# Amendments to the Accelerated Filer and Large Accelerated Filer Definitions > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2019-09932 ## Record - **Collection:** Federal Register - **Document type:** Proposed Rule - **Published:** May 29, 2019 - **Citation:** 84 FR 24876 ## Text SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 240 [Release No. 34-85814; File No. S7-06-19] RIN 3235-AM41 Amendments to the Accelerated Filer and Large Accelerated Filer Definitions AGENCY: Securities and Exchange Commission. ACTION: Proposed rules. SUMMARY: We are proposing amendments to the accelerated filer and large accelerated filer definitions to promote capital formation for smaller reporting issuers, 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. The proposed amendments would exclude from the accelerated and large accelerated filer definitions an issuer that is eligible to be a smaller reporting company and had annual revenues of less than $100 million in the most recent fiscal year for which audited financial statements are available. In addition, the proposed amendments would 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. Finally, the proposed amendments would add a revenue test to the transition thresholds for exiting both accelerated and large accelerated filer status. As a result of the amendments, certain low-revenue issuers would not be required to have their assessment of the effectiveness of internal control over financial reporting attested to, and reported on, by an independent auditor, although they would continue to be required to make such assessments and to establish and maintain the effectiveness of their internal control over financial reporting. DATES: Comments should be received on or before July 29, 2019. ADDRESSES: Comments may be submitted by any of the following methods: Electronic Comments • Use our internet comment form ( https://www.sec.gov/rules/proposed.shtml ); or • Send an email to rule-comments@sec.gov. Please include File No. S7-06-19 on the subject line. Paper Comments • Send paper comments to Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090. All submissions should refer to File Number S7-06-19. This file number should be included on the subject line if email is used. To help us process and review your comments more efficiently, please use only one method. We will post all comments on our internet website ( https://www.sec.gov/rules/proposed.shtml ). Comments are also available for website viewing and printing in our Public Reference Room, 100 F Street NE, Washington, DC 20549 on official business days between the hours of 10:00 a.m. and 3:00 p.m. All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make available publicly. We or the staff may add studies, memoranda, or other substantive items to the comment file during this rulemaking. A notification of the inclusion in the comment file of any such materials will be made available on our website. To ensure direct electronic receipt of such notifications, sign up through the “Stay Connected” option at www.sec.gov to receive notifications by email. FOR FURTHER INFORMATION CONTACT: John Fieldsend, Special Counsel, or Jennifer Riegel, Special Counsel, in the Division of Corporation Finance, at (202) 551-3430, U.S. Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-3628. SUPPLEMENTARY INFORMATION: We are proposing amendments to 17 CFR 12b-2 (“Rule 12b-2”) under the Securities Exchange Act of 1934 (“Exchange Act”). 1 1 15 U.S.C. 78a et seq. Table of Contents I. Introduction A. Background B. Summary of the Proposed Amendments II. Discussion of the Proposed Amendments A. Historical and Current Relationship Between the SRC and Accelerated and Large Accelerated Filer Definitions B. ICFR Requirements C. Proposed Amendments To Exclude Low-Revenue SRCs From the Accelerated and Large Accelerated Filer Definitions D. Proposed Amendments to the Transition Provisions in the Accelerated and Large Accelerated Filer Definitions E. Request for Comment III. 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. Comparison Populations 3. Potential Benefits of Eliminating the ICFR Auditor Attestation Requirement for Affected Issuers 4. Potential Costs of Eliminating the ICFR Auditor Attestation Requirement for Affected Issuers 5. Potential Benefits and Costs Related to Other Aspects of the Proposed Amendments 6. Alternatives to the Proposed Amendments D. Request for Comment IV. Paperwork Reduction Act A. Summary of the Collections of Information B. Burden and Cost Estimates Related to the Proposed Amendments 1. ICFR Auditor Attestation Requirement 2. Filing Deadlines; Disclosure Regarding Filing Availability and Unresolved Staff Comments 3. Total Burden Reduction C. Request for Comment V. Small Business Regulatory Enforcement Fairness Act VI. Initial Regulatory Flexibility Act Analysis A. Reasons for, and Objectives of, the Proposing Action B. Legal Basis C. Small Entities Subject to the Proposed Rules D. Projected Reporting, Recordkeeping, and Other Compliance Requirements E. Duplicative, Overlapping, or Conflicting Federal Rules F. Significant Alternatives G. Request for Comment VII. Statutory Authority and Text of Proposed Rule Amendments I. Introduction A. Background In 2002, the Commission introduced a reporting regime that categorized issuers subject to the Exchange Act reporting requirements as non-accelerated, accelerated, and large accelerated filers. 2 Under this regime, accelerated and large accelerated filers are subject to shorter filing deadlines for quarterly and annual reports and are subject to some disclosure 3 and other requirements that do not apply to non-accelerated filers. The only difference between the requirements for accelerated and large accelerated filers is that large accelerated filers are subject to a filing deadline for their annual reports on Form 10-K that is 15 days shorter than the deadline for accelerated filers. 4 2 See Acceleration of Periodic Report Filing Dates and Disclosure Concerning website Access to Reports, Release No. 33-8128 (Sept. 5, 2002) [67 FR 58480 (Sept. 16, 2002)]. The definitions in Rule 12b-2 are not enumerated, including the definition of “accelerated filer and large accelerated filer.” The paragraphs under the “accelerated filer and large accelerated filer” definition, however, are enumerated. Paragraph (1) defines “accelerated filer,” paragraph (2) defines “large accelerated filer,” and paragraph (3) discusses entering and exiting accelerated filer and large accelerated filer status. Also, although Rule 12b-2 defines the terms “accelerated filer” and “large accelerated filer,” it does not define the term “non-accelerated filer.” See paragraphs (1) and (2) under the “accelerated filer and large accelerated filer” definition in Rule 12b-2. If an issuer does not meet the definition of accelerated filer or large accelerated filer, it is considered a non-accelerated filer. See Table 1 in Section II.C. below for the definitions of “accelerated filer” and “large accelerated filer.” 3 Accelerated and large accelerated filers are required to provide the disclosure required by Item 1B of 17 CFR 249.310 (“Form 10-K”) and Item 4A of 17 CFR 249.220f (“Form 20-F”) about unresolved staff comments on their periodic and/or current reports. Also, accelerated and large accelerated filers are required to provide certain disclosures about whether they make filings available on or through their internet website. See 17 CFR 229.101(e)(4). 4 See Table 6 in Section III.B.1 below. A significant requirement that applies to accelerated and large accelerated filers, but not to non-accelerated filers, is the requirement that an issuer's independent auditor must attest to, and report on, management's assessment of the effectiveness of the issuer's internal control over financial reporting (“ICFR”). 5 Section 404(a) of the Sarbanes-Oxley Act (“SOX”) 6 requires almost all issuers, including smaller reporting companies (“SRCs”), that file reports pursuant to Exchange Act Section 13(a) or 15(d) to establish and maintain ICFR and have their management assess the effectiveness of their ICFR. 7 In addition, SOX Section 404(b) 8 requires those issuers to have the independent accounting firm that prepares or issues their financial statement audit report attest to, and report on, management's assessment of the effectiveness of their ICFR (“ICFR auditor attestation”). 9 SOX Section 404(c), 10 however, exempts from the ICFR auditor attestation requirement issuers that are neither large accelerated nor accelerated filers. Congress introduced the ICFR auditor attestation requirement as part of a package of regulations intended to improve the accuracy and reliability of corporate disclosures. 11 Although there are benefits to the ICFR auditor attestation requirement, there are also costs and burdens, which we discuss in more detail below. 12 5 See 17 CFR 240.13a-15(f) and 17 CFR 240.15d-15(f) (defining ICFR). 6 15 U.S.C. 7262(a). 7 See 17 CFR 240.13a-15 and 17 CFR 240.15d-15. 8 15 U.S.C. 7262(b). 9 See 15 U.S.C. 7262(b). 10 See 15 U.S.C. 7262(c). 11 See 15 U.S.C. 7262 (SOX's subheading is, “AN ACT To protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes.”). 12 See Section III.C below. Initially, the categories of issuers under the accelerated and large accelerated filer reporting regime existed separately from categories that the Commission created to provide regulatory relief to smaller entities. 13 However, in 2007, when the Commission combined its separate disclosure regime for small business issuers with the regime for larger issuers, it attempted to align the SRC and non-accelerated filer categories, to the extent feasible, to avoid unnecessary complexity. 14 As a result, an SRC generally was not an accelerated or large accelerated filer and did not have to comply with the accelerated or large accelerated filing deadlines or the ICFR auditor attestation requirement. 15 13 See, e.g., Smaller Reporting Company Regulatory Relief and Simplification, Release No. 33-8876 (Dec. 19, 2007) [73 FR 934 (Jan. 4, 2008)] (“SRC Regulatory Relief Release”) (discussing small business issuers and Regulation S-B). 14 See id. 15 In addition, an SRC also was not required to provide the disclosure required by Item 1B of Form 10-K, and a non-accelerated filer was not required to provide the disclosure required by Item 4A of Form 20-F about unresolved staff comments on its periodic and/or current reports. Further, non-accelerated filers were not required to provide certain disclosures about whether they make filings available on or through their internet website. See 17 CFR 229.101(e)(4). This alignment changed in June 2018 when the Commission adopted amendments 16 to the SRC definition 17 to expand the number of issuers that qualify for scaled disclosure accommodations. The revised SRC definition allows an issuer to use either a public float 18 test or a revenue test (“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. 19 The Commission also expanded the revenue test to include issuers with annual revenues 20 of less than $100 million if they have no public float or a public float of less than $700 million. 21 Before the amendments, the revenue test in the SRC definition applied only to issuers with no public float. In the SRC Adopting Release, the Commission estimated that raising the threshold used in the public float test and expanding the revenue test in the SRC definition would result in an additional 966 issuers being eligible for SRC status in the first year under the new definition. 22 The Commission intended the amendments to promote capital formation for smaller reporting issuers by reducing compliance costs for the newly-eligible SRCs while maintaining appropriate investor protections. 23 16 See Smaller Reporting Company Definition, Release No. 33-10513 (June 28, 2018) [83 FR 31992 (July 10, 2018)] (“SRC Adopting Release”). 17 See 17 CFR 229.10(f)(1)(i), 17 CFR 230.405 (“Rule 405”), and Rule 12b-2. 18 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 17 CFR 229.10(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. 19 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, lower threshold for issuers that did not initially qualify as an SRC. 20 Annual revenues are measured as of the most recently completed fiscal year for which audited financials are available. See 17 CFR 229.10(f)(2)(i)(B), Rule 405, and Rule 12b-2. 21 See 17 CFR 229.10(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 16 above, at 31995. The lower transition thresholds under the revenue test for an issuer that did not initially qualify as an SRC 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 17 CFR 229.10(f)(2)(iii)(B), Rule 405, and Rule 12b-2. 22 SRC Adopting Release, note 16 above, at 32005. 23 Id. 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. 24 One result of these amendments is that some issuers now are categorized as both SRCs and accelerated or large accelerated filers. 25 These issuers have some, but not all, of the benefits of scaled regulation and, in particular, are required to comply with earlier filing deadlines for annual and quarterly reports and the ICFR auditor attestation requirement. 24 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. 25 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. An issuer is eligible to be an SRC and a large accelerated filer if it: (1) Previously qualified as a large accelerated filer because its public float was $700 million or more; (2) its revenues for the most recent fiscal year were less than $100 million; and (3) its public float as of the end of the most recent second quarter is less than $560 million (or, for the first year after the new SRC rules are effective, is less than $700 million), such that it is eligible to be an SRC, but does not fall below the $500 million transition threshold necessary to exit large accelerated filer status. See SRC Adopting Release, note 16 above, at 31994 n.31 and 32001 n.128. We are proposing to revise the “large accelerated filer” definition so that an issuer that would be eligible to be an SRC under the SRC revenue test would not also qualify as a large accelerated filer. At the time of the SRC Adopting Release, as noted in that release, the Chairman directed the staff to formulate recommendations to the Commission for possible rule amendments that, if adopted, would have the effect of reducing the number of issuers that qualify as accelerated filers to promote capital formation by reducing compliance costs for certain registrants, while maintaining appropriate investor protections. 26 As part of the staff's consideration of possible amendments to recommend, the Chairman directed the staff to consider, among other things, the historical and current relationship between the SRC and accelerated filer definitions. 26 See SRC Adopting Release, note 16 above, at 32001. B. Summary of the Proposed Amendments We are proposing to amend the accelerated and large accelerated filer definitions in Rule 12b-2 to exclude any issuer that is eligible to be an SRC under the SRC revenue test. The effect of this proposal would be that such an issuer would not be subject to accelerated or large accelerated filing deadlines for its annual and quarterly reports or to the ICFR auditor attestation requirement. 27 Other issuers that are eligible to be SRCs but are not excluded from the accelerated or large accelerated filer definition would need to satisfy all of the requirements applicable to an accelerated or large accelerated filer, including the ICFR auditor attestation requirement. 27 The issuer also would not have to 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 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). Additionally, we are proposing to revise the transition provisions set forth in the “Entering and exiting accelerated filer and large accelerated filer status” section applicable to the Rule 12b-2 accelerated and large accelerated filer definitions. The proposed amendments would revise the public float transition threshold for accelerated and large accelerated filers to become a non-accelerated filer from $50 million to $60 million. Also, the proposed amendments would increase the exit threshold in the large accelerated filer transition provision from $500 million to $560 million in public float to align the SRC and large accelerated filer transition thresholds. Finally, the proposed amendments would allow an accelerated or a large accelerated filer to become a non-accelerated filer if it becomes eligible to be an SRC under the SRC revenue test. II. Discussion of the Proposed Amendments A. Historical and Current Relationship Between the SRC and Accelerated and Large Accelerated Filer Definitions Prior to the SRC amendments, the SRC category of filers generally did not overlap with either the accelerated or large accelerated filer categories. 28 In addition, the accelerated and large accelerated filer definitions explicitly excluded any issuer eligible to use the SRC accommodations. 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 29 will be both an SRC and an accelerated filer 30 if it has: 28 See SRC Adopting Release, note 16 above, at 32001. 29 As discussed in Section II.C below, the 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 25 above, some issuers that meet the “large accelerated filer” definition may be eligible to be an SRC. 30 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. EP29MY19.000 When the Commission proposed the amendments to the SRC definition, 31 it did not propose to exclude the newly-eligible SRCs from the accelerated or large accelerated filer definitions but solicited comment on this point. Some commenters recommended that the Commission increase the threshold in the accelerated filer definition to be consistent with changes to the SRC definition, 32 reduce compliance costs associated with the ICFR auditor attestation requirement, 33 and maintain uniformity across the rules. 34 31 Amendments to Smaller Reporting Company Definition, Release No. 33-10107 (June 27, 2016) [81 FR 43130 (July 1, 2016)] (“SRC Proposing Release”). 32 See, e.g., letters from Acorda Therapeutics, Inc. et al. (Aug. 23, 2016) (“Acorda, et al.” ); Advanced Medical Technology Association (Aug. 20, 2016) (“AMTA”); Biotechnology Innovation Organization, (Aug. 30, 2016) (“BIO”); Calithera Biosciences (Aug. 8, 2016) (“Calithera”); CONNECT (Aug. 4, 2016) (“CONNECT”); Corporate Governance Coalition for Investor Value (Aug. 30, 2016) (“Coalition”); Council of State Bioscience Associations (Aug. 26, 2016) (“CSBA”); Independent Community Bankers of America (Aug. 29, 2016) (“ICBA”); The Dixie Group, Inc. (July 11, 2016) (“Dixie”); MidSouth Bancorp, Inc. (Aug. 24, 2016) (“MidSouth”); Nasdaq (Aug. 30, 2016) (“Nasdaq”); National Venture Capital Association (Aug. 25, 2016) (“NVCA”); NYSE Group (July 25, 2016) (“NYSE”); and Seneca Foods Corporation (Aug. 2, 2016) (“Seneca”). However, some commenters expressed concern about amending the public float thresholds. See letters from BDO USA, LLP (Aug. 29, 2016); Center for Audit Quality and Counsel of Institutional Investors. (Aug. 30, 2016) (“CAQ/CII”); CFA Institute (Aug. 30, 2016) (“CFA”); and Ernst & Young LLP (Sept. 8, 2016) (“EY”). References to comment letters in this release refer to comments on the SRC Proposing Release, available at https://www.sec.gov/comments/s7-12-16/s71216.htm, unless otherwise specified. 33 See, e.g., letters from Acorda, et al.; AMTA; BIO; Calithera; CONNECT; Coalition; CSBA; ICBA; MidSouth; Nasdaq; NVCA; NYSE; and Seneca. 34 See BIO; Coalition; Nasdaq; NVCA; and NYSE. B. ICFR Requirements Issuer obligations with respect to internal accounting controls and ICFR derive primarily from the Foreign Corrupt Practices Act (“FCPA”), which added Section 13(b)(2)(B) to the Exchange Act; 35 SOX Sections 302 36 and 404(a); and related rules. 37 Exchange Act Section 13(b)(2)(B) requires every issuer that is required to file reports pursuant to Exchange Act Section 13(a) or 15(d) to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions are executed in accordance with management's general or specific authorization and recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles or any other criteria applicable to such statements and to maintain accountability for assets. 38 Additionally, Exchange Act Section 13(b)(2)(B) requires that the issuer's system of internal accounting controls provide reasonable assurances that access to assets is permitted only in accordance with management's general or specific authorization and that the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences. 39 35 15 U.S.C. 78m(b)(2)(B) (referring to “internal accounting controls” rather than ICFR). 36 15 U.S.C. 7241. 37 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. 38 15 U.S.C. 78m(b)(2)(B)(i)-(ii). 39 15 U.S.C. 78m(b)(2)(B)(iii)-(iv). Similarly, pursuant to SOX Section 302, the Commission adopted rules requiring the principal executive and financial officers of certain issuers filing reports pursuant to Exchange Act Section 13(a) or 15(d) to certify that, among other things, they are responsible for establishing and maintaining ICFR, have designed ICFR to ensure material information relating to the issuer and its consolidated subsidiaries is made known to such officers by others within those entities, and evaluated and reported on the effectiveness of the issuer's ICFR. 40 Also, pursuant to SOX Section 404(a), the Commission adopted rules requiring each annual report required by Exchange Act Section 13(a) or 15(d) to include a statement that it is management's responsibility to establish and maintain adequate ICFR and to provide management's assessment of the effectiveness of the issuer's ICFR. 41 Issuers must evaluate and disclose any change to their ICFR that occurred during each fiscal quarter. 42 40 See 17 CFR 240.13a-14 or 17 CFR 240.15d-14 (requiring certification) and 17 CFR 229.601(b)(31) (prescribing certification content). 41 See 17 CFR 229.308, 17 CFR 240.13a-15, 17 CFR 240.15d-15, Item 15 of Form 20-F, and Certifications 4 and 5 of Form 40-F. Effective ICFR is designed to provide reasonable assurance that an issuer's financial disclosures are reliable and prepared in accordance with U.S. Generally Accepted Accounting Principles (“U.S. GAAP”) or International Financial Reporting Standards (“IFRS”). See 17 CFR 240.13a-15(f) and 17 CFR 240.15d-15(f). Effective ICFR includes policies and procedures designed to maintain records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the issuer are being made only in accordance with authorizations of management and directors of the issuer; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the issuer's assets that could have a material effect on the financial statements. See 17 CFR 240.13a-15(f) and 17 CFR 240.15d-15(f). These controls can help prevent or detect financial misstatements, whether intentional or unintentional. Id. 42 See 17 CFR 240.13a-15(d) and 17 CFR 240.15d-15(d). See also 17 CFR 229.308(c). A registered investment company (“RIC”) must disclose in each report on Form N-CSR any change in its ICFR that has materially affected, or is reasonably likely to materially affect, its ICFR. See Item 11(b) of Form N-CSR [17 CFR 249.331; 17 CFR 274.128]. Although SOX Section 404 generally requires and directs the Commission to adopt rules regarding internal accounting controls and ICFR that apply to every issuer that is required to file reports pursuant to Exchange Act Section 13(a) or 15(d), RICs under Section 8 of the Investment Company Act of 1940 (“Investment Company Act”) 43 are specifically exempted from SOX Section 404 by SOX Section 405. 44 In addition, the Commission's rules implementing the FCPA and SOX Section 404 exempted other types of issuers, such as asset-backed securities (“ABS”) issuers, from the ICFR obligations. 45 The Commission also determined that foreign private issuers (“FPIs”) and Canadian multijurisdictional disclosure system (“MJDS”) issuers must have their management assess and report annually on the effectiveness of their ICFR as of the end of their fiscal year and evaluate and disclose any change in their ICFR that occurred during the period covered by the annual report. 46 43 15 U.S.C 80a-8. 44 15 U.S.C. 7263. Notwithstanding the exemption pursuant to SOX Section 405, RICs are required to provide the certifications pursuant to SOX Section 302 and to maintain ICFR. See 17 CFR 270.30a-2 and 270.30a-3; see also Management's Report on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports, Release No. 34-47986 (June 5, 2003) [68 FR 36635 (June 18, 2003)]. RICs that are management companies, other than small business investment companies, are also required to file a copy of their independent public accountant's report on internal controls. See Form N-CEN (17 CFR 274.101); see also Investment Company Reporting Modernization, Release No. IC-32314, notes 879-881 and accompanying text (Oct. 13, 2016) [81 FR 81870 (Nov. 18, 2016)]. Additionally, business development companies (“BDCs”) are subject to the rules adopted by the Commission to implement SOX Section 404. BDCs are a type of closed-end investment company that is not registered under the Investment Company Act and, therefore, not within the exemption provided by SOX Section 405. 45 See Asset-Backed Securities, Release No. 33-8518 (Dec. 22, 2004) [70 FR 1506, 1510 n.41 (Jan. 7, 2005)] (“ABS Release”). See also 17 CFR 240.13a-15(a) and 17 CFR 240.15d-15(a) and Instruction J to Form 10-K. 46 See Items 15(b) and (d) of Form 20-F and Certifications 4 and 5 of Form 40-F. In addition to the responsibility of the issuer's management to establish and maintain an effective internal control structure and procedures for financial reporting, the independent accounting firm that prepares or issues a financial statement audit report also helps support effective ICFR. SOX Section 404(b) requires any issuer subject to the rules the Commission adopted related to SOX Section 404(a), other than an emerging growth company (“EGC”), 47 to have the accounting firm that prepares or issues its financial statement audit report attest to, and report on, management's assessment of the effectiveness of the issuer's ICFR. Under the current Public Company Accounting Oversight Board (“PCAOB”) risk assessment standards, 48 the independent auditor for the ICFR attestation considers certain information that is similar to information it considers for purposes of the issuer's financial statement audit. SOX Section 404(c) exempts non-accelerated filers from SOX Section 404(b)'s ICFR auditor attestation requirement. 47 An EGC is defined as an issuer that had total annual gross revenues of less than $1.07 million during its most recently completed fiscal year. See Rule 405; Rule 12b-2; 15 U.S.C. 77b(a)(19); 15 U.S.C. 78c(a)(80); and Inflation Adjustments and Other Technical Amendments under Titles I and II of the JOBS Act, Release No. 33-10332 (Mar. 31, 2017) [82 FR 17545 (Apr. 12, 2017)]. Similar to other issuers, BDCs that qualify as an EGC or as a non-accelerated filer are not subject to the auditor attestation requirement in SOX Section 404(b). Unlike the Commission's SRC definition, the statutory definition of EGC does not exclude BDCs. See 15 U.S.C. 78c(80). Given the existing regulatory regime for BDCs and the context of the Jumpstart Our Business Startups (“JOBS”) Act of 2012, Public Law 112-106, Sec. 103, 126 Stat. 306 (2012), we believe that BDCs can qualify as EGCs. BDCs invest in startup companies and EGCs for which they make available significant managerial experience, and are subject to many of the disclosure and other requirements from which Title I of the JOBS Act provides exemptions, including executive compensation disclosure, say-on-pay votes, management discussion and analysis, and SOX Section 404(b). 48 See PCAOB Accounting Standard (“AS”) 2110, Identifying and Assessing Risks of Material Misstatement, paragraphs .18-.40. The ICFR auditor attestation requirement is intended to enhance the reliability of management's disclosure related to ICFR. It also may help an issuer identify and disclose a significant deficiency or material weakness in ICFR that had not been identified or properly characterized by management. 49 In response to the SRC Proposing Release, some commenters indicated that the ICFR auditor attestation requirement strengthens the quality and reliability of issuers' ICFR, which enhances investor protection. 50 At the same time, the ICFR auditor attestation requirement is associated with certain costs that may be significant, particularly for low-revenue issuers. In response to the SRC Proposing Release, several commenters indicated that this requirement is the most costly aspect of being an accelerated filer 51 and that audit fees and other costs associated with the ICFR auditor attestation requirement can divert capital from core business needs. 52 Some commenters asserted that these costs are especially burdensome for emerging and growing biotechnology issuers, 53 with a few of these commenters specifying that the costs of the requirement represent over $1 million of capital diversion from such issuers. 54 49 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 97-99 and 102-104 (Apr. 2011) (“2011 SEC Staff Study”), available at https://www.sec.gov/news/studies/2011/404bfloat-study.pdf. 50 See, e.g., letters from CAQ, CFA, and Deloitte (Aug. 23, 2016). 51 See, e.g., letters from Acorda et al., AMTA, BIO, Calithera, Coalition, CONNECT, CSBA, Dixie, and Seneca. One commenter estimated that it will spend more than $400,000 annually on compliance with SOX Section 404(b) upon expiration of its EGC status. See letter from Calithera. Another commenter estimated that relief from SOX Section 404(b) would result in a 35% reduction in compliance costs. See letter from Seneca. 52 See, e.g., letters from Acorda et al., BIO, CSBA, ICBA, and NVCA. One commenter stated that expanding relief from the ICFR auditor attestation requirement to issuers with a public float of less than $250 million would encourage capital formation because the reduced audit and disclosure requirements may encourage companies that have been hesitant to go public to do so. See letter from ICBA (citing a 2005 ICBA study that estimated that audit fees for publicly held bank holding companies would drop dramatically—some by as much as 50%—if these companies were exempted from the ICFR auditor attestation requirement). 53 See, e.g., letters from Acorda et al., BIO, CONNECT, CSBA, and Seneca. 54 See, e.g., letters from Acorda et al. and CONNECT. C. Proposed Amendments To Exclude Low-Revenue SRCs From the Accelerated and Large Accelerated Filer Definitions We are proposing amendments to revise the accelerated and large accelerated filer definitions to exclude from those definitions issuers that are eligible to be an SRC under the SRC revenue test. Permitting these issuers to avoid the burdens of being an accelerated or large accelerated filer may enhance their ability to preserve capital without significantly affecting the ability of investors to make informed investment decisions based on the financial reporting of those issuers. Additionally, the benefits of having those issuers comply with the accelerated and large accelerated filer requirements may be more limited than for other issuers. Further, the proposed amendments are targeted at issuers whose representation in public markets has decreased over the years, and may be a positive factor in the decision of additional companies to register their offering or a class of their securities, which would provide an increased level of transparency and investor protection with respect to those companies. As discussed below, 55 the number of issuers listed on major exchanges with market capitalizations below $700 million decreased by about 65%, 56 and the number of listed issuers with less than $100 million in revenue decreased by about 60% 57 from 1998 to 2017. The issuers targeted by the proposed amendments would not incur the cost of the ICFR attestation until they exceed the SRC revenue test. 55 See Section III.C.1 below. 56 This figure is based on staff analysis of data from the Center for Research in Security Prices database for December 1998 versus December 2018. The estimates exclude RICs and issuers of American depositary receipts (“ADRs”). 57 This figure 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 estimates exclude RICs and issuers of ADRs. Under the existing accelerated filer definition in Rule 12b-2, an issuer must satisfy three conditions to be an accelerated filer. First, the issuer must have 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. Second, the issuer must have been subject to the requirements of Exchange Act Section 13(a) or 15(d) for a period of at least twelve calendar months. Third, the issuer must have filed at least one annual report pursuant to those same Exchange Act sections. Similarly, to be a large accelerated filer, an issuer must meet the second and third conditions just described and have a public float of $700 million or more as of the same measurement date. 58 We are proposing to add a new condition to the definitions of accelerated filer and large accelerated filer that would exclude from those definitions an issuer eligible to be an SRC under the SRC revenue test. 59 58 See the large accelerated filer definition in Rule 12b-2. 59 See proposed subparagraph (1)(iv) of the definition of accelerated filer and proposed subparagraph (2)(iv) of the definition of large accelerated filer in Rule 12b-2. The table below summarizes the current and proposed conditions to be considered an accelerated and large accelerated filer under Rule 12b-2. Table 1—Current and Proposed Accelerated Filer and Large Accelerated Filer Conditions Current accelerated filer conditions Proposed 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 Same. 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 Same. The issuer has filed at least one annual report pursuant Exchange Act Section 13(a) or 15(d) Same. The issuer is not eligible to use the requirements for SRCs under the revenue test in paragraphs (2) or (3)(iii)(B), as applicable, of the “smaller reporting company” definition in Rule 12b-2. Current large accelerated filer conditions Proposed large accelerated filer conditions 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. 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 Same. The issuer has filed at least one annual report pursuant Exchange Act Section 13(a) or 15(d) Same. The issuer is not eligible to use the requirements for SRCs under the revenue test in paragraphs (2) or (3)(iii)(B), as applicable, of the “smaller reporting company” definition in Rule 12b-2. The proposed new conditions would only be available to issuers that are eligible to be an SRC under the SRC revenue test. 60 Issuers that are eligible to be an SRC that have a public float between $75 million and $250 million 61 would be accelerated filers if their annual revenues are $100 million or more, and thus they would remain subject to all of the requirements applicable to accelerated filers. We are proposing to refer to “paragraphs (2) or (3)(iii)(B), as applicable” of the SRC definition in the proposed rule text instead of referring to the actual numerical thresholds specified in those paragraphs. We preliminarily believe that referring to the SRC definition would be the clearest and most efficient way to codify the requirement given that the thresholds could change in the future. 60 Under the proposed amendments, an FPI that qualifies as an SRC under the SRC revenue test and is eligible to use the scaled disclosure requirements available to SRCs would qualify for the exclusion under the accelerated filer definition. This position is consistent with past guidance we have provided to FPIs. See Smaller Reporting Company Regulatory Relief and Simplification, Release No. 33-8876 (Dec. 19, 2007) [73 FR 934 (Jan. 4, 2008)] (“2007 SRC Adopting Release”) (noting that an FPI may also qualify as an SRC and has the option to make filings on forms available to U.S. domestic issuers if it presents financial statements pursuant to U.S. GAAP). 61 See paragraphs (1) and (3)(iii)(A) of the SRC definition in Rule 12b-2. The SRC definition excludes ABS issuers, RICs, BDCs, and majority-owned subsidiaries of issuers that do not qualify as an SRC. ABS issuers are exempt from ICFR reporting obligations. 62 While RICs are also exempt from SOX Section 404, 63 BDCs are not exempt. BDCs and majority-owned subsidiaries of a non-SRC parent are subject to the ICFR auditor attestation requirement to the same extent as other accelerated and large accelerated filers. As a result, even if these issuers were to fall within the public float and revenue thresholds in the SRC revenue test, they cannot rely on the SRC revenue test because they are excluded from the SRC definition. We estimate that 28 BDCs would meet the same public float and revenue thresholds as the issuers affected by the proposed rules, which constitutes about 60% of the total number of BDCs. 64 We further estimate that one majority-owned subsidiary of a non-SRC parent may meet the same thresholds. 62 See ABS Release, note 45 above, at 1501 n.41. See also Instruction J to Form 10-K. 63 See note 44 above. 64 See Section III.C.6.b below. We considered potential amendments to the definition of accelerated filer and large accelerated filer that would specifically address BDCs. Unlike investors in low-revenue non-investment company issuers, investors in BDCs may place greater significance on the financial reporting of BDCs, many of which hold illiquid portfolio securities valued using level three inputs of the U.S. GAAP fair value hierarchy. 65 The SRC revenue test would not be meaningful for BDCs because BDCs prepare financial statements under Article 6 of Regulation S-X 66 and generally do not report revenue. Instead, BDCs report investment income (dividends, interest on securities, fee income, and other income) and realized and unrealized gains and losses on investments on their statements of operations. 67 RICs also prepare financial statements under Article 6 of Regulation S-X. Even though RICs are not subject to SOX Section 404, RICs are subject to an independent public accountant's report on internal controls requirement through Form N-CEN. 68 Expanding BDCs' ability to be considered non-accelerated filers, in contrast, would reduce auditor review of internal controls for a significant majority of BDCs. Accordingly, the proposed amendments to the definitions of accelerated and large accelerated filer do not specifically address BDCs. 69 65 See Fair Value Measurement (Topic 820), Financial Accounting Standards Board (“FASB”) Accounting Standards Update No. 2010-06 (Jan. 2010). 66 17 CFR 210.6-01 et seq. 67 See 17 CFR 210.6-07. 68 Form N-CEN requires that the report be based on the review, study, and evaluation of the accounting system, internal accounting controls, and procedures for safeguarding securities made during the audit of the financial statements for the reporting period. The report should disclose any material weaknesses in: (a) The accounting system; (b) system of internal accounting control; or (c) procedures for safeguarding securities which exist as of the end of the registrant's fiscal year. See Instruction 3 to Item G.1 of Form N-CEN. 69 Although the proposed amendments do not specifically address BDCs, we are soliciting comment on whether alternative approaches would be appropriate and the relative costs and benefits of such alternatives. The tables below summarize the current and proposed relationships between SRCs and non-accelerated and accelerated filers. 70 70 Tables 2 and 3 include only the initial SRC and accelerated filer thresholds and exclude the transition thresholds. A large accelerated filer may be eligible to be an SRC only through the transition threshold, so the table does not reflect the relationship between SRCs and large accelerated filers. Table 2—Existing Relationships Between SRCs and Non-Accelerated and Accelerated Filers Existing relationships between SRCs and non-accelerated and accelerated filers Status Public float Annual revenues SRC and Non-Accelerated Filer Less than $75 million N/A. SRC and Accelerated Filer $75 million to less than $250 million N/A. $250 million to less than $700 million Less than $100 million. Accelerated Filer (not SRC) $250 million to less than $700 million $100 million or more. Table 3—Proposed Relationships Between SRCs and Non-Accelerated and Accelerated Filers Proposed relationships between SRCs and non-accelerated and accelerated filers Status Public float Annual revenues SRC and Non-Accelerated Filer Less than $75 million N/A. $75 million to less than $700 million Less than $100 million. SRC and Accelerated Filer $75 million to less than $250 million $100 million or more. Accelerated Filer (not SRC) $250 million to less than $700 million $100 million or more. The proposed amendments would increase the number of issuers that are exempt from the ICFR auditor attestation requirement by increasing the number of non-accelerated filers. Although the proposed amendments could, in some cases, result in investors receiving less or different disclosure about material weaknesses in ICFR at low-revenue SRCs than under our current rules, based on our experience with these matters, including in the cases of EGCs, SRCs, and other smaller reporting issuers, we believe it is unlikely there would be a significant effect on the ability of investors to make informed investment decisions based on the financial reporting of those issuers. A non-accelerated filer that meets the SRC revenue test would remain subject to many of the same obligations as accelerated and large accelerated filers with respect to ICFR, including the requirements for establishing, maintaining, and assessing the effectiveness of ICFR and for management to assess internal controls. Additionally, pursuant to the PCAOB's recently adopted risk assessment standards in financial statement audits, in many cases auditors are testing operating effectiveness of certain internal controls even if they are not performing an integrated audit. For instance, an auditor may rely on internal controls to reduce substantive testing in the financial statement audit. To rely on internal controls, the auditor must obtain evidence that the controls selected for testing are effectively designed and operating effectively during the entire period of reliance. 71 Also, an auditor must test the controls related to each relevant financial statement assertion for which substantive procedures alone cannot provide sufficient appropriate audit evidence. 72 71 See AS 2301, The Auditor's Response to the Risks of Material Misstatement, paragraph .16. 72 See id., paragraph .17. The proposed amendments would not relieve an independent auditor of its obligation to consider ICFR in the performance of its financial statement audit of an issuer, if applicable, regardless of whether the issuer is subject to the ICFR auditor attestation requirement, as is the case today with respect to issuers that are non-accelerated filers. 73 For example, the risk assessment requirement in a financial statement audit is similar to that in an ICFR attestation audit. In a financial statement audit, the auditor is required to identify and assess the risks of material misstatements. The auditor is, therefore, required to “obtain a sufficient understanding of each component of [ICFR] to (a) identify the types of potential misstatements, (b) assess the factors that affect the risks of material misstatement, and (c) design further audit procedures.” 74 This understanding includes evaluating the design of the controls relevant to the audit and determining whether the controls have been implemented. 75 A similar evaluation is required in an ICFR attestation. 76 73 See 2110, note 48 above, paragraphs .18-.40. 74 See id., paragraph .18. 75 See id., paragraph .20. 76 See generally AS 2201, An Audit of Internal Control Over Financial Reporting That Is Integrated with An Audit of Financial Statements. This standard relates to testing of design and whether the controls are implemented are part of the ICFR auditor attestation requirement. Also, evaluation and communication to management and the audit committee of significant deficiencies and material weaknesses in ICFR are required in both a financial statement audit and an ICFR attestation audit. 77 When the auditor becomes aware of a material weakness, it 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, including in a financial statement audit. 78 Further, as discussed above, auditors may also test operating effectiveness of internal controls in a financial statement audit, such as when the auditor determines to rely on those controls to reduce the substantive testing. 77 See AS 1305, Communications About Control Deficiencies in an Audit of Financial Statements, and id., at paragraphs .78-.80. 78 See generally AS 2710, Other Information in Documents Containing Audited Financial Statements. We note that, because certain of the information considered by the independent auditor for the ICFR attestation is also considered by the auditor for purposes of the issuer's financial statement audit, some of the audit fees and the other audit-related costs associated with the ICFR auditor attestation requirement are included in the issuer's financial statement audit costs. However, for issuers with less complex financial systems and controls, such as issuers with lower revenues, this may be less likely to be the case under the proposed amendments. For these issuers, the auditor could determine that, in the absence of an ICFR auditor attestation requirement, it may be a more effective and efficient financial statement audit approach to not rely on and have to test the operating effectiveness of certain controls, such as those related to revenue recognition. Therefore, eliminating the ICFR auditor attestation requirement could have a greater impact in the reduction of costs for such issuers. As discussed in more detail in the Economic Analysis section below, 79 there are a number of component costs of the ICFR auditor attestation requirement. In general, the largest individual cost component relates to audit fees that would typically not be incurred in audits in which an ICFR attestation is not required. 80 We estimate that such audit fees would average approximately $110,000 per year for accelerated filers with revenues of less than $100 million. The ICFR auditor attestation requirement is also associated with additional costs, 81 and we estimate that these non-audit costs would average approximately $100,000 per year for accelerated filers. We believe that the proposed amendments would eliminate these two types of costs for issuers that are eligible to be an SRC under the SRC revenue test. 79 See Section III.C.3 below. 80 See Section III.C.3.b below. 81 See Section III.C.3.c below. Although certain requirements and costs of the ICFR attestation overlap with those associated with a financial statement audit, we continue to believe that the ICFR auditor attestation requirement incrementally can contribute to the reliability of financial disclosures, particularly for issuers that typically have more complex financial reporting requirements and processes. Accordingly, the proposed amendments would not eliminate the requirement for all accelerated filers that are SRCs. Instead, the proposed amendments reflect a more tailored approach that recognizes that the impact of the ICFR auditor attestation requirement on the reliability of an issuer's financial disclosures is not necessarily the same across all issuers, including all SRCs. 82 82 Although the proposed amendments would not eliminate the attestation requirement for all accelerated filers that are SRCs, we are soliciting comment on whether such an approach would be appropriate and the relative costs and benefits of such an approach for both issuers and investors. As noted in this section above, and discussed in greater detail below, 83 the compliance costs associated with the ICFR auditor attestation requirement may be disproportionately burdensome for the issuers that are eligible to be an SRC under the SRC revenue test and, as with all compliance requirements, these costs may divert funds otherwise available for reinvestment by these issuers because they have less access than other issuers to internally-generated capital. In this regard, the issuers we expect to be affected by the proposed amendments are concentrated in a few specific industries. For example, 36.1% of the issuers that are eligible to be an SRC under the SRC revenue test are in the “Pharmaceutical Products” or “Medical Equipment” industries, 84 and a number of commenters noted that the attestation requirement is especially burdensome for biotechnology issuers. 85 We believe these and other low-revenue issuers would particularly benefit from the cost savings associated with non-accelerated filer status and could re-direct those savings into growing their business without significantly affecting the ability of investors to make informed investment decisions based on the financial reporting of those issuers. 83 See Section III.A below. 84 See Section III.C.1 below. 85 See, e.g., letters from Acorda et al., BIO, CONNECT, CSBA, and Seneca. Further, the benefits of the ICFR auditor attestation requirement may be smaller for issuers with low revenues because they may be less susceptible to the risk of certain kinds of misstatements, such as those related to revenue recognition. Also, it is possible that low-revenue issuers may have less complex financial systems and controls and, therefore, be less likely than other issuers to fail to detect and disclose material weaknesses in the absence of an ICFR auditor attestation. Additionally, we note the financial statements of low-revenue issuers may, in many cases, be less critical to assessing their valuation given, for example, the relative importance of their future prospects. 86 86 See Section III.C.4.a below. Providing this benefit to low-revenue SRCs is consistent with our historical practice of providing scaled disclosure and other accommodations for smaller issuers 87 and with recent actions by Congress to reduce burdens on new and smaller issuers. 88 Issuers that are eligible to be an SRC under the SRC revenue test no longer would be required to comply with accelerated or large accelerated filer requirements, reducing these issuers' compliance costs and thereby enhancing their ability to preserve capital without significantly affecting the ability of investors to make informed investment decisions based on the financial reporting of those issuers. 87 See, e.g., SRC Regulatory Relief Release, note 13 above, 2007 SRC Adopting Release, note 60 above, and SRC Adopting Release, note 16 above. 88 For example, Title I of the JOBS Act amended SOX Section 404(b) to exempt EGCs from the ICFR auditor attestation requirement. 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). D. Proposed Amendments to the Transition Provisions in the Accelerated and Large Accelerated Filer Definitions We are also proposing to amend the transition thresholds for issuers exiting accelerated and large accelerated filer status. First, the proposed amendments would revise the public float transition threshold for accelerated and large accelerated filers to become a non-accelerated filer from $50 million to $60 million. 89 Second, the large accelerated filer public float transition provision would be revised from $500 million to $560 million. 90 Finally, the proposed amendments would add the SRC revenue test to the transition threshold for accelerated 91 and large accelerated filers. 92 89 See proposed paragraphs (3)(ii) and (iii) of the “accelerated and large accelerated filer” definition in Rule 12b-2. 90 See proposed paragraph (3)(iii) of the “accelerated and large accelerated filer” definition in Rule 12b-2. 91 See proposed paragraph (3)(ii) of the “accelerated and large accelerated filer” definition in Rule 12b-2. 92 See proposed paragraph (3)(iii) of the “accelerated and large accelerated filer” definition in Rule 12b-2. Under the current rules, once an issuer is an accelerated or a large accelerated filer, it will not become a non-accelerated or accelerated filer until its public float falls below a specified lower threshold than the public float threshold that it needed to become an accelerated or large accelerated filer initially. The purpose of this lower threshold 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. Currently, 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. 93 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. 94 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. 95 93 See paragraph (3)(ii) of the “accelerated and large accelerated filer” definition in Rule 12b-2. 94 See paragraph (3)(iii) of the “accelerated and large accelerated filer” definition in Rule 12b-2. 95 For example, under the current rules, 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. The table below summarizes the existing transition thresholds and how an issuer's filer status changes based on its subsequent public float determination. Table 4—Subsequent Determination of Filer Status Based on Public Float Under Existing Requirements Existing requirements Initial public float determination Resulting filer status Subsequent public float determination Resulting filer status $700 million or more Large Accelerated Filer $500 million or more Large Accelerated Filer. Less than $500 million but $50 million or more Accelerated Filer. Less than $50 million Non-Accelerated Filer. Less than $700 million but $75 million or more Accelerated Filer Less than $700 million but $50 million or more Accelerated Filer. Less than $50 million Non-Accelerated Filer. The proposed amendments would 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 preliminarily believe it would be appropriate to increase these transition thresholds because doing so would make the public float transition thresholds 80% of the initial thresholds, which would be consistent with the percentage used in the transition thresholds for SRC eligibility. In the SRC Adopting Release, 96 we amended the SRC rules so that the SRC transition thresholds were set at 80% of the corresponding initial qualification thresholds. Revising these transition thresholds to be 80% of the corresponding initial qualification thresholds would align the transition thresholds across the SRC, accelerated filer, and large accelerated filer definitions. Additionally, 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. 96 See note 16 above. Table 5—Subsequent Determination of Filer Status Based on Public Float Under Proposed Amendments Proposed amendments to the public float thresholds Initial public float determination Resulting filer status Subsequent public float determination Resulting filer status $700 million or more Large Accelerated Filer $560 million or more Large Accelerated Filer. Less than $560 million but $60 million or more Accelerated Filer. Less than $60 million Non-Accelerated Filer. Less than $700 million but $75 million or more Accelerated Filer Less than $700 million but $60 million or more Accelerated Filer. Less than $60 million Non-Accelerated Filer. In addition, the proposed amendments would add the SRC revenue test to the public float transition thresholds for accelerated and large accelerated filers. We are proposing that an issuer that is already an accelerated filer will 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 paragraphs (2) or (3)(iii)(B), as applicable, of the SRC definition. 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. As discussed above, 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. 97 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 applicable revenue threshold ($80 million or $100 million), at which point it would become a non-accelerated filer. 97 Under the proposed 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 could transition to non-accelerated filer status in a subsequent year if it had revenues of less than $100 million. For example, assuming the proposed amendments were in effect, an issuer with a December 31 fiscal year end that has a public float as of June 29, 2018 of $230 million and annual revenues for the fiscal year ended December 31, 2017 of $101 million would be eligible to be an SRC under the public float test, but because the issuer would not be eligible to be an SRC under the SRC revenue test it would be an accelerated filer (assuming the other conditions described in Table 1 were also met). At the next determination date (June 28, 2019), if its public float as of June 28, 2019 remained at $230 million and its annual revenues for the fiscal year ended December 31, 2018 were less than $100 million, that issuer would be eligible to be an SRC under the SRC revenue test (in addition to the public float test) and thus it would also become a non-accelerated filer. On the other hand, assuming the proposed amendments were in effect, an issuer with a December 31 fiscal year end that has a public float as of June 29, 2018 of $400 million and annual revenues for the fiscal year ended December 31, 2017 of $101 million would not be eligible to be an SRC under either the public float test or the SRC revenue test and would be an accelerated filer (assuming the other conditions described in Table 1 were also met). At the next determination date (June 28, 2019), if its public float as of June 28, 2019 remained at $400 million, that issuer would not be eligible to be an SRC under the SRC revenue test unless its annual revenues for the fiscal year ended December 31, 2018 were less than $80 million, at which point it would be eligible to be an SRC under the SRC revenue test and also become a non-accelerated filer. Similarly, we are proposing conforming amendments to the large accelerated filer transition provisions that describe when an issuer that is already a large accelerated filer transitions to either accelerated or non-accelerated filer status. As discussed above, 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 or it meets the revenue test in paragraph (2) or (3)(iii)(B), as applicable, of the SRC definition. For a large accelerated filer to meet the SRC revenue test, generally, its public float would need to fall below $560 million as of the last business day of its most recently completed second fiscal quarter and its annual revenues would need to fall below the applicable revenue threshold ($80 million or $100 million). 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. 98 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. For example, if the SRC revenue test is not added to the transition provisions, an accelerated filer with a public float that remains more than $60 million but less than $700 million and with annual revenues of $100 million or more would not be able to become a non-accelerated filer even if its annual revenues subsequently fall below $80 million. 98 See SRC Adopting Release, note 16 above, at note 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.”) E. Request for Comment We request and encourage any interested person to submit comments regarding the proposed amendments, specific issues discussed in this release and other matters that may have an effect on the proposals. We note that comments are of the greatest assistance if accompanied by supporting data and analysis of the issues addressed in those comments. 1. Should we exclude an issuer that is eligible to be an SRC under the SRC revenue test from the accelerated and large accelerated filer definitions, as proposed? Why or why not? Are there investor protection benefits in distinguishing an issuer that is eligible to be an SRC under the SRC revenue test from an SRC that does not meet the revenue test and therefore would be an accelerated or large accelerated filer? Should we use different criteria to identify issuers to exclude from the accelerated and large accelerated filer definitions? If so, what criteria should we use and why? 2. With respect to the ICFR auditor attestation requirement, is the issuer's level of revenues relevant to the complexity of its financial systems and controls and the nature of its ICFR? If so, how does that complexity affect the benefits and costs of ICFR auditor attestation? How do the benefits and costs of the ICFR auditor attestation requirement vary with the complexity of an issuer's financial reporting? Are the financial statements of low-revenue issuers less susceptible to the risk of material misstatements or control deficiencies such that the effect of an ICFR auditor attestation may be less significant than for other types of issuers? Would the proposed approach allow low-revenue issuers to benefit from cost savings without significantly affecting the ability of investors to make informed investment decisions based on the financial reporting of those issuers? 3. As an alternative, should we instead exclude all SRCs from the accelerated and large accelerated filer definitions? Why or why not? What would be the effects, including the benefits and costs, of such an approach for issuers and investors? What would be the effects on the reliability of such issuers' financial reporting or their susceptibility to the risk of material misstatements or control deficiencies? What would be the effects on these issuers' willingness to be public companies? How would such an alternative affect investor protection? Are there additional considerations relevant to such issuers that we should consider? If we were to adopt such an approach, should we adjust the public float and annual revenue thresholds in the accelerated filer definition to be the same as those in the SRC definition? That is, should the accelerated filer definition include only issuers with a public float of $250 million or more but less than $700 million that had revenues of $100 million or more in the previous year? Would this approach have an effect on the transition between accelerated filer and non-accelerated status? If so, what would be the effect? If we were to adopt this approach, should we revise the transition thresholds for large accelerated, accelerated, and/or non-accelerated filers? Alternatively, should we exclude SRCs from the definition of accelerated filer without changing the thresholds in the definition itself? Why or why not? Would these approaches have different effects that we should consider? 4. In the SRC Adopting Release, the Commission established the SRC revenue test to include issuers with annual revenues of less than $100 million if they have no public float or a public float of less than $700 million. The proposed amendments would use the SRC revenue test's $100 million annual revenue threshold to determine whether an issuer would qualify as an accelerated or large accelerated filer. Should the proposed amendments use the SRC revenue test's $100 million annual revenue threshold? Why or why not? Should there be a different annual revenue threshold for determining whether an issuer is an accelerated or large accelerated filer? Why or why not? 5. Would it be more appropriate to determine filer status for any given year by using the average of an issuer's public float, or applying some other metric, such as the issuer's volume-weighted average price (“VWAP”)? What would be the appropriate way to calculate an issuer's VWAP? If filer status were determined through the use of a VWAP calculation, should shares held by affiliates be included in the calculation of the issuer's market value or public float? Why or why not? Should a VWAP calculation reflect the average VWAP over a longer period of time? If so, what longer period of time ( e.g., three consecutive trading days, one week, one month, or one quarter), or different metric, would be more appropriate? What costs and benefits would be associated with use of a longer period of time or a different valuation standard? For example, if an average of an issuer's public float over a longer period of time is used, are there additional costs to issuers to compute their aggregate worldwide number of shares of common equity held by non-affiliates on each of the respective days? If we used a longer period of time or different valuation standard in the accelerated filer definitions, should we similarly revise other provisions that require an issuer to calculate its public float on a single day, such as in the Rule 12b-2 definition of an SRC? 6. Should all SRCs that meet the accelerated filer definition be excluded from only the accelerated reporting deadlines? Would investors be adversely affected by expanding the population of issuers that would report later than they do today? 7. Should we increase the non-accelerated filer transition threshold from $50 million to $60 million and/or the large accelerated filer transition threshold from $500 million to $560 million, as proposed? Why or why not? Should we revise the non-accelerated filer transition threshold to one other than $60 million and/or the large accelerated filer transition threshold to one other than $560 million? If so, what threshold would be appropriate? 8. Should we align the transition thresholds in the accelerated filer and large accelerated filer definitions with the SRC revenue test transition threshold, as proposed? Why or why not? Instead of aligning the transition thresholds, should we consider other approaches to the transition thresholds in the accelerated filer and large accelerated filer definitions? For example, should we adjust the transition provisions of the large accelerated filer definition to permit all issuers with a public float below $700 million and annual revenues below $100 million to become non-accelerated filers even if such issuers would not meet the transition thresholds to qualify as SRCs? Why or why not? For example, what would be the effects of any such alternatives on the frequency with which an issuer enters and exits large accelerated, accelerated, or non-accelerated filer status due to small fluctuations in public float or revenues? 9. Should we adjust the transition provisions of the accelerated filer and large accelerated filer definitions to include the respective public float and annual revenue thresholds in the definitions, rather than referencing the SRC revenue test? Why or why not? 10. We request comment on alternative approaches that would include or exclude additional issuer types from the accelerated and large accelerated filer definitions. For example, should we exclude FPIs from the proposed amendments? Why or why not? Should we permit BDCs and majority-owned subsidiaries of non-SRCs, which are excluded from the definition of SRC, to be non-accelerated filers if they meet the SRC revenue test thresholds? Why or why not? The SRC revenue test thresholds are based, in part, on an issuer's annual revenues. Are there alternative metrics that should be applied for BDCs instead of revenue? For example, should we use investment income received by the BDC rather than revenue? Should we include realized gains and losses from the sale of portfolio securities? Should unrealized gains and losses affect a BDC's revenue for this purpose, and if so, how? Should we use the net increase or decrease in net assets resulting from operations? Alternatively, should we also exclude BDCs if they meet the public float test in the SRC definition alone? Should we have a specific BDC test of $250 million or less in public float and $50 million or less in investment income? 99 Why or why not? Are there other alternatives we should consider, such as providing an independent accountant's report on internal controls similar to the one required by Form N-CEN? If we were to require a Form N-CEN report, should we apply the requirement only to those BDCs that were previously required to provide a report under SOX Section 404(b)? 99 A $250 million or less public float threshold would be consistent with the SRC definition, and we estimate that the average of the investment income of BDCs with market capitalization ranging from $75 to $700 million is $50 million. See Section III.C.6 below. 11. Should we provide a definition for the term “non-accelerated filer?” If so, should we define it as a filer that is not an accelerated or large accelerated filer? Why or why not? Should we use some other definition? 12. The proposed rule would refer to “paragraphs (2) or (3)(iii)(B)” of the SRC definition instead of referring to the actual numerical thresholds specified in those paragraphs. Should we include the actual numerical thresholds? Why or why not? 13. For the low-revenue issuers that would be newly exempted from the ICFR auditor attestation requirement under the proposed amendments, would an auditor engaged for the purpose of a financial statement only audit be as likely to test the operating effectiveness of certain of the issuer's internal controls to reduce the amount of substantive testing it performs as it may do under our existing rules? Given the potential for such testing as well as the risk assessment standards that apply to a financial statement only audit, to what extent would the consideration of internal controls by the auditors of these issuers change as a result of the proposed amendments? 14. Should we consider any changes in how and where issuers report their accelerated filer status, public float, or revenue? Should we consider any new disclosure requirements associated with the proposed amendments? For example, should we permit or require issuers that voluntarily comply with SOX Section 404(b) to disclose that information, such as on the cover page of their periodic filings? If so, should we require issuers that voluntarily comply with SOX Section 404(b) to include the ICFR auditor attestation with the filing? 15. In lieu of, or in addition to, the proposed amendments, should we consider amendments that would result in ICFR attestation audits being required at a reduced frequency? For example, should we require the proposed affected issuers to provide an ICFR auditor attestation only once every three years? If required once every three years, what financial reporting periods should we require the ICFR attestation audit to cover? Currently, the ICFR attestation audit is required to cover only the current period. Should we require the ICFR attestation audit to cover only the current period or should it include all three years? III. Economic Analysis We are mindful of the costs and benefits of the proposed amendments. Exchange Act Section 3(f) requires us, when engaging in rulemaking that requires us to consider or determine whether an action is necessary or appropriate in the public interest, to consider, in addition to the protection of shareholders, whether the action will promote efficiency, competition, and capital formation. 100 Exchange Act Section 23(a)(2) requires us, when adopting rules, to consider the impact that any new rule would have on competition and prohibits any rule that would impose a burden on competition that is not necessary or appropriate in furtherance of the purposes of the Exchange Act. 101 100 15 U.S.C. 78c(f). 101 15 U.S.C. 78w(a)(2). The discussion below addresses the economic effects of the proposed amendments, including their anticipated costs and benefits, as well as the likely effects of the proposed amendments on efficiency, competition, and capital formation. We also analyze the potential costs and benefits of reasonable alternatives to what is proposed. Where practicable, we have attempted to quantify the economic effects of the proposal; 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 proposing amendments to the definition of “accelerated filer” that will expand the number of issuers that qualify as non-accelerated filers. Currently, issuers with no public float or public float of less than $75 million are generally non-accelerated filers. The proposed amendments would generally extend non-accelerated filer status to issuers with a greater public float if they are eligible to be SRCs and their revenues are less than $100 million. As non-accelerated filers, these issuers would not be required to obtain an ICFR auditor attestation pursuant to SOX Section 404(b). They also would 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. 102 The proposed amendments also would 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. 102 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. As discussed above, the ICFR auditor attestation requirement was introduced together with other changes to the financial reporting control environment with the intention of improving the accuracy and reliability of corporate disclosures. Section III.C.4.a discusses the evidence that the imposition of the ICFR auditor attestation requirement has been associated with benefits to issuers and investors. However, this requirement has also been associated with significant compliance costs. Relative to other issuers that are subject to this requirement, the affected issuers may find the costs to be particularly burdensome, while the ICFR auditor attestation requirement may, on average, provide fewer benefits related to the accuracy and reliability of these issuers' financial statements. Further, 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. 103 The proposed amendments are therefore intended to reduce compliance costs for these issuers without significantly affecting the ability of investors to make informed investment decisions based on the financial reporting of those issuers. 103 As discussed below, issuers may not always choose to voluntarily obtain an ICFR auditor attestation even when the total benefits of doing so would exceed the total costs because they may not internalize some of the market-level benefits of compliance and because the incentives of managers may not be aligned perfectly with those of shareholders. In particular, we estimate that the affected issuers have median annual revenues of about $40 million and a median number of employees of about 125, while their median public float is about $145 million. 104 The costs of providing an ICFR auditor attestation include some fixed costs that do not scale proportionately with size, and may therefore be disproportionately burdensome for smaller issuers. For the affected issuers, these costs may represent a meaningful percentage of their cash flows. Importantly, because these issuers have limited access to internally-generated capital, compliance costs may be more likely to displace spending on other things such as investment, research, or hiring than for other issuers subject to the ICFR auditor attestation requirement. Exempting these issuers from this requirement would allow them the discretion to invest their funds in the way they believe is most value-enhancing. At the same time, the ICFR auditor attestation requirement may, on average, provide fewer benefits related to these issuers versus other issuers subject to this requirement. 104 See Section III.C.1 for detail on the data sources and methodologies underlying these estimates. We find preliminary evidence consistent with the argument that, compared to other issuers subject to the ICFR auditor attestation requirement, the affected issuers may be less susceptible to the risk of certain kinds of misstatements (such as those related to revenue recognition). Although we expect that exempting these issuers may result in some adverse effects on the effectiveness of their ICFR and their restatement rates, we preliminarily believe that these effects are unlikely to result in a rate of restatements for the affected issuers that exceeds that for the issuers that would remain subject to this requirement. Moreover, in many cases, the market value of the affected issuers may be driven to a greater degree by their future prospects than by the current period's financial statements. We find evidence consistent with this argument, which could further mitigate the extent of the adverse effects of eliminating the ICFR auditor attestation requirement for these issuers. The discussion that follows examines the potential benefits and costs of the proposed amendments in detail, with consideration for 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 proposed 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 6 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 6—Filing Deadlines for Periodic Reports Category of filer Calendar days after period end Annual Quarterly Non-Accelerated Filer 90 45 Accelerated Filer 75 40 Large Accelerated Filer 60 40 Section II.B. above discusses in detail the issuer and auditor responsibilities with respect to disclosure controls and procedures and ICFR for issuers of different filer types. These responsibilities reflect the FCPA requirements with respect to internal accounting controls as well as a number of different changes to the financial reporting control environment that were introduced by SOX. In particular, all issuers 105 are required to devise and maintain an adequate system of internal accounting controls 106 and to have their corporate officers assess the effectiveness of the issuer's disclosure controls and procedures 107 and disclose the conclusions of their assessments, typically on a quarterly basis. 108 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. 109 All issuers other than RICs and ABS issuers 110 are also required to include management's assessment of the effectiveness of their ICFR in their annual reports. 111 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. 112 Also, an auditor engaged in a financial statement only audit may choose, though it is not required, to test the operating effectiveness of some internal controls in order to reduce the extent of substantive testing required to issue an opinion on the financial statements. 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. 113 Importantly, all of these responsibilities with respect to financial reporting and ICFR apply equally to non-accelerated as well as accelerated and large accelerated filers. 105 Specifically, the requirements apply to all issuers that file reports pursuant to Section 13(a) or 15(d) of the Exchange Act. 106 See Section 13(b)(2)(B) of the Exchange Act. 107 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. 108 See 17 CFR 240.13a-14 and 17 CFR 240.15d-14. 109 See 17 CFR 240.13a-14(b) and 17 CFR 240.15d-14(b). 110 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. 111 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 auditor assessments of ICFR, 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”). 112 See AS 2110, note 48 above. See also the discussion below in this section about this auditing standard. 113 See 17 CFR 240.10A-3. 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 and reporting procedures (the “FDIC auditor attestation requirement”). 114 Some issuers that are not required to comply with SOX Section 404(b) voluntarily obtain an ICFR auditor attestation. 115 Estimates of the number of issuers of each filer type are provided in Table 7 below. 114 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. 115 Up to about seven percent of exempt issuers voluntarily provided an ICFR auditor attestation from 2005 through 2011. 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”). 116 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 2017, excluding any such filings that pertain to fiscal years prior to 2016. 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. Foreign issuers in this table 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 rarely file on the annual report types considered. This table also excludes 135 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. 117 The estimated number of non-accelerated filers includes approximately 586 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. Table 7—Filer Status for Issuers Filing Annual Reports in 2017 116 Non- accelerated 117 Accelerated Large accelerated Total 3,899 1,497 2,138 Foreign 240 146 255 EGC 1,201 375 0 Audits of ICFR and the associated ICFR auditor attestation reports are made in accordance with AS 2201, 118 previously known as Auditing Standard Number 5 (“AS No. 5”). 119 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. 120 Among other things, the 2007 standard facilitates the scaling of the evaluation of ICFR for smaller, less complex issuers. 121 It was accompanied by Commission guidance similarly facilitating the scaling of SOX Section 404(a) management evaluations of ICFR. 122 Relative to AS No. 2, AS 2201 facilitates the scaling of audits of ICFR by, for example, encouraging auditors to use top-down risk-based approaches and to rely on the work of others in the attestation process. 118 See note 76 above. 119 AS No. 5 was renumbered as AS 2201, 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). 120 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 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)]. 121 Id. 122 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. 123 However, several studies have provided evidence that, at least initially, audits of ICFR under the revised standard may not have been as effective in improving the quality of ICFR as those under AS No. 2. 124 PCAOB inspections of auditors began, around 2010, to include a heightened focus on whether auditing firms had obtained sufficient evidence to support their opinions on the effectiveness of ICFR. 125 There is some evidence that these inspections have led to an improvement in the reliability of ICFR auditor attestations, 126 but also concerns about whether they have resulted in increased audit fees. 127 123 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). 124 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 (“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 http://aaajournals.org/doi/abs/10.2308/accr-52197. 125 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. 126 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”). 127 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. In 2010, the PCAOB adopted enhanced auditing standards related to the auditor's assessment of and response to risk. 128 The enhanced risk assessment standards have likely reduced 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. 129 128 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)]. 129 See AS 2110, note 48 above, paragraphs .18-.40. 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. 130 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. 131 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. 132 130 See Inspection Observations Related to PCAOB “Risk Assessment” Auditing Standards (No. 8 through No.15), PCAOB Release No. 2015-007 i-iii (Oct. 15, 2015). 131 See PCAOB Release No. 2010-004, note 128 above, at 7 and A10-41. As discussed above, even in a financial statement only audit, if the auditor becomes aware of a 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 77 and 78 above. 132 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). 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. 133 Recent changes in audit technology, such as the potential for automated controls testing and process automation, 134 may result in improvements in ICFR regardless of the ICFR auditor attestation requirement. Such automation could also reduce audit fees, including the costs of an audit of ICFR, but the uptake of these technologies has been slow. 135 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. 136 133 Information on these and other FASB Accounting Standards updates is available at https://www.fasb.org/jsp/FASB/Page/SectionPage&cid=1176156316498. 134 See, e.g., Kevin Moffitt, Andrea Rozario, & Miklos Vasarhelyi (2018), Robotic Process Automation for Auditing, Journal of Emerging Technologies, 15(1) Acct. 1 (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 . . . .”). 135 See, e.g., Protiviti survey results, Benchmarking SOX Costs, Hours and Controls (2018) (“Protiviti 2018 Report”). 136 See, e.g., 2011 SEC Staff Study, note 49 above, at 106 (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”). 137 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. 2. Characteristics of Accelerated Filer Population Per Table 7, there were approximately 1,500 accelerated filers in total in 2017. Figure 2 presents the distribution of public float across these issuers. 137 BILLING CODE 8011-01-P EP29MY19.001 The distribution of public float among accelerated filers is skewed towards lower levels of float, but higher levels of float are also significantly represented. 138 The estimates in the figure are based on staff analysis of data from XBRL filings. See note 116 above for details on the identification of the population of accelerated filers. Figure 3 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 $8 billion, about 90% 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. EP29MY19.002 BILLING CODE 8011-01-C 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. 139 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 2017, because the SRC revenue test is based on the prior year's revenues. See note 116 above for details on the identification of the population of accelerated filers. 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 14.2% of accelerated filers, followed by “Pharmaceutical Products” (12.8%), “Financial Trading” (7.7%), “Business Services” (6.7%), “Computer Software” (4.5%), “Electronic Equipment” (4.3%) and “Petroleum and Natural Gas” (4.0%). 140 140 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 http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/Data_Library/det_49_ind_port.html. See note 116 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 8, we present the timing in recent years of annual report filings by these different groups of issuers relative to their corresponding deadlines. Table 8—Filing Timing for Annual Reports in Years 2014 Through 2017, By Filer Status 141 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 73% 91% 95%. Over 5 days early 45% 64% 63%. After deadline 27% 9% 5%. Over 15 days after deadline 11% 4% 3%. Table 8 documents that accelerated and large accelerated filers file their annual reports, on average, four or five days before the applicable deadline. Nine percent and five 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 11% of non-accelerated filers filing after the 15-day grace period obtained by filing Form NT. 141 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 2017 other than amendments. 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 116 above for details on the identification of filer type. 4. Internal Controls and Restatements We next consider the current rates of ineffective ICFR and restatements 142 among issuers that are accelerated filers under the baseline relative to other filer types. 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 9 presents the percentage of issuers reporting ineffective ICFR in recent years by filer type. 142 Unless otherwise specified, statistics and analysis regarding restatements are not restricted to those restatements requiring Form 8-K Item 4.02 disclosure. Table 9—Percentage of Issuers Reporting Ineffective ICFR 143 Ineffective ICFR year reported in: Non-accelerated (percent) Accelerated (percent) Large accelerated (percent) Management Report 2014 40.3 7.8 3.1 2015 41.2 8.8 3.7 2016 38.4 9.3 4.5 2017 40.3 9.4 4.9 Average/year 40.1 8.8 4.1 Auditor Attestation 2014 n/a 8.0 3.3 2015 n/a 8.8 3.7 2016 n/a 8.9 4.5 2017 n/a 9.6 4.8 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 eight or nine percent of accelerated filers reported at least one material weakness in ICFR in a given year. 144 This represents a moderately higher rate than that among large accelerated filers, approximately four percent, on average, of which reported ineffective ICFR, 145 and a substantially lower rate than that among non-accelerated filers, more than a third of which reported ineffective ICFR each year. 146 For issuers subject to the ICFR auditor attestation requirement, the rates of ineffective ICFR reported by management and by auditors are similar. This may not be surprising, as management will be made aware of any material weaknesses discovered by the auditor and vice versa. 143 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 116 above for details on the identification of filer type. 144 Per the second column of the first panel of Table 9, the rate of ineffective ICFR among accelerated filers has ranged from 7.8 to 9.4% for the years 2014 through 2017, for an average per year of 8.8%. 145 Per the third column of the first panel of Table 9, the rate of ineffective ICFR among large accelerated filers has ranged from 3.1 to 4.9% for the years 2014 through 2017, for an average per year of 4.1%. 146 Per the first column of the first panel of Table 9, the rate of ineffective ICFR among non-accelerated filers has ranged from 38.4 to 41.2% for the years 2014 through 2017, for an average per year of 40.1%. We next consider the persistence of material weaknesses across these issuer categories. Table 10 presents the percentage of issuers that reported two, three, or four consecutive years of ineffective ICFR culminating in 2017, by filer type. Table 10—Percentage of Issuers Reporting Consecutive Years of Ineffective ICFR in Management Report, by 2017 Filer Status 147 Ineffective ICFR years: Non-accelerated Accelerated Large accelerated As % of issuers 2016-2017 (at least 2 years) 27.5 4.3 1.6 2015-2017 (at least 3 years) 20.6 2.2 0.4 2014-2017 (4 years) 15.4 1.3 0.2 As % of issuers with 2017 ineffective ICFR 2016-2017 (at least 2 years) 68.6 48.9 39.0 2015-2017 (at least 3 years) 51.4 25.0 9.8 2014-2017 (4 years) 38.4 14.8 4.9 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 0.2% of large accelerated filers reporting ineffective ICFR for four consecutive years, representing about 15% of the accelerated filers and about five percent of the large accelerated filers that reported ineffective ICFR in 2017. A larger percentage of non-accelerated filers persistently report material weaknesses, with about 15% of these issuers, or more than one-third of those reporting ineffective ICFR in 2017, having reported material weaknesses for four consecutive years. 147 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 2017 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 2017 (see the fourth row of Table 9). See note 116 above for details on the identification of filer type. Table 11 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 2016 (and even more so for 2017, which we do not report for this reason), as issuers may yet restate their results from recent years. Table 11—Percentage of Issuers Issuing Restatements By Year of Restated Data 148 Restated Non-accelerated (ex. EGCs) (percent) Accelerated (ex. EGCs) (percent) Large accelerated (percent) EGC (percent) Total Restatements: 2014 10.9 11.4 13.8 17.0 2015 8.9 11.1 11.8 15.5 2016 5.9 7.2 6.6 8.0 Average/year 8.5 9.9 10.8 13.5 8-K Item 4.02 Restatements: 2014 3.3 2.9 2.1 4.9 2015 2.6 3.1 1.4 4.7 2016 1.7 2.1 1.0 2.5 Average/year 2.5 2.7 1.5 4.0 The first panel of Table 11 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 or adjustments 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 restatements or Item 4.02 restatements [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2019-09932. Public record. Not legal advice.