Washington Editor

WASHINGTON - The SEC last week issued plans to relieve the burden placed on small public companies by the Sarbanes-Oxley Act, at the same time lawmakers here introduced a bill aimed at a legislative fix.

Both represent positive developments for the biotech industry.

There has been a barrage of complaints on the costs of compliance with one part of the law, Section 404, which principally deals with internal and external auditing requirements, and lately some weighty reports have seconded those charges.

In particular, companies with little to no revenue have found themselves paying large fees for testing internal controls in order to comply with Sarbanes-Oxley's Section 404, and in a notable statement, the SEC said it would consider reform proposals scaled to the individual circumstances.

"The steps we are [announcing are] designed to further improve the reliability of financial statements and to better protect investors," SEC Chairman Christopher Cox said in a statement, "while making the Section 404 process more efficient and cost effective."

Multiple reports delivered to the SEC in recent weeks - from the Government Accountability Office and the SEC's own Advisory Committee on Smaller Public Companies - have found that its one-size-fits-all approach is particularly burdensome for smaller companies. Feedback also came from a recent SEC roundtable event on second-year experiences with Section 404.

Stephen Sherwin, chairman and CEO of Cell Genesys Inc. in South San Francisco, was part of that roundtable, and he called the SEC's subsequent assertion to consider scaled reforms "an extremely important" recognition to address "the particularly disproportionate burden" on small firms.

At the roundtable as a representative of the Biotechnology Industry Organization - he serves as the chairman of its emerging company section - Sherwin said he gets the sense that the SEC appreciates the benefit a scaled reform would provide. "That statement," he told BioWorld Today, "we take heart in."

It is estimated that the average compliance cost for Section 404 is $3.8 million, with smaller businesses paying more than twice as much (as a percentage of revenue) as large businesses.

Biotech firms in particular have been vocal in expressing their displeasure over internal control testing, which frequently falls to outside companies and strips away funds from research and development. Such costs for Cell Genesys, for example, led to a $1.2 million increase in general and administrative expenses last quarter compared to a year ago, an escalation "primarily due to the implementation of procedures related to Section 404," Sherwin said.

"Section 404 needs to be scaled to the size of companies based on product revenues," said Lauren Choi, BIO's director of capital formation policy. "Product revenues drive the complexity of corporate structure," she added, arguing that since there is little in the way of product revenues within the biotech industry, there is little need for overly stringent controls.

The regulatory agency said no companies would receive an outright exemption from Section 404 requirements, though it is giving an extended grace period for the smallest company filers, those with market caps less than $75 million. Opponents to Section 404 reform, such as the so-called "Big Four" public audit firms, have argued against any exemptions, regardless of size, and instead favor a strict adherence to the original legislation.

Choi said BIO has never lobbied for exemptions, but rather the scaled reform that the SEC now says it will consider. The agency last month received advisory committee recommendations on scaled reforms that include relief from management and external auditor attestation requirements for companies defined as small cap or having market caps of $787 million with less than $10 million in product revenues, microcap firms that represent the bottom 1 percent in market cap, and companies with less than $125 million in revenues.

The committee also recommended relief for those with a market cap no higher than $787 million and less than $250 million in revenues.

In addition to considering the reforms, the SEC plans to work with the Public Company Accounting Oversight Board to more clearly define auditors' methods for confirming companies' internal control testing, which could keep costs down.

Still, a final SEC decision is months away.

The newly introduced bill also was well received by the biotech industry, with its proposed fixes for Section 404 essentially in line with recommendations already championed by BIO.

Sen. Jim DeMint (R-S.C.) and Rep. Tom Feeney (R-Fla.) unveiled the measure, called the Competitive and Open Markets Protecting and Enhancing Treatment of Entrepreneurs (COMPETE) Act. It would allow companies to sidestep Section 404 and instead voluntarily comply with standards that better fit their size - those with less than $125 million in product revenue would be allowed to opt out of the internal control requirements.

"It recognizes that there's a problem," Choi said, "that Section 404 is broken."

Sherwin conceded difficulty in predicting whether the proposed legislative fix would make it into the books, but he noted that "it will keep the dialogue active" going forward, at the forefront of policy-makers' minds.

"We're encouraged by both activities," Choi concluded. "Members on the Hill understand the problem, and so does the SEC."