirement, the benefits and costs of expanding the exemption from the ICFR auditor attestation requirement are both expected to be limited. As discussed in Section IV.B.1. above, the FDIC auditor attestation requirement is substantively similar to the ICFR auditor attestation requirement, and is thus expected to require similar expenditures and have similar financial reporting benefits as the ICFR auditor attestation. We estimate that approximately 90 percent of the affected issuers (whether including or excluding EGCs) have securities that are listed on national exchanges.350 The representation in public markets of issuers similar to the affected issuers has decreased relative to the years before SOX. In particular, over the past two decades, the number of issuers listed on major exchanges has decreased by about 40 percent,351 but the decline has been concentrated among smaller size issuers. Specifically, a public float of at least $50 million but less than $60 million. 350 Staff extracted information regarding whether issuers reported having securities registered under Section 12(b) of the Exchange Act from the cover page of annual report filings using a computer program supplemented with hand collection. See note 336 above for details on the identification of the population of affected issuers. 351 This estimate is based on staff analysis of data from the Center for Research in Security Prices database for December 1998 versus December 2018. The estimate excludes RICs and issuers of ADRs. PO 00000 Frm 00027 Fmt 4701 Sfmt 4700 17203 the number of listed issuers with market capitalization below $700 million has decreased by about 65 percent,352 and the number of listed issuers with less than $100 million in revenue has decreased by about 60 percent.353 One commenter noted that these statistics do not establish that the costs of the ICFR auditor attestation materially contributed to the decline in listed issuers, and that there are a number of other factors that are likely implicated in the decline of listings.354 We cite these statistics to characterize the affected issuers, not to attribute the decline in listings to any particular cause. As noted below, the amendments could be a positive factor in the decision of additional companies to enter public markets, but it may not be the decisive factor, and the direct impact of the amendments on the number of public companies may be limited to the extent that companies may be more focused on other factors associated with the decision to go public.355 Figure 4 356 presents the distribution of public float across the full sample of affected issuers.357 BILLING CODE 8011–01–P 352 Id. 353 This estimate is based on staff analysis of data from Standard & Poor’s Compustat and Center for Research in Security Prices databases for fiscal year 1998 versus fiscal year 2017. The estimate excludes RICs and issuers of ADRs. 354 See letter from CFA. 355 See Section IV.C.2.d. below. E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations Relative to the distribution for all accelerated filers presented in Figure 2, the sample of affected issuers is more strongly skewed toward lower levels of public float, with higher levels of public float only thinly represented. However, some of the affected issuers do have public float approaching the top of the range for accelerated filers. Figure 5 presents the distribution of revenues across the 520 accelerated filers (or large accelerated filers with public float of less than $560 million) that will be newly classified as nonaccelerated filers because they have revenues (or, in the case of BDCs, investment income) of less than $100 million.358 356 The estimates in this figure are based on staff analysis of data from XBRL filings. We corrected the public float data based on hand-collection from Form 10–K filings for five affected issuers whose public float reported in XBRL format was 1,000 times the public float reported on the cover page of the corresponding Form 10–K filing, resulting in values of over $50 billion in public float reported in XBRL. See note 336 above for details on the identification of the population of affected issuers. 357 Because of the accelerated filer transition provisions, some of the affected issuers have public float of at least $50 million but below $75 million. See note 320 above. 358 The estimates in this figure are based on staff analysis of data from XBRL filings, Compustat, and Calcbench. The revenue data used is from the last fiscal year prior to the annual report in calendar year 2018, because the SRC revenue test is based on the prior year’s revenues. See note 336 above for details on the identification of the population of affected issuers. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 PO 00000 Frm 00028 Fmt 4701 Sfmt 4700 E:\FR\FM\26MRR2.SGM 26MRR2 ER26MR20.003</GPH> lotter on DSKBCFDHB2PROD with RULES2 17204 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations Other than a concentration of issuers with zero or near zero revenues,359 these affected issuers are fairly evenly distributed over different levels of revenue up to $100 million in revenues. The additional seven affected issuers with revenues of at least $100 million but a public float of less than $60 million have revenues ranging from $119 million to $2.1 billion, with a mean of about $770 million in revenues. The affected issuers are estimated to have median total assets of about $185 million, a median number of employees of about 115, and a median age of about 12 years.360 For those issuers that will be newly exempt from all ICFR auditor lotter on DSKBCFDHB2PROD with RULES2 359 Approximately 13 percent of the estimated 520 affected issuers with revenues of less than $100 million and approximately 11 percent of the estimated 290 affected issuers with revenues of less than $100 million that would be newly exempt from all ICFR auditor attestation requirements (i.e., those that are not EGCs and are not banks subject to the FDIC auditor attestation requirement) have zero revenues. 360 These estimates are based on staff analysis of data from Compustat. See note 336 above for details on the identification of the population of affected issuers. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 attestation requirements (i.e., those that are not EGCs and are not banks subject to the FDIC auditor attestation requirement), the median total assets and median number of employees are somewhat lower at about $125 million and 85 employees, and the median issuer age is slightly higher at about 19 years.361 The majority of the affected issuers have negative net income and negative net cash flows from operations.362 The affected issuers are heavily concentrated, based on the number of issuers, in the ‘‘Pharmaceutical Products’’ (29.1 percent), ‘‘Banking’’ (22.4 percent),363 ‘‘Financial Trading’’ 361 Id. 362 Id. For the 295 affected issuers that would be newly exempt from all ICFR auditor attestation requirements (i.e., those that are not EGCs and are not banks subject to the FDIC auditor attestation requirement), the median net income is approximately negative $6 million and the median net cash flows from operations is approximately negative $6 million. 363 For the 295 affected issuers that would be newly exempt from all ICFR auditor attestation requirements (i.e., those that are not EGCs and are not banks subject to the FDIC auditor attestation requirement), the proportion of ‘‘Banking’’ issuers PO 00000 Frm 00029 Fmt 4701 Sfmt 4700 (16.0 percent), ‘‘Medical Equipment’’ (4.4 percent), and ‘‘Electronic Equipment’’ (3.8 percent) industries.364 If the distribution of eligible issuers does not change over time, the amendments could lead to a noticeable decrease in the presence of ‘‘Pharmaceutical Products’’ and ‘‘Banking’’ issuers in the pool of accelerated filers. One commenter noted they sought to understand the industry concentration of the affected issuers based on measures such as their public float, drops to 7.8 percent. By contrast, the proportion in other industries does not change by more than a few percentage points. 364 These estimates are based on staff analysis of data including SIC codes from XBRL filings and Ives Group Audit Analytics, using the Fama-French 49-industry classification system. BDCs are manually-classified as members of the ‘‘Financial Trading’’ industry under this system as SIC codes were unavailable from our sources for the vast majority of these issuers. See https:// mba.tuck.dartmouth.edu/pages/faculty/ken.french/ Data_Library/det_49_ind_port.html. See note 336 above for details on the identification of the population of affected issuers. E:\FR\FM\26MRR2.SGM 26MRR2 ER26MR20.004</GPH> BILLING CODE 8011–01–C 17205 17206 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations revenues, and total assets.365 Based on their public float relative to the aggregate public float of the affected issuers, the affected issuers are heavily concentrated in the ‘‘Pharmaceutical Products’’ (33.5 percent), ‘‘Banking’’ (20.0 percent), ‘‘Financial Trading’’ (17.0 percent), and ‘‘Medical Equipment’’ (5.0 percent) industries.366 Because revenues and total assets may be less comparable across industries of different types, we do not present the fraction of the aggregate revenue and assets of the affected issuers represented by each industry. As an alternative that we believe may be more informative, we present, in Table 10, the estimated proportion of all of the accelerated filers in each industry that will be affected by the amendments (i.e., become nonaccelerated), calculated based on several different measures of the size of the affected issuer pool in a given industry.367 We focus this table on nonEGCs, and present affected issuers in the ‘‘Banking’’ industry both including and excluding those that will remain subject to the FDIC auditor attestation requirement, in order to highlight the disproportionate effects by industry in terms of the issuers that will newly be exempt from the ICFR auditor attestation requirement. TABLE 10—PERCENTAGE OF ACCELERATED FILERS IN EACH INDUSTRY THAT WILL BE AFFECTED ISSUERS, EXCLUDING EGCS Percentage of accelerated filers (ex. EGCs) that are affected (ex. EGCs), calculated based on: Industry * Number of issuers (%) Pharmaceutical Products ................................................................................. Banking ............................................................................................................ Banking (ex. issuers subject to FDIC att. requirement) .................................. Medical Equipment .......................................................................................... Financial Trading ............................................................................................. Electronic Equipment ....................................................................................... Other ................................................................................................................ Total assets (%) 77.9 63.5 14.5 59.3 58.5 32.7 16.0 54.4 37.6 5.2 28.9 22.5 7.4 4.0 Revenue (%) 36.8 33.2 10.9 22.4 5.0 4.3 1.8 Public float (%) 78.7 43.1 17.5 60.9 61.6 33.1 11.8 * Excluding EGCs, we estimate that there are 74 affected issuers in the ‘‘Pharmaceutical Products’’ industry, 101 in ‘‘Banking’’ (23 after excluding issuers that would be subject to the FDIC attestation requirement), 62 in ‘‘Financial Trading,’’ 16 in ‘‘Medical Equipment,’’ and 16 in ‘‘Electronic Equipment.’’ The table excludes two affected issuers for which an industry classification was unavailable. Amongst the industries in which the affected issuers are most greatly concentrated, issuers in the ‘‘Pharmaceutical Products’’ industry are the most disproportionately affected based on the number, total assets, revenues, and public float of the affected issuers (other than EGCs) relative to the representation of this industry among accelerated filers (other than EGCs). While a substantial fraction of accelerated filers other than EGCs in the ‘‘Banking’’ industry are also affected issuers, consistent with one commenter’s finding that ‘‘Banking’’ is the industry most affected by the amendments,368 the proportion of this industry that is affected is significantly reduced once we exclude banks that would be subject to the FDIC auditor attestation requirement and are therefore expected to experience limited 365 See letter from CFA Inst. estimates are based on staff analysis of data including SIC codes from XBRL filings and Ives Group Audit Analytics, using the Fama-French 49-industry classification system. See note 364 above for more details. We corrected the public float data based on hand-collection from Form 10– K filings for five affected issuers whose public float reported in XBRL format was 1,000 times the public float reported on the cover page of the corresponding Form 10–K filing, resulting in values of over $50 billion in public float reported in XBRL. For the 295 affected issuers that would be newly exempt from all ICFR auditor attestation lotter on DSKBCFDHB2PROD with RULES2 366 These VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 benefits and costs as a result of the amendments. 2. Potential Benefits of Expanding the Exemption From the ICFR Auditor Attestation Requirement for Affected Issuers The ICFR auditor attestation requirement has been associated with increased audit fees and other compliance costs. Exempting the affected issuers from this requirement therefore is likely to have the benefit of reducing compliance costs for these issuers. Given the disproportionate burden that the fixed component of compliance costs imposes on smaller issuers, as well as the likelihood that many of the affected issuers face financing constraints, these costs savings may enhance capital formation and competition. The discussion below explores the anticipated cost savings and their potential implications in requirements (i.e., those that are not EGCs and are not banks subject to the FDIC auditor attestation requirement), the proportions are ‘‘Pharmaceutical Products’’ (27.9 percent), ‘‘Financial Trading’’ (22.5 percent), ‘‘Real Estate’’ (7.6 percent), ‘‘Medical Equipment’’ (7.5 percent), and ‘‘Banking’’ (5.4 percent). 367 The estimates in Table 10 are based on staff analysis of data including data on total assets from Compustat and SIC codes from XBRL filings and Ives Group Audit Analytics, using the Fama-French 49-industry classification system. See note 364 above for more details. Both the numerators (related to the affected issuers) and denominators (related to PO 00000 Frm 00030 Fmt 4701 Sfmt 4700 detail. This discussion is focused on affected issuers that are not expected to be subject to the FDIC auditor attestation requirement. We begin by summarizing evidence on the indirect costs and net costs of the ICFR auditor attestation requirement. We then estimate the anticipated effects on audit fees and on other compliance costs of expanding the exemption from this requirement for the affected issuers, using reported audit fees, survey data, and existing studies. Finally, we discuss the implications of the cost savings and other potential benefits. a. Evidence on Possible Indirect Costs of the ICFR Auditor Attestation Requirement The ICFR auditor attestation requirement may impose costs on issuers and investors beyond the direct costs of compliance. For example, an increased focus on ICFR as a result of accelerated filers) exclude EGCs. We corrected the public float data based on hand-collection from Form 10–K filings for five affected issuers and six unaffected issuers whose public float reported in XBRL format was about 1,000 times (in one case, about 1,000,000 times) the public float reported on the cover page of the corresponding Form 10–K filing, resulting in values of over $50 billion in public float reported in XBRL. See note 336 above for details on the source of revenue and public float data and on the identification of the affected issuers. See note 298 above for details on the identification of filer type. 368 See letter from CFA Inst. E:\FR\FM\26MRR2.SGM 26MRR2 lotter on DSKBCFDHB2PROD with RULES2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations 404(b) ICFR auditor attestation requirement.374 We are unable to quantify the potential indirect cost savings resulting from the amendments due to the lack of reliable evidence and data that would allow us to quantitatively identify such effects. 17207 the ICFR auditor attestation requirement could have negative effects on issuer performance, if it creates a distraction from operational matters or reduces investment or risk-taking.369 One issuer noted in its comments that its managers’ attention was diverted away from its operating performance in its first year complying with the ICFR auditor attestation requirement, and that, without this requirement, its managers’ time could have been more productively spent focusing on opportunities to grow the company.370 Broader evidence of the indirect costs of the ICFR auditor attestation requirement is inconclusive. Studies have documented a decrease in investment and risk-taking by U.S. companies compared to companies in other countries around the passage of SOX.371 However, others have demonstrated that these findings are merely the continuation of a trend that began many years before the passage of SOX 372 and that they do not appear to be driven by the applicability of the ICFR auditor attestation or SOX Section 404(a) management ICFR reporting requirements.373 Another study associates the SOX Section 404 requirements with a decrease in patents and patent citations, but the findings are limited to the early years of implementation of these requirements and the study is not able to distinguish to what extent the effects are attributable to the SOX Section 404(a) management ICFR reporting requirements versus the SOX Section i. Studies Involving Avoidance Behavior Some studies have provided evidence that non-accelerated filers may seek to avoid crossing the $75 million public float threshold and becoming accelerated filers.376 Related studies have also found that issuers near or below this threshold are more likely than comparable issuers to take actions that may reduce or avoid an increase in their public float, such as disclosing more negative news in the second fiscal quarter (when public float is measured), increasing payouts to shareholders, reducing investment in property, plant, equipment, intangibles and acquisitions, and increasing the number of shares held by insiders.377 One study uses this avoidance behavior to estimate the net costs of compliance with the ICFR auditor attestation requirement for issuers close to the $75 million public float threshold.378 The study concludes that the overall costs, net of any benefits, of the ICFR auditor attestation requirement for these issuers is roughly $1 million to $2 million per year, but we note that the methodology used to translate the avoidance behavior into a dollar cost may be unreliable.379 Avoidance of the $75 million public float threshold would be consistent with smaller issuers finding the net costs associated with the ICFR auditor attestation requirement to be significant, though there could be other reasons for avoiding the threshold. For example, as one commenter argued, such avoidance may reflect managers who would like to avoid the scrutiny of an audit of ICFR because they are engaging in opportunistic behavior,380 although we are unaware of direct evidence supporting this hypothesis. One commenter, representing 48 accounting and law professors, requested that we confirm whether the ‘‘bunching’’ of companies below the $75 million public float threshold remains present in today’s markets.381 The commenter noted that such an analysis could help provide confidence that the costs of the ICFR auditor attestation requirement remain as high as previously documented.382 In response to this comment, our staff conducted supplemental analysis, presented in Figure 6.383 However, as discussed below, the conclusions in this Economic Analysis do not rely on this analysis. 369 See John Coates & Suraj Srinivasan, SOX after Ten Years: A Multidisciplinary Review, 28(3) Acct. Horizons 627 at 643–645 (2014) (‘‘Coates and Srinivasan 2014 Study’’) (discussing these possible effects and summarizing related studies). 370 See letter from Guaranty. 371 See Coates and Srinivasan 2014 Study, note 369 above (summarizing these studies). 372 Id. 373 See Ana Albuquerque & Julie Zhu (2018), Has Section 404 of the Sarbanes-Oxley Act Discouraged Corporate Risk-Taking? New Evidence from a Natural Experiment, Mgmt. Sci. (forthcoming) (using the staggered implementation of SOX Section 404 to better identify its effects on smaller issuers, with public float of less than $150 million, and finding no evidence of a decrease in the investment and risk-taking activities for issuers that were subject to SOX Section 404 versus those that were not), available at https://papers.ssrn.com/sol3/ papers.cfm?abstract_id=3049232. 374 See Huasheng Gao & Jin Zhang, SOX Section 404 and Corporate Innovation,’’ J. of Fin. and Quantitative Analysis (2018) (forthcoming), available at https://papers.ssrn.com/sol3/ papers.cfm?abstract_id=3130588. 375 While we quantify both anticipated costs and benefits of the amendments, there are many costs and benefits that we cannot quantify, so we are unable to quantify the net benefit or net cost of the amendments. See Section IV.C.3.d. for further discussion of this point. 376 See, e.g., Peter Iliev, The Effect of SOX Section 404: Costs, Earnings Quality, and Stock Prices, 45 J. of Fin. 1163 (2010) (‘‘Iliev 2010 Study’’) (finding that a disproportionate number of issuers had a public float of just under $75 million in 2004, when ICFR auditor attestations and management ICFR reports were first required for accelerated filers, but not in earlier years); Dhammika Dharmapala, Estimating the Compliance Costs of Securities Regulation: A Bunching Analysis of Sarbanes-Oxley Section 404(b), Working Paper (2016), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_ id=2885849 (‘‘Dharmapala 2016 study’’); and McCallen et al. 2019 study, note 308 above. 377 See F. Gao, J.S. Wu & J. Zimmerman, Unintended Consequences of Granting Small Firms Exemptions from Securities Regulation: Evidence from the Sarbanes-Oxley Act, 47(2) J. of Acct. Res. 459 (2009) and M. E. Nondorf, Z. Singer, & H. You, A Study of Firms Surrounding the Threshold of Sarbanes-Oxley Section 404 Compliance, 28(1) Advances in Acct. 96 (2012). See also F. Gao, To Comply or Not to Comply: Understanding the Discretion in Reporting Public Float and SEC Regulations, 33(3) Contemporary Acct. Res. 1075 (2016) (presenting evidence that companies that expected higher compliance costs may have used discretion in defining affiliates in order to report lower float). 378 See Dharmapala 2016 study, note 376 above. 379 Id. This paper estimates a net cost of compliance for companies near the threshold of $4 million to $6 million for a few years of compliance (i.e., $1 million to $2 million per year). The analysis leading to this estimate relies on the relation between public float and market capitalization for other companies to approximate the stock market value forgone by those that are estimated to be manipulating their public float downwards. However, we note that the ratio of market capitalization to public float for other companies may simply reflect their propensity towards having affiliated ownership rather than being a reliable basis with which to measure the cost incurred by manipulating public float. 380 See letter from Prof. Barth et al. 381 See letter from Prof. Honigsberg et al. 382 Id. 383 The estimates in this figure are based on staff analysis of data from XBRL filings associated with annual reports filed in calendar year 2018. The figure includes all issuers with an annual report on Form 10–K, 20–F or 40–F in calendar year 2018 and with public float data available in XBRL, excluding banks, ABS issuers, and RICs (although we note there were no instances of the latter two types of issuers in this sample before these filters were applied). Banks are identified as issuers with SIC codes of 6020 (commercial banks), 6021 (national commercial banks), 6022 (state commercial banks), 6029 (NEC commercial banks), 6035 (savings institutions, federally-chartered) or 6036 (savings institutions, not federally-chartered). VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 b. Evidence on Net Costs of the ICFR Auditor Attestation Requirement While we are unable to quantify the extent to which the expected cost savings exceed any loss of benefits associated with the ICFR auditor attestation requirement,375 we note that certain studies have attempted to estimate such ‘‘net costs’’ of the requirement in specific contexts. PO 00000 Frm 00031 Fmt 4701 Sfmt 4700 E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations Figure 6 presents the distribution of public float across issuers other than banks, ABS issuers, and RICs. We exclude ABS issuers and RICs because they are unlikely to be sensitive to the public float threshold as they would not be subject to the ICFR auditor attestation requirement (or able to avail themselves of the disclosure accommodations for SRCs) regardless of their public float. We exclude banks because they may be subject to the FDIC auditor attestation requirement, which, as discussed above, is comparable to the ICFR auditor attestation requirement, regardless of their public float. While EGCs would not be subject to the ICFR auditor attestation requirement regardless of their public float, we nevertheless include them in Figure 6 because it is a temporary exemption and such issuers may already consider the implications of their public float in advance of graduating from this status. However, we obtain similar results when we include or exclude any of these categories of issuers. The pattern in Figure 6 demonstrates that there may be some ‘‘bunching’’ of VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 public floats below the $75 million threshold in 2018. The pattern is similar to that presented in two recent studies that find a discontinuity in public float at the $75 million threshold when considering data across the 12 or 13 year period ending in 2015.384 Our findings for 2018 also are consistent with a yearby-year analysis in one of these studies that suggests that this behavior does not appear to change significantly over the time period studied.385 Our findings are less consistent with another analysis of public float, which failed to find evidence of ‘‘bunching’’ in 2017.386 This analysis was cited in a submission to the comment file.387 When we examine the data underlying 384 See McCallen et al. 2019 study, note 308 above, and Dharmapala 2016 study, note 376 above. 385 See McCallen et al. 2019 study, note 308 above. 386 See Commissioner Jackson’s Statement. While we provide results for 2018 in Figure 6 in order to present the most recent and reliable available data, we obtain very similar results when running the same analysis for 2017. 387 See letter from Prof. Barth et al., citing an analysis in Commissioner Jackson’s Statement that finds no evidence of bunching in 2017. PO 00000 Frm 00032 Fmt 4701 Sfmt 4700 this analysis,388 we find that, although we obtain public float data from different sources,389 our public float values are over 90 percent correlated with those used in tthis analysis. We note, however, that the analysis applies sample selection filters that exclude, among other issuers, issuers that would become newly subject to an ICFR auditor attestation requirement (and, during this time period, lose the disclosure accommodations for SRCs) upon crossing the $75 million public float threshold. The exclusions result in a sample size that is approximately half as large as that in our analysis.390 For 388 See ‘‘Public Float Data (2017)’’ available at https://www.sec.gov/news/public-statement/ jackson-statement-proposed-amendmentsaccelerated-filer-definition. 389 The data underlying the analysis cited by a commenter is generated by using a computer program to extract text from annual reports, applying computer algorithms and filters to isolate public float numbers, and then manually checking the results. See Commissioner Jackson’s Statement. The data underlying our analysis is based on XBRL filings. 390 The figure in the other analysis reflects 388 issuers, compared to 731, or almost twice as many issuers, in our analysis. E:\FR\FM\26MRR2.SGM 26MRR2 ER26MR20.005</GPH> lotter on DSKBCFDHB2PROD with RULES2 17208 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations example, we understand that the other analysis excludes all financial institutions and issuers with a market capitalization of greater than $150 million.391 This difference, we find, accounts for the bulk of the difference in our figures. Thus, our analysis reflects a significantly larger and more representative sample of issuers and may therefore be more reliable. As discussed above, if issuers seek to avoid crossing the $75 million public float threshold, such behavior could reflect a high net cost of the ICFR auditor attestation requirement but could also reflect a self-serving desire to avoid scrutiny. Any such behavior could also be influenced by other requirements associated with this public float threshold during this time period, such as the loss of scaled disclosure accommodations available to SRCs.392 Thus, though we have considered the studies, evidence, and comments received regarding this avoidance behavior, the conclusions in this Economic Analysis do not rely on these findings. lotter on DSKBCFDHB2PROD with RULES2 ii. Studies Based on Comparative Analysis or Market Reactions We have also considered studies that have used other methodologies to attempt to quantify the net costs or benefits of the ICFR auditor attestation requirement. One study attempts to quantify and compare certain costs and benefits of exempting non-accelerated filers from the ICFR auditor attestation requirement, focusing on those costs and benefits that the study deems to be measurable, and finds that the cost savings associated with exempting these issuers (an estimated $388 million in aggregate audit fee savings) have been less than the lost benefits (e.g., an aggregate $719 million in lower earnings) in aggregate present value terms.393 Studies have also used stock 391 Financial institutions are issuers with SIC codes between 6000 and 6999 and include issuers that are not banks. Other filters applied in that analysis include requiring that market capitalization data be available and that the reported public float be at least 10%, but no more than three times, the market capitalization. 392 The analysis presented in Figure 6 is based on annual reports filed in calendar year 2018, which generally pertain to 2017 fiscal years. The amendments to the SRC definition were effective on September 10, 2018. See SRC Adopting Release, note 12 above. 393 We note that the estimates in this study rely on a number of critical assumptions and estimations. See Weili Ge, Allison Koester, & Sarah McVay, Benefits and Costs of Sarbanes-Oxley Section 404(b) Exemption: Evidence from Small Firms’ Internal Control Disclosures, 63 J. of Acct. and Econ. 358 (2017) (‘‘Ge et al. 2017 Study’’) (estimating the effect on audit fees by comparing the audit fees of non-accelerated filers to those of accelerated filers with market capitalization of $300 VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 market reactions to changes in the applicability of the ICFR auditor attestation requirement to estimate its net costs or benefits, because the stock market valuation should incorporate both expected costs and expected benefits from a shareholder’s perspective. We focus on studies that consider events that allow the effects of the ICFR auditor attestation requirement to be isolated from those of the other requirements that were imposed by SOX, as many early studies did not isolate the effects of the ICFR auditor attestation requirement from other changes required by the same legislation, such as the audit committee requirements of SOX Section 301 394 and the certifications required pursuant to SOX Section 302. Regardless, the results of the studies we focus on have been mixed, perhaps due in part to changes over time in how the ICFR auditor attestation requirement has been implemented. For example, a study analyzing the response to announcements of initial delays in the application of the requirements to some issuers in order to identify the stock market reaction associated with the ICFR auditor attestation requirement found that this requirement was associated with a net reduction in stock market valuation for foreign issuers.395 On the other hand, a study of the response to the later permanent exemption from the ICFR auditor attestation requirement for some issuers found that this requirement was associated with a net increase in stock market valuation for smaller issuers.396 million or less; and estimating the effect on earnings by estimating the percentage of nonaccelerated filers that may newly disclose ineffective ICFR upon entering an ICFR auditor attestation requirement, based on changes in the rate of disclosure of ineffective ICFR by issuers that transition into accelerated filer status, and applying to this estimate a further estimate of the difference in return on assets that could be associated with such disclosure and any related remediation, based on the results of a multivariate regression relating issuers’ change in return on assets to a number of factors, including whether or not they disclosed and remediated ineffective ICFR). This study also estimates a delay over three years in the timing of a market value decline (that would otherwise have occurred at the beginning of this three year period) of $935 million associated with the exemption from the ICFR auditor attestation requirement. 394 15 U.S.C. 78j–1. 395 See Iliev 2010 Study, note 376 above. This study also finds a net reduction in value for small domestic issuers from the SOX Section 404 requirements, but is not able, for these issuers, to isolate the effect attributable to the ICFR auditor attestation requirement versus the SOX Section 404(a) management ICFR reporting requirement. 396 See Kareen Brown, Fayez Elayan, Jingyu Li, Emad Mohammad, Parunchana Pacharn, & Zhefeng Frank Liu, To Exempt or not to Exempt NonAccelerated Filers from Compliance with the Auditor Attestation Requirement of Section 404(b) of the Sarbanes-Oxley Act, 28(2) Res. in Acct. Reg. PO 00000 Frm 00033 Fmt 4701 Sfmt 4700 17209 The latter finding is consistent with studies that conclude that the requirement is value-enhancing based on a negative stock market reaction to issuers excluding acquired operations from management’s assessment of ICFR and the ICFR auditor attestation, though these studies do not determine the extent to which this effect is attributable to the ICFR auditor attestation.397 Similarly, a study of smaller issuers that switched regimes over time found that being subject to the ICFR auditor attestation requirement was associated with an increase in stock market valuation for these issuers.398 iii. Other Evidence on Net Costs The rate of exempt issuers voluntarily obtaining an ICFR auditor attestation has generally been low.399 Consistent with this finding, a commenter indicated that small biotechnology companies are rarely asked by investors to voluntarily obtain an ICFR auditor attestation.400 This may indicate that exempt issuers, when considering their own net cost or benefit of compliance, including how investors would react to their decisions, have typically deemed it to be more beneficial to expend these resources on other uses. However, as discussed in Section IV.C.3.d. below, it is probably not the case that issuers would voluntarily obtain an ICFR auditor attestation in every case in which, from the market or an investor’s perspective, the total benefits of doing so would exceed the total costs. When considering the net tradeoff between costs and benefits for accelerated filers with low revenues in particular, we also re-examined data 86 (2016) (‘‘Brown et al. 2016 Study’’). See also Christina Leuz & Peter Wysocki, The Economics of Disclosure and Financial Reporting Regulation: Evidence and Suggestions for Future Research, 54(2) J. of Acct. Res. 525 at 566–569 (2016) (‘‘Leuz and Wysocki 2016 Study’’) (summarizing mixed evidence from earlier event studies related to SOX that were unable to differentiate the effects of the ICFR auditor attestation requirement from other requirements imposed by SOX). 397 See, e.g., Robert Carnes, Dane Christensen, & Phillip Lamoreaux, Investor Demand for Internal Control Audits of Large U.S. Companies: Evidence from a Regulatory Exemption for M&A Transactions, 94(1) The Acct. Rev. 71 (2019) (‘‘Carnes et al. 2019 Study’’). 398 See Hongmei Jia, Hong Xie, & David Ziebart, An Analysis of the Costs and Benefits of Auditor Attestation of Internal Control over Financial Reporting, Working Paper (2014) (‘‘Jia et al. 2014 study’’), available at https://www.lsu.edu/business/ accounting/files/researchseries/20141027JXZ.PDF. 399 See note 297 above. 400 See letter from BIO. See also letter from Ardelyx Presentation, referencing similar statements in the BIO Study, note 69 above, (which states that ‘‘the low rate of voluntary compliance by [biotechnology EGCs] suggests that investors do not demand or value costly Section 404(b) auditor attestations’’). E:\FR\FM\26MRR2.SGM 26MRR2 17210 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations from the SEC-sponsored survey of financial executives conducted during December 2008 and January 2009 (‘‘2008–09 Survey’’).401 While the results of this survey might not be directly applicable a decade later, particularly given the changes over time discussed in Section IV.B.1. above, they provide some suggestive evidence that low-revenue issuers are more likely than other accelerated filers to believe that the costs of complying with SOX Section 404 substantially outweigh the benefits. In particular, when asked about the net costs or benefits of complying with SOX Section 404, 30 percent of respondents at an accelerated filer with revenues below $100 million indicated that the costs far outweighed the benefits, in contrast to 14 percent of respondents at an accelerated filer with greater revenues.402 However, as noted by a commenter, these survey findings represent the views of issuers and may not be reflective of the views of investors.403 lotter on DSKBCFDHB2PROD with RULES2 c. Potential Reduction in Audit Fees While issuers disclose their total audit fees, they are not required to disclose the portion of these fees that is attributable to the ICFR auditor attestation requirement. Studies of the initial implementation of the ICFR auditor attestation requirement found that it was associated with a roughly 100 percent increase in audit fees for small accelerated filers.404 However, 401 See 2009 SEC Staff Study, note 304 above, and Cindy Alexander, Scott Bauguess, Gennaro Bernile, Alex Lee, & Jennifer Marietta-Westberg, The Economic Effects of SOX Section 404 Compliance: A Corporate Insider Perspective, 56 J. of Acct and Econ. 267 (2013) (‘‘Alexander et al. 2013 Study’’). 402 These estimates are based on staff analysis of data from the 2008–09 Survey. The analysis considers responses pertaining to the most recent year for which a given respondent provided a response. We note that the rate of responses to the question about net benefits was lower than for other questions. See the 2009 SEC Staff Study, note 304 above, and Alexander et al. 2013 Study, note 401 above, for details on the survey and analysis methodology. 403 See letter from Crowe. 404 See, e.g., William Kinney & Marcy Shepardson, Do Control Effectiveness Disclosures Require SOX 404(b) Internal Control Audits? A Natural Experiment with Small U.S. Public Companies, 49(2) J. of Acct. Res. 413 (2011) (‘‘Kinney and Shepardson 2011 Study’’) (considering those accelerated filers that have newly crossed the $75 million public float threshold in a given year); Iliev 2010 Study, note 376 above (considering those accelerated filers with between $75 million and $100 million in public float); Michael Ettredge, Matthew Sherwood, & Lili Sun, Effects of SOX 404(b) Implementation on Audit Fees by SEC Filer Size Category, 37 (1) J. of Acct. and Pub. Pol’y 21 (2017) (considering accelerated filers as a category, as opposed to large accelerated filers, but also finding a contemporaneous 42.7 percent increase in audit fees for non-accelerated filers even though were not subject to the ICFR auditor attestation requirement); VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 these early estimates likely include some initial start-up costs, which were found to diminish over time.405 Further, these estimates do not incorporate the effect of later developments such as the adoption of AS 2201, which was expected to reduce compliance costs for smaller issuers, and the adoption of the new risk assessment auditing standards, which may reduce the incremental cost of an integrated audit over a financialstatement only audit. In the Proposing Release, we presented an analysis of audit fees from 2014–2017 for low-revenue issuers that are subject to the ICFR auditor attestation requirement compared to low-revenue issuers not subject to this requirement.406 In particular, we compared audit fees in these recent years for accelerated filers that are subject to the ICFR auditor attestation requirement and have revenues of less than $100 million, relative to the audit fees of issuers in our comparison populations (non-accelerated filers, other than EGCs, and EGCs, neither of which is required to comply with the ICFR auditor attestation requirement) 407 that also have revenues of less than $100 million. Based on this analysis, and with consideration for the difference in size of the affected issuers versus the comparison sample, we derived a percentage estimate of 25 percent of total audit fees, and a dollar estimate of about $110,000 per year, that would be saved by issuers newly exempt from the ICFR auditor attestation requirement.408 As discussed in more detail in the Proposing Release, the percentage estimate is generally consistent with the estimates, ranging from approximately five to 35 percent of total audit fees, from a variety of other analyses using data from after the 2007 change in the ICFR auditing standard. Several commenters indicated that the expected cost savings are difficult to accurately quantify.409 We acknowledge and Susan Elridge & Burch Kealey, SOX Costs: Auditor Attestation under Section 404, Working Paper (2005), available at https://papers.ssrn.com/ sol3/papers.cfm?abstract_id=743285 (considering accelerated filers in the lowest quintile of total assets). 405 See, e.g., Alexander et al. 2013 Study, note 401 above. 406 See Section III.C.3.b. of the Proposing Release, note 4 above. 407 The Proposing Release, note 4 above, provides more information on why we rely on these comparison populations, how they compare to the affected issuers, and how differences between the comparison populations and the affected issuers could affect our inference. See Section III.C.2. of the Proposing Release, note 4 above. 408 See Section III.C.3.b. of the Proposing Release, note 4 above. 409 See, e.g., letters from EY, Grant Thornton, and RSM. PO 00000 Frm 00034 Fmt 4701 Sfmt 4700 that, as discussed in more detail in the Proposing Release, our estimate is subject to significant uncertainty.410 However, these commenters did not provide alternative methodologies or data for obtaining an estimate of the average savings. One recent study focusing on low public float issuers separately considered the subset of issuers with less than $100 million in revenues in their sample and estimated that an exemption from the ICFR auditor attestation requirement would result in an audit fee savings of $135,000 per year for these issuers.411 While this analysis was focused on lower float issuers, it is generally supportive of the order of magnitude of our estimate. One commenter questioned whether our estimate considers the incremental costs associated with an audit approach that does not have the benefit of a related audit of ICFR.412 We note that our analysis is intended to capture this effect, as the issuers in the comparison samples which we use to derive our estimate generally require this type of an audit approach because they are not subject to the ICFR auditor attestation requirement. We therefore maintain, without change, our estimate of $110,000 in average audit fee savings per year per affected issuer that would be newly exempt from the ICFR auditor attestation requirement. As noted in the Proposing Release, the audit fee savings are expected to vary across the affected issuers, with some experiencing smaller savings and some experiencing much larger savings depending on their individual circumstances. In line with this expectation, several commenters insisted that any reductions in audit fees resulting from the amendments would depend on facts and circumstances and vary widely among issuers.413 Consistent with these costs savings being highly varied, a number of commenters to the Proposing Release provided estimates of costs that specific issuers had incurred or expected to save ranging from $40,000 per year to costs of over $2 million dollars, though most of these estimates include costs other than audit fees (which are discussed below), some include one-time start-up costs as well as ongoing annual costs, and the largest estimate includes costs attributable to SOX Section 404(a) and 410 See Section III.C.3.b. of the Proposing Release, note 4 above. 411 See McCallen et al. 2019 study, note 308 above. 412 See letter from BDO. 413 See, e.g., letters from EY, Grant Thornton, and PWC. E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 other SOX requirements.414 Similarly, a few of the commenters to the SRC Proposing Release cited costs of $400,000 to over $1 million associated with the ICFR auditor attestation requirement (though it is possible that these estimates also include costs other than audit fees).415 One commenter noted that the requirement to implement scaled, riskbased audits of ICFR should already result in an appropriately reduced cost of the ICFR auditor attestation requirement for many affected issuers.416 We note that our quantitative methodology is intended to reflect the current cost of the ICFR auditor attestation requirement, including the benefits of scaling. Also, while the adoption of AS 2201 in 2007, which facilitated the scaling of audits of ICFR, was found to have initially led to lower audit fees, there is evidence that these costs began to increase again around the year 2010.417 Finally, we note that some issuers may voluntarily choose to continue to make these expenditures if they deem the benefits of the ICFR auditor attestation to exceed the cost, and that the extent of savings may be affected if auditors continue to test the operating effectiveness of some controls as part of their financial statement audit. In such cases, the audit fee savings may be reduced, but we would expect the potential costs of expanding the exemption from the ICFR auditor attestation requirement to be correspondingly lower as well. 414 See letters from Cerecor (estimating a total of $1 million in expected savings for 2020 associated with an exemption from the ICFR auditor attestation requirement), Concert (estimating expected audit fees associated with the ICFR auditor attestation requirement to represent approximately 45 percent of its total audit fees), Guaranty (estimating future annual costs of $40,000 in personnel and external audit costs associated with ongoing compliance with the ICFR auditor attestation requirement, as well as a higher estimate of costs expended for their first year of compliance in 2018 of $167,745 in audit fees as well as $72,000 and 2,340 labor hours expended across the issuer’s accounting, information technology and risk management offices), Pieris (estimating that their first year of compliance with the ICFR auditor attestation requirement would be associated with a total of $1.5 million in costs), Syros (estimating that its expected additional costs for compliance with the ICFR auditor attestation requirement would range from $250,000 to $400,000 per year, including incremental external auditor fees, consultant fees, and an increased burden on employee resources), and Terra Tech (estimating over $2 million in costs expended in 2018 for meeting all of its SOX compliance requirements, including but not limited to the ICFR auditor attestation requirement, representing costs to build a new information technology infrastructure, to hire new staff and consultants, and to pay auditing fees). 415 See note 208 of the Proposing Release, note 4 above. 416 See letter from CFA. 417 See Section IV.B.1. above. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 d. Additional Potential Compliance Cost Savings The ICFR auditor attestation requirement is associated with other compliance costs beyond audit fees, including outside vendor costs and internal labor costs.418 However, these costs are difficult to measure because they are not required to be reported. Practitioner studies based on surveys of issuers often report non-audit costs of the internal control assessment and reporting requirements of SOX Section 404 in particular or of SOX in general, but the costs attributable to the ICFR auditor attestation requirement versus the SOX Section 404(a) management ICFR reporting requirements or other requirements are generally not broken out separately.419 The Proposing Release presented an analysis of data from the 2008–09 Survey on the non-audit costs of SOX Section 404 in general, such as outside vendor costs, labor, and non-labor costs (such as software, hardware and travel costs), as well as the percentage of the outside vendor costs and labor hours that were attributable to the ICFR auditor attestation requirement. Based on this analysis, we estimated that the average non-audit costs attributable to the ICFR auditor attestation requirement at the time of the survey were approximately $125,000 per year.420 Adjusting this historical cost downward slightly to account for the fact that some of these expenditures may now be required even in the case of a financial statement only audit (due to the risk assessment auditing standards issued subsequent to this survey), we estimated that the average non-audit costs attributable to the ICFR auditor attestation requirement are currently approximately $100,000 per year.421 As noted in the Proposing Release, this estimate is subject to uncertainty because it is unclear exactly how the current costs may differ from the survey responses a decade ago, and the costs may be different for low-revenue issuers. 418 See, e.g., Leuz and Wysocki 2016 Study, note 396 above. 419 See, e.g., Protiviti 2018 Report, note 317 above (finding, for example, total internal costs associated with all aspects of SOX compliance to be $282,900 for 2018 for respondents with less than $100 million in revenues) and SOX & Internal Controls Professionals Group, Moss Adams LLP, and Workiva (2017), ‘‘2017 State of the SOX/Internal Controls Market Survey’’ (‘‘2017 SICPG Survey Report’’), available at www.mossadams.com/ landingpages/2017-sox-and-internal-controlsmarket-survey. 420 See Section III.C.3.c. of the Proposing Release, note 4 above. 421 Id. PO 00000 Frm 00035 Fmt 4701 Sfmt 4700 17211 Commenters did not provide alternative methodologies for obtaining an estimate of the average non audit-fee savings. One recent study focusing on low public float issuers considered the potential effect of the ICFR auditor attestation requirement on selling, general and administrative (‘‘SG&A’’) expenses other than audit fees, and concluded that there was an association with an increase in these internal costs, but was unable to reliably estimate the magnitude of this effect.422 We therefore maintain, without change, our estimate of $100,000 in average non-audit compliance cost savings per year per affected issuer that would be newly exempt from the ICFR auditor attestation requirement. As in the case of audit fees, some of the affected issuers are expected to experience lower cost savings while others would experience greater savings, depending on their individual circumstances. For example, we noted in the Proposing Release that some issuers had reported potential cost savings other than audit fees ranging from about $110,000 to about $350,000.423 While commenters to the Proposing Release generally did not separately break out these non-audit costs, they reported total costs including audit fees but also internal labor and consultant costs ranging from $40,000 to over $2 million, though, as noted above, some include one-time start-up costs as well as ongoing annual costs, and the largest estimate includes costs attributable to SOX Section 404(a) and other SOX requirements.424 e. Implications of the Cost Savings While we estimate the average compliance cost associated with the ICFR auditor attestation requirement for the affected issuers, it is more difficult to discern whether incurring the costs of this requirement represents the most effective use of funds for these issuers. As discussed in Section IV.C.3.c. below, issuers for whom the requirement is eliminated may determine that it is worthwhile to use these funds to voluntarily undergo an audit of ICFR.425 Alternatively, some of these issuers could directly invest the compliance cost savings in improving their 422 See McCallen et al. 2019 study, note 308 above. 423 See note 211 of the Proposing Release, note 4 above. 424 See letters from Cerecor, Guaranty, Pieris, Syros, and Terra Tech, as discussed in more detail in above note 414. See also Ardelyx Presentation, citing the BIO Study, note 69 above. 425 See letter from BIO (supporting allowing ‘‘issuers and their investors the flexibility to determine for themselves whether Section 404(b) is relevant to their business’’). E:\FR\FM\26MRR2.SGM 26MRR2 17212 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 operations and prospects for growth, or in their control systems. In total, we estimate an average cost savings of $210,000 per issuer per year, with some of the affected issuers experiencing lesser or greater savings.426 While a few commenters noted that ICFR auditor attestations have become less expensive over time 427 or that they should already be less expensive for the affected issuers due to the ability to scale the audit of ICFR,428 we note that our analysis, using only recent years of data and low-revenue issuers, is intended to capture any such effects. Several commenters argued that these cost savings are economically small.429 In particular, they estimated that the savings represent 0.5 percent of the average affected issuer’s revenue and 0.1 percent of its market value.430 Similarly, many commenters asserted that the proposed amendments would not enhance capital formation—and some indicated they could even reduce capital formation.431 Others noted that, in general, the costs of the ICFR auditor attestation requirement are substantial,432 and that by eliminating the requirement for certain issuers, the proposed amendments would enhance capital formation or allow those issuers to preserve capital.433 We continue to believe that the average expected savings is likely, in many cases, to represent a meaningful cost savings for issuers with less than $100 million in revenue and may thus have beneficial economic effects on competition and capital formation. In particular, while the average annual cost savings may represent a 426 As noted above, this estimate is not intended to apply to affected issuers that would not otherwise be subject to the ICFR auditor attestation requirement (i.e., EGCs) or that would remain subject to the FDIC auditor attestation requirement (i.e., banks with assets of over $1 billion). 427 See, e.g., letters from CFA Inst. and Deloitte. 428 See letter from CFA. 429 See, e.g., letters from CFA, CFA Inst., CII, and Prof. Barth et al. 430 We obtain similar estimates. Specifically, we estimate that the annual savings represents of 0.7 percent of the median revenue and 0.1 percent of the median market capitalization of the affected issuers that would be newly exempt from all ICFR auditor attestation requirements. We note, however, that 12 percent of these issuers have zero revenues, and that the savings are estimated for a single year while market capitalization incorporates expectations regarding all future years of performance. 431 See, e.g., letters from Better Markets, CII, CFA, and Prof. Ge et al. See also CFA Inst. (stating that the Proposing Release, note 4 above, does not demonstrate that eliminating the ICFR auditor attestation requirement would enhance capital formation). 432 See, e.g., letters from BIO, Broadmark, Carver, Guaranty, ICBA, MSB, SSB, and Syros. 433 See, e.g., letters from Andersen, CLSA, Concert, ICBA, and NASBA. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 small percentage of the average affected issuers’ revenues and market capitalizations, it is significant relative to the income and cash flows of these issuers. As noted in the Proposing Release, low-revenue issuers are likely to face financing constraints because they do not have access to internallygenerated capital.434 A majority of the affected issuers that will be newly exempt from the ICFR auditor attestation requirement, and that will not be subject to the FDIC auditor attestation requirement, have negative net income and negative net cash flows from operations.435 In the absence of significant income generation, the average savings of $210,000 per year may be likely to be put to productive use,436 such as towards capital investments, which would enhance capital formation. A number of issuers commented that they anticipated that the savings would allow for increased investment in their core business.437 Also, while some issuers may experience lesser savings, some commented that they expect to experience substantially greater savings,438 so the cost savings are likely to be significant for some, even if not all, of the affected issuers. Further, several commenters cited fixed costs of compliance that do not scale with size.439 Because of the fixed costs component of compliance costs, smaller issuers generally bear proportionately higher compliance costs than larger issuers.440 To illustrate this 434 For example, the Proposing Release, note 4 above, cited one commenter that indicated that ‘‘pre-revenue small businesses utilize only investment dollars to fund their work’’ and that any cost savings thus ‘‘could lead to funding for a new life-saving medicine.’’ See note 213 of the Proposing Release, note 4 above. 435 See note 362 above. 436 For example, in a survey of issuers in the biotech industry, among 11 biotech EGCs that responded to a question regarding how an extension of the exemption from the ICFR auditor attestation requirement would affect them given the costs associated with the requirement, eight out of the 11 issuers indicated that they expected a positive impact on investments in research and development and six out of the 11 issuers indicated that they expected a positive impact on hiring employees. See BIO Study, note 69 above. 437 See, e.g., letters from Cerecor, Concert, Guaranty, Pieris and Syros. 438 See, e.g., letters from Cerecor, Corvus, and Terratech, estimating savings of $1 to $2 million. 439 See letters from ASA, Broadmark, Chamber, and Guaranty. 440 While it is difficult to identify the specific source of the fixed component of compliance costs, there is empirical evidence of such fixed costs based on differences in the ratio of such costs to measures of issuer size across issuer size categories. For example, the ratio of the costs for accelerated filers of complying with Section 404 to the book value of the issuer’s assets decreases with issuer size. See, e.g., Figure 1 of Alexander et al. 2013 Study, note 401 above. There is evidence of some PO 00000 Frm 00036 Fmt 4701 Sfmt 4700 disparity, we estimated in the Proposing Release that total audit fees represent about 22 percent of revenues on average for accelerated filers with less than $100 million in revenues, versus 0.5 percent of revenue for those above $100 million in revenues.441 Reducing the affected issuers’ costs would reduce their overhead expenses and may enhance their ability to compete with larger issuers. The alleviation of these costs could be a positive factor in the decision of additional companies to enter public markets.442 That is, if future compliance costs associated with ICFR auditor attestations weigh against these companies becoming publicly traded, reducing these expected future costs may enhance capital formation in the public markets and the efficient allocation of capital at the market level. As noted above, the expected compliance cost savings are likely to vary across issuers. The amendments may be most likely to influence the decision to enter the public markets for companies that anticipate particularly high costs to obtain an ICFR auditor attestation and that expect low levels of revenue to persist for many years into the future. Some commenters suggested that the amendments would encourage companies to enter the public markets.443 On the other hand, other commenters maintained that the ICFR auditor attestation requirement does not prevent companies from entering the public markets.444 Research investigating the link between SOX and companies exiting or choosing not to enter public markets has been inconclusive.445 We agree with commenters who stated that a number of other factors have been associated such fixed costs persisting even after the 2007 change in the ICFR auditing standard facilitating the scaling of an audit of ICFR, as demonstrated by the results in the cited figure for issuers that had been complying with Section 404(b) for five years (as observations in the figure pertaining to lesser years of experience may include costs experienced by some issuers in years prior to the 2007 changes). 441 See Section III.C.2.d. of the Proposing Release, note 4 above. 442 See, e.g., letter from ICBA. 443 See, e.g., letters from AdvaMed, AdvaMed et al., Broadmark, Cerecor, and ICBA. 444 See, e.g., letters from CFA, CFA Inst., CII, and Crowe. 445 There is some evidence of a decreased rate of IPOs and an increased rate of going private transactions and deregistrations in the United States after SOX. However, it is unclear to what extent these changes can be attributed to SOX (or to the auditor attestation requirement in particular) versus other factors, and to what extent these changes are a cause for concern. See e.g., Coates and Srinivasan 2014 Study, note 369 above, at 636–640 (summarizing a number of studies in this area). E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations with the decline in listings.446 Further, newly public issuers can already avail themselves of an exemption from the ICFR auditor attestation requirement for at least one and generally up to five years after their IPO.447 While the amendments could be a positive factor in the decision of additional companies to enter public markets, it may not be the decisive factor, and the direct impact of the amendments on the number of publicly traded companies may be limited to the extent that companies may be more focused on other factors associated with the decision to go public. lotter on DSKBCFDHB2PROD with RULES2 3. Potential Costs of Expanding the Exemption From the ICFR Auditor Attestation Requirement for Affected Issuers Exempting the affected issuers from the ICFR auditor attestation requirement may result, over time, in management at this category of issuers being less likely to maintain effective ICFR, which in turn may result in less reliable financial statements, on average, for these issuers. The discussion below explores this potential effect and its implications in detail. We also consider two mitigating factors that could be associated with the affected issuers on average, though we acknowledge that they may not apply equally to all of the affected issuers. First, low-revenue issuers may, on average, be less susceptible to the risk of certain kinds of misstatements, such as errors associated with revenue recognition.448 Second, in many cases, the market value of such issuers may be driven to a greater degree by their future prospects than by the current period’s financial statements, which may affect how, on average, investors use these issuers’ financial statements. This discussion is focused on affected issuers that will be newly exempt from the ICFR auditor attestation requirement and will not be subject to the FDIC auditor attestation requirement. Exempting the affected issuers from the ICFR auditor attestation requirement 446 See, e.g., letters from CFA, CFA Inst., CII, and Crowe. Other factors commenters cited include the expansion of exemptions to registration that increase companies’ ability to raise funds privately, see, e.g., letters from CFA, CII, and Crowe; corporate consolidations, see, e.g., letters from CFA and CII; market conditions, see letter from CFA; and the general regulatory environment, see letter from Crowe. 447 See note 11 above regarding the exemption of EGCs from the auditor attestation requirement. 448 See BIO Study, note 69 above (finding that biotechnology EGCs have lower restatement frequencies than other issuers, after controlling for other factors, and attributing this to their ‘‘absence of product revenue’’ based on findings that revenue recognition is one of the most frequent drivers of financial restatements). VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 could also increase the risk that material weaknesses in ICFR may not be detected and disclosed, and thereby reduce the information available to investors for gauging the reliability of these issuers’ financial statements. In this regard, we also discuss below the potential effects related to the identification and disclosure of material weaknesses in ICFR at the affected issuers. However, given the size of the estimated effect as well as recent findings discussed in Section IV.C.3.a. below on how ICFR auditor attestations may provide limited information about the risk of future restatements,449 we believe that any such effect would not significantly affect investors’ overall ability to make informed investment decisions. a. Broad Considerations and Evidence Regarding the Effects of ICFR Auditor Attestations on Financial Reporting This section summarizes a number of broad economic considerations related to the possible effects of an ICFR auditor attestation requirement on financial reporting in order to provide context for the more detailed analysis of the costs of exempting the affected parties from this requirement that follows. As discussed below, the anticipated effects of changes to the population of issuers subject to the ICFR auditor attestation requirement will depend on the characteristics of the specific group of issuers that will be affected. In this regard we note that prior research has not focused on the effects of the ICFR auditor attestation requirement on lowrevenue issuers in particular. As discussed in Section IV.B.1., there also have been significant changes over time in the implementation of the ICFR auditor attestation requirement, the standards applying to a financial statement audit even in the absence of an audit of ICFR, and the execution of audits of financial statements and of ICFR, which may have had the effect of reducing both the incremental costs and incremental benefits of an ICFR auditor attestation since the periods studied in much of the existing research. We therefore acknowledge that, while we believe that consideration of the past research is an important part of our analysis, these factors limit our ability to rely on the findings of past research to predict how the amendments would affect the particular class of issuers implicated by this rulemaking. ICFR auditor attestations can have two primary types of benefits. First, the ICFR auditor attestation reports can provide incremental information to 449 See notes 453 through 459 below and accompanying text. PO 00000 Frm 00037 Fmt 4701 Sfmt 4700 17213 investors about the reliability of the financial statements. Second, the reliability of the financial statements can be enhanced. That is, the expectation of, or process involved in, the ICFR auditor attestation could lead issuers to maintain better controls, which could lead to more reliable financial reporting. Importantly for our evaluation of these possible benefits, however, we do not directly observe the effectiveness of ICFR and the reliability of financial statements, but only the associated disclosures by issuers. For example, while restatements may indicate that controls have failed, such restatements are often predicated on the underlying misstatements being detected. Given such limitations with the available data, the analysis in existing studies and in this release is necessarily less than definitive. Regarding the first possible benefit of ICFR auditor attestations, academic research provides some evidence that ICFR auditor attestation reports contain information about the reliability of financial statements, but also demonstrates that the incremental information provided by these reports may be limited. The 2011 SEC Staff Study summarizes evidence that ICFR auditor attestations generally resulted in the identification and disclosure of material weaknesses that were not previously identified or whose severity was misclassified when identified by management in its assessment of ICFR, and that investor risk assessments and investment decisions were associated with the findings in auditor attestation reports.450 As noted by a commenter,451 various survey results are also supportive of these reports being informative to investors.452 However, more recent studies have found that auditor identification of material weaknesses in ICFR tends to be concurrent with the disclosure of restatements, rather than providing advance warning of the potential for 450 See 2011 SEC Staff Study, note 198 above, at 97–99 and 102–104. See also Coates and Srinivasan 2014 Study, note 369 above. 451 See letter from CII. 452 See Lawrence Brown, Andrew Call, Michael Clement, and Nathan Sharp, The Activities of BuySide Analysts and the Determinants of their Stock Recommendations, 62 J. of Acct. and Econ. 139 (2016) (finding, in a survey of buy-side analysts, that 60 percent responded that material weaknesses in ICFR are definitely a red flag of management potentially misrepresenting financial results, and that the existence of a material weakness in ICFR was the most cited red flag for misrepresentation followed by weak corporate governance; however, this survey did not differentiate between firms subject or not subject to the ICFR auditor attestation requirement). E:\FR\FM\26MRR2.SGM 26MRR2 17214 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 restatements.453 While these findings do not imply that ICFR auditor attestation reports fail to provide any useful information about the risk of future restatements,454 they demonstrate that this information may be limited. Further, researchers have been able to predict the identification by auditors of material weaknesses in ICFR beyond those identified by management, to some extent, by using otherwise available information about issuers beyond current restatements, such as their institutional ownership, aggregate losses, past restatements, and late filings.455 One commenter notes that this predictability does not imply that there is limited incremental information provided by ICFR auditor attestation reports, as their analysis suggests that investors are not able to fully discern misreporting by issuers about their ICFR.456 Still, we believe that the evidence suggests that markets at least partially, though perhaps not fully, incorporate this information even in the absence of an ICFR auditor attestation.457 Limitations to the incremental information provided by ICFR auditor attestation reports about the risk of future restatements may 453 See, e.g., Sarah Rice & David Weber, How Effective is Internal Control Reporting under SOX 404? Determinants of the (Non-)Disclosure of Existing Material Weaknesses, 50(3) J. of Acct. Res. 811 (2012); William Kinney, Roger Martin, & Marcy Shepardson, Reflections on a Decade of SOX 404(b) Audit Production and Alternatives, 27(4) Acct. Horizons 799 (2013); and Daniel Aobdia, Preeti Choudhary, & Gil Sadka, Do Auditors Correctly Identify and Assess Internal Control Deficiencies? Evidence from the PCAOB Data, Working Paper (2018), available at https://papers.ssrn.com/sol3/ papers.cfm?abstract_id=2838896. See also Kinney and Shepardson 2011 Study, note 404 above. 454 See, e.g., 2011 SEC Staff Study, note 198 above, at 86 (citing evidence that while both issuers subject to SOX Section 404(b) as well as those only subject to SOX Section 404(a) often report restatements despite previously reporting that their ICFR was effective, such restatements were 46 percent higher among those filing only SOX Section 404(a) reports). See also PCAOB Investor Advisory Group, Report from the Working Group on the Investor Survey (2015), available at https:// pcaobus.org/News/Events/Documents/09092015_ IAGMeeting/Investor_Survey_Slides.pdf (reporting survey findings that 72 percent of institutional investors indicated that they relied on ICFR auditor attestations either ‘‘extensively’’ or ‘‘a good bit’’). 455 See, e.g., Ge et al. 2017 Study, note 393 above. 456 See letter from Prof. Ge et al. 457 See, e.g., H. Ashbaugh-Skaife, D. Collins, W. Kinney, & R. LaFond, The Effect of SOX Internal Control Deficiencies on Firm Risk and Cost of Equity, 47(1) J. of Acct. Res. 1 (2009) (‘‘AshbaughSkaife et al. 2009 Study’’) (finding that companies that newly disclose material weaknesses in their ICFR have an increase in their cost of capital, but that this increase is lower for companies with the characteristics most associated with having such material weaknesses, i.e., those for which the market may be least surprised by the disclosures, at about 50 basis points, and higher for companies without such characteristics, at about 125 basis points). VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 result from disincentives, such as the increased risk of litigation and greater likelihood of management and auditor turnover that have been associated with earlier material weakness disclosures, for issuers and their auditors to disclose material weaknesses in the absence of restatements.458 It may also result from issues with the quality of the audit of ICFR. In this regard, researchers have found that PCAOB scrutiny of these audits has been associated with a slightly higher rate of identification of material weaknesses in ICFR prior to a later restatement.459 A further reason why ICFR auditor attestation reports may provide only a weak warning about future restatements is that the audit of ICFR may contribute to the avoidance of misstatements, leading us to observe only the residual restatements where the misstatement risk was not foreseen or a misstatement was not detected for reasons unrelated to internal controls. Thus, the second possible benefit we consider is that the audit of ICFR may encourage management to maintain more effective controls and thereby deter accounting errors and fraud. The academic research discussed below documents substantial evidence that would be consistent with such effects, though, as is common in financial economics, it is difficult to determine whether the documented differences can be causally linked to the audit of ICFR.460 In particular, while issuers are subject to a number of requirements discussed above that are intended to help to provide adequate internal controls and 458 See Sarah Rice, David Weber, & Biyu Wu, Does SOX 404 Have Teeth? Consequences of the Failure to Report Existing Internal Control Weaknesses, 90(3) Acct. Rev. 1169 (2015). We note that auditors have a duty to follow auditing standards and, if they do not, face associated enforcement, inspection, reputation, and litigation risks that provide a countervailing incentive. 459 See, e.g., Defond and Lennox 2017 Study, note 307 above (finding that PCAOB inspections may increase auditors’ issuance of adverse internal control opinions to clients with later restatements; in particular, the study documents that in 2010, 96 percent of financial statements that were later restated were accompanied by ICFR auditor attestations disclosing no material weaknesses in ICFR, while this rate dropped to 91 percent by 2013). 460 See Coates and Srinivasan 2014 Study, note 369 above, and Leuz and Wysocki 2016 Study, note 396 above (both articles discussing the limited ability to make causal attribution based on research on the effects of the provisions of SOX, but also highlighting the specific studies that can more plausibly make causal claims). See also Report to Congress: Access to Capital and Market Liquidity, August 2017 SEC Staff study 24–27 (discussing similar limitations, in a different context, in the ability to make causal inferences about the effects of regulation because of data and experimental design issues), available at https://www.sec.gov/ files/access-to-capital-and-market-liquidity-studydera-2017.pdf. PO 00000 Frm 00038 Fmt 4701 Sfmt 4700 reliable financial statements,461 studies have documented a significant association between audits of ICFR and the maintenance of better internal controls. The 2011 SEC Staff Study provides analysis and summarizes research indicating that issuers that were not required to obtain an ICFR auditor attestation disclosed ineffective ICFR at a greater rate than those that were subject to such requirements,462 and newer studies demonstrate that this difference has remained consistent in recent years.463 Further, a recent paper finds that the ICFR auditor attestation requirement, but not management ICFR reporting requirements alone, are associated with enhanced quarterly earnings accrual quality, and argues that this is an indication of the improved quality of internal controls.464 We note, however, that this study finds that the improvements for issuers subject to the ICFR auditor attestation requirement are attenuated after the 2007 change in the ICFR auditing standard discussed in Section IV.B.1. above.465 The ICFR auditor attestation requirement has also been associated with a higher rate of remediation of material weaknesses after they are disclosed.466 As noted by 461 See Section IV.B.1. above. 2011 SEC Staff Study, note 198 above, at 41 and 86–87. The rate of ineffective ICFR is based on the findings of management reports on ICFR pursuant to SOX Section 404(a). Because auditor attestations of ICFR are associated with an increased detection and disclosure of material weaknesses, as discussed above, the rate of ineffective ICFR reported by issuers not subject to the auditor attestation requirement may be understated, which would result in this difference also being understated. 463 See, e.g., Audit Analytics, SOX 404 Disclosures: A Fourteen Year Review (Sept. 2018) (‘‘2018 Audit Analytics Study’’), available at www.auditanalytics.com/blog/sox-404-disclosuresa-fourteen-year-review/. 464 See Schroeder and Shepardson 2016 Study, note 305 above (using quarterly accruals quality, measured by the level of quarterly discretionary working capital accruals and the quarterly accrual estimation error, as a proxy for internal control quality based on the argument that internal control improvements should be exhibited in unaudited financial reports). 465 Id. 466 See Vishal Munsif & Meghna Singhvi, Internal Control Reporting and Audit Fees of NonAccelerated Filers, 15(4) J. of Acct., Ethics & Pub. Pol’y 902 at 915 (2014) (finding that 49 out of 160, or 30 percent, of non-accelerated filers that disclosed a material weakness in 2008 reported no material weaknesses in 2009, in contrast to 64 out of 83, or 77 percent, of accelerated filers in a similar situation). See also Jacqueline Hammersley, Linda Myers, & Jian Zhou, The Failure to Remediate Previously Disclosed Material Weaknesses in Internal Controls, 31(2) Auditing: J. Prac. & Theory 73 (2012); and Karla Johnstone, Chan Li, & Kathleen Rupley, Changes in Corporate Governance Associated with the Revelation of Internal Control Material Weaknesses and their Subsequent Remediation, 28(1) Contemp. Acct. Res. 331 (2011) (both finding a similar rate of remediation for accelerated filers for an earlier sample period). 462 See E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations a commenter,467 survey evidence is also consistent with this requirement being associated with more effective ICFR. For example, this commenter cites a recent survey of public companies that found that 57 percent responded that one of the primary benefits of the ICFR auditor attestation requirement was ‘‘improved internal control over financial reporting (ICFR) structure.’’ 468 To the extent that the ICFR auditor attestation requirement leads to more effective ICFR, this requirement may thereby lead to more reliable financial statements. Some studies have found that a failure to maintain effective ICFR has been associated with a higher rate of future restatements and lower earnings quality,469 a higher rate of future fraud revelations,470 more profitable insider trading,471 and less accurate analyst forecasts.472 Generally, ICFR auditor attestations also have been found to be directly associated with financial statements that are more reliable than in the absence of these attestations.473 We note, however, that two recent studies, using different methodologies, find evidence that conflicts with these other studies. In particular, the evidence in these studies, which use data from 2007 through 467 See letter from CII. See also Benchmarking SOX Costs, Hours and Controls, Protiviti (June 24, 2019), available at https://www.protiviti.com/sites/default/files/ united_states/insights/2019_sarbanes_oxley_ compliance_surveyprotiviti.pdf. 469 See Coates and Srinivasan 2014 Study, note 369 above, at 649–650. 470 See Dain Donelson, Matthew Ege, & John McInnis, Internal Control Weaknesses and Financial Reporting Fraud, 36(3) Auditing: A J. of Prac. and Theory 45 (2017) (‘‘Donelson et al. 2017 Study’’) (finding that issuers with a material weakness in ICFR are 1.24 percentage points more likely to have a fraud revelation within the next three years compared to issuers without a material weakness, relative to a 1.60 percent unconditional probability of fraud). 471 See Hollis Asbhaugh-Skaife, David Veenman, & Daniel Wangerin, Internal Control over Financial Reporting and Managerial Rent Extraction: Evidence from the Profitability of Insider Trading, 55(1) J. of Acct. and Econ. 91 (2013). 472 See, e.g., Sarah Clinton, Arianna Pinello, & Hollis Skaife, The Implications of Ineffective Internal Control and SOX 404 Reporting for Financial Analysts, 33(4) J. of Acct. and Pub. Pol’y 303 (2014). 473 See 2011 SEC Staff Study, note 198 above, at 98–100. For more recent evidence, see, e.g., Yuping Zhao, Jean Bedard, & Rani Hoitash, SOX 404, Auditor Effort, and the Prevention of Financial Report Misstatements, 36(4) Auditing: A J. of Prac. & Theory 151 (2017); and Lucy Chen, Jayanthi Krishnan, Heibatollah Sami, & Haiyan Zhou, Auditor Attestation under SOX Section 404 and Earnings Informativeness, 32(1) Auditing: A J. of Prac. & Theory 61 (2013). lotter on DSKBCFDHB2PROD with RULES2 468 Id. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 2013 474 and 2014,475 respectively, does not support the conclusion that the ICFR auditor attestation requirement is associated with more reliable financial statements, and one of the studies 476 even finds an association with lower reliability, consistent with concerns discussed in Section IV.B.1. above that the quality of audits of ICFR dropped at least temporarily after 2007. To evaluate the economic implications of any effects the ICFR auditor attestation requirement has on ICFR and financial statements, we can consider factors such as production or investment at the issuer or market level. For example, at the issuer level, more reliable disclosures are generally expected, based on economic theory, to lead investors to demand a lower expected return to hold an issuer’s securities (i.e., a lower cost of capital).477 A lower cost of capital may enhance capital formation by encouraging issuers to issue additional securities in order to raise funds for new investments. Empirically, material weaknesses in ICFR,478 restatements,479 474 See Bhaskar et al. 2018 Study, note 305 above (finding that, among companies with less than $150 million in market capitalization, those providing auditor attestations of ICFR, whether voluntarily or because they are accelerated filers, had a higher rate of material misstatements and lower earnings quality than others in this category in the period from 2007 through 2013). 475 See McCallen et al. 2019 Study, note 308 above (finding that, among companies with close to $75 million in public float, those above this threshold, which are likely subject to the ICFR auditor attestation requirement, do not experience lower restatements than those below this threshold in the period from 2007 through 2015). 476 See Bhaskar et al. 2018 Study, note 305 above. 477 See, e.g., Douglas Diamond & Robert Verrecchia, Disclosure, Liquidity, and the Cost of Capital, 46(4) J. of Fin. 1325 (1991) (‘‘Diamond and Verrecchia 1991 Study’’); David Easley & Maureen O’Hara, ‘Information and the Cost of Capital,’ 59(4) J. of Fin. 1553 (2004); Richard Lambert, Christian Leuz, & Robert Verrecchia, Accounting Information, Disclosure, and the Cost of Capital,’’ 45(2) J. of Acct. Res. 385 (2007); and Christopher Armstrong, John Core, Daniel Taylor, & Robert Verrecchia, When Does Information Asymmetry Affect the Cost of Capital? 49(1) J. of Acct. Res. 1 (2011). We note that these articles also detail limited theoretical circumstances under which more reliable disclosures could lead to a higher cost of capital, such as in the case where improved disclosure is sufficient to reduce incentives for market making. 478 See, e.g., Dragon Tang, Feng Tian, & Hong Yan, Internal Control Quality and Credit Default Swap Spreads, 29(3) Acct. Horizons 603 (2015); Lawrence Gordon & Amanda Wilford, An Analysis of Multiple Consecutive Years of Material Weaknesses in Internal Control, 87(6) Acct. Rev. 2027 (2012) (‘‘Gordon and Wilford 2012 Study’’); and Ashbaugh-Skaife et al. 2009 Study, note 457 above. We note that earlier work did not detect an association between SOX Section 404 material weaknesses and the equity cost of capital. See, e.g., M. Ogneva, K. R. Subramanyam, & K. Rachunandan, Internal Control Weakness and Cost of Equity: Evidence from SOX Section 404 Disclosures, 82(5) Acct. Rev. 1255 (2007) (‘‘Ogneva et al. 2007 Study’’). See also 2011 SEC Staff Study, note 198 above, at 101–102. PO 00000 Frm 00039 Fmt 4701 Sfmt 4700 17215 and low earnings quality 480 have all been associated with a higher cost of debt or equity 481 capital. More effective ICFR and more reliable financial reporting may also lead to improved efficiency of production if managers themselves thereby have access to more reliable data that facilitates better operating and investing decisions.482 For example, one study finds that the investment efficiency of issuers improves, in that both underinvestment and over-investment are curtailed, after the disclosure and remediation of material weaknesses.483 Another study finds that issuers that remediate material weaknesses in ICFR that are related to inventory tracking thereafter experience higher inventory turnover, together with improvements in sales and profitability.484 That said, it is difficult to generalize the results 479 See, e.g., Paul Hribar & Nicole Jenkins, The Effect of Accounting Restatements on Earnings Revisions and the Estimated Cost of Capital, 9 Rev. of Acct. Stud. 337 (2004) (‘‘Hribar and Jenkins 2004 Study’’). 480 See, e.g., Jennifer Francis, Ryan LaFond, Per M. Olsson, & Katherine Schipper, Cost of Equity and Earnings Attributes, 79(4) Acct. Rev. 967 (2004) (‘‘Francis et al. 2004 Study’’). 481 We note that empirical studies of the cost of equity capital face particular challenges in accurately measuring the cost of equity capital, which can reduce their reliability, but that this is mitigated in studies that look at changes over time, see, e.g., Gordon and Wilford 2012 Study, note 478 above; Ashbaugh-Skaife et al. 2009 Study, note 457 above; and Hribar and Jenkins 2004 Study, note 479 above, rather than in the cross-section. See, e.g., Ogneva et al. 2007 Study, note 478 above, and Francis et al. 2004 Study, note 480 above. See also, e.g., Stephannie Larocque & Matthew R. Lyle, Implied Cost of Equity Capital Estimates as Predictors of Accounting Returns and Stock Returns, 2(1) J. of Fin. Rep. 69 (2017) (discussing concerns about measures of the cost of equity capital); and Charles M. C. Lee, Eric C. So, & Charles C. Y. Wang, Evaluating Firm-Level Expected-Return Proxies, Harvard Business School Working Paper 15–022 (2017) (finding that ‘‘in the vast majority of research settings, biases in [equity cost of capital measures] are irrelevant’’ and that the cost of equity capital measures used in the accounting literature ‘‘are particularly useful in tracking time-series variations in expected returns’’). 482 See, e.g., Ge et al. 2017 Study at 359, note 393 above (arguing that internal control misreporting leads to lower operating performance due to the non-remediation of ineffective controls, and estimating the degree of such underperformance based on the improvement shown by issuers that are non-accelerated filers after disclosing and remediating material weaknesses, relative to other such issuers that are suspected of having unreported material weaknesses). 483 See Mei Cheng, Dan Dhaliwal, & Yuan Zheng, Does Investment Efficiency Improve After the Disclosure of Material Weaknesses in Internal Control over Financial Reporting?, 56(1) J. of Acct. and Econ. 1 (2013). 484 See Mei Feng, Chan Li, Sarah McVay, & Hollis Skaife, Does Ineffective Internal Control Over Financial Reporting Affect a Firm’s Operations? Evidence From Firms’ Inventory Management,’’ 90(2) Acct. Rev., 529 (2015) (‘‘Feng et al. 2015 Study’’). E:\FR\FM\26MRR2.SGM 26MRR2 17216 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 beyond these samples to determine whether non-remediating issuers or issuers with different types of material weaknesses in ICFR could expect similar operational benefits from remediation. The ICFR auditor attestation requirement may also result in benefits at the market level, though these are more difficult to measure than those at the issuer level.485 The potential for market-level impact is largely driven by network effects (which are associated with the broad adoption of practices) and by other externalities (i.e., spillover effects on issuers or parties beyond the issuer in question). For example, to the extent that the ICFR auditor attestation requirement leads to more reliable financial statements at a large number of issuers, it may lead to a more efficient allocation of capital across different investment opportunities at the market level.486 The ICFR auditor attestation requirement also can enhance capital formation to the extent that it improves overall investor confidence, for which there is some suggestive evidence,487 and thus encourages investment in public markets.488 Many commenters cited the benefits that have been ascribed to the ICFR auditor attestation requirement in general and attested to their importance. For example, some stated that the ICFR auditor attestation requirement promotes more effective ICFR and more accurate ICFR disclosures,489 including a greater likelihood and timeliness of 485 See, e.g., Leuz and Wysocki 2016 Study, note 396 above (stating that researchers ‘‘generally lack evidence on market-wide effects and externalities from regulation, yet such evidence is central to the economic justification of regulation’’ and acknowledging that ‘‘the identification of such market-wide effects and externalities is even more difficult than the identification of direct economic consequences on individual firms’’). 486 There is also some evidence that more reliable financial disclosures also facilitate a more effective market for corporate control, which can increase overall market discipline and thus enhance the efficiency of production by incentivizing more effective management. See Amir Amel-Zadeh & Yuan Zhang, The Economic Consequences of Financial Restatements: Evidence from the Market for Corporate Control, 90(1) Acct. Rev. 1 (2015). See also Vidhi Chhaochharia, Clemens Otto, & Vikrant Vig, The Unintended Effects of the Sarbanes-Oxley Act, 167(1) J. of Institutional and Theoretical Econ. 149 (2011). 487 See, e.g., 2013 GAO Study, note 297246 above (finding that 52 percent of the companies surveyed reported greater confidence in the financial reports of other companies due to the ICFR auditor attestation requirement; in contrast, 30 percent of the respondents reported that they believed this requirement raised investor confidence in their own company). 488 For a further discussion of potential externalities, see Coates and Srinivasan 2014 Study, note 369 above, at 657–659. 489 See, e.g., letters from Better Markets, CFA, CII, Crowe, Grant Thornton, Prof. Barth et al., and PWC. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 disclosing ineffective or weak ICFR,490 and that effective ICFR leads to better and more reliable financial statements,491 audit quality,492 and analyst forecasts 493 as well as fewer restatements, misstatements,494 and instances of fraud and insider trading.495 Others more directly linked the ICFR auditor attestation requirement with enhanced transparency,496 a higher quality and reliability of issuers’ financial statements,497 and corporate governance 498 and a reduced number of restatements, misstatements,499 and instances of fraud.500 Some commenters noted that the ICFR auditor attestation requirement increases investor confidence generally 501 and that investors view the requirement as beneficial.502 Importantly, all of these benefits, at both the issuer and market level, likely vary across issuers of different types. For example, younger, loss-incurring issuers with lower market capitalization and lower institutional ownership, as well as those with more segments, tend to be more likely to newly disclose material weaknesses as they transition into the ICFR auditor attestation requirement.503 However, the market appears to account for the association of material weaknesses with these and other observable issuer characteristics. Thus, issuers that have the characteristics associated with a higher rate of material weaknesses (and which investors may therefore value under the assumption that they are likely to have ineffective ICFR) but that receive an auditor attestation report that does not report any material weaknesses are found to have the greatest cost of capital 490 See, e.g., letters from Better Markets, CFA, Crowe, and Prof. Barth et al. 491 See, e.g., letters from CAQ, CFA, CII, and Grant Thornton. 492 See, e.g., letter from CAQ. 493 See, e.g., letter from CFA. 494 See, e.g., letters from CAQ and CFA. 495 See, e.g., letter from CFA. 496 See, e.g., letter from EY. 497 See, e.g., letters from Better Markets, CFA, CII, Deloitte, EY, Grant Thornton, PWC, and RSM. 498 See, e.g., letter from Deloitte. 499 See, e.g., letters from CAQ, CFA Inst., Crowe, Deloitte, EY, Grant Thornton, and Prof. Barth et al. 500 See, e.g., letters from Better Markets and Deloitte. 501 See, e.g., letters from Better Markets, CAQ, CFA, and EY. 502 See, e.g., letters from CII, CFA Inst., and EY. 503 See Ge et al. 2017 Study, note 393 above (regarding the term ‘‘younger,’’ this study defines company age as the number of years a company has been covered in the Compustat database). See also 2011 SEC Staff Study, note 198 above, at 96 (summarizing previous research finding that internal control deficiencies are associated with smaller, complex, riskier, and more financiallydistressed issuers). PO 00000 Frm 00040 Fmt 4701 Sfmt 4700 benefit from such a report.504 Small, loss-incurring issuers are also disproportionately represented amongst issuers that have allegedly engaged in financial disclosure frauds, indicating that any benefits in terms of investor protection and investor confidence may be particularly important for this population of issuers.505 On the other hand, marginal changes in the reliability of the financial statements of issuers whose valuation is driven primarily by their future prospects—which could also include small, loss-incurring issuers—could have limited issuer- and market-level effects to the extent that the current financial statements of these issuers are less critical to assessing their valuation.506 b. Estimated Effects on ICFR, the Reliability of Financial Statements, and Potential Fraud The academic literature discussed in Section IV.C.3.a. above suggests that the scrutiny associated with the ICFR auditor attestation may lead issuers that are required to obtain this attestation to maintain more effective ICFR and to remediate material weaknesses in ICFR more quickly, leading to more reliable financial statements. Further, as discussed above, studies have highlighted that smaller issuers are disproportionately represented in populations of issuers with ineffective ICFR and financial statements that require material restatement. In addition, smaller issuers are less likely to have significant external scrutiny in the form of analyst and media coverage and monitoring by institutional owners,507 which could otherwise 504 See Ashbaugh-Skaife et al. 2009 Study, note 457 above. 505 See, e.g., COSO 2010 Fraud Study (finding that companies allegedly engaging in financial disclosure fraud in the period from 1998 through 2007 had median assets and revenue under $100 million and were often loss-incurring or close to breakeven) and Characteristics of Financial Restatements and Frauds, CPA J. (Nov. 2017), available at www.cpajournal.com/2017/11/20/ characteristics-financial-restatements-frauds/ (for more recent evidence). 506 See, e.g., Patricia Dechow & Catherine Schrand, Earnings Quality, Res. Found. of CFA Inst. 12 (2004) (‘‘Dechow and Schrand 2004 Monograph’’). 507 See, e.g., Joel Peress & Lily Fang, Media Coverage and the Cross-Section of Stock Returns, 64(5) J. of Fin. 2023 at 2030 (2009) (finding that ‘‘firm size has an overwhelming effect on media coverage: large firms are much more likely to be covered’’); Armando Gomes, Gary Gorton, & Leonardo Madureira, SEC Regulation Fair Disclosure, Information, and the Cost of Capital, 13 J. of Corp. Fin. 300 at 307 (2007) (stating that ‘‘there is overwhelming evidence that size can explain analyst following’’); and Eliezer Fich, Jarrad Harford, & Anh Tran, Motivated Monitors: The Importance of Institutional Investors’ Portfolio Weights, 118(1) J. of Fin. Econ. 21 (2015) (finding E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 provide another source of discipline to maintain the reliability of financial statements. However, two of the studies cited above find that the ICFR auditor attestation requirement was not associated with more reliable financial statements for lower market capitalization issuers from 2007 through 2013 or 2014,508 and the existing studies in general may not be directly applicable to current circumstances given the 2010 change in risk assessment auditing standards, the 2007 change in the ICFR auditing standard and other recent changes discussed in Section IV.B.1. above. Importantly, the existing literature and most of the results cited by commenters regarding the benefits of the ICFR auditor attestation also do not directly examine low-revenue issuers. This section therefore provides an analysis of low-revenue issuers using recent data to complement the existing studies and better inform our consideration of the possible costs of the amendments. However, some uncertainty will remain due to the challenges discussed above in measurement and in ascribing causality in any such analysis, the limited sample sizes that result when restricting the analysis to recent years, and the general difficulty of predicting how the parties involved will react to the amendments. As discussed in more detail in the Proposing Release,509 our analysis includes an examination of two comparison populations of issuers that are not subject to the ICFR auditor attestation requirement but that otherwise have similar responsibilities with respect to ICFR (i.e., nonaccelerated filers, other than EGCs, and EGCs), with consideration given to the ways in which these issuers differ from the affected issuers. One commenter suggested that we should more carefully consider the audit risks linked to specific industries that are expected to be affected by the amendments, highlighting the banking industry as one that may have special considerations.510 We note that, as discussed above, the majority of the affected banking issuers are expected to remain subject to the FDIC auditor attestation requirement and therefore that institutional monitoring is greatest when a company represents a significant allocation of funds in the institution’s portfolio, which is strongly associated with company size). 508 See Bhaskar et al. 2018 Study, note 305 above, as discussed in note 474 above, and McCallen et al. 2019 Study, note 308 above, as discussed in note 475 above. 509 See Sections III.C.2. and III.C.4. of the Proposing Release, note 4 above. 510 See letter from CFA Inst. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 are not expected to be significantly affected by the amendments. Further, because of the small sample of affected issuers, we have a limited ability to split our sample and maintain statistical reliability. However, our aggregate estimates should reflect the overall diversity in the population of affected issuers. Another commenter indicated that the primary quantifiable cost of an exemption from the ICFR auditor attestation requirement stems from misreporting regarding the effectiveness of ICFR.511 While we consider this effect and its quantifiable implications in more detail below, we continue to believe that the incentive provided by the ICFR auditor attestation requirement to actually maintain better controls (versus just to more accurately report their status) remains a key benefit with certain quantifiable implications that could be lost due to an exemption from this requirement. i. Effects on the Prevalence of Ineffective ICFR We first consider possible effects related to the effectiveness of the affected issuers’ ICFR. In the Proposing Release, we presented an analysis of the rate of ineffective ICFR from 2014–2018 among low-revenue issuers that are subject to the ICFR auditor attestation requirement compared to low-revenue issuers not subject to this requirement.512 In particular, we compared the reported rate of ineffective ICFR in these recent years for accelerated filers that are subject to the ICFR auditor attestation requirement and have revenues of less than $100 million, relative to the reported rate of ineffective ICFR for issuers in our comparison populations (nonaccelerated filers, other than EGCs, and EGCs, neither of which is required to comply with the ICFR auditor attestation requirement) that also have revenues of less than $100 million. We focused on SOX Section 404(a) management reports on ICFR, with the caveat that management may not report as many material weaknesses in the absence of an audit of ICFR.513 Based on this analysis, and with consideration for the difference in size, maturity, and overall resources of the affected issuers versus the comparison sample, we estimated that an additional 15 percent of the affected issuers may fail to 511 See letter from Prof. Ge et al. Section III.C.4.b. of the Proposing Release, note 4 above. 513 We separately consider this potential underreporting of material weaknesses in the analysis below. 512 See PO 00000 Frm 00041 Fmt 4701 Sfmt 4700 17217 maintain effective ICFR.514 We did not receive comment on this specific estimate or comments providing data or methodologies that would improve our estimate. Our estimate is consistent with the estimated effect on ICFR based on a study of issuers transitioning into the ICFR auditor attestation requirement.515 We do not expect the full estimated effect to be experienced immediately upon effectiveness of the amendments. Instead, as discussed in detail at the end of this section, we expect a movement towards this higher rate of ineffective ICFR over time as some of the affected issuers make incremental changes in their investment in ICFR and as additional issuers enter the category of affected issuers. ii. Effects on the Detection and Disclosure of Material Weaknesses in ICFR Because the previous analysis focuses on disclosed rates of ineffective ICFR, it does not address the extent to which the amendments may affect the detection and disclosure of material weaknesses 514 See Section III.C.4.b. of the Proposing Release, note 4 above. We also noted in this section of the Proposing Release, note 4 above, that our findings may not be surprising, as certain material weaknesses in ICFR may be corrected by, for example, hiring additional staff, which managers of an issuer that is not currently producing much revenue may prefer to defer to a later time. Indeed, about 80 to 85 percent of the low-revenue issuers reporting ineffective ICFR in the comparison populations in 2017 reported at least one staffingrelated material weakness, though these were generally accompanied by other types of material weaknesses. See note 259 of the Proposing Release, note 4 above, and the accompanying text. 515 See Ge et al. 2017 Study, note 393 above, at 372 (finding that 62.5 percent of companies that reported material weaknesses as non-accelerated filers remediate such weaknesses upon entering accelerated filer status). To compare the result from this study to our estimate, note that we find in Table 7 above that about nine percent of accelerated filers report ineffective ICFR (further, the Proposing Release, note 4 above, found that the rate was similar for low and high revenue issuers). Our estimate of an additional 15 percentage points of the affected issuers reporting ineffective ICFR in the absence of an ICFR auditor attestation requirement would lead to a total of 24 percent (nine percent plus 15 percent) of the issuers reporting material weaknesses in ICFR in the absence of the requirement as compared to nine percent reporting material weaknesses in ICFR when subjected to the requirement. This is the same result one would get by applying the 62.5 percent remediation estimate from the cited study. In other words, if 62.5 percent of the issuers reporting material weaknesses in the absence of the ICFR auditor attestation requirement remediated their material weaknesses upon entering accelerated filer status and becoming subject to the requirement, that would mean that the rest of the issuers (37.5 percent) failed to remediate when becoming subject to the requirement. This would imply that a 24 percent rate of ineffective ICFR reported by the issuers in the absence of the requirement would correspond to a nine percent rate (24 percent times 37.5 percent) of ineffective ICFR reported by the issuers when subjected to the requirement. E:\FR\FM\26MRR2.SGM 26MRR2 17218 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 in ICFR. As discussed in Section IV.C.3.a. above, studies have found that audits of ICFR often result in the identification and disclosure of material weaknesses that were not previously identified or whose severity was misclassified in management’s initial assessment. Thus, extending the exemption from the ICFR auditor attestation requirement to the affected issuers may decrease the likelihood that, when these issuers have underlying material weaknesses in ICFR, these material weaknesses are detected and disclosed. In the Proposing Release, we noted that low-revenue issuers may be less likely than other issuers to fail to detect and disclose material weaknesses in the absence of an ICFR auditor attestation, perhaps because they have less complex financial systems and controls.516 Consistent with this hypothesis, we found that the low-revenue issuers that are not subject to the ICFR auditor attestation requirement report relatively high rates of ineffective ICFR despite these reports not being subject to the additional scrutiny of an ICFR auditor attestation. In the Proposing Release, we did not quantitatively estimate a potential effect on the detection and disclosure of material weaknesses in ICFR, though we did qualitatively consider how the amendments could affect issuers depending on their proclivity to detect and disclose underlying material weaknesses in the absence of an ICFR auditor attestation.517 Several commenters indicated that they expected the amendments to affect the detection and disclosure of material weaknesses in ICFR,518 with one stating that ‘‘the primary quantifiable cost of 404(b) attestation exemption arises from internal control misreporting.’’ 519 Further, other commenters noted that factors other than the complexity of issuers’ systems and controls, such as their accounting personnel resources 520 or the intricacies of the issuers’ business and industry, the strength of their governance, the competency of their management, and their international reach,521 should be considered in 516 See 2017 SICPG Survey Report, note 419 above, at 6 (finding that 33 percent of survey respondents with revenues of $75 million or less reported that they manage no more than 100 total controls, as compared to 13 percent of those with revenues of $76 to $700 million and zero percent of those with revenues greater than $700 million). 517 See Section III.C.4.c of the Proposing Release, note 4 above. 518 See, e.g., letters from CFA Inst., EY, and Prof. Ge et al. 519 See letter from Prof. Ge et al. 520 See letters from CAQ and EY. 521 See letter from RSM. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 assessing the risk of misreporting with respect to ICFR effectiveness. In response to these comments, we conducted a quantitative estimation of this effect and its potential implications. Because undetected and undisclosed material weaknesses cannot be directly observed, we are not able to directly estimate the extent of such issues in our comparison samples of low-revenue issuers that are not subject to the ICFR auditor attestation requirement. Instead, we rely on a recent study that estimates that an incremental 3.5 percent of issuers misreport their ICFR as being effective when not subject to the ICFR auditor attestation requirement as compared to when they are subjected to this requirement.522 To obtain this estimate, the study uses the characteristics associated with ineffective ICFR to predict the actual rate of ineffective ICFR as opposed to the disclosed rate of ineffective ICFR, and uses changes in reporting around transitions into accelerated filer status to predict the proportion of suspected misreporters that would correctly report under an ICFR auditor attestation requirement.523 We directly apply the results from the study and estimate that 3.5 percent of the affected issuers that will be newly exempt from all ICFR auditor attestation requirements may misreport that their ICFR is effective, but would not misreport if subjected to those requirements. To be conservative, we do not adjust this estimate based on our conjecture that low-revenue issuers may be less likely than other issuers to fail to detect and disclose material weaknesses in the absence of an ICFR auditor attestation, perhaps because they have less complex financial systems and controls. However, we note that the estimate may be somewhat inflated to the extent that this conjecture is correct. iii. Effects on Restatements We next consider the extent to which the possible effects on reported and unreported material weaknesses in ICFR might translate into less reliable financial statements. By definition, material weaknesses represent a reasonable possibility that a material misstatement of the issuer’s financial statements will not be prevented or 522 See Ge et al. 2017 Study, note 393 above (estimating, based on data from 2007 through 2014, that 9.3 percent of non-accelerated filers incorrectly report their ICFR to be effective and that 38.1 percent of these, or 3.5 percent, would correctly report their ICFR to be ineffective if subjected to the ICFR auditor attestation requirement). 523 Id. PO 00000 Frm 00042 Fmt 4701 Sfmt 4700 detected on a timely basis,524 and as discussed above, existing studies have demonstrated that ineffective ICFR are associated with less reliable financial statements. Thus, our estimated increase in the rate of ineffective ICFR likely would translate into a decrease in the reliability of the financial statements of the affected issuers. However, lowrevenue issuers could be less susceptible, on average, to at least certain kinds of misstatements. In particular, 10 to 20 percent of restatements and about 60 percent of the cases of financial disclosure fraud in recent times have been associated with improper revenue recognition,525 which is less of a risk, for example, for issuers that currently have no revenues. We explored this possibility empirically in the Proposing Release, by comparing the percentage of issuers in different categories that eventually restated some of the financial statements that they reported for a given year, for the years 2014 through 2016. Because we directly considered differences in actual restatements across these groups of issuers, these results should incorporate the effects of differences across the groups in both reported and unreported material weaknesses in ICFR. Our analysis demonstrated that issuers with revenues of less than $100 million have, on average, restatement rates that are three to nine percentage points lower than those for higherrevenue issuers of the same filer status.526 This result is consistent with low-revenue issuers being less likely to make restatements, even when they experience high rates of ineffective ICFR, perhaps because they are less susceptible to certain kinds of misstatements (such as those related to revenue recognition). 524 See Regulation S–X Rule 1–02(a)(4). Audit Analytics, 2017 Financial Restatements: A Seventeen Year Comparison, (May 2018), available at https://blog.auditanalytics.com/ 2017-financial-restatements-review/, and COSO 2010 Fraud Study, note 505 above. 526 See Section III.C.4.b. of the Proposing Release, note 4 above. As discussed in the Proposing Release, note 4 above, while observed restatements reflect misstatements that were detected and may only be a subset of actual misstatements, we believe that the lower restatement rates for low-revenue issuers are not driven by a difference in the ability to detect misstatements among these categories because we see this pattern for issuers with low rates of ineffective ICFR as well as for other issuers. This result is also consistent with the BIO Study, which finds that biotechnology EGCs have a two to three percentage point lower restatement rate than other non-accelerated or accelerated filers and attribute this to their ‘‘absence of product revenue.’’ See BIO Study, note 69 above (finding a 6.20 percent restatement rate for biotechnology EGCs compared to rates of 7.98 percent and 9.25 percent for other non-accelerated and accelerated filers respectively). 525 See E:\FR\FM\26MRR2.SGM 26MRR2 17219 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations A number of commenters maintained that the risks of financial statement restatements or misstatements are greater for the issuers that would not be subject to the ICFR auditor attestation requirement under the proposed amendments than for other issuers.527 A few of these commenters cited research that concludes that, since 2003, nonaccelerated U.S. filers accounted for 62 percent of the total U.S. financial statement restatements.528 However, we note that this research is not specific to low-revenue issuers, unlike our analysis. As our analysis in the Proposing Release demonstrated, restatements are less frequent for lowrevenue issuers even among nonaccelerated filers. Further, the cited research does not adjust for the high proportion of non-accelerated filers among all issuers. Other commenters noted that lowrevenue issuers may be more susceptible to misstatements in revenue recognition 529 or in areas other than revenue recognition,530 and that a higher risk of misstatements may be driven by characteristics of these issuers other than their low revenue, such as their lower resources or fewer personnel,531 complex transactions or arrangements,532 or activities that require significant accounting judgments.533 We note that our analysis is intended to capture all of these risks of restatements, by directly comparing rates of empirical restatements, and that we still find that the lower revenue issuers, taken in aggregate, are less likely to restate their financial statements than other issuers of the same filer status. Thus, while certain subsets of the affected issuers may be more prone to restatements than others based on their specific characteristics, on average the affected issuers as a group appear to have a lower overall risk of restatement than higher-revenue issuers. However, in response to the comments, we further examine the argument that the affected issuers may be less susceptible to certain kinds of misstatements, such as those related to revenue recognition, by examining the types of restatements among low- and higher-revenue accelerated filers other than EGCs in Table 11.534 We note that the categorization of types and the names of these categories are based on the categories and category titles provided in the Ives Group Audit Analytics restatement database. TABLE 11—PERCENTAGE OF ALL ACCELERATED FILERS OTHER THAN EGCS WITH RESTATEMENTS OF DIFFERENT TYPES, BY REVENUE CATEGORY, FOR FINANCIAL STATEMENTS FROM 2014–2018 Accelerated filers (ex. EGCs) Restatement type Revenue <$100M lotter on DSKBCFDHB2PROD with RULES2 Revenue recognition issues ........................................................................................................ Cash flows statement (SFAS 95) classification errors ................................................................ Tax expense/benefit/deferral/other (FAS 109) issues ................................................................. Inventory, vendor and/or cost of sales issues ............................................................................. Debt, quasi-debt, warrants & equity (BCF) security issues ........................................................ Liabilities, payables, reserves and accrual estimate failures ...................................................... Accounts/loans receivable, investments & cash issues .............................................................. Expense (payroll, SGA, other) recording issues ......................................................................... Acquisitions, mergers, disposals, re-org acct issues .................................................................. Acquisitions, mergers, only (subcategory) acct issues ............................................................... Deferred, stock-based and/or executive comp issues ................................................................ EPS, ratio and classification of income statement issues .......................................................... Balance sheet classification of assets issues ............................................................................. Lease, SFAS 5, legal, contingency and commitment issues ...................................................... Foreign, related party, affiliated, or subsidiary issues ................................................................. Table 11 presents the percentage of low-revenue and higher-revenue accelerated filers other than EGCs restating their financial statements under a particular category of restatement for a given year from 2014 through 2018. The table presents the results for the 15 most common restatement categories for low-revenue accelerated filers other than EGCs. Restatements can fall into more than one category, so the total of these percentages across all restatement categories would exceed the average rate of restatements. We also report the relative percentage of the restatement 527 See, e.g., letters from Better Markets, CAQ, EY, Grant Thornton, IMA, Prof. Barth et al., and RSM. 528 See, e.g., letters from CAQ and CFA Inst. 529 See, e.g., letters from Better Markets and Prof. Barth et al. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 rate in a given category among the lowrevenue issuers relative to the higherrevenue issuers. Table 11 demonstrates that 1.3 percent of low-revenue accelerated filers other than EGCs restated their financial statements for a given year from 2014 to 2018 due to revenue recognition issuers, representing about 40 percent of the rate of this type of restatement among higher-revenue accelerated filers other than EGCs. Similarly, for the next three most common categories of restatements for low-revenue accelerated filers other than EGCs, the restatement rates of these issuers represented 42– to 60 percent of 530 See, e.g., letter from BDO. e.g., letters from CAQ, Crowe, EY, and Grant Thornton. 532 See, e.g., letter from BDO. 533 See, e.g., letters from CFA Inst. and BDO. 531 See, PO 00000 Frm 00043 Fmt 4701 Sfmt 4700 1.3 1.0 1.0 0.8 0.7 0.7 0.7 0.6 0.5 0.4 0.4 0.3 0.3 0.3 0.3 Revenue ≥$100M 3.3 1.7 2.4 1.8 0.6 1.9 1.3 1.5 0.9 0.6 0.5 0.6 0.4 0.6 0.7 Relative percentage 40 60 42 45 115 37 53 43 55 65 85 53 77 53 34 the corresponding rates among higherrevenue accelerated filers other than EGCs. Thus, this evidence supports our belief that the affected issuers may be less susceptible to certain kinds of misstatements, such as those related to revenue recognition. However, consistent with commenters concerns about other sources of misstatements, particularly with respect to complex contracts and arrangements, we find that the rate of restatements in some other categories is more similar across the two groups. For example, the rate of restatements related to ‘‘Debt, quasidebt, warrants & equity (BCF) security 534 These estimates are based on staff analysis of data from Ives Group Audit Analytics. See note 298 above for details on the identification of filer type. The sample includes 2,017 issuer-year level observations that have low revenues and 3,862 issuer-year observations that have higher revenues. E:\FR\FM\26MRR2.SGM 26MRR2 17220 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations issues’’ and ‘‘Deferred, stock-based and/ or executive comp issues’’ for the lowrevenue issuers represent 115 percent and 85 percent respectively of the corresponding rates among the higherrevenue issuers. However, the rate of restatements is greater for the lowrevenue issuers as compared to higherrevenue issuers only in the ‘‘Debt, quasidebt, warrants & equity (BCF) security issues’’ category, and only by a small margin: The restatement rates in this category are within 0.1 percentage points of each other, such that they are not statistically differentiable in our sample.535 We therefore continue to believe that the evidence supports our hypothesis that the affected issuers are less likely to make restatements, perhaps because they are, on average, less susceptible to certain kinds of misstatements (such as those related to revenue recognition), than other accelerated filers. While this finding may mitigate the adverse effects on the reliability of financial statements for the affected issuers that will newly be exempt from all ICFR auditor attestation requirements, we nonetheless expect some such effects. Based on the analysis in the Proposing Release, and with consideration for the difference in size and maturity of the affected issuers versus the comparison sample, we estimated that the rate of restatements among the affected issuers may increase by two percentage points.536 Given their lower current rates of restatement, even after such an increase the affected issuers may, on average, restate their financial statements at a rate that is lower than that of issuers that will remain accelerated filers, and that does not exceed that of non-accelerated filers and EGCs with comparable revenues. Several commenters indicated that we should have given consideration to the magnitude of restatements.537 In response to these comments, we have undertaken two types of analysis. First, we consider the potential effects on restatements that are deemed by issuers to be material. To do this, we begin by repeating our analysis for all types of restatements from the Proposing Release for the subset of Item 4.02 restatements, which, as discussed above, are the restatements that issuers deem to be material and report in Form 8–K Item 4.02 disclosures, in Table 12.538 TABLE 12—PERCENTAGE OF ISSUERS ISSUING ITEM 4.02 RESTATEMENTS BY YEAR OF RESTATED FINANCIALS, BY REVENUE CATEGORY Accelerated (ex. EGCs) Restated year Revenue <$100M: 2014 ...................................................................................................................................... 2015 ...................................................................................................................................... 2016 ...................................................................................................................................... Average/year ................................................................................................................. Revenue ≥$100M: 2014 ...................................................................................................................................... 2015 ...................................................................................................................................... 2016 ...................................................................................................................................... Average/year ................................................................................................................. lotter on DSKBCFDHB2PROD with RULES2 Difference in average/year ..................................................................................... Nonaccelerated (ex. EGCs) EGC 2.4 3.5 3.3 3.0 3.9 3.1 2.6 3.2 5.8 4.2 3.4 4.5 4.1 3.7 2.4 3.4 4.7 4.3 2.3 3.8 2.7 8.7 2.6 4.7 ¥0.4 ¥0.6 ¥0.2 Table 12 demonstrates that, among low-revenue issuers, the accelerated filers other than EGCs have a 0.2 percentage point (relative to nonaccelerated filers other than EGCs) or 1.5 percentage point (relative to EGCs) lower rate of Item 4.02 restatements than the issuers in the comparison populations, which are not subject to the ICFR auditor attestation requirement. Following our analysis in the Proposing Release, given the difference in size and maturity of the affected issuers versus the comparison samples, we look to the lower end of this range and, with rounding, estimate that the rate of Item 4.02 restatements among the affected issuers may increase by 0.5 percentage points. Given how low the rates of Item 4.02 restatements are, the sample sizes in Table 12 are not sufficient to reliably differentiate between these rates. We are nevertheless comfortable with this estimate because it is consistent with the estimate that would be obtained by applying the average rate of Item 4.02 restatements out of all restatements, per Table 9 above,539 to our estimate of the effect on total restatements. This estimate of the effects on restatements that issuers deem to be material may help to provide some perspective on the magnitude of the anticipated effect. We provide further analysis of these magnitudes by exploring the market and financial statement impacts of the estimated effect on restatements. Table 15 in Section IV.C.3.c below provides related estimates per Item 4.02 restatement for low-revenue, seasoned issuers. In particular, the average net income impact for Item 4.02 restatements is estimated to be ¥$1.9 million per year of restated financials for the 80 percent of cases where there is a net income impact, which is ¥$1.9 million times 80 percent or ¥$1.5 million on average across all cases. The average stock market impact is estimated to be ¥$1.4 535 There is also a slightly higher rate of restatements without a specified category among the low-revenue issuers, with 0.1 percent of their issuer-year level observations being associated with ‘‘Unspecified (amounts or accounts) restatement adjustments’’ compared to 0.0 percent among the higher-revenue issuers. 536 See Section III.C.4.b. of the Proposing Release, note 4 above. 537 See, e.g., letters from Better Markets, CFA Inst., and Prof. Barth et al. 538 The estimates in this table are based on staff analysis of Ives Group Audit Analytics data. Percentages are computed out of all issuers of a given filer type and revenue category with revenue data and a SOX Section 404(a) management report available in the Ives Group Audit Analytics database. The accelerated and non-accelerated categories exclude EGCs. See note 298 above for details on the identification of filer type. 539 The ratio of Item 4.02 restatements to all restatements in Table 7 ranges from 15 percent for large accelerated filers other than EGCs (1.6 percent divided by 10.6 percent) up to 35 percent for nonaccelerated filers other than EGCs (2.9 percent divided by 8.5 percent). Applying these rates to our estimated 2 percentage point effect on total restatements would result in an estimate of a 0.3 to 0.7 percentage point effect on Item 4.02 restatements. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 PO 00000 Frm 00044 Fmt 4701 Sfmt 4700 E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 million divided by 1.4 years or ¥$1 million per year of restated financials. We multiply these estimates by our estimate that an additional 0.5 percentage points of the affected issuers may have an Item 4.02 restatement of their financial statements for a given year to obtain estimates of ¥$7,500 in net income impact or ¥$5,000 in stock market impact per year per affected issuer that will newly be exempt from all ICFR auditor attestation requirements. One commenter provided alternative estimates of the magnitude of the effect on restatements, estimating that the affected issuers restated a total of $295 million in net income over the five years from 2014 through 2018 and that the 2018 restatements reduced market capitalizations by $294 million in aggregate.540 We do not rely on these estimates for two primary reasons. First, these estimates reflect restatements that have occurred while these issuers are subject to the ICFR auditor attestation requirement.541 They do not provide us with information about the magnitude of new restatements that would be experienced if this requirement were to be removed. The use of this estimate would reflect an assumption that restatements would increase by 100 percent upon removal of the ICFR auditor attestation requirement, and we do not believe that there is evidence to support such an assumption. If anything, these estimates demonstrate the limitations of the ICFR auditor attestation requirement, in that significant restatements still occur despite the requirement, rather than informing us of the risks of removing the requirement. Secondly, these estimates reflect the years in which restatements were announced rather than when the actual misstatement occurred. Effective ICFR is intended to reduce the risk of material misstatements, so we believe it is important to focus on when misstatements occurred, not when earlier misstatements were detected and announced, which could actually be a 540 See letter from Prof. Barth et al. See also letter from Better Markets, citing these estimates. 541 Similarly, one commenter cites charges of misconduct at a low-revenue issuer and argues that ‘‘a well-designed ICFR audit might have uncovered the control deficiencies, and related revenue recognition violations, more quickly.’’ See letter from CFA. However, based on its EDGAR filings, the issuer was in fact subject to the ICFR auditor attestation requirement in fiscal year 2014, the beginning of the period of alleged misconduct (and may have been subject to the requirement in the remainder of the period of alleged misconduct as well, but did not file Form 10–K in the following year), and the auditor’s report in the associated Form 10–K attested that the issuer’s ICFR was effective. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 sign of a careful audit and effective ICFR. Focusing on the year of the restatement announcement rather than the year of the misstatement could capture firms that may not have qualified as affected issuers during the time the misstatements were made, but only dropped into the category of affected issuers because of the reduction in public float or revenue that resulted from the major restatement and related issues.542 In contrast to the commenter’s analysis, our analysis is designed to measure the rate and magnitude of the incremental restatements that can be attributed to misstatements in years in which the issuers would qualify under the amendments to be exempt from the ICFR auditor attestation requirement and that would not have occurred if the issuers were subjected to this requirement. iv. Effects on Fraudulent Financial Reporting Several commenters indicated that we should give additional consideration to the potential impacts of the amendments on the risk of fraud.543 Further, a number of commenters cautioned that the risks of fraudulent financial reporting may be particularly high for low-revenue issuers,544 perhaps because of their incentives to demonstrate strong growth 545 or because of their high implied price-torevenue multiples.546 As part of our consideration of these comments, we conducted certain supplemental analysis regarding the risk of fraudulent financial reporting. That analysis, discussed below, provides additional context for considering the possible effects of the amendments. We note that commenters did not provide their own analyses or suggest specific 542 For example, a media report identified a particular issuer included in one commenter’s analysis of significant restatements among issuers that were proposed to be exempted. See Dave Michaels, SEC Plan Gives Audit Relief to Firms that Wiped Out over $290 Million, Wall St. J., July 26, 2019. See also letter from Prof. Barth et al. (providing statistics but not identifying specific issuers). Based on its EDGAR filings, the identified issuer had revenues substantially in excess of $100 million, even after the revisions described in the article, for fiscal years 2015 and 2016 (the periods with misstatements that were later restated). Further, this issuer was subject to the ICFR auditor attestation requirement as a large accelerated filer in 2015 and an accelerated filer in 2016. Therefore, we do not believe the amendments, if effective during those fiscal years, would have exempted this issuer from the ICFR auditor attestation requirement during the period in which the misstatements were made. 543 See, e.g., letters from CFA Inst., CII, and Prof. Barth et al. 544 See, e.g., letter from CFA, CFA Inst., CII and Prof. Barth et al. 545 See, e.g., letter from CFA. 546 See, e.g., letters from CII and Prof. Barth et al. PO 00000 Frm 00045 Fmt 4701 Sfmt 4700 17221 methodologies for estimating any potential impact of the amendments on the risk of fraud. We acknowledge that fraudulent misconduct does occur, including at low-revenue issuers, and that the incentives to engage in such misconduct could be heightened for certain lowrevenue issuers, depending on their specific situation. It is less clear what the average risk of fraud is across lowrevenue issuers in general, and how this overall risk may be affected by the ICFR auditor attestation requirement. Measuring these effects is challenging because the sample sizes associated with typical measures of fraud are small, making reliable statistical determinations difficult. Further, we do not have an observable measure of all latent fraudulent conduct, but can only examine fraud that has been detected and that led to some observable action, which may not be a representative sample of all actual fraudulent activity. However, we acknowledge that it is important to carefully consider the potential impact of the amendments on the risk of fraud. We therefore use the available evidence and data to analyze this risk. We start by considering Accounting and Auditing Enforcement Releases (‘‘AAERs’’) 547 and cases of ‘‘financial misconduct’’ or ‘‘financial reporting fraud’’ based on subsets of these enforcement actions, as discussed below. A commenter noted that the Proposing Release did not consider the historical rate of fraud, the incidence of AAERs, the incidence of Wells notices and of formal SEC investigations.548 While ‘‘fraud’’ may be defined in different ways, our analysis below considers the historical rate of fraud, based on analysis of a subset of AAERs, and the incidence of AAERs. We believe that these are more appropriate measures of potential fraud risk, as they reflect incidents in which the Commission proceeded with charges. In contrast, formal investigations and Wells notices do not always uncover, and/or result in charges of, wrongdoing.549 The small sample size of 547 AAERs refer to certain financial reporting related enforcement actions concerning civil lawsuits brought by the Commission in federal court and notices and orders concerning the institution and/or settlement of administrative proceedings. Links to these releases since 1999 are available at https://www.sec.gov/divisions/enforce/ friactions.shtml. 548 See letter from Prof. Barth et al. 549 See David Solomon and Eugene Soltes, Is ‘‘Not Guilty’’ the Same as ‘‘Innocent’’? Evidence from SEC Financial Fraud Investigations, Working Paper (2019), available at https://papers.ssrn.com/sol3/ papers.cfm?abstract_id=3402780 (finding that, for E:\FR\FM\26MRR2.SGM Continued 26MRR2 17222 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations AAERs limits our ability to apply the methodology we used to estimate the potential impact on the prevalence of ineffective ICFR and the rate of restatements 550 to reliably estimate a potential effect on the incidence of AAERs. Instead, we begin by examining the representation of low-revenue as compared to higher-revenue issuers in the population of issuers with AAERs or subsets of AAERs that include certain types of charges, as compared to their representation in the broader population of issuers, in order to investigate commenters concerns that the affected issuers may face particularly high risks of fraudulent financial reporting. We then separately apply results from existing studies on fraudulent financial reporting to obtain an estimate of the potential impact of the amendments on such misconduct. Because the overall sample size of AAERs is limited, we use the full sample of years for which data is available, such that the alleged misconduct we analyze ranges from fiscal year 1971 to 2016 (based on AAERs issued from 1982 through 2018). We focus on issuers that are not within five years of their IPO (‘‘seasoned issuers’’) to better represent the affected issuers. Revenues are measured as of the date of the first misstated financial statements associated with an AAER, rather than at the date of the enforcement action, which is generally many years after this date.551 TABLE 13—REPRESENTATION OF LOW-REVENUE AND HIGHER-REVENUE SEASONED ISSUERS IN THE POPULATION AND AMONG THOSE WITH AAERS Among issuers not within 5 years of IPO * Percent with revenue <$100M Total issuer-year level observations with revenue data ** ...................................................................................... Issuers with AAERs: With alleged ‘‘financial misstatements’’ *** ....................................................................................................... and with ‘‘financial misconduct’’ charges **** ................................................................................................... and with ‘‘financial reporting fraud’’ charges ***** ............................................................................................ Percent with revenue ≥$100M 50 50 42 24 30 58 76 70 lotter on DSKBCFDHB2PROD with RULES2 * The years after an issuer’s IPO are computed as of the first date of the financial statements associated with the AAERs. ** This row includes data for fiscal years from 1971 through 2016 to reflect the full horizon of years of alleged misconduct identified in the U.S.C. Marshall AAER Database. As noted below, data on ‘‘financial misconduct’’ charges and ‘‘financial reporting fraud’’ charges was only collected for AAERs issued from 2002 through 2018. While these charges represent alleged misconduct dating back to as early as 1985, they are more likely to reflect relatively more recent years than those reflected in the full sample of AAERs. We therefore note, for the purpose of consideration of the last two rows of Table 13, that the percentage of low-revenue issuers among the total issuer-year observations of seasoned issuers with revenue data is reduced somewhat in the more recent part of this sample, to about 47 percent when considering data from fiscal years 1985 through 2016 or about 42 percent when considering data from fiscal years 2000 through 2016. *** This row represents AAERs that the U.S.C. Marshall AAER Database indicates as being associated with alleged financial misstatements. **** This row represents AAERs among those included in the previous row that also include charges under Section 13(b)(2)(A) (requiring issuers to make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer), Section 13(b)(2)(B) (requiring an issuer to devise and maintain a system of internal accounting controls sufficient to provide certain reasonable assurances), or Section 13(b)(5) (requiring that no person shall knowingly circumvent or knowingly fail to implement a system of internal accounting controls or knowingly falsify any book, record, or account) of the Securities Exchange Act, or Rules 13b2–1 (requiring that no person directly or indirectly, falsify or cause to be falsified, any book, record or account) or 13b2–2 (requiring certain representations and conduct by directors and officers in connection with the preparation of required reports and documents) under the Securities Exchange Act. We only supplemented the U.S.C. Marshall AAER Database with information about these specific charges where applicable for AAERs issued from 2002 through 2018 (which include alleged misconduct associated with financial statements from fiscal year 1985 through 2016), so the set of AAERs considered in the computations in this row reflect a substantially smaller population of AAERs than those included in the second row of this table, which includes earlier AAERs (issued beginning in 1982). Our estimates do not significantly change if we remove charges associated only with third parties rather than the issuer in question and/or its staff from the sample before running the analysis. ***** This row represents AAERs among those included in the previous row that also include charges under the anti-fraud statutes in Section 17(a)(1) of the Securities Act or Section 10(b) of the Securities Exchange Act. See also note **** above regarding limitations on the population of AAERs for which we supplemented the U.S.C. Marshall AAER Database with information on these charges. Our estimates do not significantly change if we remove charges associated only with third parties rather than the issuer in question and/or its staff from the sample before running the analysis. In Table 13, we consider all AAERs with alleged financial misstatements (row 2), as well as two subsets of these AAERs that we identify for those issued in, roughly, the past two decades.552 The first subset (row 3) represents those that we can identify as including charges under Section 13(b)(2)(A), Section 13(b)(2)(B), or Section 13(b)(5) of the Securities Exchange Act, or Rules 13b2–1 or 13b2–2 under the Securities Exchange Act. These cases have been identified by researchers as representing ‘‘financial misconduct.’’ 553 The second financial fraud investigations by the Commission between 2002 and 2005, only 25 percent resulted in enforcement actions); and Jean Eaglesham, SEC Drops 20% of Probes After ‘‘Wells Notice,’’ Wall St. J., Oct. 9, 2013 (reporting that, for the two-year period that ended in September 2012, 20 percent of the Wells notices issued were associated with investigations that were later closed without taking action being taken against the indicated parties). See also Terrence Blackburne, John Kepler, Phillip Quinn and Daniel Taylor, Undisclosed SEC Investigations, Working Paper (2019), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_ id=3507083 (finding that, for Commission investigations that were closed between 2000 and 2017, only 44 percent were eventually publicly disclosed, though the study does not identify the subset of these cases involving charges or any action being taken). 550 See Tables 13 and 14 of the Proposing Release, note 4 above, and the accompanying text. 551 The estimates in Table 13 are based on staff analysis of the U.S.C. Marshall AAER Database, which contains information on AAERs issued between May 1982 and December 2018, supplemented with information from AAERs (for a smaller sample, as discussed below) and data from Compustat. Multiple AAERs associated with the same financial statement years are treated as a single case. Consecutive years of financial statements associated with AAERs are also treated as a single case. 552 The population of AAERs considered in these subsets is limited to those issued from 2002 through 2018. See Table 13 above. 553 See Jonathan Karpoff, Allison Koester, D. Scott Lee, and Gerald Martin, Proxies and Databases in Financial Misconduct Research, 92(6) Acct. Rev. 129 (2017) (‘‘Karpoff et al. 2017 Study’’). This study also raised concerns about omissions in the U.S.C. Marshall AAER Database, which they refer to as the CFRM database, but they noted that they understood that this issue was being addressed and VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 PO 00000 Frm 00046 Fmt 4701 Sfmt 4700 E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 subset (row 4) is the subset of the ‘‘financial misconduct’’ cases that we can identify as also including charges under Section 17(a)(1) of the Securities Act or Section 10(b) of the Securities Exchange Act, which is one common way of identifying cases of ‘‘financial reporting fraud.’’ 554 We note that others may define ‘‘financial misconduct’’ and ‘‘financial reporting fraud’’ differently.555 Per the second through fourth rows of Table 13, the representation of lowrevenue seasoned issuers among all seasoned issuers with any of these types of AAERs ranges from 24 to 42 percent. For comparison, we also derive the representation of low-revenue seasoned issuers among all seasoned issuers in the population. Per the first row of Table 13, across all of the years of our sample, and specifically among the seasoned issuers, 50 percent of the issuer-year observations are associated with low revenues.556 Thus, we do not find evidence based on the available data that low-revenue issuers are more highly represented in the set of seasoned issuers associated with ‘‘financial misconduct’’ or ‘‘financial reporting fraud’’ than they are in the overall population of seasoned issuers. A caveat to this finding is that it only reflects cases of discovered and charged alleged misconduct, and may not be representative of all cases of actual misconduct.557 Also, this analysis is that users of the newer iterations of this dataset, after the date of the study, should face lower or zero rates of effective omissions. 554 See, e.g., Karpoff et al. 2017 Study, note 553 above, and COSO 2010 Fraud Study, note 505 above. 555 See, e.g., Karpoff et al. 2017 Study, note 553 above, (describing certain other measures researchers have used and their limitations), note 553 above. 556 While the latter two rows of Table 13, regarding ‘‘financial misconduct’’ and ‘‘financial reporting fraud,’’ are based on relatively more recent data (AAERs issued from 2002 through 2018, reflecting alleged misconduct from 1985 to 2016), we note that considering the prevalence of lowrevenue issuers in relatively more recent years does not change our conclusions. For example, the percentage of low-revenue issuers among the total issuer-year observations of seasoned issuers with revenue data is about 47 percent when considering data from 1985 through 2016 (reaching a minimum of 38 percent in 2016), which still exceeds the 25 to 30 percent of the seasoned issuers associated with ‘‘financial misconduct’’ or ‘‘financial reporting fraud’’ that have low revenues. 557 We note that the required data, such as data on revenues, may be less likely to be available for low-revenue issuers to the extent that, like other small issuers, they are less likely to be covered by traditional databases. This could reduce our ability to detect a higher representation of these issuers among those with various types of AAERs. However, this should generally be accounted for in our analysis because we draw comparisons only within the population of issuers with available data, and the same limitation applies to our ability to estimate the representation of such issuers in the VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 limited to the population of AAERs. There may be additional cases of alleged misconduct with respect to financial reporting that are charged but not associated with AAERs, and lowrevenue issuers could be more highly represented among these cases.558 Further, even if the affected issuers may not be more likely to engage in fraudulent financial reporting than other seasoned issuers on average, certain of these affected issuers may have heightened incentives to engage in such activities, as noted by the commenters cited above. We next consider whether expanding the exemption from the ICFR auditor attestation requirement for such issuers would affect their likelihood of engaging in such activities. To address this question, we rely on a study that associates material weaknesses in ICFR with an increased rate of ‘‘financial reporting fraud.’’ 559 In particular, the study associates reporting ‘‘entity-level’’ material weaknesses in ICFR,560 but not other types of material weaknesses, with a 1.22 percentage point increase in the rate of ‘‘financial reporting fraud’’ over the following three years, or 0.41 percentage points (1.22 divided by three) per year. Given that any impact of the ICFR auditor attestation requirement on the risk of fraud is likely to result from the effect of this requirement on the overall population as in the population with AAERs. 558 For example, not all of the enforcement actions listed in the category of ‘‘Issuer Reporting/ Auditing & Accounting’’ in the Annual Report of the Commission’s Division of Enforcement are associated with AAERs. See, e.g., 2019 Annual Report, Division of Enforcement, available at https://www.sec.gov/enforcement-annual-report2019.pdf. 559 See Donelson et al. 2017 Study, note 470 above. This study identifies ‘‘financial reporting fraud’’ as either (1) the sample of ‘‘fraud’’ cases in the ‘‘financial misrepresentation dataset’’ from www.fesreg.com that underlies the Karpoff et al. 2017 Study, note 553 above, which, based on the latter study, represents the subset of Commission or Department of Justice enforcement actions that include charges under Sections 13(b)(2)(A), Section 13(b)(2)(B), or Section 13(b)(5) of the Securities Exchange Act, or Rules 13b2–1 or 13b2–2 under the Securities Exchange Act, that also include charges under the anti-fraud statutes in Section 17(a)(1) of the Securities Act or Section 10(b) of the Securities Exchange Act; or (2) settled securities class-action lawsuits that allege violations of GAAP. 560 This study defines entity-level material weaknesses as those that Ives Group Audit Analytics identifies as being in any of the following categories: (1) Non-routine transaction control issues; (2) journal entry control issues; (3) foreign, related-party, affiliated, or subsidiary issues; (4) an ineffective, nonexistent, or understaffed audit committee; (5) senior management competency, tone, or reliability issues; (6) an insufficient or nonexistent internal audit function; (7) ethical or compliance issues with personnel; or (8) accounting personnel resources, competency, or training issues. See Donelson et al. 2017 Study, note 470 above. PO 00000 Frm 00047 Fmt 4701 Sfmt 4700 17223 effectiveness of ICFR, we apply the results of this study to our estimated effect on ICFR to quantify the potential increase in this risk that could be associated with the amendments. Per the results earlier in this section, we estimate that the amendments may eventually result in an additional 15 percentage points of the affected issuers maintaining ineffective ICFR. Examining the types of material weaknesses experienced by low-revenue issuers of different filer statuses, we find that up to 85 percent of their material weaknesses would be classified as ‘‘entity-level’’ material weaknesses as defined by the study we are relying on.561 Applying the above annualized estimate of a 0.41 percentage point increase in the rate of financial reporting fraud for issuers reporting ‘‘entity-level’’ material weaknesses to our estimate of a 12.75 percentage point (15 percentage points times 85 percent) increase in the prevalence of such material weaknesses, we estimate that the amendments could eventually lead to an additional 0.05 percentage points (0.41 percent times 12.75 percentage points) of the affected issuers being associated with alleged ‘‘financial reporting fraud’’ with respect to their financial statements for a given year. To better understand the magnitude of this potential effect, we rely on another study that estimates that issuers lose a total of 38 percent of their equity market value upon announcements of ‘‘financial misrepresentation,’’ or, given that the alleged violation periods in their sample span 27 months on average, 17 percent of equity market capitalization for each affected year.562 The affected issuers that will be newly exempt from all ICFR auditor attestation requirements have an average equity market capitalization of about $205 million. We therefore estimate that the magnitude of the potential increase in fraud risk is 0.05 percentage points (our estimated annualized rate of the increase in issuer-years associated with 561 See note 560 above. Jonathan Karpoff, D. Scott Lee, and Gerald Martin, The Cost to Firms of Cooking the Books, 48(3) J. of Fin. and Quantitative Analysis 581 (2008) (‘‘Karpoff et al. 2008 Study’’). The study defines ‘‘financial misrepresentation’’ consistently with the ‘‘financial misrepresentation dataset’’ from www.fesreg.com which, based on the Karpoff et al. 2017 Study, note 553 above, represents the subset of Commission or Department of Justice enforcement actions that include charges under Sections 13(b)(2)(A), Section 13(b)(2)(B), or Section 13(b)(5) of the Securities Exchange Act, or Rules 13b2–1 or 13b2–2 under the Securities Exchange Act. While the ‘‘financial misrepresentation’’ sample does not also require charges under the antifraud statutes, the Karpoff et al. 2008 Study indicates that over three-fourths of this sample was associated with fraud charges. 562 See E:\FR\FM\26MRR2.SGM 26MRR2 17224 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations ‘‘financial reporting fraud’’) times 17 percent times $205 million, or about $17,500 in market capitalization per year per affected issuer that will be newly exempt from the ICFR auditor attestation requirements. We view this estimate as conservative because the study we rely on includes issuers that are younger and significantly smaller than the affected issuers, and we believe that the percentage of market capitalization loss is likely to be greater for such firms. Overall, this analysis does not cause us to change our primary conclusions regarding the potential effects of the amendments. lotter on DSKBCFDHB2PROD with RULES2 v. Timing of the Effects We anticipate that the potential adverse effects of the amendments will develop gradually and are likely to be relatively limited in the short term. We discuss the reasons that we expect a gradual evolution in the remainder of this section. Nevertheless, we recognize that a delay in realizing some of the associated costs from the amendments would not necessarily mitigate their ultimate effects. The preceding discussion is based on the comparison of steady-state differences across issuers in different categories, and represents an analysis of the eventual effects of the amendments. Because the amendments will allow some current accelerated filers to transition to non-accelerated filer status, some issuers that have already been subject to an audit of ICFR for one or more years may no longer be required to obtain an ICFR auditor attestation. While other issuers will enter into the affected issuers category without having previously obtained an ICFR auditor attestation, and such issuers are likely to represent a larger fraction of the affected issuers over time, initially issuers with experience with ICFR auditor attestations are expected to represent a substantial fraction of the affected issuers. Newly exempt issuers may have implemented control improvements that would persist regardless of a transition. For example, they may have made investments in systems, procedures, or training that are unlikely to be reversed. It is difficult to predict the degree of inertia in ICFR and financial reporting in order to gauge how quickly, if at all, issuers that cease audits of ICFR may evolve such that their ICFR and the reliability of their financial statements is more characteristic of exempt issuers.563 563 We note that there is a relatively small sample of accelerated filers transitioning to non-accelerated filer status because of changes in their public float, as compared to transitions in the other direction, VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 The gradual nature of such an evolution, and the associated halo effect of the last disclosed ICFR auditor attestation, may limit the short-term costs of the amendments. In addition, issuers that believe control improvements are valuable for reporting and certifying results will be free to spend the resources saved on the attestations on such improvements. Affected issuers with experience with audits of ICFR may also be more likely to continue to obtain an ICFR auditor attestation on a voluntary basis than other exempt issuers are to begin voluntary audits of ICFR. This may be due to such issuers having already incurred certain start-up costs or facing demand from their current investors to continue to provide ICFR auditor attestations. Some issuers in the groups that we use for comparison, which are not subject to an ICFR auditor attestation requirement, voluntarily obtain an ICFR auditor attestation. Thus, the comparisons made above at least partially account for the fact that some issuers may choose to obtain an ICFR auditor attestation even in the absence of a requirement. However, to the extent the rate of voluntary ICFR auditor attestations would be higher amongst the issuers that will be newly exempt from the ICFR auditor attestation requirement than other exempt issuers, the anticipated costs of the amendments in the near term may be further reduced. c. Implications for Investor DecisionMaking While we anticipate that the frequency of ineffective ICFR and, to a lesser extent, restatements may increase among the affected issuers as a result of the amendments, the economic effects of these changes may be reduced by another factor that may apply to many of these issuers. In particular, the usefulness of more reliable financial statements is linked to the degree to which they factor into the decisions of investors,564 for example, with respect to these investors’ valuations of issuers.565 The financial statements of many low-revenue issuers may have relatively lower relevance for market and that such transitions likely represent special circumstances such as underperformance. Therefore, such transitions are not particularly helpful for predicting the outcomes of accelerated filers transitioning to non-accelerated filer status because of the amendments. 564 See, e.g., Dechow and Schrand 2004 Monograph, note 506 above. 565 See, e.g., Jennifer Francis & Katherine Schipper, Have Financial Statements Lost Their Relevance?, 37(2) J. of Acct. Res. 319 (1999) (‘‘Francis and Schipper 1999 Study’’); and S. P. Kothari, Capital Markets Research in Accounting, 31 J. of Acct. and Econ. 105 (2001). PO 00000 Frm 00048 Fmt 4701 Sfmt 4700 performance if, for example, relative to higher-revenue issuers, their valuation hinges more on their future prospects than on their current financial performance. We explored this possibility empirically in the Proposing Release, which used the methodology applied in previous studies to calculate, for issuers above and below the $100 million revenue threshold, the extent to which the variation in market performance is related to the variation in financial measures. For issuers at or above $100 million in revenue, we found, consistent with the findings of previous studies of all issuers, that key financial variables (the book value of assets and liabilities, the book value of equity, earnings, and the change in earnings) explain about 60 to 70 percent of the variation in equity market capitalization and 7.5 percent of the variation in stock returns.566 In contrast, for issuers with revenues of less than $100 million, we found that these financial variables explain about 30 percent of the variation in equity market capitalization and just over 4.5 percent of the variation in stock returns. One commenter indicated that a lowrevenue issuer could have a large market capitalization and thus ‘‘greater investor exposure.’’ 567 While we agree that such affected issuers would generally expose more investors to risk, we note that the results discussed above suggest that, on average, relative to higher-revenue issuers, less of this risk seems to be associated with the issuers’ current financial statements than with their future prospects.568 Another commenter agreed that future prospects are important to the valuation of entities in a growth phase, but noted that the financial variables we consider in our analysis are more likely to be considered in the valuation of lowrevenue issuers that are more seasoned, and that we should therefore more fully consider the implications for these issuers in particular.569 This commenter 566 See Table 15 of the Proposing Release, note 4 above. See also Francis and Schipper 1999 Study note 565 above. While that study ends in 1994, before our 20 year horizon, the results are similar. For example, for the most recent ten years in that study, the book values of assets and liabilities explain 54 to 70 percent of the variation in equity market valuation, the book value of equity and earnings explain 63 to 78 percent of the variation in equity market valuation, and earnings and the change in earnings explain six to 20 percent of the variation in stock returns. 567 See letter from Grant Thornton. 568 Also, the affected parties are limited to issuers with no more than $700 million in public float. Further, as discussed in Section IV.C.3.d. below, we estimate that in aggregate the affected issuers that will be newly exempt from all ICFR auditor attestation requirements represent 0.2 percent of the total equity market capitalization of issuers. 569 See letter from Crane. E:\FR\FM\26MRR2.SGM 26MRR2 17225 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations also suggested that we might consider additional financial variables that may be more relevant to the valuation of lowrevenue issuers, such as the rate of revenue growth and measures of liquidity. In response to this comment, we conducted supplemental analysis of the empirical relevance of financial statements for low-revenue issuers in Table 14.570 Specifically, because the affected issuers that will newly be exempt from the ICFR auditor attestation requirement are generally not within five years of their IPO, we limit the analysis to more seasoned issuers. Further, we run the analysis with additional variables, as discussed below. TABLE 14—PERCENTAGE OF VARIATION IN MARKET PERFORMANCE EXPLAINED BY VARIATION IN FINANCIAL PERFORMANCE FOR 1999 THROUGH 2018, BY REVENUE CATEGORY Market variable Seasoned issuers (not within five years of IPO): Market value of equity ........................................... Market value of equity ........................................... Stock return ........................................................... Seasoned issuers, additional variables: Market value of equity ........................................... Stock return ........................................................... lotter on DSKBCFDHB2PROD with RULES2 Revenue <$100M Explanatory variables Revenue ≥$100M Book value of assets, book value of liabilities ............. Book value of equity, earnings ..................................... Earnings, change in earnings ....................................... 40.9 46.2 5.5 58.8 70.2 7.6 Book value of equity, earnings, revenue, R&D expense, quick ratio. Earnings, change in earnings, revenue, change in revenue, R&D expense, change in R&D expense. 55.8 81.5 8.4 9.0 The first three rows of Table 14 are similar to the analysis in the Proposing Release, but are limited to issuers that are not within five years of their IPO. Focusing on this subsample of lowrevenue issuers, which is more representative of the affected issuers that would be newly exempt from the ICFR auditor attestation requirement, we find that the financial variables considered in the Proposing Release explain about 40 to 45 percent of the variation in equity market capitalization and about 5.5 percent of the variation in stock returns. These percentages are slightly higher than our results for all low-revenue issuers in the Proposing Release (for which the variables explain about 30 percent and 4.5 percent of the variation in equity market capitalization and stock returns respectively, as noted above). However, they remain substantially lower than the results for higher-revenue seasoned issuers, for which the variables explain about 60 to 70 percent of the variation in equity market capitalization and about 7.5 percent of the variation in stock returns. The second panel of Table 14 considers additional variables based on the comment letter discussed above and on academic accounting literature on key value-relevant metrics. For example, the role of the book value of equity in valuation may reflect, among other things, the liquidation or adaptation value of an issuer.571 However, a commenter noted that, for issuers with little to no revenue, liquidity metrics are often relevant to a user’s evaluation of future prospects.572 We agree that there is evidence that, for certain issuers, liquidity metrics that relate current assets to current liabilities may provide key additional information on the likelihood of, and value upon, liquidation.573 We therefore include the quick ratio (current assets less inventories, which may be difficult to monetize in the short term, minus current liabilities) in the analysis as a supplement to the book value of equity. In considering further variables that would be appropriate to include in this analysis, we note that low-revenue issuers are significantly more likely to be loss-making than higher-revenue issuers.574 The academic literature provides evidence that for loss firms, revenues (and the change in revenues, or revenue growth) can be more valuerelevant than earnings (and the change in earnings).575 A commenter also identified the rate of revenue growth as an example of a financial statement variable that investors may consider for low-revenue firms.576 Separately, we note that research and development (‘‘R&D’’) costs are expensed and thereby reduce earnings, while there is evidence that the future benefits of R&D activity may not be reflected in the earnings of loss-making firms.577 For these reasons, we include revenues and R&D expenses (and the change in these measures) as a supplement to earnings (and the change in earnings) in the analysis in the second panel of Table 14. As demonstrated in the last two rows of Table 14, including these additional variables does increase the amount of variation in equity market capitalization and stock returns explained by the financial statement variables. However, the percentage of explained variation remains lower for low-revenue seasoned issuers than for higher-revenue seasoned issuers. These results demonstrate that financial statement information is not irrelevant for low-revenue issuers. That is, information from financial statements is associated with market prices and returns for these issuers as well as other issuers. Thus, the potential reduction in the reliability of financial 570 The reported statistics are adjusted R-squared statistics based on regression analysis by staff using data from the Standard & Poor’s Compustat and Center for Research in Security Prices databases. Seasoned issuers are those for which the data date is not within five years of the reported IPO date, where IPO dates are available. Market value and financial variables are measured as of the end of the fiscal year. Earnings is income before extraordinary items. Stock return is the 15-month stock return ending three months after fiscal year-end, to account for reporting lags. For the stock return regression, the explanatory variables are scaled by the lagged market value of equity, and outliers in one percent tails of variable distributions are dropped to reduce noise. See Francis and Schipper 1999 Study, note 565 above, for additional details. 571 See, e.g., Philip Berger, Eli Ofek, and Itzahk Swary, Investor Valuation of the Abandonment Option, 42(2) J. of Fin. Econ. 259 (1996); David Burgstahler and Ilia Dichev, Earnings, Adaptation and Equity Value, 72(2) Acct. Rev. 187 (1997). 572 See letter from Crowe. 573 See, e.g., Sergei Davydenko, When Do Firms Default? A Study of the Default Boundary, Working Paper (2012), available at https://papers.ssrn.com/ sol3/papers.cfm?abstract_id=672343 (finding that the quick ratio is highly correlated with the shortterm probability of default, particularly for firms with less access to external capital). 574 In this analysis, about half of the low-revenue issuers are loss-making, compared to about ten percent of the higher-revenue issuers. 575 See, e.g., Aswath Damodaran, The Dark Side of Valuation: Firms with No Earnings, No History and No Comparables, Working Paper (1999), available at https://papers.ssrn.com/sol3/ papers.cfm?abstract_id=1297075. 576 See letter from Crowe. 577 See, e.g., Laurel Franzen and Suresh Radhakrisnan, The Value Relevance of R&D across Profit and Loss Firms, 28 (1) J. of Acct. and Pub. Pol’y 16 (2009). VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 PO 00000 Frm 00049 Fmt 4701 Sfmt 4700 E:\FR\FM\26MRR2.SGM 26MRR2 17226 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations statements for the affected issuers is expected to have some negative implications. However, the lower empirical relevance of financial statements on average for these issuers may partially mitigate the potential adverse effects of the amendments. In contrast to these findings, a number of commenters cited analysis in Commissioner Jackson’s Statement suggesting that, based on the stock market reaction to annual report filings disclosing material weaknesses in ICFR, investors care most about the information provided by the ICFR auditor attestation of low-revenue issuers.578 Further, one of these commenters stated that the markets impose a ‘‘much heftier penalty’’ on small companies that restate than they do on larger companies.579 On the other hand, other commenters expressed the view that the ICFR auditor attestation requirement is not important or material to the investors of affected issuers, based on their own experience and/or a study referencing an analysis of the market reaction to Section 302 internal control weakness disclosures.580 As lotter on DSKBCFDHB2PROD with RULES2 578 See, e.g., letters from CFA, CFA Inst., and CII, citing the event study analysis in Commissioner Jackson’s Statement. 579 See letter from CFA. 580 See, e.g., letters from Adamas, Ardelyx, ASA, BIO, Carver, Catalyst, Chiasma, Corvus, CymaBay, Equillium, Evoke, Gritstone, Kezar, Marinus, Millendo, Organovo, Pieris, Revance, SI–BONE, Syros, Teligent, and Zynerba. Many of these letters cited the BIO Study, note 69 above, which in turn cites Jacqueline Hammersley, Linda Myers, and Catherina Shakespeare, Market Reactions to the Disclosure of Internal Control Weaknesses and to the Characteristics of those Weaknesses under Section 302 of the Sarbanes Oxley Act of 2002, VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 further evidence, two of these commenters asserted that investors rarely ask an issuer that is exempt from obtaining an ICFR auditor attestation to voluntarily comply with the requirement.581 In response to these comments, we have conducted analyses of the investor response to ICFR disclosures and restatement announcements at low-revenue issuers versus other issuers. First, we consider the market reaction to the filing of annual reports that contain ICFR auditor attestations reporting material weaknesses in ICFR. We only consider ICFR auditor attestation reports, as opposed to Section 404(a) management reports, in order to focus on a sample of issuers comparable to the affected issuers 582 and those reports that would no longer be required under the amendments. Because material weaknesses may persist across years, consecutive disclosures that continue to report material weaknesses are not likely to represent news to the market. We 13(1) Rev. of Acct. Stud. 141 (2008) (‘‘Hammersley et al. 2008 Study’’). The BIO letter also directly cites the latter study. The BIO Study and BIO letter highlight the finding of the Hammersley et al. 2008 Study that the market response to issuers disclosing material weaknesses in disclosure controls in their Section 302 disclosures is, in the whole sample, not statistically different from zero. However, we note that this study does find evidence of a statistically significant negative market reaction to such disclosures in a subsample uncontaminated by other announcements in the event window. 581 See letters from Ardelyx and BIO. 582 In particular, Section 404(a) management reports are required of all issuers other than RICs and ABS issuers, including those that are already non-accelerated filers and would therefore not be affected by the amendments. PO 00000 Frm 00050 Fmt 4701 Sfmt 4700 therefore focus on material weakness disclosures that are preceded by an ICFR auditor attestation reporting effective ICFR. We consider issuers with revenues of less than $100 million and higher-revenue issuers, but exclude those within five years of their IPO to more closely represent the affected issuers.583 Figure 7 584 presents the results of our event study analysis for disclosures in the last decade.585 583 We obtain substantially similar results if we consider all issuers, rather than excluding those within five years of their IPO, or if we include consecutive annual reports with material weakness disclosures, rather than focusing on new material weakness disclosures. 584 This figure is based on results from the Event Study by WRDS module available through Wharton Research Data Services and staff analysis of data from Ives Group Audit Analytics, Compustat, and CRSP. The figure includes all seasoned issuers that have an auditor attestation of ICFR that newly reports material weaknesses in ICFR following a previous attestation to effective ICFR in annual reports filed in calendar years 2009 through 2018. We exclude issuers for which the data date is within five years of the IPO date (i.e., non-seasoned issuers), if available. The cumulative average abnormal returns are calculated with respect to expected returns based on a multi-factor model including the three Fama French factors and a momentum factor, where the model parameters are calculated over an estimation period of up to 100 trading days ending 50 trading days before the event period. 585 This time horizon was chosen to maximize the sample size while limiting the study to the period after the effectiveness of AS No. 5 (now referred to as AS 2201, note 292 above), which may have changed the nature of ICFR auditor attestations. See Section IV.B.1. above for a discussion of this auditing standard and the evidence that the nature of ICFR auditor attestations may have changed as a result of its adoption. Our results are substantially similar when considering alternative time horizons, such as the past five years. E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations 586 The analysis applies the standardized crosssectional test, which is robust to cross-sectional dependence in abnormal returns (which often results when events cluster in time, as in the case of annual report filing dates) as well as any eventinduced increase in the variance of returns, to measure the statistical significance of the abnormal returns. See Ekkehart Boehmer, Jim Musumeci, and Annette Poulsen, Event-Study Methodology under Conditions of Event-Induced Variance, 30(2) J. of Fin. Econ. 253 (1991) (‘‘Boehmer et al. 1991’’). 587 About 30% of the low-revenue observations in the analysis are exact duplicates in terms of company identifiers, event date, revenue and returns. See ‘‘Abnormal Returns Data,’’ available at https://www.sec.gov/news/public-statement/ VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 generally occurs when there is both an ICFR auditor attestation and a Section 404(a) management report reporting a material weakness in the same annual report. While the duplicate observations appear to have only a modest effect on the pattern of the measured cumulative abnormal returns, they likely have the effect of biasing downward the width of the confidence interval presented in the analysis. When we remove the duplicates, we find that, as in our own analysis, the cumulative average abnormal returns for low-revenue issuers are not statistically differentiable from zero at conventional confidence levels for any day within the 11-day event period surrounding the disclosure date.588 Also, we note that even without this adjustment, the confidence jackson-statement-proposed-amendmentsaccelerated-filer-definition. 588 The width of the confidence interval at the far right side of the figure (for day +5) in the analysis cited by commenters appears to be about 0.85 percentage points. We understand that the standard errors in that analysis are simple cross-sectional standard errors (which are robust to event-induced increases in the variance of returns but not to any cross-sectional dependence in abnormal returns). Removing the duplicates, we find that the width of the corresponding 95% confidence interval would be 2.02 percentage points using this approach, which is about 2.4 times wider than the reported confidence interval. PO 00000 Frm 00051 Fmt 4701 Sfmt 4700 intervals plotted in the other analysis indicate that, by the end of the presented event period, the cumulative average abnormal returns are no longer statistically differentiable from zero for issuers with below $100 million in revenues.589 Second, more than half of the nonduplicate low-revenue observations in the other analysis appear to reflect reports of material weaknesses in Section 404(a) management reports in the absence of an ICFR auditor attestation. As discussed above, our analysis excludes observations where there is only a Section 404(a) management report because we believe they have limited relevance when considering the affected issuers and the effects of the amendments. Third, the other analysis reflects a different time horizon (2004 through 2017) than our analysis (2009 through 2018). In our analysis, we restrict the time horizon to the period after the effectiveness of AS No. 5 because the nature of ICFR auditor attestations may have changed after this point. These additional differences in 589 In particular, the presented confidence bands for the cumulative abnormal returns include zero by day 11 of the analysis, which considers the 11-day period beginning five days prior and ending five days subsequent to the date of disclosure. E:\FR\FM\26MRR2.SGM 26MRR2 ER26MR20.006</GPH> lotter on DSKBCFDHB2PROD with RULES2 Our analysis does not suggest that investors care more about the information produced by the ICFR auditor attestation requirement at lowrevenue issuers. In particular, investors did not react more negatively to lowrevenue issuers disclosing material weaknesses than to such disclosures by the higher-revenue issuers. None of the cumulative average abnormal returns plotted in the figure, whether for lowor higher-revenue issuers, are statistically differentiable from zero at conventional confidence levels.586 Our figure differs from the similar analysis that was cited by commenters for a number of reasons. First, that analysis includes a number of duplicate observations.587 The duplication 17227 17228 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations the underlying sample appear to drive the differences in the pattern of the cumulative average abnormal returns in the analysis cited by commenters relative to our own analysis.590 However, even if we were to use the broader set of reports and/or the time horizon of the other analysis, we continue to find that the cumulative average abnormal returns are not statistically differentiable from zero at conventional confidence levels for any day within the 11-day event period surrounding the disclosure date. There is substantial noise inherent to an analysis of the disclosure of material weaknesses in annual reports, both because these reports often contain or are accompanied by significant confounding information 591 and because material weaknesses are often disclosed in advance of the annual report.592 We therefore also undertook analysis of the market and financial statement impact of material restatements disclosed in Item 4.02 Form 8–K filings, which are relatively less likely to be accompanied by unrelated news or to be disclosed in advance of the filing. We consider restatements over the 10-year horizon from 2009 through 2018 to obtain more reliable estimates while still focusing on a recent period that should be reasonably representative of the current environment.593 TABLE 15—ESTIMATED EFFECTS OF ITEM 4.02 8–K RESTATEMENTS ANNOUNCED BY SEASONED ISSUERS IN 2009–2018, BY REVENUE CATEGORY AT TIME OF THE MISSTATEMENT Issuers not within five years of IPO Average 2-day announcement return (%) ................................................................................................ Announcement return statistically distinguishable from zero (95% confidence level) ............................. Average 2-day announcement return (95% confidence interval) ............................................................. Average 2-day announcement effect ($) .................................................................................................. Percent with adverse financial statement effect * ..................................................................................... Percent with income effect ....................................................................................................................... Among those with income effect, average net income effect ($) per year of restated financials ........... Average length of restated period ............................................................................................................ Revenue <$100M Revenue ≥$100M ¥0.9% .................. No ......................... ¥2.2% to +0.3% .. ¥$1.4M ................ 78% ....................... 83% ....................... ¥$1.9M ................ 1.4 years ............... ¥3.3%. Yes. ¥4.2% to ¥2.3%. ¥$22.0M. 80%. 81%. ¥$13.2M. 2.0 years. lotter on DSKBCFDHB2PROD with RULES2 * This row, based on the ‘‘Effect’’ variable from Ives Group Audit Analytics, indicates whether the net effect to the financial statements (income statement, balance sheet or cash flows) was negative. As with our previous analyses, this supplemental analysis also does not support the assertion that investors care more about the reliability of the information in the financial statements of low-revenue issuers than that of higher-revenue issuers. The market reaction to Item 4.02 Form 8–K filings is statistically indistinguishable from zero for low-revenue, seasoned issuers, but is negative and statistically significant for higher-revenue issuers. While the point estimates for the market impact of the restatements are uncertain, as demonstrated by the confidence intervals presented in the second row of Table 15, the corresponding point estimates for the dollar market impact per restatement announcement are also substantially lower (at $1.4 million versus $22.0 million) for low-revenue seasoned issuers as compared to higher-revenue seasoned issuers. The rate of Item 4.02 restatements with negative financial statement impact or with net income impact is similar for both categories of issuers, at about 80 percent. We also consider how the average dollar market impact of the restatements relates to the average dollar correction in annualized net income, in case investors react more strongly per dollar of the correction in annualized net income for low-revenue issuers. However, Table 15 does not provide evidence that the corresponding point estimate dollar market impact is proportionately greater relative to the average annualized effect on net income for low-revenue seasoned issuers than for high revenue seasoned issuers.594 Overall, we acknowledge that a lower reliability of their financial statements may have significant effects on the valuation of certain low-revenue issuers. It is possible, for example, as one commenter stated, that ‘‘[for] many lowrevenue companies that are struggling to become high revenue companies . . . their ability to attract capital may depend primarily on their ability to convince analysts and investors that their revenues are strong and steadily rising.’’ 595 However, when we consider 590 While, as discussed above, we also refine the analysis presented in Figure 7 to exclude consecutive disclosures that continue to report material weaknesses and to limit the analysis to seasoned issuers, we find that these choices have more modest effects on the pattern of cumulative average abnormal returns. 591 Staff analysis of material weakness disclosures that were accompanied by large positive or negative stock returns found evidence of announcements of confounding news that are associated with large positive returns (e.g., significantly beat earnings estimates, positive news about Phase III trial, liquidity infusion, merger announcement) and large negative returns (e.g., significantly miss earnings estimates, liquidity problems and security issuance at significant discount). See also, e.g., Paul Griffin, Got Information? Investor Response to Form 10–K and Form 10–Q EDGAR Filings, 8(4) Rev. of Acct. Stud. 433 (2003) (for more detail on the overall information content of annual reports) and Edward Li and K. Ramesh, Market Reaction Surrounding the Filing of Periodic SEC Reports, 84(4) Acct. Rev 1171 (2009) (for further analysis of the information content released in, and at the time of, annual report filing). 592 Staff analysis of material weakness disclosures that were preceded by an ICFR auditor attestation reporting effective ICFR found that in about onethird of cases these new material weaknesses had been disclosed prior to the annual report, such as in an Item 4.02 Form 8–K or a Form 10–Q filing. 593 The estimates in Table 15 are based on staff analysis of restatements associated with an Item 4.02 8–K dated within calendar years 2009 through 2018. The sample includes, for issuers that are not within five years of their IPO, 260 restatements by low-revenue issuers and 384 restatements for higher-revenue issuers with non-missing stock returns. The data on restatements, including their financial statement effects, are from Audit Analytics. Revenues are measured as of the beginning of the restated period. The data on revenues and IPO dates are from Compustat. The announcement returns are cumulative abnormal returns based on results from the Event Study by WRDS module available through Wharton Research Data Services. They represent the cumulative abnormal returns for the two-day event period including the date of the associated 8–K filing and the following trading day. These abnormal returns are estimated relative to a benchmark model of returns based on the three Fama-French factors and a momentum factor, where the model parameters are calculated over an estimation period of up to 100 trading days ending 50 trading days before the event date. The confidence intervals are based on the standardized cross-sectional test of Boehmer et al. 1991, note 586 above. 594 In particular, the ratio of average dollar market impact of the restatements relative to the average dollar correction in annualized net income for lowrevenue seasoned issuers is ¥$1.4M/¥$1.9M or about 0.7, while the corresponding ratio for higherrevenue seasoned issuers is ¥$22.0/¥$13.2 or about 1.7. 595 See letter from CFA. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 PO 00000 Frm 00052 Fmt 4701 Sfmt 4700 E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations the evidence in aggregate across the population of low-revenue and higherrevenue seasoned issuers based on the three different types of analyses in this section, we find some evidence that financial statements and their reliability are less associated with market prices for low-revenue issuers and no evidence that there is a stronger association with market prices for low-revenue issuers than for higher-revenue issuers. Therefore, we continue to believe that the evidence supports the supposition that relative to higher-revenue issuers, the value of low-revenue issuers, on average, hinges more on their future prospects than on their current financial performance, and that this consideration should mitigate the potential adverse effects of the amendments. lotter on DSKBCFDHB2PROD with RULES2 d. Potential Economic Costs of Effects on ICFR, the Reliability of Financial Statements, and Potential Fraud A number of commenters indicated that we should make further attempts to quantify the potential costs of the amendments.596 A few commenters further asserted that the costs of the amendments will significantly outweigh any benefits.597 In the previous section, we estimated that the affected issuers that will newly be exempt from all ICFR auditor attestation requirements may eventually experience a 15 percentage point increase in ineffective ICFR and, for a given year of financial statements, an estimated 2 percentage point increase in restatements, a 0.5 percentage point increase in Item 4.02 restatements, and a 0.05 percentage point increase in ‘‘financial reporting fraud’’ associated with those financial statements. In this section, we provide additional monetized estimates of the impact, in dollar terms, which may be associated with certain potential adverse effects. As noted earlier, this discussion and these estimates are focused on affected issuers that will be newly exempt from the ICFR auditor attestation requirement and are not expected to be subject to the FDIC auditor attestation requirement. Overall, as discussed in more detail below, we are able to quantitatively estimate, per year per affected issuer, a total of approximately $60,000 in costs and an additional approximately $10,000 in transfers across shareholders, which represent costs to some shareholders and benefits to other shareholders.598 These estimates reflect 596 See, e.g., letters from Better Markets, CFA Inst., CII, Prof. Barth et al., and Prof. Ge et al. 597 See, e.g., letters from Better Markets and Prof. Barth et al. 598 The costs we estimate represent actual forgone value, while the transfers simply represent VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 our quantification, based on the available evidence and data, of potential effects related to operating performance, restatements, and financial reporting fraud. We note that we are unable to adjust the dominant component of the estimates (the estimated effect on operating performance) for the mitigating factors associated with lowrevenue issuers that we discuss throughout this release, so the total estimate of costs may be inflated. Given that our estimate of the cost savings per year per affected issuer is $210,000, we do not find evidence to support the views of the commenters that indicated that the costs of the amendments would significantly outweigh the benefits. However, we note two main caveats associated with our estimates of the costs and transfer that may result from the amendments, and with the underlying components of these estimates, which are discussed in more detail below. First, these estimates are necessarily more uncertain than our monetized estimates of cost savings to issuers because they are based on a larger number of assumptions. Secondly, we caution against attempts to over-interpret the relation between our quantitative estimates of monetized benefits and monetized costs, because neither of these measures is complete. For example, we are not able to monetize the potential benefit of reduced management distraction from operating activities 599 or the potential market-level costs of reduced efficiency of investor allocation across investment opportunities or reduced investor confidence.600 We therefore are not able to quantify the overall net benefit or cost of the amendments. i. Computation of Monetized Estimates of Costs We provide further quantification of potential adverse effects of the amendments in this section, while the next section provides a discussion of these costs as well as other economic costs that we are unable to quantify. We begin by considering costs that may represent deadweight losses, or net costs to society, followed by a consideration of transfers across shareholders. First, we estimate the potential deadweight losses associated with a potential increase in the risk of fraud. In Section IV.C.3.b.iv. above, we estimated the magnitude of the potential increase in fraud risk to be about $17,500 in market capitalization per year per affected issuer that will be newly exempt from the ICFR auditor attestation requirements. A study that breaks down the equity market impact of fraud into deadweight losses (such as legal costs and impaired reputation) versus the effects that reflect the market adjusting to a more accurate representation of issuers’ financial situations estimates that the former constitute approximately 75 percent of the total equity market loss.601 We therefore estimate the potential average incremental deadweight loss associated with fraud to be $17,500 times 75 percent or roughly $13,000 per year per affected issuer. We consider the remainder of the estimated equity market effect, which represents a transfer from some investors to other investors, separately below. Commenters suggested that we should quantify effects on operating performance associated with ICFR misreporting,602 which are less likely to be corrected by remediation because the underlying material weaknesses are likely undetected. As discussed in the Proposing Release, potential effects of the amendments on operating performance are difficult to measure because the existing studies may not be generalizable to the affected issuers and the methods used in previous studies are difficult to apply to a comparable sample of low-revenue issuers in recent years.603 However, in response to these comments, we rely on the results of a recent study 604 to provide an estimate of the possible loss in profits per year associated with ICFR misreporting. While we expect that the anticipated effect on the affected issuers would be reduced relative to those in the study given the mitigating factors specific to low-revenue issuers discussed above, we are unable to estimate an appropriate adjustment to reflect these factors. The study estimates that the difference in return on assets for issuers misreporting that they have effective ICFR versus those that properly report that they have ineffective ICFR (and thereby perhaps also work towards remediating their ICFR) is 3.3 percentage points over three years, or 1.1 percentage point per year. We multiply this difference by our estimate of the potential increase in misreporting of effective ICFR from Section IV.C.3.b.ii. above, which (based on statistics from the same study) is 3.5 percentage points, and the estimated average total assets of the affected 601 See Karpoff et al. 2008 Study, note 562 above. e.g., letters from CII, Prof. Barth et al., and Prof. Ge et al. 603 See Section III.C.4.c. of the Proposing Release, note 4 above. 604 See Ge et al. 2017 Study, note 393 above. 602 See, corrections to reflect an issuer’s true financial position. 599 See, e.g., letter from Sutro. 600 See, e.g., letter from CII. PO 00000 Frm 00053 Fmt 4701 Sfmt 4700 17229 E:\FR\FM\26MRR2.SGM 26MRR2 lotter on DSKBCFDHB2PROD with RULES2 17230 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations issuers that will be newly exempt from all ICFR auditor attestation requirements from Section IV.C.1 above, which is $125 million. This results in an estimated reduction in potential earnings of about $48,000 per year on average for an affected issuer. As noted above, this estimate may be inflated, as it does not reflect any of the mitigating factors specific to low-revenue issuers discussed above. In total, we estimate potential issuerlevel costs of $48,000 in reduced earnings plus $13,000 in losses related to the increased risk of fraud, or roughly $60,000 in costs per year on average per affected issuer, though we view this estimate as conservative because it does not fully account for the mitigating factors discussed above. Next, we note that some of the potential adverse effects quantified in Section IV.C.3.b. above may be associated with stock market values that fail, at a given time, to reflect issuers’ actual financial position. This potential inflation and later correction of stock market values would result in transfers that benefit some shareholders and harm other shareholders. Further, the same shareholder may benefit in certain of his shareholdings and be harmed in other shareholdings. Also, at any given time, the stock price may be inflated for certain reasons but have corrected for other prior inflation, depending on the timing of the revelation of the underlying issues. For the purpose of quantification of these potential transfers, we assume that issues are revealed gradually and smoothly over time, such that there is an even effect across years. The first source of mispricing we consider is misstatements that later translate into restatements. In Section IV.C.3.b.iii. above, we estimated that the magnitude of the potential increase in Item 4.02 restatements represented ¥$5,000 in stock market impact per year per affected issuer. Secondly, we estimated earlier in this section that the magnitude of the potential increase in fraud risk is about ¥$17,500 in market capitalization per year per affected issuer, of which 25 percent or about ¥$4,500 reflects the market adjusting to a more accurate representation of issuers’ financial situations.605 Summing these quantified effects, and rounding up, we estimate that there may be approximately $10,000 of pure transfers across shareholders per year 605 We note that some portion of this correction may already be incorporated in our estimate with respect to restatements given that we do no separately consider restatements that are associated with specific charges or allegations versus other statements. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 per affected issuer representing these corrections in stock values to reflect issuers’ actual financial positions. As discussed above, these estimates are intended to be responsive to commenters who indicated that further quantitative analysis of the costs of the amendments would be appropriate. One commenter also provided alternative quantified estimates of the costs of expanding the exemption from the ICFR auditor attestation requirement, estimating a $1.7 million loss in future earnings and $2.2 million in forgone market value per issuer.606 While we rely on evidence from the same underlying study that this commenter uses for some of our estimates, we do not rely on these specific estimates for two primary reasons. First, the underlying study indicates that these per issuer estimates apply not to all issuers but only to those issuers that are suspected of misreporting that their ICFR is effective when exempted from the ICFR attestation requirement, which the study estimates to be only 9.3 percent of the issuers.607 Secondly, these estimates reflect aggregate effects over three years and we scale everything to annualized effects for better comparability.608 We also note that the estimate described by the commenter as forgone market value is described in the underlying study as a delay in a market value decline that would otherwise happen currently, not as an increase in market capitalization that could be captured under the ICFR auditor attestation requirement.609 606 See 607 See letter from Prof. Barth et al. Ge et al. 2017 Study, note 393 above. 608 Id. 609 Id. In particular, this study estimates a stock market value correction that would be delayed until ICFR misreporters experience the negative consequences of ineffective ICFR (such as restatements or lower operating performance), rather than resulting immediately because of a disclosure of ineffective ICFR. The study estimates that a $2.2 million stock market value correction would be delayed across a period of three years per suspected misreporter, who are estimated to represent 9.3 percent of the issuers exempt from the ICFR auditor attestation requirement. Annualizing and generalizing the study’s estimate across issuers’ results in an estimated delayed stock market correction per year per affected issuer of about $70,000 ($2.2 million divided by three years times 9.3 percent). We note that this estimate is similar to the likely stock market impact of the quantified costs and transfers that we estimate may result from the adverse effects of removing the ICFR auditor attestation requirement for the affected issuers (such as restatements and lower operating performance). In particular, our estimate of about $10,000 in potential transfers per year per affected issuer represents a $10,000 potential stock market correction per year per affected issuer. Our estimate of quantified potential costs of about $60,000 per year per affected issuer would likely be reflected in a similarly-sized stock market reaction, for a further potential stock market correction of about $60,000 per year per affected issuer, and a total of about PO 00000 Frm 00054 Fmt 4701 Sfmt 4700 Another commenter 610 cited the same underlying study’s 611 estimates of quantified costs and benefits associated with the ICFR auditor attestation. As discussed above, the study estimates, in aggregate and in present value terms, a total of $388 million in aggregate audit fee savings and a total of $719 million in lower earnings associated with exempting non-accelerated filers.612 While the commenter did not suggest that we adopt those specific estimates, we note that we do not rely directly on those estimates, which apply to a different context. In particular, the estimates in that study are intended to quantify the costs and benefits associated with the exemption that applies to all existing non-accelerated filers, versus those associated with extending the exemption to the smaller number and different type of affected issuers discussed in this release. However, as discussed in more detail throughout the release, we do rely on some results and approaches from that study in constructing our own estimates. ii. Discussion of Economic Costs While the previous section provided computations of monetary estimates of certain potential adverse effects of the amendments, this section provides further discussion of those costs as well as other economic costs that we are unable to quantify. Per the discussion in Section IV.C.3.a. above, any impact of the amendments on the effectiveness of ICFR and the reliability of financial statements may have issuer-level implications as well as market-level implications. At the issuer level, the potential increase, on average, in the rate of ineffective ICFR and restatements may lead investors to charge a somewhat higher average cost of capital for the affected issuers. An issuer’s cost of capital, or the expected return that investors demand to hold its securities, determines the price at which it can raise funds. Thus, any such increase may be associated with a reduction in $70,000 ($10,000 plus $60,000) in stock market effects per year per affected issuer, the same as the estimate implied by the study. That said, we differ somewhat in the attribution of this total to deadweight costs versus transfers, as the Ge et al. 2017 study, note 393 above, suggests that the total estimated stock market effect may represent only a difference in timing of the effect and thus a transfer across shareholders. 610 See letter from Prof. Ge et al. 611 See Ge et al. 2017 Study, note 393 above. 612 This study also estimates a delay over three years in the timing of a market value decline (that would otherwise have occurred at the beginning of this three year period) of $935 million associated with the exemption from the ICFR auditor attestation requirement. See Section IV.C.2.b.ii. above. E:\FR\FM\26MRR2.SGM 26MRR2 lotter on DSKBCFDHB2PROD with RULES2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations capital formation to the extent that it decreases the rate at which the affected issuers raise new capital towards new investments. Further, the affected issuers may also experience reduced operational efficiency because of the reduced reliability of financial information available to management for the purpose of making operating decisions. These potential effects are supported by a number of studies discussed above.613 Finally, there may be legal and reputational costs associated with any increase in the risk of fraud, which would represent deadweight losses, or net costs to society. Several commenters expressed the view that eliminating the ICFR auditor attestation requirement would increase the cost of capital for certain issuers because of the potential effects of this change on the reliability of the financial statements of the affected issuers.614 The potential issuer-level effect on the cost of capital is difficult to confirm and to quantify for the affected issuers because the existing studies may not be generalizable to the affected issuers and to the current nature of ICFR auditor attestations (i.e., after the 2007 change in the ICFR auditing standard, the 2010 change in risk assessment auditing standards, and recent PCAOB inspections focused on these aspects of audits). Further, some of these studies provide mixed evidence, as discussed in Section IV.C.3.a. above. Moreover, the methods used in previous studies are difficult to apply to a comparable sample of low-revenue issuers in more recent years because, for example, there would only be a small sample of such issuers that recently switched filing status and because methods of measuring the implied cost of capital are particularly problematic for such issuers.615 Commenters did not provide us with estimates or data that could be used to estimate potential effects on the cost of capital. The available evidence supports the qualitative, directional effects on cost of capital noted above. That is, some of the affected issuers could experience an increase in their cost of capital. However, the previous section demonstrated that the potential increase in material weaknesses in ICFR that we estimate could occur may translate into a more limited effect on the reliability of disclosures, as measured, for example, by the rate of restatements, for the affected issuers. Also, based on our analysis, the financial metrics of these 613 See Section IV.C.3.a. above. e.g., letters from BDO and CFA. 615 See note 481 above. 614 See, VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 issuers have lower explanatory power for investors’ determination of their value than in the case of other issuers. These two factors may mitigate the potential adverse effects on the affected issuers’ cost of capital. In addition, some of the costs of extending the exemption from the ICFR auditor attestation requirement to additional issuers may be further mitigated by the fact that some issuers, even if exempted, may voluntarily choose to bear the costs of obtaining such an attestation.616 Affected issuers that expect a lower cost of capital with an ICFR auditor attestation, such as those with effective ICFR,617 and particularly those that will be raising new debt or equity capital,618 are more likely to voluntarily obtain an ICFR auditor attestation. We note that lowrevenue issuers have less access to internally-generated capital, as discussed above, so they may be more reliant on external financing for capital. Consistent with this argument, commenters suggested that issuers may voluntarily obtain an ICFR auditor attestation if it were demanded by investors,619 not complying would have a negative impact on investment analysts’ coverage,620 or issuers deem it a good use of their capital resources.621 Further, as discussed in Section IV.C.4.d. below, we note that the benefits and therefore likelihood of voluntarily obtaining ICFR auditor attestations may be increased by the new check-box disclosure on annual reports required by the amendments, in that investors should be more able to readily discern which issuers obtained an ICFR auditor attestation.622 However, it is probably not the case that issuers would voluntarily obtain an ICFR auditor attestation in every case in 616 Studies have associated voluntary compliance with the ICFR auditor attestation requirement with decreased cost of capital and value enhancements. See, e.g., Cory Cassell, Linda Myers, & Jian Zhou, The Effect of Voluntary Internal Control Audits on the Cost of Capital, Working Paper (2013) (Cassell et al. 2013 Study), available at https:// papers.ssrn.com/sol3/papers.cfm?abstract_ id=1734300; Todd Kravet, Sarah McVay, & David Weber, Costs and Benefits of Internal Control Audits: Evidence from M&A Transactions, Rev. of Acct. Stud. (forthcoming 2018), available at https:// papers.ssrn.com/sol3/papers.cfm?abstract_ id=2958318; and Carnes et al. 2019 Study, note 397 above. We note that the latter two studies are not able to differentiate between the effects of the ICFR auditor attestation and of management’s assessment of ICFR under SOX Section 404(a). 617 See Brown et al. 2016 Study, note 396 above. 618 See Cassell et al. 2013 Study, note 616 above. 619 See, e.g., letters from BIO and Guaranty. 620 See, e.g., letter from Guaranty. 621 Id. 622 See 2013 GAO Study, note 246 above. PO 00000 Frm 00055 Fmt 4701 Sfmt 4700 17231 which the total benefits of doing so would exceed the total costs.623 The available evidence also supports the qualitative, directional effects on operating performance noted above. That is, some of the affected issuers could experience lower operating performance due to reliance on less reliable financial statements in their decision-making. Like the potential effects on the cost of capital, the potential effect on issuer operating performance associated with reported ineffective ICFR is also difficult to estimate and is likely to be mitigated by the multiple factors discussed above. Further, the point estimates in one study demonstrate that issuers that remediate their reported material weaknesses in ICFR might be able to make up a substantial amount of the previous operating underperformance.624 We do, however, quantify potential effects on operating performance associated with ICFR misreporting, which are less likely to be corrected by remediation because the underlying material weaknesses are likely undetected. We also estimate potential deadweight losses (e.g., legal and reputational costs) associated with a possible increase in the risk of fraud. In total, per Section IV.C.3.d.i. above, we estimate potential issuer-level costs of $48,000 in reduced earnings plus $13,000 in losses related to the increased risk of fraud, or roughly $60,000 in costs per year on average per affected issuer, though we view this estimate as conservative because it does not fully account for the mitigating factors specific to low-revenue issuers discussed above. We note that issuers and other market participants may adapt to the proposed changes in various ways, which may serve to enhance or mitigate the anticipated issuer-level costs. However, these actions, and therefore their net effects, are difficult to predict. For 623 There is substantial literature describing the fact that in certain circumstances the incentives of managers are not perfectly aligned with those of shareholders. See, e.g., Michael Jensen & William Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3(4) J. of Fin. Econ. 305 (1976). Also, as discussed in Section IV.C.3.a. above, the ICFR auditor attestation requirement can have important market-level benefits through network and spillover effects that issuers are unlikely to internalize. That is, issuers are likely to balance the issuer-level benefits against the issuer-level costs of voluntary compliance without considering these externalities. 624 See Feng et al. 2015 Study, note 484 above, (with point estimates of a one percent reduction in ROA in years with material weaknesses in ICFR and a 2.6 percent increase in ROA upon remediation, though there is significant uncertainty around these rates). E:\FR\FM\26MRR2.SGM 26MRR2 17232 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations example, it has been posited that issuers reacted to the requirements of SOX by reducing accruals-based earnings management and, in its stead, making suboptimal business decisions for the purpose of real earnings management.625 It is therefore possible that newly exempt issuers could, to some extent, reduce real earnings management in favor of accruals-based management. Another possibility is that scrutiny from analysts may provide an alternative source of discipline for some of the affected issuers, although there is evidence that analysts may stop covering issuers whose financial statements are deemed to have become less reliable.626 While the preceding analysis considers the average effects across the affected issuers on the effectiveness of ICFR and the reliability of financial statements, the potential issuer-level costs of the proposed extension of the exemption from the ICFR auditor attestation requirement likely vary across different types of affected issuers. For example, the effects may vary based on issuers’ proclivity to detect and disclose material weaknesses in ICFR in the absence of an ICFR auditor attestation requirement and whether the issuers’ have characteristics that the market associates with having such material weaknesses. We discuss this variation in detail in the Proposing Release.627 We next consider effects at the market-level. Some of these effects are associated with the transfers across shareholders that we estimated in Section IV.C.3.d.i. above. In total, we estimated that there may be approximately $10,000 of pure transfers across shareholders per year per affected issuer representing corrections in stock values to reflect issuers’ actual financial positions. These transfers and the associated mispricing may reduce the efficient allocation of capital at the market level. Further, to the extent that the reliability of financial statements is somewhat reduced on average at the issuer level for the affected issuers, the lotter on DSKBCFDHB2PROD with RULES2 625 See Daniel Cohen, Aiyesha Dey, & Thomas Lys, Real and Accrual-Based Earnings Management in the Pre- and Post-Sarbanes Oxley Periods, 83(3) Acct. Rev. 757 (2008) (finding that an increase in real earnings management partially offset the decrease in accruals-based earnings management that followed SOX). See also Coates and Srinivasan 2014 Study, note 369 above, at 646–647. 626 See Sarah Clinton, Arianna Pinello, & Hollis Ashbaugh-Skaife, The Implications of Ineffective Internal Control and SOX 404 Reporting for Financial Analysts,’’ 33(4) J. of Acct. and Pub. Pol’y 303 (2013) (finding that the disclosure of internal control weaknesses is followed by a decline in analyst coverage). 627 See Section III.C.4.c. of the Proposing Release, note 4 above. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 efficient allocation of capital at the market level may be negatively affected given a diminished ability to reliably evaluate different investment alternatives.628 The reduced reliability of financial statements could also negatively impact capital formation through a reduction in investor confidence. Several commenters noted that they expected the amendments to have a negative effect on investor confidence.629 In contrast, one commenter asserted that there is no correlation between a smaller company’s compliance with the ICFR auditor attestation requirement and stronger markets in general,630 while two others noted that they did not expect effects on investor confidence with respect to affected issuers that are banks.631 Section IV.C.3.a. provides additional discussion of these market-level factors. While we are unable to directly quantify the market-level effects on the efficient allocation of capital and on investor confidence, we anticipate that these effects may be limited due to the size of the expected effect on the reliability of these issuers’ disclosures and potential transfers across shareholders as well as the small percentage of the total value of traded securities that is represented by the affected issuers. In particular, we estimate that the affected issuers that will be newly exempt from all ICFR auditor attestation requirements represent 0.2 percent of the total equity market capitalization of issuers.632 4. Potential Benefits and Costs Related to Other Aspects of the Amendments In this section we consider the potential effects of the amendments with regard to other implications of accelerated filer status, specifically with respect to the timing of filing deadlines, certain required disclosures, and the determination of filer status. We also consider below some incremental effects of the amendments to the thresholds for exiting accelerated and large accelerated filer status and the new check-box 628 The efficient allocation of capital may be further reduced to the extent that the potential cost of capital effects discussed above operate through a reduction in the liquidity of the market for these issuers’ shares, which increases the costs to investors looking to adjust their investments or redeploy their capital. See Diamond and Verrecchia 1991 Study, note 477 above. 629 See, e.g., letters from Better Markets and CII. 630 See letter from BIO. 631 See letters from BSC and SCBA. 632 This statistic is based on staff analysis of data from Compustat. The total population of issuers used to construct this estimate are those that have annual reports on Forms 10–K, 20–F, or 40–F in calendar year 2018 and data on market capitalization in Compustat. See above note 336 for detail on the identification of affected issuers. PO 00000 Frm 00056 Fmt 4701 Sfmt 4700 disclosure required on the cover page of annual reports on Form 10–K, 20–F, or 40–F. a. Filing Deadlines As discussed in Section IV.B.1. above, non-accelerated filers are permitted an additional 15 days and five days, respectively, beyond the deadlines that apply to accelerated filers, to file their annual and quarterly reports. Extending these later deadlines to the affected issuers may provide these issuers with additional flexibility in preparing their disclosures, while modestly decreasing the timeliness of the data for investors. Table 6 in Section IV.B.3. demonstrates that while the filing deadlines are not a binding constraint for most accelerated filers, with 63 percent filing their annual reports over five days early in recent years, some accelerated filers are likely to benefit from the extended deadline. For example, filing Form NT automatically provides a grace period of an additional 15 days to file an annual report, and over the past four years, about four percent of accelerated filers filed their annual reports within this grace period rather than by the original deadline. A further five percent of accelerated filers filed their annual reports after these additional 15 days had passed. Even affected issuers that would otherwise have filed by the accelerated filer deadline may avail themselves of the additional time provided under the amendments to balance other obligations or to prepare higher quality disclosures. The 2003 acceleration of filing deadlines for accelerated filers from 90 to 75 days was associated, at least initially, with a higher rate of restatements for the affected issuers.633 This finding suggests that a later deadline may allow some issuers to provide more reliable financial disclosures. While these issuers could alternatively file Form NT to receive an automatic extension, studies have found that investors interpret such filings as a negative signal, resulting in a negative stock price reaction.634 Issuers may thus 633 See, e.g., Colleen Boland, Scott Bronson, & Chris Hogan, Accelerated Filing Deadlines, Internal Controls, and Financial Statement Quality: The Case of Originating Misstatements, 29(3) Acct. Horizons 551 (2015) (‘‘Boland et al. 2015 Study’’); and Lisa Bryant-Kutcher, Emma Yan Peng, & David Weber, Regulating the Timing of Disclosure: Insights from the Acceleration of 10–K Filing Deadlines, 32(6) J. of Acct. and Pub. Pol’y 475– (2013). 634 See Joost Impink, Martien Lubberink, & Bart van Praag, Did Accelerated Filing Requirements and SOX Section 404 Affect the Timeliness of 10–K Filings?, 17(2) Rev. of Acct. Stud. 227 (2012) and Eli Bartov & Yaniv Konchitchki, SEC Filings, Regulatory Deadlines, and Capital Market Consequences, 31(4) Acct. Horizons 109 (2017). E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 prefer to meet the original deadline if possible. On the other hand, allowing the affected issuers to file according to the later non-accelerated filer deadlines may reduce the timeliness and therefore usefulness of the disclosures to investors. Studies have found a reduction in the market reaction to disclosure when the reporting lag between the end of the period in question and the disclosure date is lengthy, as more of the information becomes available through other public channels.635 Researchers have also questioned whether such lags increase information asymmetries, because some investors are more able to access or process information that could provide indirect insight into an issuer’s financial status or performance through alternative channels.636 One study found that the 2003 acceleration of filing deadlines was associated with a decrease in the market reaction to the disclosure of annual reports for accelerated filers.637 Based on this result and supplementary tests regarding the change in disclosure quality and change in timeliness after the acceleration of deadlines, the authors concluded that the negative effect of the shorter deadline on the quality of disclosure appeared to dominate the beneficial effect on the timeliness of the disclosure for these issuers.638 While this finding might not be directly applicable 15 years later, and there is some evidence that some of these effects were temporary,639 in the absence of other evidence we expect the net effect of the extended filing deadlines to be beneficial on average but modest overall. One commenter, citing the complexity of current accounting standards and the volume of disclosure requirements, agreed that the benefits of the extended deadlines for the affected issuers were likely to outweigh their 635 See, e.g., Dan Givoly & Dan Palmon, Timeliness of Annual Earnings Announcements: Some Empirical Evidence, 57(3) Acct. Rev. 486 (1982). 636 See, e.g., Nils Hakansson, Interim Disclosure and Public Forecasts: An Economic Analysis and a Framework for Choice, 52(2) Acct. Rev. 396 (1977) and Baruch Lev, Toward a Theory of Equitable and Efficient Accounting Policy, 63(1) Acct. Rev. 1 (1988). We note that Regulation FD generally prohibits public companies from disclosing nonpublic, material information to selected parties unless the information is distributed to the public first or simultaneously. See 17 CFR 243.100 to 17 CFR 243.103. 637 See Jeffrey Doyle & Matthew Magilke, Decision Usefulness and Accelerated Filing Deadlines, 51(3) J. of Acct. Res. 549 (2013). We note that this study found the reverse to be true for large accelerated filers. 638 Id. 639 See, e.g., Boland et al. 2015 Study, note 633 above. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 costs.640 Other commenters did not opine on the costs and benefits of the changes in filing deadlines for the affected issuers. b. Disclosures Required of Accelerated Filers Non-accelerated filers are not required to provide disclosure regarding the availability of their filings under Item 101(e)(4) of Regulation S–K. While some investors may benefit from reduced search costs due to such disclosures, we do not expect that extending the exemption from these disclosures to the affected issuers will have significant economic effects. Non-accelerated filers also are not required to provide disclosure required by Item 1B of Form 10–K or Item 4A of Form 20–F about unresolved staff comments on their periodic and/or current reports. Studies have found that the eventual disclosure of staff comments and related correspondence, as well as interim information about these comments before they are made public, are value-relevant (in that they affect the pricing of securities) for investors.641 While our understanding is that Items 1B and 4A disclosures are relatively uncommon,642 extending the exemption from the requirement to disclose unresolved staff comments to the affected issuers may, in some circumstances, prevent the timely disclosure of value-relevant information to public market investors. Moreover, because Item 1B of Form 10–K and Item 4A of Form 20–F requires unresolved staff comments to be disclosed if they were made not less than 180 days prior to the end of that fiscal year, issuers no longer subject to this disclosure requirement may have a reduced incentive to resolve comments in a timely manner, which could decrease the quality of reporting for the period over which comments continue to be unresolved. We did not receive any comments on these potential effects. c. Transition Thresholds The amendments include revisions to the transition thresholds that address when an accelerated filer or large accelerated filer can transition into a different filer status. The amendments will allow accelerated or large 640 See letter from BDO. e.g., Patricia Dechow, Alastair Lawrence, & James Ryans, SEC Comment Letters and Insider Sales, 91(2) Acct. Rev. 401 (2015) and Lauren Cunningham, Roy Schmardebeck, & Wei Wang, SEC Comment Letters and Bank Lending, Working Paper (2017), available at https://papers.ssrn.com/sol3/ papers.cfm?abstract_id=2727860. 642 Based on staff analysis using the Intelligize database, approximately 20 issuers included Item 1B disclosures in Forms 10–K filed in 2017. 641 See, PO 00000 Frm 00057 Fmt 4701 Sfmt 4700 17233 accelerated filers to become nonaccelerated filers if they qualify under the SRC revenue test or meet a revised public float transition threshold. An issuer whose revenues previously exceeded the SRC initial revenue threshold of $100 million will not qualify under the SRC revenue test unless its revenues fall below $80 million. The $80 million transition threshold for the SRC revenue test is 80 percent of the initial threshold of $100 million in revenue. An issuer whose public float previously exceeded the $75 million initial threshold for accelerated filer status will become a nonaccelerated filer if its public float falls below $60 million, or 80 percent of that initial threshold, as opposed to the current threshold of $50 million. Finally, the amendments also revise the public float transition threshold for exiting large accelerated filer status and becoming an accelerated filer from $500 million to $560 million in public float, or 80 percent of the $700 million entry threshold, to align with the transition threshold for entering SRC status after having exceeded $700 million in public float. The filer type exit thresholds in Rule 12b–2 are set below the corresponding entry thresholds to provide some stability in issuer classification given normal variation in public float and revenues. The exact placement of these thresholds involves a tradeoff between the degree of volatility in classification versus the extent to which the categories persistently include issuers that are below the initial entry thresholds. The Proposing Release presented a quantitative analysis of this tradeoff using 20 years of data on the evolution of market capitalizations (as a proxy for public float) and revenues.643 In particular, this analysis demonstrated that a higher exit threshold is associated with more volatility in classification. For example, exit thresholds set at 100 percent of the public float entry thresholds would have led eight to ten percent of new entrants into a filer status to immediately exit the following year and then re-enter once again the year after that. Issuers and investors may be confused as a result of such frequent fluctuations in filer type. They may also bear resulting costs, such as (for issuers) the cost of frequently revising their disclosure schedules and continually considering the impact of whether they are subject to the ICFR auditor attestation requirement from one year to the next and (for investors) any incremental cost of evaluating the 643 See Table 16 of the Proposing Release, note 4 above. E:\FR\FM\26MRR2.SGM 26MRR2 17234 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations lotter on DSKBCFDHB2PROD with RULES2 reliability of financial disclosures for an issuer that is not consistently subject to the ICFR auditor attestation requirement. On the other hand, the analysis in the Proposing Release also illustrated that a lower exit threshold is associated with a greater number of issuers remaining in a particular category despite falling below the entry threshold. For example, exit thresholds set at 60 percent of the public float entry thresholds would have prevented four to six percent of the new entrants into a filer status from exiting that status despite being below the entry threshold in the next two years. A low exit threshold can thus risk having a filer status effectively apply to a broader group of issuers than intended. The analysis in the Proposing Release further demonstrated that the balance between limiting filer status volatility while enabling filer status mobility provided by an exit threshold of 80 percent is similar around a $250 million, $75 million, and $700 million market capitalization. In particular, while five to six percent of the new entrants into a filer status would be expected to transition out and back into the status in the following two years, one to two percent of those entrants would be expected to remain within the same filer status despite being below the entry threshold for the two following years. We therefore expect the increase in the public float thresholds to exit accelerated and large accelerated filer status to $60 and $560 million, or 80 percent of the entry threshold in each case, to lead to a similar tradeoff in these factors as the 80 percent public float threshold to re-enter SRC status. One commenter noted that certain of the affected issuers may recognize revenues unevenly across periods due to certain collaborative arrangements.644 When considering issuers that have empirically crossed a $100 million revenue entry threshold in the past, the analysis in the Proposing Release demonstrated that, on average, these issuers would not be subject to significant volatility in classification. Thus, while some issuers may be subject to such volatility,645 this does not appear to be a widespread concern. In fact, the analysis in the Proposing Release demonstrated that revenue is on 644 See letter from EY. that expect significant volatility in their classification could consider voluntarily obtaining an ICFR auditor attestation in years where one is not required, given that commenters suggested that there would be no significant cost savings from obtaining an ICFR auditor attestation every three years as opposed to annually. See, e.g., letters from Crowe and KPMG. 645 Issuers VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 average more stable than market capitalization, so the 80 percent threshold in the revenue test for exiting accelerated and large accelerated filer status is expected to provide a lower degree of filer status fluctuations for a comparable degree of filer status mobility. Overall, we expect the amended transition thresholds to provide a tradeoff between filer status mobility and volatility that is consistent with the tradeoff provided by the recently revised SRC transition provisions. prominent disclosure would enhance these benefits, it may be a positive factor in the decision of additional firms to voluntarily obtain an ICFR auditor attestation. Such voluntary action by some of the issuers for which the requirement will be eliminated could, as discussed above, mitigate some of the potential negative effects of the amendments, although it is difficult to predict the frequency with which voluntary compliance might occur. d. Disclosure The amendments add a check box to the cover pages of Forms 10–K, 20–F, and 40–F to indicate whether an ICFR auditor attestation is included in the filing. While filer status is reported prominently on the cover page of annual reports for most issuers, there is currently not similarly prominent disclosure of whether an ICFR auditor attestation is provided. Such disclosure has been recommended by the GAO,646 as well as some commenters.647 Investors can already ascertain whether an ICFR auditor attestation is included by searching within an issuer’s annual report, and including additional items on the annual report cover page could marginally decrease the salience of each item already reported there. However, several commenters noted that it is currently difficult for investors to easily determine whether an issuer’s filing includes an ICFR auditor attestation.648 The cover page check box disclosure requirement will make it easier for investors to identify issuers that undergo an ICFR auditor attestation with only minimal additional disclosure expense for registrants. This may, on the margin, increase the efficiency of investment decisions and the allocation of capital across the market. It may also enhance the value to issuers of pursuing an ICFR auditor attestation, even when one is not required, by making it more likely that investors recognize that an issuer has obtained an ICFR auditor attestation and therefore account for this factor in their investment decisions. While issuers that voluntarily obtain an ICFR auditor attestation would bear additional costs to do so, we expect they would voluntarily bear these costs only if they believe that the associated issuerlevel benefits (e.g., a reduced cost of capital) would more than offset those costs. Thus, to the extent that more Below we consider the relative costs and benefits of reasonable alternatives to the implementation choices in the amendments. 646 See 2013 GAO Study, note 246 above. e.g., letters from CAQ, CFA Inst., CII, Grant Thornton, and KPMG. 648 See, e.g., letters from CAQ, CFA Inst., and Grant Thornton. See also 2013 GAO Study, note 246 above. 647 See, PO 00000 Frm 00058 Fmt 4701 Sfmt 4700 5. Alternatives to the Amendments a. Exclude All SRCs From Accelerated Filer Category We considered excluding all SRCs from the accelerated filer definition, consistent with the past alignment of the SRC and non-accelerated filer categories. This alternative would include SRCs that meet the revenue test, as under the adopted amendments, as well as those that have a public float of less than $250 million when initially determining SRC status. Several commenters supported this approach.649 This alternative would have several benefits, such as promoting regulatory simplicity and reducing any frictions or confusion caused by issuers having to make multiple determinations of their filer type. This alternative would also expand the benefits of the amendments to additional issuers. We estimate that 268 additional issuers 650 would be nonaccelerated filers rather than accelerated filers under this alternative, of which 48 are EGCs and 220 would newly be exempt from the ICFR auditor attestation requirement under SOX Section 404(b) (although we estimate that six of these newly exempt filers would still be subject to the FDIC auditor attestation requirement). In the 649 See, e.g., letters from ASA, Guaranty, NAM, and Nasdaq. 650 This estimate is based on staff analysis of the number of accelerated filers in 2018 with public float of at least $60 million but less than $250 million and prior fiscal year revenues (or, in the case of BDCs, investment income) of at least $100 million and that are eligible to be SRCs (i.e., excluding ABS issuers, RICs, BDCs, subsidiaries of non-SRCs, and FPIs filing on foreign forms or using IFRS) or are BDCs (though we estimate that there are no BDCs that meet these criteria). Revenue data is sourced from XBRL filings, Compustat, and Calcbench. See note 298 above for details on the identification of the population of accelerated filers. We note that the incremental number of affected issuers could be higher than this estimate because there are approximately 65 issuers for which filer status and/or public float data are not available (and revenue data is either unavailable or revenues are at least $100 million). E:\FR\FM\26MRR2.SGM 26MRR2 lotter on DSKBCFDHB2PROD with RULES2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations Proposing Release,651 we performed an analysis of the audit fees of lower-float issuers of different types and estimated an average compliance cost savings of $415,000 per year for the additional issuers that would be affected under this alternative, with some of these issuers experiencing lesser or greater savings. This likely represents a significant cost savings for issuers with less than $250 million in public float and may thus have beneficial economic effects on competition and capital formation. As discussed above, smaller issuers generally bear proportionately higher compliance costs than larger issuers. Reducing these additional issuers’ costs would reduce their overhead expenses and may enhance their ability to compete with larger issuers. To the extent that the cost savings for the additional affected issuers enable capital investments that would not otherwise be made, this alternative would also lead to additional benefits in capital formation. However, we expect the costs of this alternative to be greater than for the amendments, primarily due to the broader application of the exemption from the ICFR auditor attestation requirement and the diminished impact of some of the mitigating factors discussed in Section IV.C.3. above on SRCs that meet the public float test rather than the revenue test. In particular, we estimated in the Proposing Release 652 that extending the exemption from the ICFR auditor attestation requirement to issuers that are eligible to be SRCs based on their public float may result in an average increase in the rate of ineffective ICFR of about 25 percentage points among these issuers, somewhat higher than our estimate for low-revenue issuers. The analysis in the Proposing Release 653 also demonstrated that low public float issuers restate their financial statements at rates comparable to higher public float issuers, unlike low-revenue issuers, whose restatement rates were three to nine percentage points lower than for higher-revenue issuers of the same filer status. We therefore believe that the proposition that low-revenue issuers may, on average, be less susceptible to certain kinds of misstatements may not apply to the same extent to issuers with low public float. We estimated in the Proposing Release that the increase in restatement rates for the additional affected issuers may be comparable to the two 651 See Section III.C.6.a. of the Proposing Release, note 4 above. 652 Id. 653 Id. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 percentage points we estimated for lowrevenue issuers, but that, in contrast to the results for low-revenue issuers, this would likely result in higher restatement rates for the additional affected issuers than for the higher public float issuers that would remain accelerated filers. The Proposing Release also tested whether the potential adverse impact of such a change may be mitigated by a lower empirical relevance of financial statements for the market valuation of these issuers. However, we did not find evidence that the market relies on financial statements to a lesser extent for the valuation of issuers with public float less than $250 million (as compared to issuers with a larger public float), and so this further mitigating factor that applies to low-revenue issuers likely does not apply equally to lower public float issuers. Finally, as in Section IV.C.3., we reexamined responses to the 2008–09 Survey. When asked about the net benefits of complying with SOX Section 404, 16 percent of respondents at accelerated filers with public float of less than $250 million claimed that the costs far outweighed the benefits, in contrast to, as reported above, 30 percent of respondents at accelerated filers with revenues of less than $100 million.654 While this survey data is somewhat dated, it provides an indication as to the perception by executives at issuers at that time of the relative costs and benefits of the ICFR auditor attestation requirement. To the extent that this perception is borne out by the actual costs and benefits of the ICFR auditor attestation requirement for issuers that meet the SRC revenue test and for those that would otherwise be SRCs under the public float test, this data may suggest that low-revenue issuers would benefit more from qualifying as non-accelerated filers than would other types of SRCs. We did not receive any comments on our analysis of the benefits and costs of extending non-accelerated filer status to all SRCs. b. Include or Exclude Certain Issuer Types Alternatively, we considered approaches that would include or exclude additional issuer types, or 654 These estimates are based on staff analysis of data from the 2008–09 Survey. The analysis considers responses pertaining to the most recent year for which a given respondent provided a response. We note that the rate of responses to the question about net benefits was lower than for other questions. See 2009 SEC Staff Study, note 304 above, and Alexander et al. 2013 Study, note 401 above, for details on the survey and analysis methodology. PO 00000 Frm 00059 Fmt 4701 Sfmt 4700 17235 apply different requirements to particular issuer types. For example, we could extend non-accelerated filer status to other issuers with between $75 million and $700 million in public float that meet the SRC revenue test but would not be eligible to be SRCs because they are majority-owned subsidiaries of non-SRCs. However, in the Proposing Release, we estimated that only one majority-owned subsidiary of a non-SRC parent would meet the same public float and revenue thresholds as the affected issuers. Given the minimal number of such issuers and the responsibilities of the parent of any such issuers with respect to the ICFR of their subsidiaries, we expect the incremental costs and benefits of this alternative to be minimal. As discussed above, in a change from the proposal, the final amendments also exclude BDCs from the accelerated and large accelerated filer definitions under circumstances that are analogous to the exclusions for other issuers under the amendments. We estimate that approximately 28 BDCs will therefore be affected by the amendments, of which seven are EGCs and therefore already exempt from the ICFR auditor attestation requirement. We recognize, as stated in the Proposing Release, that investors in BDCs generally may place greater significance on the financial reporting of BDCs relative to low-revenue noninvestment company issuers. However, given the small number of BDCs, it is difficult to assess to what extent our findings with respect to the anticipated costs and benefits of the amendments for the broader pool of affected issuers would apply similarly to BDCs as an isolated subset of these issuers.655 We note, however, that one commenter urged that we pursue the adopted approach, stating that, among other reasons, ‘‘[a]llowing smaller BDCs to benefit from non-accelerated filer status, and thereby ease regulatory costs and burdens, could encourage more BDCs to enter the public markets, creating greater access to capital for small operating companies and expanding investment opportunities for retail investors.’’.656 Given the limited 655 While more refined analysis is difficult, we note that, for the 54 to 75 BDCs for which a management report on ICFR is available in Audit Analytics for years 2014 through 2017, the rate of ineffective ICFR reported by management is 9.0 percent, the rate of restatements is 9.8 percent, and the rate of Item 4.02 restatements is 2.3 percent on average across these years, which are comparable to the corresponding rates for all accelerated filers other than EGCs under the baseline. See Section IV.B.4. above. 656 See letter from Proskauer. E:\FR\FM\26MRR2.SGM 26MRR2 17236 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations number of affected issuers that are BDCs, we preliminarily expect the aggregate incremental costs and benefits of this alternative relative to the adopted approach to be modest, as compared to the universe of Form 10–K filers, although they could be significant for any particular issuer and significant for traded BDCs as a class of Form 10–K filers as we estimate the total number of traded BDC filers to be 51 (of which seven have a market capitalization below $75 million and would be already considered non-accelerated filers).657 We also considered alternative thresholds for BDCs, given that BDCs do not report revenue on their financial statements. The amendments exclude a BDC from the accelerated and large accelerated filer definitions in Rule 12b–2 if the BDC: (1) Has a public float of $75 million or more, but less than $700 million; and (2) has investment income of less than $100 million. Table 16 below provides statistics from the Proposing Release on other incomerelated metrics for BDCs with between $70 million and $700 million in public float.658 TABLE 16—CHARACTERISTICS OF BDCS WITH MARKET CAPITALIZATION BETWEEN $75 AND $700 MILLION [In millions] Market capitalization as of February 2019 lotter on DSKBCFDHB2PROD with RULES2 High .......................................................................................... Low .......................................................................................... Average .................................................................................... Median ..................................................................................... Investment income for most recent fiscal year $507.91 89.69 255.30 244.72 Net realized and unrealized gains and losses for most recent fiscal year $108.28 1.62 49.37 47.67 $43.12 (¥123.33) (¥11.15) (¥4.44) Net increase in net assets resulting from operations for most recent fiscal year 60.69 (¥$114.28) $7.70 $13.01 The commenter that supported expanding the proposed amendment to the definition of accelerated filer and large accelerated filer to exclude BDCs suggested that we exclude entities with total investment income of less than $80 million in the most recently completed fiscal year for which audited financial statements are available and either no public float or public float of less than $700 million. Of the 29 BDCs identified in the Proposing Release with a market capitalization between $75 million and $700 million, 28 had investment income of below $100 million and 26 had investment income of below $80 million. We therefore anticipate that the incremental costs and benefits of a threshold of $80 million in investment income as compared to the adopted threshold of $100 million in investment income would be limited. We also considered whether to require or permit BDCs to provide an independent public accountant’s report on internal controls, similar to the one required by RICs on Form N–CEN, since both RICs and BDCs prepare financial statements under Article 6 of Regulation S–X, in place of the auditor attestation required by SOX Section 404(b). We considered whether such a substitution should be permitted for all BDCs or only required for those BDCs that would no longer be required to provide a report under SOX Section 404(b). We do not have any data and did not receive any public comment, however, regarding the potential benefits and costs of using a Form N–CEN-type report on internal controls as compared to the auditor attestation required by SOX Section 404(b). We also considered excluding all FPIs, which are included in the affected issuers to the extent that they meet the required thresholds and other qualifications, from the amendments. Researchers have found that the restatement rates of foreign issuers may be artificially depressed due to a lower likelihood of detection and disclosure of misstatements for these issuers.659 It is therefore possible that encouraging more effective ICFR through an ICFR auditor attestation requirement may be particularly important for such issuers. On the other hand, because low-revenue FPIs may have similar characteristics to low-revenue domestic issuers, including them in the group of affected issuers may help to maintain an even playing field for competition amongst these issuers and avoid discouraging foreign companies from issuing securities in U.S. public markets. The amendments attempt to strike a balance between these considerations by allowing FPIs to avail themselves of the amendments only if they file on domestic forms and present their financial statements pursuant to U.S. GAAP, as well as meeting the required thresholds and other qualifications.660 Because of limitations in the availability of data such as filing status or public float for many FPIs, we are unable to reliably measure the potential effects for this subset of issuers. Commenters did not provide data that would allow us to further analyze the potential effects for these issuers. 657 Nontraded BDCs also file on Form 10–K, but these issuers are already non-accelerated filers because they do not have public float. 658 This analysis used market capitalization valuations as of February 2019 to determine the set of potentially affected BDCs under different alternatives. While this methodology is different than the approach used by Rule 12b–2, which uses the aggregate worldwide market value of the voting and non-voting common equity held by nonaffiliates as of the last business day of the issuer’s most recent second fiscal quarter, we do not believe that it would substantially change our analysis. This analysis did not remove BDCs who may qualify as non-accelerated filers based on their status as EGCs. After identifying the set of potentially affected BDCs, our staff manually reviewed the then-most recent Form 10–K filed on our EDGAR system for each BDC. The affected parties estimates in Section IV.C.1. above uses selfidentified filer status to identify affected BDCs (as well as other affected issuers), rather than using market capitalization data for this purpose. In particular, current status as an accelerated filer implies that the issuer’s Rule 12b–2 public float does not exceed $700 million. See above note 336. Also, the public float of the affected BDCs was manually collected for the purpose of related statistics in Section IV.C.1. See notes 356, 366, and 367 above. 659 See, e.g., Suraj Srinivasan, Aida Sijamic Wahid, & Gwen Yu, Admitting Mistakes: Home Country Effect on the Reliability of Restatement Reporting, 90(3) Acct. Rev. 1201 (2015). 660 While we currently estimate that no FPIs would currently qualify based on these requirements, we note that there are FPIs that otherwise meet the required thresholds and other qualifications and that might choose to file on domestic forms using U.S. GAAP in order to benefit from the amendments as well as the scaled disclosure accommodations available to SRCs if these benefits outweigh the costs of changing their disclosure regime. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 PO 00000 Frm 00060 Fmt 4701 Sfmt 4700 c. Alternative Threshold We considered alternative levels at which a revenue threshold could be set. A $100 million dollar revenue threshold E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations was recommended, in conjunction with a public float threshold, for the accelerated filer definition as well as the SRC definition by the 2017 Small Business Forum and a participant at the September 2017 meeting of the former Advisory Committee on Small and Emerging Companies (‘‘ACSEC’’).661 The $100 million threshold is also aligned with the SRC revenue test. Empirically, we find no obvious break in the distribution of revenue or in the results of our analysis. In general, lowering the revenue threshold would reduce the expected benefits of the amendments by reducing the number of issuers that would experience cost savings, while also reducing the expected costs of the amendments by reducing the potential adverse impact on the reliability of financial statements. Increasing the threshold would increase the expected benefits while also increasing the expected costs. We did not receive comments on the costs or benefits of alternative levels of a revenue threshold or of alternative metrics that should be used instead of revenue (except in the case of BDCs, as discussed above). V. Paperwork Reduction Act lotter on DSKBCFDHB2PROD with RULES2 A. Summary of the Collections of Information Certain provisions of our rules and forms that would be affected by the amendments contain ‘‘collection of information’’ requirements within the meaning of the Paperwork Reduction Act (‘‘PRA’’). The Commission published a notice requesting comment on the collection of information requirements in the Proposing Release, and submitted the proposed amendments to the Office of Management and Budget (‘‘OMB’’) for review in accordance with the PRA.662 While several commenters provided comments on the possible costs of the proposed amendments,663 no 661 See Final Report of the 2017 SEC Government Business Forum on Small Business Capital Formation (Mar. 2018), available at https:// www.sec.gov/files/gbfor36.pdf; and William J. Newell, Presentation at the ACSEC Meeting, Sarbanes-Oxley Section 404(b): Costs of Compliance and Proposed Reforms, (Sept. 13, 2017), available at https://www.sec.gov/info/ smallbus/acsec/william-newell-acsec091317.pdf. 662 44 U.S.C. 3507(d) and 5 CFR 1320.11. 663 See, e.g., letters from Ardelyx Presentation, Cerecor, CFA, CFA Inst., CII, Concert, Corvus, Guaranty, ICBA, Nasdaq, Pieris, Prof. Barth et al., Prof. Ge et al., Summit, Syros, and Terra Tech. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 commenters specifically addressed our PRA analysis. Where appropriate, we have revised our burden estimates after considering these comments as well as differences between the proposed and final rules. The hours and costs associated with preparing and filing the forms and reports constitute reporting and cost burdens imposed by each collection of information. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information requirement unless it displays a currently valid OMB control number. Compliance with the information collections is mandatory. Responses to the information collections are not kept confidential and there is no mandatory retention period for the information disclosed. The titles for the affected collections of information are: • ‘‘Form 10–K’’ (OMB Control No. 3235–0063); 664 and • ‘‘Form 10–Q’’ 665 (OMB Control No. 3235–0070).666 The regulation and forms listed above were adopted under the Exchange Act. The regulation and forms set forth the disclosure requirements for periodic reports filed by registrants to help investors make informed investment decisions. A description of the final amendments, including the need for the information and its use, as well as a description of the likely respondents, can be found in Section II above, and a discussion of the economic effects of the final amendments can be found in Section IV above. B. Burden and Cost Estimates Related to the Final Amendments We estimate that the final amendments will result in approximately 527 additional issuers being classified as non-accelerated 664 The paperwork burden from 17 CFR 240.12b– 1 through 240.12b–37 (‘‘Regulation 12B’’) is imposed through the forms that are subject to the requirements in that regulation and is reflected in the analyses of those forms. Our estimate for Forms 10–K takes into account the burden that will be incurred by including the disclosure in the applicable annual report. After the Proposing Release, note 4 above, was issued, the Office of Management and Budget (‘‘OMB’’) discontinued the OMB control number for Regulation 12B, so that the PRA inventory would not reflect duplicative burdens. 665 17 CFR 249.308a. 666 The only revision to this form will be changing filing deadlines, which will neither increase nor decrease the burden hours necessary to prepare the filing because there will be no change to the amount of information required in the filing. PO 00000 Frm 00061 Fmt 4701 Sfmt 4700 17237 filers.667 Accelerated filers are subject to the ICFR auditor attestation requirement and shorter deadlines for filing their Exchange Act periodic reports.668 Additionally, accelerated filers must provide disclosure regarding the availability of their filings and the disclosure required by Item 1B of Form 10–K and Item 4A of Form 20–F about unresolved staff comments on their periodic and/or current reports.669 1. ICFR Auditor Attestation Requirement We believe that expanding the exemption from the ICFR auditor attestation requirement would reduce the PRA burden for 373 of the 527 affected issuers.670 An ICFR auditor attestation is required only in annual reports. Table 17, below, shows the estimated number of affected issuers that are subject to the ICFR auditor attestation requirement that file on each of these forms and the average estimated audit-fee and non-audit costs, as described above,671 to comply with the ICFR auditor attestation requirement. 667 See Section IV.C.1. above. We estimate that there are no FPIs that file on domestic forms and present their financial statements pursuant to U.S. GAAP that would meet the required thresholds and other qualifications of the amendments. However, there are an estimated 31 FPIs that file on forms only available to FPIs, but otherwise meet the required thresholds and other qualifications. In the Proposing Release, note 4 above, we included FPIs that file the forms available only to FPIs, but otherwise meet the required thresholds and other qualifications, in the number of affected issuers. While these issuers could become subject to the amendments by changing their reporting regime, it is difficult to predict how many would do so, as a result, we do not include them in the number of affected issuers in this release. Accordingly, we do not estimate any effect on the collections of information corresponding to Forms 20–F or 40–F. 668 See Section II.A. above. 669 See note 25 above. 670 We estimate that the remaining 154 of the 527 affected issuers are EGCs, which are not required to comply with the ICFR auditor attestation requirement under SOX Section 404(b). See Section IV.C.1. above. In addition to the 154 EGCs, we estimate that a further 78 of the 527 affected issuers are currently also subject to the FDIC’s auditor attestation requirement. See Section 18A of Appendix A to FDIC Rule 363. These issuers would continue to incur burden hours and costs associated with an auditor attestation requirement even under the final amendments. However, the FDIC’s auditor attestation requirement is not part of our rules. For purposes of considering the PRA effects of the final amendments, therefore, we have reduced the burden hours and costs for these 78 issuers as we would for the other affected issuers that are not EGCs. 671 See Sections IV.C.3. and IV.C.5. above. E:\FR\FM\26MRR2.SGM 26MRR2 17238 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations TABLE 17—ESTIMATED ANNUAL COSTS PER ISSUER OF ICFR AUDITOR ATTESTATION REQUIREMENT FOR SPECIFIED FORMS Form type Number of affected issuers Audit-fee costs per issuer Non-audit costs per issuer Form 10–K ................................................................................................................................... 373 $110,000 $100,000 Because these issuers would no longer be subject to the ICFR auditor attestation requirement under the final amendments, they would no longer incur these costs. For purposes of the PRA, this reduction in total burden is to be allocated between a reduction in internal burden hours and a reduction in outside professional costs. Table 18, below, sets forth the percentage estimates we typically use for the burden allocation for each form. Table 18 above. However, we believe TABLE 18—STANDARD ESTIMATED BURDEN ALLOCATION FOR SPECIFIED that 100 percent of the $110,000 annual burden reduction for audit-fee costs FORMS Form type Internal (%) Outside professionals (%) Form 10–K .... 75 25 For the $100,000 reduction in annual non-audit costs,672 we allocate the burden based on the percentages in related to the ICFR auditor attestation requirement should be ascribed to outside professional costs because that amount is an estimate of fees paid to the independent auditor conducting the ICFR attestation audit. Table 19, below, shows the resulting estimated reduction in cost per issuer associated with outside professionals. TABLE 19—ESTIMATED REDUCTION IN OUTSIDE PROFESSIONAL COSTS FROM ELIMINATION OF ICFR AUDITOR ATTESTATION REQUIREMENT Issuer type (form used) Outside professional costs per issuer (non-audit) Outside professional costs per issuer (audit fees) Total outside professional costs per issuer (non-audit + audit fees) Number of affected issuers Total reduction in outside professional costs [A] [B] [C] [D] [E] (D × E) [F] Form 10–K ........................................................................... $25,000 $110,000 $135,000 373 $50,355,000 For PRA purposes, an issuer’s internal burden is estimated in internal burden hours. We are, therefore, converting the internal portions of the non-audit costs to burden hours. These activities would mostly be performed by a number of different employees with different levels of knowledge, expertise, and responsibility. We believe these internal labor costs will be less than the $400 per hour figure we typically use for outside professionals retained by the issuer. Therefore, we use an average rate of $200 per hour to estimate an issuer’s internal non-audit labor costs. Table 20, below, shows the resulting estimated reduction in internal burden hours from the elimination of the ICFR auditor attestation requirement. TABLE 20—ESTIMATED REDUCTION IN INTERNAL BURDEN HOURS FROM ELIMINATION OF ICFR AUDITOR ATTESTATION REQUIREMENT Issuer type (form used) Internal cost per issuer (non-audit) Burden hours per issuer Number of affected issuers Total reduction in internal burden hours [A] [B] (B/$200) [C] [D] (C × D) [E] Form 10–K ....................................................................................................... $75,000 375 373 139,875 lotter on DSKBCFDHB2PROD with RULES2 2. Filing Deadlines, Disclosure Regarding Filing Availability, and Unresolved Staff Comments neither increases nor decreases the burden hours necessary to prepare the filing because there is no change to the amount of information required in the As the Commission has recognized previously, changing filing deadlines 672 As discussed in Section IV.C.3, above, in deriving this estimate of the reduction in non-audit costs, we have looked to outside vendor and internal labor costs, and not to non-labor costs, because we believe that those non-labor costs (such VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 as software, hardware, and travel costs) are primarily attributable to management’s ICFR responsibilities under SOX Section 404(a) and thus would continue to be incurred. To the extent elimination of the auditor attestation requirement PO 00000 Frm 00062 Fmt 4701 Sfmt 4700 also results in a reduction in management’s time burden, we believe this reduction generally would be captured by the estimated $100,000 reduction, as this amount reflects an overall reduction in nonaudit costs. E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations their periodic and/or current reports will reduce their burden hours and costs, but we do not expect that reduction to be significant. For purposes of the PRA, we estimate the reduction to be approximately one hour for each affected issuer.674 However, as opposed to the burden reduction resulting from the elimination of the ICFR auditor filing.673 Therefore, we do not believe that the change to the filing deadlines will affect an issuer’s burden hours or costs for PRA purposes. We believe that eliminating the requirements to provide disclosure regarding the availability of their filings and the disclosure required by Item 1B of Form 10–K and Item 4A of Form 20– F about unresolved staff comments on 17239 attestation requirement, which would apply only to 373 of the 527 total affected issuers that are not EGCs, the burden reduction from eliminating these disclosure requirements will apply to all the 527 affected issuers, including the 154 affected issuers that are EGCs. That reduction is allocated by form as shown in Table 21, below. TABLE 21—ESTIMATED REDUCTION IN INTERNAL BURDEN HOURS PER ISSUER FROM ELIMINATION OF DISCLOSURE REQUIREMENTS REGARDING FILING AVAILABILITY AND UNRESOLVED STAFF COMMENTS Form type Burden hours per issuer Number of affected issuers Reduction in internal burden hours [A] [B] [C] (B × C) [D] Form 10–K ................................................................................................................................... 1 527 527 3. Check Box Disclosure In a change from the proposed amendments, the final amendments add a check box to the cover pages of their annual reports on Forms 10–K, 20–F, and 40–F for issuers to indicate that they included an ICFR auditor attestation in the filing. In addition, if the issuer is otherwise required to tag cover page disclosure data using Inline XBRL, it must also to tag the cover page check box disclosure using Inline XBRL. Issuers must already determine whether they are subject to the ICFR auditor attestation requirement, so requiring issuers to add a check box to the cover pages of their annual reports on Forms 10–K, 20–F, and 40–F, and check that box if they provide the ICFR auditor attestation, will not substantively modify existing collection of information requirements or otherwise affect the overall burden estimates associated with these forms. Therefore, we are not adjusting any burden or cost estimates in connection with the check box requirement in the final amendments 4. Total Burden Reduction Table 22, below, shows the total estimated reduction in internal burden hours and outside professional costs for all aspects of the final amendments. TABLE 22—REQUESTED PAPERWORK BURDEN UNDER THE FINAL AMENDMENTS Current burden 10–K .............. Burden change Current annual responses Current burden hours Current cost burden Change in company hours from auditor attestation (A) (B) (C) (D) (E) (F) = (D) + (E) (G) (H) = (B) + (F) (I) = (C) + (G) 8,137 14,198,780 $1,895,224,719 (139,875) (527) (140,402) ($50,355,000) 14,058,378 $1,844,869,719 lotter on DSKBCFDHB2PROD with RULES2 VI. Regulatory Flexibility Act Analysis The Regulatory Flexibility Act (‘‘RFA’’) 675 requires the Commission, in promulgating rules under Section 553 of the Administrative Procedure Act,676 to consider the impact of those rules on small entities. We have prepared this Final Regulatory Flexibility Analysis (‘‘FRFA’’) in accordance with Section 604 of the RFA.677 This FRFA relates to the amendments to the accelerated filer and large accelerated filer definitions in Rule 12b–2 under the Exchange Act and the addition of a check box to the cover pages of Forms 10–K, 20–F, and 40–F to 673 Revisions to Accelerated Filer Definition and Accelerated Deadlines for Filing Periodic Reports, Release No. 33–8644 (Dec. 21, 2005) [70 FR 76634 (Dec. 27, 2005)]. VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 Change in company hours from disclosure requirement Elimination Total change in company hours Change in professional costs Burden hours for affected responses Cost burden for affected responses indicate whether an ICFR auditor attestation is included in the filing. An Initial Regulatory Flexibility Analysis (‘‘IRFA’’) was prepared in accordance with the RFA and was included in the Proposing Release. A. Need for, and Objectives of, the Final Amendments The purpose of the amendments to the accelerated filer and large accelerated filer definitions in Rule 12b–2 is to promote capital formation by more appropriately tailoring the types of issuers that are included in the category of accelerated filers and revising the 674 We believe that this one-hour reduction will be solely for an issuer’s internal burden hours. 675 5 U.S.C. 601 et seq. PO 00000 Frm 00063 Fmt 4701 Sfmt 4700 transition thresholds for accelerated and large accelerated filers. The addition of the check box to the cover pages of Forms 10–K, 20–F, and 40–F is intended to provide more prominent and easily accessible disclosure of this information for investors and market participants while imposing only minimal burdens on issuers. The need for, and objectives of, the amendments are discussed in more detail in Sections I and II above. B. Significant Issues Raised by Public Comments In the Proposing Release, we requested comment on all aspects of the 676 5 677 5 E:\FR\FM\26MRR2.SGM U.S.C. 553. U.S.C. 604. 26MRR2 17240 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations IRFA, including the number of small entities that would be affected by the proposed amendments, the existence or nature of the potential impact of the proposals on small entities discussed in the analysis, and how to quantify the impact of the proposed amendments. We did not receive any comments specifically addressing the IRFA. However, we received a number of comments on the proposed amendments, generally,678 and have considered all of these comments in developing the FRFA because the final amendments are focused on smaller issuers. We believe that the final amendments will reduce disclosure burdens by expanding the number of registrants that will no longer qualify as accelerated or large accelerated filers, which will eliminate the ICFR auditor attestation requirement for those issuers, while maintaining investor protections. C. Small Entities Subject to the Amendments The final amendments will affect some registrants that are small entities. The RFA defines ‘‘small entity’’ to mean ‘‘small business,’’ ‘‘small organization,’’ or ‘‘small governmental jurisdiction.’’ 679 For purposes of the RFA, under our rules, an issuer, other than an investment company, is a ‘‘small business’’ or ‘‘small organization’’ if it had total assets of $5 million or less on the last day of its most recent fiscal year.680 We estimate that there are 1,171 issuers that file with the Commission, other than investment companies, which may be considered small entities and are potentially subject to the final amendments.681 Investment companies, which include BDCs, qualify as small entities if, together with other investment companies in the same group of related investment companies, they have net assets of $50 million or less as of the end of their most recent fiscal year.682 Commission staff estimates that, as of June 2019, approximately 16 BDCs are small entities.683 We believe it is likely that 678 See Section II.B.2. above. U.S.C. 601(6). 680 See 17 CFR 240.0–10(a) under the Exchange Act. 681 This estimate is based on staff analysis of issuers, excluding co-registrants, with EDGAR filings of Form 10–K, 20–F and 40–F, or amendments, filed during the calendar year of January 1, 2018 to December 31, 2018. This analysis is based on data from XBRL filings, Compustat, and Ives Group Audit Analytics. 682 17 CFR 270.0–10(a). 683 These estimates are based on staff analysis of Morningstar data and data submitted by investment company registrants in forms filed on EDGAR as of June 2019. lotter on DSKBCFDHB2PROD with RULES2 679 5 VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 virtually all issuers that would be considered small businesses or small organizations, as defined in our rules, are already non-accelerated filers and would continue to be encompassed within that category. To the extent any such issuers are not already nonaccelerated filers, we believe it is likely that the final amendments will capture those entities. D. Projected Reporting, Recordkeeping, and Other Compliance Requirements As noted above, the final amendments will reduce the number of accelerated and large accelerated filers, which will reduce the compliance burden for those issuers, some of which may be small entities, because they would no longer have to satisfy the ICFR auditor attestation requirement, comply with accelerated deadlines for filing their Exchange Act periodic reports, provide disclosure regarding the availability of their filings, or provide disclosure required by Item 1B of Form 10–K and Item 4A of Form 20–F about unresolved staff comments on their periodic and/or current reports.684 The ICFR auditor attestation requirement applies only to accelerated and large accelerated filers, and most small entities would not qualify for either filer status. Compliance with certain rules affected by the amendments require the use of professional skills, including accounting and legal skills. The final amendments are discussed in detail in Sections I and II above. We discuss the economic effect including the estimated costs and burdens, of the final amendments on all registrants, including small entities, in Section IV above. E. Agency Action To Minimize Effect on Small Entities The RFA directs us to consider alternatives that would accomplish our stated objectives, while minimizing any significant adverse effect on small entities. Accordingly, we considered the following alternatives: • Establishing different compliance or reporting requirements or timetables that take into account the resources available to small entities; • Clarifying, consolidating or simplifying compliance and reporting requirements for small entities under our rules as revised by the amendments; • Using performance rather than design standards; and • Exempting small entities from coverage of all or part of the amendments. 684 The amendments to include a check box on Forms 10–K, 20–F, and 40–F are not expected to affect the overall burden estimates associated with these forms. See Section V.C.3. above. PO 00000 Frm 00064 Fmt 4701 Sfmt 4700 We do not believe that establishing different compliance or reporting obligations in conjunction with the final amendments is necessary. The final amendments would not impose any significant new compliance obligations. In fact, the final amendments would reduce the compliance obligations of affected issuers by increasing the number of issuers, including small entities, that are subject to the different, less burdensome, compliance and reporting obligations for non-accelerated filers. Similarly, because the final amendments would reduce the burdens for these issuers, we do not believe it is appropriate to exempt small entities from all or part of the proposed amendments. We believe that some of the issuers that would become eligible to be nonaccelerated filers under the final amendments may be smaller entities. Therefore, to the extent that any small entities would become newly eligible for non-accelerated filer status under the final amendments, their compliance and reporting requirements would be further simplified. We note in this regard that the Commission’s existing disclosure requirements provide for scaled disclosure requirements and other accommodations for small entities, and the final amendments would not alter these existing accommodations. The check box requirement should not affect small entities unless they voluntarily choose to comply with the ICFR auditor attestation requirements. Further, we note that the compliance burden associated with the check box is expected to be minimal, and establishing a different compliance requirement, providing additional clarification of the requirement, or exempting a small entity would not, therefore, have a meaningful impact on the small entity. Finally, with respect to the use of performance rather than design standards, because the final amendments are not expected to have any significant adverse effect on small entities (and may, in fact, relieve burdens for some such entities), we do not believe it is necessary to use performance standards in connection with this rulemaking. Statutory Authority and Text of Rule Amendments The rule amendments described in this release are being adopted pursuant to Sections 7, 10, 19(a), and 28 of the Securities Act, as amended, and Sections 3(b), 12, 13, 15(d), and 23(a) of the Exchange Act, as amended. E:\FR\FM\26MRR2.SGM 26MRR2 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations List of Subjects in 17 CFR Part 229, 230, 240, and 249 Reporting and recordkeeping requirements, Securities. For the reasons set out in the preamble, the Commission amends title 17, chapter II of the Code of Federal Regulations as follows: PART 229—STANDARD INSTRUCTIONS FOR FILING FORMS UNDER SECURITIES ACT OF 1933, SECURITIES EXCHANGE ACT OF 1934, AND ENERGY POLICY AND CONSERVATION ACT OF 1975— REGULATION S–K 1. The authority citation for part 229 continues to read as follows: ■ Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 77k, 77s, 77z–2, 77z–3, 77aa(25), 77aa(26), 77ddd, 77eee, 77ggg, 77hhh, 77iii, 77jjj, 77nnn, 77sss, 78c, 78i, 78j, 78j–3, 78l, 78m, 78n, 78n–1, 78o, 78u–5, 78w, 78ll, 78mm, 80a–8, 80a–9, 80a–20, 80a–29, 80a– 30, 80a–31(c), 80a–37, 80a–38(a), 80a–39, 80b–11, and 7201 et seq.; 18 U.S.C. 1350; sec. 953(b), Pub. L. 11–203, 124 Stat. 1904 (2010); and sec. 102(c), Pub. L. 112–106, 126 Stat. 310 (2012). * * * * * 2. Amend § 229.10 by adding Instruction 2 to paragraph (f) to read as follows: ■ § 229.10 (Item 10) General. * * * * * (f) * * * Instruction 2 to paragraph (f): A foreign private issuer is not eligible to use the requirements for smaller reporting companies unless it uses the forms and rules designated for domestic issuers and provides financial statements prepared in accordance with U.S. Generally Accepted Accounting Principles. PART 230—GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933 3. The authority citation for part 230 continues to read in part as follows: ■ Authority: 15 U.S.C. 77b, 77b note, 77c, 77d, 77f, 77g, 77h, 77j, 77r, 77s, 77z–3, 77sss, 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78o–7 note, 78t, 78w, 78ll(d), 78mm, 80a–8, 80a–24, 80a– 28, 80a–29, 80a–30, and 80a–37, and Pub. L. 112–106, sec. 201(a), sec. 401, 126 Stat. 313 (2012), unless otherwise noted. lotter on DSKBCFDHB2PROD with RULES2 * * * * * Sections 230.400 to 230.499 issued under secs. 6, 8, 10, 19, 48 Stat. 78, 79, 81, and 85, as amended (15 U.S.C. 77f, 77h, 77j, and 77s). * * * * * 4. Amend § 230.405 by adding Instruction 2 to the definition of ‘‘smaller reporting company’’ to read as follows: ■ VerDate Sep<11>2014 20:29 Mar 25, 2020 Jkt 250001 § 230.405 Definitions of terms. 17241 (2) * * * (iv) The issuer is not eligible to use the requirements for smaller reporting companies under the revenue test in paragraph (2) or (3)(iii)(B) of the ‘‘smaller reporting company’’ definition in this section, as applicable. (3) * * * (ii) Once an issuer becomes an accelerated filer, it will remain an accelerated filer unless: The issuer determines, at the end of a fiscal year, that the aggregate worldwide market value of the voting and non-voting common equity held by its non-affiliates was less than $60 million, as of the last PART 240—GENERAL RULES AND business day of the issuer’s most REGULATIONS, SECURITIES recently completed second fiscal EXCHANGE ACT OF 1934 quarter; or it determines that it is eligible to use the requirements for ■ 5. The authority citation for part 240 smaller reporting companies under the continues to read, in part, as follows: revenue test in paragraph (2) or Authority: 15 U.S.C. 77c, 77d, 77g, 77j, (3)(iii)(B) of the ‘‘smaller reporting 77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn, company’’ definition in this section, as 77sss, 77ttt, 78c, 78c–3, 78c–5, 78d, 78e, 78f, applicable. An issuer that makes either 78g, 78i, 78j, 78j–1, 78k, 78k–1, 78l, 78m, of these determinations becomes a non78n, 78n–1, 78o, 78o–4, 78o–10, 78p, 78q, 78q–1, 78s, 78u–5, 78w, 78x, 78dd, 78ll, accelerated filer. The issuer will not 78mm, 80a–20, 80a–23, 80a–29, 80a–37, 80b– become an accelerated filer again unless 3, 80b–4, 80b–11, and 7201 et seq., and 8302; it subsequently meets the conditions in 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 paragraph (1) of this definition. U.S.C. 1350; Pub. L. 111–203, 939A, 124 Stat. (iii) Once an issuer becomes a large 1376 (2010); and Pub. L. 112–106, secs. 503 accelerated filer, it will remain a large and 602, 126 Stat. 326 (2012), unless accelerated filer unless: It determines, at otherwise noted. the end of a fiscal year, that the * * * * * aggregate worldwide market value of the Sections 240.12b–1 to 240.12b–36 also voting and non-voting common equity issued under secs. 3, 12, 13, 15, 48 Stat. 892, as amended, 894, 895, as amended; 15 U.S.C. held by its non-affiliates (‘‘aggregate worldwide market value’’) was less than 78c, 78l, 78m, and 78o.6. $560 million, as of the last business day * * * * * of the issuer’s most recently completed ■ 6. Amend § 240.12b–2 by: second fiscal quarter or it determines ■ a. In the definition of ‘‘Accelerated that it is eligible to use the requirements filer and large accelerated filer’’: for smaller reporting companies under ■ i. Removing ‘‘.’’ at the end of the revenue test in paragraph (2) or paragraph (1)(iii) and adding in its place (3)(iii)(B) of the ‘‘smaller reporting ‘‘; and’’; company’’ definition in this section, as ■ ii. Adding paragraph (1)(iv); applicable. If the issuer’s aggregate ■ iii. Removing ‘‘.’’ at the end of worldwide market value was $60 paragraph (2)(iii) and adding in its place million or more, but less than $560 ‘‘; and’’; million, as of the last business day of ■ iv. Adding paragraph (2)(iv); the issuer’s most recently completed ■ v. Revising paragraphs (3)(ii) and second fiscal quarter, and it is not (3)(iii); eligible to use the requirements for ■ vi. Adding paragraph (4); and smaller reporting companies under the ■ b. Adding Instruction 2 to the revenue test in paragraph (2) or definition of ‘‘smaller reporting (3)(iii)(B) of the ‘‘smaller reporting company’’. company’’ definition in this section, as The addition and revisions read as applicable, it becomes an accelerated follows: filer. If the issuer’s aggregate worldwide § 240.12b–2 Definitions. market value was less than $60 million, as of the last business day of the issuer’s * * * * * most recently completed second fiscal Accelerated filer and large quarter, or it is eligible to use the accelerated filer—(1) * * * requirements for smaller reporting (iv) The issuer is not eligible to use companies under the revenue test in the requirements for smaller reporting paragraph (2) or (3)(iii)(B) of the companies under the revenue test in ‘‘smaller reporting company’’ definition paragraph (2) or (3)(iii)(B) of the ‘‘smaller reporting company’’ definition in this section, it becomes a nonaccelerated filer. An issuer will not in this section, as applicable. * * * * * Smaller reporting company. * * * Instruction 2 to definition of ‘‘smaller reporting company’’: A foreign private issuer is not eligible to use the requirements for smaller reporting companies unless it uses the forms and rules designated for domestic issuers and provides financial statements prepared in accordance with U.S. Generally Accepted Accounting Principles. * * * * * PO 00000 Frm 00065 Fmt 4701 Sfmt 4700 E:\FR\FM\26MRR2.SGM 26MRR2 17242 Federal Register / Vol. 85, No. 59 / Thursday, March 26, 2020 / Rules and Regulations become a large accelerated filer again unless it subsequently meets the conditions in paragraph (2) of this definition. * * * * * (4) For purposes of paragraphs (1), (2), and (3) of this definition only, a business development company is considered to be eligible to use the requirements for smaller reporting companies under the revenue test in paragraph (2) or (3)(iii)(B) of the ‘‘smaller reporting company’’ definition in this section, provided that the business development company meets the requirements of the test using annual investment income under Rule 6–07.1 of Regulation S–X (17 CFR 210.6–07.1) as the measure of its ‘‘annual revenues’’ for purposes of the test. * * * * * Smaller reporting company. * * * Instruction 2 to definition of ‘‘smaller reporting company’’: A foreign private issuer is not eligible to use the requirements for smaller reporting companies unless it uses the forms and rules designated for domestic issuers and provides financial statements prepared in accordance with U.S. Generally Accepted Accounting Principles. * * * * * PART 249—FORMS, SECURITIES EXCHANGE ACT OF 1934 7. The authority citation for part 249 continues to read in part as follows: ■ Authority: 15 U.S.C. 78a et seq. and 7201 et seq.; 12 U.S.C. 5461 et seq.; 18 U.S.C. 1350; Sec. 953(b), Pub. L. 111–203, 124 Stat. 1904; Sec. 102(a)(3), Pub. L. 112–106, 126 Stat. 309 (2012); Sec. 107, Pub. L. 112–106, 126 Stat. 313 (2012), and Sec. 72001, Pub. L. 114–94, 129 Stat. 1312 (2015), unless otherwise noted. * * * * lotter on DSKBCFDHB2PROD with RULES2 * * VerDate Sep<11>2014 * * 20:29 Mar 25, 2020 * * * * * 8. Amend Form 20–F (referenced in § 249.220f) by adding a field to the cover page to include a check box indicating whether the registrant has included an ICFR auditor attestation in the filing: ■ Note: The text of Form 20–F does not, and this amendment will not, appear in the Code of Federal Regulations. UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 20–F * * * * * †The term ‘‘new or revised financial accounting standard’’ refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012. Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the SarbanesOxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. b * * * * * ■ 9. Amend Form 40–F (referenced in § 249.240f) by adding a field to the cover page to include a check box indicating whether the registrant has included an ICFR auditor attestation in the filing: Note: The text of Form 40–F does not, and this amendment will not, appear in the Code of Federal Regulations. UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 * Section 249.220f is also issued under secs. 3(a), 202, 208, 302, 306(a), 401(a), 401(b), 406 and 407, Pub. L. 107–204, 116 Stat. 745. Section 249.240f is also issued under secs. 3(a), 202, 208, 302, 306(a), 401(a), 406 and 407, Pub. L. 107–204, 116 Stat. 745. * Section 249.310 is also issued under secs. 3(a), 202, 208, 302, 406 and 407, Pub. L. 107– 204, 116 Stat. 745. Jkt 250001 FORM 40–F * * * * * †The term ‘‘new or revised financial accounting standard’’ refers to any update issued by the Financial Accounting Standards Board to its PO 00000 Frm 00066 Fmt 4701 Sfmt 9990 Accounting Standards Codification after April 5, 2012. Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the SarbanesOxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. b * * * * * 10. Amend Form 10–K (referenced in § 249.310) by adding a field to the cover page to include a check box indicating whether the registrant has included an ICFR auditor attestation in the filing: ■ Note: The text of Form 40–F does not, and this amendment will not, appear in the Code of Federal Regulations. UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10–K * * * * * If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. b Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the SarbanesOxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. b * * * * * By the Commission. Dated: March 12, 2020. Vanessa A. Countryman, Secretary. [FR Doc. 2020–05546 Filed 3–25–20; 8:45 am] BILLING CODE 8011–01–P E:\FR\FM\26MRR2.SGM 26MRR2

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 85, Number 59 (Thursday, March 26, 2020)]
[Rules and Regulations]
[Pages 17178-17242]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-05546]

[[Page 17177]]

Vol. 85

Thursday,

No. 59

March 26, 2020

Part II

Securities and Exchange Commission

-----------------------------------------------------------------------

17 CFR Parts 229, 230, 240, et al.

Accelerated Filer and Large Accelerated Filer Definitions; Final Rule

Federal Register / Vol. 85 , No. 59 / Thursday, March 26, 2020 /
Rules and Regulations

[[Page 17178]]

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 229, 230, 240, and 249

[Release No. 34-88365; File No. S7-06-19]
RIN 3235-AM41

Accelerated Filer and Large Accelerated Filer Definitions

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

-----------------------------------------------------------------------

SUMMARY: The Securities and Exchange Commission (``Commission'') is
adopting amendments to the accelerated filer and large accelerated
filer definitions to more appropriately tailor the types of issuers
that are included in the categories of accelerated and large
accelerated filers and promote capital formation, preserve capital, and
reduce unnecessary burdens for certain smaller issuers while
maintaining investor protections. The amendments exclude from the
accelerated and large accelerated filer definitions an issuer that is
eligible to be a smaller reporting company and that had annual revenues
of less than $100 million in the most recent fiscal year for which
audited financial statements are available. The amendments also include
a specific provision excluding business development companies from the
accelerated and large accelerated filer definitions in analogous
circumstances. In addition, the amendments increase the transition
thresholds for accelerated and large accelerated filers becoming non-
accelerated filers from $50 million to $60 million, and for exiting
large accelerated filer status from $500 million to $560 million.
Further, the amendments add a revenue test to the transition thresholds
for exiting from both accelerated and large accelerated filer status.
Finally, the amendments add a check box to the cover pages of Forms 10-
K, 20-F, and 40-F to indicate whether an internal control over
financial reporting (``ICFR'') auditor attestation is included in the
filing. As a result of the amendments, certain low-revenue issuers will
remain obligated, among other things, to establish and maintain ICFR
and have management assess the effectiveness of ICFR, but they will not
be required to have their management's assessment of the effectiveness
of ICFR attested to, and reported on, by an independent auditor.

DATES: This final rule is effective April 27, 2020.

FOR FURTHER INFORMATION CONTACT: John Fieldsend, Special Counsel, in
the Division of Corporation Finance, at (202) 551-3430, and Brian
Johnson, Assistant Director, in the Division of Investment Management,
at (202) 551-6792, U.S. Securities and Exchange Commission, 100 F
Street NE, Washington, DC 20549-3628.

SUPPLEMENTARY INFORMATION: We are amending 17 CFR 229.10(f) (``Item
10(f)'') under Regulation S-K; \1\ 17 CFR 230.405 (``Rule 405'') under
the Securities Act of 1933; \2\ and 17 CFR 12b-2 (``Rule 12b-2''), 17
CFR 249.220f (``Form 20-F''), 17 CFR 249.240f (``Form 40-F''), and 17
CFR 249.310 (``Form 10-K'') under the Securities Exchange Act of 1934
(``Exchange Act'').\3\
---------------------------------------------------------------------------

\1\ 15 U.S.C. 229.10 through 229.1305.
\2\ 15 U.S.C. 77a et seq.
\3\ 15 U.S.C. 78a et seq.
---------------------------------------------------------------------------

Table of Contents

I. Introduction
II. Discussion of the Final Amendments
A. Background
B. Amendments to Exclude Low-Revenue SRCs From the Accelerated
and Large Accelerated Filer Definitions
1. Proposed Amendments
2. Comments on the Proposed Amendments
a. Comments on Using Revenue for Determining Accelerated and
Large Accelerated Filer Status
b. Comments on the Proposed Amendments' Effect on Capital
Formation and the Number of Public Issuers
c. Comments on the Proposed Amendments' Effect on Investor
Protection
d. Comments on the Disproportionate Costs and Benefits of the
ICFR Auditor Attestation Requirement to Small and Low-Revenue
Companies
e. Comments on the Relationship Between Non-Accelerated Filers
and SRCs
f. Other Comments
3. Final Amendments
a. Using Revenue for Determining Accelerated and Large
Accelerated Filer Status
b. Effect on Capital Formation and the Number of Public
Companies
c. Effect on Investor Protection
d. Disproportionate Costs and Benefits of the ICFR Auditor
Attestation for Small and Low-Revenue Companies
e. Relationship Between Non-Accelerated Filers and SRCs
f. Effect on Business Development Companies
g. Effect on Foreign Private Issuers
h. Requiring ICFR Auditor Attestation Less Frequently Than
Annually
i. Check Box Indicating Whether an ICFR Auditor Attestation Is
Included in a Filing
C. Amendments To Increase the Public Float Transition Thresholds
From $50 million to $60 million and $500 million to $560 million and
To Add the SRC Revenue Test to the Transition Threshold
1. Proposed Amendments
2. Comments
3. Final Amendments
D. Transition Issues
III. Other Matters
IV. Economic Analysis
A. Introduction
B. Baseline
1. Regulatory Baseline
2. Characteristics of Accelerated Filer Population
3. Timing of Filings
4. Internal Controls and Restatements
C. Discussion of Economic Effects
1. Affected Issuers
2. Potential Benefits of Expanding the Exemption From the ICFR
Auditor Attestation Requirement for Affected Issuers
a. Evidence on Possible Indirect Costs of the ICFR Auditor
Attestation Requirement
b. Evidence on Net Costs of the ICFR Auditor Attestation
Requirement
i. Studies Involving Avoidance Behavior
ii. Studies Based on Comparative Analysis or Market Reactions
iii. Other Evidence on Net Costs
c. Potential Reduction in Audit Fees
d. Additional Potential Compliance Cost Savings
e. Implications of the Cost Savings
3. Potential Costs of Expanding the Exemption From the ICFR
Auditor Attestation Requirement for Affected Issuers
a. Broad Considerations and Evidence Regarding the Effects of
ICFR Auditor Attestations on Financial Reporting
b. Estimated Effects on ICFR, the Reliability of Financial
Statements, and Potential Fraud
i. Effects on the Prevalence of Ineffective ICFR
ii. Effects on the Detection and Disclosure of Material
Weaknesses in ICFR
iii. Effects on Restatements
iv. Effects on Fraudulent Financial Reporting
v. Timing of the Effects
c. Implications for Investor Decision-Making
d. Potential Economic Costs of Effects on ICFR, the Reliability
of Financial Statements, and Potential Fraud
i. Computation of Monetized Estimates of Costs
ii. Discussion of Economic Costs
4. Potential Benefits and Costs Related to Other Aspects of the
Amendments
a. Filing Deadlines
b. Disclosures Required of Accelerated Filers
c. Transition Thresholds
d. Disclosure
5. Alternatives to the Amendments
a. Exclude All SRCs From Accelerated Filer Category
b. Include or Exclude Certain Issuer Types
c. Alternative Threshold
V. Paperwork Reduction Act
A. Summary of the Collections of Information
B. Burden and Cost Estimates Related to the Final Amendments
1. ICFR Auditor Attestation Requirement

[[Page 17179]]

2. Filing Deadlines, Disclosure Regarding Filing Availability,
and Unresolved Staff Comments
3. Check Box Disclosure
4. Total Burden Reduction
VI. Regulatory Flexibility Act Analysis
A. Need for, and Objectives of, the Final Amendments
B. Significant Issues Raised by Public Comments
C. Small Entities Subject to the Amendments
D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
E. Agency Action To Minimize Effect on Small Entities
Statutory Authority and Text of Rule Amendments

I. Introduction

On May 9, 2019, we proposed amendments \4\ to the ``accelerated
filer'' and ``large accelerated filer'' definitions in Rule 12b-2.\5\
We proposed these amendments to promote capital formation for certain
smaller issuers while maintaining investor protections by more
appropriately tailoring the types of issuers that are included in the
categories of accelerated and large accelerated filers and revising the
transition thresholds for accelerated and large accelerated filers.
Specifically, we proposed to exclude from the accelerated and large
accelerated filer definitions an issuer that is eligible to be a
smaller reporting company (``SRC'') \6\ and that has annual revenue of
less than $100 million in the most recent fiscal year for which audited
financial statements are available (``SRC revenue test''), with the
effect that such an issuer would not need to satisfy the requirements
applicable to an accelerated or large accelerated filer. We also
proposed to increase the public float transition threshold for
accelerated and large accelerated filers to become a non-accelerated
filer from $50 million to $60 million, and to increase the exit
threshold in the large accelerated filer transition provision from $500
million to $560 million in public float. Finally, we proposed to add a
revenue test to the transition thresholds for exiting both accelerated
and large accelerated filer status.
---------------------------------------------------------------------------

\4\ Amendments to the Accelerated and Large Accelerated Filer
Definitions, Release No. 34-85814 (May 9, 2019) [84 FR 24876 (May
29, 2019)] (``Proposing Release'').
\5\ Although Rule 12b-2 defines the terms ``accelerated filer''
and ``large accelerated filer,'' it does not define the term ``non-
accelerated filer.'' If an issuer does not meet the definition of
accelerated filer or large accelerated filer, it is considered a
non-accelerated filer.
\6\ See Item 10(f), Rule 405, and Rule 12b-2 (defining SRC).
---------------------------------------------------------------------------

We received over 60 comment letters on the proposal, including over
40 unique letters and approximately 20 letters that were substantially
similar. Many of the commenters generally supported the proposed
amendments \7\ while other commenters generally opposed them or
suggested the need for further empirical study.\8\ In addition, the
SEC's Small Business Capital Formation Advisory Committee (``SBCFAC'')
adopted a recommendation supporting the proposed amendments,\9\ and the
2019 SEC Government-Business Forum on Small Business Capital Formation
(``SEC Small Business Forum'') provided a recommendation on the
accelerated filer definition.\10\ After taking into consideration these
recommendations and the public comments, we are adopting the amendments
substantially as proposed. The final amendments are consistent with our
historical practice of providing scaled disclosure and other
accommodations for smaller issuers and with recent actions by Congress
to reduce unnecessary burdens on new and smaller issuers.\11\
---------------------------------------------------------------------------

\7\ See, e.g., letters from Adamas Pharmaceuticals, Inc. (July
19, 2019) (``Adamas''); Advanced Medical Technology Association
Accel (July 26, 2019) (``AdvaMed''); Aequor, Inc. (July 18, 2019)
(``Aequor''); Ardelyx, Inc. (July 18, 2019) (``Ardelyx''); American
Securities Association (July 29, 2019) (``ASA''); Biotechnology
Innovation Organization (July 29, 2019) (``BIO''); Broadmark Capital
(July 29, 2019) (``Broadmark''); California Life Sciences
Association (Jun. 10, 2019) (``CLSA''); Catalyst Biosciences, Inc.
(July 29, 2019) (``Catalyst''); Cerecor Inc. (July 3, 2019)
(``Cerecor''); Chiasma, Inc. (July 11, 2019) (``Chiasma'');
Coalition of Four Small Businesses and their Investors (July 24,
2019) (``AdvaMed et al.''); Concert Pharmaceuticals, Inc. (July 1,
2019) (``Concert''); Corvus Pharmaceuticals, Inc. (July 19, 2019)
(``Corvus''); Council of State Bioscience Associations (July 25,
2019) (``CSBA''); CSB Bancorp, Inc. (July 26, 2019) (``CSB'');
CymaBay Therapeutics, Inc. (July 24, 2019) (``CymaBay'');
Dar[eacute] Bioscience, Inc. (July 10, 2019) (``Dar[eacute]'');
Darian B. Andersen, General Counsel, PC (Jun. 5, 2019)
(``Andersen''); Equillium, Inc. (July 22, 2019) (``Equillium'');
Evoke Pharma, Inc. (July 17, 2019) (``Evoke''); Gritstone Oncology
Inc. (July 24, 2019) (``Gritstone''); Guaranty Federal Bancshares,
Inc. (July 23, 2019) (``Guaranty''); Independent Community Bankers
of America (July 24, 2019) (``ICBA''); Kezar Life Sciences, Inc.
(July 17, 2019) (``Kezar''); Kyle Carver (May 25, 2019)
(``Carver''); Marinus Pharmaceuticals, Inc. (July 17, 2019)
(``Marinus''); Millendo Therapeutics, Inc. (July 29, 2019)
(``Millendo''); MSB Financial Corp. (July 19, 2019) (``MSB'');
Nasdaq, Inc. (July 29, 2019) (``Nasdaq''); Organovo, Inc. (July 18,
2019) (``Organovo''); Pieris Pharmaceuticals, Inc. (July 11, 2019)
(``Pieris''); Revance Therapeutics, Inc. (July 22, 2019)
(``Revance''); SI-BONE, Inc. (July 19, 2019) (``SI-BONE''); South
Carolina Bankers Association (July 26, 2019) (``SCBA''); Summit
State Bank (May 28, 2019) (``Summit''); Sutro Biopharma, Inc. (July
8, 2019) (``Sutro''); Syros Pharmaceuticals, Inc. (July 22, 2019)
(``Syros''); Teligent, Inc. (July 23, 2019) (``Teligent''); Terra
Tech Corp. (May 29, 2019) (``Terra Tech''); The Bank of South
Carolina (July 26, 2019) (``BSC''); U.S. Chamber of Commerce's
Center for Capital Markets Competitiveness (July 29, 2019)
(``Chamber''); Xenon Pharmaceuticals Inc. (Jun. 19, 2019)
(``Xenon''); and Zynerba Pharmaceuticals, Inc. (July 8, 2019)
(``Zynerba'').
\8\ See, e.g., letters from BDO USA, LLP (July 29, 2019)
(``BDO''); Better Markets, Inc. (July 29, 2019) (``Better
Markets''); Center for Audit Quality (July 29, 2019) (``CAQ''); CFA
Institute, in consultation with its Corporate Disclosure Policy
Council (Aug. 22, 2019) (``CFA Inst.''); Colleen Honigsberg,
Associate Professor of Law, Stanford Law School, et al. (July 22,
2019) (``Prof. Honigsberg et al.''); Consumer Federation of America
(July 29, 2019) (``CFA''); Council of Institutional Investors (July
25, 2019) (``CII''); Crowe LLP (July 29, 2019) (``Crowe''); Deloitte
& Touche LLP (July 26, 2019) (``Deloitte''); Grant Thornton LLP
(July 17, 2019) (``Grant Thornton''); John Hassell, Indiana
University (May 19, 2019) (``Prof. Hassell''); Mary Barth, Stanford
University, Wayne Landsman, University of North Carolina, Joseph
Schroeder, Indiana University, and Daniel Taylor, University of
Pennsylvania (July 11, 2019) (``Prof. Barth et al.''); RSM US LLP
(July 29, 2019) (``RSM''); and Weili Ge, University of Washington;
Allison Koester, Georgetown University; and Sarah McVay, University
of Washington (July 26, 2019) (``Prof. Ge et al.'').
\9\ See U.S. Sec. and Exch. Comm'n Small Bus. Capital Formation
Advisory Comm., Recommendation on the Commission's Proposal to Amend
the Accelerated and Large Accelerated Filer Definitions (Aug. 23,
2019) (``SBCFAC Recommendations''), available at https://www.sec.gov/spotlight/sbcfac/recommendations-rule-3-05-and-accelerated-filer-definition.pdf. Although it supported the proposed
amendments, the SBCFAC stated that it ``would welcome the Commission
to explore additional further amendments'' to the accelerated and
large accelerated filer definitions and recommended exploring
raising the revenue threshold to be a non-accelerated filer to one
higher than $100 million, basing the revenue test for an issuer to
qualify as a non-accelerated filer on a three-year rolling average
instead of basing it on the revenue in the most recent fiscal year,
and looking at whether all SRCs should be non-accelerated filers.
\10\ See U.S. Sec. and Exch. Comm'n Gov't-Bus. Forum on Small
Bus. Capital Formation, Report on the 38th Annual Government-
Business Forum on Small Business Capital Formation (Aug. 14, 2019)
(``SEC Small Business Forum''), available at https://www.sec.gov/files/small-business-forum-report-2019.pdf. The SEC Small Business
Forum recommended aligning the definition of non-accelerated filer
with the definition of SRC to include issuers with a public float
less than $250 million or with annual revenues less than $100
million (and either no public float or a public float less than $700
million).
\11\ For example, Title I of the Jumpstart Our Business Startups
Act of 2012 (``JOBS Act'') amended Section 404(b) of the Sarbanes-
Oxley Act (``SOX''), 15 U.S.C. 7262(b), which relates to an issuer's
ICFR to exempt emerging growth companies (``EGCs'') from the
requirement of SOX Section 404(b). In particular, SOX Section 404(b)
requires that an issuer's independent auditor attest to, and report
on, management's assessment of the effectiveness of the issuer's
ICFR (``ICFR auditor attestation''). See Public Law 112-106, Sec.
103, 126 Stat. 306 (2012). In addition, Section 72002 of the Fixing
America's Surface Transportation Act of 2015 requires the Commission
to revise Regulation S-K to further scale or eliminate requirements
to reduce the burden on EGCs, accelerated filers, SRCs, and other
smaller issuers, while still providing all material information to
investors. See Public Law 114-94, 129 Stat. 1312 (2015).
---------------------------------------------------------------------------

II. Discussion of the Final Amendments

A. Background

In June 2018, the Commission adopted amendments \12\ to the SRC

[[Page 17180]]

definition \13\ to expand the number of issuers that qualify for scaled
disclosure accommodations. The amended SRC definition allows an issuer
to use either a public float \14\ test or the SRC revenue test to
determine whether it is an SRC. The amendments increased the threshold
in the public float test for an issuer to initially qualify as an SRC
from less than $75 million to less than $250 million.\15\ The
Commission also expanded the revenue test to include issuers with
annual revenues \16\ of less than $100 million if they have no public
float or a public float of less than $700 million.\17\ The Commission
intended the amendments to promote capital formation for smaller
issuers by reducing compliance costs for the newly eligible SRCs while
maintaining appropriate investor protections.\18\
---------------------------------------------------------------------------

\12\ See Smaller Reporting Company Definition, Release No. 33-
10513 (June 28, 2018) [83 FR 31992 (July 10, 2018)] (``SRC Adopting
Release'').
\13\ See note 6 above.
\14\ Public float is defined in paragraph (3)(i)(A) of the SRC
definition in Rule 12b-2, which states that public float is measured
as of the last business day of the issuer's most recently completed
second fiscal quarter and computed by multiplying the aggregate
worldwide number of shares of its voting and non-voting common
equity held by non-affiliates by the price at which the common
equity was last sold, or the average of the bid and asked prices of
common equity, in the principal market for the common equity. See
also Item 10(f) (2)(i)(A) and Rule 405. An entity with no public
float because, for example, it has equity securities outstanding but
is not trading in any public trading market would not be able to
qualify on the basis of a public float test alone. That entity must
look to the SRC revenue test to determine whether it qualifies as an
SRC.
\15\ To avoid situations where an issuer frequently enters and
exits SRC status, each test includes two thresholds--one for
initially determining whether an issuer qualifies as an SRC and a
subsequent transition threshold that is lower for issuers that did
not initially qualify as an SRC, or that no longer qualify as an SRC
because they exceeded the initial thresholds.
\16\ Annual revenues are measured as of the most recently
completed fiscal year for which audited financial statements are
available. See Item 10(f)(2)(i)(B), Rule 405, and Rule 12b-2.
\17\ See Item 10(f)(1), Rule 405, and Rule 12b-2. The prior
revenue test included issuers with no public float and annual
revenues of less than $50 million. See SRC Adopting Release, note 12
above, at 31995. The lower transition thresholds under the revenue
test for an issuer that did not initially qualify as an SRC, or that
no longer qualifies as an SRC because it exceeded the initial
thresholds, were revised from less than $40 million of annual
revenues and no public float to less than $80 million of annual
revenues and either no public float or a public float of less than
$560 million. See Item 10(f)(2)(iii)(B), Rule 405, and Rule 12b-2.
\18\ SRC Adopting Release, note 12 above, at 31992.
---------------------------------------------------------------------------

In conjunction with these amendments, the Commission also revised
the accelerated filer and large accelerated filer definitions in Rule
12b-2 to remove the condition that, for an issuer to be an accelerated
filer or a large accelerated filer, it must not be eligible to use the
SRC accommodations.\19\ One result of these amendments is that some
issuers now are categorized as both SRCs and accelerated or large
accelerated filers.\20\ These issuers have some, but not all, of the
benefits of scaled regulation. In particular, issuers that are
categorized as both SRCs and accelerated or large accelerated filers
must comply with the earlier filing deadlines required of accelerated
and large accelerated filers for annual and quarterly reports and the
requirement of SOX Section 404(b).\21\
---------------------------------------------------------------------------

\19\ This amendment, among other things, preserved the existing
thresholds in those definitions and did not change the number of
issuers subject to the ICFR auditor attestation requirement.
\20\ Although rare, under our existing rules, some issuers that
meet the large accelerated filer definition may be eligible to be an
SRC because of the expanded revenue test in the SRC definition. See
Proposing Release, note 4 above, at 24877, n. 25. As discussed
below, in Section II.B.3., we are adopting the proposed amendment to
the ``large accelerated filer'' definition so that an issuer that is
eligible to be an SRC under the SRC revenue test would not also
qualify as a large accelerated filer.
\21\ 15 U.S.C. 7262(b).
---------------------------------------------------------------------------

Prior to the SRC amendments, the SRC category of filers generally
did not overlap with either the accelerated or large accelerated filer
categories.\22\ Now, however, as illustrated in Figure 1 of this
section, because the public float tests in the SRC and accelerated
filer definitions partially overlap, and the accelerated and large
accelerated filer definitions no longer specifically exclude an issuer
that is eligible to be an SRC, an issuer meeting the accelerated filer
definition will be both an SRC and an accelerated filer \23\ if it has:
---------------------------------------------------------------------------

\22\ See SRC Adopting Release, note 12 above, at 32001.
\23\ The thresholds provided below are based on the initial
thresholds of each definition; however, due to the transition
provisions of the accelerated and large accelerated filer
definitions, additional issuers may also be both an SRC and an
accelerated or large accelerated filer.
---------------------------------------------------------------------------

A public float of $75 million or more, but less than $250
million, regardless of annual revenues; or
Less than $100 million in annual revenues, and a public
float of $250 million or more, but less than $700 million.
[GRAPHIC] [TIFF OMITTED] TR26MR20.000

B. Amendments To Exclude Low-Revenue SRCs From the Accelerated and
Large Accelerated Filer Definitions

1. Proposed Amendments
Under the existing accelerated filer and large accelerated filer
definitions in Rule 12b-2, an issuer must satisfy three conditions to
be an accelerated filer or large accelerated filer.\24\ We proposed to

[[Page 17181]]

add a new condition to the definitions of accelerated filer and large
accelerated filer that would exclude from those definitions an issuer
that is eligible to be an SRC and that meets the SRC revenue test. The
most notable effect of the proposed amendments \25\ would be that an
issuer that is eligible to be an SRC and that meets the SRC revenue
test would not be subject to the requirement of SOX Section 404(b) that
an issuer's independent auditor must attest to, and report on,
management's assessment of the effectiveness of the issuer's ICFR.\26\
The final amendments do not change an auditor's role in a financial
statement audit.\27\
---------------------------------------------------------------------------

\24\ The three existing conditions for qualifying as an
accelerated filer are that an issuer: (1) Had an aggregate worldwide
public float of $75 million or more, but less than $700 million, as
of the last business day of the issuer's most recently completed
second fiscal quarter; (2) has been subject to the requirements of
15 U.S.C. 78m (Exchange Act Section 13(a)) or 15 U.S.C. 78o(d)
(Exchange Act Section 15(d)) for a period of at least twelve
calendar months; and (3) has filed at least one annual report
pursuant to those sections. For a large accelerated filer,
conditions (2) and (3) are the same, but condition (1) is that an
issuer had an aggregate worldwide public float of $700 million or
more, as of the last business day of the issuer's most recently
completed second fiscal quarter. Also, as discussed in note 20
above, some issuers that meet the ``large accelerated filer''
definition may be eligible to be an SRC.
\25\ The issuer also would not have to abide by the filing
deadlines of an accelerated or large accelerated filer, provide the
disclosure required by Item 1B of Form 10-K and Item 4A of Form 20-F
about unresolved staff comments on its periodic and/or current
reports, or provide the disclosure required by Item 101(e)(4) of
Regulation S-K about whether it makes filings available on or
through its internet website. See 17 CFR 229.101(e)(4).
\26\ See 17 CFR 240.13a-15(f) and 17 CFR 240.15d-15(f) (defining
ICFR).
\27\ See letter from Deloitte (suggesting that the Commission
explain how an auditor's role in a financial statement audit will
change as a result of the amendments).
---------------------------------------------------------------------------

SOX Section 404(a) \28\ requires almost all issuers, including
SRCs, that file reports pursuant to Exchange Act Section 13(a) or 15(d)
\29\ to establish and maintain ICFR and have their management assess
the effectiveness of their ICFR.\30\ SOX Section 404(b) subjects
certain issuers not otherwise exempted to the ICFR auditor attestation
requirement.\31\ The most significant exemption from the ICFR auditor
attestation requirement is the exemption provided to EGCs pursuant to
Title I of the JOBS Act (``JOBS Act Exemption''). Generally, an EGC is
a company that has total annual gross revenues of less than $1.07
billion during its most recently completed fiscal year end and that has
not sold common equity securities under a registration statement.\32\
The JOBS Act Exemption provides EGCs with a five-year exemption from
the ICFR auditor attestation requirement. We estimate that the JOBS Act
Exemption applies to issuers with an aggregate market capitalization of
about $585 billion, compared to about $95 billion in aggregate for the
issuers that are newly exempt from the ICFR auditor attestation
requirement under the amendments.\33\
---------------------------------------------------------------------------

\28\ 15 U.S.C. 7262(a).
\29\ See 17 CFR 240.13a-15 and 17 CFR 240.15d-15.
\30\ Investment companies registered under Section 8 of the
Investment Company Act of 1940, 15 U.S.C 80a-8, are specifically
exempted from SOX Section 404 by SOX Section 405, 15 U.S.C. 7263.
Notwithstanding the exemption pursuant to SOX Section 405, these
registered investment companies are subject to other requirements
regarding internal controls. See Proposing Release, note 4 above, at
24879, n. 44.
\31\ For example, SOX Section 404(c) exempts from Section 404(b)
any issuer that is neither a large accelerated filer nor an
accelerated filer. See 15 U.S.C. 7262(c).
\32\ See 15 U.S.C. 77(b)(a)(19).
\33\ These estimates are based on staff analysis of data on
market values from Compustat for annual reports in calendar year
2018. See note 298 below for details on the identification of the
population of different filer types. See note 336 below for details
on the identification of the population of affected issuers. Out of
the 1,430 issuers who qualified as EGCs in 2018, 1,097 are also non-
accelerated filers. The remaining EGCs are still exempt from the
ICFR auditor attestation requirement solely due to the JOBS Act
Exemption, and those issuers are significantly larger in terms of
aggregate market capitalization (approximately $145 billion) than
the issuers newly exempted under the amendments (approximately $95
billion). This estimate excludes 41 EGCs with an aggregate of
approximately $20 billion in market capitalization for which we are
unable to determine non-accelerated filer status, the majority of
which are Canadian issuers filing on Form 40-F.
---------------------------------------------------------------------------

2. Comments on the Proposed Amendments
Many commenters supported the portion of the proposed amendments
that would exclude an issuer that is eligible to be an SRC and that
meets the SRC revenue test from the accelerated and large accelerated
filer definitions.\34\ Other commenters opposed the proposed amendments
or suggested the need for further analysis.\35\ Commenters' views on
different aspects of the proposal, as well as its effects, are
discussed topically, below.
---------------------------------------------------------------------------

\34\ See, e.g., letters from Adamas, AdvaMed, AdvaMed et al.,
Aequor, Andersen, Ardelyx, Ardelyx's slides from its presentation to
the SBCFAC Meeting (Aug. 13, 2019) (``Ardelyx Presentation''), ASA,
BIO, Broadmark, BSC, Carver, Catalyst, Cerecor, Chamber, Chiasma,
CLSA, Concert, Corvus, CSB, CSBA, CymaBay, Dar[eacute], Equillium,
Evoke, Gritstone, Guaranty, ICBA, Institute of Management
Accountants' Financial Reporting and Small Business Committees (July
16, 2019) (``IMA''), Kezar, Marinus, Millendo, MSB, National
Association of Manufacturers (July 26, 2019) (``NAM''), Nasdaq,
Organovo, Pieris, Revance, SCBA, SI-BONE, Summit, Sutro, Syros,
Teligent, Terra Tech, Xenon, and Zynerba.
\35\ See, e.g., letters from BDO, Better Markets, CAQ, CFA, CFA
Inst., CII, Crowe, Deloitte, Grant Thornton, Prof. Barth et al.,
Prof. Ge et al., Prof. Hassell, Prof. Honigsberg et al., and RSM.
---------------------------------------------------------------------------

a. Comments on Using Revenue for Determining Accelerated and Large
Accelerated Filer Status
A number of commenters stated explicitly that they supported using
revenue as a measure to determine whether an issuer should be subject
to the ICFR auditor attestation requirement.\36\ These commenters
suggested that using a revenue measurement is preferable to using a
public float measurement \37\ because public float is often affected by
industry or economic trends not specific to any particular issuer,\38\
and that revenue is more predictable,\39\ a better indicator of an
issuer's complexity,\40\ and a better indicator of an issuer's ability
to absorb the burdens of the ICFR auditor attestation requirement.\41\
Other commenters questioned whether revenue is an appropriate measure
for determining whether an issuer should be a non-accelerated filer in
all cases.\42\ One commenter asserted that low-revenue companies may
have less sophisticated or experienced accounting functions and some
aspects of their business may be associated with accounting
complexities.\43\ This commenter also suggested that issuers may
recognize revenue in ways that could result in them frequently
transitioning in and out of non-accelerated filer status.\44\ Another
commenter indicated that an issuer could have a relatively low amount
of revenue but still have a large market capitalization and thus
``greater investor exposure.'' \45\
---------------------------------------------------------------------------

\36\ See, e.g., letters from BIO, Broadmark, Chamber, Concert,
Corvus, and MSB.
\37\ See, e.g., letters from Broadmark, Chamber, Concert,
Corvus, and MSB.
\38\ See letter from MSB.
\39\ See letter from Broadmark.
\40\ See, e.g., letters from Concert and Corvus.
\41\ See letter from Broadmark.
\42\ See letter from Ernst & Young LLP (July 29, 2019) (``EY''),
Grant Thornton, and National Association of State Boards of
Accountancy (July 23, 2019) (``NASBA'').
\43\ See letter from EY.
\44\ Id.
\45\ See letter from Grant Thornton.
---------------------------------------------------------------------------

b. Comments on the Proposed Amendments' Effect on Capital Formation and
the Number of Public Issuers
Commenters expressed mixed views on the effect that the proposed
amendments would have on capital formation, the cost of capital, and
the decisions of companies as to whether to enter the public capital
markets. Some commenters agreed with the view expressed in the
Proposing Release that, by expanding the JOBS Act Exemption, the
proposed amendments would enhance capital formation or allow affected
issuers to preserve capital \46\ while also maintaining investor

[[Page 17182]]

protection.\47\ One commenter, questioning the benefits, if any, of the
ICFR auditor attestation requirement, asserted that there is no
correlation between a smaller issuer's compliance with the ICFR auditor
attestation requirement and stronger markets in general.\48\
Additionally, some commenters suggested that eliminating the ICFR
auditor attestation requirement would encourage certain companies to
enter the public markets.\49\
---------------------------------------------------------------------------

\46\ See, e.g., letters from Andersen, CLSA, Concert, ICBA, and
NASBA.
\47\ See, e.g., letters from ICBA and NASBA.
\48\ See letter from BIO.
\49\ See, e.g., letters from AdvaMed, AdvaMed et al., Broadmark,
Cerecor, and ICBA.
---------------------------------------------------------------------------

Conversely, other commenters asserted that the proposed amendments
would not enhance capital formation, and some indicated they could even
reduce capital formation.\50\ Two of these commenters expressed the
view that eliminating the ICFR auditor attestation requirement could
increase the cost of capital for certain issuers because investors
would require a premium to invest in issuers due to the heightened risk
of ineffective internal controls.\51\ In addition, some commenters
maintained that the ICFR auditor attestation requirement does not
prevent companies from entering the public markets.\52\ For example,
one commenter suggested that the Proposing Release's statement about
the significant decline in the number of issuers listed on major
exchanges implied that the cost of compliance with the ICFR auditor
attestation requirement has contributed materially to that decline.\53\
This commenter and some others asserted that the decline can be
attributed to many other factors.\54\ Some commenters stated that
confidence in the U.S. capital market system, likely stems, at least in
part, from financial reporting safeguards, including the ICFR auditor
attestation requirement, and contended that the proposed amendments
would thereby reduce investor confidence in issuers' financial
reporting.\55\
---------------------------------------------------------------------------

\50\ See, e.g., letters from Better Markets, CII, CFA, CFA
Inst., and Prof. Ge et al.
\51\ See letters from Better Markets and CFA.
\52\ See, e.g., letters from CFA, CFA Inst., CII, and Crowe.
\53\ See letter from CFA.
\54\ See, e.g., letters from CII, CFA, CFA Inst., and Crowe.
Other factors commenters cited include the expansion of exemptions
to registration that increase companies' ability to raise funds
privately, see, e.g., letters from CFA, CII, and Crowe; corporate
consolidations, see, e.g., letters from CFA and CII; market
conditions, see letter from CFA; and the general regulatory
environment, see letter from Crowe.
\55\ See, e.g., letters from CAQ and CII.
---------------------------------------------------------------------------

Several commenters indicated that the ICFR auditor attestation
requirement is not necessary because issuers are permitted to
voluntarily obtain an ICFR auditor attestation if they believe it is in
their interest to do so.\56\ Some instances in which commenters
suggested that issuers may choose to voluntarily obtain an ICFR auditor
attestation include when their investors demand it,\57\ when not
obtaining it would have a negative impact on investment analysts'
coverage,\58\ or when issuers otherwise deem it a good use of their
capital resources.\59\ In this regard, one commenter suggested
clarifying that it is the authority and responsibility of the issuer's
audit committee to determine whether the issuer should voluntarily
obtain an ICFR auditor attestation.\60\
---------------------------------------------------------------------------

\56\ See, e.g., letters from ASA, BIO, Broadmark, Chamber,
Guaranty, and Nasdaq.
\57\ See, e.g., letters from BIO and Guaranty.
\58\ See letter from Guaranty.
\59\ Id.
\60\ See letter from EY.
---------------------------------------------------------------------------

c. Comments on the Proposed Amendments' Effect on Investor Protection
Commenters' views as to the effect of the proposed amendments on
investor protection were also mixed. Many commenters asserted that,
even if the ICFR auditor attestation requirement did not apply, other
existing requirements would provide investors in these issuers with
sufficient protection.\61\ Commenters cited a number of these other
requirements, including SOX Section 404(a); \62\ Nasdaq's listing
standards, surveillance, and enforcement; \63\ the required management
certifications; \64\ and the obligation of an independent auditor to
consider ICFR when conducting a financial statement audit.\65\
---------------------------------------------------------------------------

\61\ See, e.g., letters from ASA, Broadmark, BSC, Carver,
Cerecor, Guaranty, ICBA, MSB, NAM, Nasdaq, Pieris, SCBA, and Xenon.
\62\ See, e.g., letters from ASA, Broadmark, Carver, ICBA, MSB,
Nasdaq, and Xenon.
\63\ See letter from Nasdaq.
\64\ See 17 CFR 229.601(31)(i), 17 CFR 240.13a-14(a), and 17 CFR
240.15d-14(a). See, e.g., letters from MSB, Nasdaq, and Xenon.
\65\ See, e.g., letters from ASA, Carver, Cerecor, MSB, NAM, and
Xenon.
---------------------------------------------------------------------------

For example, several commenters noted that, when conducting a
financial statement audit, the auditor is required to obtain an
understanding of each component of ICFR,\66\ which a few of these
commenters asserted would provide investors with sufficient protection
absent the ICFR auditor attestation requirement.\67\ Other commenters
noted that the requirement that an auditor communicate to the issuer's
management and its audit committee any significant deficiencies or
material weaknesses related to ICFR in a financial statement audit
would provide a certain level of protection for investors in the
affected issuers.\68\ Some commenters expressed a view that the ICFR
auditor attestation requirement is not important or material to
investors generally.\69\ A few of these commenters asserted that
investors rarely ask an issuer that is exempt from the ICFR auditor
attestation requirement to voluntarily obtain such an attestation.\70\
One commenter \71\ cited a study \72\ that found no statistically
significant market response on average to disclosures of material
weaknesses in disclosure controls, which suggests, according to the
commenter, that investors do not significantly change their long-term
value assessment of an issuer based on these disclosures.
---------------------------------------------------------------------------

\66\ See, e.g., letters from ASA, CAQ, CFA Inst., Crowe, EY,
Grant Thornton, Guaranty, NASBA, Nasdaq, PricewaterhouseCoopers LLP
(July 25, 2019) (``PWC''), and RSM.
\67\ See, e.g., letters from ASA, Guaranty, and Nasdaq.
\68\ See letter from Nasdaq.
\69\ See, e.g., letters from Adamas; Ardelyx; Ardelyx
Presentation, ASA, BIO, Carver, Catalyst, Chiasma, Corvus, CymaBay,
Equillium, Evoke, Gritstone, Kezar, Marinus, Millendo, Organovo,
Pieris, Revance, SI-BONE, Syros, Teligent, and Zynerba. Some of
these commenters and others asserted that the ICFR auditor
attestation requirement is not material for, or important to,
investors based on the results of a study and their own experience.
See, e.g., letters from Adamas, Ardelyx, Catalyst, Chiasma, Corvus,
CymaBay, Equillium, Evoke, Gritstone, Kezar, Marinus, Millendo,
Organovo, Pieris, Revance, SI-BONE, Syros, Teligent, and Zynerba
(citing Craig Lewis and Joshua White, Science or Compliance: Will
Section 404(b) Compliance impede Innovation by Emerging Growth
Companies in the Biotech Industry, (Feb. 2019) (``BIO Study''),
available at https://www.bio.org/sites/default/files/BIO_EGC_White_Paper_02_11_2019_FINAL.pdf).
\70\ See, e.g., letters from Ardelyx Presentation and BIO.
\71\ See letter from BIO.
\72\ Jacqueline Hammersley, Linda Myers, and Catherina
Shakespeare, Market Reactions to the Disclosure of Internal Control
Weaknesses and to the Characteristics of those Weaknesses under
Section 302 of the Sarbanes Oxley Act of 2002 (Mar. 2008), available
at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=979538.
---------------------------------------------------------------------------

In addition to these broader points, several commenters in the
banking sector pointed out that community banks and bank holding
companies are subject to extensive supervision and regulation by
federal and state banking regulators, which they stated would protect
investors in this industry even if the affected issuers were not
subject to the ICFR auditor attestation requirement.\73\
---------------------------------------------------------------------------

\73\ See, e.g., letters from BSC, Guaranty, ICBA, and SCBA.
---------------------------------------------------------------------------

Conversely, other commenters asserted that the ICFR auditor
attestation requirement is an important investor protection and that
eliminating it would undermine such protection.\74\

[[Page 17183]]

One commenter disputed the contention in the Proposing Release that
eliminating the ICFR auditor attestation requirement for low-revenue
issuers would not significantly affect the ability of investors to make
informed investment decisions.\75\ Some commenters stated that the ICFR
auditor attestation requirement increases investor confidence generally
\76\ and that investors view the requirement as beneficial.\77\
---------------------------------------------------------------------------

\74\ See, e.g., letters from Better Markets, Grant Thornton, and
Prof. Barth et al.
\75\ See letter from Prof. Barth et al.
\76\ See, e.g., letters from Better Markets, CAQ, CFA Inst., and
EY.
\77\ See, e.g., letters from CII, CFA Inst., and EY.
---------------------------------------------------------------------------

Some commenters asserted that the SOX Section 404(a) requirement
would not provide investors in low-revenue SRCs with sufficient
protection if they were not also subject to the ICFR auditor
attestation requirement \78\ because, as one commenter stated, the ICFR
auditor attestation requirement acts as an effective check on SOX
Section 404(a).\79\ Another commenter asserted that management's
assessment is weakened when management knows that it will not be
challenged by an ICFR auditor attestation.\80\ A third commenter
claimed that investors would place undue reliance on management's
report when not accompanied by an ICFR auditor attestation.\81\
---------------------------------------------------------------------------

\78\ See, e.g., letters from Better Markets, CFA Inst., Crowe,
Grant Thornton, and Prof. Barth et al.
\79\ See letter from Better Markets.
\80\ See letter from CFA Inst.
\81\ See letter from Grant Thornton.
---------------------------------------------------------------------------

A few commenters noted that a financial statement audit does not
provide the same level of assurance as an integrated audit \82\ because
a financial statement audit's objective is different from that of an
integrated audit as it relates to ICFR.\83\ Therefore, some commenters
asserted that, without the ICFR auditor attestation requirement, the
requirement for auditors to obtain an understanding of each component
of ICFR when conducting a financial statement audit would not provide
sufficient investor protection.\84\ Similarly, other commenters
suggested that some testing of ICFR conducted as part of a financial
statement audit would not provide sufficient investor protection.\85\
One commenter asserted that the control testing performed by a
financial statement auditor would not be as extensive as testing
performed in an ICFR auditor attestation and that it is more difficult
for a financial statement auditor to challenge the design of ICFR.\86\
Another commenter noted that, despite the requirement that a financial
statement auditor communicate any significant deficiencies or material
weaknesses related to ICFR to the issuer's management and its audit
committee, a financial statement audit is not designed to identify such
significant deficiencies or material weaknesses.\87\
---------------------------------------------------------------------------

\82\ See, e.g., letters from CFA Inst., Crowe, and EY.
\83\ See, e.g., letters from CAQ, CFA Inst., and RSM (noting
that a financial statement audit's objective is for the auditor to
obtain an understanding of the issuer's ICFR that is sufficient to
assess the factors that affect the risks of material misstatement
and to design further audit procedures, whereas an integrated
audit's objective is to test and express an opinion on the
effectiveness of the issuer's ICFR).
\84\ See, e.g., letters from CAQ, CFA Inst. Crowe, EY, and RSM.
\85\ See, e.g., letters from EY, Grant Thornton, and NASBA.
\86\ See letter from EY.
\87\ Id.
---------------------------------------------------------------------------

Some commenters indicated that the ICFR auditor attestation
requirement promotes effective ICFR and more accurate disclosures
related to ICFR,\88\ including the likelihood and timeliness of
disclosing ineffective ICFR.\89\ Also, a number of commenters noted
that, as discussed in the Proposing Release, effective ICFR, generally,
and the ICFR auditor attestation requirement, more specifically,
enhances transparency; \90\ increases the quality and reliability of
issuers' financial statements,\91\ corporate governance,\92\
audits,\93\ and analyst forecasts; \94\ and reduces the number of
issuers' restatements, misstatements,\95\ the instances of fraud,\96\
and occurrences of insider trading.\97\
---------------------------------------------------------------------------

\88\ See, e.g., letters from Better Markets, CFA, CII, Crowe,
Grant Thornton, Prof. Barth et al., and PWC.
\89\ See, e.g., letters from Better Markets, CFA, Crowe, and
Prof. Barth et al.
\90\ See letter from EY.
\91\ See, e.g., letters from Better Markets, CAQ, CFA, CII,
Deloitte, EY, Grant Thornton, Prof. Barth et al., PWC, and RSM.
\92\ See letter from Deloitte.
\93\ See letter from CAQ.
\94\ See letter from CFA.
\95\ See, e.g., letters from CAQ, CFA, CFA Inst., Crowe,
Deloitte, EY, Grant Thornton, and Prof. Barth et al.
\96\ See, e.g., letters from Better Markets and Deloitte.
\97\ See letter from CFA.
---------------------------------------------------------------------------

A few commenters expressed concern about the effect that the
amendments could have on the reliability of key performance indicators
and other measures. One commenter indicated that investors in certain
issuers that would become non-accelerated filers under the amendments
rely on key performance indicators that are derived from their
financial statements, such as backlog, sales orders, and number of
customers, and asserted that eliminating the ICFR auditor attestation
requirement could reduce the reliability of those indicators.\98\
Another commenter noted that investors in those issuers rely on non-
GAAP financial measures, key performance indicators, and other
disclosures and stated that the Commission may wish to consider auditor
involvement with that information to address potential risks related to
completeness and accuracy.\99\
---------------------------------------------------------------------------

\98\ See letter from NASBA.
\99\ See letter from CAQ.
---------------------------------------------------------------------------

d. Comments on the Disproportionate Costs and Benefits of the ICFR
Auditor Attestation Requirement to Small and Low-Revenue Companies
A number of commenters stated that the ICFR auditor attestation
requirement is quite costly.\100\ One of these commenters indicated
that the ICFR auditor attestation requirement ``is the most costly
aspect of being an [a]ccelerated [f]iler.'' \101\ Several commenters
asserted more specifically that the ICFR auditor attestation
requirement is disproportionally costly to small and/or low-revenue
issuers.\102\ Some of these commenters indicated that the reason for
the disproportionate costs is that there are fixed costs associated
with the ICFR auditor attestation requirement that are not scalable for
smaller issuers.\103\ Other commenters stated that the benefits of the
ICFR auditor attestation requirement do not outweigh the costs,\104\
including the costs associated with ICFR auditor attestation fees,\105\
issuer personnel time,\106\ and outside consultants.\107\
---------------------------------------------------------------------------

\100\ See, e.g., letters from BIO, Broadmark, Carver, Guaranty,
ICBA, MSB, Summit, and Syros.
\101\ Letter from Guaranty.
\102\ See, e.g., letters from AdvaMed et al., Andersen, BIO,
Broadmark, Chamber, CLSA, CSB, Guaranty, and NAM.
\103\ See, e.g., letters from Broadmark and Guaranty.
\104\ See, e.g., letters from ICBA, MSB, and Syros.
\105\ See, e.g., letters from MSB and Summit.
\106\ See, e.g., letters from Carver, MSB, and Summit.
\107\ See, e.g., letters from MSB and Summit.
---------------------------------------------------------------------------

Some commenters asserted that eliminating the ICFR auditor
attestation requirement would not substantially reduce costs to
issuers.\108\ A few of these commenters noted that ICFR auditor
attestations have become less expensive and more effective because
auditors are more experienced in conducting them.\109\ Some commenters
stated that potential compliance cost reductions may be negated if
there is a loss of investor confidence and protection,\110\ if ICFR
deficiencies go undetected,\111\ if there is an increase in
restatements and misstatements,\112\ or if there are higher

[[Page 17184]]

costs of capital.\113\ Additionally, some commenters stated that any
cost reductions would vary widely among issuers \114\ and would be hard
to quantify.\115\
---------------------------------------------------------------------------

\108\ See, e.g., letters from BDO, Better Markets, CFA, CFA
Inst., EY, Grant Thornton, and RSM.
\109\ See, e.g., letters from CFA Inst. and Deloitte.
\110\ See, e.g., letters from Better Markets and CII.
\111\ See letter from CFA Inst.
\112\ See, e.g., letters from BDO, CFA, and CFA Inst.
\113\ See, e.g., letters from CFA and CFA Inst.
\114\ See, e.g., letters from EY, Grant Thornton, and PWC.
\115\ See, e.g., letters from Grant Thornton, PWC, and RSM.
---------------------------------------------------------------------------

Other commenters asserted that the benefits of the ICFR auditor
attestation requirement are not as great for low-revenue and smaller
issuers as they are for other issuers.\116\ These commenters expressed
the view that the issuers that would be exempt from the ICFR auditor
attestation requirement under the proposed amendments are less likely
to have ineffective ICFR than other issuers. One commenter cited a
study that concluded that biotech EGCs are less likely to have
ineffective ICFR than other issuers.\117\ Another commenter noted that
ineffective ICFR is less of a concern for banking issuers because of
the ``federal and state regulatory oversight and internal control
audits of community banks.'' \118\
---------------------------------------------------------------------------

\116\ See, e.g., letters from BIO and Guaranty.
\117\ See letter from BIO (citing the BIO Study). Note that the
BIO Study investigates only the incremental effect of being in the
category of biotech EGCs after accounting for the association of
ineffective ICFR with the other characteristics of these issuers
(such as their size and return on assets). It is unclear from the
study whether these issuers have a higher or lower rate of
ineffective ICFR on average, when considering all of their
characteristics.
\118\ See letter from Guaranty.
---------------------------------------------------------------------------

Conversely, a number of other commenters contended that the
benefits of the ICFR auditor attestation requirement are greater for
low-revenue and smaller issuers than for other issuers.\119\ Some of
the commenters discussed how those issuers are more likely to have
ineffective ICFR.\120\ Commissioner Robert J. Jackson Jr.'s dissent
from the Proposing Release (``Commissioner Jackson's Statement'') \121\
asserted that investors care most about ICFR auditor attestations at
those issuers that would not be subject to the ICFR auditor attestation
requirement under the proposed amendments, and that high-growth
companies, which potentially would include some of the affected
issuers, are those in which the risk and consequences of fraud are the
greatest.\122\ Some commenters referred to statistics cited in the
Proposing Release to argue that issuers not subject to the ICFR auditor
attestation requirement have higher levels of ineffective ICFR compared
with issuers subject to that requirement.\123\ Additionally, commenters
observed that some low-revenue issuers or smaller companies may still
have complex financial statements that require sophisticated
accounting.\124\
---------------------------------------------------------------------------

\119\ See, e.g., letters from Better Markets, CAQ, CFA, CFA
Inst., CII, Crowe, EY, Grant Thornton, IMA, NASBA, Prof. Barth et
al., Prof. Hassell, and RSM.
\120\ See, e.g., letters from Better Markets, CAQ, CFA, CII,
Grant Thornton, IMA, NASBA, Prof. Barth et al., and Prof. Hassell.
\121\ Commissioner Robert J. Jackson Jr., Statement on Proposed
Amendments to Sarbanes Oxley 404(b) Accelerated Filer Definition
(May 9, 2019), available at https://www.sec.gov/news/public-statement/jackson-statement-proposed-amendments-accelerated-filer-definition. A few commenters cited Commissioner Jackson's Statement.
See, e.g., letters from CFA, CFA Inst., and CII.
\122\ We address Commissioner Jackson's Statement in the
Economic Analysis. See Section IV.C.3.c. below.
\123\ Commenters cited the statistics in the Proposing Release,
note 4 above, that over 40 percent of non-accelerated filers that
are not subject to the ICFR auditor attestation requirement have
ineffective ICFR, compared to less than approximately nine and five
percent of accelerated and large accelerated filers, respectively.
As noted in the Proposing Release, note 4 above, over 68 percent of
non-accelerated filers have reported two consecutive years of
ineffective ICFR and over 38 percent have reported four consecutive
years of ineffective ICFR in their annual reports. See, e.g.,
letters from Better Markets and Grant Thornton.
\124\ See, e.g., letters from BDO and RSM.
---------------------------------------------------------------------------

Finally, some commenters maintained that the risks of fraud \125\
and financial statement restatements or misstatements \126\ are greater
for the issuers that would not be subject to the ICFR auditor
attestation requirement under the proposed amendments than they are for
other issuers. Other commenters cited research that concludes that,
since 2003, non-accelerated U.S. filers accounted for 62 percent of the
total U.S. financial statement restatements.\127\ Some commenters
contended that issuers that would not be subject to the ICFR auditor
attestation requirement under the proposed amendments have fewer
resources and personnel,\128\ which could result in increased
misstatements,\129\ unidentified material weaknesses,\130\ and
ineffective ICFR.\131\
---------------------------------------------------------------------------

\125\ See, e.g., letters from Better Markets, CFA, CII, and
Prof. Barth et al.
\126\ See, e.g., letters from Better Markets, CAQ, EY, Grant
Thornton, IMA, Prof. Barth et al., and RSM.
\127\ See, e.g., letters from CAQ and CFA Inst.
\128\ See, e.g., letters from CAQ, Crowe, EY, and Grant
Thornton.
\129\ See, e.g., letter from Crowe.
\130\ See, e.g., letter from EY.
\131\ See, e.g., letters from CAQ and Grant Thornton.
---------------------------------------------------------------------------

e. Comments on the Relationship Between Non-Accelerated Filers and SRCs
A number of commenters discussed the relationship between the non-
accelerated filer and SRC definitions.\132\ Some commenters noted the
current relationship is incongruent, which results in complexity.\133\
Several commenters indicated that the proposed amendments would reduce
some of this complexity by more closely aligning the definitions.\134\
In contrast, other commenters asserted that the proposed amendments
would increase the complexity of determining filer status.\135\
---------------------------------------------------------------------------

\132\ See, e.g., letters from ASA, BDO, BIO, Broadmark, CFA, CFA
Inst., Chamber, EY, Grant Thornton, Guaranty, KPMG LLP (July 29,
2019) (``KPMG''), NAM, Nasdaq, PWC, and RSM.
\133\ See, e.g., letters from BDO, BIO, Broadmark, CFA, and
Nasdaq.
\134\ See, e.g., letters from BIO, Grant Thornton, KPMG, and
Nasdaq.
\135\ See, e.g., letters from BDO, CFA Inst., EY, PWC, and RSM.
See also SBCFAC Meeting Transcript (Aug. 13, 2019), available at
https://www.sec.gov/info/smallbus/acsec/sbcfac-transcript-081319.pdf.
---------------------------------------------------------------------------

While supporting the proposed amendments, some commenters
recommended that the final amendments completely align the SRC and non-
accelerated filer definitions.\136\ Additionally, one commenter
recommended further extending the relief from the ICFR auditor
attestation requirement to issuers with a public float that exceeds
$700 million if their annual revenues are less than $100 million.\137\
---------------------------------------------------------------------------

\136\ See, e.g., letters from ASA, Guaranty, NAM, and Nasdaq.
\137\ See letter from Corvus.
---------------------------------------------------------------------------

f. Other Comments
We received a variety of other comments on the Proposing Release.
Some commenters noted that it is difficult for investors to easily
determine whether an issuer's filing includes an ICFR auditor
attestation.\138\ These commenters suggested requiring issuers to
disclose whether they are exempt from the ICFR auditor attestation
requirement \139\ and/or have voluntarily obtained an ICFR auditor
attestation \140\ either on a filing's cover page,\141\ such as with a
check box,\142\ or in management's report on ICFR.\143\ Two commenters
recommended that the Commission engage in a post-implementation review
of the impact of the final amendments,\144\ with one of these
commenters recommending that

[[Page 17185]]

the final amendments require a review of the impact of the changes on
the affected registrants five years after adoption of the
amendments.\145\ Some commenters requested that we allow sufficient
time and notice for auditors and issuers to prepare for compliance with
the final amendments,\146\ whereas other commenters noted that some
issuers may be subject to the ICFR auditor attestation requirement for
only a short time \147\ and requested the Commission adopt final
amendments quickly.\148\ One commenter asserted that the measurement
date for non-accelerated filer status and the timing of the start of
the auditor's attestation of ICFR is burdensome to small biotech
registrants.\149\
---------------------------------------------------------------------------

\138\ See, e.g., letters from CAQ, CFA Inst., and Grant
Thornton.
\139\ See, e.g., letters from CFA Inst., CII, and Grant
Thornton.
\140\ See, e.g., letters from CFA Inst. and KPMG.
\141\ See, e.g., letters from CAQ, CFA Inst., CII, and Grant
Thornton.
\142\ See, e.g., letters from CAQ and Grant Thornton.
\143\ See letter from Grant Thornton.
\144\ See letters from IMA and PWC.
\145\ See letter from IMA.
\146\ See, e.g., letters from BDO, CAQ, Crowe, EY, KPMG, PWC,
and RSM.
\147\ See, e.g., letters from Concert, MSB, Nasdaq, and Xenon.
\148\ See, e.g., letters from MSB and Summit.
\149\ See letter from Corvus. Public float for both SRC status
and accelerated and large accelerated filer status is measured on
the last business day of the issuer's most recently completed second
fiscal quarter, and revenue for purposes of determining SRC status
is measured based on annual revenues for the most recent fiscal year
completed before the last business day of the second fiscal quarter.
Therefore, an issuer will be aware of any change in SRC status or
accelerated or large accelerated filer status as of that date.
Although an issuer that determines it will no longer be eligible to
be an SRC is permitted to continue to use the SRC accommodations for
the Form 10-K for the year in which it fails the measurement test,
an issuer that becomes an accelerated or large accelerated filer on
that same measurement date would be required to include the ICFR
auditor attestation in that Form 10-K. See Rule 12b-2, Item
10(f)(2)(i)(C), and Rule 405. Although the transition provisions
apply differently, the measurement dates for SRC status and
accelerated and large accelerated filer status each provide an
issuer with at least six months to prepare for a change in its
status, and we continue to believe that this is an adequate amount
of time to prepare for the transition.
---------------------------------------------------------------------------

Additionally, although we did not propose amendments to the
accelerated and large accelerated filer definitions that would
specifically address foreign private issuers (``FPI'') or business
development companies (``BDC''), we solicited comment on these points
and a few commenters requested we do so.\150\ One commenter asserted
that there should be no disparity between an FPI that presents its
financial statements in accordance with International Financial
Reporting Standards (``IFRS'') and a domestic issuer or FPI that
presents its financial statements in accordance with U.S. GAAP.\151\
The commenter noted that an FPI that presents its financial statements
in accordance with IFRS cannot be an SRC, so such an FPI cannot rely on
the proposed amendments. Another commenter recommended that the
Commission extend the benefits of non-accelerated filer status to BDCs
if they have total investment income of less than $80 million in their
most recently completed fiscal year for which audited financial
statements are available and have either no public float or public
float of less than $700 million.\152\ The commenter stated that
allowing BDCs to qualify as non-accelerated filers under this modified
SRC revenue test would reduce regulatory asymmetry between BDCs and
operating companies, consistent with recent congressional mandates to
allow BDCs to use the same offering rules as operating companies. The
commenter also suggested that allowing smaller BDCs to benefit from
non-accelerated filer status would ease regulatory costs and burdens,
which could encourage more BDCs to enter public markets, creating
greater access to capital for small operating companies and expanding
investment opportunities for retail investors.\153\
---------------------------------------------------------------------------

\150\ See, e.g., letters from Dorsey & Whitney LLP (Aug. 16,
2019) (``Dorsey & Whitney'') and Proskauer Rose LLP (July 26, 2019)
(``Proskauer'').
\151\ See letter from Dorsey & Whitney.
\152\ See letter from Proskauer.
\153\ Id.
---------------------------------------------------------------------------

3. Final Amendments
After considering the comments, we are adopting the final
amendments substantially as proposed. The final amendments add a new
condition to the accelerated and large accelerated filer definitions in
Rule 12b-2 that excludes an issuer that is eligible to be an SRC and
that had annual revenues of less than $100 million in the most recent
fiscal year for which audited financial statements are available. The
amendments also allow BDCs to qualify for this exclusion if they meet
the requirements of the SRC revenue test using their annual investment
income as the measure of annual revenue, although BDCs would continue
to be ineligible to be SRCs.\154\ The final amendments are consistent
with our historical practice of providing scaled disclosure and other
accommodations for smaller issuers \155\ and with recent actions by
Congress to reduce burdens on new and smaller issuers.\156\ The table
below summarizes the conditions required to be considered an
accelerated and large accelerated filer under the final amendments to
Rule 12b-2.
---------------------------------------------------------------------------

\154\ See Section II.B.3.f. below.
\155\ See, e.g., Smaller Reporting Company Regulatory Relief and
Simplification, Release No. 33-8876 (Dec. 19, 2007) [73 FR 934 (Jan.
4, 2008)]; Smaller Reporting Company Regulatory Relief and
Simplification, Release No. 33-8876 (Dec. 19, 2007) [73 FR 934 (Jan.
4, 2008)] (``2007 SRC Adopting Release''); and SRC Adopting Release,
note 12 above.
\156\ See note 11 above.

Table 1--Accelerated Filer and Large Accelerated Filer Conditions Under
the Final Amendments
------------------------------------------------------------------------
Final large accelerated
Final accelerated filer conditions filer conditions
------------------------------------------------------------------------
The issuer has a public float of $75 The issuer has a public
million or more, but less than $700 float of $700 million or
million, as of the last business day of more, as of the last
the issuer's most recently completed business day of the
second fiscal quarter. issuer's most recently
completed second fiscal
quarter.
The issuer has been subject to the Same.
requirements of Exchange Act Section 13(a)
or 15(d) for a period of at least twelve
calendar months.
The issuer has filed at least one annual Same.
report pursuant Exchange Act Section 13(a)
or 15(d).
The issuer is not eligible to use the Same.
requirements for SRCs under the revenue
test in paragraph (2) or (3)(iii)(B), as
applicable, of the ``smaller reporting
company'' definition in Rule 12b-2 or, in
the case of a BDC, does not meet the
requirements of the revenue test in those
paragraphs using annual investment income
as the measure of its annual revenues.
------------------------------------------------------------------------

Below we discuss specific aspects of the final amendments about
which we received significant public comment and our response to those
comments. In many cases, our responses reflect analysis and data that
is more comprehensively presented in the Economic Analysis.\157\
---------------------------------------------------------------------------

\157\ See Section IV. below.

---------------------------------------------------------------------------

[[Page 17186]]

a. Using Revenue for Determining Accelerated and Large Accelerated
Filer Status
As discussed above,\158\ several commenters supported the use of
revenue in the proposal, providing a variety of reasons that a revenue
measurement is preferable to using a public float measurement.\159\
Others, however, questioned whether revenue is an appropriate measure
for determining whether an issuer should be considered a non-
accelerated filer.\160\ One of these commenters asserted that low-
revenue issuers may have less sophisticated or experienced accounting
functions and some aspects of their business may be associated with
accounting complexities.\161\ Also, the commenter suggested that these
issuers may recognize revenue in ways that could result in them
frequently transitioning in and out of non-accelerated filer
status.\162\
---------------------------------------------------------------------------

\158\ See Section II.A.2.a. above.
\159\ See, e.g., letters from Broadmark, Chamber, Concert,
Corvus, and MSB.
\160\ See, e.g., letters from EY and Grant Thornton, and NASBA.
\161\ See letter from EY.
\162\ Id.
---------------------------------------------------------------------------

As we discuss in more detail below,\163\ we continue to believe, as
a general matter, that there may be greater costs and relatively lower
benefits to including low-revenue issuers, as compared to other
issuers, in the accelerated and large accelerated filer definitions.
While we recognize that the circumstances of individual issuers and
their accounting systems and processes may vary, we believe that low-
revenue issuers may, on average, be less susceptible to the risk of
certain types of restatements, such as those related to revenue
recognition.\164\ We also note that the revisions to the transition
thresholds included in the final amendments may help minimize the risk
of frequent reclassifications of issuer status.\165\ For these reasons,
we continue to believe that revenue is an appropriate measure for
determining whether an issuer should be considered a non-accelerated
filer.
---------------------------------------------------------------------------

\163\ See Sections II.B.3.d. and Section IV.C.2.d. below.
\164\ See Section IV.C.3. below.
\165\ See Section II.C. below.
---------------------------------------------------------------------------

b. Effect on Capital Formation and the Number of Public Companies
Under the final amendments, an issuer that is eligible to be an SRC
and that meets the SRC revenue test will not be required to comply with
accelerated or large accelerated filer requirements and, thereby, will
not be subject to the ICFR auditor attestation requirement. Not
subjecting these affected issuers to the ICFR auditor attestation
requirement should reduce their compliance costs. As discussed in the
Economic Analysis,\166\ we estimate that, consistent with the proposal,
an issuer no longer subject to the ICFR auditor attestation requirement
would save approximately $210,000 per year comprised of approximately
$110,000 per year reduction in audit fees and an additional reduction
in non-audit costs of approximately $100,000.
---------------------------------------------------------------------------

\166\ See Section IV.C.2.b. below.
---------------------------------------------------------------------------

Some commenters stated that eliminating the ICFR auditor
attestation requirement would enhance capital formation or allow those
issuers to preserve capital.\167\ We note, however, that a number of
other commenters asserted that these cost savings would be small,\168\
and may not help capital formation.\169\ As we discuss in the Economic
Analysis,\170\ we continue to believe that the expected savings are
likely to represent a meaningful cost savings for many of the affected
issuers and, therefore, may have a positive effect on capital
preservation and formation. Although the average annual cost savings
may represent a small percentage of the average affected issuer's
revenues and market capitalization, we believe those savings may be
meaningful given that affected issuers have, on average, negative net
income and negative net cash flows from operations.\171\ More
generally, low-revenue issuers are likely to face financing constraints
because they do not have access to internally generated capital.\172\
Therefore, the average savings of $210,000 per year for these issuers
may be put to productive use \173\ such as developing the company.\174\
---------------------------------------------------------------------------

\167\ See, e.g., letters from Andersen, CLSA, Concert, ICBA, and
NASBA.
\168\ See letters from CFA, CFA Inst., CII, and Prof. Barth et
al.
\169\ See note 50 above.
\170\ See Section IV.C.2.d. below.
\171\ See note 362 below.
\172\ This information is based on staff analysis of data from
Compustat. See Section IV.C.2.d. below.
\173\ For example, in a survey of issuers in the biotech
industry, among 11 biotech EGCs that responded to a question
regarding how an extension of the exemption from the ICFR auditor
attestation requirement would affect them given the costs associated
with the requirement, eight out of the 11 issuers indicated that
they expected a positive impact on investments in research and
development and six out of the 11 issuers indicated that they
expected a positive impact on hiring employees. See BIO Study, note
423 above.
\174\ See, e.g., letters from Adamas, Aequor, Andersen, Ardelyx,
Catalyst, Chiasma, CLSA, Concert, Corvus, CymaBay, Dar[eacute],
Evoke, Equillium, Gritstone, ICBA, Kezar, Marinus, Millendo, NASBA,
Organovo, Pieris, Revance, SI-BONE, Sutro, Syros, Teligent, and
Zynerba.
---------------------------------------------------------------------------

As we noted in the Proposing Release,\175\ the affected issuers are
a type of smaller issuer whose representation in public markets has
decreased relative to the years before SOX. Over the past two decades,
the number of issuers listed on major exchanges has decreased by about
40 percent,\176\ but the decline has been concentrated among smaller
size issuers. For example, the number of listed issuers with a market
capitalization below $700 million has decreased by about 65
percent,\177\ and the number of issuers with less than $100 million in
revenue has decreased by about 60 percent.\178\ Although factors other
than the ICFR auditor attestation requirement may have contributed to
the decline,\179\ we believe that the described cost reductions
associated with the final amendments could be a positive factor in
encouraging additional small companies to register their securities
offerings or a class of their securities, which would provide an
increased level of transparency and investor protection with respect to
those companies.\180\
---------------------------------------------------------------------------

\175\ See Section III.C.1. of the Proposing Release, note 4
above. Staff extracted information regarding whether issuers
reported having securities registered under Section 12(b) of the
Exchange Act from the cover page of annual report filings using a
computer program supplemented with hand collection. See note 336
below for details on the identification of the population of
affected issuers.
\176\ This estimate is based on staff analysis of data from the
Center for Research in Security Prices database for December 1998
versus December 2018. The estimate excludes RICs and issuers of
ADRs.
\177\ Id.
\178\ This estimate is based on staff analysis of data from
Standard & Poor's Compustat and Center for Research in Security
Prices databases for fiscal year 1998 versus fiscal year 2017. The
estimate excludes RICs and issuers of ADRs.
\179\ See note 54 above.
\180\ See, e.g., letters from AdvaMed, AdvaMed et al.,
Broadmark, Cerecor, and ICBA.
---------------------------------------------------------------------------

c. Effect on Investor Protection
We continue to believe that the amendments are not likely to have a
significant effect on the overall ability of investors in the affected
issuers to make informed investment decisions and note that many
commenters agreed with this assessment.\181\ As discussed in greater
detail in the Proposing Release,\182\ issuers have a number of other
obligations that we believe will provide sufficient protections for
investors in the affected issuers and allow investors in those issuers
to make informed investment decisions. These responsibilities derive
from the Foreign Corrupt Practices Act (``FCPA'')

[[Page 17187]]

requirements with respect to internal accounting controls \183\ as well
as a number of different changes to financial reporting that were
introduced by SOX.\184\
---------------------------------------------------------------------------

\181\ See note 61 to 68 above and accompanying text.
\182\ See Section II.B. of the Proposing Release, note 4 above.
\183\ The FCPA added Section 13(b)(2)(B) to the Exchange Act, 15
U.S.C 78m(b)(2)(B) (referring to ``internal accounting controls''
rather than ICFR).
\184\ See, e.g., SOX Sections 302, 15 U.S.C. 7241, and 404(a)
and related rules. See 17 CFR 229.308, 17 CFR 240.13a-15, 17 CFR
240.15d-15, Form 20-F, Form 40-F, 17 CFR 270.30a-2, and 17 CFR
270.30a-3.
---------------------------------------------------------------------------

For example, although a non-accelerated filer that is eligible to
be an SRC and that meets the SRC revenue test will not be subject to
the ICFR auditor attestation requirement, it will remain subject to the
SOX Section 404(a) requirement to state in its annual report the
responsibility of management for establishing and maintaining an
adequate control structure and procedures for financial reporting, and
for that report to contain an assessment of the effectiveness of that
structure and its procedures. In addition, affected issuers are
required to devise and maintain a system of internal accounting
controls sufficient to provide reasonable assurances that transactions
are recorded as necessary to permit the preparation of financial
statements in conformity with GAAP.\185\ Also, the principal executive
and financial officers of certain issuers are required to certify that,
among other things, they are responsible for establishing and
maintaining ICFR, have designed disclosure controls and procedures to
ensure material information relating to the issuer and its consolidated
subsidiaries is made known to such officers by others within those
entities, and have evaluated and reported on the effectiveness of the
issuer's disclosure controls and procedures.\186\
---------------------------------------------------------------------------

\185\ 15 U.S.C. 78m(b)(2)(B).
\186\ See 17 CFR 240.13a-14 or 17 CFR 240.15d-14 (requiring
certification) and 17 CFR 229.601(b)(31) (prescribing certification
content). These rules were adopted pursuant to SOX Section 302. See
15 U.S.C. 7241.
---------------------------------------------------------------------------

Furthermore, the issuers that are subject to the final amendments
will remain subject to a financial statement audit by an independent
auditor, which will help maintain appropriate investor protections.
Even without an ICFR auditor attestation requirement, an independent
auditor is required to consider ICFR in the performance of a financial
statement audit.\187\ We acknowledge, as stated by some
commenters,\188\ that the objective of a financial statement audit and
the level of control testing performed is different from an ICFR audit.
However, we believe that the requirements of a financial statement
audit, among other requirements, provide some additional protections
and that, for low-revenue SRCs, this and the other protections and
factors associated with these issuers described above sufficiently
mitigate the risk that the final amendments will adversely affect the
ability of investors to make informed investment decisions.\189\
---------------------------------------------------------------------------

\187\ See Public Company Accounting Oversight Board (``PCAOB'')
Accounting Standard (``AS'') 2110, Identifying and Assessing Risks
of Material Misstatement, paragraphs .18 through .40 (``PCAOB AS
2110''), paragraphs .18 through .40.
\188\ See note 83 above.
\189\ See Section IV.C.3.b. below (stating that, in the
Proposing Release, note 4 above, we noted that low-revenue issuers
may be less likely than other issuers to fail to detect and disclose
material weaknesses in the absence of an ICFR auditor attestation,
perhaps because they have less complex financial systems and
controls).
---------------------------------------------------------------------------

For example, the auditor in a financial statement audit is required
to identify and assess the risks of material misstatements, which is
similar to the risk assessment evaluation required in an ICFR auditor
attestation. Additionally, the auditor engaged in a financial statement
audit often may test the operating effectiveness of certain internal
controls even if not performing an integrated audit to reduce the
extent of substantive testing required to issue an opinion on the
financial statements. Moreover, even if an auditor decides not to rely
on internal controls to reduce the extent of substantive testing, the
auditor may still identify internal control deficiencies during such
substantive testing in a financial statement audit.
Under PCAOB standards, the evaluation and communication of
significant deficiencies and material weaknesses in ICFR to management
and the issuer's audit committee is required in both a financial
statement audit and an ICFR auditor attestation.\190\ The evaluation of
the severity of a control deficiency identified by the auditor is the
same for a financial statement audit and an ICFR auditor attestation.
Further, a financial statement auditor has the responsibility to review
management's disclosure for any misstatement of facts, such as a
statement that ICFR is effective when there is a known material
weakness.\191\ Therefore, we continue to believe significant
deficiencies and material weaknesses that an ICFR auditor attestation
may uncover also may be uncovered as a part of the financial statement
audit of a low-revenue SRC. As discussed above,\192\ because of these
requirements, a number of commenters agreed that an auditor of the
financial statements of a low-revenue issuer that would be exempt from
the ICFR auditor attestation requirement under the final amendments
would still be required to consider ICFR and therefore this process
would provide sufficient investor protection.
---------------------------------------------------------------------------

\190\ See Section II.C. of the Proposing Release, note 4 above.
\191\ Id.
\192\ See notes 61 to 68 above and accompanying text.
---------------------------------------------------------------------------

Other developments may serve to reinforce these existing investor
protections. In 2010, the PCAOB adopted enhanced auditing standards
related to the auditor's assessment of, and response to, risk that, in
part, clarify and augment the extent to which internal controls are to
be considered in a financial statement audit.\193\ In particular, these
risk assessment standards require auditors in both an integrated and
financial statement audit to evaluate the design of certain
controls.\194\ The PCAOB has expressed concern about the number and
significance of deficiencies in auditing firm compliance with these
risk assessment auditing standards, but it has also noted promising
improvements in their application.\195\
---------------------------------------------------------------------------

\193\ See Auditing Standards Related to the Auditor's Assessment
of and Response to Risk and Related Amendments to PCAOB Standards,
PCAOB Release No. 2010-004 (Aug. 5, 2010) (``PCAOB Release No. 2010-
004''). See also Public Company Accounting Oversight Board; Order
Approving Proposed Rules on Auditing Standards Related to the
Auditor's Assessment of and Response to Risk and Related Amendments
to PCAOB Standards, Release No. 34-63606, File No. PCAOB 2010-01
(Dec. 23, 2010) [75 FR 82417 (Dec. 30, 2010)] (``PCAOB Release No.
2010-01''). These auditing standards are discussed in further detail
in the Economic Analysis. See Section IV.B.1. below.
\194\ See AS 2110, paragraphs .18 through .40, note 187 above.
\195\ See Inspection Observations Related to PCAOB ``Risk
Assessment'' Auditing Standards (No. 8 through No.15), PCAOB Release
No. 2015-007 i through iii (Oct. 15, 2015) (``PCAOB Release No.
2015-007'').
---------------------------------------------------------------------------

Additionally, recent settled charges against four public companies
for failing to maintain effective ICFR for seven to 10 consecutive
annual reporting periods \196\ may have a deterrent effect on issuers
failing to remediate material weaknesses, which could reduce the
overall rate of persistence of material weaknesses in ICFR. Also, if
management elects to obtain and use automated controls testing and
process automation,\197\ this may result in

[[Page 17188]]

improvements in ICFR regardless of the ICFR auditor attestation
requirement if their increased application results in more robust
financial reporting with fewer opportunities for ICFR deficiencies and/
or in an increase by management in their testing and related
improvements of controls. In Section IV.C.3.b.5, we note, as an
example, that issuers may have made investments in systems, procedures,
or training to explain how control improvements may persist for certain
affected issuers. Finally, we note that auditors have had many years of
experience with the 2010 risk assessment standards, and therefore
auditors may be more likely to test ICFR, even if an ICFR auditor
attestation is not required, as a means of enhancing auditing
efficiency.\198\
---------------------------------------------------------------------------

\196\ See SEC Charges Four Public Companies with Longstanding
ICFR Failures, press release (Jan. 29,2019) (``SEC Press Release''),
available at https://www.sec.gov/news/press-release/2019-6.
\197\ See, e.g., Kevin Moffitt, Andrea Rozario, & Miklos
Vasarhelyi (2018), Robotic Process Automation for Auditing, Journal
of Emerging Technologies, 15(1) Acct. 1 (``Robotic Process
Automation'') (describing how, for example, a robotic process
automation program can be ``set up to automatically match purchase
orders, invoices, and shipping documents [and] can check that the
price and quantity on each of the documents match [to] help auditors
validate the effectiveness of preventive internal controls . . .
.'').
\198\ See Study and Recommendations on Section 404(b) of the
Sarbanes-Oxley Act of 2002 For Issuers With Public Float Between $75
and $250 Million at 106 (Apr. 2011) (``2011 SEC Staff Study''),
available at https://www.sec.gov/news/studies/2011/404bfloat-study.pdf (stating that ``. . . once effective controls are in place
at the issuer, the auditor is more likely to continue to test them
even if [it is] not issuing an auditor attestation during a
particular year in order to rely on them for purposes of reducing
substantive testing in the audit of the financial statements,
particularly for issuers that are larger and more complex'').
---------------------------------------------------------------------------

We recognize that some commenters disagreed with this assessment
and asserted that investor protections other than the ICFR auditor
attestation requirement would not be sufficient because, among other
reasons, a financial statement audit has a different objective than an
integrated audit,\199\ testing of ICFR in a financial statement audit
is not as extensive,\200\ it is more difficult for a financial
statement auditor to challenge the design of ICFR,\201\ and a financial
statement audit is not designed to identify significant ICFR
deficiencies or material weaknesses.\202\ As discussed in the Economic
Analysis, we acknowledge that the amendments may be associated with
some adverse effects on the effectiveness of ICFR and the reliability
of financial statements for the affected issuers.\203\ However, the
Proposing Release presented evidence that suggests that these effects
and their impact on investor protection are likely to be mitigated in
the case of the affected issuers as compared to other accelerated
filers. The Economic Analysis provides further related analysis in
response to commenter feedback and does not find evidence that leads us
to alter this view.\204\
---------------------------------------------------------------------------

\199\ See, e.g., letters from CAQ, CFA Inst., and RSM.
\200\ See letter from EY.
\201\ Id.
\202\ Id.
\203\ See Section IV.A. below.
\204\ Id.
---------------------------------------------------------------------------

One commenter indicated that a low-revenue issuer could have a
large market capitalization and thus ``greater investor exposure.''
\205\ As discussed in the Economic Analysis,\206\ we agree that, as
capitalization increases, there is more investor capital at risk. We
note, however, that relative to higher-revenue issuers, on average,
risk among these issuers is likely more associated with their future
prospects than their current financial statements.\207\ Therefore,
exempting low-revenue issuers from the ICFR auditor attestation
requirement is less likely to affect investor protections with respect
to those issuers.
---------------------------------------------------------------------------

\205\ See letter from Grant Thornton.
\206\ See Section IV.C.3.d. below.
\207\ Also, the affected parties are limited to issuers with no
more than $700 million in public float. Further, as discussed in
Section IV.C.3.d below, we estimate that in aggregate the affected
issuers that will be newly exempt from all ICFR auditor attestation
requirements represent 0.2 percent of the total equity market
capitalization of issuers.
---------------------------------------------------------------------------

One commenter noted its concern that certain issuers that would no
longer be subject to the ICFR auditor attestation requirement are
conducting large initial public offerings (``IPOs'') based on key
performance indicators that are derived from financial systems, and
that eliminating the ICFR auditor attestation requirement could result
in potentially less robust internal controls and unreliable data.\208\
To the extent the commenter is primarily concerned with the information
available to investors at the time of an IPO, we note that the affected
issuers that would be newly exempt from the ICFR auditor attestation
requirement are generally more mature firms that are not within five
years of their IPO.
---------------------------------------------------------------------------

\208\ See letter from NASBA.
---------------------------------------------------------------------------

Also, we believe the risk for those low-revenue issuers for which
key performance indicators are material to investors and that are
derived from financial systems is mitigated by the requirement to
maintain, evaluate, and disclose effectiveness of disclosure controls
and procedures \209\ on a quarterly basis.\210\ Key performance
indicators or non-GAAP measures disclosed within a report filed or
submitted to the Commission generally are within the scope of
disclosure controls and procedures. The financial systems from which an
issuer derives the key performance indicator or non-GAAP measure would
normally be included in ICFR and, therefore, within the scope of
management's assessments as well. Further, the Commission recently
issued disclosure guidance on key performance indicators and metrics
and reminded issuers of the importance of effective controls and
procedures when disclosing material key performance indicators or
metrics that are derived from their own information.\211\
---------------------------------------------------------------------------

\209\ Although there is substantial overlap between an issuer's
disclosure controls and procedures and ICFR, there are elements of
each that are not subsumed by the other. See 17 CFR 240.13a-15 and
17 CFR 240.15d-15.
\210\ See 17 CFR 240.13a-14 and 17 CFR 240.15d-14.
\211\ See Commission Guidance on Management's Discussion and
Analysis of Financial Condition and Results of Operations, Release
No. 34-88094 (Jan. 30, 2020).
---------------------------------------------------------------------------

d. Disproportionate Costs and Benefits of the ICFR Auditor Attestation
for Small and Low-Revenue Companies
Not only is the ICFR auditor attestation requirement costly in
general, as discussed above, a number of commenters asserted that the
ICFR auditor attestation requirement is disproportionally costly to
small and low-revenue issuers.\212\ We agree that the costs of the ICFR
auditor attestation requirement may be particularly burdensome for
these issuers because they include fixed costs that are not scalable
for smaller issuers, as also noted by several commenters.\213\ Further,
low-revenue issuers have limited access to internally generated
capital, and so the costs may more directly impact their ability to
spend on investments or hiring.\214\ We therefore expect that reducing
these costs would have a more beneficial impact on small and low-
revenue issuers than it would for other issuers. Some commenters
similarly expressed the view that the amendments would enhance these
issuers' ability to preserve capital without significantly affecting
the ability of investors to make informed investment decisions based on
the financial reporting of those issuers.\215\
---------------------------------------------------------------------------

\212\ See note 102 above and accompanying text.
\213\ See letters from ASA, Broadmark, Chamber, and Guaranty.
\214\ See, e.g., letters from Dar[eacute], Summit and Xenon.
\215\ See letters from Andersen, CLSA, Concert, ICBA, and NASBA.
---------------------------------------------------------------------------

As discussed above, other commenters claimed that eliminating the
ICFR auditor attestation requirement would not substantially reduce
costs to issuers \216\ and that there would be other negative impacts
of this change.\217\ We acknowledge that the magnitude of these cost
savings likely will vary among issuers depending upon their

[[Page 17189]]

particular facts and circumstances \218\ and, as some commenters
asserted,\219\ ICFR auditor attestations have become less expensive
over time because auditors are more experienced in conducting them.
However, based on the comments received and our own analysis of
available data,\220\ we believe the cost reductions from not being
subject to the ICFR auditor attestation requirement could be
substantial for affected issuers.
---------------------------------------------------------------------------

\216\ See note 108 above and accompanying text.
\217\ See notes 110 to 113 above and accompanying text.
\218\ See, e.g., letters from EY, Grant Thornton, and PWC.
\219\ See, e.g., letters from CFA Inst. and Deloitte.
\220\ See Section IV.C.2.d.
---------------------------------------------------------------------------

We believe the benefits of the ICFR auditor attestation requirement
likely are fewer for low-revenue SRCs than for other issuers, an
assessment supported by some commenters.\221\ As a result, obtaining
the ICFR auditor attestation is likely, on average, to be less
meaningful for these issuers, and not obtaining one should have less of
an impact on investor protection than for other types of issuers.
First, we note that low-revenue SRCs may be less susceptible to the
risk of certain kinds of misstatements, such as those related to
revenue recognition. As discuss in the Economic Analysis,\222\ 10 to 20
percent of restatements and about 60 percent of financial disclosure
fraud cases in recent times have been associated with improper revenue
recognition,\223\ which is less of a risk, for example, for issuers
that currently have little to no revenue.
---------------------------------------------------------------------------

\221\ See notes 116 to 118 above and accompanying text.
\222\ See Section IV.C.3. below.
\223\ See Audit Analytics, 2017 Financial Restatements: A
Seventeen Year Comparison, (May 2018), and Committee of Sponsoring
Organizations of the Treadway Commission, (``COSO''), Fraudulent
Financial Reporting 1998-2007: An Analysis of U.S. Public Companies
(2010).) (``COSO 2010 Fraud Study''), available at https://www.coso.org/documents/COSO-Fraud-Study-2010-001.pdf.
---------------------------------------------------------------------------

Second, as we noted in Table 14 of the Proposing Release,\224\
issuers with revenues of less than $100 million have, on average,
restatement rates that are three to nine percentage points lower than
those for higher-revenue issuers. Moreover, certain low-revenue SRCs
likely have less complex financial systems and controls and, therefore,
may be less likely than other issuers to fail to detect and disclose
material weaknesses in the absence of an ICFR auditor attestation.
---------------------------------------------------------------------------

\224\ See Section III.C.4.b. of the Proposing Release, note 4
above.
---------------------------------------------------------------------------

Third, we believe that those issuers' financial statements may be
less critical to assessing their valuation given, for example, the
relative importance of their future prospects. We recognize that other
commenters disagreed and asserted that benefits of the ICFR auditor
attestation requirement are greater for lower-revenue and smaller
issuers than for other issuers.\225\ We carefully considered these
comments and, as discussed in the Economic Analysis, investigated the
claims by conducting supplemental analysis, but we did not find
evidence that led us to alter our views.\226\
---------------------------------------------------------------------------

\225\ See notes 119 to 124 above and accompanying text.
\226\ See Section IV.C.3.a. below.
---------------------------------------------------------------------------

e. Relationship Between Non-Accelerated Filers and SRCs
Under the final amendments, some, but not all, SRCs would become
non-accelerated filers. We are not adopting an alternative suggested by
some commenters of fully aligning the SRC and non-accelerated filer
definitions. As we note in the Economic Analysis,\227\ although full
alignment of the two definitions could provide several benefits,
including greater regulatory simplicity, reducing any frictions or
confusion associated with issuers' determination of their filer status
or reporting regime, and expanding the number of issuers that qualify
as non-accelerated filers, fully aligning the two definitions also
could result in costs that are greater than those for the amendments we
are adopting. For example, the mitigating factors associated with
exempting low-revenue issuers, such as a potential lower susceptibility
to the risks of certain kinds of misstatements and a greater role of
future prospects relative to current financial statements in driving
market valuations for these issuers as compared to other issuers,\228\
may not be present or may be more limited, for other types of SRCs.
---------------------------------------------------------------------------

\227\ See Section IV.C.5.a. below.
\228\ See Section IV.C.3. below.
---------------------------------------------------------------------------

As a result, fully aligning the SRC and non-accelerated filer
thresholds could have adverse effects on the reliability of the
financial statements of the issuers with higher revenues and the
ability of investors to make informed investment decisions about those
issuers.\229\ Therefore, we do not believe it would be appropriate at
this time to increase the public float threshold for non-accelerated
filers to align that definition with the SRC definition. Additionally,
we note that many non-accelerated filers remain eligible for the JOBS
Act Exemption for their first five years as a public company. The table
below summarizes the relationships between SRCs and non-accelerated and
accelerated filers under the final amendments.
---------------------------------------------------------------------------

\229\ Id.

Table 2--Relationships Between SRCs and Non-Accelerated, Accelerated, and Large Accelerated Filers Under the
Final Amendments
----------------------------------------------------------------------------------------------------------------
Relationships between SRCs and non-accelerated, accelerated, and large accelerated filers under the final
amendments
-----------------------------------------------------------------------------------------------------------------
Status Public float Annual revenues
----------------------------------------------------------------------------------------------------------------
SRC and Non-Accelerated Filer......... Less than $75 million.... N/A.
$75 million to less than Less than $100 million.
$700 million.
SRC and Accelerated Filer............. $75 million to less than $100 million or more.
$250 million.
Accelerated Filer (not SRC)........... $250 million to less than $100 million or more.
$700 million.
Large Accelerated Filer (not SRC)..... $700 million or more..... N/A.
----------------------------------------------------------------------------------------------------------------

f. Effect on Business Development Companies
In a change from the proposal, the final amendments also exclude
BDCs from the accelerated and large accelerated filer definitions under
circumstances that are analogous to the exclusions for other issuers
under the amendments. The amendments include a specific provision
applicable to BDCs, because BDCs are not eligible to be SRCs and to
provide a definition of ``revenue'' for BDCs to use for this
purpose.\230\ Specifically, a BDC will be excluded from the accelerated
and large

[[Page 17190]]

accelerated filer definitions in Rule 12b-2 if the BDC: (1) Has a
public float of $75 million or more, but less than $700 million; and
(2) has investment income of less than $100 million.\231\ The
amendments to Rule 12b-2 provide that, for this purpose, a BDC's
revenue is the BDC's investment income, as defined in Rule 6-07.1 of
Regulation S-X.\232\ BDCs are subject to the same transition provisions
for accelerated filer and large accelerated status that apply to other
issuers under the amendments, except that the amendments' BDC-specific
``revenue'' definition will apply to these transition provisions as
well.\233\
---------------------------------------------------------------------------

\230\ Although a BDC is considered to be eligible to use the
requirements for SRCs under the revenue test in paragraph (2) or
(3)(iii)(B) of the ``smaller reporting company'' definition in Rule
12b-2 for purposes of the amended accelerated filer and large
accelerated filer definitions, BDCs will continue to be ineligible
to be SRCs under the final amendments.
\231\ See paragraphs (1)(iv), (2)(iv), and (4) of the amended
definitions of accelerated filer and large accelerated filer in Rule
12b-2. Consistent with the current definitions of these terms, a BDC
with public float of less than $75 million is already a non-
accelerated filer, regardless of the amount of its annual investment
income.
\232\ See 17 CFR 210.6-07.1.
\233\ See Section II.C. below (discussing the amended transition
provisions more generally).
---------------------------------------------------------------------------

Although the Commission did not propose to exclude BDCs from the
accelerated and large accelerated filer definitions using the SRC
revenue test, the Commission did solicit comment on such an approach
and discussed the relative costs and benefits of this alternative in
the Proposing Release.\234\ In response, one commenter urged that we
adopt such an approach, stating that, among other reasons, the policy
reasons that support providing regulatory relief to smaller reporting
companies should apply equally to smaller BDCs.\235\ This commenter
suggested that the Commission expand the proposed amendment to the
definition of accelerated filer and large accelerated filer to exclude
BDCs with total investment income of less than $80 million in the most
recently completed fiscal year for which audited financial statements
are available and either no public float or public float of less than
$700 million.
---------------------------------------------------------------------------

\234\ See Sections II.C., II.E., and III.C.6. of the Proposing
Release, note 4 above.
\235\ See letter from Proskauer.
---------------------------------------------------------------------------

Although we observed in the Proposing Release that the SRC revenue
test would not be meaningful for BDCs because BDCs prepare financial
statements under Article 6 of Regulation S-X and generally do not
report revenue, the final amendments' definition of ``revenue'' for
purposes of the BDC-specific provisions incorporate information that
BDCs report in their financial statements. A BDC's investment income
includes income from dividends, interest on securities, and other
income.\236\ We recognize, as stated in the Proposing Release, that
investors in BDCs generally may place greater significance on the
financial reporting of BDCs relative to low-revenue non-investment
company issuers and BDC financial statements will continue to be
audited by an independent auditor. As the commenter supporting this
approach observed, however, the policy considerations supporting the
final amendments generally apply to BDCs.\237\ Moreover, BDCs that are
excluded from the accelerated and large accelerated filer definitions
will remain obligated, among other things, to establish and maintain
internal control over financial reporting and have management assess
the effectiveness of internal control over financial reporting. The
final amendments also are consistent with other rulemaking initiatives
in which we have sought to provide BDCs parity with other reporting
companies in appropriate circumstances.\238\
---------------------------------------------------------------------------

\236\ A BDC's annual investment income is equivalent to annual
revenues solely for purposes of the accelerated filer and large
accelerated filer definitions. These amendments do not affect the
meaning of ``revenue'' or ``investment income'' in other Commission
rules or provisions of the securities laws.
\237\ See letter from Proskauer.
\238\ See Securities Offering Reform for Closed-End Investment
Companies, Release No. 33427 (Mar. 20, 2019) [84 FR 14448 (Apr. 10,
2019)].
---------------------------------------------------------------------------

g. Effect on Foreign Private Issuers
Under the proposed amendments, an FPI would be excluded from the
accelerated and large accelerated filer definitions if it qualifies as
an SRC \239\ under the SRC revenue test in Exchange Act Rule 12b-2. One
commenter asserted that the final amendments should permit an FPI that
presents its financial statements using IFRS to qualify for the
exemption based on the low-revenue test.\240\ We note that foreign
issuers that qualify as FPIs or SRCs are permitted to avail themselves
of special accommodations unique to each reporting regime, but must
select one reporting regime or the other. The final amendments provide
an exemption from the ICFR auditor attestation requirement for low-
revenue SRCs. Issuers that qualify as FPIs and elect to use the FPI
reporting regime have other accommodations available to them, such as
the ability to disclose material changes in their ICFR and
effectiveness of disclosure controls and procedures on an annual basis,
as compared to the quarterly basis required of U.S. issuers, including
SRCs.\241\
---------------------------------------------------------------------------

\239\ See 2007 SRC Adopting Release, note 155 above, Section II,
and Acceptance From Foreign Private Issuers of Financial Statements
Prepared in Accordance with International Financial Reporting
Standards without Reconciliation to U.S. GAAP, Release No. 33-8879
(Dec. 21, 2007) [73 FR 985 (Jan. 4, 2008)], Section III.E.4.
(stating that an FPI is not an SRC unless it makes its filings on
forms available to U.S. domestic issuers and otherwise qualifies to
use the SRC scaled disclosure accommodations). We are adding
instructions to the SRC definitions in Item 10(f), Rule 405, and
Rule 12b-2 clarifying our position that an FPI is not eligible to
use the requirements for SRCs unless it uses the forms and rules
designated for domestic issuers and provides financial statements
prepared in accordance with U.S. GAAP.
\240\ See letter from Dorsey & Whitney.
\241\ See Rule 13a-15(d), Rule 15d-15(d), Item 15(d) of Form 20-
F, and General Instruction B(6)(e) of Form 40-F.
---------------------------------------------------------------------------

h. Requiring ICFR Auditor Attestation Less Frequently Than Annually
The final amendments do not revise our rules to require an ICFR
auditor attestation requirement less frequently than annually. Issuers
that are accelerated or large accelerated filers will be required to
obtain an ICFR auditor attestation every year, unless they qualify as
EGCs, as under our current rules. We did not propose to revise this
requirement, but requested comment on this matter, and every commenter
that discussed the subject \242\ asserted that issuers that are subject
to the ICFR auditor attestation requirement should obtain one annually.
A few of these commenters asserted that requiring the ICFR auditor
attestation only once every three years would not decrease costs
significantly because auditors consider prior year audit results when
planning and performing the current year audit, so performing an audit
of ICFR every three years would reduce efficiencies gained from
performing audits annually and add complexity and costs.\243\ Also, one
commenter indicated that auditors in many instances may continue to
test internal controls in the financial statement audit, which
potentially limits any resulting cost reduction.\244\
---------------------------------------------------------------------------

\242\ See, e.g., letters from Crowe, KPMG, and NASBA.
\243\ See, e.g., letters from Crowe and KPMG.
\244\ See letter from KPMG.
---------------------------------------------------------------------------

i. Check Box Indicating Whether an ICFR Auditor Attestation Is Included
in a Filing
Although we did not propose a requirement that issuers report
whether they have obtained an ICFR auditor attestation, we requested
comment on whether we should do so. As discussed above,\245\ some
commenters recommended that the final rule include a requirement for an
issuer to prominently disclose in its filing whether an ICFR auditor
attestation is included. This type of disclosure was also recommended
by the Government Accountability Office (``GAO'') in a

[[Page 17191]]

2013 study of internal controls requirements.\246\ No commenters
opposed such a requirement. Disclosure of the ICFR auditor attestation
is currently required within the auditor's report on the financial
statements and management's annual report on ICFR.\247\ After reviewing
these comments, we are persuaded to add a check box to the cover pages
of Forms 10-K, 20-F, and 40-F to indicate whether an ICFR auditor
attestation is included in the filing because we agree that more
prominent and easily accessible disclosure of this information would be
useful to investors and market participants while imposing only minimal
burdens on issuers.
---------------------------------------------------------------------------

\245\ See notes 138 to 143 above and the accompanying text.
\246\ See U.S. Gov't Accountability Office, GAO-13-582, Internal
Controls: SEC Should Consider Requiring Companies to Disclose
Whether They Obtained an Auditor Attestation (July 2013) (``2013 GAO
Study'').
\247\ See Item 308 of Regulation S-K and PCAOB AS 3101.
---------------------------------------------------------------------------

Under the new rule, issuers will be required to include the check
box on their cover pages in any annual report filed on or after the
final amendments' effective date. Once issuers are required to tag the
cover page disclosure data using Inline eXtensible Business Reporting
Language (``Inline XBRL''), they will also be required to tag this
cover page check box disclosure in Inline XBRL because Item 406 of
Regulation S-T (``Item 406''),\248\ Item 601(b)(104),\249\ paragraph
104 to ``Instructions as to Exhibits'' of Form 20-F, and paragraph B.17
under the ``General Instructions'' of Form 40-F require those issuers
to tag every data point on the cover pages of Form 10-K, Form 20-F, and
Form 40-F.\250\ We do not expect the incremental compliance burden
associated with tagging the additional cover page information to be
significant, given that registrants already are being required on a
phased-in basis to tag other cover page information as well as
information in their financial statements.\251\
---------------------------------------------------------------------------

\248\ 17 CFR 232.406.
\249\ 17 CFR 229.601(b)(4).
\250\ Item 406 mandates that companies required to tag their
financial statements in Inline XBRL must also tag their cover page
data in Inline XBRL. Operating companies are required to tag their
financial statements in Inline XBRL on a phase-in basis. See Inline
XBRL Filing of Tagged Data, Release No. 33-10514 (June 28, 2018) [83
FR 40846 (July 10, 2018)] and 17 CFR 232.405.
\251\ Electronic Data Gathering, Analysis and Retrieval System
(``EDGAR'') filers that are required by Item 406 to provide cover
page Inline XBRL data tagging will be required to tag the ICFR data
element only after a revised Document Entity Identifier taxonomy has
been posted to SEC.gov and the Commission has adopted a new EDGAR
Filer Manual that reflects appropriate changes to the submission of
Forms 10-K, 20-F and 40-F.
---------------------------------------------------------------------------

C. Amendments To Increase the Public Float Transition Thresholds From
$50 Million to $60 Million and $500 Million to $560 Million and To Add
the SRC Revenue Test to the Transition Threshold

1. Proposed Amendments
An issuer initially becomes an accelerated filer after it first
meets certain conditions as of the end of its fiscal year, including
that it had a public float of $75 million or more but less than $700
million as of the last business day of its most recently completed
second fiscal quarter. An issuer initially becomes a large accelerated
filer in a similar manner, including that it had a public float of $700
million or more as of the last business day of its most recently
completed second fiscal quarter. Once the issuer becomes an accelerated
filer, it will not become a non-accelerated filer unless it determines
at the end of a fiscal year that its public float had fallen below $50
million on the last business day of its most recently completed second
fiscal quarter. Similarly, a large accelerated filer will remain one
unless its public float had fallen below $500 million on the last
business day of its most recently completed second fiscal quarter. If
the large accelerated filer's public float falls below $500 million but
is $50 million or more, it becomes an accelerated filer. Alternatively,
if the issuer's public float falls below $50 million, it becomes a non-
accelerated filer.\252\ The purpose of these transition thresholds is
to avoid situations in which an issuer frequently enters and exits
accelerated and large accelerated filer status due to small
fluctuations in its public float.
---------------------------------------------------------------------------

\252\ For example, under the rules prior to these amendments, if
an issuer that is a non-accelerated filer determines at the end of
its fiscal year that it had a public float of $75 million or more,
but less than $700 million, on the last business day of its most
recently completed second fiscal quarter, it will become an
accelerated filer. On the last business day of its next fiscal year,
the issuer must re-determine its public float to re-evaluate its
filer status. If the accelerated filer's public float fell to $70
million on the last business day of its most recently completed
second fiscal quarter, it would remain an accelerated filer because
its public float did not fall below the $50 million transition
threshold. Alternatively, if the issuer's public float fell to $49
million, it would then become a non-accelerated filer because its
newly determined public float is below $50 million. As another
example, an issuer that has not been a large accelerated filer but
had a public float of $700 million or more on the last business day
of its most recently completed second fiscal quarter would then
become a large accelerated filer at the end of its fiscal year. If,
on the last business day of its subsequently completed second fiscal
quarter, the issuer's public float fell to $600 million, it would
remain a large accelerated filer because its public float did not
fall below $500 million. If, however, the issuer's public float fell
to $490 million at the end of its most recently completed second
fiscal quarter, it would become an accelerated filer at the end of
the fiscal year because its public float fell below $500 million.
Similarly, if the issuer's public float fell to $49 million, the
issuer would become a non-accelerated filer.
---------------------------------------------------------------------------

In the SRC Adopting Release,\253\ we amended the SRC rules so that
the SRC transition thresholds were set at 80 percent of the
corresponding initial qualification thresholds. In the Proposing
Release, we proposed to revise the accelerated and large accelerated
filer transition thresholds to be 80 percent of the corresponding
initial qualification thresholds to align the transition thresholds
across the SRC, accelerated filer, and large accelerated filer
definitions. Additionally, we indicated that revising these thresholds
would limit the cases in which an issuer could be both an accelerated
filer and an SRC or a large accelerated filer and an SRC, thereby
reducing regulatory complexity.
---------------------------------------------------------------------------

\253\ See note 12 above.
---------------------------------------------------------------------------

We proposed to revise the transition threshold for becoming a non-
accelerated filer from $50 million to $60 million and the transition
threshold for leaving the large accelerated filer status from $500
million to $560 million. We also proposed to add the SRC revenue test
to the public float transition thresholds for accelerated and large
accelerated filers. If the SRC revenue test were not added to the
accelerated filer and large accelerated filer transition provisions, an
issuer's annual revenues would never factor into determining whether an
accelerated filer could become a non-accelerated filer, or whether a
large accelerated filer could become an accelerated or non-accelerated
filer. We proposed that an issuer that is already an accelerated filer
would remain one unless either its public float falls below $60 million
or it becomes eligible to use the SRC accommodations under the revenue
test in paragraph (2) or (3)(iii)(B) of the SRC definition,\254\ as
applicable.\255\ Therefore, under the proposed amendments, an
accelerated filer would remain an accelerated filer until its public
float falls below $60 million or its annual revenues fall below the

[[Page 17192]]

applicable revenue threshold ($80 million or $100 million), at which
point it would become a non-accelerated filer.
---------------------------------------------------------------------------

\254\ Paragraph (2) of the SRC definition states that an issuer
qualifies as an SRC if its annual revenues are less than $100
million and it has no public float or a public float of less than
$700 million. Paragraph (3)(iii)(B) of the SRC definition states,
among other things, that an issuer that initially determines it does
not qualify as an SRC because its annual revenues are $100 million
or more cannot become an SRC until its annual revenues fall below
$80 million.
\255\ An issuer that is initially applying the SRC definition or
previously qualified as an SRC would apply paragraph (2) of the SRC
definition. Once an issuer determines that it does not qualify for
SRC status, it would apply paragraph (3)(iii)(B) of the SRC
definition at its next annual determination.
---------------------------------------------------------------------------

Similarly, we proposed conforming amendments to the large
accelerated filer transition provisions for when an issuer that is
already a large accelerated filer transitions to either accelerated or
non-accelerated filer status. To transition out of large accelerated
filer status at the end of the issuer's fiscal year, an issuer would
need to have a public float below $560 million as of the last business
day of its most recently completed second fiscal quarter or meet the
revenue test in paragraph (2) or (3)(iii)(B), as applicable, of the SRC
definition. A large accelerated filer would become an accelerated filer
at the end of its fiscal year if its public float fell to $60 million
or more but less than $560 million as of the last business day of its
most recently completed second fiscal quarter and its annual revenues
are not below the applicable revenue threshold ($80 million or $100
million). The large accelerated filer would become a non-accelerated
filer if its public float fell below $60 million as of the last
business day of its most recently completed second fiscal quarter or
its annual revenues fell below the applicable revenue threshold ($80
million or $100 million).\256\
---------------------------------------------------------------------------

\256\ One exception to this requirement is that an issuer that
was a large accelerated filer whose public float had fallen below
$700 million (but remained $560 million or more) but became eligible
to be an SRC under the SRC revenue test in the first year the SRC
amendments became effective would become a non-accelerated filer
even though its public float remained at or above $560 million. See
SRC Adopting Release, note 12 above, at n. 31 (``For purposes of the
first fiscal year ending after effectiveness of the amendments, a
registrant will qualify as a SRC if it meets one of the initial
qualification thresholds in the revised definition as of the date it
is required to measure its public float or revenues (the
`measurement date'), even if such registrant previously did not
qualify as a SRC.'').
---------------------------------------------------------------------------

2. Comments
We received very few comments regarding the proposed changes to the
transition thresholds. The commenters who discussed the proposed
amendments to increase the public float transition thresholds supported
them.\257\ One commenter also suggested that the Commission consider
indexing the thresholds to inflation in a manner similar to the
indexing that applies to the EGC definition.\258\ Only two commenters
addressed the proposed amendments to add the SRC revenue test to the
transition thresholds, and these commenters supported that
proposal.\259\
---------------------------------------------------------------------------

\257\ See, e.g., letters from CLSA, Nasdaq, and RSM.
\258\ See letter from RSM.
\259\ See letters from CLSA and Nasdaq.
---------------------------------------------------------------------------

3. Final Amendments
After considering the comments, we are adopting the final
amendments as proposed. As discussed in greater detail in the Economic
Analysis,\260\ transition thresholds in Rule 12b-2 are lower than entry
thresholds to keep issuers from frequently needing to reclassify their
filer status. The frequent reclassifications that would result without
the transition thresholds may cause confusion for issuers and investors
as to the issuer's status. Also, such frequent reclassifications may
increase issuers' costs because they would frequently need to revise
their disclosure schedules and continually consider the impact of
whether they are subject to the ICFR auditor attestation requirement
from one year to the next, and may increase investors' incremental
costs of evaluating the reliability of the issuer's financial
disclosures. Therefore, we believe a transition threshold is
appropriate. However, we recognize that providing a transition
threshold results in some issuers remaining in their filer status even
though their public float or revenues are below that filer status's
entry threshold.
---------------------------------------------------------------------------

\260\ See Section IV.C.4.c below.
---------------------------------------------------------------------------

The final amendments revise the public float transition threshold
for accelerated and large accelerated filers to become a non-
accelerated filer from $50 million to $60 million and revise the public
float transition threshold for a large accelerated filer to lose its
large accelerated filer status from $500 million to $560 million. Prior
to the final amendments, the public float threshold for an accelerated
and large accelerated filer to become a non-accelerated filer was $50
million and the public float transition threshold for a large
accelerated filer to lose its large accelerated filer status was $500
million. We believe these threshold amounts are too low and result in
more issuers than intended being classified as an accelerated or large
accelerated filer. However, we believe there should be some transition
threshold so as to avoid some volatility. The amendments would make the
public float transition thresholds 80 percent of the initial
thresholds, which is consistent with the percentage used in the
transition thresholds for SRC eligibility. We believe this approach
appropriately balances the risk of frequent reclassifications resulting
from a higher percentage threshold against the risk of delaying
appropriate transitions due to a lower threshold. The table below
summarizes how an issuer's filer status will change based on its
subsequent public float determination.

Table 3--Subsequent Determination of Filer Status Based on Public Float Under Final Amendments
----------------------------------------------------------------------------------------------------------------
Final amendments to the public float thresholds
-----------------------------------------------------------------------------------------------------------------
Subsequent public float
Initial public float determination Resulting filer status determination Resulting filer status
----------------------------------------------------------------------------------------------------------------
$700 million or more................. Large Accelerated Filer $560 million or more... Large Accelerated
Filer.
Less than $560 million Accelerated Filer.
but $60 million or
more.
Less than $60 million.. Non-Accelerated Filer.
Less than $700 million but $75 Accelerated Filer...... Less than $700 million Accelerated Filer.
million or more. but $60 million or
more.
Less than $60 million.. Non-Accelerated Filer.
----------------------------------------------------------------------------------------------------------------

[[Page 17193]]

The final amendments also add the SRC revenue test to the
transition threshold for accelerated and large accelerated filers. As
we noted in the Proposing Release, if we do not add the SRC revenue
test to the accelerated filer and large accelerated filer transition
provisions, an issuer's annual revenues would never factor into
determining whether an accelerated filer could become a non-accelerated
filer, or whether a large accelerated filer could become an accelerated
or non-accelerated filer. We note that one commenter stated that the
manner in which issuers may recognize revenue could cause them to
frequently lose and gain non-accelerated filer status.\261\ We believe
that providing transition thresholds should mitigate any such concern.
---------------------------------------------------------------------------

\261\ See letter from EY.
---------------------------------------------------------------------------

Under the final amendments, an accelerated filer with revenues of
$100 million or more that is eligible to be an SRC based on the public
float test contained in paragraphs (1) and (3)(iii)(A) of the SRC
definition can transition to non-accelerated filer status in a
subsequent year if it has revenues of less than $100 million. For
example, an issuer with a December 31 fiscal year end that did not
exceed the public float threshold in the prior year and that has a
public float, as of June 30, 2020, of $230 million and annual revenues
for the fiscal year ended December 31, 2019 of $101 million will be
eligible to be an SRC under the public float test; however, because the
issuer would not be eligible to be an SRC under the SRC revenue test,
it will be an accelerated filer (assuming the other conditions
described in Table 1 are also met). At the next determination date
(June 30, 2021), if its public float, as of June 30, 2020, remains at
$230 million and its annual revenues for the fiscal year ended December
31, 2019 are less than $100 million, the issuer will be eligible to be
an SRC under the SRC revenue test (in addition to the public float
test) and thus it will become a non-accelerated filer.
On the other hand, an issuer with a December 31 fiscal year end
that has a public float, as of June 30, 2020, of $400 million and
annual revenues for the fiscal year ended December 31, 2019 of $101
million will not be eligible to be an SRC under either the public float
test or the SRC revenue test and will be an accelerated filer (assuming
the other conditions described in Table 1 also are met). At the next
determination date (June 30, 2021), if its public float, as of June 30,
2021, remains at $400 million, that issuer will not be eligible to be
an SRC under the SRC revenue test unless its annual revenues for the
fiscal year ended December 31, 2020 are less than $80 million, at which
point it will be eligible to be an SRC under the SRC revenue test and
to become a non-accelerated filer.

D. Transition Issues

The final amendments will become effective 30 days after they are
published in the Federal Register. The final amendments will apply to
an annual report filing due on or after the effective date. Even if
that annual report is for a fiscal year ending before the effective
date, the issuer may apply the final amendments to determine its status
as a non-accelerated, accelerated, or large accelerated filer. For
example, an issuer that has a March 31, 2020 fiscal year end and that
is due to file its annual report after the effective date of the
amendments may apply the final amendments to determine its filing
status even though its fiscal year end date precedes the effective
date. An issuer that determines it is eligible to be a non-accelerated
filer under the final amendments will not be subject to the ICFR
auditor attestation requirement for its annual report due and submitted
after the effective date of the amendments and may comply with the
filing deadlines that apply, and other accommodations available, to
non-accelerated filers.

III. Other Matters

If any of the provisions of these amendments, or the application of
these provisions to any person or circumstance, is held to be invalid,
such invalidity shall not affect other provisions or application of
such provisions to other persons or circumstances that can be given
effect without the invalid provision or application. Pursuant to the
Congressional Review Act,\262\ the Office of Information and Regulatory
Affairs has designated these amendments as not ``a major rule,'' as
defined by 5 U.S.C. 804(2).
---------------------------------------------------------------------------

\262\ 5 U.S.C. 801 et seq.
---------------------------------------------------------------------------

IV. Economic Analysis

We are mindful of the costs and benefits of the amendments. The
discussion below addresses the economic effects of the amendments,
including their anticipated costs and benefits, as well as the likely
effects of the amendments on efficiency, competition, and capital
formation.\263\ We also analyze the potential costs and benefits of
reasonable alternatives to the amendments. Where practicable, we have
attempted to quantify the economic effects of the amendments; however,
in certain cases, we are unable to do so because either the necessary
data are unavailable or certain effects are not quantifiable. In these
cases, we provide a qualitative assessment of the likely economic
effects.
---------------------------------------------------------------------------

\263\ Section 2(b), 15 U.S.C. 77b(b), and Section 3(f) of the
Exchange Act, 15 U.S.C. 78c(f), directs the Commission, when
engaging in rulemaking where it is required to consider or determine
whether an action is necessary or appropriate in the public
interest, to consider, in addition to the protection of investors,
whether the action will promote efficiency, competition, and capital
formation. Further, Section 23(a)(2) of the Exchange Act, 15 U.S.C.
78w(a)(2), requires the Commission, when making rules under the
Exchange Act, to consider the impact that the rules would have on
competition, and prohibits the Commission from adopting any rule
that would impose a burden on competition not necessary or
appropriate in furtherance of the purposes of the Exchange Act.
---------------------------------------------------------------------------

A. Introduction

As discussed above, we are adopting amendments to the definitions
of ``accelerated filer'' and ``large accelerated filer'' that will
generally extend non-accelerated filer status to issuers with up to
$700 million in public float if they are eligible to be SRCs and their
revenues are less than $100 million. As non-accelerated filers, among
other things, these issuers will not be required to obtain an ICFR
auditor attestation pursuant to SOX Section 404(b). The amendments are
intended to reduce compliance costs for these issuers while maintaining
investor protections by more appropriately tailoring the types of
issuers that are included in the categories of accelerated and large
accelerated filers.
In the Proposing Release, we presented evidence that the imposition
of the ICFR auditor attestation requirement has been associated with
benefits to issuers and investors, such as reduced rates of ineffective
ICFR and more reliable financial statements.\264\ However, as explained
in the Proposing Release, the affected issuers may find the costs of
this requirement to be particularly burdensome given certain fixed
costs that may not scale with size. Importantly, because these issuers
have limited access to internally-generated capital, savings on
compliance costs may be more likely to be applied to additional
investment, research, or hiring.
---------------------------------------------------------------------------

\264\ See Section III.C.4.a. of the Proposing Release, note 4
above,. See also Section IV.C.3.a. below.
---------------------------------------------------------------------------

We acknowledged, in the Proposing Release, that exempting these
low-revenue issuers from the ICFR auditor attestation requirement may
result in adverse effects such as an increased prevalence of
ineffective ICFR and

[[Page 17194]]

restatements, and we estimated the potential effects on the rates of
such issues among the affected issuers. At the same time, we provided
evidence in support of two mitigating factors specific to the affected
issuers.\265\ First, we documented that low-revenue issuers have
relatively low rates of restatement, which could mean that the affected
issuers may, on average, be less susceptible to the risk of certain
kinds of misstatements. Next, we provided evidence that the market
value of the low-revenue issuers was not as associated with
contemporary financial statements as for higher-revenue issuers, which
could imply that their valuations are driven to a greater degree by
their future prospects.
---------------------------------------------------------------------------

\265\ We also noted in the Proposing Release, note 4 above, that
issuers exempted from this requirement may choose to voluntarily
obtain an ICFR auditor attestation if investors demand it or the
issuers otherwise deem it, from their perspective, to be the best
use of their resources.
---------------------------------------------------------------------------

Commenters raised a number of concerns with our analysis and
conclusions in the Proposing Release. We carefully reviewed all of the
comments received and in a few instances, conducted supplemental
analysis in response to the issues and questions raised by those
comments. Overall, based on our analysis of the available evidence and
data, our primary conclusions have not substantively changed. While we
address the comments in detail in the body of the Economic Analysis
below, we highlight certain of our findings in relation to some
commenter concerns here.
One concern raised by commenters is that rather than targeting
issuers where there may be relatively fewer benefits of the ICFR
auditor attestation requirement, the amendments will remove this
requirement for exactly those issuers where the benefits may be
greatest.\266\ These commenters supported this assertion by, for
example, claiming that investors react more strongly to news of
restatements or material weaknesses in ICFR--and thus care more about
the benefits of an ICFR auditor attestation--at small or low-revenue
issuers as compared to other issuers.\267\ In response to these
comments, we have conducted additional analyses of the investor
response to ICFR disclosures and restatement announcements. We do not
find any evidence that investors react more negatively to restatements
or to auditors reporting material weaknesses in ICFR at low-revenue
issuers than at higher-revenue issuers. Further, based on the
suggestions of a commenter,\268\ we have refined our analysis of the
extent to which financial statement variables are associated with the
valuation of different types of issuers. We continue to find that
financial statement variables explain a greater amount of the variation
in stock prices and returns for higher-revenue issuers than for low-
revenue issuers, even when we focus on more seasoned issuers similar to
those that would be affected by the amendments or when we expand the
set of variables that we consider. Overall, our analysis does not
provide support for the assertion that investors care more about the
information produced by the ICFR auditor attestation requirement at
low-revenue issuers than at other issuers.
---------------------------------------------------------------------------

\266\ See, e.g., letters from CFA, CFA Inst., and CII. See also
Commissioner Jackson's Statement.
\267\ Id.
\268\ See letter from Crowe.
---------------------------------------------------------------------------

A few commenters asserted that the costs of the amendments will
significantly outweigh any benefits.\269\ We have conducted
supplemental analysis and quantification of the potential costs of the
amendments and do not find evidence to support the views of these
commenters. We carefully considered the cost estimates provided by
commenters and found them useful in refining our own analysis. However,
we found some of these estimates to be overstated. For example, some
estimates applied costs associated with a small fraction of issuers to
all of the affected issuers or implicitly compared aggregate estimates
of costs over multiple years to the estimated savings for a single
year.\270\ Others identified investor harms that occurred despite the
ICFR auditor attestation requirement being in place, which may
demonstrate the limitations of the ICFR auditor attestation requirement
rather than informing us of the risks of removing the requirement.\271\
---------------------------------------------------------------------------

\269\ See, e.g., letters from Better Markets and Prof. Barth et
al.
\270\ See letter from Prof. Barth et al. (with respect to
quantified benefits of ICFR audit for the average company).
\271\ See letters from Better Markets and Prof. Barth et al.
(with respect to estimates of income and stock market impact of
restatements).
---------------------------------------------------------------------------

Some commenters stated that the Proposing Release did not provide
sufficient quantification of the costs of the amendments.\272\ In
response to those comments, as additional context for our consideration
of the possible effects of the final amendments, we conducted
supplemental analysis of the expected frequency, type, and magnitude of
potential adverse effects. We consider effects resulting from potential
misreporting about the effectiveness of ICFR as well as those driven by
potential changes in the actual effectiveness of ICFR. Where possible,
we estimate dollar costs as well as dollar transfers across
shareholders, which represent costs to some shareholders and benefits
to other shareholders. We note that these cost estimates do not fully
adjust for the mitigating factors that we find to be associated with
low-revenue issuers and may therefore be inflated. Also, we caution
against attempts to over-interpret the relation between our
quantitative estimates of monetized benefits and monetized costs
because we are not able to place dollar values on all of the potential
costs and benefits of the amendments.
---------------------------------------------------------------------------

\272\ See, e.g., letters from Better Markets, CFA Inst., CII,
Prof. Barth et al., and Prof. Ge et al.
---------------------------------------------------------------------------

Several commenters argued that the expected cost savings are too
small to be economically meaningful,\273\ and that the amendments are
unlikely to have capital formation benefits.\274\ We acknowledge that,
while the amendments could be a positive factor in the decision of
additional companies to enter public markets, it may not be the
decisive factor, and the direct impact of the amendments on the number
of public companies may be limited to the extent that companies may be
more focused on other factors associated with the decision to go
public. However, we continue to believe that the expected savings is
likely, in many cases, to represent a meaningful cost savings for the
affected issuers.\275\ In particular, while the average annual cost
savings may represent a small percentage of the average affected
issuers' revenues and market capitalizations, it is still likely to be
meaningful given that the net income and operating cash flows of the
affected issuers are typically negative.\276\ These savings may thus
have beneficial economic effects on net capital formation through the
productive use of

[[Page 17195]]

this preserved capital towards, for example, new investments.
---------------------------------------------------------------------------

\273\ See, e.g., letters from CFA, CFA Inst., CII, and Prof.
Barth et al.
\274\ See, e.g., letters from Better Markets, CII, CFA, CFA
Inst., and Prof. Ge et al.
\275\ One commenter requested that we replicate, with recent
data, the analysis in a previous study that found a ``bunching'' of
firms below the public float threshold for entering accelerated
filer status, in order to explore whether the costs of the ICFR
auditor attestation requirement remain as high as previously
documented. See letter from Prof. Honigsberg, et al. See also
Commissioner Jackson's Statement. As discussed in more detail below,
we provide this analysis and find that there may be some such
``bunching,'' but we note that our conclusion that the cost savings
may be meaningful to the affected issuers does not rely on this
analysis or the related study.
\276\ See note 362 below.
---------------------------------------------------------------------------

Some commenters indicated that the Proposing Release did not
adequately consider the risk of fraud,\277\ or that the risks of
fraudulent financial reporting may be particularly high for low-revenue
issuers.\278\ We acknowledge the argument that incentives to engage in
misconduct could be different for low-revenue issuers and, in response
to these comments, we conducted supplemental analysis concerning the
risk of fraud. In particular, we conducted an analysis to investigate
this risk and did not find evidence based on the available data that
low-revenue issuers that, like the affected issuers, are not within
five years of their IPO (``seasoned'' issuers), are more highly
represented in the set of seasoned issuers associated with financial
misconduct or financial reporting fraud than they are in the overall
population of seasoned issuers.We also estimated the extent to which
expanding the exemption from the ICFR auditor attestation requirement
could affect the likelihood of the affected issuers engaging in such
activities and include a quantification of the associated costs of this
risk in our overall assessment of the potential costs of the
amendments. Overall, this supplemental analysis does not cause us to
change our primary conclusions regarding the potential effects of the
amendments.
---------------------------------------------------------------------------

\277\ See, e.g., letters from CFA Inst., CII, and Prof. Barth et
al.
\278\ See, e.g., letter from CFA, CFA Inst., CII and Prof. Barth
et al.
---------------------------------------------------------------------------

The economic analysis also considers other changes associated with
the amendments. For example, the affected issuers will be permitted an
additional 15 days and five days, respectively, after the end of each
period to file their annual and quarterly reports, relative to the
deadlines that apply to accelerated filers.\279\ The amendments also
revise the transition provisions for accelerated and large accelerated
filer status, including increasing the public float thresholds to exit
accelerated and large accelerated filer status from $50 million and
$500 million in public float to $60 million and $560 million in public
float. Additionally, the amendments introduce a new check-box
disclosure on the cover page of annual reports on Forms 10-K, 20-F, and
40-F to indicate whether an ICFR auditor attestation is included in the
filing.
---------------------------------------------------------------------------

\279\ Non-accelerated filers also are not required to provide
disclosure required by Item 1B of Form 10-K and Item 4A of Form 20-F
about unresolved staff comments on their periodic and/or current
reports or disclosure required by Item 101(e)(4) of Regulation S-K
about whether they make filings available on or through their
internet websites.
---------------------------------------------------------------------------

The discussion that follows examines the potential benefits and
costs of the amendments in detail. As part of our analysis, we consider
both the comments received on the Proposing Release and the likelihood
that the effects of the ICFR auditor attestation have changed over time
with changes in auditing standards and other market conditions.

B. Baseline

To assess the economic impact of the amendments, we are using as
our baseline the current state of the market under the existing
definition of ``accelerated filer.'' This section discusses the current
regulatory requirements and market practices. It also provides
statistics characterizing accelerated filers, the timing of filings,
disclosures about ineffective ICFR, and restatement rates under the
baseline.
1. Regulatory Baseline
Our baseline includes existing statutes and Commission rules that
govern the responsibilities of issuers with respect to financial
reporting, as well as PCAOB auditing standards and market standards
related to the implementation of these responsibilities.
In particular, accelerated and large accelerated filers are subject
to accelerated filing deadlines for their periodic reports relative to
non-accelerated filers. These deadlines are summarized in Table 4
below. All registrants can file Form 12b-25 (``Form NT'') to avail
themselves of an additional 15 calendar days to file an annual report,
or an additional five calendar days to file a quarterly report, and
still have their report deemed to have been timely filed.

Table 4--Filing Deadlines for Periodic Reports
------------------------------------------------------------------------
Calendar days after
period end
Category of filer -----------------------
Annual Quarterly
------------------------------------------------------------------------
Non-Accelerated Filer........................... 90 45
Accelerated Filer............................... 75 40
Large Accelerated Filer......................... 60 40
------------------------------------------------------------------------

The Proposing Release discusses in detail the issuer and auditor
responsibilities with respect to disclosure controls and procedures and
ICFR for issuers of different filer types.\280\ These responsibilities
derive from the FCPA requirements with respect to internal accounting
controls as well as a number of different changes to financial
reporting that were introduced by SOX.
---------------------------------------------------------------------------

\280\ See Sections II.B. and III.B.1. of the Proposing Release,
note 4 above.
---------------------------------------------------------------------------

In particular, all issuers \281\ are required to devise and
maintain an adequate system of internal accounting controls \282\ and
to have their corporate officers assess the effectiveness of the
issuer's disclosure controls and procedures \283\ and disclose the
conclusions of their assessments, typically on a quarterly basis.\284\
In addition, all issuers are required to have their corporate officers
certify in each of their periodic reports that the information in the
report fairly presents, in all material respects, the issuer's
financial condition and results of operations.\285\ All issuers other
than RICs and asset-backed securities (``ABS'') issuers \286\ are also
required to include management's assessment of the effectiveness of
their ICFR in their annual reports.\287\ Further, all issuers are
required to have the financial statements in their annual reports
examined and reported on by an independent auditor, who, even if not
engaged to provide an ICFR auditor attestation, is responsible for
considering ICFR in the performance of the financial statement
audit.\288\ Also, an auditor engaged in a financial statement only
audit may test the operating effectiveness of some internal controls in
order to reduce the extent of substantive testing performed in the
audit. Importantly, all of these responsibilities with respect to
financial reporting and ICFR apply equally to

[[Page 17196]]

non-accelerated as well as accelerated and large accelerated filers.
Finally, all issuers listed on national exchanges are required to have
an audit committee that is composed solely of independent directors and
is directly responsible for the appointment, compensation, retention
and oversight of the issuer's independent auditors.\289\ The amendments
do not change any of these requirements, including the requirements of
a financial statement audit.
---------------------------------------------------------------------------

\281\ Specifically, the requirements apply to all issuers that
file reports pursuant to Section 13(a) or 15(d) of the Exchange Act.
\282\ See Section 13(b)(2)(B) of the Exchange Act.
\283\ See note 209 above.
\284\ See note 210 above.
\285\ See 17 CFR 240.13a-14(b) and 17 CFR 240.15d-14(b).
\286\ See 17 CFR 240.13a-15 and 17 CFR 240.15d-15. A newly
public issuer is also not required to provide a SOX Section 404(a)
management report on ICFR until its second annual report filed with
the Commission. See Instructions to Item 308 of Regulation S-K.
\287\ See Management's Report on Internal Control Over Financial
Reporting and Certification of Disclosure in Exchange Act Periodic
Reports, Release No. 33-8238 (June 5, 2003) [68 FR 36635 (June 18,
2003)]. These evaluations of ICFR, as well as any associated ICFR
auditor attestations, should be based on a suitable, recognized
control framework. The most widely used framework for this purpose
is the one set forth in a report of the Committee of Sponsoring
Organizations of the Treadway Commission (``COSO'').
\288\ See PCAOB AS 2110, note 187 above. See also the discussion
below in this section about this auditing standard.
\289\ See 17 CFR 240.10A-3. In the absence of an ICFR auditor
attestation requirement, we note that the audit committee is
responsible for approving whether to voluntarily obtain an ICFR
auditor attestation, and would be alerted by the auditor engaged in
a financial statement only audit if the auditor becomes aware of a
significant deficiency or material weakness in ICFR.
---------------------------------------------------------------------------

Beyond these requirements, accelerated filers and large accelerated
filers other than EGCs, RICs, and ABS issuers are required under SOX
Section 404(b) and related rules to include an ICFR auditor attestation
in their annual reports. In addition, certain banks, even if they are
non-accelerated filers, are required under Federal Deposit Insurance
Corporation (``FDIC'') rules to have their auditor attest to, and
report on, management's assessment of the effectiveness of the bank's
ICFR (the ``FDIC auditor attestation requirement'').\290\
---------------------------------------------------------------------------

\290\ Part 363 of the FDIC regulations requires that the auditor
of an insured depository institution with consolidated total assets
of $1 billion or more (as of the beginning of the fiscal year)
examine, attest to, and report separately on the assertion of
management concerning the effectiveness of the institution's
internal control structure and procedures for financial reporting.
---------------------------------------------------------------------------

One commenter raised questions about the nature of the FDIC auditor
attestation requirement and how it compares to the ICFR auditor
attestation requirement.\291\ For banks that are subject to the ICFR
auditor attestation requirement, the FDIC regulations require ICFR
attestation engagements to be performed according to the same standards
as the ICFR auditor attestation requirement under SOX Section 404(b)
(i.e., AS 2201,\292\ as discussed below).\293\ For other banks, the
FDIC allows ICFR attestations to be performed either according to AS
2201 or according to the American Institute of Certified Public
Accountants (``AICPA'') attestation standard.\294\ In 2015, the
Auditing Standards Board of the AICPA issued Statement on Auditing
Standards (``SAS'') No. 130, revising their attestation standard with
the intention of adhering as closely as possible to AS 2201 while
aligning with their generally accepted auditing standards and avoiding
unintended consequences in practice.\295\ The FDIC also requires that
the attestation reports be made available for public inspection (at the
bank's main and branch offices or, alternatively, by mail to anyone who
requests it).\296\ Per Section IV.B.4 below, material weaknesses
reported in SOX Section 404(a) reports and the corresponding SOX
Section 404(b) reports typically mirror each other, so material
weaknesses identified by the FDIC auditor attestation may also become
publicly known via corresponding SOX Section 404(a) management reports.
Finally, we note that FDIC and Federal Reserve examiners may also
independently review and assess the adequacy of ICFR of banks.
---------------------------------------------------------------------------

\291\ See letter from CFA Inst.
\292\ See AS 2201, An Audit of Internal Control Over Financial
Reporting That Is Integrated with An Audit of Financial Statements
(``AS 2201'').
\293\ See Section 18A of Appendix A to Part 363 of the FDIC
regulations.
\294\ Id.
\295\ See Executive Summary to SAS 130 (October 2015), available
at https://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/SAS_130_Summary.pdf.
\296\ See Section 363.4 of Part 363 of the FDIC regulations.
---------------------------------------------------------------------------

Some issuers that are not required to comply with SOX Section
404(b) voluntarily obtain an ICFR auditor attestation.\297\ Estimates
of the number of issuers of each filer type are provided in Table 5
below.\298\
---------------------------------------------------------------------------

\297\ Up to about seven percent of exempt issuers voluntarily
provided an ICFR auditor attestation from 2005 through 2011. See
2013 GAO Study, note 246 above. We find similar results when
examining data for non-accelerated filers and EGCs in calendar years
2014 through 2018 from Ives Group Audit Analytics to identify, among
issuers of these types that have a SOX Section 404(a) management
report, how many also have an ICFR auditor attestation report
available in the database. See note 298 below regarding the
identification of filer types.
\298\ The estimates in this table are based on staff analysis of
self-identified filer status for issuers filing annual reports on
Forms 10-K, 20-F, or 40-F in calendar year 2018, excluding any such
filings that pertain to fiscal years prior to 2017. Staff extracted
filer status from filings using a computer program supplemented with
hand collection and compared the results for robustness with data
from XBRL filings, Ives Group Audit Analytics, and Calcbench. FPIs
represent those filing on Forms 20-F or 40-F and do not include FPIs
that choose to file on Form 10-K. EGC issuers are identified by
using data from Ives Group Audit Analytics and/or by using a
computer program to search issuer filings, including filings other
than annual reports, for a statement regarding EGC status. The
estimates generally exclude RICs because these issuers do not file
on the annual report types considered. This table also excludes 143
issuers, mostly Canadian MJDS issuers filing on Form 40-F (which
does not require disclosure of filer status or public float), for
which filer type is unavailable.

Table 5--Filer Status for Issuers Filing Annual Reports in 2018
----------------------------------------------------------------------------------------------------------------
Non- Large
accelerated * Accelerated accelerated
----------------------------------------------------------------------------------------------------------------
FPI............................................................. 265 137 264
EGC............................................................. 1,097 333 0
-----------------------------------------------
Total....................................................... 3,900 1,416 2,266
----------------------------------------------------------------------------------------------------------------
* The estimated number of non-accelerated filers includes approximately 621 ABS issuers, which are not required
to comply with SOX Section 404. Staff estimates that very few, if any, ABS issuers are accelerated or large
accelerated filers. ABS issuers are identified as issuers that made distributions reported via Form 10-D.

[[Page 17197]]

Audits of ICFR and the associated ICFR auditor attestation reports
are made in accordance with AS 2201,\299\ previously known as Auditing
Standard Number 5 (``AS No. 5'').\300\ This standard, which replaced
Auditing Standard Number 2 (``AS No. 2'') in 2007, was intended to
focus auditors on the most important matters in the audit of ICFR and
eliminate procedures that the PCAOB believed were unnecessary to an
effective audit of ICFR.\301\ Among other things, the 2007 standard
facilitates the scaling of the evaluation of ICFR for smaller, less
complex issuers by, for example, encouraging auditors to use top-down
risk-based approaches and to use the work of others in the attestation
process.\302\ It was accompanied by Commission guidance similarly
facilitating the scaling of SOX Section 404(a) management evaluations
of ICFR.\303\
---------------------------------------------------------------------------

\299\ See note 292 above.
\300\ AS No. 5 was renumbered as AS 2201, note 292 above,
effective Dec. 31, 2016. See Reorganization of PCAOB Auditing
Standards and Related Amendments to PCAOB Standards and Rules, PCAOB
Release No. 2015-002 (Mar. 31, 2015).
\301\ See Auditing Standard No. 5, An Audit of Internal Control
Over Financial Reporting That Is Integrated with An Audit of
Financial Statements, and Related Independence Rule and Conforming
Amendments, PCAOB Release No. 2007-005A (June 12, 2007). See also
Public Company Accounting Oversight Board; Order Approving Proposed
Auditing Standard No. 5, An Audit of Internal Control Over Financial
Reporting that is Integrated with an Audit of Financial Statements,
a Related Independence Rule, and Conforming Amendments, Release No.
34-56152, File No. PCAOB 2007-02 (July 27, 2007) [72 FR 42141 (Aug.
1, 2007)].
\302\ Id.
\303\ See Commission Guidance Regarding Management's Report on
Internal Control Over Financial Reporting Under Section 13(a) or
15(d) of the Securities Exchange Act of 1934, Release No. 33-8810
(June 20, 2007) [72 FR 35323 (June 27, 2007)]. See also Amendments
to Rules Regarding Management's Report on Internal Control Over
Financial Reporting, Release No. 33-8810 (June 20, 2007) [72 FR
35309 (June 27, 2007)].
---------------------------------------------------------------------------

The adoption of AS 2201 in 2007 has been found to have lowered
audit fees.\304\ However, several studies have provided evidence that,
at least initially, after the adoption of AS 2201, the quality of ICFR
of issuers subject to the ICFR auditor attestation requirement
decreased relative to that of other issuers.\305\ Around 2010, PCAOB
inspections of auditors began to include a heightened focus on whether
auditing firms had obtained sufficient evidence to support their
opinions on the effectiveness of ICFR.\306\ There is some evidence that
these inspections have led to an improvement in the reliability of ICFR
auditor attestations,\307\ but also concerns that audit fees also
increased around the same time.\308\
---------------------------------------------------------------------------

\304\ See, e.g., Study of the Sarbanes-Oxley Act of 2002 Section
404 Internal Control over Financial Reporting Requirements (Sept.
2009) (``2009 SEC Staff Study''), available at https://www.sec.gov/news/studies/2009/sox-404_study.pdf; Rajib Doogar, Padmakumar
Sivadasan, & Ira Solomon, 48(4) J. of Acct. Res. 795 (2010).
\305\ See, e.g., Joseph Schroeder & Marcy Shepardson, Do SOX 404
Control Audits and Management Assessments Improve Overall Internal
Control System Quality?, 91(5) Acct. Rev. 1513 (2016) (``Schroeder
and Shepardson 2016 Study''); Lori Bhaskar, Joseph Schroeder, &
Marcy Shepardson, Integration of Internal Control and Financial
Statement Audits: Are Two Audits Better than One? Acct. Rev.
(forthcoming 2018) (``Bhaskar et al. 2018 Study''), available at
https://aaajournals.org/doi/abs/10.2308/accr-52197. See Section
IV.C.3.a. and notes 464 and 474 below for more information on these
studies.
\306\ See Jeanette Franzel, Board Member, PCAOB, Speech by PCAOB
board member at the American Accounting Association Annual Meeting,
Current Issues, Trends, and Open Questions in Audits of Internal
Control over Financial Reporting (2015), available at https://pcaobus.org/News/Speech/Pages/08102015_Franzel.aspx.
\307\ See Mark Defond & Clive Lennox, Do PCAOB Inspections
Improve the Quality of Internal Control Audits?, 55(3) J. OF ACCT.
RES. 591 (2017) (``Defond and Lennox 2017 Study'').
\308\ See, e.g., Tammy Whitehouse, Audit Inspections:
Improvement? Maybe. Costs? Yes, Compliance Week (April 14, 2015),
available at https://www.complianceweek.com/news/news-article/audit-inspections-improvement-maybe-costs-yes#.W5LW7mlpCEd; and Jennifer
McCallen, Roy Schmardebeck, Jonathan Shipman, & Robert Whited, Have
the Costs and Benefits of SOX Section 404(b) Compliance Changed Over
Time?, Working Paper (Nov. 2019), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3420787 (``McCallen et
al. 2019 study'').
---------------------------------------------------------------------------

In 2010, the PCAOB adopted enhanced auditing standards related to
the auditor's assessment of and response to risk.\309\ The enhanced
risk assessment standards have likely reduced, to some extent, the
degree of difference between a financial statement only audit and an
integrated audit (which includes an audit of ICFR) because the
standards clarify and augment the extent to which internal controls are
to be considered even in a financial statement only audit. In
particular, the risk assessment standards applying to both types of
audits require auditors, in either case, to evaluate the design of
certain controls, including whether the controls are implemented.\310\
---------------------------------------------------------------------------

\309\ See PCAOB Release No. 2010-004 and PCAOB Release No. 2010-
01, note 193 above.
\310\ See AS 2110, paragraphs .18-.40, note 187 above.
---------------------------------------------------------------------------

Based on the results of inspections in the several years after the
adoption of the new risk assessment auditing standards, the PCAOB
expressed concern about the number and significance of deficiencies in
auditing firm compliance with these standards, but also noted promising
improvements in the application of these standards.\311\ While the risk
assessment standards may reduce the degree of difference between a
financial statement only audit and an integrated audit, there remain
important differences in the requirements of these audits as they
relate to controls. For example, in an integrated audit, but not a
financial statement only audit, the auditor is required to identify
likely sources of misstatements in considering the evaluation of
ICFR.\312\ Also, the extent of the procedures necessary to obtain the
required understanding of controls generally will be greater in an
integrated audit due to the different objectives of such an audit as
compared to a financial statement only audit.\313\
---------------------------------------------------------------------------

\311\ See PCAOB Release No. 2015-007, note 195 above.
\312\ See PCAOB Release No. 2010-004, note 309 above, at 7 and
A10-41. As discussed above, even in a financial statement only
audit, if the auditor becomes aware of a significant deficiency or
material weakness in ICFR, it is required to inform management and
the audit committee of this finding and has the responsibility to
review management's disclosure for any misstatement of facts, such
as a statement that ICFR is effective when there is a known material
weakness. See notes 190 to 191 above and the accompanying text.
\313\ See Proposed Auditing Standards Related to the Auditor's
Assessment of and Response to Risk and Conforming Amendments to
PCAOB Standards, PCAOB Release No. 2008-006 A9-8 (Oct. 21, 2008).
---------------------------------------------------------------------------

The Commission recently settled charges against four public
companies for failing to maintain effective ICFR for seven to 10
consecutive annual reporting periods.\314\ These enforcement cases may
have a deterrent effect among issuers failing to remediate material
weaknesses, which might reduce the overall rate of persistence of
material weaknesses in ICFR.
---------------------------------------------------------------------------

\314\ See SEC Press Release, note 196 above.
---------------------------------------------------------------------------

We also note that there have been some recent changes in accounting
and auditing that are part of our baseline and could increase the
uncertainty of our analysis due to their effects on factors such as
audit fees, restatements, and ICFR. For example, three new reporting
standards have been issued recently by FASB, on the topics of revenue
recognition, leases, and credit losses, which could temporarily
increase audit fees as issuers and auditors adjust to the new
standards.\315\ Recent changes in technology, such as the potential for
management to use automated controls testing and process
automation,\316\ may result in improvements in ICFR regardless of the
ICFR auditor attestation requirement if their increased application
results in more robust financial reporting processes with fewer
opportunities for deficiencies and/or in an increase by

[[Page 17198]]

management in control testing and related improvements. Such automation
could also reduce audit fees, including the costs of an audit of ICFR,
but at least one report suggests that the uptake of these technologies
has been slow.\317\ Finally, auditors have had many years of experience
with integrated audits, as well as risk assessment standards that
require the consideration of ICFR even in the absence of an ICFR
auditor attestation. This experience may affect their execution of
financial statement only audits of issuers for whom the ICFR auditor
attestation requirement is eliminated. For example, given their
experience, auditors may be more likely to detect control deficiencies
or to increase their auditing efficiency by reducing substantive
testing in favor of testing some related controls even when an ICFR
auditor attestation is not required.\318\
---------------------------------------------------------------------------

\315\ Information on these and other FASB Accounting Standards
updates is available at https://www.fasb.org/jsp/FASB/Page/SectionPage&cid=1176156316498.
\316\ See, e.g., Robotic Process Automation, note 197 above.
\317\ See, e.g., Protiviti survey results, Benchmarking SOX
Costs, Hours and Controls (2018) (``Protiviti 2018 Report'').
\318\ 2011 SEC Staff Study, note 198 above, (stating that ``. .
. once effective controls are in place at the issuer, the auditor is
more likely to continue to test them even if [it is] not issuing an
auditor attestation during a particular year in order to rely on
them for purposes of reducing substantive testing in the audit of
the financial statements, particularly for issuers that are larger
and more complex'').
---------------------------------------------------------------------------

2. Characteristics of Accelerated Filer Population
Per Table 5, there were approximately 1,400 accelerated filers in
total in 2018. Figure 2 \319\ presents the distribution of public float
across these issuers.\320\
---------------------------------------------------------------------------

\319\ The estimates in the figure are based on staff analysis of
data from XBRL filings. See note 298 above for details on the
identification of the population of accelerated filers.
\320\ Because of the accelerated filer transition provisions,
some accelerated filers have float below $75 million. The public
float of these issuers would previously have exceeded $75 million,
causing them to enter accelerated filer status, but has not dropped
below the $50 million public float level required to exit
accelerated filer status.
---------------------------------------------------------------------------

BILLING CODE 8011-01-P
[GRAPHIC] [TIFF OMITTED] TR26MR20.001

BILLING CODE 8011-01-C
The distribution of public float among accelerated filers is skewed
towards lower levels of float, but higher levels of float are also
significantly represented.
Figure 3 \321\ presents the distribution of revenues across those
accelerated filers that have less than $1 billion in revenues. While
the full population of accelerated filers has revenues of up to over
$20 billion, about 90 percent of accelerated filers have less than $1
billion in revenues. We restrict the figure to this subset in order to
more clearly display the distribution in this range.
---------------------------------------------------------------------------

\321\ The estimates of revenues are based on staff analysis of
data from XBRL filings, Compustat, and Calcbench. The revenue data
used is from the last fiscal year prior to the annual report in
calendar year 2018, because the SRC revenue test is based on the
prior year's revenues. See note 298 above for details on the
identification of the population of accelerated filers.

---------------------------------------------------------------------------

[[Page 17199]]

[GRAPHIC] [TIFF OMITTED] TR26MR20.002

The distribution of revenues for accelerated filers is heavily
skewed towards lower levels of revenue, with roughly three-quarters of
accelerated filers having revenues of less than $500 million and more
than a third having revenues of less than $100 million. Other than a
clustering of issuers with zero or near zero revenues, there are no
obvious breaks in the distribution.
While a large range of industries are represented among accelerated
filers, a small number of industries account for the majority of these
issuers. The ``Banking'' industry accounts for about 14.1 percent of
accelerated filers, followed by ``Pharmaceutical Products'' (13.9
percent) ``Financial Trading'' (8.0 percent), ``Business Services''
(5.7 percent), ``Petroleum and Natural Gas'' (4.8 percent), ``Computer
Software'' (4.4 percent), ``Retail'' (4.4 percent), ``Transportation''
(4.2 percent), and ``Electronic Equipment'' (4.1 percent).\322\
---------------------------------------------------------------------------

\322\ These estimates are based on staff analysis of data
including SIC codes from XBRL filings and Ives Group Audit
Analytics, using the Fama-French 49-industry classification system.
See https://mba.tuck.dartmouth.edu/pages/faculty/ken.french/Data_Library/det_49_ind_port.html. See note 298 above for details on
identification of population of accelerated filers.
---------------------------------------------------------------------------

3. Timing of Filings
As discussed above, non-accelerated, accelerated, and large
accelerated filers face different filing deadlines for their periodic
reports. In Table 6, we present the timing in recent years of annual
report filings by these different groups of issuers relative to their
corresponding deadlines.\323\
---------------------------------------------------------------------------

\323\ The estimates in this table are based on staff analysis of
EDGAR filings. These statistics include all annual reports on Forms
10-K, 20-F, and 40-F filed in calendar years 2014 through 2018 other
than amendments. If multiple annual reports (excluding amendments)
are filed in the same calendar year, the analysis considers only the
latest such filing. Given the effect of weekends and holidays,
filings are considered to be on time if within two calendar days
after the original deadline. The ``5 days early'' and ``over 15 days
after'' categories are similarly adjusted to account for the
possible effect of weekends and holidays. See note 298 above for
details on the identification of filer type.

Table 6--Filing Timing for Annual Reports in Years 2014 Through 2018, by Filer Status
----------------------------------------------------------------------------------------------------------------
Non-accelerated Accelerated Large accelerated
----------------------------------------------------------------------------------------------------------------
Annual report filing deadline.... 90 days.................. 75 days................. 60 days.
Average days to file............. 101 days................. 70 days................. 56 days.
Percentage filed:
By deadline.................. 72%...................... 91%..................... 94%.
Over 5 days early............ 44%...................... 63%..................... 61%.
After deadline............... 28%...................... 9%...................... 6%.
Over 15 days after deadline.. 13%...................... 5%...................... 4%.
----------------------------------------------------------------------------------------------------------------

[[Page 17200]]

Table 6 documents that accelerated and large accelerated filers
file their annual reports, on average, four or five days before the
applicable deadline. Nine percent and six percent, respectively, of
accelerated and large accelerated filers submit their annual reports
after the initial deadline, with roughly half of these filers
surpassing the 15-day grace period that is obtained by filing Form NT.
Non-accelerated filers are less likely to meet their initial deadline
or extended deadline, with the average non-accelerated filer submitting
its annual report 11 days after the initial deadline and 13 percent of
non-accelerated filers filing after the 15-day grace period obtained by
filing Form NT.
4. Internal Controls and Restatements
We next consider the current rates of ineffective ICFR and
restatements \324\ among issuers that are accelerated filers under the
baseline relative to other filer types. The data for all years of the
analysis has been updated relative to the analysis in the Proposing
Release.\325\ Throughout our analysis, we use the term restatement to
refer to a restatement that is associated with some type of
misstatement. As discussed above, non-accelerated filers and EGCs are
statutorily exempted from the ICFR auditor attestation requirement.
Table 7 presents the percentage of issuers reporting ineffective ICFR
in recent years by filer type.\326\
---------------------------------------------------------------------------

\324\ Unless otherwise specified, statistics and analysis
regarding restatements are not restricted to those restatements
requiring Form 8-K Item 4.02 disclosure.
\325\ Previous years of data may be revised due to, for example,
newly disclosed restatements that reflect misstatements in these
earlier years, restated internal control reports that relate to
previous fiscal years, previously incomplete data that was later
populated, or other updates or database changes.
\326\ The estimates in this table are based on staff analysis of
Ives Group Audit Analytics data. ICFR effectiveness is based on the
last amended management or auditor attestation report for the fiscal
year. Percentages are computed out of all issuers of a given filer
type with the specified type of report available in the Ives Group
Audit Analytics database. See note 298 above for details on the
identification of filer type.

Table 7--Percentage of Issuers Reporting Ineffective ICFR
----------------------------------------------------------------------------------------------------------------
Non- Large
Ineffective ICFR year reported in accelerated Accelerated accelerated
(%) (%) (%)
----------------------------------------------------------------------------------------------------------------
Management Report:
2014........................................................ 40.1 7.8 3.2
2015........................................................ 41.2 9.2 3.8
2016........................................................ 38.3 9.5 4.6
2017........................................................ 40.2 9.2 5.0
2018........................................................ 40.3 8.9 3.8
Average/year............................................ 40.0 8.9 4.1
Auditor Attestation:
2014........................................................ n/a 8.0 3.3
2015........................................................ n/a 9.1 3.8
2016........................................................ n/a 9.0 4.6
2017........................................................ n/a 9.4 4.9
2018........................................................ n/a 8.7 3.8
Average/year............................................ n/a 8.8 4.1
----------------------------------------------------------------------------------------------------------------

Based on management's SOX Section 404(a) reports on ICFR from
recent years, on average, about nine percent of accelerated filers
reported at least one material weakness in ICFR in a given year.\327\
This represents a moderately higher rate than that among large
accelerated filers, approximately four percent, on average, of which
reported ineffective ICFR,\328\ and a substantially lower rate than
that among non-accelerated filers, more than a third of which reported
ineffective ICFR each year.\329\ For issuers subject to the ICFR
auditor attestation requirement, the rates of ineffective ICFR reported
by management and by auditors are similar.\330\ This may not be
surprising, as management will be made aware of any material weaknesses
discovered by the auditor and vice versa.
---------------------------------------------------------------------------

\327\ Per the second column of the first panel of Table 7, the
rate of ineffective ICFR among accelerated filers has ranged from
7.8 to 9.5 percent for the years 2014 through 2018, for an average
per year of 8.9 percent.
\328\ Per the third column of the first panel of Table 7, the
rate of ineffective ICFR among large accelerated filers has ranged
from 3.2 to 5.0 percent for the years 2014 through 2018, for an
average per year of 4.1 percent.
\329\ Per the first column of the first panel of Table 7, the
rate of ineffective ICFR among non-accelerated filers has ranged
from 38.3 to 41.2 percent for the years 2014 through 2018, for an
average per year of 40.0 percent.
\330\ Per the second column of Table 7, the average rate of
ineffective ICFR for accelerated filers across years 2014 through
2018 was 8.9 percent as reported in management reports and 8.8
percent as reported in auditor reports. Similarly, per the third
column of Table 7, the average rate of ineffective ICFR for large
accelerated filers across years 2014 through 2018 was 4.1 percent as
reported in management reports and 4.1 percent as reported in
auditor reports.
---------------------------------------------------------------------------

We next consider the persistence of material weaknesses across
these issuer categories. Table 8 \331\ presents the percentage of
issuers that reported two, three, or four consecutive years of
ineffective ICFR culminating in 2018, by filer type.\332\
---------------------------------------------------------------------------

\331\ The estimates in this table are based on staff analysis of
Ives Group Audit Analytics data. ICFR effectiveness is based on the
last amended management report for the fiscal year. Percentages in
the first panel are computed out of all issuers of a given filer
type in 2018 with SOX Section 404(a) management reports available in
Ives Group Audit Analytics database, while percentages in the second
panel are computed out of issuers of a given filer type reporting
ineffective ICFR in their SOX Section 404(a) management report for
2018. See fourth row of Table 7 and note 298 above for details on
the identification of filer type.
\332\ One commenter noted that the Proposing Release, note 4
above, indicated that over 68 percent of non-accelerated filers have
reported two consecutive years of ineffective ICFR and over 38
percent have reported four consecutive years of ineffective ICFR in
their annual reports. See letter from Better Markets. To clarify, we
note that these statistics, like those reported in the second panel
of Table 8 below, reflect percentages out of the issuers in each
category that maintained ineffective ICFR in the last year of the
analysis, not percentages of all issuers in each category.

[[Page 17201]]

Table 8--Percentage of Issuers Reporting Consecutive Years of Ineffective ICFR in Management Report, by 2018
Filer Status
----------------------------------------------------------------------------------------------------------------
Non- Large
Ineffective ICFR years accelerated Accelerated accelerated
(%) (%) (%)
----------------------------------------------------------------------------------------------------------------
Issuers with persistent ineffective ICFR/All issuers:
2017-2018 (at least 2 years)................................ 28.4 3.5 1.4
2016-2018 (at least 3 years)................................ 20.8 2.0 0.5
2015-2018 (4 years)......................................... 16.1 1.0 0.3
Issuers with persistent ineffective ICFR/Issuers with 2018
ineffective ICFR:
2017-2018 (at least 2 years)................................ 70.4 39.2 36.4
2016-2018 (at least 3 years)................................ 51.6 22.4 14.1
2015-2018 (4 years)......................................... 39.9 11.3 7.2
----------------------------------------------------------------------------------------------------------------

The first panel of Table 8 is intended to demonstrate the overall
rate of persistently ineffective ICFR among issuers of different types,
while the second panel is intended to demonstrate the degree of
persistence of ineffective ICFR among the subset of issuers of each
type that report ineffective ICFR in 2018. Compared to non-accelerated
filers, we find that a smaller percentage of accelerated and large
accelerated filers report material weaknesses that persist for multiple
years, with about one percent of accelerated filers and about 0.3
percent of large accelerated filers reporting ineffective ICFR for four
consecutive years (per the third row of the table), representing about
11 percent of the accelerated filers and about seven percent of the
large accelerated filers that reported ineffective ICFR in 2018 (per
the last row of the table). A larger percentage of non-accelerated
filers persistently report material weaknesses, with about 16 percent
of these issuers (per the third row of the table), or about 40 percent
of those reporting ineffective ICFR in 2018 (per the last row of the
table), having reported material weaknesses for four consecutive years.
As discussed above, it is possible that recent Commission enforcement
actions might lead to a reduction in the persistence of material
weaknesses in ICFR to the extent that they change issuers' awareness of
the risks of longstanding ICFR failures.
Table 9 presents the rate of restatements among each of these filer
types, excluding EGCs, and for EGCs separately. For each year, we
consider the percentage of issuers that eventually restated the
financial statements for that year. The reporting lag before
restatements are filed results in a lower observed rate in the later
years of our sample, particularly for 2017 (and even more so for 2018,
which we do not report for this reason), as issuers may yet restate
their results from recent years.\333\

Table 9--Percentage of Issuers Issuing Restatements by Year of Restated Data
----------------------------------------------------------------------------------------------------------------
Non-
accelerated Accelerated Large
Restated (ex. EGCs) (ex. EGCs) accelerated EGC (%)
(%) (%) (%)
----------------------------------------------------------------------------------------------------------------
Total Restatements:
2014........................................ 10.9 11.9 14.5 17.7
2015........................................ 9.2 12.5 12.7 16.0
2016........................................ 6.8 9.6 8.9 9.3
2017........................................ 6.9 7.5 6.3 8.3
Average/year............................ 8.5 10.4 10.6 12.8
8-K Item 4.02 Restatements:
2014........................................ 3.9 3.6 2.4 5.0
2015........................................ 3.1 3.6 1.8 4.7
2016........................................ 2.4 2.7 1.3 3.0
2017........................................ 2.3 2.0 0.7 3.1
Average/year............................ 2.9 2.9 1.6 3.9
----------------------------------------------------------------------------------------------------------------

The first panel of Table 9 presents the percentage of issuers that
make at least one restatement, of any type, while the second panel
presents those that make at least one restatement requiring Form 8-K
Item 4.02 disclosure. The latter type of restatement (``Item 4.02
restatements'') reflects material misstatements, while other
restatements deal with misstatements that are considered immaterial. We
find that EGCs, which are not subject to the ICFR auditor attestation
requirement and generally are also younger issuers than those in the
other groups, restate their financial statements at higher rates than
other issuers, whether we consider all restatements or only Item 4.02
restatements. For non-accelerated filers, which also are not subject to
the ICFR auditor attestation requirement, we find that the percentage
of issuers reporting Item 4.02 restatements is similar to, and the rate
of all restatements slightly lower than, that for accelerated filers
who are subject to the ICFR auditor attestation requirement. We note
that there is a greater proportion of low-revenue issuers in the non-
accelerated filer category than in other categories, and that, in the
Proposing Release, we found such issuers to have lower rates of
restatement than other issuers.\334\ When, in the Proposing Release, we

[[Page 17202]]

separately considered issuers with revenues below $100 million, we
found that the accelerated filers in this category are less likely to
restate their financial statements than non-accelerated filers in the
same revenue category.\335\
---------------------------------------------------------------------------

\333\ The estimates in this table are based on staff analysis of
Ives Group Audit Analytics data. Percentages are computed out of all
issuers of a given filer type with a SOX Section 404(a) management
report available in the Ives Group Audit Analytics database.
Accelerated and non-accelerated categories exclude EGCs that are in
these filer categories. See note 298 above for details on the
identification of filer type.
\334\ See Table 14 in the Proposing Release, note 4 above.
\335\ Id.
---------------------------------------------------------------------------

C. Discussion of Economic Effects

The costs and benefits of the amendments, including impacts on
efficiency, competition, and capital formation, are discussed below. We
first address the population and characteristics of issuers that will
newly qualify as non-accelerated filers under the amendments, and then
introduce certain categories of issuers that are used for comparison
purposes. We next discuss the anticipated costs and benefits associated
with the proposed change in applicability of the ICFR auditor
attestation requirement. Following this discussion, we consider the
costs and benefits associated with the proposed changes with respect to
filing deadlines, exit thresholds, and other required disclosures.
Finally, we consider the relative benefits and costs of the principal
reasonable alternatives to the amendments.
1. Affected Issuers
We estimate that the amendments will result in 527 additional
issuers being classified as non-accelerated filers, and therefore no
longer subject to the filing deadlines and ICFR auditor attestation
requirement applicable to accelerated filers.\336\ Of these, an
estimated 154 issuers are EGCs and are thereby already exempt from the
ICFR auditor attestation requirement.\337\ Among the total 527 affected
issuers, an estimated 492 issuers are accelerated filers (or large
accelerated filers that have public float of less than $560 million)
that will be newly classified as non-accelerated filers because they
have annual revenues of less than $100 million and are eligible to be
SRCs.\338\ An additional 28 issuers are BDCs that will be newly
classified as non-accelerated filers because they are currently
accelerated filers (and therefore have public float of less than $700
million) and have annual investment income of less than $100
million.\339\ The remaining seven affected issuers are accelerated
filers that will be newly classified as non-accelerated filers despite
having revenues of at least $100 million because they have a public
float of at least $50 million but less than $60 million.\340\ Our
estimate of the number of affected issuers excludes issuers for which
we were unable to determine filer classification or revenues, which
could represent up to approximately an additional 30 affected issuers.
---------------------------------------------------------------------------

\336\ The number of affected issuers is based on staff estimates
of: (i) The number of accelerated filers in 2018 that have prior
fiscal year revenues of less than $100 million and are eligible to
be SRCs (i.e., excluding ABS issuers, RICs, BDCs, subsidiaries of
non-SRCs, and FPIs filing on foreign forms or using IFRS) or are
BDCs with prior year investment income of less than $100 million;
(ii) the number of large accelerated filers in 2018 that have a
public float of less than $560 million and prior fiscal year
revenues of less than $100 million and are eligible to be SRCs; and
(iii) the number of accelerated filers in 2018 that have a public
float of at least $50 million but less than $60 million. The
estimate of the number of affected issuers does not include large
accelerated filers that have a public float of at least $560 million
but less than $700 million even though such issuers could become
non-accelerated filers under the amendments if they became eligible
to be SRCs under the SRC revenue test in the first year the SRC
amendments became effective due to the limited horizon of this
accommodation. See note 252 above (describing the accommodation
provided in the SRC Adopting Release). Revenue data is sourced from
XBRL filings, Compustat, and Calcbench. Public float data is from
XBRL. See note 298 above for details on the identification of the
population of accelerated and large accelerated filers and other
filer types.
\337\ Id.
\338\ Id.
\339\ Id.
\340\ Id.
---------------------------------------------------------------------------

Our estimate of the number of affected issuers does not include any
FPIs. We estimate that there are no FPIs that file on domestic forms
and present their financial statements pursuant to U.S. GAAP, and that
also meet the required thresholds and other qualifications to be an
affected issuer under the amendments. However, there are an estimated
31 FPIs that file on foreign forms, but otherwise meet the required
thresholds and other qualifications. There are also FPIs filing on
foreign forms for which we were unable to determine filer
classification or revenues, which could represent up to approximately
an additional 90 FPIs that file on foreign forms but that may meet the
required thresholds and other qualifications.\341\ While we do not
include these issuers in our counts of the number of affected
issuers,\342\ some of these 30 to 120 additional issuers might choose
to file on domestic forms using U.S. GAAP in order to benefit from the
amendments if these benefits, together with other benefits of such a
choice (such as the ability to rely on the scaled disclosure
accommodations available to SRCs) outweigh the costs of changing their
disclosure regime. However, many factors are involved in the choice of
a reporting regime, and it is difficult to predict how many of these
issuers are likely to change their reporting practices due to the
amendments.
---------------------------------------------------------------------------

\341\ The majority of these potential additional issuers are
Canadian MJDS filers that are not required to disclose filer type or
public float. See note 298 above.
\342\ In the Proposing Release, note 4 above, we included FPIs
that file on foreign forms, but otherwise meet the required
thresholds and other qualifications, in the number of affected
issuers. While these issuers could become subject to the amendments
by changing their reporting regime, it is difficult to predict how
many would do so and therefore, to be conservative, we do not
include them in the number of affected issuers in this release.
---------------------------------------------------------------------------

As noted above, the total number of affected issuers includes an
estimated 154 EGCs (including 152 EGCs with annual revenues or, in the
case of BDCs, investment income of less than $100 million and two EGCs
that will be affected because they have a public float of at least $50
million but less than $60 million).\343\ It also includes an estimated
78 banks with $1 billion or more in total assets that are not
EGCs.\344\ The estimated 154 EGCs are not required to comply with the
ICFR auditor attestation requirement under SOX Section 404(b). We
estimate that the remaining 373 affected issuers will, including 21
BDCs, be newly exempt from this requirement.\345\ Two commenters
provided estimates of 382 affected issuers and 385 affected issuers,
respectively, as the number of issuers that would be newly exempt from
the ICFR auditor attestation requirement under the proposal.\346\ While
these estimates are largely consistent with our estimate, we note that
the commenters' estimates apply some simplifications and use different
underlying data sources than our estimate.\347\
---------------------------------------------------------------------------

\343\ See note 336 above.
\344\ Banks are identified as issuers with SIC codes of 6020
(commercial banks), 6021 (national commercial banks), 6022 (state
commercial banks), 6029 (NEC commercial banks), 6035 (savings
institutions, federally-chartered) or 6036 (savings institutions,
not federally-chartered).
\345\ Of these 373 issuers, 368 had less than $100 million in
revenues (or, in the case of BDCs, investment income) in their last
fiscal year, while the remaining five would be affected despite
having greater revenues because of the revised transition provisions
(i.e., because their public float is at least $50 million but less
than $60 million).
\346\ See letters from CFA Inst. and Prof. Barth et al. See also
letter from Nasdaq, estimating that at least 399 Nasdaq-listed
companies may be affected by the amendments.
\347\ For example, neither commenter excludes from its estimate
issuers that are not eligible to be SRCs or adjusts for the effect
of the revised transition thresholds as described in note 336 above
and note 151 of the Proposing Release, note 4 above. The letter from
CFA Inst. appears to rely on a footnote in the Proposing Release
that, while citing to the correct definitions of EGC in our rules,
incorrectly stated that an EGC is an issuer that has total annual
gross revenues of ``less than $1.07 million'' during its most
recently completed fiscal year (rather than the correct threshold of
``less than $1.07 billion'') and did not identify the other
requirements to be an EGC (such as not having reached the last day
of the fiscal year following the fifth anniversary of the date of
the first sale of common equity securities of the issuer under an
effective Securities Act registration statement as an EGC). See
footnote 47 of the Proposing Release, note 4 above. The estimate in
the letter from CFA Inst. also excluded all 10-K filers with the SIC
code 6200 (``Security & Commodity Brokers, Dealers, Exchanges &
Services''), which we do not believe is appropriate. While the
letter correctly indicates that the ICFR auditor attestation
requirement does not apply to audits of brokers and dealers
performed pursuant to SEC Rule 17a-5, these audits apply to the
reports required by Rule 17a-5, which are distinct from a Form 10-K
filing. Issuers filing Form 10-Ks that have a subsidiary that is a
broker or dealer are not treated differently from other issuers with
respect to the ICFR auditor attestation requirement.

---------------------------------------------------------------------------

[[Page 17203]]

Of the 373 issuers that will be newly exempt from the ICFR auditor
attestation requirement, we estimate that the 78 banks identified above
will be subject to the FDIC auditor attestation requirement,\348\ while
the remaining 295 issuers will not be subject to any such auditor
attestation requirement.\349\ For the banks that will be newly exempt
from the ICFR auditor attestation requirement but will remain subject
to the FDIC auditor attestation requirement, the benefits and costs of
expanding the exemption from the ICFR auditor attestation requirement
are both expected to be limited. As discussed in Section IV.B.1. above,
the FDIC auditor attestation requirement is substantively similar to
the ICFR auditor attestation requirement, and is thus expected to
require similar expenditures and have similar financial reporting
benefits as the ICFR auditor attestation.
---------------------------------------------------------------------------

\348\ If these banks are no longer subject to the SOX Section
404(b) auditor attestation requirement, their auditors may follow
the AICPA's auditing standards in lieu of the PCAOB's auditing
standards for the FDIC auditor attestation. See Section 18A of
Appendix A to FDIC Rule 363 and the AICPA's AU-C Section 940. See
also Section III.B.1. above.
\349\ Of these 274 issuers, 269 are accelerated filers (or large
accelerated filers that have public float of less than $560 million)
that will be newly classified as non-accelerated filers because they
have annual revenues of less than $100 million and are eligible to
be SRCs, while the remaining five will be newly classified as non-
accelerated filers despite having revenues of at least $100 million
because they have a public float of at least $50 million but less
than $60 million.
---------------------------------------------------------------------------

We estimate that approximately 90 percent of the affected issuers
(whether including or excluding EGCs) have securities that are listed
on national exchanges.\350\ The representation in public markets of
issuers similar to the affected issuers has decreased relative to the
years before SOX. In particular, over the past two decades, the number
of issuers listed on major exchanges has decreased by about 40
percent,\351\ but the decline has been concentrated among smaller size
issuers. Specifically, the number of listed issuers with market
capitalization below $700 million has decreased by about 65
percent,\352\ and the number of listed issuers with less than $100
million in revenue has decreased by about 60 percent.\353\ One
commenter noted that these statistics do not establish that the costs
of the ICFR auditor attestation materially contributed to the decline
in listed issuers, and that there are a number of other factors that
are likely implicated in the decline of listings.\354\ We cite these
statistics to characterize the affected issuers, not to attribute the
decline in listings to any particular cause. As noted below, the
amendments could be a positive factor in the decision of additional
companies to enter public markets, but it may not be the decisive
factor, and the direct impact of the amendments on the number of public
companies may be limited to the extent that companies may be more
focused on other factors associated with the decision to go
public.\355\
---------------------------------------------------------------------------

\350\ Staff extracted information regarding whether issuers
reported having securities registered under Section 12(b) of the
Exchange Act from the cover page of annual report filings using a
computer program supplemented with hand collection. See note 336
above for details on the identification of the population of
affected issuers.
\351\ This estimate is based on staff analysis of data from the
Center for Research in Security Prices database for December 1998
versus December 2018. The estimate excludes RICs and issuers of
ADRs.
\352\ Id.
\353\ This estimate is based on staff analysis of data from
Standard & Poor's Compustat and Center for Research in Security
Prices databases for fiscal year 1998 versus fiscal year 2017. The
estimate excludes RICs and issuers of ADRs.
\354\ See letter from CFA.
\355\ See Section IV.C.2.d. below.
---------------------------------------------------------------------------

Figure 4 \356\ presents the distribution of public float across the
full sample of affected issuers.\357\
---------------------------------------------------------------------------

\356\ The estimates in this figure are based on staff analysis
of data from XBRL filings. We corrected the public float data based
on hand-collection from Form 10-K filings for five affected issuers
whose public float reported in XBRL format was 1,000 times the
public float reported on the cover page of the corresponding Form
10-K filing, resulting in values of over $50 billion in public float
reported in XBRL. See note 336 above for details on the
identification of the population of affected issuers.
\357\ Because of the accelerated filer transition provisions,
some of the affected issuers have public float of at least $50
million but below $75 million. See note 320 above.
---------------------------------------------------------------------------

BILLING CODE 8011-01-P

[[Page 17204]]

[GRAPHIC] [TIFF OMITTED] TR26MR20.003

Relative to the distribution for all accelerated filers presented
in Figure 2, the sample of affected issuers is more strongly skewed
toward lower levels of public float, with higher levels of public float
only thinly represented. However, some of the affected issuers do have
public float approaching the top of the range for accelerated filers.
Figure 5 presents the distribution of revenues across the 520
accelerated filers (or large accelerated filers with public float of
less than $560 million) that will be newly classified as non-
accelerated filers because they have revenues (or, in the case of BDCs,
investment income) of less than $100 million.\358\
---------------------------------------------------------------------------

\358\ The estimates in this figure are based on staff analysis
of data from XBRL filings, Compustat, and Calcbench. The revenue
data used is from the last fiscal year prior to the annual report in
calendar year 2018, because the SRC revenue test is based on the
prior year's revenues. See note 336 above for details on the
identification of the population of affected issuers.

---------------------------------------------------------------------------

[[Page 17205]]

[GRAPHIC] [TIFF OMITTED] TR26MR20.004

BILLING CODE 8011-01-C
Other than a concentration of issuers with zero or near zero
revenues,\359\ these affected issuers are fairly evenly distributed
over different levels of revenue up to $100 million in revenues. The
additional seven affected issuers with revenues of at least $100
million but a public float of less than $60 million have revenues
ranging from $119 million to $2.1 billion, with a mean of about $770
million in revenues.
---------------------------------------------------------------------------

\359\ Approximately 13 percent of the estimated 520 affected
issuers with revenues of less than $100 million and approximately 11
percent of the estimated 290 affected issuers with revenues of less
than $100 million that would be newly exempt from all ICFR auditor
attestation requirements (i.e., those that are not EGCs and are not
banks subject to the FDIC auditor attestation requirement) have zero
revenues.
---------------------------------------------------------------------------

The affected issuers are estimated to have median total assets of
about $185 million, a median number of employees of about 115, and a
median age of about 12 years.\360\ For those issuers that will be newly
exempt from all ICFR auditor attestation requirements (i.e., those that
are not EGCs and are not banks subject to the FDIC auditor attestation
requirement), the median total assets and median number of employees
are somewhat lower at about $125 million and 85 employees, and the
median issuer age is slightly higher at about 19 years.\361\ The
majority of the affected issuers have negative net income and negative
net cash flows from operations.\362\
---------------------------------------------------------------------------

\360\ These estimates are based on staff analysis of data from
Compustat. See note 336 above for details on the identification of
the population of affected issuers.
\361\ Id.
\362\ Id. For the 295 affected issuers that would be newly
exempt from all ICFR auditor attestation requirements (i.e., those
that are not EGCs and are not banks subject to the FDIC auditor
attestation requirement), the median net income is approximately
negative $6 million and the median net cash flows from operations is
approximately negative $6 million.
---------------------------------------------------------------------------

The affected issuers are heavily concentrated, based on the number
of issuers, in the ``Pharmaceutical Products'' (29.1 percent),
``Banking'' (22.4 percent),\363\ ``Financial Trading'' (16.0 percent),
``Medical Equipment'' (4.4 percent), and ``Electronic Equipment'' (3.8
percent) industries.\364\ If the distribution of eligible issuers does
not change over time, the amendments could lead to a noticeable
decrease in the presence of ``Pharmaceutical Products'' and ``Banking''
issuers in the pool of accelerated filers.
---------------------------------------------------------------------------

\363\ For the 295 affected issuers that would be newly exempt
from all ICFR auditor attestation requirements (i.e., those that are
not EGCs and are not banks subject to the FDIC auditor attestation
requirement), the proportion of ``Banking'' issuers drops to 7.8
percent. By contrast, the proportion in other industries does not
change by more than a few percentage points.
\364\ These estimates are based on staff analysis of data
including SIC codes from XBRL filings and Ives Group Audit
Analytics, using the Fama-French 49-industry classification system.
BDCs are manually-classified as members of the ``Financial Trading''
industry under this system as SIC codes were unavailable from our
sources for the vast majority of these issuers. See https://mba.tuck.dartmouth.edu/pages/faculty/ken.french/Data_Library/det_49_ind_port.html. See note 336 above for details on the
identification of the population of affected issuers.
---------------------------------------------------------------------------

One commenter noted they sought to understand the industry
concentration of the affected issuers based on measures such as their
public float,

[[Page 17206]]

revenues, and total assets.\365\ Based on their public float relative
to the aggregate public float of the affected issuers, the affected
issuers are heavily concentrated in the ``Pharmaceutical Products''
(33.5 percent), ``Banking'' (20.0 percent), ``Financial Trading'' (17.0
percent), and ``Medical Equipment'' (5.0 percent) industries.\366\
Because revenues and total assets may be less comparable across
industries of different types, we do not present the fraction of the
aggregate revenue and assets of the affected issuers represented by
each industry. As an alternative that we believe may be more
informative, we present, in Table 10, the estimated proportion of all
of the accelerated filers in each industry that will be affected by the
amendments (i.e., become non-accelerated), calculated based on several
different measures of the size of the affected issuer pool in a given
industry.\367\ We focus this table on non-EGCs, and present affected
issuers in the ``Banking'' industry both including and excluding those
that will remain subject to the FDIC auditor attestation requirement,
in order to highlight the disproportionate effects by industry in terms
of the issuers that will newly be exempt from the ICFR auditor
attestation requirement.
---------------------------------------------------------------------------

\365\ See letter from CFA Inst.
\366\ These estimates are based on staff analysis of data
including SIC codes from XBRL filings and Ives Group Audit
Analytics, using the Fama-French 49-industry classification system.
See note 364 above for more details. We corrected the public float
data based on hand-collection from Form 10-K filings for five
affected issuers whose public float reported in XBRL format was
1,000 times the public float reported on the cover page of the
corresponding Form 10-K filing, resulting in values of over $50
billion in public float reported in XBRL. For the 295 affected
issuers that would be newly exempt from all ICFR auditor attestation
requirements (i.e., those that are not EGCs and are not banks
subject to the FDIC auditor attestation requirement), the
proportions are ``Pharmaceutical Products'' (27.9 percent),
``Financial Trading'' (22.5 percent), ``Real Estate'' (7.6 percent),
``Medical Equipment'' (7.5 percent), and ``Banking'' (5.4 percent).
\367\ The estimates in Table 10 are based on staff analysis of
data including data on total assets from Compustat and SIC codes
from XBRL filings and Ives Group Audit Analytics, using the Fama-
French 49-industry classification system. See note 364 above for
more details. Both the numerators (related to the affected issuers)
and denominators (related to accelerated filers) exclude EGCs. We
corrected the public float data based on hand-collection from Form
10-K filings for five affected issuers and six unaffected issuers
whose public float reported in XBRL format was about 1,000 times (in
one case, about 1,000,000 times) the public float reported on the
cover page of the corresponding Form 10-K filing, resulting in
values of over $50 billion in public float reported in XBRL. See
note 336 above for details on the source of revenue and public float
data and on the identification of the affected issuers. See note 298
above for details on the identification of filer type.

Table 10--Percentage of Accelerated Filers in Each Industry That Will Be Affected Issuers, Excluding EGCs
----------------------------------------------------------------------------------------------------------------
Percentage of accelerated filers (ex. EGCs) that are affected
(ex. EGCs), calculated based on:
Industry * ---------------------------------------------------------------
Number of Total assets Public float
issuers (%) (%) Revenue (%) (%)
----------------------------------------------------------------------------------------------------------------
Pharmaceutical Products......................... 77.9 54.4 36.8 78.7
Banking......................................... 63.5 37.6 33.2 43.1
Banking (ex. issuers subject to FDIC att. 14.5 5.2 10.9 17.5
requirement)...................................
Medical Equipment............................... 59.3 28.9 22.4 60.9
Financial Trading............................... 58.5 22.5 5.0 61.6
Electronic Equipment............................ 32.7 7.4 4.3 33.1
Other........................................... 16.0 4.0 1.8 11.8
----------------------------------------------------------------------------------------------------------------
* Excluding EGCs, we estimate that there are 74 affected issuers in the ``Pharmaceutical Products'' industry,
101 in ``Banking'' (23 after excluding issuers that would be subject to the FDIC attestation requirement), 62
in ``Financial Trading,'' 16 in ``Medical Equipment,'' and 16 in ``Electronic Equipment.'' The table excludes
two affected issuers for which an industry classification was unavailable.

Amongst the industries in which the affected issuers are most
greatly concentrated, issuers in the ``Pharmaceutical Products''
industry are the most disproportionately affected based on the number,
total assets, revenues, and public float of the affected issuers (other
than EGCs) relative to the representation of this industry among
accelerated filers (other than EGCs). While a substantial fraction of
accelerated filers other than EGCs in the ``Banking'' industry are also
affected issuers, consistent with one commenter's finding that
``Banking'' is the industry most affected by the amendments,\368\ the
proportion of this industry that is affected is significantly reduced
once we exclude banks that would be subject to the FDIC auditor
attestation requirement and are therefore expected to experience
limited benefits and costs as a result of the amendments.
---------------------------------------------------------------------------

\368\ See letter from CFA Inst.
---------------------------------------------------------------------------

2. Potential Benefits of Expanding the Exemption From the ICFR Auditor
Attestation Requirement for Affected Issuers
The ICFR auditor attestation requirement has been associated with
increased audit fees and other compliance costs. Exempting the affected
issuers from this requirement therefore is likely to have the benefit
of reducing compliance costs for these issuers. Given the
disproportionate burden that the fixed component of compliance costs
imposes on smaller issuers, as well as the likelihood that many of the
affected issuers face financing constraints, these costs savings may
enhance capital formation and competition. The discussion below
explores the anticipated cost savings and their potential implications
in detail. This discussion is focused on affected issuers that are not
expected to be subject to the FDIC auditor attestation requirement.
We begin by summarizing evidence on the indirect costs and net
costs of the ICFR auditor attestation requirement. We then estimate the
anticipated effects on audit fees and on other compliance costs of
expanding the exemption from this requirement for the affected issuers,
using reported audit fees, survey data, and existing studies. Finally,
we discuss the implications of the cost savings and other potential
benefits.
a. Evidence on Possible Indirect Costs of the ICFR Auditor Attestation
Requirement
The ICFR auditor attestation requirement may impose costs on
issuers and investors beyond the direct costs of compliance. For
example, an increased focus on ICFR as a result of

[[Page 17207]]

the ICFR auditor attestation requirement could have negative effects on
issuer performance, if it creates a distraction from operational
matters or reduces investment or risk-taking.\369\ One issuer noted in
its comments that its managers' attention was diverted away from its
operating performance in its first year complying with the ICFR auditor
attestation requirement, and that, without this requirement, its
managers' time could have been more productively spent focusing on
opportunities to grow the company.\370\ Broader evidence of the
indirect costs of the ICFR auditor attestation requirement is
inconclusive. Studies have documented a decrease in investment and
risk-taking by U.S. companies compared to companies in other countries
around the passage of SOX.\371\ However, others have demonstrated that
these findings are merely the continuation of a trend that began many
years before the passage of SOX \372\ and that they do not appear to be
driven by the applicability of the ICFR auditor attestation or SOX
Section 404(a) management ICFR reporting requirements.\373\ Another
study associates the SOX Section 404 requirements with a decrease in
patents and patent citations, but the findings are limited to the early
years of implementation of these requirements and the study is not able
to distinguish to what extent the effects are attributable to the SOX
Section 404(a) management ICFR reporting requirements versus the SOX
Section 404(b) ICFR auditor attestation requirement.\374\ We are unable
to quantify the potential indirect cost savings resulting from the
amendments due to the lack of reliable evidence and data that would
allow us to quantitatively identify such effects.
---------------------------------------------------------------------------

\369\ See John Coates & Suraj Srinivasan, SOX after Ten Years: A
Multidisciplinary Review, 28(3) Acct. Horizons 627 at 643-645 (2014)
(``Coates and Srinivasan 2014 Study'') (discussing these possible
effects and summarizing related studies).
\370\ See letter from Guaranty.
\371\ See Coates and Srinivasan 2014 Study, note 369 above
(summarizing these studies).
\372\ Id.
\373\ See Ana Albuquerque & Julie Zhu (2018), Has Section 404 of
the Sarbanes-Oxley Act Discouraged Corporate Risk-Taking? New
Evidence from a Natural Experiment, Mgmt. Sci. (forthcoming) (using
the staggered implementation of SOX Section 404 to better identify
its effects on smaller issuers, with public float of less than $150
million, and finding no evidence of a decrease in the investment and
risk-taking activities for issuers that were subject to SOX Section
404 versus those that were not), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3049232.
\374\ See Huasheng Gao & Jin Zhang, SOX Section 404 and
Corporate Innovation,'' J. of Fin. and Quantitative Analysis (2018)
(forthcoming), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3130588.
---------------------------------------------------------------------------

b. Evidence on Net Costs of the ICFR Auditor Attestation Requirement
While we are unable to quantify the extent to which the expected
cost savings exceed any loss of benefits associated with the ICFR
auditor attestation requirement,\375\ we note that certain studies have
attempted to estimate such ``net costs'' of the requirement in specific
contexts.
---------------------------------------------------------------------------

\375\ While we quantify both anticipated costs and benefits of
the amendments, there are many costs and benefits that we cannot
quantify, so we are unable to quantify the net benefit or net cost
of the amendments. See Section IV.C.3.d. for further discussion of
this point.
---------------------------------------------------------------------------

i. Studies Involving Avoidance Behavior
Some studies have provided evidence that non-accelerated filers may
seek to avoid crossing the $75 million public float threshold and
becoming accelerated filers.\376\ Related studies have also found that
issuers near or below this threshold are more likely than comparable
issuers to take actions that may reduce or avoid an increase in their
public float, such as disclosing more negative news in the second
fiscal quarter (when public float is measured), increasing payouts to
shareholders, reducing investment in property, plant, equipment,
intangibles and acquisitions, and increasing the number of shares held
by insiders.\377\ One study uses this avoidance behavior to estimate
the net costs of compliance with the ICFR auditor attestation
requirement for issuers close to the $75 million public float
threshold.\378\ The study concludes that the overall costs, net of any
benefits, of the ICFR auditor attestation requirement for these issuers
is roughly $1 million to $2 million per year, but we note that the
methodology used to translate the avoidance behavior into a dollar cost
may be unreliable.\379\
---------------------------------------------------------------------------

\376\ See, e.g., Peter Iliev, The Effect of SOX Section 404:
Costs, Earnings Quality, and Stock Prices, 45 J. of Fin. 1163 (2010)
(``Iliev 2010 Study'') (finding that a disproportionate number of
issuers had a public float of just under $75 million in 2004, when
ICFR auditor attestations and management ICFR reports were first
required for accelerated filers, but not in earlier years); Dhammika
Dharmapala, Estimating the Compliance Costs of Securities
Regulation: A Bunching Analysis of Sarbanes-Oxley Section 404(b),
Working Paper (2016), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2885849 (``Dharmapala 2016 study''); and
McCallen et al. 2019 study, note 308 above.
\377\ See F. Gao, J.S. Wu & J. Zimmerman, Unintended
Consequences of Granting Small Firms Exemptions from Securities
Regulation: Evidence from the Sarbanes[hyphen]Oxley Act, 47(2) J. of
Acct. Res. 459 (2009) and M. E. Nondorf, Z. Singer, & H. You, A
Study of Firms Surrounding the Threshold of Sarbanes[hyphen]Oxley
Section 404 Compliance, 28(1) Advances in Acct. 96 (2012). See also
F. Gao, To Comply or Not to Comply: Understanding the Discretion in
Reporting Public Float and SEC Regulations, 33(3) Contemporary Acct.
Res. 1075 (2016) (presenting evidence that companies that expected
higher compliance costs may have used discretion in defining
affiliates in order to report lower float).
\378\ See Dharmapala 2016 study, note 376 above.
\379\ Id. This paper estimates a net cost of compliance for
companies near the threshold of $4 million to $6 million for a few
years of compliance (i.e., $1 million to $2 million per year). The
analysis leading to this estimate relies on the relation between
public float and market capitalization for other companies to
approximate the stock market value forgone by those that are
estimated to be manipulating their public float downwards. However,
we note that the ratio of market capitalization to public float for
other companies may simply reflect their propensity towards having
affiliated ownership rather than being a reliable basis with which
to measure the cost incurred by manipulating public float.
---------------------------------------------------------------------------

Avoidance of the $75 million public float threshold would be
consistent with smaller issuers finding the net costs associated with
the ICFR auditor attestation requirement to be significant, though
there could be other reasons for avoiding the threshold. For example,
as one commenter argued, such avoidance may reflect managers who would
like to avoid the scrutiny of an audit of ICFR because they are
engaging in opportunistic behavior,\380\ although we are unaware of
direct evidence supporting this hypothesis. One commenter, representing
48 accounting and law professors, requested that we confirm whether the
``bunching'' of companies below the $75 million public float threshold
remains present in today's markets.\381\ The commenter noted that such
an analysis could help provide confidence that the costs of the ICFR
auditor attestation requirement remain as high as previously
documented.\382\ In response to this comment, our staff conducted
supplemental analysis, presented in Figure 6.\383\ However, as
discussed below, the conclusions in this Economic Analysis do not rely
on this analysis.
---------------------------------------------------------------------------

\380\ See letter from Prof. Barth et al.
\381\ See letter from Prof. Honigsberg et al.
\382\ Id.
\383\ The estimates in this figure are based on staff analysis
of data from XBRL filings associated with annual reports filed in
calendar year 2018. The figure includes all issuers with an annual
report on Form 10-K, 20-F or 40-F in calendar year 2018 and with
public float data available in XBRL, excluding banks, ABS issuers,
and RICs (although we note there were no instances of the latter two
types of issuers in this sample before these filters were applied).
Banks are identified as issuers with SIC codes of 6020 (commercial
banks), 6021 (national commercial banks), 6022 (state commercial
banks), 6029 (NEC commercial banks), 6035 (savings institutions,
federally-chartered) or 6036 (savings institutions, not federally-
chartered).

---------------------------------------------------------------------------

[[Page 17208]]

[GRAPHIC] [TIFF OMITTED] TR26MR20.005

Figure 6 presents the distribution of public float across issuers
other than banks, ABS issuers, and RICs. We exclude ABS issuers and
RICs because they are unlikely to be sensitive to the public float
threshold as they would not be subject to the ICFR auditor attestation
requirement (or able to avail themselves of the disclosure
accommodations for SRCs) regardless of their public float. We exclude
banks because they may be subject to the FDIC auditor attestation
requirement, which, as discussed above, is comparable to the ICFR
auditor attestation requirement, regardless of their public float.
While EGCs would not be subject to the ICFR auditor attestation
requirement regardless of their public float, we nevertheless include
them in Figure 6 because it is a temporary exemption and such issuers
may already consider the implications of their public float in advance
of graduating from this status. However, we obtain similar results when
we include or exclude any of these categories of issuers.
The pattern in Figure 6 demonstrates that there may be some
``bunching'' of public floats below the $75 million threshold in 2018.
The pattern is similar to that presented in two recent studies that
find a discontinuity in public float at the $75 million threshold when
considering data across the 12 or 13 year period ending in 2015.\384\
Our findings for 2018 also are consistent with a year-by-year analysis
in one of these studies that suggests that this behavior does not
appear to change significantly over the time period studied.\385\
---------------------------------------------------------------------------

\384\ See McCallen et al. 2019 study, note 308 above, and
Dharmapala 2016 study, note 376 above.
\385\ See McCallen et al. 2019 study, note 308 above.
---------------------------------------------------------------------------

Our findings are less consistent with another analysis of public
float, which failed to find evidence of ``bunching'' in 2017.\386\ This
analysis was cited in a submission to the comment file.\387\ When we
examine the data underlying this analysis,\388\ we find that, although
we obtain public float data from different sources,\389\ our public
float values are over 90 percent correlated with those used in tthis
analysis. We note, however, that the analysis applies sample selection
filters that exclude, among other issuers, issuers that would become
newly subject to an ICFR auditor attestation requirement (and, during
this time period, lose the disclosure accommodations for SRCs) upon
crossing the $75 million public float threshold. The exclusions result
in a sample size that is approximately half as large as that in our
analysis.\390\ For

[[Page 17209]]

example, we understand that the other analysis excludes all financial
institutions and issuers with a market capitalization of greater than
$150 million.\391\ This difference, we find, accounts for the bulk of
the difference in our figures. Thus, our analysis reflects a
significantly larger and more representative sample of issuers and may
therefore be more reliable.
---------------------------------------------------------------------------

\386\ See Commissioner Jackson's Statement. While we provide
results for 2018 in Figure 6 in order to present the most recent and
reliable available data, we obtain very similar results when running
the same analysis for 2017.
\387\ See letter from Prof. Barth et al., citing an analysis in
Commissioner Jackson's Statement that finds no evidence of bunching
in 2017.
\388\ See ``Public Float Data (2017)'' available at https://www.sec.gov/news/public-statement/jackson-statement-proposed-amendments-accelerated-filer-definition.
\389\ The data underlying the analysis cited by a commenter is
generated by using a computer program to extract text from annual
reports, applying computer algorithms and filters to isolate public
float numbers, and then manually checking the results. See
Commissioner Jackson's Statement. The data underlying our analysis
is based on XBRL filings.
\390\ The figure in the other analysis reflects 388 issuers,
compared to 731, or almost twice as many issuers, in our analysis.
\391\ Financial institutions are issuers with SIC codes between
6000 and 6999 and include issuers that are not banks. Other filters
applied in that analysis include requiring that market
capitalization data be available and that the reported public float
be at least 10%, but no more than three times, the market
capitalization.
---------------------------------------------------------------------------

As discussed above, if issuers seek to avoid crossing the $75
million public float threshold, such behavior could reflect a high net
cost of the ICFR auditor attestation requirement but could also reflect
a self-serving desire to avoid scrutiny. Any such behavior could also
be influenced by other requirements associated with this public float
threshold during this time period, such as the loss of scaled
disclosure accommodations available to SRCs.\392\ Thus, though we have
considered the studies, evidence, and comments received regarding this
avoidance behavior, the conclusions in this Economic Analysis do not
rely on these findings.
---------------------------------------------------------------------------

\392\ The analysis presented in Figure 6 is based on annual
reports filed in calendar year 2018, which generally pertain to 2017
fiscal years. The amendments to the SRC definition were effective on
September 10, 2018. See SRC Adopting Release, note 12 above.
---------------------------------------------------------------------------

ii. Studies Based on Comparative Analysis or Market Reactions
We have also considered studies that have used other methodologies
to attempt to quantify the net costs or benefits of the ICFR auditor
attestation requirement. One study attempts to quantify and compare
certain costs and benefits of exempting non-accelerated filers from the
ICFR auditor attestation requirement, focusing on those costs and
benefits that the study deems to be measurable, and finds that the cost
savings associated with exempting these issuers (an estimated $388
million in aggregate audit fee savings) have been less than the lost
benefits (e.g., an aggregate $719 million in lower earnings) in
aggregate present value terms.\393\ Studies have also used stock market
reactions to changes in the applicability of the ICFR auditor
attestation requirement to estimate its net costs or benefits, because
the stock market valuation should incorporate both expected costs and
expected benefits from a shareholder's perspective. We focus on studies
that consider events that allow the effects of the ICFR auditor
attestation requirement to be isolated from those of the other
requirements that were imposed by SOX, as many early studies did not
isolate the effects of the ICFR auditor attestation requirement from
other changes required by the same legislation, such as the audit
committee requirements of SOX Section 301 \394\ and the certifications
required pursuant to SOX Section 302. Regardless, the results of the
studies we focus on have been mixed, perhaps due in part to changes
over time in how the ICFR auditor attestation requirement has been
implemented. For example, a study analyzing the response to
announcements of initial delays in the application of the requirements
to some issuers in order to identify the stock market reaction
associated with the ICFR auditor attestation requirement found that
this requirement was associated with a net reduction in stock market
valuation for foreign issuers.\395\ On the other hand, a study of the
response to the later permanent exemption from the ICFR auditor
attestation requirement for some issuers found that this requirement
was associated with a net increase in stock market valuation for
smaller issuers.\396\ The latter finding is consistent with studies
that conclude that the requirement is value-enhancing based on a
negative stock market reaction to issuers excluding acquired operations
from management's assessment of ICFR and the ICFR auditor attestation,
though these studies do not determine the extent to which this effect
is attributable to the ICFR auditor attestation.\397\ Similarly, a
study of smaller issuers that switched regimes over time found that
being subject to the ICFR auditor attestation requirement was
associated with an increase in stock market valuation for these
issuers.\398\
---------------------------------------------------------------------------

\393\ We note that the estimates in this study rely on a number
of critical assumptions and estimations. See Weili Ge, Allison
Koester, & Sarah McVay, Benefits and Costs of Sarbanes-Oxley Section
404(b) Exemption: Evidence from Small Firms' Internal Control
Disclosures, 63 J. of Acct. and Econ. 358 (2017) (``Ge et al. 2017
Study'') (estimating the effect on audit fees by comparing the audit
fees of non-accelerated filers to those of accelerated filers with
market capitalization of $300 million or less; and estimating the
effect on earnings by estimating the percentage of non-accelerated
filers that may newly disclose ineffective ICFR upon entering an
ICFR auditor attestation requirement, based on changes in the rate
of disclosure of ineffective ICFR by issuers that transition into
accelerated filer status, and applying to this estimate a further
estimate of the difference in return on assets that could be
associated with such disclosure and any related remediation, based
on the results of a multivariate regression relating issuers' change
in return on assets to a number of factors, including whether or not
they disclosed and remediated ineffective ICFR). This study also
estimates a delay over three years in the timing of a market value
decline (that would otherwise have occurred at the beginning of this
three year period) of $935 million associated with the exemption
from the ICFR auditor attestation requirement.
\394\ 15 U.S.C. 78j-1.
\395\ See Iliev 2010 Study, note 376 above. This study also
finds a net reduction in value for small domestic issuers from the
SOX Section 404 requirements, but is not able, for these issuers, to
isolate the effect attributable to the ICFR auditor attestation
requirement versus the SOX Section 404(a) management ICFR reporting
requirement.
\396\ See Kareen Brown, Fayez Elayan, Jingyu Li, Emad Mohammad,
Parunchana Pacharn, & Zhefeng Frank Liu, To Exempt or not to Exempt
Non-Accelerated Filers from Compliance with the Auditor Attestation
Requirement of Section 404(b) of the Sarbanes-Oxley Act, 28(2) Res.
in Acct. Reg. 86 (2016) (``Brown et al. 2016 Study''). See also
Christina Leuz & Peter Wysocki, The Economics of Disclosure and
Financial Reporting Regulation: Evidence and Suggestions for Future
Research, 54(2) J. of Acct. Res. 525 at 566-569 (2016) (``Leuz and
Wysocki 2016 Study'') (summarizing mixed evidence from earlier event
studies related to SOX that were unable to differentiate the effects
of the ICFR auditor attestation requirement from other requirements
imposed by SOX).
\397\ See, e.g., Robert Carnes, Dane Christensen, & Phillip
Lamoreaux, Investor Demand for Internal Control Audits of Large U.S.
Companies: Evidence from a Regulatory Exemption for M&A
Transactions, 94(1) The Acct. Rev. 71 (2019) (``Carnes et al. 2019
Study'').
\398\ See Hongmei Jia, Hong Xie, & David Ziebart, An Analysis of
the Costs and Benefits of Auditor Attestation of Internal Control
over Financial Reporting, Working Paper (2014) (``Jia et al. 2014
study''), available at https://www.lsu.edu/business/accounting/files/researchseries/20141027JXZ.PDF.
---------------------------------------------------------------------------

iii. Other Evidence on Net Costs
The rate of exempt issuers voluntarily obtaining an ICFR auditor
attestation has generally been low.\399\ Consistent with this finding,
a commenter indicated that small biotechnology companies are rarely
asked by investors to voluntarily obtain an ICFR auditor
attestation.\400\ This may indicate that exempt issuers, when
considering their own net cost or benefit of compliance, including how
investors would react to their decisions, have typically deemed it to
be more beneficial to expend these resources on other uses. However, as
discussed in Section IV.C.3.d. below, it is probably not the case that
issuers would voluntarily obtain an ICFR auditor attestation in every
case in which, from the market or an investor's perspective, the total
benefits of doing so would exceed the total costs.
---------------------------------------------------------------------------

\399\ See note 297 above.
\400\ See letter from BIO. See also letter from Ardelyx
Presentation, referencing similar statements in the BIO Study, note
69 above, (which states that ``the low rate of voluntary compliance
by [biotechnology EGCs] suggests that investors do not demand or
value costly Section 404(b) auditor attestations'').
---------------------------------------------------------------------------

When considering the net tradeoff between costs and benefits for
accelerated filers with low revenues in particular, we also re-examined
data

[[Page 17210]]

from the SEC-sponsored survey of financial executives conducted during
December 2008 and January 2009 (``2008-09 Survey'').\401\ While the
results of this survey might not be directly applicable a decade later,
particularly given the changes over time discussed in Section IV.B.1.
above, they provide some suggestive evidence that low-revenue issuers
are more likely than other accelerated filers to believe that the costs
of complying with SOX Section 404 substantially outweigh the benefits.
In particular, when asked about the net costs or benefits of complying
with SOX Section 404, 30 percent of respondents at an accelerated filer
with revenues below $100 million indicated that the costs far
outweighed the benefits, in contrast to 14 percent of respondents at an
accelerated filer with greater revenues.\402\ However, as noted by a
commenter, these survey findings represent the views of issuers and may
not be reflective of the views of investors.\403\
---------------------------------------------------------------------------

\401\ See 2009 SEC Staff Study, note 304 above, and Cindy
Alexander, Scott Bauguess, Gennaro Bernile, Alex Lee, & Jennifer
Marietta-Westberg, The Economic Effects of SOX Section 404
Compliance: A Corporate Insider Perspective, 56 J. of Acct and Econ.
267 (2013) (``Alexander et al. 2013 Study'').
\402\ These estimates are based on staff analysis of data from
the 2008-09 Survey. The analysis considers responses pertaining to
the most recent year for which a given respondent provided a
response. We note that the rate of responses to the question about
net benefits was lower than for other questions. See the 2009 SEC
Staff Study, note 304 above, and Alexander et al. 2013 Study, note
401 above, for details on the survey and analysis methodology.
\403\ See letter from Crowe.
---------------------------------------------------------------------------

c. Potential Reduction in Audit Fees
While issuers disclose their total audit fees, they are not
required to disclose the portion of these fees that is attributable to
the ICFR auditor attestation requirement. Studies of the initial
implementation of the ICFR auditor attestation requirement found that
it was associated with a roughly 100 percent increase in audit fees for
small accelerated filers.\404\ However, these early estimates likely
include some initial start-up costs, which were found to diminish over
time.\405\ Further, these estimates do not incorporate the effect of
later developments such as the adoption of AS 2201, which was expected
to reduce compliance costs for smaller issuers, and the adoption of the
new risk assessment auditing standards, which may reduce the
incremental cost of an integrated audit over a financial-statement only
audit.
---------------------------------------------------------------------------

\404\ See, e.g., William Kinney & Marcy Shepardson, Do Control
Effectiveness Disclosures Require SOX 404(b) Internal Control
Audits? A Natural Experiment with Small U.S. Public Companies, 49(2)
J. of Acct. Res. 413 (2011) (``Kinney and Shepardson 2011 Study'')
(considering those accelerated filers that have newly crossed the
$75 million public float threshold in a given year); Iliev 2010
Study, note 376 above (considering those accelerated filers with
between $75 million and $100 million in public float); Michael
Ettredge, Matthew Sherwood, & Lili Sun, Effects of SOX 404(b)
Implementation on Audit Fees by SEC Filer Size Category, 37 (1) J.
of Acct. and Pub. Pol'y 21 (2017) (considering accelerated filers as
a category, as opposed to large accelerated filers, but also finding
a contemporaneous 42.7 percent increase in audit fees for non-
accelerated filers even though were not subject to the ICFR auditor
attestation requirement); and Susan Elridge & Burch Kealey, SOX
Costs: Auditor Attestation under Section 404, Working Paper (2005),
available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=743285 (considering accelerated filers in the
lowest quintile of total assets).
\405\ See, e.g., Alexander et al. 2013 Study, note 401 above.
---------------------------------------------------------------------------

In the Proposing Release, we presented an analysis of audit fees
from 2014-2017 for low-revenue issuers that are subject to the ICFR
auditor attestation requirement compared to low-revenue issuers not
subject to this requirement.\406\ In particular, we compared audit fees
in these recent years for accelerated filers that are subject to the
ICFR auditor attestation requirement and have revenues of less than
$100 million, relative to the audit fees of issuers in our comparison
populations (non-accelerated filers, other than EGCs, and EGCs, neither
of which is required to comply with the ICFR auditor attestation
requirement) \407\ that also have revenues of less than $100 million.
Based on this analysis, and with consideration for the difference in
size of the affected issuers versus the comparison sample, we derived a
percentage estimate of 25 percent of total audit fees, and a dollar
estimate of about $110,000 per year, that would be saved by issuers
newly exempt from the ICFR auditor attestation requirement.\408\ As
discussed in more detail in the Proposing Release, the percentage
estimate is generally consistent with the estimates, ranging from
approximately five to 35 percent of total audit fees, from a variety of
other analyses using data from after the 2007 change in the ICFR
auditing standard.
---------------------------------------------------------------------------

\406\ See Section III.C.3.b. of the Proposing Release, note 4
above.
\407\ The Proposing Release, note 4 above, provides more
information on why we rely on these comparison populations, how they
compare to the affected issuers, and how differences between the
comparison populations and the affected issuers could affect our
inference. See Section III.C.2. of the Proposing Release, note 4
above.
\408\ See Section III.C.3.b. of the Proposing Release, note 4
above.
---------------------------------------------------------------------------

Several commenters indicated that the expected cost savings are
difficult to accurately quantify.\409\ We acknowledge that, as
discussed in more detail in the Proposing Release, our estimate is
subject to significant uncertainty.\410\ However, these commenters did
not provide alternative methodologies or data for obtaining an estimate
of the average savings. One recent study focusing on low public float
issuers separately considered the subset of issuers with less than $100
million in revenues in their sample and estimated that an exemption
from the ICFR auditor attestation requirement would result in an audit
fee savings of $135,000 per year for these issuers.\411\ While this
analysis was focused on lower float issuers, it is generally supportive
of the order of magnitude of our estimate. One commenter questioned
whether our estimate considers the incremental costs associated with an
audit approach that does not have the benefit of a related audit of
ICFR.\412\ We note that our analysis is intended to capture this
effect, as the issuers in the comparison samples which we use to derive
our estimate generally require this type of an audit approach because
they are not subject to the ICFR auditor attestation requirement.
---------------------------------------------------------------------------

\409\ See, e.g., letters from EY, Grant Thornton, and RSM.
\410\ See Section III.C.3.b. of the Proposing Release, note 4
above.
\411\ See McCallen et al. 2019 study, note 308 above.
\412\ See letter from BDO.
---------------------------------------------------------------------------

We therefore maintain, without change, our estimate of $110,000 in
average audit fee savings per year per affected issuer that would be
newly exempt from the ICFR auditor attestation requirement. As noted in
the Proposing Release, the audit fee savings are expected to vary
across the affected issuers, with some experiencing smaller savings and
some experiencing much larger savings depending on their individual
circumstances. In line with this expectation, several commenters
insisted that any reductions in audit fees resulting from the
amendments would depend on facts and circumstances and vary widely
among issuers.\413\ Consistent with these costs savings being highly
varied, a number of commenters to the Proposing Release provided
estimates of costs that specific issuers had incurred or expected to
save ranging from $40,000 per year to costs of over $2 million dollars,
though most of these estimates include costs other than audit fees
(which are discussed below), some include one-time start-up costs as
well as ongoing annual costs, and the largest estimate includes costs
attributable to SOX Section 404(a) and

[[Page 17211]]

other SOX requirements.\414\ Similarly, a few of the commenters to the
SRC Proposing Release cited costs of $400,000 to over $1 million
associated with the ICFR auditor attestation requirement (though it is
possible that these estimates also include costs other than audit
fees).\415\
---------------------------------------------------------------------------

\413\ See, e.g., letters from EY, Grant Thornton, and PWC.
\414\ See letters from Cerecor (estimating a total of $1 million
in expected savings for 2020 associated with an exemption from the
ICFR auditor attestation requirement), Concert (estimating expected
audit fees associated with the ICFR auditor attestation requirement
to represent approximately 45 percent of its total audit fees),
Guaranty (estimating future annual costs of $40,000 in personnel and
external audit costs associated with ongoing compliance with the
ICFR auditor attestation requirement, as well as a higher estimate
of costs expended for their first year of compliance in 2018 of
$167,745 in audit fees as well as $72,000 and 2,340 labor hours
expended across the issuer's accounting, information technology and
risk management offices), Pieris (estimating that their first year
of compliance with the ICFR auditor attestation requirement would be
associated with a total of $1.5 million in costs), Syros (estimating
that its expected additional costs for compliance with the ICFR
auditor attestation requirement would range from $250,000 to
$400,000 per year, including incremental external auditor fees,
consultant fees, and an increased burden on employee resources), and
Terra Tech (estimating over $2 million in costs expended in 2018 for
meeting all of its SOX compliance requirements, including but not
limited to the ICFR auditor attestation requirement, representing
costs to build a new information technology infrastructure, to hire
new staff and consultants, and to pay auditing fees).
\415\ See note 208 of the Proposing Release, note 4 above.
---------------------------------------------------------------------------

One commenter noted that the requirement to implement scaled, risk-
based audits of ICFR should already result in an appropriately reduced
cost of the ICFR auditor attestation requirement for many affected
issuers.\416\ We note that our quantitative methodology is intended to
reflect the current cost of the ICFR auditor attestation requirement,
including the benefits of scaling. Also, while the adoption of AS 2201
in 2007, which facilitated the scaling of audits of ICFR, was found to
have initially led to lower audit fees, there is evidence that these
costs began to increase again around the year 2010.\417\
---------------------------------------------------------------------------

\416\ See letter from CFA.
\417\ See Section IV.B.1. above.
---------------------------------------------------------------------------

Finally, we note that some issuers may voluntarily choose to
continue to make these expenditures if they deem the benefits of the
ICFR auditor attestation to exceed the cost, and that the extent of
savings may be affected if auditors continue to test the operating
effectiveness of some controls as part of their financial statement
audit. In such cases, the audit fee savings may be reduced, but we
would expect the potential costs of expanding the exemption from the
ICFR auditor attestation requirement to be correspondingly lower as
well.
d. Additional Potential Compliance Cost Savings
The ICFR auditor attestation requirement is associated with other
compliance costs beyond audit fees, including outside vendor costs and
internal labor costs.\418\ However, these costs are difficult to
measure because they are not required to be reported. Practitioner
studies based on surveys of issuers often report non-audit costs of the
internal control assessment and reporting requirements of SOX Section
404 in particular or of SOX in general, but the costs attributable to
the ICFR auditor attestation requirement versus the SOX Section 404(a)
management ICFR reporting requirements or other requirements are
generally not broken out separately.\419\
---------------------------------------------------------------------------

\418\ See, e.g., Leuz and Wysocki 2016 Study, note 396 above.
\419\ See, e.g., Protiviti 2018 Report, note 317 above (finding,
for example, total internal costs associated with all aspects of SOX
compliance to be $282,900 for 2018 for respondents with less than
$100 million in revenues) and SOX & Internal Controls Professionals
Group, Moss Adams LLP, and Workiva (2017), ``2017 State of the SOX/
Internal Controls Market Survey'' (``2017 SICPG Survey Report''),
available at www.mossadams.com/landingpages/2017-sox-and-internal-controls-market-survey.
---------------------------------------------------------------------------

The Proposing Release presented an analysis of data from the 2008-
09 Survey on the non-audit costs of SOX Section 404 in general, such as
outside vendor costs, labor, and non-labor costs (such as software,
hardware and travel costs), as well as the percentage of the outside
vendor costs and labor hours that were attributable to the ICFR auditor
attestation requirement. Based on this analysis, we estimated that the
average non-audit costs attributable to the ICFR auditor attestation
requirement at the time of the survey were approximately $125,000 per
year.\420\ Adjusting this historical cost downward slightly to account
for the fact that some of these expenditures may now be required even
in the case of a financial statement only audit (due to the risk
assessment auditing standards issued subsequent to this survey), we
estimated that the average non-audit costs attributable to the ICFR
auditor attestation requirement are currently approximately $100,000
per year.\421\ As noted in the Proposing Release, this estimate is
subject to uncertainty because it is unclear exactly how the current
costs may differ from the survey responses a decade ago, and the costs
may be different for low-revenue issuers.
---------------------------------------------------------------------------

\420\ See Section III.C.3.c. of the Proposing Release, note 4
above.
\421\ Id.
---------------------------------------------------------------------------

Commenters did not provide alternative methodologies for obtaining
an estimate of the average non audit-fee savings. One recent study
focusing on low public float issuers considered the potential effect of
the ICFR auditor attestation requirement on selling, general and
administrative (``SG&A'') expenses other than audit fees, and concluded
that there was an association with an increase in these internal costs,
but was unable to reliably estimate the magnitude of this effect.\422\
We therefore maintain, without change, our estimate of $100,000 in
average non-audit compliance cost savings per year per affected issuer
that would be newly exempt from the ICFR auditor attestation
requirement.
---------------------------------------------------------------------------

\422\ See McCallen et al. 2019 study, note 308 above.
---------------------------------------------------------------------------

As in the case of audit fees, some of the affected issuers are
expected to experience lower cost savings while others would experience
greater savings, depending on their individual circumstances. For
example, we noted in the Proposing Release that some issuers had
reported potential cost savings other than audit fees ranging from
about $110,000 to about $350,000.\423\ While commenters to the
Proposing Release generally did not separately break out these non-
audit costs, they reported total costs including audit fees but also
internal labor and consultant costs ranging from $40,000 to over $2
million, though, as noted above, some include one-time start-up costs
as well as ongoing annual costs, and the largest estimate includes
costs attributable to SOX Section 404(a) and other SOX
requirements.\424\
---------------------------------------------------------------------------

\423\ See note 211 of the Proposing Release, note 4 above.
\424\ See letters from Cerecor, Guaranty, Pieris, Syros, and
Terra Tech, as discussed in more detail in above note 414. See also
Ardelyx Presentation, citing the BIO Study, note 69 above.
---------------------------------------------------------------------------

e. Implications of the Cost Savings
While we estimate the average compliance cost associated with the
ICFR auditor attestation requirement for the affected issuers, it is
more difficult to discern whether incurring the costs of this
requirement represents the most effective use of funds for these
issuers. As discussed in Section IV.C.3.c. below, issuers for whom the
requirement is eliminated may determine that it is worthwhile to use
these funds to voluntarily undergo an audit of ICFR.\425\
Alternatively, some of these issuers could directly invest the
compliance cost savings in improving their

[[Page 17212]]

operations and prospects for growth, or in their control systems.
---------------------------------------------------------------------------

\425\ See letter from BIO (supporting allowing ``issuers and
their investors the flexibility to determine for themselves whether
Section 404(b) is relevant to their business'').
---------------------------------------------------------------------------

In total, we estimate an average cost savings of $210,000 per
issuer per year, with some of the affected issuers experiencing lesser
or greater savings.\426\ While a few commenters noted that ICFR auditor
attestations have become less expensive over time \427\ or that they
should already be less expensive for the affected issuers due to the
ability to scale the audit of ICFR,\428\ we note that our analysis,
using only recent years of data and low-revenue issuers, is intended to
capture any such effects.
---------------------------------------------------------------------------

\426\ As noted above, this estimate is not intended to apply to
affected issuers that would not otherwise be subject to the ICFR
auditor attestation requirement (i.e., EGCs) or that would remain
subject to the FDIC auditor attestation requirement (i.e., banks
with assets of over $1 billion).
\427\ See, e.g., letters from CFA Inst. and Deloitte.
\428\ See letter from CFA.
---------------------------------------------------------------------------

Several commenters argued that these cost savings are economically
small.\429\ In particular, they estimated that the savings represent
0.5 percent of the average affected issuer's revenue and 0.1 percent of
its market value.\430\ Similarly, many commenters asserted that the
proposed amendments would not enhance capital formation--and some
indicated they could even reduce capital formation.\431\ Others noted
that, in general, the costs of the ICFR auditor attestation requirement
are substantial,\432\ and that by eliminating the requirement for
certain issuers, the proposed amendments would enhance capital
formation or allow those issuers to preserve capital.\433\ We continue
to believe that the average expected savings is likely, in many cases,
to represent a meaningful cost savings for issuers with less than $100
million in revenue and may thus have beneficial economic effects on
competition and capital formation.
---------------------------------------------------------------------------

\429\ See, e.g., letters from CFA, CFA Inst., CII, and Prof.
Barth et al.
\430\ We obtain similar estimates. Specifically, we estimate
that the annual savings represents of 0.7 percent of the median
revenue and 0.1 percent of the median market capitalization of the
affected issuers that would be newly exempt from all ICFR auditor
attestation requirements. We note, however, that 12 percent of these
issuers have zero revenues, and that the savings are estimated for a
single year while market capitalization incorporates expectations
regarding all future years of performance.
\431\ See, e.g., letters from Better Markets, CII, CFA, and
Prof. Ge et al. See also CFA Inst. (stating that the Proposing
Release, note 4 above, does not demonstrate that eliminating the
ICFR auditor attestation requirement would enhance capital
formation).
\432\ See, e.g., letters from BIO, Broadmark, Carver, Guaranty,
ICBA, MSB, SSB, and Syros.
\433\ See, e.g., letters from Andersen, CLSA, Concert, ICBA, and
NASBA.
---------------------------------------------------------------------------

In particular, while the average annual cost savings may represent
a small percentage of the average affected issuers' revenues and market
capitalizations, it is significant relative to the income and cash
flows of these issuers. As noted in the Proposing Release, low-revenue
issuers are likely to face financing constraints because they do not
have access to internally-generated capital.\434\ A majority of the
affected issuers that will be newly exempt from the ICFR auditor
attestation requirement, and that will not be subject to the FDIC
auditor attestation requirement, have negative net income and negative
net cash flows from operations.\435\ In the absence of significant
income generation, the average savings of $210,000 per year may be
likely to be put to productive use,\436\ such as towards capital
investments, which would enhance capital formation. A number of issuers
commented that they anticipated that the savings would allow for
increased investment in their core business.\437\ Also, while some
issuers may experience lesser savings, some commented that they expect
to experience substantially greater savings,\438\ so the cost savings
are likely to be significant for some, even if not all, of the affected
issuers.
---------------------------------------------------------------------------

\434\ For example, the Proposing Release, note 4 above, cited
one commenter that indicated that ``pre-revenue small businesses
utilize only investment dollars to fund their work'' and that any
cost savings thus ``could lead to funding for a new life-saving
medicine.'' See note 213 of the Proposing Release, note 4 above.
\435\ See note 362 above.
\436\ For example, in a survey of issuers in the biotech
industry, among 11 biotech EGCs that responded to a question
regarding how an extension of the exemption from the ICFR auditor
attestation requirement would affect them given the costs associated
with the requirement, eight out of the 11 issuers indicated that
they expected a positive impact on investments in research and
development and six out of the 11 issuers indicated that they
expected a positive impact on hiring employees. See BIO Study, note
69 above.
\437\ See, e.g., letters from Cerecor, Concert, Guaranty, Pieris
and Syros.
\438\ See, e.g., letters from Cerecor, Corvus, and Terratech,
estimating savings of $1 to $2 million.
---------------------------------------------------------------------------

Further, several commenters cited fixed costs of compliance that do
not scale with size.\439\ Because of the fixed costs component of
compliance costs, smaller issuers generally bear proportionately higher
compliance costs than larger issuers.\440\ To illustrate this
disparity, we estimated in the Proposing Release that total audit fees
represent about 22 percent of revenues on average for accelerated
filers with less than $100 million in revenues, versus 0.5 percent of
revenue for those above $100 million in revenues.\441\ Reducing the
affected issuers' costs would reduce their overhead expenses and may
enhance their ability to compete with larger issuers.
---------------------------------------------------------------------------

\439\ See letters from ASA, Broadmark, Chamber, and Guaranty.
\440\ While it is difficult to identify the specific source of
the fixed component of compliance costs, there is empirical evidence
of such fixed costs based on differences in the ratio of such costs
to measures of issuer size across issuer size categories. For
example, the ratio of the costs for accelerated filers of complying
with Section 404 to the book value of the issuer's assets decreases
with issuer size. See, e.g., Figure 1 of Alexander et al. 2013
Study, note 401 above. There is evidence of some such fixed costs
persisting even after the 2007 change in the ICFR auditing standard
facilitating the scaling of an audit of ICFR, as demonstrated by the
results in the cited figure for issuers that had been complying with
Section 404(b) for five years (as observations in the figure
pertaining to lesser years of experience may include costs
experienced by some issuers in years prior to the 2007 changes).
\441\ See Section III.C.2.d. of the Proposing Release, note 4
above.
---------------------------------------------------------------------------

The alleviation of these costs could be a positive factor in the
decision of additional companies to enter public markets.\442\ That is,
if future compliance costs associated with ICFR auditor attestations
weigh against these companies becoming publicly traded, reducing these
expected future costs may enhance capital formation in the public
markets and the efficient allocation of capital at the market level. As
noted above, the expected compliance cost savings are likely to vary
across issuers. The amendments may be most likely to influence the
decision to enter the public markets for companies that anticipate
particularly high costs to obtain an ICFR auditor attestation and that
expect low levels of revenue to persist for many years into the future.
---------------------------------------------------------------------------

\442\ See, e.g., letter from ICBA.
---------------------------------------------------------------------------

Some commenters suggested that the amendments would encourage
companies to enter the public markets.\443\ On the other hand, other
commenters maintained that the ICFR auditor attestation requirement
does not prevent companies from entering the public markets.\444\
---------------------------------------------------------------------------

\443\ See, e.g., letters from AdvaMed, AdvaMed et al.,
Broadmark, Cerecor, and ICBA.
\444\ See, e.g., letters from CFA, CFA Inst., CII, and Crowe.
---------------------------------------------------------------------------

Research investigating the link between SOX and companies exiting
or choosing not to enter public markets has been inconclusive.\445\ We
agree with commenters who stated that a number of other factors have
been associated

[[Page 17213]]

with the decline in listings.\446\ Further, newly public issuers can
already avail themselves of an exemption from the ICFR auditor
attestation requirement for at least one and generally up to five years
after their IPO.\447\ While the amendments could be a positive factor
in the decision of additional companies to enter public markets, it may
not be the decisive factor, and the direct impact of the amendments on
the number of publicly traded companies may be limited to the extent
that companies may be more focused on other factors associated with the
decision to go public.
---------------------------------------------------------------------------

\445\ There is some evidence of a decreased rate of IPOs and an
increased rate of going private transactions and deregistrations in
the United States after SOX. However, it is unclear to what extent
these changes can be attributed to SOX (or to the auditor
attestation requirement in particular) versus other factors, and to
what extent these changes are a cause for concern. See e.g., Coates
and Srinivasan 2014 Study, note 369 above, at 636-640 (summarizing a
number of studies in this area).
\446\ See, e.g., letters from CFA, CFA Inst., CII, and Crowe.
Other factors commenters cited include the expansion of exemptions
to registration that increase companies' ability to raise funds
privately, see, e.g., letters from CFA, CII, and Crowe; corporate
consolidations, see, e.g., letters from CFA and CII; market
conditions, see letter from CFA; and the general regulatory
environment, see letter from Crowe.
\447\ See note 11 above regarding the exemption of EGCs from the
auditor attestation requirement.
---------------------------------------------------------------------------

3. Potential Costs of Expanding the Exemption From the ICFR Auditor
Attestation Requirement for Affected Issuers
Exempting the affected issuers from the ICFR auditor attestation
requirement may result, over time, in management at this category of
issuers being less likely to maintain effective ICFR, which in turn may
result in less reliable financial statements, on average, for these
issuers. The discussion below explores this potential effect and its
implications in detail. We also consider two mitigating factors that
could be associated with the affected issuers on average, though we
acknowledge that they may not apply equally to all of the affected
issuers. First, low-revenue issuers may, on average, be less
susceptible to the risk of certain kinds of misstatements, such as
errors associated with revenue recognition.\448\ Second, in many cases,
the market value of such issuers may be driven to a greater degree by
their future prospects than by the current period's financial
statements, which may affect how, on average, investors use these
issuers' financial statements. This discussion is focused on affected
issuers that will be newly exempt from the ICFR auditor attestation
requirement and will not be subject to the FDIC auditor attestation
requirement.
---------------------------------------------------------------------------

\448\ See BIO Study, note 69 above (finding that biotechnology
EGCs have lower restatement frequencies than other issuers, after
controlling for other factors, and attributing this to their
``absence of product revenue'' based on findings that revenue
recognition is one of the most frequent drivers of financial
restatements).
---------------------------------------------------------------------------

Exempting the affected issuers from the ICFR auditor attestation
requirement could also increase the risk that material weaknesses in
ICFR may not be detected and disclosed, and thereby reduce the
information available to investors for gauging the reliability of these
issuers' financial statements. In this regard, we also discuss below
the potential effects related to the identification and disclosure of
material weaknesses in ICFR at the affected issuers. However, given the
size of the estimated effect as well as recent findings discussed in
Section IV.C.3.a. below on how ICFR auditor attestations may provide
limited information about the risk of future restatements,\449\ we
believe that any such effect would not significantly affect investors'
overall ability to make informed investment decisions.
---------------------------------------------------------------------------

\449\ See notes 453 through 459 below and accompanying text.
---------------------------------------------------------------------------

a. Broad Considerations and Evidence Regarding the Effects of ICFR
Auditor Attestations on Financial Reporting
This section summarizes a number of broad economic considerations
related to the possible effects of an ICFR auditor attestation
requirement on financial reporting in order to provide context for the
more detailed analysis of the costs of exempting the affected parties
from this requirement that follows. As discussed below, the anticipated
effects of changes to the population of issuers subject to the ICFR
auditor attestation requirement will depend on the characteristics of
the specific group of issuers that will be affected. In this regard we
note that prior research has not focused on the effects of the ICFR
auditor attestation requirement on low-revenue issuers in particular.
As discussed in Section IV.B.1., there also have been significant
changes over time in the implementation of the ICFR auditor attestation
requirement, the standards applying to a financial statement audit even
in the absence of an audit of ICFR, and the execution of audits of
financial statements and of ICFR, which may have had the effect of
reducing both the incremental costs and incremental benefits of an ICFR
auditor attestation since the periods studied in much of the existing
research. We therefore acknowledge that, while we believe that
consideration of the past research is an important part of our
analysis, these factors limit our ability to rely on the findings of
past research to predict how the amendments would affect the particular
class of issuers implicated by this rulemaking.
ICFR auditor attestations can have two primary types of benefits.
First, the ICFR auditor attestation reports can provide incremental
information to investors about the reliability of the financial
statements. Second, the reliability of the financial statements can be
enhanced. That is, the expectation of, or process involved in, the ICFR
auditor attestation could lead issuers to maintain better controls,
which could lead to more reliable financial reporting. Importantly for
our evaluation of these possible benefits, however, we do not directly
observe the effectiveness of ICFR and the reliability of financial
statements, but only the associated disclosures by issuers. For
example, while restatements may indicate that controls have failed,
such restatements are often predicated on the underlying misstatements
being detected. Given such limitations with the available data, the
analysis in existing studies and in this release is necessarily less
than definitive.
Regarding the first possible benefit of ICFR auditor attestations,
academic research provides some evidence that ICFR auditor attestation
reports contain information about the reliability of financial
statements, but also demonstrates that the incremental information
provided by these reports may be limited. The 2011 SEC Staff Study
summarizes evidence that ICFR auditor attestations generally resulted
in the identification and disclosure of material weaknesses that were
not previously identified or whose severity was misclassified when
identified by management in its assessment of ICFR, and that investor
risk assessments and investment decisions were associated with the
findings in auditor attestation reports.\450\ As noted by a
commenter,\451\ various survey results are also supportive of these
reports being informative to investors.\452\
---------------------------------------------------------------------------

\450\ See 2011 SEC Staff Study, note 198 above, at 97-99 and
102-104. See also Coates and Srinivasan 2014 Study, note 369 above.
\451\ See letter from CII.
\452\ See Lawrence Brown, Andrew Call, Michael Clement, and
Nathan Sharp, The Activities of Buy-Side Analysts and the
Determinants of their Stock Recommendations, 62 J. of Acct. and
Econ. 139 (2016) (finding, in a survey of buy-side analysts, that 60
percent responded that material weaknesses in ICFR are definitely a
red flag of management potentially misrepresenting financial
results, and that the existence of a material weakness in ICFR was
the most cited red flag for misrepresentation followed by weak
corporate governance; however, this survey did not differentiate
between firms subject or not subject to the ICFR auditor attestation
requirement).
---------------------------------------------------------------------------

However, more recent studies have found that auditor identification
of material weaknesses in ICFR tends to be concurrent with the
disclosure of restatements, rather than providing advance warning of
the potential for

[[Page 17214]]

restatements.\453\ While these findings do not imply that ICFR auditor
attestation reports fail to provide any useful information about the
risk of future restatements,\454\ they demonstrate that this
information may be limited. Further, researchers have been able to
predict the identification by auditors of material weaknesses in ICFR
beyond those identified by management, to some extent, by using
otherwise available information about issuers beyond current
restatements, such as their institutional ownership, aggregate losses,
past restatements, and late filings.\455\ One commenter notes that this
predictability does not imply that there is limited incremental
information provided by ICFR auditor attestation reports, as their
analysis suggests that investors are not able to fully discern
misreporting by issuers about their ICFR.\456\ Still, we believe that
the evidence suggests that markets at least partially, though perhaps
not fully, incorporate this information even in the absence of an ICFR
auditor attestation.\457\ Limitations to the incremental information
provided by ICFR auditor attestation reports about the risk of future
restatements may result from disincentives, such as the increased risk
of litigation and greater likelihood of management and auditor turnover
that have been associated with earlier material weakness disclosures,
for issuers and their auditors to disclose material weaknesses in the
absence of restatements.\458\ It may also result from issues with the
quality of the audit of ICFR. In this regard, researchers have found
that PCAOB scrutiny of these audits has been associated with a slightly
higher rate of identification of material weaknesses in ICFR prior to a
later restatement.\459\
---------------------------------------------------------------------------

\453\ See, e.g., Sarah Rice & David Weber, How Effective is
Internal Control Reporting under SOX 404? Determinants of the (Non-
)Disclosure of Existing Material Weaknesses, 50(3) J. of Acct. Res.
811 (2012); William Kinney, Roger Martin, & Marcy Shepardson,
Reflections on a Decade of SOX 404(b) Audit Production and
Alternatives, 27(4) Acct. Horizons 799 (2013); and Daniel Aobdia,
Preeti Choudhary, & Gil Sadka, Do Auditors Correctly Identify and
Assess Internal Control Deficiencies? Evidence from the PCAOB Data,
Working Paper (2018), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2838896. See also Kinney and Shepardson 2011
Study, note 404 above.
\454\ See, e.g., 2011 SEC Staff Study, note 198 above, at 86
(citing evidence that while both issuers subject to SOX Section
404(b) as well as those only subject to SOX Section 404(a) often
report restatements despite previously reporting that their ICFR was
effective, such restatements were 46 percent higher among those
filing only SOX Section 404(a) reports). See also PCAOB Investor
Advisory Group, Report from the Working Group on the Investor Survey
(2015), available at https://pcaobus.org/News/Events/Documents/09092015_IAGMeeting/Investor_Survey_Slides.pdf (reporting survey
findings that 72 percent of institutional investors indicated that
they relied on ICFR auditor attestations either ``extensively'' or
``a good bit'').
\455\ See, e.g., Ge et al. 2017 Study, note 393 above.
\456\ See letter from Prof. Ge et al.
\457\ See, e.g., H. Ashbaugh-Skaife, D. Collins, W. Kinney, & R.
LaFond, The Effect of SOX Internal Control Deficiencies on Firm Risk
and Cost of Equity, 47(1) J. of Acct. Res. 1 (2009) (``Ashbaugh-
Skaife et al. 2009 Study'') (finding that companies that newly
disclose material weaknesses in their ICFR have an increase in their
cost of capital, but that this increase is lower for companies with
the characteristics most associated with having such material
weaknesses, i.e., those for which the market may be least surprised
by the disclosures, at about 50 basis points, and higher for
companies without such characteristics, at about 125 basis points).
\458\ See Sarah Rice, David Weber, & Biyu Wu, Does SOX 404 Have
Teeth? Consequences of the Failure to Report Existing Internal
Control Weaknesses, 90(3) Acct. Rev. 1169 (2015). We note that
auditors have a duty to follow auditing standards and, if they do
not, face associated enforcement, inspection, reputation, and
litigation risks that provide a countervailing incentive.
\459\ See, e.g., Defond and Lennox 2017 Study, note 307 above
(finding that PCAOB inspections may increase auditors' issuance of
adverse internal control opinions to clients with later
restatements; in particular, the study documents that in 2010, 96
percent of financial statements that were later restated were
accompanied by ICFR auditor attestations disclosing no material
weaknesses in ICFR, while this rate dropped to 91 percent by 2013).
---------------------------------------------------------------------------

A further reason why ICFR auditor attestation reports may provide
only a weak warning about future restatements is that the audit of ICFR
may contribute to the avoidance of misstatements, leading us to observe
only the residual restatements where the misstatement risk was not
foreseen or a misstatement was not detected for reasons unrelated to
internal controls. Thus, the second possible benefit we consider is
that the audit of ICFR may encourage management to maintain more
effective controls and thereby deter accounting errors and fraud. The
academic research discussed below documents substantial evidence that
would be consistent with such effects, though, as is common in
financial economics, it is difficult to determine whether the
documented differences can be causally linked to the audit of
ICFR.\460\
---------------------------------------------------------------------------

\460\ See Coates and Srinivasan 2014 Study, note 369 above, and
Leuz and Wysocki 2016 Study, note 396 above (both articles
discussing the limited ability to make causal attribution based on
research on the effects of the provisions of SOX, but also
highlighting the specific studies that can more plausibly make
causal claims). See also Report to Congress: Access to Capital and
Market Liquidity, August 2017 SEC Staff study 24-27 (discussing
similar limitations, in a different context, in the ability to make
causal inferences about the effects of regulation because of data
and experimental design issues), available at https://www.sec.gov/files/access-to-capital-and-market-liquidity-study-dera-2017.pdf.
---------------------------------------------------------------------------

In particular, while issuers are subject to a number of
requirements discussed above that are intended to help to provide
adequate internal controls and reliable financial statements,\461\
studies have documented a significant association between audits of
ICFR and the maintenance of better internal controls. The 2011 SEC
Staff Study provides analysis and summarizes research indicating that
issuers that were not required to obtain an ICFR auditor attestation
disclosed ineffective ICFR at a greater rate than those that were
subject to such requirements,\462\ and newer studies demonstrate that
this difference has remained consistent in recent years.\463\ Further,
a recent paper finds that the ICFR auditor attestation requirement, but
not management ICFR reporting requirements alone, are associated with
enhanced quarterly earnings accrual quality, and argues that this is an
indication of the improved quality of internal controls.\464\ We note,
however, that this study finds that the improvements for issuers
subject to the ICFR auditor attestation requirement are attenuated
after the 2007 change in the ICFR auditing standard discussed in
Section IV.B.1. above.\465\ The ICFR auditor attestation requirement
has also been associated with a higher rate of remediation of material
weaknesses after they are disclosed.\466\ As noted by

[[Page 17215]]

a commenter,\467\ survey evidence is also consistent with this
requirement being associated with more effective ICFR. For example,
this commenter cites a recent survey of public companies that found
that 57 percent responded that one of the primary benefits of the ICFR
auditor attestation requirement was ``improved internal control over
financial reporting (ICFR) structure.'' \468\
---------------------------------------------------------------------------

\461\ See Section IV.B.1. above.
\462\ See 2011 SEC Staff Study, note 198 above, at 41 and 86-87.
The rate of ineffective ICFR is based on the findings of management
reports on ICFR pursuant to SOX Section 404(a). Because auditor
attestations of ICFR are associated with an increased detection and
disclosure of material weaknesses, as discussed above, the rate of
ineffective ICFR reported by issuers not subject to the auditor
attestation requirement may be understated, which would result in
this difference also being understated.
\463\ See, e.g., Audit Analytics, SOX 404 Disclosures: A
Fourteen Year Review (Sept. 2018) (``2018 Audit Analytics Study''),
available at www.auditanalytics.com/blog/sox-404-disclosures-a-fourteen-year-review/.
\464\ See Schroeder and Shepardson 2016 Study, note 305 above
(using quarterly accruals quality, measured by the level of
quarterly discretionary working capital accruals and the quarterly
accrual estimation error, as a proxy for internal control quality
based on the argument that internal control improvements should be
exhibited in unaudited financial reports).
\465\ Id.
\466\ See Vishal Munsif & Meghna Singhvi, Internal Control
Reporting and Audit Fees of Non-Accelerated Filers, 15(4) J. of
Acct., Ethics & Pub. Pol'y 902 at 915 (2014) (finding that 49 out of
160, or 30 percent, of non-accelerated filers that disclosed a
material weakness in 2008 reported no material weaknesses in 2009,
in contrast to 64 out of 83, or 77 percent, of accelerated filers in
a similar situation). See also Jacqueline Hammersley, Linda Myers, &
Jian Zhou, The Failure to Remediate Previously Disclosed Material
Weaknesses in Internal Controls, 31(2) Auditing: J. Prac. & Theory
73 (2012); and Karla Johnstone, Chan Li, & Kathleen Rupley, Changes
in Corporate Governance Associated with the Revelation of Internal
Control Material Weaknesses and their Subsequent Remediation, 28(1)
Contemp. Acct. Res. 331 (2011) (both finding a similar rate of
remediation for accelerated filers for an earlier sample period).
\467\ See letter from CII.
\468\ Id. See also Benchmarking SOX Costs, Hours and Controls,
Protiviti (June 24, 2019), available at https://www.protiviti.com/sites/default/files/united_states/insights/2019_sarbanes_oxley_compliance_surveyprotiviti.pdf.
---------------------------------------------------------------------------

To the extent that the ICFR auditor attestation requirement leads
to more effective ICFR, this requirement may thereby lead to more
reliable financial statements. Some studies have found that a failure
to maintain effective ICFR has been associated with a higher rate of
future restatements and lower earnings quality,\469\ a higher rate of
future fraud revelations,\470\ more profitable insider trading,\471\
and less accurate analyst forecasts.\472\
---------------------------------------------------------------------------

\469\ See Coates and Srinivasan 2014 Study, note 369 above, at
649-650.
\470\ See Dain Donelson, Matthew Ege, & John McInnis, Internal
Control Weaknesses and Financial Reporting Fraud, 36(3) Auditing: A
J. of Prac. and Theory 45 (2017) (``Donelson et al. 2017 Study'')
(finding that issuers with a material weakness in ICFR are 1.24
percentage points more likely to have a fraud revelation within the
next three years compared to issuers without a material weakness,
relative to a 1.60 percent unconditional probability of fraud).
\471\ See Hollis Asbhaugh-Skaife, David Veenman, & Daniel
Wangerin, Internal Control over Financial Reporting and Managerial
Rent Extraction: Evidence from the Profitability of Insider Trading,
55(1) J. of Acct. and Econ. 91 (2013).
\472\ See, e.g., Sarah Clinton, Arianna Pinello, & Hollis
Skaife, The Implications of Ineffective Internal Control and SOX 404
Reporting for Financial Analysts, 33(4) J. of Acct. and Pub. Pol'y
303 (2014).
---------------------------------------------------------------------------

Generally, ICFR auditor attestations also have been found to be
directly associated with financial statements that are more reliable
than in the absence of these attestations.\473\ We note, however, that
two recent studies, using different methodologies, find evidence that
conflicts with these other studies. In particular, the evidence in
these studies, which use data from 2007 through 2013 \474\ and
2014,\475\ respectively, does not support the conclusion that the ICFR
auditor attestation requirement is associated with more reliable
financial statements, and one of the studies \476\ even finds an
association with lower reliability, consistent with concerns discussed
in Section IV.B.1. above that the quality of audits of ICFR dropped at
least temporarily after 2007.
---------------------------------------------------------------------------

\473\ See 2011 SEC Staff Study, note 198 above, at 98-100. For
more recent evidence, see, e.g., Yuping Zhao, Jean Bedard, & Rani
Hoitash, SOX 404, Auditor Effort, and the Prevention of Financial
Report Misstatements, 36(4) Auditing: A J. of Prac. & Theory 151
(2017); and Lucy Chen, Jayanthi Krishnan, Heibatollah Sami, & Haiyan
Zhou, Auditor Attestation under SOX Section 404 and Earnings
Informativeness, 32(1) Auditing: A J. of Prac. & Theory 61 (2013).
\474\ See Bhaskar et al. 2018 Study, note 305 above (finding
that, among companies with less than $150 million in market
capitalization, those providing auditor attestations of ICFR,
whether voluntarily or because they are accelerated filers, had a
higher rate of material misstatements and lower earnings quality
than others in this category in the period from 2007 through 2013).
\475\ See McCallen et al. 2019 Study, note 308 above (finding
that, among companies with close to $75 million in public float,
those above this threshold, which are likely subject to the ICFR
auditor attestation requirement, do not experience lower
restatements than those below this threshold in the period from 2007
through 2015).
\476\ See Bhaskar et al. 2018 Study, note 305 above.
---------------------------------------------------------------------------

To evaluate the economic implications of any effects the ICFR
auditor attestation requirement has on ICFR and financial statements,
we can consider factors such as production or investment at the issuer
or market level. For example, at the issuer level, more reliable
disclosures are generally expected, based on economic theory, to lead
investors to demand a lower expected return to hold an issuer's
securities (i.e., a lower cost of capital).\477\ A lower cost of
capital may enhance capital formation by encouraging issuers to issue
additional securities in order to raise funds for new investments.
Empirically, material weaknesses in ICFR,\478\ restatements,\479\ and
low earnings quality \480\ have all been associated with a higher cost
of debt or equity \481\ capital.
---------------------------------------------------------------------------

\477\ See, e.g., Douglas Diamond & Robert Verrecchia,
Disclosure, Liquidity, and the Cost of Capital, 46(4) J. of Fin.
1325 (1991) (``Diamond and Verrecchia 1991 Study''); David Easley &
Maureen O'Hara, `Information and the Cost of Capital,' 59(4) J. of
Fin. 1553 (2004); Richard Lambert, Christian Leuz, & Robert
Verrecchia, Accounting Information, Disclosure, and the Cost of
Capital,'' 45(2) J. of Acct. Res. 385 (2007); and Christopher
Armstrong, John Core, Daniel Taylor, & Robert Verrecchia, When Does
Information Asymmetry Affect the Cost of Capital? 49(1) J. of Acct.
Res. 1 (2011). We note that these articles also detail limited
theoretical circumstances under which more reliable disclosures
could lead to a higher cost of capital, such as in the case where
improved disclosure is sufficient to reduce incentives for market
making.
\478\ See, e.g., Dragon Tang, Feng Tian, & Hong Yan, Internal
Control Quality and Credit Default Swap Spreads, 29(3) Acct.
Horizons 603 (2015); Lawrence Gordon & Amanda Wilford, An Analysis
of Multiple Consecutive Years of Material Weaknesses in Internal
Control, 87(6) Acct. Rev. 2027 (2012) (``Gordon and Wilford 2012
Study''); and Ashbaugh-Skaife et al. 2009 Study, note 457 above. We
note that earlier work did not detect an association between SOX
Section 404 material weaknesses and the equity cost of capital. See,
e.g., M. Ogneva, K. R. Subramanyam, & K. Rachunandan, Internal
Control Weakness and Cost of Equity: Evidence from SOX Section 404
Disclosures, 82(5) Acct. Rev. 1255 (2007) (``Ogneva et al. 2007
Study''). See also 2011 SEC Staff Study, note 198 above, at 101-102.
\479\ See, e.g., Paul Hribar & Nicole Jenkins, The Effect of
Accounting Restatements on Earnings Revisions and the Estimated Cost
of Capital, 9 Rev. of Acct. Stud. 337 (2004) (``Hribar and Jenkins
2004 Study'').
\480\ See, e.g., Jennifer Francis, Ryan LaFond, Per M. Olsson, &
Katherine Schipper, Cost of Equity and Earnings Attributes, 79(4)
Acct. Rev. 967 (2004) (``Francis et al. 2004 Study'').
\481\ We note that empirical studies of the cost of equity
capital face particular challenges in accurately measuring the cost
of equity capital, which can reduce their reliability, but that this
is mitigated in studies that look at changes over time, see, e.g.,
Gordon and Wilford 2012 Study, note 478 above; Ashbaugh-Skaife et
al. 2009 Study, note 457 above; and Hribar and Jenkins 2004 Study,
note 479 above, rather than in the cross-section. See, e.g., Ogneva
et al. 2007 Study, note 478 above, and Francis et al. 2004 Study,
note 480 above. See also, e.g., Stephannie Larocque & Matthew R.
Lyle, Implied Cost of Equity Capital Estimates as Predictors of
Accounting Returns and Stock Returns, 2(1) J. of Fin. Rep. 69 (2017)
(discussing concerns about measures of the cost of equity capital);
and Charles M. C. Lee, Eric C. So, & Charles C. Y. Wang, Evaluating
Firm-Level Expected-Return Proxies, Harvard Business School Working
Paper 15-022 (2017) (finding that ``in the vast majority of research
settings, biases in [equity cost of capital measures] are
irrelevant'' and that the cost of equity capital measures used in
the accounting literature ``are particularly useful in tracking
time-series variations in expected returns'').
---------------------------------------------------------------------------

More effective ICFR and more reliable financial reporting may also
lead to improved efficiency of production if managers themselves
thereby have access to more reliable data that facilitates better
operating and investing decisions.\482\ For example, one study finds
that the investment efficiency of issuers improves, in that both under-
investment and over-investment are curtailed, after the disclosure and
remediation of material weaknesses.\483\ Another study finds that
issuers that remediate material weaknesses in ICFR that are related to
inventory tracking thereafter experience higher inventory turnover,
together with improvements in sales and profitability.\484\ That said,
it is difficult to generalize the results

[[Page 17216]]

beyond these samples to determine whether non-remediating issuers or
issuers with different types of material weaknesses in ICFR could
expect similar operational benefits from remediation. The ICFR auditor
attestation requirement may also result in benefits at the market
level, though these are more difficult to measure than those at the
issuer level.\485\ The potential for market-level impact is largely
driven by network effects (which are associated with the broad adoption
of practices) and by other externalities (i.e., spillover effects on
issuers or parties beyond the issuer in question). For example, to the
extent that the ICFR auditor attestation requirement leads to more
reliable financial statements at a large number of issuers, it may lead
to a more efficient allocation of capital across different investment
opportunities at the market level.\486\ The ICFR auditor attestation
requirement also can enhance capital formation to the extent that it
improves overall investor confidence, for which there is some
suggestive evidence,\487\ and thus encourages investment in public
markets.\488\
---------------------------------------------------------------------------

\482\ See, e.g., Ge et al. 2017 Study at 359, note 393 above
(arguing that internal control misreporting leads to lower operating
performance due to the non-remediation of ineffective controls, and
estimating the degree of such underperformance based on the
improvement shown by issuers that are non-accelerated filers after
disclosing and remediating material weaknesses, relative to other
such issuers that are suspected of having unreported material
weaknesses).
\483\ See Mei Cheng, Dan Dhaliwal, & Yuan Zheng, Does Investment
Efficiency Improve After the Disclosure of Material Weaknesses in
Internal Control over Financial Reporting?, 56(1) J. of Acct. and
Econ. 1 (2013).
\484\ See Mei Feng, Chan Li, Sarah McVay, & Hollis Skaife, Does
Ineffective Internal Control Over Financial Reporting Affect a
Firm's Operations? Evidence From Firms' Inventory Management,''
90(2) Acct. Rev., 529 (2015) (``Feng et al. 2015 Study'').
\485\ See, e.g., Leuz and Wysocki 2016 Study, note 396 above
(stating that researchers ``generally lack evidence on market-wide
effects and externalities from regulation, yet such evidence is
central to the economic justification of regulation'' and
acknowledging that ``the identification of such market-wide effects
and externalities is even more difficult than the identification of
direct economic consequences on individual firms'').
\486\ There is also some evidence that more reliable financial
disclosures also facilitate a more effective market for corporate
control, which can increase overall market discipline and thus
enhance the efficiency of production by incentivizing more effective
management. See Amir Amel-Zadeh & Yuan Zhang, The Economic
Consequences of Financial Restatements: Evidence from the Market for
Corporate Control, 90(1) Acct. Rev. 1 (2015). See also Vidhi
Chhaochharia, Clemens Otto, & Vikrant Vig, The Unintended Effects of
the Sarbanes-Oxley Act, 167(1) J. of Institutional and Theoretical
Econ. 149 (2011).
\487\ See, e.g., 2013 GAO Study, note 297246 above (finding that
52 percent of the companies surveyed reported greater confidence in
the financial reports of other companies due to the ICFR auditor
attestation requirement; in contrast, 30 percent of the respondents
reported that they believed this requirement raised investor
confidence in their own company).
\488\ For a further discussion of potential externalities, see
Coates and Srinivasan 2014 Study, note 369 above, at 657-659.
---------------------------------------------------------------------------

Many commenters cited the benefits that have been ascribed to the
ICFR auditor attestation requirement in general and attested to their
importance. For example, some stated that the ICFR auditor attestation
requirement promotes more effective ICFR and more accurate ICFR
disclosures,\489\ including a greater likelihood and timeliness of
disclosing ineffective or weak ICFR,\490\ and that effective ICFR leads
to better and more reliable financial statements,\491\ audit
quality,\492\ and analyst forecasts \493\ as well as fewer
restatements, misstatements,\494\ and instances of fraud and insider
trading.\495\ Others more directly linked the ICFR auditor attestation
requirement with enhanced transparency,\496\ a higher quality and
reliability of issuers' financial statements,\497\ and corporate
governance \498\ and a reduced number of restatements,
misstatements,\499\ and instances of fraud.\500\ Some commenters noted
that the ICFR auditor attestation requirement increases investor
confidence generally \501\ and that investors view the requirement as
beneficial.\502\
---------------------------------------------------------------------------

\489\ See, e.g., letters from Better Markets, CFA, CII, Crowe,
Grant Thornton, Prof. Barth et al., and PWC.
\490\ See, e.g., letters from Better Markets, CFA, Crowe, and
Prof. Barth et al.
\491\ See, e.g., letters from CAQ, CFA, CII, and Grant Thornton.
\492\ See, e.g., letter from CAQ.
\493\ See, e.g., letter from CFA.
\494\ See, e.g., letters from CAQ and CFA.
\495\ See, e.g., letter from CFA.
\496\ See, e.g., letter from EY.
\497\ See, e.g., letters from Better Markets, CFA, CII,
Deloitte, EY, Grant Thornton, PWC, and RSM.
\498\ See, e.g., letter from Deloitte.
\499\ See, e.g., letters from CAQ, CFA Inst., Crowe, Deloitte,
EY, Grant Thornton, and Prof. Barth et al.
\500\ See, e.g., letters from Better Markets and Deloitte.
\501\ See, e.g., letters from Better Markets, CAQ, CFA, and EY.
\502\ See, e.g., letters from CII, CFA Inst., and EY.
---------------------------------------------------------------------------

Importantly, all of these benefits, at both the issuer and market
level, likely vary across issuers of different types. For example,
younger, loss-incurring issuers with lower market capitalization and
lower institutional ownership, as well as those with more segments,
tend to be more likely to newly disclose material weaknesses as they
transition into the ICFR auditor attestation requirement.\503\ However,
the market appears to account for the association of material
weaknesses with these and other observable issuer characteristics.
Thus, issuers that have the characteristics associated with a higher
rate of material weaknesses (and which investors may therefore value
under the assumption that they are likely to have ineffective ICFR) but
that receive an auditor attestation report that does not report any
material weaknesses are found to have the greatest cost of capital
benefit from such a report.\504\ Small, loss-incurring issuers are also
disproportionately represented amongst issuers that have allegedly
engaged in financial disclosure frauds, indicating that any benefits in
terms of investor protection and investor confidence may be
particularly important for this population of issuers.\505\ On the
other hand, marginal changes in the reliability of the financial
statements of issuers whose valuation is driven primarily by their
future prospects--which could also include small, loss-incurring
issuers--could have limited issuer- and market-level effects to the
extent that the current financial statements of these issuers are less
critical to assessing their valuation.\506\
---------------------------------------------------------------------------

\503\ See Ge et al. 2017 Study, note 393 above (regarding the
term ``younger,'' this study defines company age as the number of
years a company has been covered in the Compustat database). See
also 2011 SEC Staff Study, note 198 above, at 96 (summarizing
previous research finding that internal control deficiencies are
associated with smaller, complex, riskier, and more financially-
distressed issuers).
\504\ See Ashbaugh-Skaife et al. 2009 Study, note 457 above.
\505\ See, e.g., COSO 2010 Fraud Study (finding that companies
allegedly engaging in financial disclosure fraud in the period from
1998 through 2007 had median assets and revenue under $100 million
and were often loss-incurring or close to breakeven) and
Characteristics of Financial Restatements and Frauds, CPA J. (Nov.
2017), available at www.cpajournal.com/2017/11/20/characteristics-financial-restatements-frauds/ (for more recent evidence).
\506\ See, e.g., Patricia Dechow & Catherine Schrand, Earnings
Quality, Res. Found. of CFA Inst. 12 (2004) (``Dechow and Schrand
2004 Monograph'').
---------------------------------------------------------------------------

b. Estimated Effects on ICFR, the Reliability of Financial Statements,
and Potential Fraud
The academic literature discussed in Section IV.C.3.a. above
suggests that the scrutiny associated with the ICFR auditor attestation
may lead issuers that are required to obtain this attestation to
maintain more effective ICFR and to remediate material weaknesses in
ICFR more quickly, leading to more reliable financial statements.
Further, as discussed above, studies have highlighted that smaller
issuers are disproportionately represented in populations of issuers
with ineffective ICFR and financial statements that require material
restatement. In addition, smaller issuers are less likely to have
significant external scrutiny in the form of analyst and media coverage
and monitoring by institutional owners,\507\ which could otherwise

[[Page 17217]]

provide another source of discipline to maintain the reliability of
financial statements. However, two of the studies cited above find that
the ICFR auditor attestation requirement was not associated with more
reliable financial statements for lower market capitalization issuers
from 2007 through 2013 or 2014,\508\ and the existing studies in
general may not be directly applicable to current circumstances given
the 2010 change in risk assessment auditing standards, the 2007 change
in the ICFR auditing standard and other recent changes discussed in
Section IV.B.1. above. Importantly, the existing literature and most of
the results cited by commenters regarding the benefits of the ICFR
auditor attestation also do not directly examine low-revenue issuers.
---------------------------------------------------------------------------

\507\ See, e.g., Joel Peress & Lily Fang, Media Coverage and the
Cross-Section of Stock Returns, 64(5) J. of Fin. 2023 at 2030 (2009)
(finding that ``firm size has an overwhelming effect on media
coverage: large firms are much more likely to be covered''); Armando
Gomes, Gary Gorton, & Leonardo Madureira, SEC Regulation Fair
Disclosure, Information, and the Cost of Capital, 13 J. of Corp.
Fin. 300 at 307 (2007) (stating that ``there is overwhelming
evidence that size can explain analyst following''); and Eliezer
Fich, Jarrad Harford, & Anh Tran, Motivated Monitors: The Importance
of Institutional Investors' Portfolio Weights, 118(1) J. of Fin.
Econ. 21 (2015) (finding that institutional monitoring is greatest
when a company represents a significant allocation of funds in the
institution's portfolio, which is strongly associated with company
size).
\508\ See Bhaskar et al. 2018 Study, note 305 above, as
discussed in note 474 above, and McCallen et al. 2019 Study, note
308 above, as discussed in note 475 above.
---------------------------------------------------------------------------

This section therefore provides an analysis of low-revenue issuers
using recent data to complement the existing studies and better inform
our consideration of the possible costs of the amendments. However,
some uncertainty will remain due to the challenges discussed above in
measurement and in ascribing causality in any such analysis, the
limited sample sizes that result when restricting the analysis to
recent years, and the general difficulty of predicting how the parties
involved will react to the amendments. As discussed in more detail in
the Proposing Release,\509\ our analysis includes an examination of two
comparison populations of issuers that are not subject to the ICFR
auditor attestation requirement but that otherwise have similar
responsibilities with respect to ICFR (i.e., non-accelerated filers,
other than EGCs, and EGCs), with consideration given to the ways in
which these issuers differ from the affected issuers.
---------------------------------------------------------------------------

\509\ See Sections III.C.2. and III.C.4. of the Proposing
Release, note 4 above.
---------------------------------------------------------------------------

One commenter suggested that we should more carefully consider the
audit risks linked to specific industries that are expected to be
affected by the amendments, highlighting the banking industry as one
that may have special considerations.\510\ We note that, as discussed
above, the majority of the affected banking issuers are expected to
remain subject to the FDIC auditor attestation requirement and
therefore are not expected to be significantly affected by the
amendments. Further, because of the small sample of affected issuers,
we have a limited ability to split our sample and maintain statistical
reliability. However, our aggregate estimates should reflect the
overall diversity in the population of affected issuers.
---------------------------------------------------------------------------

\510\ See letter from CFA Inst.
---------------------------------------------------------------------------

Another commenter indicated that the primary quantifiable cost of
an exemption from the ICFR auditor attestation requirement stems from
misreporting regarding the effectiveness of ICFR.\511\ While we
consider this effect and its quantifiable implications in more detail
below, we continue to believe that the incentive provided by the ICFR
auditor attestation requirement to actually maintain better controls
(versus just to more accurately report their status) remains a key
benefit with certain quantifiable implications that could be lost due
to an exemption from this requirement.
---------------------------------------------------------------------------

\511\ See letter from Prof. Ge et al.
---------------------------------------------------------------------------

i. Effects on the Prevalence of Ineffective ICFR
We first consider possible effects related to the effectiveness of
the affected issuers' ICFR. In the Proposing Release, we presented an
analysis of the rate of ineffective ICFR from 2014-2018 among low-
revenue issuers that are subject to the ICFR auditor attestation
requirement compared to low-revenue issuers not subject to this
requirement.\512\ In particular, we compared the reported rate of
ineffective ICFR in these recent years for accelerated filers that are
subject to the ICFR auditor attestation requirement and have revenues
of less than $100 million, relative to the reported rate of ineffective
ICFR for issuers in our comparison populations (non-accelerated filers,
other than EGCs, and EGCs, neither of which is required to comply with
the ICFR auditor attestation requirement) that also have revenues of
less than $100 million. We focused on SOX Section 404(a) management
reports on ICFR, with the caveat that management may not report as many
material weaknesses in the absence of an audit of ICFR.\513\ Based on
this analysis, and with consideration for the difference in size,
maturity, and overall resources of the affected issuers versus the
comparison sample, we estimated that an additional 15 percent of the
affected issuers may fail to maintain effective ICFR.\514\ We did not
receive comment on this specific estimate or comments providing data or
methodologies that would improve our estimate. Our estimate is
consistent with the estimated effect on ICFR based on a study of
issuers transitioning into the ICFR auditor attestation
requirement.\515\ We do not expect the full estimated effect to be
experienced immediately upon effectiveness of the amendments. Instead,
as discussed in detail at the end of this section, we expect a movement
towards this higher rate of ineffective ICFR over time as some of the
affected issuers make incremental changes in their investment in ICFR
and as additional issuers enter the category of affected issuers.
---------------------------------------------------------------------------

\512\ See Section III.C.4.b. of the Proposing Release, note 4
above.
\513\ We separately consider this potential under-reporting of
material weaknesses in the analysis below.
\514\ See Section III.C.4.b. of the Proposing Release, note 4
above. We also noted in this section of the Proposing Release, note
4 above, that our findings may not be surprising, as certain
material weaknesses in ICFR may be corrected by, for example, hiring
additional staff, which managers of an issuer that is not currently
producing much revenue may prefer to defer to a later time. Indeed,
about 80 to 85 percent of the low-revenue issuers reporting
ineffective ICFR in the comparison populations in 2017 reported at
least one staffing-related material weakness, though these were
generally accompanied by other types of material weaknesses. See
note 259 of the Proposing Release, note 4 above, and the
accompanying text.
\515\ See Ge et al. 2017 Study, note 393 above, at 372 (finding
that 62.5 percent of companies that reported material weaknesses as
non-accelerated filers remediate such weaknesses upon entering
accelerated filer status). To compare the result from this study to
our estimate, note that we find in Table 7 above that about nine
percent of accelerated filers report ineffective ICFR (further, the
Proposing Release, note 4 above, found that the rate was similar for
low and high revenue issuers). Our estimate of an additional 15
percentage points of the affected issuers reporting ineffective ICFR
in the absence of an ICFR auditor attestation requirement would lead
to a total of 24 percent (nine percent plus 15 percent) of the
issuers reporting material weaknesses in ICFR in the absence of the
requirement as compared to nine percent reporting material
weaknesses in ICFR when subjected to the requirement. This is the
same result one would get by applying the 62.5 percent remediation
estimate from the cited study. In other words, if 62.5 percent of
the issuers reporting material weaknesses in the absence of the ICFR
auditor attestation requirement remediated their material weaknesses
upon entering accelerated filer status and becoming subject to the
requirement, that would mean that the rest of the issuers (37.5
percent) failed to remediate when becoming subject to the
requirement. This would imply that a 24 percent rate of ineffective
ICFR reported by the issuers in the absence of the requirement would
correspond to a nine percent rate (24 percent times 37.5 percent) of
ineffective ICFR reported by the issuers when subjected to the
requirement.
---------------------------------------------------------------------------

ii. Effects on the Detection and Disclosure of Material Weaknesses in
ICFR
Because the previous analysis focuses on disclosed rates of
ineffective ICFR, it does not address the extent to which the
amendments may affect the detection and disclosure of material
weaknesses

[[Page 17218]]

in ICFR. As discussed in Section IV.C.3.a. above, studies have found
that audits of ICFR often result in the identification and disclosure
of material weaknesses that were not previously identified or whose
severity was misclassified in management's initial assessment. Thus,
extending the exemption from the ICFR auditor attestation requirement
to the affected issuers may decrease the likelihood that, when these
issuers have underlying material weaknesses in ICFR, these material
weaknesses are detected and disclosed.
In the Proposing Release, we noted that low-revenue issuers may be
less likely than other issuers to fail to detect and disclose material
weaknesses in the absence of an ICFR auditor attestation, perhaps
because they have less complex financial systems and controls.\516\
Consistent with this hypothesis, we found that the low-revenue issuers
that are not subject to the ICFR auditor attestation requirement report
relatively high rates of ineffective ICFR despite these reports not
being subject to the additional scrutiny of an ICFR auditor
attestation.
---------------------------------------------------------------------------

\516\ See 2017 SICPG Survey Report, note 419 above, at 6
(finding that 33 percent of survey respondents with revenues of $75
million or less reported that they manage no more than 100 total
controls, as compared to 13 percent of those with revenues of $76 to
$700 million and zero percent of those with revenues greater than
$700 million).
---------------------------------------------------------------------------

In the Proposing Release, we did not quantitatively estimate a
potential effect on the detection and disclosure of material weaknesses
in ICFR, though we did qualitatively consider how the amendments could
affect issuers depending on their proclivity to detect and disclose
underlying material weaknesses in the absence of an ICFR auditor
attestation.\517\ Several commenters indicated that they expected the
amendments to affect the detection and disclosure of material
weaknesses in ICFR,\518\ with one stating that ``the primary
quantifiable cost of 404(b) attestation exemption arises from internal
control misreporting.'' \519\ Further, other commenters noted that
factors other than the complexity of issuers' systems and controls,
such as their accounting personnel resources \520\ or the intricacies
of the issuers' business and industry, the strength of their
governance, the competency of their management, and their international
reach,\521\ should be considered in assessing the risk of misreporting
with respect to ICFR effectiveness. In response to these comments, we
conducted a quantitative estimation of this effect and its potential
implications.
---------------------------------------------------------------------------

\517\ See Section III.C.4.c of the Proposing Release, note 4
above.
\518\ See, e.g., letters from CFA Inst., EY, and Prof. Ge et al.
\519\ See letter from Prof. Ge et al.
\520\ See letters from CAQ and EY.
\521\ See letter from RSM.
---------------------------------------------------------------------------

Because undetected and undisclosed material weaknesses cannot be
directly observed, we are not able to directly estimate the extent of
such issues in our comparison samples of low-revenue issuers that are
not subject to the ICFR auditor attestation requirement. Instead, we
rely on a recent study that estimates that an incremental 3.5 percent
of issuers misreport their ICFR as being effective when not subject to
the ICFR auditor attestation requirement as compared to when they are
subjected to this requirement.\522\ To obtain this estimate, the study
uses the characteristics associated with ineffective ICFR to predict
the actual rate of ineffective ICFR as opposed to the disclosed rate of
ineffective ICFR, and uses changes in reporting around transitions into
accelerated filer status to predict the proportion of suspected
misreporters that would correctly report under an ICFR auditor
attestation requirement.\523\
---------------------------------------------------------------------------

\522\ See Ge et al. 2017 Study, note 393 above (estimating,
based on data from 2007 through 2014, that 9.3 percent of non-
accelerated filers incorrectly report their ICFR to be effective and
that 38.1 percent of these, or 3.5 percent, would correctly report
their ICFR to be ineffective if subjected to the ICFR auditor
attestation requirement).
\523\ Id.
---------------------------------------------------------------------------

We directly apply the results from the study and estimate that 3.5
percent of the affected issuers that will be newly exempt from all ICFR
auditor attestation requirements may misreport that their ICFR is
effective, but would not misreport if subjected to those requirements.
To be conservative, we do not adjust this estimate based on our
conjecture that low-revenue issuers may be less likely than other
issuers to fail to detect and disclose material weaknesses in the
absence of an ICFR auditor attestation, perhaps because they have less
complex financial systems and controls. However, we note that the
estimate may be somewhat inflated to the extent that this conjecture is
correct.
iii. Effects on Restatements
We next consider the extent to which the possible effects on
reported and unreported material weaknesses in ICFR might translate
into less reliable financial statements. By definition, material
weaknesses represent a reasonable possibility that a material
misstatement of the issuer's financial statements will not be prevented
or detected on a timely basis,\524\ and as discussed above, existing
studies have demonstrated that ineffective ICFR are associated with
less reliable financial statements. Thus, our estimated increase in the
rate of ineffective ICFR likely would translate into a decrease in the
reliability of the financial statements of the affected issuers.
However, low-revenue issuers could be less susceptible, on average, to
at least certain kinds of misstatements. In particular, 10 to 20
percent of restatements and about 60 percent of the cases of financial
disclosure fraud in recent times have been associated with improper
revenue recognition,\525\ which is less of a risk, for example, for
issuers that currently have no revenues.
---------------------------------------------------------------------------

\524\ See Regulation S-X Rule 1-02(a)(4).
\525\ See Audit Analytics, 2017 Financial Restatements: A
Seventeen Year Comparison, (May 2018), available at https://blog.auditanalytics.com/2017-financial-restatements-review/, and
COSO 2010 Fraud Study, note 505 above.
---------------------------------------------------------------------------

We explored this possibility empirically in the Proposing Release,
by comparing the percentage of issuers in different categories that
eventually restated some of the financial statements that they reported
for a given year, for the years 2014 through 2016. Because we directly
considered differences in actual restatements across these groups of
issuers, these results should incorporate the effects of differences
across the groups in both reported and unreported material weaknesses
in ICFR. Our analysis demonstrated that issuers with revenues of less
than $100 million have, on average, restatement rates that are three to
nine percentage points lower than those for higher-revenue issuers of
the same filer status.\526\ This result is consistent with low-revenue
issuers being less likely to make restatements, even when they
experience high rates of ineffective ICFR, perhaps because they are
less susceptible to certain kinds of misstatements (such as those
related to revenue recognition).
---------------------------------------------------------------------------

\526\ See Section III.C.4.b. of the Proposing Release, note 4
above. As discussed in the Proposing Release, note 4 above, while
observed restatements reflect misstatements that were detected and
may only be a subset of actual misstatements, we believe that the
lower restatement rates for low-revenue issuers are not driven by a
difference in the ability to detect misstatements among these
categories because we see this pattern for issuers with low rates of
ineffective ICFR as well as for other issuers. This result is also
consistent with the BIO Study, which finds that biotechnology EGCs
have a two to three percentage point lower restatement rate than
other non-accelerated or accelerated filers and attribute this to
their ``absence of product revenue.'' See BIO Study, note 69 above
(finding a 6.20 percent restatement rate for biotechnology EGCs
compared to rates of 7.98 percent and 9.25 percent for other non-
accelerated and accelerated filers respectively).

---------------------------------------------------------------------------

[[Page 17219]]

A number of commenters maintained that the risks of financial
statement restatements or misstatements are greater for the issuers
that would not be subject to the ICFR auditor attestation requirement
under the proposed amendments than for other issuers.\527\ A few of
these commenters cited research that concludes that, since 2003, non-
accelerated U.S. filers accounted for 62 percent of the total U.S.
financial statement restatements.\528\ However, we note that this
research is not specific to low-revenue issuers, unlike our analysis.
As our analysis in the Proposing Release demonstrated, restatements are
less frequent for low-revenue issuers even among non-accelerated
filers. Further, the cited research does not adjust for the high
proportion of non-accelerated filers among all issuers.
---------------------------------------------------------------------------

\527\ See, e.g., letters from Better Markets, CAQ, EY, Grant
Thornton, IMA, Prof. Barth et al., and RSM.
\528\ See, e.g., letters from CAQ and CFA Inst.
---------------------------------------------------------------------------

Other commenters noted that low-revenue issuers may be more
susceptible to misstatements in revenue recognition \529\ or in areas
other than revenue recognition,\530\ and that a higher risk of
misstatements may be driven by characteristics of these issuers other
than their low revenue, such as their lower resources or fewer
personnel,\531\ complex transactions or arrangements,\532\ or
activities that require significant accounting judgments.\533\ We note
that our analysis is intended to capture all of these risks of
restatements, by directly comparing rates of empirical restatements,
and that we still find that the lower revenue issuers, taken in
aggregate, are less likely to restate their financial statements than
other issuers of the same filer status. Thus, while certain subsets of
the affected issuers may be more prone to restatements than others
based on their specific characteristics, on average the affected
issuers as a group appear to have a lower overall risk of restatement
than higher-revenue issuers.
---------------------------------------------------------------------------

\529\ See, e.g., letters from Better Markets and Prof. Barth et
al.
\530\ See, e.g., letter from BDO.
\531\ See, e.g., letters from CAQ, Crowe, EY, and Grant
Thornton.
\532\ See, e.g., letter from BDO.
\533\ See, e.g., letters from CFA Inst. and BDO.
---------------------------------------------------------------------------

However, in response to the comments, we further examine the
argument that the affected issuers may be less susceptible to certain
kinds of misstatements, such as those related to revenue recognition,
by examining the types of restatements among low- and higher-revenue
accelerated filers other than EGCs in Table 11.\534\ We note that the
categorization of types and the names of these categories are based on
the categories and category titles provided in the Ives Group Audit
Analytics restatement database.
---------------------------------------------------------------------------

\534\ These estimates are based on staff analysis of data from
Ives Group Audit Analytics. See note 298 above for details on the
identification of filer type. The sample includes 2,017 issuer-year
level observations that have low revenues and 3,862 issuer-year
observations that have higher revenues.

Table 11--Percentage of All Accelerated Filers Other Than EGCS With Restatements of Different Types, by Revenue
Category, for Financial Statements From 2014-2018
----------------------------------------------------------------------------------------------------------------
Accelerated filers (ex. EGCs)
-----------------------------------------------
Restatement type Revenue Revenue Relative
<$100M >=$100M percentage
----------------------------------------------------------------------------------------------------------------
Revenue recognition issues...................................... 1.3 3.3 40
Cash flows statement (SFAS 95) classification errors............ 1.0 1.7 60
Tax expense/benefit/deferral/other (FAS 109) issues............. 1.0 2.4 42
Inventory, vendor and/or cost of sales issues................... 0.8 1.8 45
Debt, quasi-debt, warrants & equity (BCF) security issues....... 0.7 0.6 115
Liabilities, payables, reserves and accrual estimate failures... 0.7 1.9 37
Accounts/loans receivable, investments & cash issues............ 0.7 1.3 53
Expense (payroll, SGA, other) recording issues.................. 0.6 1.5 43
Acquisitions, mergers, disposals, re-org acct issues............ 0.5 0.9 55
Acquisitions, mergers, only (subcategory) acct issues........... 0.4 0.6 65
Deferred, stock-based and/or executive comp issues.............. 0.4 0.5 85
EPS, ratio and classification of income statement issues........ 0.3 0.6 53
Balance sheet classification of assets issues................... 0.3 0.4 77
Lease, SFAS 5, legal, contingency and commitment issues......... 0.3 0.6 53
Foreign, related party, affiliated, or subsidiary issues........ 0.3 0.7 34
----------------------------------------------------------------------------------------------------------------

Table 11 presents the percentage of low-revenue and higher-revenue
accelerated filers other than EGCs restating their financial statements
under a particular category of restatement for a given year from 2014
through 2018. The table presents the results for the 15 most common
restatement categories for low-revenue accelerated filers other than
EGCs. Restatements can fall into more than one category, so the total
of these percentages across all restatement categories would exceed the
average rate of restatements. We also report the relative percentage of
the restatement rate in a given category among the low-revenue issuers
relative to the higher-revenue issuers.
Table 11 demonstrates that 1.3 percent of low-revenue accelerated
filers other than EGCs restated their financial statements for a given
year from 2014 to 2018 due to revenue recognition issuers, representing
about 40 percent of the rate of this type of restatement among higher-
revenue accelerated filers other than EGCs. Similarly, for the next
three most common categories of restatements for low-revenue
accelerated filers other than EGCs, the restatement rates of these
issuers represented 42- to 60 percent of the corresponding rates among
higher-revenue accelerated filers other than EGCs. Thus, this evidence
supports our belief that the affected issuers may be less susceptible
to certain kinds of misstatements, such as those related to revenue
recognition. However, consistent with commenters concerns about other
sources of misstatements, particularly with respect to complex
contracts and arrangements, we find that the rate of restatements in
some other categories is more similar across the two groups. For
example, the rate of restatements related to ``Debt, quasi-debt,
warrants & equity (BCF) security

[[Page 17220]]

issues'' and ``Deferred, stock-based and/or executive comp issues'' for
the low-revenue issuers represent 115 percent and 85 percent
respectively of the corresponding rates among the higher-revenue
issuers. However, the rate of restatements is greater for the low-
revenue issuers as compared to higher-revenue issuers only in the
``Debt, quasi-debt, warrants & equity (BCF) security issues'' category,
and only by a small margin: The restatement rates in this category are
within 0.1 percentage points of each other, such that they are not
statistically differentiable in our sample.\535\
---------------------------------------------------------------------------

\535\ There is also a slightly higher rate of restatements
without a specified category among the low-revenue issuers, with 0.1
percent of their issuer-year level observations being associated
with ``Unspecified (amounts or accounts) restatement adjustments''
compared to 0.0 percent among the higher-revenue issuers.
---------------------------------------------------------------------------

We therefore continue to believe that the evidence supports our
hypothesis that the affected issuers are less likely to make
restatements, perhaps because they are, on average, less susceptible to
certain kinds of misstatements (such as those related to revenue
recognition), than other accelerated filers. While this finding may
mitigate the adverse effects on the reliability of financial statements
for the affected issuers that will newly be exempt from all ICFR
auditor attestation requirements, we nonetheless expect some such
effects. Based on the analysis in the Proposing Release, and with
consideration for the difference in size and maturity of the affected
issuers versus the comparison sample, we estimated that the rate of
restatements among the affected issuers may increase by two percentage
points.\536\ Given their lower current rates of restatement, even after
such an increase the affected issuers may, on average, restate their
financial statements at a rate that is lower than that of issuers that
will remain accelerated filers, and that does not exceed that of non-
accelerated filers and EGCs with comparable revenues.
---------------------------------------------------------------------------

\536\ See Section III.C.4.b. of the Proposing Release, note 4
above.
---------------------------------------------------------------------------

Several commenters indicated that we should have given
consideration to the magnitude of restatements.\537\ In response to
these comments, we have undertaken two types of analysis. First, we
consider the potential effects on restatements that are deemed by
issuers to be material. To do this, we begin by repeating our analysis
for all types of restatements from the Proposing Release for the subset
of Item 4.02 restatements, which, as discussed above, are the
restatements that issuers deem to be material and report in Form 8-K
Item 4.02 disclosures, in Table 12.\538\
---------------------------------------------------------------------------

\537\ See, e.g., letters from Better Markets, CFA Inst., and
Prof. Barth et al.
\538\ The estimates in this table are based on staff analysis of
Ives Group Audit Analytics data. Percentages are computed out of all
issuers of a given filer type and revenue category with revenue data
and a SOX Section 404(a) management report available in the Ives
Group Audit Analytics database. The accelerated and non-accelerated
categories exclude EGCs. See note 298 above for details on the
identification of filer type.

Table 12--Percentage of Issuers Issuing Item 4.02 Restatements by Year of Restated Financials, by Revenue
Category
----------------------------------------------------------------------------------------------------------------
Non-
Restated year Accelerated accelerated EGC
(ex. EGCs) (ex. EGCs)
----------------------------------------------------------------------------------------------------------------
Revenue <$100M:
2014........................................................ 2.4 3.9 5.8
2015........................................................ 3.5 3.1 4.2
2016........................................................ 3.3 2.6 3.4
Average/year............................................ 3.0 3.2 4.5
Revenue >=$100M:
2014........................................................ 4.1 4.7 2.7
2015........................................................ 3.7 4.3 8.7
2016........................................................ 2.4 2.3 2.6
Average/year............................................ 3.4 3.8 4.7
-----------------------------------------------
Difference in average/year.......................... -0.4 -0.6 -0.2
----------------------------------------------------------------------------------------------------------------

Table 12 demonstrates that, among low-revenue issuers, the
accelerated filers other than EGCs have a 0.2 percentage point
(relative to non-accelerated filers other than EGCs) or 1.5 percentage
point (relative to EGCs) lower rate of Item 4.02 restatements than the
issuers in the comparison populations, which are not subject to the
ICFR auditor attestation requirement. Following our analysis in the
Proposing Release, given the difference in size and maturity of the
affected issuers versus the comparison samples, we look to the lower
end of this range and, with rounding, estimate that the rate of Item
4.02 restatements among the affected issuers may increase by 0.5
percentage points. Given how low the rates of Item 4.02 restatements
are, the sample sizes in Table 12 are not sufficient to reliably
differentiate between these rates. We are nevertheless comfortable with
this estimate because it is consistent with the estimate that would be
obtained by applying the average rate of Item 4.02 restatements out of
all restatements, per Table 9 above,\539\ to our estimate of the effect
on total restatements.
---------------------------------------------------------------------------

\539\ The ratio of Item 4.02 restatements to all restatements in
Table 7 ranges from 15 percent for large accelerated filers other
than EGCs (1.6 percent divided by 10.6 percent) up to 35 percent for
non-accelerated filers other than EGCs (2.9 percent divided by 8.5
percent). Applying these rates to our estimated 2 percentage point
effect on total restatements would result in an estimate of a 0.3 to
0.7 percentage point effect on Item 4.02 restatements.
---------------------------------------------------------------------------

This estimate of the effects on restatements that issuers deem to
be material may help to provide some perspective on the magnitude of
the anticipated effect. We provide further analysis of these magnitudes
by exploring the market and financial statement impacts of the
estimated effect on restatements. Table 15 in Section IV.C.3.c below
provides related estimates per Item 4.02 restatement for low-revenue,
seasoned issuers. In particular, the average net income impact for Item
4.02 restatements is estimated to be -$1.9 million per year of restated
financials for the 80 percent of cases where there is a net income
impact, which is -$1.9 million times 80 percent or -$1.5 million on
average across all cases. The average stock market impact is estimated
to be -$1.4

[[Page 17221]]

million divided by 1.4 years or -$1 million per year of restated
financials. We multiply these estimates by our estimate that an
additional 0.5 percentage points of the affected issuers may have an
Item 4.02 restatement of their financial statements for a given year to
obtain estimates of -$7,500 in net income impact or -$5,000 in stock
market impact per year per affected issuer that will newly be exempt
from all ICFR auditor attestation requirements.
One commenter provided alternative estimates of the magnitude of
the effect on restatements, estimating that the affected issuers
restated a total of $295 million in net income over the five years from
2014 through 2018 and that the 2018 restatements reduced market
capitalizations by $294 million in aggregate.\540\ We do not rely on
these estimates for two primary reasons. First, these estimates reflect
restatements that have occurred while these issuers are subject to the
ICFR auditor attestation requirement.\541\ They do not provide us with
information about the magnitude of new restatements that would be
experienced if this requirement were to be removed. The use of this
estimate would reflect an assumption that restatements would increase
by 100 percent upon removal of the ICFR auditor attestation
requirement, and we do not believe that there is evidence to support
such an assumption. If anything, these estimates demonstrate the
limitations of the ICFR auditor attestation requirement, in that
significant restatements still occur despite the requirement, rather
than informing us of the risks of removing the requirement.
---------------------------------------------------------------------------

\540\ See letter from Prof. Barth et al. See also letter from
Better Markets, citing these estimates.
\541\ Similarly, one commenter cites charges of misconduct at a
low-revenue issuer and argues that ``a well-designed ICFR audit
might have uncovered the control deficiencies, and related revenue
recognition violations, more quickly.'' See letter from CFA.
However, based on its EDGAR filings, the issuer was in fact subject
to the ICFR auditor attestation requirement in fiscal year 2014, the
beginning of the period of alleged misconduct (and may have been
subject to the requirement in the remainder of the period of alleged
misconduct as well, but did not file Form 10-K in the following
year), and the auditor's report in the associated Form 10-K attested
that the issuer's ICFR was effective.
---------------------------------------------------------------------------

Secondly, these estimates reflect the years in which restatements
were announced rather than when the actual misstatement occurred.
Effective ICFR is intended to reduce the risk of material
misstatements, so we believe it is important to focus on when
misstatements occurred, not when earlier misstatements were detected
and announced, which could actually be a sign of a careful audit and
effective ICFR. Focusing on the year of the restatement announcement
rather than the year of the misstatement could capture firms that may
not have qualified as affected issuers during the time the
misstatements were made, but only dropped into the category of affected
issuers because of the reduction in public float or revenue that
resulted from the major restatement and related issues.\542\ In
contrast to the commenter's analysis, our analysis is designed to
measure the rate and magnitude of the incremental restatements that can
be attributed to misstatements in years in which the issuers would
qualify under the amendments to be exempt from the ICFR auditor
attestation requirement and that would not have occurred if the issuers
were subjected to this requirement.
---------------------------------------------------------------------------

\542\ For example, a media report identified a particular issuer
included in one commenter's analysis of significant restatements
among issuers that were proposed to be exempted. See Dave Michaels,
SEC Plan Gives Audit Relief to Firms that Wiped Out over $290
Million, Wall St. J., July 26, 2019. See also letter from Prof.
Barth et al. (providing statistics but not identifying specific
issuers). Based on its EDGAR filings, the identified issuer had
revenues substantially in excess of $100 million, even after the
revisions described in the article, for fiscal years 2015 and 2016
(the periods with misstatements that were later restated). Further,
this issuer was subject to the ICFR auditor attestation requirement
as a large accelerated filer in 2015 and an accelerated filer in
2016. Therefore, we do not believe the amendments, if effective
during those fiscal years, would have exempted this issuer from the
ICFR auditor attestation requirement during the period in which the
misstatements were made.
---------------------------------------------------------------------------

iv. Effects on Fraudulent Financial Reporting
Several commenters indicated that we should give additional
consideration to the potential impacts of the amendments on the risk of
fraud.\543\ Further, a number of commenters cautioned that the risks of
fraudulent financial reporting may be particularly high for low-revenue
issuers,\544\ perhaps because of their incentives to demonstrate strong
growth \545\ or because of their high implied price-to-revenue
multiples.\546\ As part of our consideration of these comments, we
conducted certain supplemental analysis regarding the risk of
fraudulent financial reporting. That analysis, discussed below,
provides additional context for considering the possible effects of the
amendments. We note that commenters did not provide their own analyses
or suggest specific methodologies for estimating any potential impact
of the amendments on the risk of fraud.
---------------------------------------------------------------------------

\543\ See, e.g., letters from CFA Inst., CII, and Prof. Barth et
al.
\544\ See, e.g., letter from CFA, CFA Inst., CII and Prof. Barth
et al.
\545\ See, e.g., letter from CFA.
\546\ See, e.g., letters from CII and Prof. Barth et al.
---------------------------------------------------------------------------

We acknowledge that fraudulent misconduct does occur, including at
low-revenue issuers, and that the incentives to engage in such
misconduct could be heightened for certain low-revenue issuers,
depending on their specific situation. It is less clear what the
average risk of fraud is across low-revenue issuers in general, and how
this overall risk may be affected by the ICFR auditor attestation
requirement. Measuring these effects is challenging because the sample
sizes associated with typical measures of fraud are small, making
reliable statistical determinations difficult. Further, we do not have
an observable measure of all latent fraudulent conduct, but can only
examine fraud that has been detected and that led to some observable
action, which may not be a representative sample of all actual
fraudulent activity. However, we acknowledge that it is important to
carefully consider the potential impact of the amendments on the risk
of fraud. We therefore use the available evidence and data to analyze
this risk.
We start by considering Accounting and Auditing Enforcement
Releases (``AAERs'') \547\ and cases of ``financial misconduct'' or
``financial reporting fraud'' based on subsets of these enforcement
actions, as discussed below. A commenter noted that the Proposing
Release did not consider the historical rate of fraud, the incidence of
AAERs, the incidence of Wells notices and of formal SEC
investigations.\548\ While ``fraud'' may be defined in different ways,
our analysis below considers the historical rate of fraud, based on
analysis of a subset of AAERs, and the incidence of AAERs. We believe
that these are more appropriate measures of potential fraud risk, as
they reflect incidents in which the Commission proceeded with charges.
In contrast, formal investigations and Wells notices do not always
uncover, and/or result in charges of, wrongdoing.\549\ The small sample
size of

[[Page 17222]]

AAERs limits our ability to apply the methodology we used to estimate
the potential impact on the prevalence of ineffective ICFR and the rate
of restatements \550\ to reliably estimate a potential effect on the
incidence of AAERs. Instead, we begin by examining the representation
of low-revenue as compared to higher-revenue issuers in the population
of issuers with AAERs or subsets of AAERs that include certain types of
charges, as compared to their representation in the broader population
of issuers, in order to investigate commenters concerns that the
affected issuers may face particularly high risks of fraudulent
financial reporting. We then separately apply results from existing
studies on fraudulent financial reporting to obtain an estimate of the
potential impact of the amendments on such misconduct.
---------------------------------------------------------------------------

\547\ AAERs refer to certain financial reporting related
enforcement actions concerning civil lawsuits brought by the
Commission in federal court and notices and orders concerning the
institution and/or settlement of administrative proceedings. Links
to these releases since 1999 are available at https://www.sec.gov/divisions/enforce/friactions.shtml.
\548\ See letter from Prof. Barth et al.
\549\ See David Solomon and Eugene Soltes, Is ``Not Guilty'' the
Same as ``Innocent''? Evidence from SEC Financial Fraud
Investigations, Working Paper (2019), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3402780 (finding that,
for financial fraud investigations by the Commission between 2002
and 2005, only 25 percent resulted in enforcement actions); and Jean
Eaglesham, SEC Drops 20% of Probes After ``Wells Notice,'' Wall St.
J., Oct. 9, 2013 (reporting that, for the two-year period that ended
in September 2012, 20 percent of the Wells notices issued were
associated with investigations that were later closed without taking
action being taken against the indicated parties). See also Terrence
Blackburne, John Kepler, Phillip Quinn and Daniel Taylor,
Undisclosed SEC Investigations, Working Paper (2019), available at
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3507083 (finding
that, for Commission investigations that were closed between 2000
and 2017, only 44 percent were eventually publicly disclosed, though
the study does not identify the subset of these cases involving
charges or any action being taken).
\550\ See Tables 13 and 14 of the Proposing Release, note 4
above, and the accompanying text.
---------------------------------------------------------------------------

Because the overall sample size of AAERs is limited, we use the
full sample of years for which data is available, such that the alleged
misconduct we analyze ranges from fiscal year 1971 to 2016 (based on
AAERs issued from 1982 through 2018). We focus on issuers that are not
within five years of their IPO (``seasoned issuers'') to better
represent the affected issuers. Revenues are measured as of the date of
the first misstated financial statements associated with an AAER,
rather than at the date of the enforcement action, which is generally
many years after this date.\551\
---------------------------------------------------------------------------

\551\ The estimates in Table 13 are based on staff analysis of
the U.S.C. Marshall AAER Database, which contains information on
AAERs issued between May 1982 and December 2018, supplemented with
information from AAERs (for a smaller sample, as discussed below)
and data from Compustat. Multiple AAERs associated with the same
financial statement years are treated as a single case. Consecutive
years of financial statements associated with AAERs are also treated
as a single case.

Table 13--Representation of Low-Revenue and Higher-Revenue Seasoned
Issuers in the Population and Among Those With AAERs
------------------------------------------------------------------------
Among issuers not within 5
years of IPO *
-------------------------------
Percent with Percent with
revenue revenue
<$100M >=$100M
------------------------------------------------------------------------
Total issuer-year level observations 50 50
with revenue data **...................
Issuers with AAERs:
With alleged ``financial 42 58
misstatements'' ***................
and with ``financial misconduct'' 24 76
charges ****.......................
and with ``financial reporting 30 70
fraud'' charges *****..............
------------------------------------------------------------------------
* The years after an issuer's IPO are computed as of the first date of
the financial statements associated with the AAERs.
** This row includes data for fiscal years from 1971 through 2016 to
reflect the full horizon of years of alleged misconduct identified in
the U.S.C. Marshall AAER Database. As noted below, data on ``financial
misconduct'' charges and ``financial reporting fraud'' charges was
only collected for AAERs issued from 2002 through 2018. While these
charges represent alleged misconduct dating back to as early as 1985,
they are more likely to reflect relatively more recent years than
those reflected in the full sample of AAERs. We therefore note, for
the purpose of consideration of the last two rows of Table 13, that
the percentage of low-revenue issuers among the total issuer-year
observations of seasoned issuers with revenue data is reduced somewhat
in the more recent part of this sample, to about 47 percent when
considering data from fiscal years 1985 through 2016 or about 42
percent when considering data from fiscal years 2000 through 2016.
*** This row represents AAERs that the U.S.C. Marshall AAER Database
indicates as being associated with alleged financial misstatements.
**** This row represents AAERs among those included in the previous row
that also include charges under Section 13(b)(2)(A) (requiring issuers
to make and keep books, records, and accounts, which, in reasonable
detail, accurately and fairly reflect the transactions and
dispositions of the assets of the issuer), Section 13(b)(2)(B)
(requiring an issuer to devise and maintain a system of internal
accounting controls sufficient to provide certain reasonable
assurances), or Section 13(b)(5) (requiring that no person shall
knowingly circumvent or knowingly fail to implement a system of
internal accounting controls or knowingly falsify any book, record, or
account) of the Securities Exchange Act, or Rules 13b2-1 (requiring
that no person directly or indirectly, falsify or cause to be
falsified, any book, record or account) or 13b2-2 (requiring certain
representations and conduct by directors and officers in connection
with the preparation of required reports and documents) under the
Securities Exchange Act. We only supplemented the U.S.C. Marshall AAER
Database with information about these specific charges where
applicable for AAERs issued from 2002 through 2018 (which include
alleged misconduct associated with financial statements from fiscal
year 1985 through 2016), so the set of AAERs considered in the
computations in this row reflect a substantially smaller population of
AAERs than those included in the second row of this table, which
includes earlier AAERs (issued beginning in 1982). Our estimates do
not significantly change if we remove charges associated only with
third parties rather than the issuer in question and/or its staff from
the sample before running the analysis.
***** This row represents AAERs among those included in the previous row
that also include charges under the anti-fraud statutes in Section
17(a)(1) of the Securities Act or Section 10(b) of the Securities
Exchange Act. See also note **** above regarding limitations on the
population of AAERs for which we supplemented the U.S.C. Marshall AAER
Database with information on these charges. Our estimates do not
significantly change if we remove charges associated only with third
parties rather than the issuer in question and/or its staff from the
sample before running the analysis.

In Table 13, we consider all AAERs with alleged financial
misstatements (row 2), as well as two subsets of these AAERs that we
identify for those issued in, roughly, the past two decades.\552\ The
first subset (row 3) represents those that we can identify as including
charges under Section 13(b)(2)(A), Section 13(b)(2)(B), or Section
13(b)(5) of the Securities Exchange Act, or Rules 13b2-1 or 13b2-2
under the Securities Exchange Act. These cases have been identified by
researchers as representing ``financial misconduct.'' \553\ The second

[[Page 17223]]

subset (row 4) is the subset of the ``financial misconduct'' cases that
we can identify as also including charges under Section 17(a)(1) of the
Securities Act or Section 10(b) of the Securities Exchange Act, which
is one common way of identifying cases of ``financial reporting
fraud.'' \554\ We note that others may define ``financial misconduct''
and ``financial reporting fraud'' differently.\555\
---------------------------------------------------------------------------

\552\ The population of AAERs considered in these subsets is
limited to those issued from 2002 through 2018. See Table 13 above.
\553\ See Jonathan Karpoff, Allison Koester, D. Scott Lee, and
Gerald Martin, Proxies and Databases in Financial Misconduct
Research, 92(6) Acct. Rev. 129 (2017) (``Karpoff et al. 2017
Study''). This study also raised concerns about omissions in the
U.S.C. Marshall AAER Database, which they refer to as the CFRM
database, but they noted that they understood that this issue was
being addressed and that users of the newer iterations of this
dataset, after the date of the study, should face lower or zero
rates of effective omissions.
\554\ See, e.g., Karpoff et al. 2017 Study, note 553 above, and
COSO 2010 Fraud Study, note 505 above.
\555\ See, e.g., Karpoff et al. 2017 Study, note 553 above,
(describing certain other measures researchers have used and their
limitations), note 553 above.
---------------------------------------------------------------------------

Per the second through fourth rows of Table 13, the representation
of low-revenue seasoned issuers among all seasoned issuers with any of
these types of AAERs ranges from 24 to 42 percent. For comparison, we
also derive the representation of low-revenue seasoned issuers among
all seasoned issuers in the population. Per the first row of Table 13,
across all of the years of our sample, and specifically among the
seasoned issuers, 50 percent of the issuer-year observations are
associated with low revenues.\556\ Thus, we do not find evidence based
on the available data that low-revenue issuers are more highly
represented in the set of seasoned issuers associated with ``financial
misconduct'' or ``financial reporting fraud'' than they are in the
overall population of seasoned issuers.
---------------------------------------------------------------------------

\556\ While the latter two rows of Table 13, regarding
``financial misconduct'' and ``financial reporting fraud,'' are
based on relatively more recent data (AAERs issued from 2002 through
2018, reflecting alleged misconduct from 1985 to 2016), we note that
considering the prevalence of low-revenue issuers in relatively more
recent years does not change our conclusions. For example, the
percentage of low-revenue issuers among the total issuer-year
observations of seasoned issuers with revenue data is about 47
percent when considering data from 1985 through 2016 (reaching a
minimum of 38 percent in 2016), which still exceeds the 25 to 30
percent of the seasoned issuers associated with ``financial
misconduct'' or ``financial reporting fraud'' that have low
revenues.
---------------------------------------------------------------------------

A caveat to this finding is that it only reflects cases of
discovered and charged alleged misconduct, and may not be
representative of all cases of actual misconduct.\557\ Also, this
analysis is limited to the population of AAERs. There may be additional
cases of alleged misconduct with respect to financial reporting that
are charged but not associated with AAERs, and low-revenue issuers
could be more highly represented among these cases.\558\ Further, even
if the affected issuers may not be more likely to engage in fraudulent
financial reporting than other seasoned issuers on average, certain of
these affected issuers may have heightened incentives to engage in such
activities, as noted by the commenters cited above.
---------------------------------------------------------------------------

\557\ We note that the required data, such as data on revenues,
may be less likely to be available for low-revenue issuers to the
extent that, like other small issuers, they are less likely to be
covered by traditional databases. This could reduce our ability to
detect a higher representation of these issuers among those with
various types of AAERs. However, this should generally be accounted
for in our analysis because we draw comparisons only within the
population of issuers with available data, and the same limitation
applies to our ability to estimate the representation of such
issuers in the overall population as in the population with AAERs.
\558\ For example, not all of the enforcement actions listed in
the category of ``Issuer Reporting/Auditing & Accounting'' in the
Annual Report of the Commission's Division of Enforcement are
associated with AAERs. See, e.g., 2019 Annual Report, Division of
Enforcement, available at https://www.sec.gov/enforcement-annual-report-2019.pdf.
---------------------------------------------------------------------------

We next consider whether expanding the exemption from the ICFR
auditor attestation requirement for such issuers would affect their
likelihood of engaging in such activities. To address this question, we
rely on a study that associates material weaknesses in ICFR with an
increased rate of ``financial reporting fraud.'' \559\ In particular,
the study associates reporting ``entity-level'' material weaknesses in
ICFR,\560\ but not other types of material weaknesses, with a 1.22
percentage point increase in the rate of ``financial reporting fraud''
over the following three years, or 0.41 percentage points (1.22 divided
by three) per year.
---------------------------------------------------------------------------

\559\ See Donelson et al. 2017 Study, note 470 above. This study
identifies ``financial reporting fraud'' as either (1) the sample of
``fraud'' cases in the ``financial misrepresentation dataset'' from
www.fesreg.com that underlies the Karpoff et al. 2017 Study, note
553 above, which, based on the latter study, represents the subset
of Commission or Department of Justice enforcement actions that
include charges under Sections 13(b)(2)(A), Section 13(b)(2)(B), or
Section 13(b)(5) of the Securities Exchange Act, or Rules 13b2-1 or
13b2-2 under the Securities Exchange Act, that also include charges
under the anti-fraud statutes in Section 17(a)(1) of the Securities
Act or Section 10(b) of the Securities Exchange Act; or (2) settled
securities class-action lawsuits that allege violations of GAAP.
\560\ This study defines entity-level material weaknesses as
those that Ives Group Audit Analytics identifies as being in any of
the following categories: (1) Non-routine transaction control
issues; (2) journal entry control issues; (3) foreign, related-
party, affiliated, or subsidiary issues; (4) an ineffective,
nonexistent, or understaffed audit committee; (5) senior management
competency, tone, or reliability issues; (6) an insufficient or
nonexistent internal audit function; (7) ethical or compliance
issues with personnel; or (8) accounting personnel resources,
competency, or training issues. See Donelson et al. 2017 Study, note
470 above.
---------------------------------------------------------------------------

Given that any impact of the ICFR auditor attestation requirement
on the risk of fraud is likely to result from the effect of this
requirement on the effectiveness of ICFR, we apply the results of this
study to our estimated effect on ICFR to quantify the potential
increase in this risk that could be associated with the amendments. Per
the results earlier in this section, we estimate that the amendments
may eventually result in an additional 15 percentage points of the
affected issuers maintaining ineffective ICFR. Examining the types of
material weaknesses experienced by low-revenue issuers of different
filer statuses, we find that up to 85 percent of their material
weaknesses would be classified as ``entity-level'' material weaknesses
as defined by the study we are relying on.\561\ Applying the above
annualized estimate of a 0.41 percentage point increase in the rate of
financial reporting fraud for issuers reporting ``entity-level''
material weaknesses to our estimate of a 12.75 percentage point (15
percentage points times 85 percent) increase in the prevalence of such
material weaknesses, we estimate that the amendments could eventually
lead to an additional 0.05 percentage points (0.41 percent times 12.75
percentage points) of the affected issuers being associated with
alleged ``financial reporting fraud'' with respect to their financial
statements for a given year.
---------------------------------------------------------------------------

\561\ See note 560 above.
---------------------------------------------------------------------------

To better understand the magnitude of this potential effect, we
rely on another study that estimates that issuers lose a total of 38
percent of their equity market value upon announcements of ``financial
misrepresentation,'' or, given that the alleged violation periods in
their sample span 27 months on average, 17 percent of equity market
capitalization for each affected year.\562\ The affected issuers that
will be newly exempt from all ICFR auditor attestation requirements
have an average equity market capitalization of about $205 million. We
therefore estimate that the magnitude of the potential increase in
fraud risk is 0.05 percentage points (our estimated annualized rate of
the increase in issuer-years associated with

[[Page 17224]]

``financial reporting fraud'') times 17 percent times $205 million, or
about $17,500 in market capitalization per year per affected issuer
that will be newly exempt from the ICFR auditor attestation
requirements. We view this estimate as conservative because the study
we rely on includes issuers that are younger and significantly smaller
than the affected issuers, and we believe that the percentage of market
capitalization loss is likely to be greater for such firms.
---------------------------------------------------------------------------

\562\ See Jonathan Karpoff, D. Scott Lee, and Gerald Martin, The
Cost to Firms of Cooking the Books, 48(3) J. of Fin. and
Quantitative Analysis 581 (2008) (``Karpoff et al. 2008 Study'').
The study defines ``financial misrepresentation'' consistently with
the ``financial misrepresentation dataset'' from www.fesreg.com
which, based on the Karpoff et al. 2017 Study, note 553 above,
represents the subset of Commission or Department of Justice
enforcement actions that include charges under Sections 13(b)(2)(A),
Section 13(b)(2)(B), or Section 13(b)(5) of the Securities Exchange
Act, or Rules 13b2-1 or 13b2-2 under the Securities Exchange Act.
While the ``financial misrepresentation'' sample does not also
require charges under the anti-fraud statutes, the Karpoff et al.
2008 Study indicates that over three-fourths of this sample was
associated with fraud charges.
---------------------------------------------------------------------------

Overall, this analysis does not cause us to change our primary
conclusions regarding the potential effects of the amendments.
v. Timing of the Effects
We anticipate that the potential adverse effects of the amendments
will develop gradually and are likely to be relatively limited in the
short term. We discuss the reasons that we expect a gradual evolution
in the remainder of this section. Nevertheless, we recognize that a
delay in realizing some of the associated costs from the amendments
would not necessarily mitigate their ultimate effects. The preceding
discussion is based on the comparison of steady-state differences
across issuers in different categories, and represents an analysis of
the eventual effects of the amendments. Because the amendments will
allow some current accelerated filers to transition to non-accelerated
filer status, some issuers that have already been subject to an audit
of ICFR for one or more years may no longer be required to obtain an
ICFR auditor attestation. While other issuers will enter into the
affected issuers category without having previously obtained an ICFR
auditor attestation, and such issuers are likely to represent a larger
fraction of the affected issuers over time, initially issuers with
experience with ICFR auditor attestations are expected to represent a
substantial fraction of the affected issuers.
Newly exempt issuers may have implemented control improvements that
would persist regardless of a transition. For example, they may have
made investments in systems, procedures, or training that are unlikely
to be reversed. It is difficult to predict the degree of inertia in
ICFR and financial reporting in order to gauge how quickly, if at all,
issuers that cease audits of ICFR may evolve such that their ICFR and
the reliability of their financial statements is more characteristic of
exempt issuers.\563\ The gradual nature of such an evolution, and the
associated halo effect of the last disclosed ICFR auditor attestation,
may limit the short-term costs of the amendments. In addition, issuers
that believe control improvements are valuable for reporting and
certifying results will be free to spend the resources saved on the
attestations on such improvements.
---------------------------------------------------------------------------

\563\ We note that there is a relatively small sample of
accelerated filers transitioning to non-accelerated filer status
because of changes in their public float, as compared to transitions
in the other direction, and that such transitions likely represent
special circumstances such as underperformance. Therefore, such
transitions are not particularly helpful for predicting the outcomes
of accelerated filers transitioning to non-accelerated filer status
because of the amendments.
---------------------------------------------------------------------------

Affected issuers with experience with audits of ICFR may also be
more likely to continue to obtain an ICFR auditor attestation on a
voluntary basis than other exempt issuers are to begin voluntary audits
of ICFR. This may be due to such issuers having already incurred
certain start-up costs or facing demand from their current investors to
continue to provide ICFR auditor attestations. Some issuers in the
groups that we use for comparison, which are not subject to an ICFR
auditor attestation requirement, voluntarily obtain an ICFR auditor
attestation. Thus, the comparisons made above at least partially
account for the fact that some issuers may choose to obtain an ICFR
auditor attestation even in the absence of a requirement. However, to
the extent the rate of voluntary ICFR auditor attestations would be
higher amongst the issuers that will be newly exempt from the ICFR
auditor attestation requirement than other exempt issuers, the
anticipated costs of the amendments in the near term may be further
reduced.
c. Implications for Investor Decision-Making
While we anticipate that the frequency of ineffective ICFR and, to
a lesser extent, restatements may increase among the affected issuers
as a result of the amendments, the economic effects of these changes
may be reduced by another factor that may apply to many of these
issuers. In particular, the usefulness of more reliable financial
statements is linked to the degree to which they factor into the
decisions of investors,\564\ for example, with respect to these
investors' valuations of issuers.\565\ The financial statements of many
low-revenue issuers may have relatively lower relevance for market
performance if, for example, relative to higher-revenue issuers, their
valuation hinges more on their future prospects than on their current
financial performance.
---------------------------------------------------------------------------

\564\ See, e.g., Dechow and Schrand 2004 Monograph, note 506
above.
\565\ See, e.g., Jennifer Francis & Katherine Schipper, Have
Financial Statements Lost Their Relevance?, 37(2) J. of Acct. Res.
319 (1999) (``Francis and Schipper 1999 Study''); and S. P. Kothari,
Capital Markets Research in Accounting, 31 J. of Acct. and Econ. 105
(2001).
---------------------------------------------------------------------------

We explored this possibility empirically in the Proposing Release,
which used the methodology applied in previous studies to calculate,
for issuers above and below the $100 million revenue threshold, the
extent to which the variation in market performance is related to the
variation in financial measures. For issuers at or above $100 million
in revenue, we found, consistent with the findings of previous studies
of all issuers, that key financial variables (the book value of assets
and liabilities, the book value of equity, earnings, and the change in
earnings) explain about 60 to 70 percent of the variation in equity
market capitalization and 7.5 percent of the variation in stock
returns.\566\ In contrast, for issuers with revenues of less than $100
million, we found that these financial variables explain about 30
percent of the variation in equity market capitalization and just over
4.5 percent of the variation in stock returns.
---------------------------------------------------------------------------

\566\ See Table 15 of the Proposing Release, note 4 above. See
also Francis and Schipper 1999 Study note 565 above. While that
study ends in 1994, before our 20 year horizon, the results are
similar. For example, for the most recent ten years in that study,
the book values of assets and liabilities explain 54 to 70 percent
of the variation in equity market valuation, the book value of
equity and earnings explain 63 to 78 percent of the variation in
equity market valuation, and earnings and the change in earnings
explain six to 20 percent of the variation in stock returns.
---------------------------------------------------------------------------

One commenter indicated that a low-revenue issuer could have a
large market capitalization and thus ``greater investor exposure.''
\567\ While we agree that such affected issuers would generally expose
more investors to risk, we note that the results discussed above
suggest that, on average, relative to higher-revenue issuers, less of
this risk seems to be associated with the issuers' current financial
statements than with their future prospects.\568\ Another commenter
agreed that future prospects are important to the valuation of entities
in a growth phase, but noted that the financial variables we consider
in our analysis are more likely to be considered in the valuation of
low-revenue issuers that are more seasoned, and that we should
therefore more fully consider the implications for these issuers in
particular.\569\ This commenter

[[Page 17225]]

also suggested that we might consider additional financial variables
that may be more relevant to the valuation of low-revenue issuers, such
as the rate of revenue growth and measures of liquidity. In response to
this comment, we conducted supplemental analysis of the empirical
relevance of financial statements for low-revenue issuers in Table
14.\570\ Specifically, because the affected issuers that will newly be
exempt from the ICFR auditor attestation requirement are generally not
within five years of their IPO, we limit the analysis to more seasoned
issuers. Further, we run the analysis with additional variables, as
discussed below.
---------------------------------------------------------------------------

\567\ See letter from Grant Thornton.
\568\ Also, the affected parties are limited to issuers with no
more than $700 million in public float. Further, as discussed in
Section IV.C.3.d. below, we estimate that in aggregate the affected
issuers that will be newly exempt from all ICFR auditor attestation
requirements represent 0.2 percent of the total equity market
capitalization of issuers.
\569\ See letter from Crane.
\570\ The reported statistics are adjusted R-squared statistics
based on regression analysis by staff using data from the Standard &
Poor's Compustat and Center for Research in Security Prices
databases. Seasoned issuers are those for which the data date is not
within five years of the reported IPO date, where IPO dates are
available. Market value and financial variables are measured as of
the end of the fiscal year. Earnings is income before extraordinary
items. Stock return is the 15-month stock return ending three months
after fiscal year-end, to account for reporting lags. For the stock
return regression, the explanatory variables are scaled by the
lagged market value of equity, and outliers in one percent tails of
variable distributions are dropped to reduce noise. See Francis and
Schipper 1999 Study, note 565 above, for additional details.

Table 14--Percentage of Variation in Market Performance Explained by Variation in Financial Performance for 1999
Through 2018, by Revenue Category
----------------------------------------------------------------------------------------------------------------
Revenue Revenue
Market variable Explanatory variables <$100M >=$100M
----------------------------------------------------------------------------------------------------------------
Seasoned issuers (not within five years of
IPO):
Market value of equity.................... Book value of assets, book value 40.9 58.8
of liabilities.
Market value of equity.................... Book value of equity, earnings.. 46.2 70.2
Stock return.............................. Earnings, change in earnings.... 5.5 7.6
Seasoned issuers, additional variables:
Market value of equity.................... Book value of equity, earnings, 55.8 81.5
revenue, R&D expense, quick
ratio.
Stock return.............................. Earnings, change in earnings, 8.4 9.0
revenue, change in revenue, R&D
expense, change in R&D expense.
----------------------------------------------------------------------------------------------------------------

The first three rows of Table 14 are similar to the analysis in the
Proposing Release, but are limited to issuers that are not within five
years of their IPO. Focusing on this subsample of low-revenue issuers,
which is more representative of the affected issuers that would be
newly exempt from the ICFR auditor attestation requirement, we find
that the financial variables considered in the Proposing Release
explain about 40 to 45 percent of the variation in equity market
capitalization and about 5.5 percent of the variation in stock returns.
These percentages are slightly higher than our results for all low-
revenue issuers in the Proposing Release (for which the variables
explain about 30 percent and 4.5 percent of the variation in equity
market capitalization and stock returns respectively, as noted above).
However, they remain substantially lower than the results for higher-
revenue seasoned issuers, for which the variables explain about 60 to
70 percent of the variation in equity market capitalization and about
7.5 percent of the variation in stock returns.
The second panel of Table 14 considers additional variables based
on the comment letter discussed above and on academic accounting
literature on key value-relevant metrics. For example, the role of the
book value of equity in valuation may reflect, among other things, the
liquidation or adaptation value of an issuer.\571\ However, a commenter
noted that, for issuers with little to no revenue, liquidity metrics
are often relevant to a user's evaluation of future prospects.\572\ We
agree that there is evidence that, for certain issuers, liquidity
metrics that relate current assets to current liabilities may provide
key additional information on the likelihood of, and value upon,
liquidation.\573\ We therefore include the quick ratio (current assets
less inventories, which may be difficult to monetize in the short term,
minus current liabilities) in the analysis as a supplement to the book
value of equity.
---------------------------------------------------------------------------

\571\ See, e.g., Philip Berger, Eli Ofek, and Itzahk Swary,
Investor Valuation of the Abandonment Option, 42(2) J. of Fin. Econ.
259 (1996); David Burgstahler and Ilia Dichev, Earnings, Adaptation
and Equity Value, 72(2) Acct. Rev. 187 (1997).
\572\ See letter from Crowe.
\573\ See, e.g., Sergei Davydenko, When Do Firms Default? A
Study of the Default Boundary, Working Paper (2012), available at
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=672343 (finding
that the quick ratio is highly correlated with the short-term
probability of default, particularly for firms with less access to
external capital).
---------------------------------------------------------------------------

In considering further variables that would be appropriate to
include in this analysis, we note that low-revenue issuers are
significantly more likely to be loss-making than higher-revenue
issuers.\574\ The academic literature provides evidence that for loss
firms, revenues (and the change in revenues, or revenue growth) can be
more value-relevant than earnings (and the change in earnings).\575\ A
commenter also identified the rate of revenue growth as an example of a
financial statement variable that investors may consider for low-
revenue firms.\576\ Separately, we note that research and development
(``R&D'') costs are expensed and thereby reduce earnings, while there
is evidence that the future benefits of R&D activity may not be
reflected in the earnings of loss-making firms.\577\ For these reasons,
we include revenues and R&D expenses (and the change in these measures)
as a supplement to earnings (and the change in earnings) in the
analysis in the second panel of Table 14.
---------------------------------------------------------------------------

\574\ In this analysis, about half of the low-revenue issuers
are loss-making, compared to about ten percent of the higher-revenue
issuers.
\575\ See, e.g., Aswath Damodaran, The Dark Side of Valuation:
Firms with No Earnings, No History and No Comparables, Working Paper
(1999), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1297075.
\576\ See letter from Crowe.
\577\ See, e.g., Laurel Franzen and Suresh Radhakrisnan, The
Value Relevance of R&D across Profit and Loss Firms, 28 (1) J. of
Acct. and Pub. Pol'y 16 (2009).
---------------------------------------------------------------------------

As demonstrated in the last two rows of Table 14, including these
additional variables does increase the amount of variation in equity
market capitalization and stock returns explained by the financial
statement variables. However, the percentage of explained variation
remains lower for low-revenue seasoned issuers than for higher-revenue
seasoned issuers.
These results demonstrate that financial statement information is
not irrelevant for low-revenue issuers. That is, information from
financial statements is associated with market prices and returns for
these issuers as well as other issuers. Thus, the potential reduction
in the reliability of financial

[[Page 17226]]

statements for the affected issuers is expected to have some negative
implications. However, the lower empirical relevance of financial
statements on average for these issuers may partially mitigate the
potential adverse effects of the amendments.
In contrast to these findings, a number of commenters cited
analysis in Commissioner Jackson's Statement suggesting that, based on
the stock market reaction to annual report filings disclosing material
weaknesses in ICFR, investors care most about the information provided
by the ICFR auditor attestation of low-revenue issuers.\578\ Further,
one of these commenters stated that the markets impose a ``much heftier
penalty'' on small companies that restate than they do on larger
companies.\579\ On the other hand, other commenters expressed the view
that the ICFR auditor attestation requirement is not important or
material to the investors of affected issuers, based on their own
experience and/or a study referencing an analysis of the market
reaction to Section 302 internal control weakness disclosures.\580\ As
further evidence, two of these commenters asserted that investors
rarely ask an issuer that is exempt from obtaining an ICFR auditor
attestation to voluntarily comply with the requirement.\581\ In
response to these comments, we have conducted analyses of the investor
response to ICFR disclosures and restatement announcements at low-
revenue issuers versus other issuers.
---------------------------------------------------------------------------

\578\ See, e.g., letters from CFA, CFA Inst., and CII, citing
the event study analysis in Commissioner Jackson's Statement.
\579\ See letter from CFA.
\580\ See, e.g., letters from Adamas, Ardelyx, ASA, BIO, Carver,
Catalyst, Chiasma, Corvus, CymaBay, Equillium, Evoke, Gritstone,
Kezar, Marinus, Millendo, Organovo, Pieris, Revance, SI-BONE, Syros,
Teligent, and Zynerba. Many of these letters cited the BIO Study,
note 69 above, which in turn cites Jacqueline Hammersley, Linda
Myers, and Catherina Shakespeare, Market Reactions to the Disclosure
of Internal Control Weaknesses and to the Characteristics of those
Weaknesses under Section 302 of the Sarbanes Oxley Act of 2002,
13(1) Rev. of Acct. Stud. 141 (2008) (``Hammersley et al. 2008
Study''). The BIO letter also directly cites the latter study. The
BIO Study and BIO letter highlight the finding of the Hammersley et
al. 2008 Study that the market response to issuers disclosing
material weaknesses in disclosure controls in their Section 302
disclosures is, in the whole sample, not statistically different
from zero. However, we note that this study does find evidence of a
statistically significant negative market reaction to such
disclosures in a subsample uncontaminated by other announcements in
the event window.
\581\ See letters from Ardelyx and BIO.
---------------------------------------------------------------------------

First, we consider the market reaction to the filing of annual
reports that contain ICFR auditor attestations reporting material
weaknesses in ICFR. We only consider ICFR auditor attestation reports,
as opposed to Section 404(a) management reports, in order to focus on a
sample of issuers comparable to the affected issuers \582\ and those
reports that would no longer be required under the amendments. Because
material weaknesses may persist across years, consecutive disclosures
that continue to report material weaknesses are not likely to represent
news to the market. We therefore focus on material weakness disclosures
that are preceded by an ICFR auditor attestation reporting effective
ICFR. We consider issuers with revenues of less than $100 million and
higher-revenue issuers, but exclude those within five years of their
IPO to more closely represent the affected issuers.\583\ Figure 7 \584\
presents the results of our event study analysis for disclosures in the
last decade.\585\
---------------------------------------------------------------------------

\582\ In particular, Section 404(a) management reports are
required of all issuers other than RICs and ABS issuers, including
those that are already non-accelerated filers and would therefore
not be affected by the amendments.
\583\ We obtain substantially similar results if we consider all
issuers, rather than excluding those within five years of their IPO,
or if we include consecutive annual reports with material weakness
disclosures, rather than focusing on new material weakness
disclosures.
\584\ This figure is based on results from the Event Study by
WRDS module available through Wharton Research Data Services and
staff analysis of data from Ives Group Audit Analytics, Compustat,
and CRSP. The figure includes all seasoned issuers that have an
auditor attestation of ICFR that newly reports material weaknesses
in ICFR following a previous attestation to effective ICFR in annual
reports filed in calendar years 2009 through 2018. We exclude
issuers for which the data date is within five years of the IPO date
(i.e., non-seasoned issuers), if available. The cumulative average
abnormal returns are calculated with respect to expected returns
based on a multi-factor model including the three Fama French
factors and a momentum factor, where the model parameters are
calculated over an estimation period of up to 100 trading days
ending 50 trading days before the event period.
\585\ This time horizon was chosen to maximize the sample size
while limiting the study to the period after the effectiveness of AS
No. 5 (now referred to as AS 2201, note 292 above), which may have
changed the nature of ICFR auditor attestations. See Section IV.B.1.
above for a discussion of this auditing standard and the evidence
that the nature of ICFR auditor attestations may have changed as a
result of its adoption. Our results are substantially similar when
considering alternative time horizons, such as the past five years.

---------------------------------------------------------------------------

[[Page 17227]]

[GRAPHIC] [TIFF OMITTED] TR26MR20.006

Our analysis does not suggest that investors care more about the
information produced by the ICFR auditor attestation requirement at
low-revenue issuers. In particular, investors did not react more
negatively to low-revenue issuers disclosing material weaknesses than
to such disclosures by the higher-revenue issuers. None of the
cumulative average abnormal returns plotted in the figure, whether for
low- or higher-revenue issuers, are statistically differentiable from
zero at conventional confidence levels.\586\
---------------------------------------------------------------------------

\586\ The analysis applies the standardized cross-sectional
test, which is robust to cross-sectional dependence in abnormal
returns (which often results when events cluster in time, as in the
case of annual report filing dates) as well as any event-induced
increase in the variance of returns, to measure the statistical
significance of the abnormal returns. See Ekkehart Boehmer, Jim
Musumeci, and Annette Poulsen, Event-Study Methodology under
Conditions of Event-Induced Variance, 30(2) J. of Fin. Econ. 253
(1991) (``Boehmer et al. 1991'').
---------------------------------------------------------------------------

Our figure differs from the similar analysis that was cited by
commenters for a number of reasons. First, that analysis includes a
number of duplicate observations.\587\ The duplication generally occurs
when there is both an ICFR auditor attestation and a Section 404(a)
management report reporting a material weakness in the same annual
report. While the duplicate observations appear to have only a modest
effect on the pattern of the measured cumulative abnormal returns, they
likely have the effect of biasing downward the width of the confidence
interval presented in the analysis. When we remove the duplicates, we
find that, as in our own analysis, the cumulative average abnormal
returns for low-revenue issuers are not statistically differentiable
from zero at conventional confidence levels for any day within the 11-
day event period surrounding the disclosure date.\588\ Also, we note
that even without this adjustment, the confidence intervals plotted in
the other analysis indicate that, by the end of the presented event
period, the cumulative average abnormal returns are no longer
statistically differentiable from zero for issuers with below $100
million in revenues.\589\
---------------------------------------------------------------------------

\587\ About 30% of the low-revenue observations in the analysis
are exact duplicates in terms of company identifiers, event date,
revenue and returns. See ``Abnormal Returns Data,'' available at
https://www.sec.gov/news/public-statement/jackson-statement-proposed-amendments-accelerated-filer-definition.
\588\ The width of the confidence interval at the far right side
of the figure (for day +5) in the analysis cited by commenters
appears to be about 0.85 percentage points. We understand that the
standard errors in that analysis are simple cross-sectional standard
errors (which are robust to event-induced increases in the variance
of returns but not to any cross-sectional dependence in abnormal
returns). Removing the duplicates, we find that the width of the
corresponding 95% confidence interval would be 2.02 percentage
points using this approach, which is about 2.4 times wider than the
reported confidence interval.
\589\ In particular, the presented confidence bands for the
cumulative abnormal returns include zero by day 11 of the analysis,
which considers the 11-day period beginning five days prior and
ending five days subsequent to the date of disclosure.
---------------------------------------------------------------------------

Second, more than half of the non-duplicate low-revenue
observations in the other analysis appear to reflect reports of
material weaknesses in Section 404(a) management reports in the absence
of an ICFR auditor attestation. As discussed above, our analysis
excludes observations where there is only a Section 404(a) management
report because we believe they have limited relevance when considering
the affected issuers and the effects of the amendments. Third, the
other analysis reflects a different time horizon (2004 through 2017)
than our analysis (2009 through 2018). In our analysis, we restrict the
time horizon to the period after the effectiveness of AS No. 5 because
the nature of ICFR auditor attestations may have changed after this
point. These additional differences in

[[Page 17228]]

the underlying sample appear to drive the differences in the pattern of
the cumulative average abnormal returns in the analysis cited by
commenters relative to our own analysis.\590\ However, even if we were
to use the broader set of reports and/or the time horizon of the other
analysis, we continue to find that the cumulative average abnormal
returns are not statistically differentiable from zero at conventional
confidence levels for any day within the 11-day event period
surrounding the disclosure date.
---------------------------------------------------------------------------

\590\ While, as discussed above, we also refine the analysis
presented in Figure 7 to exclude consecutive disclosures that
continue to report material weaknesses and to limit the analysis to
seasoned issuers, we find that these choices have more modest
effects on the pattern of cumulative average abnormal returns.
---------------------------------------------------------------------------

There is substantial noise inherent to an analysis of the
disclosure of material weaknesses in annual reports, both because these
reports often contain or are accompanied by significant confounding
information \591\ and because material weaknesses are often disclosed
in advance of the annual report.\592\ We therefore also undertook
analysis of the market and financial statement impact of material
restatements disclosed in Item 4.02 Form 8-K filings, which are
relatively less likely to be accompanied by unrelated news or to be
disclosed in advance of the filing. We consider restatements over the
10-year horizon from 2009 through 2018 to obtain more reliable
estimates while still focusing on a recent period that should be
reasonably representative of the current environment.\593\
---------------------------------------------------------------------------

\591\ Staff analysis of material weakness disclosures that were
accompanied by large positive or negative stock returns found
evidence of announcements of confounding news that are associated
with large positive returns (e.g., significantly beat earnings
estimates, positive news about Phase III trial, liquidity infusion,
merger announcement) and large negative returns (e.g., significantly
miss earnings estimates, liquidity problems and security issuance at
significant discount). See also, e.g., Paul Griffin, Got
Information? Investor Response to Form 10-K and Form 10-Q EDGAR
Filings, 8(4) Rev. of Acct. Stud. 433 (2003) (for more detail on the
overall information content of annual reports) and Edward Li and K.
Ramesh, Market Reaction Surrounding the Filing of Periodic SEC
Reports, 84(4) Acct. Rev 1171 (2009) (for further analysis of the
information content released in, and at the time of, annual report
filing).
\592\ Staff analysis of material weakness disclosures that were
preceded by an ICFR auditor attestation reporting effective ICFR
found that in about one-third of cases these new material weaknesses
had been disclosed prior to the annual report, such as in an Item
4.02 Form 8-K or a Form 10-Q filing.
\593\ The estimates in Table 15 are based on staff analysis of
restatements associated with an Item 4.02 8-K dated within calendar
years 2009 through 2018. The sample includes, for issuers that are
not within five years of their IPO, 260 restatements by low-revenue
issuers and 384 restatements for higher-revenue issuers with non-
missing stock returns. The data on restatements, including their
financial statement effects, are from Audit Analytics. Revenues are
measured as of the beginning of the restated period. The data on
revenues and IPO dates are from Compustat. The announcement returns
are cumulative abnormal returns based on results from the Event
Study by WRDS module available through Wharton Research Data
Services. They represent the cumulative abnormal returns for the
two-day event period including the date of the associated 8-K filing
and the following trading day. These abnormal returns are estimated
relative to a benchmark model of returns based on the three Fama-
French factors and a momentum factor, where the model parameters are
calculated over an estimation period of up to 100 trading days
ending 50 trading days before the event date. The confidence
intervals are based on the standardized cross-sectional test of
Boehmer et al. 1991, note 586 above.

Table 15--Estimated Effects of Item 4.02 8-K Restatements Announced by Seasoned Issuers in 2009-2018, by Revenue
Category at Time of the Misstatement
----------------------------------------------------------------------------------------------------------------
Issuers not within five years of IPO
-----------------------------------------------------------------------
Revenue <$100M Revenue >=$100M
----------------------------------------------------------------------------------------------------------------
Average 2-day announcement return (%)... -0.9%............................. -3.3%.
Announcement return statistically No................................ Yes.
distinguishable from zero (95%
confidence level).
Average 2-day announcement return (95% -2.2% to +0.3%.................... -4.2% to -2.3%.
confidence interval).
Average 2-day announcement effect ($)... -$1.4M............................ -$22.0M.
Percent with adverse financial statement 78%............................... 80%.
effect *.
Percent with income effect.............. 83%............................... 81%.
Among those with income effect, average -$1.9M............................ -$13.2M.
net income effect ($) per year of
restated financials.
Average length of restated period....... 1.4 years......................... 2.0 years.
----------------------------------------------------------------------------------------------------------------
* This row, based on the ``Effect'' variable from Ives Group Audit Analytics, indicates whether the net effect
to the financial statements (income statement, balance sheet or cash flows) was negative.

As with our previous analyses, this supplemental analysis also does
not support the assertion that investors care more about the
reliability of the information in the financial statements of low-
revenue issuers than that of higher-revenue issuers. The market
reaction to Item 4.02 Form 8-K filings is statistically
indistinguishable from zero for low-revenue, seasoned issuers, but is
negative and statistically significant for higher-revenue issuers.
While the point estimates for the market impact of the restatements are
uncertain, as demonstrated by the confidence intervals presented in the
second row of Table 15, the corresponding point estimates for the
dollar market impact per restatement announcement are also
substantially lower (at $1.4 million versus $22.0 million) for low-
revenue seasoned issuers as compared to higher-revenue seasoned
issuers. The rate of Item 4.02 restatements with negative financial
statement impact or with net income impact is similar for both
categories of issuers, at about 80 percent. We also consider how the
average dollar market impact of the restatements relates to the average
dollar correction in annualized net income, in case investors react
more strongly per dollar of the correction in annualized net income for
low-revenue issuers. However, Table 15 does not provide evidence that
the corresponding point estimate dollar market impact is
proportionately greater relative to the average annualized effect on
net income for low-revenue seasoned issuers than for high revenue
seasoned issuers.\594\
---------------------------------------------------------------------------

\594\ In particular, the ratio of average dollar market impact
of the restatements relative to the average dollar correction in
annualized net income for low-revenue seasoned issuers is -$1.4M/-
$1.9M or about 0.7, while the corresponding ratio for higher-revenue
seasoned issuers is -$22.0/-$13.2 or about 1.7.
---------------------------------------------------------------------------

Overall, we acknowledge that a lower reliability of their financial
statements may have significant effects on the valuation of certain
low-revenue issuers. It is possible, for example, as one commenter
stated, that ``[for] many low-revenue companies that are struggling to
become high revenue companies . . . their ability to attract capital
may depend primarily on their ability to convince analysts and
investors that their revenues are strong and steadily rising.'' \595\
However, when we consider

[[Page 17229]]

the evidence in aggregate across the population of low-revenue and
higher-revenue seasoned issuers based on the three different types of
analyses in this section, we find some evidence that financial
statements and their reliability are less associated with market prices
for low-revenue issuers and no evidence that there is a stronger
association with market prices for low-revenue issuers than for higher-
revenue issuers. Therefore, we continue to believe that the evidence
supports the supposition that relative to higher-revenue issuers, the
value of low-revenue issuers, on average, hinges more on their future
prospects than on their current financial performance, and that this
consideration should mitigate the potential adverse effects of the
amendments.
---------------------------------------------------------------------------

\595\ See letter from CFA.
---------------------------------------------------------------------------

d. Potential Economic Costs of Effects on ICFR, the Reliability of
Financial Statements, and Potential Fraud
A number of commenters indicated that we should make further
attempts to quantify the potential costs of the amendments.\596\ A few
commenters further asserted that the costs of the amendments will
significantly outweigh any benefits.\597\ In the previous section, we
estimated that the affected issuers that will newly be exempt from all
ICFR auditor attestation requirements may eventually experience a 15
percentage point increase in ineffective ICFR and, for a given year of
financial statements, an estimated 2 percentage point increase in
restatements, a 0.5 percentage point increase in Item 4.02
restatements, and a 0.05 percentage point increase in ``financial
reporting fraud'' associated with those financial statements. In this
section, we provide additional monetized estimates of the impact, in
dollar terms, which may be associated with certain potential adverse
effects. As noted earlier, this discussion and these estimates are
focused on affected issuers that will be newly exempt from the ICFR
auditor attestation requirement and are not expected to be subject to
the FDIC auditor attestation requirement.
---------------------------------------------------------------------------

\596\ See, e.g., letters from Better Markets, CFA Inst., CII,
Prof. Barth et al., and Prof. Ge et al.
\597\ See, e.g., letters from Better Markets and Prof. Barth et
al.
---------------------------------------------------------------------------

Overall, as discussed in more detail below, we are able to
quantitatively estimate, per year per affected issuer, a total of
approximately $60,000 in costs and an additional approximately $10,000
in transfers across shareholders, which represent costs to some
shareholders and benefits to other shareholders.\598\ These estimates
reflect our quantification, based on the available evidence and data,
of potential effects related to operating performance, restatements,
and financial reporting fraud. We note that we are unable to adjust the
dominant component of the estimates (the estimated effect on operating
performance) for the mitigating factors associated with low-revenue
issuers that we discuss throughout this release, so the total estimate
of costs may be inflated.
---------------------------------------------------------------------------

\598\ The costs we estimate represent actual forgone value,
while the transfers simply represent corrections to reflect an
issuer's true financial position.
---------------------------------------------------------------------------

Given that our estimate of the cost savings per year per affected
issuer is $210,000, we do not find evidence to support the views of the
commenters that indicated that the costs of the amendments would
significantly outweigh the benefits. However, we note two main caveats
associated with our estimates of the costs and transfer that may result
from the amendments, and with the underlying components of these
estimates, which are discussed in more detail below. First, these
estimates are necessarily more uncertain than our monetized estimates
of cost savings to issuers because they are based on a larger number of
assumptions. Secondly, we caution against attempts to over-interpret
the relation between our quantitative estimates of monetized benefits
and monetized costs, because neither of these measures is complete. For
example, we are not able to monetize the potential benefit of reduced
management distraction from operating activities \599\ or the potential
market-level costs of reduced efficiency of investor allocation across
investment opportunities or reduced investor confidence.\600\ We
therefore are not able to quantify the overall net benefit or cost of
the amendments.
---------------------------------------------------------------------------

\599\ See, e.g., letter from Sutro.
\600\ See, e.g., letter from CII.
---------------------------------------------------------------------------

i. Computation of Monetized Estimates of Costs
We provide further quantification of potential adverse effects of
the amendments in this section, while the next section provides a
discussion of these costs as well as other economic costs that we are
unable to quantify. We begin by considering costs that may represent
deadweight losses, or net costs to society, followed by a consideration
of transfers across shareholders. First, we estimate the potential
deadweight losses associated with a potential increase in the risk of
fraud. In Section IV.C.3.b.iv. above, we estimated the magnitude of the
potential increase in fraud risk to be about $17,500 in market
capitalization per year per affected issuer that will be newly exempt
from the ICFR auditor attestation requirements. A study that breaks
down the equity market impact of fraud into deadweight losses (such as
legal costs and impaired reputation) versus the effects that reflect
the market adjusting to a more accurate representation of issuers'
financial situations estimates that the former constitute approximately
75 percent of the total equity market loss.\601\ We therefore estimate
the potential average incremental deadweight loss associated with fraud
to be $17,500 times 75 percent or roughly $13,000 per year per affected
issuer. We consider the remainder of the estimated equity market
effect, which represents a transfer from some investors to other
investors, separately below.
---------------------------------------------------------------------------

\601\ See Karpoff et al. 2008 Study, note 562 above.
---------------------------------------------------------------------------

Commenters suggested that we should quantify effects on operating
performance associated with ICFR misreporting,\602\ which are less
likely to be corrected by remediation because the underlying material
weaknesses are likely undetected. As discussed in the Proposing
Release, potential effects of the amendments on operating performance
are difficult to measure because the existing studies may not be
generalizable to the affected issuers and the methods used in previous
studies are difficult to apply to a comparable sample of low-revenue
issuers in recent years.\603\ However, in response to these comments,
we rely on the results of a recent study \604\ to provide an estimate
of the possible loss in profits per year associated with ICFR
misreporting. While we expect that the anticipated effect on the
affected issuers would be reduced relative to those in the study given
the mitigating factors specific to low-revenue issuers discussed above,
we are unable to estimate an appropriate adjustment to reflect these
factors. The study estimates that the difference in return on assets
for issuers misreporting that they have effective ICFR versus those
that properly report that they have ineffective ICFR (and thereby
perhaps also work towards remediating their ICFR) is 3.3 percentage
points over three years, or 1.1 percentage point per year. We multiply
this difference by our estimate of the potential increase in
misreporting of effective ICFR from Section IV.C.3.b.ii. above, which
(based on statistics from the same study) is 3.5 percentage points, and
the estimated average total assets of the affected

[[Page 17230]]

issuers that will be newly exempt from all ICFR auditor attestation
requirements from Section IV.C.1 above, which is $125 million. This
results in an estimated reduction in potential earnings of about
$48,000 per year on average for an affected issuer. As noted above,
this estimate may be inflated, as it does not reflect any of the
mitigating factors specific to low-revenue issuers discussed above.
---------------------------------------------------------------------------

\602\ See, e.g., letters from CII, Prof. Barth et al., and Prof.
Ge et al.
\603\ See Section III.C.4.c. of the Proposing Release, note 4
above.
\604\ See Ge et al. 2017 Study, note 393 above.
---------------------------------------------------------------------------

In total, we estimate potential issuer-level costs of $48,000 in
reduced earnings plus $13,000 in losses related to the increased risk
of fraud, or roughly $60,000 in costs per year on average per affected
issuer, though we view this estimate as conservative because it does
not fully account for the mitigating factors discussed above. Next, we
note that some of the potential adverse effects quantified in Section
IV.C.3.b. above may be associated with stock market values that fail,
at a given time, to reflect issuers' actual financial position. This
potential inflation and later correction of stock market values would
result in transfers that benefit some shareholders and harm other
shareholders. Further, the same shareholder may benefit in certain of
his shareholdings and be harmed in other shareholdings. Also, at any
given time, the stock price may be inflated for certain reasons but
have corrected for other prior inflation, depending on the timing of
the revelation of the underlying issues. For the purpose of
quantification of these potential transfers, we assume that issues are
revealed gradually and smoothly over time, such that there is an even
effect across years.
The first source of mispricing we consider is misstatements that
later translate into restatements. In Section IV.C.3.b.iii. above, we
estimated that the magnitude of the potential increase in Item 4.02
restatements represented -$5,000 in stock market impact per year per
affected issuer. Secondly, we estimated earlier in this section that
the magnitude of the potential increase in fraud risk is about -$17,500
in market capitalization per year per affected issuer, of which 25
percent or about -$4,500 reflects the market adjusting to a more
accurate representation of issuers' financial situations.\605\ Summing
these quantified effects, and rounding up, we estimate that there may
be approximately $10,000 of pure transfers across shareholders per year
per affected issuer representing these corrections in stock values to
reflect issuers' actual financial positions.
---------------------------------------------------------------------------

\605\ We note that some portion of this correction may already
be incorporated in our estimate with respect to restatements given
that we do no separately consider restatements that are associated
with specific charges or allegations versus other statements.
---------------------------------------------------------------------------

As discussed above, these estimates are intended to be responsive
to commenters who indicated that further quantitative analysis of the
costs of the amendments would be appropriate. One commenter also
provided alternative quantified estimates of the costs of expanding the
exemption from the ICFR auditor attestation requirement, estimating a
$1.7 million loss in future earnings and $2.2 million in forgone market
value per issuer.\606\ While we rely on evidence from the same
underlying study that this commenter uses for some of our estimates, we
do not rely on these specific estimates for two primary reasons. First,
the underlying study indicates that these per issuer estimates apply
not to all issuers but only to those issuers that are suspected of
misreporting that their ICFR is effective when exempted from the ICFR
attestation requirement, which the study estimates to be only 9.3
percent of the issuers.\607\ Secondly, these estimates reflect
aggregate effects over three years and we scale everything to
annualized effects for better comparability.\608\ We also note that the
estimate described by the commenter as forgone market value is
described in the underlying study as a delay in a market value decline
that would otherwise happen currently, not as an increase in market
capitalization that could be captured under the ICFR auditor
attestation requirement.\609\
---------------------------------------------------------------------------

\606\ See letter from Prof. Barth et al.
\607\ See Ge et al. 2017 Study, note 393 above.
\608\ Id.
\609\ Id. In particular, this study estimates a stock market
value correction that would be delayed until ICFR misreporters
experience the negative consequences of ineffective ICFR (such as
restatements or lower operating performance), rather than resulting
immediately because of a disclosure of ineffective ICFR. The study
estimates that a $2.2 million stock market value correction would be
delayed across a period of three years per suspected misreporter,
who are estimated to represent 9.3 percent of the issuers exempt
from the ICFR auditor attestation requirement. Annualizing and
generalizing the study's estimate across issuers' results in an
estimated delayed stock market correction per year per affected
issuer of about $70,000 ($2.2 million divided by three years times
9.3 percent). We note that this estimate is similar to the likely
stock market impact of the quantified costs and transfers that we
estimate may result from the adverse effects of removing the ICFR
auditor attestation requirement for the affected issuers (such as
restatements and lower operating performance). In particular, our
estimate of about $10,000 in potential transfers per year per
affected issuer represents a $10,000 potential stock market
correction per year per affected issuer. Our estimate of quantified
potential costs of about $60,000 per year per affected issuer would
likely be reflected in a similarly-sized stock market reaction, for
a further potential stock market correction of about $60,000 per
year per affected issuer, and a total of about $70,000 ($10,000 plus
$60,000) in stock market effects per year per affected issuer, the
same as the estimate implied by the study. That said, we differ
somewhat in the attribution of this total to deadweight costs versus
transfers, as the Ge et al. 2017 study, note 393 above, suggests
that the total estimated stock market effect may represent only a
difference in timing of the effect and thus a transfer across
shareholders.
---------------------------------------------------------------------------

Another commenter \610\ cited the same underlying study's \611\
estimates of quantified costs and benefits associated with the ICFR
auditor attestation. As discussed above, the study estimates, in
aggregate and in present value terms, a total of $388 million in
aggregate audit fee savings and a total of $719 million in lower
earnings associated with exempting non-accelerated filers.\612\ While
the commenter did not suggest that we adopt those specific estimates,
we note that we do not rely directly on those estimates, which apply to
a different context. In particular, the estimates in that study are
intended to quantify the costs and benefits associated with the
exemption that applies to all existing non-accelerated filers, versus
those associated with extending the exemption to the smaller number and
different type of affected issuers discussed in this release. However,
as discussed in more detail throughout the release, we do rely on some
results and approaches from that study in constructing our own
estimates.
---------------------------------------------------------------------------

\610\ See letter from Prof. Ge et al.
\611\ See Ge et al. 2017 Study, note 393 above.
\612\ This study also estimates a delay over three years in the
timing of a market value decline (that would otherwise have occurred
at the beginning of this three year period) of $935 million
associated with the exemption from the ICFR auditor attestation
requirement. See Section IV.C.2.b.ii. above.
---------------------------------------------------------------------------

ii. Discussion of Economic Costs
While the previous section provided computations of monetary
estimates of certain potential adverse effects of the amendments, this
section provides further discussion of those costs as well as other
economic costs that we are unable to quantify. Per the discussion in
Section IV.C.3.a. above, any impact of the amendments on the
effectiveness of ICFR and the reliability of financial statements may
have issuer-level implications as well as market-level implications. At
the issuer level, the potential increase, on average, in the rate of
ineffective ICFR and restatements may lead investors to charge a
somewhat higher average cost of capital for the affected issuers. An
issuer's cost of capital, or the expected return that investors demand
to hold its securities, determines the price at which it can raise
funds. Thus, any such increase may be associated with a reduction in

[[Page 17231]]

capital formation to the extent that it decreases the rate at which the
affected issuers raise new capital towards new investments. Further,
the affected issuers may also experience reduced operational efficiency
because of the reduced reliability of financial information available
to management for the purpose of making operating decisions. These
potential effects are supported by a number of studies discussed
above.\613\ Finally, there may be legal and reputational costs
associated with any increase in the risk of fraud, which would
represent deadweight losses, or net costs to society.
---------------------------------------------------------------------------

\613\ See Section IV.C.3.a. above.
---------------------------------------------------------------------------

Several commenters expressed the view that eliminating the ICFR
auditor attestation requirement would increase the cost of capital for
certain issuers because of the potential effects of this change on the
reliability of the financial statements of the affected issuers.\614\
The potential issuer-level effect on the cost of capital is difficult
to confirm and to quantify for the affected issuers because the
existing studies may not be generalizable to the affected issuers and
to the current nature of ICFR auditor attestations (i.e., after the
2007 change in the ICFR auditing standard, the 2010 change in risk
assessment auditing standards, and recent PCAOB inspections focused on
these aspects of audits). Further, some of these studies provide mixed
evidence, as discussed in Section IV.C.3.a. above. Moreover, the
methods used in previous studies are difficult to apply to a comparable
sample of low-revenue issuers in more recent years because, for
example, there would only be a small sample of such issuers that
recently switched filing status and because methods of measuring the
implied cost of capital are particularly problematic for such
issuers.\615\ Commenters did not provide us with estimates or data that
could be used to estimate potential effects on the cost of capital.
---------------------------------------------------------------------------

\614\ See, e.g., letters from BDO and CFA.
\615\ See note 481 above.
---------------------------------------------------------------------------

The available evidence supports the qualitative, directional
effects on cost of capital noted above. That is, some of the affected
issuers could experience an increase in their cost of capital. However,
the previous section demonstrated that the potential increase in
material weaknesses in ICFR that we estimate could occur may translate
into a more limited effect on the reliability of disclosures, as
measured, for example, by the rate of restatements, for the affected
issuers. Also, based on our analysis, the financial metrics of these
issuers have lower explanatory power for investors' determination of
their value than in the case of other issuers. These two factors may
mitigate the potential adverse effects on the affected issuers' cost of
capital.
In addition, some of the costs of extending the exemption from the
ICFR auditor attestation requirement to additional issuers may be
further mitigated by the fact that some issuers, even if exempted, may
voluntarily choose to bear the costs of obtaining such an
attestation.\616\ Affected issuers that expect a lower cost of capital
with an ICFR auditor attestation, such as those with effective
ICFR,\617\ and particularly those that will be raising new debt or
equity capital,\618\ are more likely to voluntarily obtain an ICFR
auditor attestation. We note that low-revenue issuers have less access
to internally-generated capital, as discussed above, so they may be
more reliant on external financing for capital. Consistent with this
argument, commenters suggested that issuers may voluntarily obtain an
ICFR auditor attestation if it were demanded by investors,\619\ not
complying would have a negative impact on investment analysts'
coverage,\620\ or issuers deem it a good use of their capital
resources.\621\ Further, as discussed in Section IV.C.4.d. below, we
note that the benefits and therefore likelihood of voluntarily
obtaining ICFR auditor attestations may be increased by the new check-
box disclosure on annual reports required by the amendments, in that
investors should be more able to readily discern which issuers obtained
an ICFR auditor attestation.\622\ However, it is probably not the case
that issuers would voluntarily obtain an ICFR auditor attestation in
every case in which the total benefits of doing so would exceed the
total costs.\623\
---------------------------------------------------------------------------

\616\ Studies have associated voluntary compliance with the ICFR
auditor attestation requirement with decreased cost of capital and
value enhancements. See, e.g., Cory Cassell, Linda Myers, & Jian
Zhou, The Effect of Voluntary Internal Control Audits on the Cost of
Capital, Working Paper (2013) (Cassell et al. 2013 Study), available
at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1734300; Todd
Kravet, Sarah McVay, & David Weber, Costs and Benefits of Internal
Control Audits: Evidence from M&A Transactions, Rev. of Acct. Stud.
(forthcoming 2018), available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2958318; and Carnes et al. 2019 Study, note
397 above. We note that the latter two studies are not able to
differentiate between the effects of the ICFR auditor attestation
and of management's assessment of ICFR under SOX Section 404(a).
\617\ See Brown et al. 2016 Study, note 396 above.
\618\ See Cassell et al. 2013 Study, note 616 above.
\619\ See, e.g., letters from BIO and Guaranty.
\620\ See, e.g., letter from Guaranty.
\621\ Id.
\622\ See 2013 GAO Study, note 246 above.
\623\ There is substantial literature describing the fact that
in certain circumstances the incentives of managers are not
perfectly aligned with those of shareholders. See, e.g., Michael
Jensen & William Meckling, Theory of the Firm: Managerial Behavior,
Agency Costs and Ownership Structure, 3(4) J. of Fin. Econ. 305
(1976). Also, as discussed in Section IV.C.3.a. above, the ICFR
auditor attestation requirement can have important market-level
benefits through network and spillover effects that issuers are
unlikely to internalize. That is, issuers are likely to balance the
issuer-level benefits against the issuer-level costs of voluntary
compliance without considering these externalities.
---------------------------------------------------------------------------

The available evidence also supports the qualitative, directional
effects on operating performance noted above. That is, some of the
affected issuers could experience lower operating performance due to
reliance on less reliable financial statements in their decision-
making. Like the potential effects on the cost of capital, the
potential effect on issuer operating performance associated with
reported ineffective ICFR is also difficult to estimate and is likely
to be mitigated by the multiple factors discussed above. Further, the
point estimates in one study demonstrate that issuers that remediate
their reported material weaknesses in ICFR might be able to make up a
substantial amount of the previous operating underperformance.\624\
---------------------------------------------------------------------------

\624\ See Feng et al. 2015 Study, note 484 above, (with point
estimates of a one percent reduction in ROA in years with material
weaknesses in ICFR and a 2.6 percent increase in ROA upon
remediation, though there is significant uncertainty around these
rates).
---------------------------------------------------------------------------

We do, however, quantify potential effects on operating performance
associated with ICFR misreporting, which are less likely to be
corrected by remediation because the underlying material weaknesses are
likely undetected. We also estimate potential deadweight losses (e.g.,
legal and reputational costs) associated with a possible increase in
the risk of fraud. In total, per Section IV.C.3.d.i. above, we estimate
potential issuer-level costs of $48,000 in reduced earnings plus
$13,000 in losses related to the increased risk of fraud, or roughly
$60,000 in costs per year on average per affected issuer, though we
view this estimate as conservative because it does not fully account
for the mitigating factors specific to low-revenue issuers discussed
above.
We note that issuers and other market participants may adapt to the
proposed changes in various ways, which may serve to enhance or
mitigate the anticipated issuer-level costs. However, these actions,
and therefore their net effects, are difficult to predict. For

[[Page 17232]]

example, it has been posited that issuers reacted to the requirements
of SOX by reducing accruals-based earnings management and, in its
stead, making suboptimal business decisions for the purpose of real
earnings management.\625\ It is therefore possible that newly exempt
issuers could, to some extent, reduce real earnings management in favor
of accruals-based management. Another possibility is that scrutiny from
analysts may provide an alternative source of discipline for some of
the affected issuers, although there is evidence that analysts may stop
covering issuers whose financial statements are deemed to have become
less reliable.\626\
---------------------------------------------------------------------------

\625\ See Daniel Cohen, Aiyesha Dey, & Thomas Lys, Real and
Accrual-Based Earnings Management in the Pre- and Post-Sarbanes
Oxley Periods, 83(3) Acct. Rev. 757 (2008) (finding that an increase
in real earnings management partially offset the decrease in
accruals-based earnings management that followed SOX). See also
Coates and Srinivasan 2014 Study, note 369 above, at 646-647.
\626\ See Sarah Clinton, Arianna Pinello, & Hollis Ashbaugh-
Skaife, The Implications of Ineffective Internal Control and SOX 404
Reporting for Financial Analysts,'' 33(4) J. of Acct. and Pub. Pol'y
303 (2013) (finding that the disclosure of internal control
weaknesses is followed by a decline in analyst coverage).
---------------------------------------------------------------------------

While the preceding analysis considers the average effects across
the affected issuers on the effectiveness of ICFR and the reliability
of financial statements, the potential issuer-level costs of the
proposed extension of the exemption from the ICFR auditor attestation
requirement likely vary across different types of affected issuers. For
example, the effects may vary based on issuers' proclivity to detect
and disclose material weaknesses in ICFR in the absence of an ICFR
auditor attestation requirement and whether the issuers' have
characteristics that the market associates with having such material
weaknesses. We discuss this variation in detail in the Proposing
Release.\627\
---------------------------------------------------------------------------

\627\ See Section III.C.4.c. of the Proposing Release, note 4
above.
---------------------------------------------------------------------------

We next consider effects at the market-level. Some of these effects
are associated with the transfers across shareholders that we estimated
in Section IV.C.3.d.i. above. In total, we estimated that there may be
approximately $10,000 of pure transfers across shareholders per year
per affected issuer representing corrections in stock values to reflect
issuers' actual financial positions. These transfers and the associated
mispricing may reduce the efficient allocation of capital at the market
level. Further, to the extent that the reliability of financial
statements is somewhat reduced on average at the issuer level for the
affected issuers, the efficient allocation of capital at the market
level may be negatively affected given a diminished ability to reliably
evaluate different investment alternatives.\628\
---------------------------------------------------------------------------

\628\ The efficient allocation of capital may be further reduced
to the extent that the potential cost of capital effects discussed
above operate through a reduction in the liquidity of the market for
these issuers' shares, which increases the costs to investors
looking to adjust their investments or redeploy their capital. See
Diamond and Verrecchia 1991 Study, note 477 above.
---------------------------------------------------------------------------

The reduced reliability of financial statements could also
negatively impact capital formation through a reduction in investor
confidence. Several commenters noted that they expected the amendments
to have a negative effect on investor confidence.\629\ In contrast, one
commenter asserted that there is no correlation between a smaller
company's compliance with the ICFR auditor attestation requirement and
stronger markets in general,\630\ while two others noted that they did
not expect effects on investor confidence with respect to affected
issuers that are banks.\631\
---------------------------------------------------------------------------

\629\ See, e.g., letters from Better Markets and CII.
\630\ See letter from BIO.
\631\ See letters from BSC and SCBA.
---------------------------------------------------------------------------

Section IV.C.3.a. provides additional discussion of these market-
level factors. While we are unable to directly quantify the market-
level effects on the efficient allocation of capital and on investor
confidence, we anticipate that these effects may be limited due to the
size of the expected effect on the reliability of these issuers'
disclosures and potential transfers across shareholders as well as the
small percentage of the total value of traded securities that is
represented by the affected issuers. In particular, we estimate that
the affected issuers that will be newly exempt from all ICFR auditor
attestation requirements represent 0.2 percent of the total equity
market capitalization of issuers.\632\
---------------------------------------------------------------------------

\632\ This statistic is based on staff analysis of data from
Compustat. The total population of issuers used to construct this
estimate are those that have annual reports on Forms 10-K, 20-F, or
40-F in calendar year 2018 and data on market capitalization in
Compustat. See above note 336 for detail on the identification of
affected issuers.
---------------------------------------------------------------------------

4. Potential Benefits and Costs Related to Other Aspects of the
Amendments
In this section we consider the potential effects of the amendments
with regard to other implications of accelerated filer status,
specifically with respect to the timing of filing deadlines, certain
required disclosures, and the determination of filer status. We also
consider below some incremental effects of the amendments to the
thresholds for exiting accelerated and large accelerated filer status
and the new check-box disclosure required on the cover page of annual
reports on Form 10-K, 20-F, or 40-F.
a. Filing Deadlines
As discussed in Section IV.B.1. above, non-accelerated filers are
permitted an additional 15 days and five days, respectively, beyond the
deadlines that apply to accelerated filers, to file their annual and
quarterly reports. Extending these later deadlines to the affected
issuers may provide these issuers with additional flexibility in
preparing their disclosures, while modestly decreasing the timeliness
of the data for investors.
Table 6 in Section IV.B.3. demonstrates that while the filing
deadlines are not a binding constraint for most accelerated filers,
with 63 percent filing their annual reports over five days early in
recent years, some accelerated filers are likely to benefit from the
extended deadline. For example, filing Form NT automatically provides a
grace period of an additional 15 days to file an annual report, and
over the past four years, about four percent of accelerated filers
filed their annual reports within this grace period rather than by the
original deadline. A further five percent of accelerated filers filed
their annual reports after these additional 15 days had passed.
Even affected issuers that would otherwise have filed by the
accelerated filer deadline may avail themselves of the additional time
provided under the amendments to balance other obligations or to
prepare higher quality disclosures. The 2003 acceleration of filing
deadlines for accelerated filers from 90 to 75 days was associated, at
least initially, with a higher rate of restatements for the affected
issuers.\633\ This finding suggests that a later deadline may allow
some issuers to provide more reliable financial disclosures. While
these issuers could alternatively file Form NT to receive an automatic
extension, studies have found that investors interpret such filings as
a negative signal, resulting in a negative stock price reaction.\634\
Issuers may thus

[[Page 17233]]

prefer to meet the original deadline if possible.
---------------------------------------------------------------------------

\633\ See, e.g., Colleen Boland, Scott Bronson, & Chris Hogan,
Accelerated Filing Deadlines, Internal Controls, and Financial
Statement Quality: The Case of Originating Misstatements, 29(3)
Acct. Horizons 551 (2015) (``Boland et al. 2015 Study''); and Lisa
Bryant-Kutcher, Emma Yan Peng, & David Weber, Regulating the Timing
of Disclosure: Insights from the Acceleration of 10-K Filing
Deadlines, 32(6) J. of Acct. and Pub. Pol'y 475- (2013).
\634\ See Joost Impink, Martien Lubberink, & Bart van Praag, Did
Accelerated Filing Requirements and SOX Section 404 Affect the
Timeliness of 10-K Filings?, 17(2) Rev. of Acct. Stud. 227 (2012)
and Eli Bartov & Yaniv Konchitchki, SEC Filings, Regulatory
Deadlines, and Capital Market Consequences, 31(4) Acct. Horizons 109
(2017).
---------------------------------------------------------------------------

On the other hand, allowing the affected issuers to file according
to the later non-accelerated filer deadlines may reduce the timeliness
and therefore usefulness of the disclosures to investors. Studies have
found a reduction in the market reaction to disclosure when the
reporting lag between the end of the period in question and the
disclosure date is lengthy, as more of the information becomes
available through other public channels.\635\ Researchers have also
questioned whether such lags increase information asymmetries, because
some investors are more able to access or process information that
could provide indirect insight into an issuer's financial status or
performance through alternative channels.\636\
---------------------------------------------------------------------------

\635\ See, e.g., Dan Givoly & Dan Palmon, Timeliness of Annual
Earnings Announcements: Some Empirical Evidence, 57(3) Acct. Rev.
486 (1982).
\636\ See, e.g., Nils Hakansson, Interim Disclosure and Public
Forecasts: An Economic Analysis and a Framework for Choice, 52(2)
Acct. Rev. 396 (1977) and Baruch Lev, Toward a Theory of Equitable
and Efficient Accounting Policy, 63(1) Acct. Rev. 1 (1988). We note
that Regulation FD generally prohibits public companies from
disclosing nonpublic, material information to selected parties
unless the information is distributed to the public first or
simultaneously. See 17 CFR 243.100 to 17 CFR 243.103.
---------------------------------------------------------------------------

One study found that the 2003 acceleration of filing deadlines was
associated with a decrease in the market reaction to the disclosure of
annual reports for accelerated filers.\637\ Based on this result and
supplementary tests regarding the change in disclosure quality and
change in timeliness after the acceleration of deadlines, the authors
concluded that the negative effect of the shorter deadline on the
quality of disclosure appeared to dominate the beneficial effect on the
timeliness of the disclosure for these issuers.\638\ While this finding
might not be directly applicable 15 years later, and there is some
evidence that some of these effects were temporary,\639\ in the absence
of other evidence we expect the net effect of the extended filing
deadlines to be beneficial on average but modest overall. One
commenter, citing the complexity of current accounting standards and
the volume of disclosure requirements, agreed that the benefits of the
extended deadlines for the affected issuers were likely to outweigh
their costs.\640\ Other commenters did not opine on the costs and
benefits of the changes in filing deadlines for the affected issuers.
---------------------------------------------------------------------------

\637\ See Jeffrey Doyle & Matthew Magilke, Decision Usefulness
and Accelerated Filing Deadlines, 51(3) J. of Acct. Res. 549 (2013).
We note that this study found the reverse to be true for large
accelerated filers.
\638\ Id.
\639\ See, e.g., Boland et al. 2015 Study, note 633 above.
\640\ See letter from BDO.
---------------------------------------------------------------------------

b. Disclosures Required of Accelerated Filers
Non-accelerated filers are not required to provide disclosure
regarding the availability of their filings under Item 101(e)(4) of
Regulation S-K. While some investors may benefit from reduced search
costs due to such disclosures, we do not expect that extending the
exemption from these disclosures to the affected issuers will have
significant economic effects.
Non-accelerated filers also are not required to provide disclosure
required by Item 1B of Form 10-K or Item 4A of Form 20-F about
unresolved staff comments on their periodic and/or current reports.
Studies have found that the eventual disclosure of staff comments and
related correspondence, as well as interim information about these
comments before they are made public, are value-relevant (in that they
affect the pricing of securities) for investors.\641\ While our
understanding is that Items 1B and 4A disclosures are relatively
uncommon,\642\ extending the exemption from the requirement to disclose
unresolved staff comments to the affected issuers may, in some
circumstances, prevent the timely disclosure of value-relevant
information to public market investors. Moreover, because Item 1B of
Form 10-K and Item 4A of Form 20-F requires unresolved staff comments
to be disclosed if they were made not less than 180 days prior to the
end of that fiscal year, issuers no longer subject to this disclosure
requirement may have a reduced incentive to resolve comments in a
timely manner, which could decrease the quality of reporting for the
period over which comments continue to be unresolved. We did not
receive any comments on these potential effects.
---------------------------------------------------------------------------

\641\ See, e.g., Patricia Dechow, Alastair Lawrence, & James
Ryans, SEC Comment Letters and Insider Sales, 91(2) Acct. Rev. 401
(2015) and Lauren Cunningham, Roy Schmardebeck, & Wei Wang, SEC
Comment Letters and Bank Lending, Working Paper (2017), available at
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2727860.
\642\ Based on staff analysis using the Intelligize database,
approximately 20 issuers included Item 1B disclosures in Forms 10-K
filed in 2017.
---------------------------------------------------------------------------

c. Transition Thresholds
The amendments include revisions to the transition thresholds that
address when an accelerated filer or large accelerated filer can
transition into a different filer status. The amendments will allow
accelerated or large accelerated filers to become non-accelerated
filers if they qualify under the SRC revenue test or meet a revised
public float transition threshold. An issuer whose revenues previously
exceeded the SRC initial revenue threshold of $100 million will not
qualify under the SRC revenue test unless its revenues fall below $80
million. The $80 million transition threshold for the SRC revenue test
is 80 percent of the initial threshold of $100 million in revenue. An
issuer whose public float previously exceeded the $75 million initial
threshold for accelerated filer status will become a non-accelerated
filer if its public float falls below $60 million, or 80 percent of
that initial threshold, as opposed to the current threshold of $50
million. Finally, the amendments also revise the public float
transition threshold for exiting large accelerated filer status and
becoming an accelerated filer from $500 million to $560 million in
public float, or 80 percent of the $700 million entry threshold, to
align with the transition threshold for entering SRC status after
having exceeded $700 million in public float.
The filer type exit thresholds in Rule 12b-2 are set below the
corresponding entry thresholds to provide some stability in issuer
classification given normal variation in public float and revenues. The
exact placement of these thresholds involves a tradeoff between the
degree of volatility in classification versus the extent to which the
categories persistently include issuers that are below the initial
entry thresholds. The Proposing Release presented a quantitative
analysis of this tradeoff using 20 years of data on the evolution of
market capitalizations (as a proxy for public float) and revenues.\643\
In particular, this analysis demonstrated that a higher exit threshold
is associated with more volatility in classification. For example, exit
thresholds set at 100 percent of the public float entry thresholds
would have led eight to ten percent of new entrants into a filer status
to immediately exit the following year and then re-enter once again the
year after that. Issuers and investors may be confused as a result of
such frequent fluctuations in filer type. They may also bear resulting
costs, such as (for issuers) the cost of frequently revising their
disclosure schedules and continually considering the impact of whether
they are subject to the ICFR auditor attestation requirement from one
year to the next and (for investors) any incremental cost of evaluating
the

[[Page 17234]]

reliability of financial disclosures for an issuer that is not
consistently subject to the ICFR auditor attestation requirement.
---------------------------------------------------------------------------

\643\ See Table 16 of the Proposing Release, note 4 above.
---------------------------------------------------------------------------

On the other hand, the analysis in the Proposing Release also
illustrated that a lower exit threshold is associated with a greater
number of issuers remaining in a particular category despite falling
below the entry threshold. For example, exit thresholds set at 60
percent of the public float entry thresholds would have prevented four
to six percent of the new entrants into a filer status from exiting
that status despite being below the entry threshold in the next two
years. A low exit threshold can thus risk having a filer status
effectively apply to a broader group of issuers than intended.
The analysis in the Proposing Release further demonstrated that the
balance between limiting filer status volatility while enabling filer
status mobility provided by an exit threshold of 80 percent is similar
around a $250 million, $75 million, and $700 million market
capitalization. In particular, while five to six percent of the new
entrants into a filer status would be expected to transition out and
back into the status in the following two years, one to two percent of
those entrants would be expected to remain within the same filer status
despite being below the entry threshold for the two following years. We
therefore expect the increase in the public float thresholds to exit
accelerated and large accelerated filer status to $60 and $560 million,
or 80 percent of the entry threshold in each case, to lead to a similar
tradeoff in these factors as the 80 percent public float threshold to
re-enter SRC status.
One commenter noted that certain of the affected issuers may
recognize revenues unevenly across periods due to certain collaborative
arrangements.\644\ When considering issuers that have empirically
crossed a $100 million revenue entry threshold in the past, the
analysis in the Proposing Release demonstrated that, on average, these
issuers would not be subject to significant volatility in
classification. Thus, while some issuers may be subject to such
volatility,\645\ this does not appear to be a widespread concern. In
fact, the analysis in the Proposing Release demonstrated that revenue
is on average more stable than market capitalization, so the 80 percent
threshold in the revenue test for exiting accelerated and large
accelerated filer status is expected to provide a lower degree of filer
status fluctuations for a comparable degree of filer status mobility.
Overall, we expect the amended transition thresholds to provide a
tradeoff between filer status mobility and volatility that is
consistent with the tradeoff provided by the recently revised SRC
transition provisions.
---------------------------------------------------------------------------

\644\ See letter from EY.
\645\ Issuers that expect significant volatility in their
classification could consider voluntarily obtaining an ICFR auditor
attestation in years where one is not required, given that
commenters suggested that there would be no significant cost savings
from obtaining an ICFR auditor attestation every three years as
opposed to annually. See, e.g., letters from Crowe and KPMG.
---------------------------------------------------------------------------

d. Disclosure
The amendments add a check box to the cover pages of Forms 10-K,
20-F, and 40-F to indicate whether an ICFR auditor attestation is
included in the filing. While filer status is reported prominently on
the cover page of annual reports for most issuers, there is currently
not similarly prominent disclosure of whether an ICFR auditor
attestation is provided. Such disclosure has been recommended by the
GAO,\646\ as well as some commenters.\647\
---------------------------------------------------------------------------

\646\ See 2013 GAO Study, note 246 above.
\647\ See, e.g., letters from CAQ, CFA Inst., CII, Grant
Thornton, and KPMG.
---------------------------------------------------------------------------

Investors can already ascertain whether an ICFR auditor attestation
is included by searching within an issuer's annual report, and
including additional items on the annual report cover page could
marginally decrease the salience of each item already reported there.
However, several commenters noted that it is currently difficult for
investors to easily determine whether an issuer's filing includes an
ICFR auditor attestation.\648\ The cover page check box disclosure
requirement will make it easier for investors to identify issuers that
undergo an ICFR auditor attestation with only minimal additional
disclosure expense for registrants. This may, on the margin, increase
the efficiency of investment decisions and the allocation of capital
across the market. It may also enhance the value to issuers of pursuing
an ICFR auditor attestation, even when one is not required, by making
it more likely that investors recognize that an issuer has obtained an
ICFR auditor attestation and therefore account for this factor in their
investment decisions. While issuers that voluntarily obtain an ICFR
auditor attestation would bear additional costs to do so, we expect
they would voluntarily bear these costs only if they believe that the
associated issuer-level benefits (e.g., a reduced cost of capital)
would more than offset those costs. Thus, to the extent that more
prominent disclosure would enhance these benefits, it may be a positive
factor in the decision of additional firms to voluntarily obtain an
ICFR auditor attestation. Such voluntary action by some of the issuers
for which the requirement will be eliminated could, as discussed above,
mitigate some of the potential negative effects of the amendments,
although it is difficult to predict the frequency with which voluntary
compliance might occur.
---------------------------------------------------------------------------

\648\ See, e.g., letters from CAQ, CFA Inst., and Grant
Thornton. See also 2013 GAO Study, note 246 above.
---------------------------------------------------------------------------

5. Alternatives to the Amendments
Below we consider the relative costs and benefits of reasonable
alternatives to the implementation choices in the amendments.
a. Exclude All SRCs From Accelerated Filer Category
We considered excluding all SRCs from the accelerated filer
definition, consistent with the past alignment of the SRC and non-
accelerated filer categories. This alternative would include SRCs that
meet the revenue test, as under the adopted amendments, as well as
those that have a public float of less than $250 million when initially
determining SRC status. Several commenters supported this
approach.\649\
---------------------------------------------------------------------------

\649\ See, e.g., letters from ASA, Guaranty, NAM, and Nasdaq.
---------------------------------------------------------------------------

This alternative would have several benefits, such as promoting
regulatory simplicity and reducing any frictions or confusion caused by
issuers having to make multiple determinations of their filer type.
This alternative would also expand the benefits of the amendments to
additional issuers. We estimate that 268 additional issuers \650\ would
be non-accelerated filers rather than accelerated filers under this
alternative, of which 48 are EGCs and 220 would newly be exempt from
the ICFR auditor attestation requirement under SOX Section 404(b)
(although we estimate that six of these newly exempt filers would still
be subject to the FDIC auditor attestation requirement). In the

[[Page 17235]]

Proposing Release,\651\ we performed an analysis of the audit fees of
lower-float issuers of different types and estimated an average
compliance cost savings of $415,000 per year for the additional issuers
that would be affected under this alternative, with some of these
issuers experiencing lesser or greater savings. This likely represents
a significant cost savings for issuers with less than $250 million in
public float and may thus have beneficial economic effects on
competition and capital formation. As discussed above, smaller issuers
generally bear proportionately higher compliance costs than larger
issuers. Reducing these additional issuers' costs would reduce their
overhead expenses and may enhance their ability to compete with larger
issuers. To the extent that the cost savings for the additional
affected issuers enable capital investments that would not otherwise be
made, this alternative would also lead to additional benefits in
capital formation.
---------------------------------------------------------------------------

\650\ This estimate is based on staff analysis of the number of
accelerated filers in 2018 with public float of at least $60 million
but less than $250 million and prior fiscal year revenues (or, in
the case of BDCs, investment income) of at least $100 million and
that are eligible to be SRCs (i.e., excluding ABS issuers, RICs,
BDCs, subsidiaries of non-SRCs, and FPIs filing on foreign forms or
using IFRS) or are BDCs (though we estimate that there are no BDCs
that meet these criteria). Revenue data is sourced from XBRL
filings, Compustat, and Calcbench. See note 298 above for details on
the identification of the population of accelerated filers. We note
that the incremental number of affected issuers could be higher than
this estimate because there are approximately 65 issuers for which
filer status and/or public float data are not available (and revenue
data is either unavailable or revenues are at least $100 million).
\651\ See Section III.C.6.a. of the Proposing Release, note 4
above.
---------------------------------------------------------------------------

However, we expect the costs of this alternative to be greater than
for the amendments, primarily due to the broader application of the
exemption from the ICFR auditor attestation requirement and the
diminished impact of some of the mitigating factors discussed in
Section IV.C.3. above on SRCs that meet the public float test rather
than the revenue test. In particular, we estimated in the Proposing
Release \652\ that extending the exemption from the ICFR auditor
attestation requirement to issuers that are eligible to be SRCs based
on their public float may result in an average increase in the rate of
ineffective ICFR of about 25 percentage points among these issuers,
somewhat higher than our estimate for low-revenue issuers. The analysis
in the Proposing Release \653\ also demonstrated that low public float
issuers restate their financial statements at rates comparable to
higher public float issuers, unlike low-revenue issuers, whose
restatement rates were three to nine percentage points lower than for
higher-revenue issuers of the same filer status. We therefore believe
that the proposition that low-revenue issuers may, on average, be less
susceptible to certain kinds of misstatements may not apply to the same
extent to issuers with low public float. We estimated in the Proposing
Release that the increase in restatement rates for the additional
affected issuers may be comparable to the two percentage points we
estimated for low-revenue issuers, but that, in contrast to the results
for low-revenue issuers, this would likely result in higher restatement
rates for the additional affected issuers than for the higher public
float issuers that would remain accelerated filers.
---------------------------------------------------------------------------

\652\ Id.
\653\ Id.
---------------------------------------------------------------------------

The Proposing Release also tested whether the potential adverse
impact of such a change may be mitigated by a lower empirical relevance
of financial statements for the market valuation of these issuers.
However, we did not find evidence that the market relies on financial
statements to a lesser extent for the valuation of issuers with public
float less than $250 million (as compared to issuers with a larger
public float), and so this further mitigating factor that applies to
low-revenue issuers likely does not apply equally to lower public float
issuers.
Finally, as in Section IV.C.3., we re-examined responses to the
2008-09 Survey. When asked about the net benefits of complying with SOX
Section 404, 16 percent of respondents at accelerated filers with
public float of less than $250 million claimed that the costs far
outweighed the benefits, in contrast to, as reported above, 30 percent
of respondents at accelerated filers with revenues of less than $100
million.\654\ While this survey data is somewhat dated, it provides an
indication as to the perception by executives at issuers at that time
of the relative costs and benefits of the ICFR auditor attestation
requirement. To the extent that this perception is borne out by the
actual costs and benefits of the ICFR auditor attestation requirement
for issuers that meet the SRC revenue test and for those that would
otherwise be SRCs under the public float test, this data may suggest
that low-revenue issuers would benefit more from qualifying as non-
accelerated filers than would other types of SRCs.
---------------------------------------------------------------------------

\654\ These estimates are based on staff analysis of data from
the 2008-09 Survey. The analysis considers responses pertaining to
the most recent year for which a given respondent provided a
response. We note that the rate of responses to the question about
net benefits was lower than for other questions. See 2009 SEC Staff
Study, note 304 above, and Alexander et al. 2013 Study, note 401
above, for details on the survey and analysis methodology.
---------------------------------------------------------------------------

We did not receive any comments on our analysis of the benefits and
costs of extending non-accelerated filer status to all SRCs.
b. Include or Exclude Certain Issuer Types
Alternatively, we considered approaches that would include or
exclude additional issuer types, or apply different requirements to
particular issuer types. For example, we could extend non-accelerated
filer status to other issuers with between $75 million and $700 million
in public float that meet the SRC revenue test but would not be
eligible to be SRCs because they are majority-owned subsidiaries of
non-SRCs. However, in the Proposing Release, we estimated that only one
majority-owned subsidiary of a non-SRC parent would meet the same
public float and revenue thresholds as the affected issuers. Given the
minimal number of such issuers and the responsibilities of the parent
of any such issuers with respect to the ICFR of their subsidiaries, we
expect the incremental costs and benefits of this alternative to be
minimal.
As discussed above, in a change from the proposal, the final
amendments also exclude BDCs from the accelerated and large accelerated
filer definitions under circumstances that are analogous to the
exclusions for other issuers under the amendments. We estimate that
approximately 28 BDCs will therefore be affected by the amendments, of
which seven are EGCs and therefore already exempt from the ICFR auditor
attestation requirement.
We recognize, as stated in the Proposing Release, that investors in
BDCs generally may place greater significance on the financial
reporting of BDCs relative to low-revenue non-investment company
issuers. However, given the small number of BDCs, it is difficult to
assess to what extent our findings with respect to the anticipated
costs and benefits of the amendments for the broader pool of affected
issuers would apply similarly to BDCs as an isolated subset of these
issuers.\655\ We note, however, that one commenter urged that we pursue
the adopted approach, stating that, among other reasons, ``[a]llowing
smaller BDCs to benefit from non-accelerated filer status, and thereby
ease regulatory costs and burdens, could encourage more BDCs to enter
the public markets, creating greater access to capital for small
operating companies and expanding investment opportunities for retail
investors.''.\656\ Given the limited

[[Page 17236]]

number of affected issuers that are BDCs, we preliminarily expect the
aggregate incremental costs and benefits of this alternative relative
to the adopted approach to be modest, as compared to the universe of
Form 10-K filers, although they could be significant for any particular
issuer and significant for traded BDCs as a class of Form 10-K filers
as we estimate the total number of traded BDC filers to be 51 (of which
seven have a market capitalization below $75 million and would be
already considered non-accelerated filers).\657\
---------------------------------------------------------------------------

\655\ While more refined analysis is difficult, we note that,
for the 54 to 75 BDCs for which a management report on ICFR is
available in Audit Analytics for years 2014 through 2017, the rate
of ineffective ICFR reported by management is 9.0 percent, the rate
of restatements is 9.8 percent, and the rate of Item 4.02
restatements is 2.3 percent on average across these years, which are
comparable to the corresponding rates for all accelerated filers
other than EGCs under the baseline. See Section IV.B.4. above.
\656\ See letter from Proskauer.
\657\ Nontraded BDCs also file on Form 10-K, but these issuers
are already non-accelerated filers because they do not have public
float.
---------------------------------------------------------------------------

We also considered alternative thresholds for BDCs, given that BDCs
do not report revenue on their financial statements. The amendments
exclude a BDC from the accelerated and large accelerated filer
definitions in Rule 12b-2 if the BDC: (1) Has a public float of $75
million or more, but less than $700 million; and (2) has investment
income of less than $100 million. Table 16 below provides statistics
from the Proposing Release on other income-related metrics for BDCs
with between $70 million and $700 million in public float.\658\
---------------------------------------------------------------------------

\658\ This analysis used market capitalization valuations as of
February 2019 to determine the set of potentially affected BDCs
under different alternatives. While this methodology is different
than the approach used by Rule 12b-2, which uses the aggregate
worldwide market value of the voting and non-voting common equity
held by non-affiliates as of the last business day of the issuer's
most recent second fiscal quarter, we do not believe that it would
substantially change our analysis. This analysis did not remove BDCs
who may qualify as non-accelerated filers based on their status as
EGCs. After identifying the set of potentially affected BDCs, our
staff manually reviewed the then-most recent Form 10-K filed on our
EDGAR system for each BDC. The affected parties estimates in Section
IV.C.1. above uses self-identified filer status to identify affected
BDCs (as well as other affected issuers), rather than using market
capitalization data for this purpose. In particular, current status
as an accelerated filer implies that the issuer's Rule 12b-2 public
float does not exceed $700 million. See above note 336. Also, the
public float of the affected BDCs was manually collected for the
purpose of related statistics in Section IV.C.1. See notes 356, 366,
and 367 above.

Table 16--Characteristics of BDCs With Market Capitalization Between $75 and $700 Million
[In millions]
----------------------------------------------------------------------------------------------------------------
Net increase in
Net realized and net assets
Market Investment income unrealized gains resulting from
capitalization as for most recent and losses for operations for
of February 2019 fiscal year most recent most recent
fiscal year fiscal year
----------------------------------------------------------------------------------------------------------------
High................................ $507.91 $108.28 $43.12 60.69
Low................................. 89.69 1.62 (-123.33) (-$114.28)
Average............................. 255.30 49.37 (-11.15) $7.70
Median.............................. 244.72 47.67 (-4.44) $13.01
----------------------------------------------------------------------------------------------------------------

The commenter that supported expanding the proposed amendment to
the definition of accelerated filer and large accelerated filer to
exclude BDCs suggested that we exclude entities with total investment
income of less than $80 million in the most recently completed fiscal
year for which audited financial statements are available and either no
public float or public float of less than $700 million. Of the 29 BDCs
identified in the Proposing Release with a market capitalization
between $75 million and $700 million, 28 had investment income of below
$100 million and 26 had investment income of below $80 million. We
therefore anticipate that the incremental costs and benefits of a
threshold of $80 million in investment income as compared to the
adopted threshold of $100 million in investment income would be
limited.
We also considered whether to require or permit BDCs to provide an
independent public accountant's report on internal controls, similar to
the one required by RICs on Form N-CEN, since both RICs and BDCs
prepare financial statements under Article 6 of Regulation S-X, in
place of the auditor attestation required by SOX Section 404(b). We
considered whether such a substitution should be permitted for all BDCs
or only required for those BDCs that would no longer be required to
provide a report under SOX Section 404(b). We do not have any data and
did not receive any public comment, however, regarding the potential
benefits and costs of using a Form N-CEN-type report on internal
controls as compared to the auditor attestation required by SOX Section
404(b).
We also considered excluding all FPIs, which are included in the
affected issuers to the extent that they meet the required thresholds
and other qualifications, from the amendments. Researchers have found
that the restatement rates of foreign issuers may be artificially
depressed due to a lower likelihood of detection and disclosure of
misstatements for these issuers.\659\ It is therefore possible that
encouraging more effective ICFR through an ICFR auditor attestation
requirement may be particularly important for such issuers. On the
other hand, because low-revenue FPIs may have similar characteristics
to low-revenue domestic issuers, including them in the group of
affected issuers may help to maintain an even playing field for
competition amongst these issuers and avoid discouraging foreign
companies from issuing securities in U.S. public markets. The
amendments attempt to strike a balance between these considerations by
allowing FPIs to avail themselves of the amendments only if they file
on domestic forms and present their financial statements pursuant to
U.S. GAAP, as well as meeting the required thresholds and other
qualifications.\660\ Because of limitations in the availability of data
such as filing status or public float for many FPIs, we are unable to
reliably measure the potential effects for this subset of issuers.
Commenters did not provide data that would allow us to further analyze
the potential effects for these issuers.
---------------------------------------------------------------------------

\659\ See, e.g., Suraj Srinivasan, Aida Sijamic Wahid, & Gwen
Yu, Admitting Mistakes: Home Country Effect on the Reliability of
Restatement Reporting, 90(3) Acct. Rev. 1201 (2015).
\660\ While we currently estimate that no FPIs would currently
qualify based on these requirements, we note that there are FPIs
that otherwise meet the required thresholds and other qualifications
and that might choose to file on domestic forms using U.S. GAAP in
order to benefit from the amendments as well as the scaled
disclosure accommodations available to SRCs if these benefits
outweigh the costs of changing their disclosure regime.
---------------------------------------------------------------------------

c. Alternative Threshold
We considered alternative levels at which a revenue threshold could
be set. A $100 million dollar revenue threshold

[[Page 17237]]

was recommended, in conjunction with a public float threshold, for the
accelerated filer definition as well as the SRC definition by the 2017
Small Business Forum and a participant at the September 2017 meeting of
the former Advisory Committee on Small and Emerging Companies
(``ACSEC'').\661\ The $100 million threshold is also aligned with the
SRC revenue test. Empirically, we find no obvious break in the
distribution of revenue or in the results of our analysis. In general,
lowering the revenue threshold would reduce the expected benefits of
the amendments by reducing the number of issuers that would experience
cost savings, while also reducing the expected costs of the amendments
by reducing the potential adverse impact on the reliability of
financial statements. Increasing the threshold would increase the
expected benefits while also increasing the expected costs. We did not
receive comments on the costs or benefits of alternative levels of a
revenue threshold or of alternative metrics that should be used instead
of revenue (except in the case of BDCs, as discussed above).
---------------------------------------------------------------------------

\661\ See Final Report of the 2017 SEC Government Business Forum
on Small Business Capital Formation (Mar. 2018), available at
https://www.sec.gov/files/gbfor36.pdf; and William J. Newell,
Presentation at the ACSEC Meeting, Sarbanes-Oxley Section 404(b):
Costs of Compliance and Proposed Reforms, (Sept. 13, 2017),
available at https://www.sec.gov/info/smallbus/acsec/william-newell-acsec091317.pdf.
---------------------------------------------------------------------------

V. Paperwork Reduction Act

A. Summary of the Collections of Information

Certain provisions of our rules and forms that would be affected by
the amendments contain ``collection of information'' requirements
within the meaning of the Paperwork Reduction Act (``PRA''). The
Commission published a notice requesting comment on the collection of
information requirements in the Proposing Release, and submitted the
proposed amendments to the Office of Management and Budget (``OMB'')
for review in accordance with the PRA.\662\ While several commenters
provided comments on the possible costs of the proposed
amendments,\663\ no commenters specifically addressed our PRA analysis.
Where appropriate, we have revised our burden estimates after
considering these comments as well as differences between the proposed
and final rules.
---------------------------------------------------------------------------

\662\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.
\663\ See, e.g., letters from Ardelyx Presentation, Cerecor,
CFA, CFA Inst., CII, Concert, Corvus, Guaranty, ICBA, Nasdaq,
Pieris, Prof. Barth et al., Prof. Ge et al., Summit, Syros, and
Terra Tech.
---------------------------------------------------------------------------

The hours and costs associated with preparing and filing the forms
and reports constitute reporting and cost burdens imposed by each
collection of information. An agency may not conduct or sponsor, and a
person is not required to respond to, a collection of information
requirement unless it displays a currently valid OMB control number.
Compliance with the information collections is mandatory. Responses to
the information collections are not kept confidential and there is no
mandatory retention period for the information disclosed. The titles
for the affected collections of information are:
``Form 10-K'' (OMB Control No. 3235-0063); \664\ and
---------------------------------------------------------------------------

\664\ The paperwork burden from 17 CFR 240.12b-1 through
240.12b-37 (``Regulation 12B'') is imposed through the forms that
are subject to the requirements in that regulation and is reflected
in the analyses of those forms. Our estimate for Forms 10-K takes
into account the burden that will be incurred by including the
disclosure in the applicable annual report. After the Proposing
Release, note 4 above, was issued, the Office of Management and
Budget (``OMB'') discontinued the OMB control number for Regulation
12B, so that the PRA inventory would not reflect duplicative
burdens.
---------------------------------------------------------------------------

``Form 10-Q'' \665\ (OMB Control No. 3235-0070).\666\
---------------------------------------------------------------------------

\665\ 17 CFR 249.308a.
\666\ The only revision to this form will be changing filing
deadlines, which will neither increase nor decrease the burden hours
necessary to prepare the filing because there will be no change to
the amount of information required in the filing.
---------------------------------------------------------------------------

The regulation and forms listed above were adopted under the
Exchange Act. The regulation and forms set forth the disclosure
requirements for periodic reports filed by registrants to help
investors make informed investment decisions. A description of the
final amendments, including the need for the information and its use,
as well as a description of the likely respondents, can be found in
Section II above, and a discussion of the economic effects of the final
amendments can be found in Section IV above.

B. Burden and Cost Estimates Related to the Final Amendments

We estimate that the final amendments will result in approximately
527 additional issuers being classified as non-accelerated filers.\667\
Accelerated filers are subject to the ICFR auditor attestation
requirement and shorter deadlines for filing their Exchange Act
periodic reports.\668\ Additionally, accelerated filers must provide
disclosure regarding the availability of their filings and the
disclosure required by Item 1B of Form 10-K and Item 4A of Form 20-F
about unresolved staff comments on their periodic and/or current
reports.\669\
---------------------------------------------------------------------------

\667\ See Section IV.C.1. above. We estimate that there are no
FPIs that file on domestic forms and present their financial
statements pursuant to U.S. GAAP that would meet the required
thresholds and other qualifications of the amendments. However,
there are an estimated 31 FPIs that file on forms only available to
FPIs, but otherwise meet the required thresholds and other
qualifications. In the Proposing Release, note 4 above, we included
FPIs that file the forms available only to FPIs, but otherwise meet
the required thresholds and other qualifications, in the number of
affected issuers. While these issuers could become subject to the
amendments by changing their reporting regime, it is difficult to
predict how many would do so, as a result, we do not include them in
the number of affected issuers in this release. Accordingly, we do
not estimate any effect on the collections of information
corresponding to Forms 20-F or 40-F.
\668\ See Section II.A. above.
\669\ See note 25 above.
---------------------------------------------------------------------------

1. ICFR Auditor Attestation Requirement
We believe that expanding the exemption from the ICFR auditor
attestation requirement would reduce the PRA burden for 373 of the 527
affected issuers.\670\ An ICFR auditor attestation is required only in
annual reports. Table 17, below, shows the estimated number of affected
issuers that are subject to the ICFR auditor attestation requirement
that file on each of these forms and the average estimated audit-fee
and non-audit costs, as described above,\671\ to comply with the ICFR
auditor attestation requirement.
---------------------------------------------------------------------------

\670\ We estimate that the remaining 154 of the 527 affected
issuers are EGCs, which are not required to comply with the ICFR
auditor attestation requirement under SOX Section 404(b). See
Section IV.C.1. above. In addition to the 154 EGCs, we estimate that
a further 78 of the 527 affected issuers are currently also subject
to the FDIC's auditor attestation requirement. See Section 18A of
Appendix A to FDIC Rule 363. These issuers would continue to incur
burden hours and costs associated with an auditor attestation
requirement even under the final amendments. However, the FDIC's
auditor attestation requirement is not part of our rules. For
purposes of considering the PRA effects of the final amendments,
therefore, we have reduced the burden hours and costs for these 78
issuers as we would for the other affected issuers that are not
EGCs.
\671\ See Sections IV.C.3. and IV.C.5. above.

[[Page 17238]]

Table 17--Estimated Annual Costs Per Issuer of ICFR Auditor Attestation Requirement for Specified Forms
----------------------------------------------------------------------------------------------------------------
Number of
Form type affected Audit-fee costs Non-audit costs
issuers per issuer per issuer
----------------------------------------------------------------------------------------------------------------
Form 10-K.................................................... 373 $110,000 $100,000
----------------------------------------------------------------------------------------------------------------

Because these issuers would no longer be subject to the ICFR
auditor attestation requirement under the final amendments, they would
no longer incur these costs. For purposes of the PRA, this reduction in
total burden is to be allocated between a reduction in internal burden
hours and a reduction in outside professional costs. Table 18, below,
sets forth the percentage estimates we typically use for the burden
allocation for each form.

Table 18--Standard Estimated Burden Allocation for Specified Forms
------------------------------------------------------------------------
Outside
Form type Internal professionals
(%) (%)
------------------------------------------------------------------------
Form 10-K................................ 75 25
------------------------------------------------------------------------

For the $100,000 reduction in annual non-audit costs,\672\ we
allocate the burden based on the percentages in Table 18 above.
However, we believe that 100 percent of the $110,000 annual burden
reduction for audit-fee costs related to the ICFR auditor attestation
requirement should be ascribed to outside professional costs because
that amount is an estimate of fees paid to the independent auditor
conducting the ICFR attestation audit. Table 19, below, shows the
resulting estimated reduction in cost per issuer associated with
outside professionals.
---------------------------------------------------------------------------

\672\ As discussed in Section IV.C.3, above, in deriving this
estimate of the reduction in non-audit costs, we have looked to
outside vendor and internal labor costs, and not to non-labor costs,
because we believe that those non-labor costs (such as software,
hardware, and travel costs) are primarily attributable to
management's ICFR responsibilities under SOX Section 404(a) and thus
would continue to be incurred. To the extent elimination of the
auditor attestation requirement also results in a reduction in
management's time burden, we believe this reduction generally would
be captured by the estimated $100,000 reduction, as this amount
reflects an overall reduction in non-audit costs.

Table 19--Estimated Reduction in Outside Professional Costs From Elimination of ICFR Auditor Attestation Requirement
--------------------------------------------------------------------------------------------------------------------------------------------------------
Total outside
Outside Outside professional Total reduction
professional professional costs per Number of in outside
Issuer type (form used) costs per costs per issuer (non- affected professional
issuer (non- issuer (audit audit + audit issuers costs
audit) fees) fees)
[A] [B] [C] [D] [E] (D x E)
[F]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Form 10-K.......................................................... $25,000 $110,000 $135,000 373 $50,355,000
--------------------------------------------------------------------------------------------------------------------------------------------------------

For PRA purposes, an issuer's internal burden is estimated in
internal burden hours. We are, therefore, converting the internal
portions of the non-audit costs to burden hours. These activities would
mostly be performed by a number of different employees with different
levels of knowledge, expertise, and responsibility. We believe these
internal labor costs will be less than the $400 per hour figure we
typically use for outside professionals retained by the issuer.
Therefore, we use an average rate of $200 per hour to estimate an
issuer's internal non-audit labor costs. Table 20, below, shows the
resulting estimated reduction in internal burden hours from the
elimination of the ICFR auditor attestation requirement.

Table 20--Estimated Reduction in Internal Burden Hours From Elimination of ICFR Auditor Attestation Requirement
----------------------------------------------------------------------------------------------------------------
Internal cost Number of Total reduction
Issuer type (form used) per issuer (non- Burden hours affected in internal
audit) per issuer issuers burden hours
[A] [B] (B/$200) [D] (C x D)
[C] [E]
----------------------------------------------------------------------------------------------------------------
Form 10-K................................... $75,000 375 373 139,875
----------------------------------------------------------------------------------------------------------------

2. Filing Deadlines, Disclosure Regarding Filing Availability, and
Unresolved Staff Comments
As the Commission has recognized previously, changing filing
deadlines neither increases nor decreases the burden hours necessary to
prepare the filing because there is no change to the amount of
information required in the

[[Page 17239]]

filing.\673\ Therefore, we do not believe that the change to the filing
deadlines will affect an issuer's burden hours or costs for PRA
purposes.
---------------------------------------------------------------------------

\673\ Revisions to Accelerated Filer Definition and Accelerated
Deadlines for Filing Periodic Reports, Release No. 33-8644 (Dec. 21,
2005) [70 FR 76634 (Dec. 27, 2005)].
---------------------------------------------------------------------------

We believe that eliminating the requirements to provide disclosure
regarding the availability of their filings and the disclosure required
by Item 1B of Form 10-K and Item 4A of Form 20-F about unresolved staff
comments on their periodic and/or current reports will reduce their
burden hours and costs, but we do not expect that reduction to be
significant. For purposes of the PRA, we estimate the reduction to be
approximately one hour for each affected issuer.\674\ However, as
opposed to the burden reduction resulting from the elimination of the
ICFR auditor attestation requirement, which would apply only to 373 of
the 527 total affected issuers that are not EGCs, the burden reduction
from eliminating these disclosure requirements will apply to all the
527 affected issuers, including the 154 affected issuers that are EGCs.
That reduction is allocated by form as shown in Table 21, below.
---------------------------------------------------------------------------

\674\ We believe that this one-hour reduction will be solely for
an issuer's internal burden hours.

Table 21--Estimated Reduction in Internal Burden Hours per Issuer From Elimination of Disclosure Requirements
Regarding Filing Availability and Unresolved Staff Comments
----------------------------------------------------------------------------------------------------------------
Number of Reduction in
Form type Burden hours affected internal burden
per issuer issuers hours
[A] [B] [C] (B x C)
[D]
----------------------------------------------------------------------------------------------------------------
Form 10-K.................................................... 1 527 527
----------------------------------------------------------------------------------------------------------------

3. Check Box Disclosure
In a change from the proposed amendments, the final amendments add
a check box to the cover pages of their annual reports on Forms 10-K,
20-F, and 40-F for issuers to indicate that they included an ICFR
auditor attestation in the filing. In addition, if the issuer is
otherwise required to tag cover page disclosure data using Inline XBRL,
it must also to tag the cover page check box disclosure using Inline
XBRL. Issuers must already determine whether they are subject to the
ICFR auditor attestation requirement, so requiring issuers to add a
check box to the cover pages of their annual reports on Forms 10-K, 20-
F, and 40-F, and check that box if they provide the ICFR auditor
attestation, will not substantively modify existing collection of
information requirements or otherwise affect the overall burden
estimates associated with these forms. Therefore, we are not adjusting
any burden or cost estimates in connection with the check box
requirement in the final amendments
4. Total Burden Reduction
Table 22, below, shows the total estimated reduction in internal
burden hours and outside professional costs for all aspects of the
final amendments.

Table 22--Requested Paperwork Burden Under the Final Amendments
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Current burden Burden change
------------------------------------------------------------------------------------------------------------------------------------------------
Change in Change in
Current company company hours Change in Burden hours Cost burden for
annual Current Current cost hours from from disclosure Total change in professional for affected affected
responses burden hours burden auditor requirement company hours costs responses responses
attestation Elimination
(A) (B) (C) (D) (E) (F) = (D) + (E) (G) (H) = (B) + (I) = (C) + (G)
(F)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
10-K........................................... 8,137 14,198,780 $1,895,224,719 (139,875) (527) (140,402) ($50,355,000) 14,058,378 $1,844,869,719
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

VI. Regulatory Flexibility Act Analysis

The Regulatory Flexibility Act (``RFA'') \675\ requires the
Commission, in promulgating rules under Section 553 of the
Administrative Procedure Act,\676\ to consider the impact of those
rules on small entities. We have prepared this Final Regulatory
Flexibility Analysis (``FRFA'') in accordance with Section 604 of the
RFA.\677\ This FRFA relates to the amendments to the accelerated filer
and large accelerated filer definitions in Rule 12b-2 under the
Exchange Act and the addition of a check box to the cover pages of
Forms 10-K, 20-F, and 40-F to indicate whether an ICFR auditor
attestation is included in the filing. An Initial Regulatory
Flexibility Analysis (``IRFA'') was prepared in accordance with the RFA
and was included in the Proposing Release.
---------------------------------------------------------------------------

\675\ 5 U.S.C. 601 et seq.
\676\ 5 U.S.C. 553.
\677\ 5 U.S.C. 604.
---------------------------------------------------------------------------

A. Need for, and Objectives of, the Final Amendments

The purpose of the amendments to the accelerated filer and large
accelerated filer definitions in Rule 12b-2 is to promote capital
formation by more appropriately tailoring the types of issuers that are
included in the category of accelerated filers and revising the
transition thresholds for accelerated and large accelerated filers. The
addition of the check box to the cover pages of Forms 10-K, 20-F, and
40-F is intended to provide more prominent and easily accessible
disclosure of this information for investors and market participants
while imposing only minimal burdens on issuers. The need for, and
objectives of, the amendments are discussed in more detail in Sections
I and II above.

B. Significant Issues Raised by Public Comments

In the Proposing Release, we requested comment on all aspects of
the

[[Page 17240]]

IRFA, including the number of small entities that would be affected by
the proposed amendments, the existence or nature of the potential
impact of the proposals on small entities discussed in the analysis,
and how to quantify the impact of the proposed amendments. We did not
receive any comments specifically addressing the IRFA. However, we
received a number of comments on the proposed amendments,
generally,\678\ and have considered all of these comments in developing
the FRFA because the final amendments are focused on smaller issuers.
---------------------------------------------------------------------------

\678\ See Section II.B.2. above.
---------------------------------------------------------------------------

We believe that the final amendments will reduce disclosure burdens
by expanding the number of registrants that will no longer qualify as
accelerated or large accelerated filers, which will eliminate the ICFR
auditor attestation requirement for those issuers, while maintaining
investor protections.

C. Small Entities Subject to the Amendments

The final amendments will affect some registrants that are small
entities. The RFA defines ``small entity'' to mean ``small business,''
``small organization,'' or ``small governmental jurisdiction.'' \679\
For purposes of the RFA, under our rules, an issuer, other than an
investment company, is a ``small business'' or ``small organization''
if it had total assets of $5 million or less on the last day of its
most recent fiscal year.\680\
---------------------------------------------------------------------------

\679\ 5 U.S.C. 601(6).
\680\ See 17 CFR 240.0-10(a) under the Exchange Act.
---------------------------------------------------------------------------

We estimate that there are 1,171 issuers that file with the
Commission, other than investment companies, which may be considered
small entities and are potentially subject to the final
amendments.\681\ Investment companies, which include BDCs, qualify as
small entities if, together with other investment companies in the same
group of related investment companies, they have net assets of $50
million or less as of the end of their most recent fiscal year.\682\
Commission staff estimates that, as of June 2019, approximately 16 BDCs
are small entities.\683\ We believe it is likely that virtually all
issuers that would be considered small businesses or small
organizations, as defined in our rules, are already non-accelerated
filers and would continue to be encompassed within that category. To
the extent any such issuers are not already non-accelerated filers, we
believe it is likely that the final amendments will capture those
entities.
---------------------------------------------------------------------------

\681\ This estimate is based on staff analysis of issuers,
excluding co-registrants, with EDGAR filings of Form 10-K, 20-F and
40-F, or amendments, filed during the calendar year of January 1,
2018 to December 31, 2018. This analysis is based on data from XBRL
filings, Compustat, and Ives Group Audit Analytics.
\682\ 17 CFR 270.0-10(a).
\683\ These estimates are based on staff analysis of Morningstar
data and data submitted by investment company registrants in forms
filed on EDGAR as of June 2019.
---------------------------------------------------------------------------

D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements

As noted above, the final amendments will reduce the number of
accelerated and large accelerated filers, which will reduce the
compliance burden for those issuers, some of which may be small
entities, because they would no longer have to satisfy the ICFR auditor
attestation requirement, comply with accelerated deadlines for filing
their Exchange Act periodic reports, provide disclosure regarding the
availability of their filings, or provide disclosure required by Item
1B of Form 10-K and Item 4A of Form 20-F about unresolved staff
comments on their periodic and/or current reports.\684\ The ICFR
auditor attestation requirement applies only to accelerated and large
accelerated filers, and most small entities would not qualify for
either filer status. Compliance with certain rules affected by the
amendments require the use of professional skills, including accounting
and legal skills. The final amendments are discussed in detail in
Sections I and II above. We discuss the economic effect including the
estimated costs and burdens, of the final amendments on all
registrants, including small entities, in Section IV above.
---------------------------------------------------------------------------

\684\ The amendments to include a check box on Forms 10-K, 20-F,
and 40-F are not expected to affect the overall burden estimates
associated with these forms. See Section V.C.3. above.
---------------------------------------------------------------------------

E. Agency Action To Minimize Effect on Small Entities

The RFA directs us to consider alternatives that would accomplish
our stated objectives, while minimizing any significant adverse effect
on small entities. Accordingly, we considered the following
alternatives:
Establishing different compliance or reporting
requirements or timetables that take into account the resources
available to small entities;
Clarifying, consolidating or simplifying compliance and
reporting requirements for small entities under our rules as revised by
the amendments;
Using performance rather than design standards; and
Exempting small entities from coverage of all or part of
the amendments.
We do not believe that establishing different compliance or
reporting obligations in conjunction with the final amendments is
necessary. The final amendments would not impose any significant new
compliance obligations. In fact, the final amendments would reduce the
compliance obligations of affected issuers by increasing the number of
issuers, including small entities, that are subject to the different,
less burdensome, compliance and reporting obligations for non-
accelerated filers. Similarly, because the final amendments would
reduce the burdens for these issuers, we do not believe it is
appropriate to exempt small entities from all or part of the proposed
amendments.
We believe that some of the issuers that would become eligible to
be non-accelerated filers under the final amendments may be smaller
entities. Therefore, to the extent that any small entities would become
newly eligible for non-accelerated filer status under the final
amendments, their compliance and reporting requirements would be
further simplified. We note in this regard that the Commission's
existing disclosure requirements provide for scaled disclosure
requirements and other accommodations for small entities, and the final
amendments would not alter these existing accommodations.
The check box requirement should not affect small entities unless
they voluntarily choose to comply with the ICFR auditor attestation
requirements. Further, we note that the compliance burden associated
with the check box is expected to be minimal, and establishing a
different compliance requirement, providing additional clarification of
the requirement, or exempting a small entity would not, therefore, have
a meaningful impact on the small entity.
Finally, with respect to the use of performance rather than design
standards, because the final amendments are not expected to have any
significant adverse effect on small entities (and may, in fact, relieve
burdens for some such entities), we do not believe it is necessary to
use performance standards in connection with this rulemaking.

Statutory Authority and Text of Rule Amendments

The rule amendments described in this release are being adopted
pursuant to Sections 7, 10, 19(a), and 28 of the Securities Act, as
amended, and Sections 3(b), 12, 13, 15(d), and 23(a) of the Exchange
Act, as amended.

[[Page 17241]]

List of Subjects in 17 CFR Part 229, 230, 240, and 249

Reporting and recordkeeping requirements, Securities.

For the reasons set out in the preamble, the Commission amends
title 17, chapter II of the Code of Federal Regulations as follows:

PART 229--STANDARD INSTRUCTIONS FOR FILING FORMS UNDER SECURITIES
ACT OF 1933, SECURITIES EXCHANGE ACT OF 1934, AND ENERGY POLICY AND
CONSERVATION ACT OF 1975--REGULATION S-K

0
1. The authority citation for part 229 continues to read as follows:

Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 77k, 77s, 77z-2,
77z-3, 77aa(25), 77aa(26), 77ddd, 77eee, 77ggg, 77hhh, 77iii, 77jjj,
77nnn, 77sss, 78c, 78i, 78j, 78j-3, 78l, 78m, 78n, 78n-1, 78o, 78u-
5, 78w, 78ll, 78mm, 80a-8, 80a-9, 80a-20, 80a-29, 80a-30, 80a-31(c),
80a-37, 80a-38(a), 80a-39, 80b-11, and 7201 et seq.; 18 U.S.C. 1350;
sec. 953(b), Pub. L. 11-203, 124 Stat. 1904 (2010); and sec. 102(c),
Pub. L. 112-106, 126 Stat. 310 (2012).
* * * * *

0
2. Amend Sec. 229.10 by adding Instruction 2 to paragraph (f) to read
as follows:

Sec. 229.10 (Item 10) General.

* * * * *
(f) * * *
Instruction 2 to paragraph (f): A foreign private issuer is not
eligible to use the requirements for smaller reporting companies unless
it uses the forms and rules designated for domestic issuers and
provides financial statements prepared in accordance with U.S.
Generally Accepted Accounting Principles.

PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

0
3. The authority citation for part 230 continues to read in part as
follows:

Authority: 15 U.S.C. 77b, 77b note, 77c, 77d, 77f, 77g, 77h,
77j, 77r, 77s, 77z-3, 77sss, 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78o-
7 note, 78t, 78w, 78ll(d), 78mm, 80a-8, 80a-24, 80a-28, 80a-29, 80a-
30, and 80a-37, and Pub. L. 112-106, sec. 201(a), sec. 401, 126
Stat. 313 (2012), unless otherwise noted.
* * * * *
Sections 230.400 to 230.499 issued under secs. 6, 8, 10, 19, 48
Stat. 78, 79, 81, and 85, as amended (15 U.S.C. 77f, 77h, 77j, and
77s).
* * * * *

0
4. Amend Sec. 230.405 by adding Instruction 2 to the definition of
``smaller reporting company'' to read as follows:

Sec. 230.405 Definitions of terms.

* * * * *
Smaller reporting company. * * *
Instruction 2 to definition of ``smaller reporting company'': A
foreign private issuer is not eligible to use the requirements for
smaller reporting companies unless it uses the forms and rules
designated for domestic issuers and provides financial statements
prepared in accordance with U.S. Generally Accepted Accounting
Principles.
* * * * *

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934

0
5. The authority citation for part 240 continues to read, in part, as
follows:

Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f,
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4,
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78dd, 78ll, 78mm,
80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, and 7201 et
seq., and 8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C.
1350; Pub. L. 111-203, 939A, 124 Stat. 1376 (2010); and Pub. L. 112-
106, secs. 503 and 602, 126 Stat. 326 (2012), unless otherwise
noted.
* * * * *
Sections 240.12b-1 to 240.12b-36 also issued under secs. 3, 12,
13, 15, 48 Stat. 892, as amended, 894, 895, as amended; 15 U.S.C.
78c, 78l, 78m, and 78o.6.
* * * * *

0
6. Amend Sec. 240.12b-2 by:
0
a. In the definition of ``Accelerated filer and large accelerated
filer'':
0
i. Removing ``.'' at the end of paragraph (1)(iii) and adding in its
place ``; and'';
0
ii. Adding paragraph (1)(iv);
0
iii. Removing ``.'' at the end of paragraph (2)(iii) and adding in its
place ``; and'';
0
iv. Adding paragraph (2)(iv);
0
v. Revising paragraphs (3)(ii) and (3)(iii);
0
vi. Adding paragraph (4); and
0
b. Adding Instruction 2 to the definition of ``smaller reporting
company''.
The addition and revisions read as follows:

Sec. 240.12b-2 Definitions.

* * * * *
Accelerated filer and large accelerated filer--(1) * * *
(iv) The issuer is not eligible to use the requirements for smaller
reporting companies under the revenue test in paragraph (2) or
(3)(iii)(B) of the ``smaller reporting company'' definition in this
section, as applicable.
(2) * * *
(iv) The issuer is not eligible to use the requirements for smaller
reporting companies under the revenue test in paragraph (2) or
(3)(iii)(B) of the ``smaller reporting company'' definition in this
section, as applicable.
(3) * * *
(ii) Once an issuer becomes an accelerated filer, it will remain an
accelerated filer unless: The issuer determines, at the end of a fiscal
year, that the aggregate worldwide market value of the voting and non-
voting common equity held by its non-affiliates was less than $60
million, as of the last business day of the issuer's most recently
completed second fiscal quarter; or it determines that it is eligible
to use the requirements for smaller reporting companies under the
revenue test in paragraph (2) or (3)(iii)(B) of the ``smaller reporting
company'' definition in this section, as applicable. An issuer that
makes either of these determinations becomes a non-accelerated filer.
The issuer will not become an accelerated filer again unless it
subsequently meets the conditions in paragraph (1) of this definition.
(iii) Once an issuer becomes a large accelerated filer, it will
remain a large accelerated filer unless: It determines, at the end of a
fiscal year, that the aggregate worldwide market value of the voting
and non-voting common equity held by its non-affiliates (``aggregate
worldwide market value'') was less than $560 million, as of the last
business day of the issuer's most recently completed second fiscal
quarter or it determines that it is eligible to use the requirements
for smaller reporting companies under the revenue test in paragraph (2)
or (3)(iii)(B) of the ``smaller reporting company'' definition in this
section, as applicable. If the issuer's aggregate worldwide market
value was $60 million or more, but less than $560 million, as of the
last business day of the issuer's most recently completed second fiscal
quarter, and it is not eligible to use the requirements for smaller
reporting companies under the revenue test in paragraph (2) or
(3)(iii)(B) of the ``smaller reporting company'' definition in this
section, as applicable, it becomes an accelerated filer. If the
issuer's aggregate worldwide market value was less than $60 million, as
of the last business day of the issuer's most recently completed second
fiscal quarter, or it is eligible to use the requirements for smaller
reporting companies under the revenue test in paragraph (2) or
(3)(iii)(B) of the ``smaller reporting company'' definition in this
section, it becomes a non-accelerated filer. An issuer will not

[[Page 17242]]

become a large accelerated filer again unless it subsequently meets the
conditions in paragraph (2) of this definition.
* * * * *
(4) For purposes of paragraphs (1), (2), and (3) of this definition
only, a business development company is considered to be eligible to
use the requirements for smaller reporting companies under the revenue
test in paragraph (2) or (3)(iii)(B) of the ``smaller reporting
company'' definition in this section, provided that the business
development company meets the requirements of the test using annual
investment income under Rule 6-07.1 of Regulation S-X (17 CFR 210.6-
07.1) as the measure of its ``annual revenues'' for purposes of the
test.
* * * * *
Smaller reporting company. * * *
Instruction 2 to definition of ``smaller reporting company'': A
foreign private issuer is not eligible to use the requirements for
smaller reporting companies unless it uses the forms and rules
designated for domestic issuers and provides financial statements
prepared in accordance with U.S. Generally Accepted Accounting
Principles.
* * * * *

PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934

0
7. The authority citation for part 249 continues to read in part as
follows:

Authority: 15 U.S.C. 78a et seq. and 7201 et seq.; 12 U.S.C.
5461 et seq.; 18 U.S.C. 1350; Sec. 953(b), Pub. L. 111-203, 124
Stat. 1904; Sec. 102(a)(3), Pub. L. 112-106, 126 Stat. 309 (2012);
Sec. 107, Pub. L. 112-106, 126 Stat. 313 (2012), and Sec. 72001,
Pub. L. 114-94, 129 Stat. 1312 (2015), unless otherwise noted.
* * * * *
Section 249.220f is also issued under secs. 3(a), 202, 208, 302,
306(a), 401(a), 401(b), 406 and 407, Pub. L. 107-204, 116 Stat. 745.
Section 249.240f is also issued under secs. 3(a), 202, 208, 302,
306(a), 401(a), 406 and 407, Pub. L. 107-204, 116 Stat. 745.
* * * * *
Section 249.310 is also issued under secs. 3(a), 202, 208, 302,
406 and 407, Pub. L. 107-204, 116 Stat. 745.
* * * * *

0
8. Amend Form 20-F (referenced in Sec. 249.220f) by adding a field to
the cover page to include a check box indicating whether the registrant
has included an ICFR auditor attestation in the filing:

Note: The text of Form 20-F does not, and this amendment will
not, appear in the Code of Federal Regulations.

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 20-F

* * * * *
[dagger]The term ``new or revised financial accounting standard''
refers to any update issued by the Financial Accounting Standards Board
to its Accounting Standards Codification after April 5, 2012.
Indicate by check mark whether the registrant has filed a report on
and attestation to its management's assessment of the effectiveness of
its internal control over financial reporting under Section 404(b) of
the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public
accounting firm that prepared or issued its audit report. [square]
* * * * *

0
9. Amend Form 40-F (referenced in Sec. 249.240f) by adding a field to
the cover page to include a check box indicating whether the registrant
has included an ICFR auditor attestation in the filing:

Note: The text of Form 40-F does not, and this amendment will
not, appear in the Code of Federal Regulations.

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 40-F

0
10. Amend Form 10-K (referenced in Sec. 249.310) by adding a field to
the cover page to include a check box indicating whether the registrant
has included an ICFR auditor attestation in the filing:

Note: The text of Form 40-F does not, and this amendment will
not, appear in the Code of Federal Regulations.

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

* * * * *
If an emerging growth company, indicate by check mark if the
registrant has elected not to use the extended transition period for
complying with any new or revised financial accounting standards
provided pursuant to Section 13(a) of the Exchange Act. [square]
Indicate by check mark whether the registrant has filed a report on
and attestation to its management's assessment of the effectiveness of
its internal control over financial reporting under Section 404(b) of
the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public
accounting firm that prepared or issued its audit report. [square]
* * * * *

By the Commission.

Dated: March 12, 2020.
Vanessa A. Countryman,
Secretary.
[FR Doc. 2020-05546 Filed 3-25-20; 8:45 am]
BILLING CODE 8011-01-P

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.