WASHINGTON - Smaller biotech companies soon could see some relief from one of the Sarbanes-Oxley Act’s more burdensome regulations, if the SEC adopts recommendations put forth by an advisory committee last week.
Importantly for the biotech industry, the SEC’s 21-member Advisory Committee on Smaller Public Companies has proposed changes to Section 404 of the corporate governance law, which has been criticized for its one-size-fits-all approach. The Biotechnology Industry Organization, which has played a central role in pushing for reforms because of its charge that Sarbanes-Oxley was written without forethought to small companies, is largely behind the recommendations.
"We’re very supportive of the findings," said Lauren Choi, BIO’s director of capital formation policy. Noting that a revenue test is key to determining corporate structures, she added that "this is a real recognition by the committee that that’s how it should be looked at."
Section 404 reform is atop the list of the draft report recommendations.
Notable are definitions of smaller public companies, which if adopted would encompass 80 percent of all U.S. public companies, though reforms would impact only a few of them. Specifically, the committee proposed that microcap companies have common stock (or equivalent) equal to the lowest 1 percent of total U.S. equity market capitalization (currently about $128 million), and smallcap companies include those with common stock (or equivalent) that totals the next lowest 5 percent. Therefore, smaller public companies - microcap and smallcap - would comprise the lowest 6 percent of U.S. market cap.
Certain smaller public companies would benefit from the committee’s recommendations for reforming Section 404 of Sarbanes-Oxley, viewed by many as its most onerous aspect. Section 404 calls for upper management to attest to financial statements and employ external auditors, which Choi called "duplicative and burdensome." The management attestation provision is essentially repetitive, as Section 302 of Sarbanes-Oxley already requires the filing of financial reports, and the external audit provision has proven overly costly to companies with little to no revenue.
The committee’s endorsements include an outright exemption to Section 404’s requirements to microcap companies with less than $125 million in annual revenue and smallcap companies with less than $10 million in annual revenue, provided that their corporate governance controls include adherence to additional standards under earlier laws. The committee further suggested that smallcap companies be exempt from external auditor involvement in the Section 404 process if their annual revenue ranges between $10 million and $250 million, subject to compliance with the same aforementioned corporate governance standards.
Choi told BioWorld Today that an additional category for exemption illustrates the committee’s understanding of Sarbanes-Oxley’s underlying intent relative to the biotech industry. It would excuse companies with revenues of less than $10 million but with a market cap up to $787 million. "Revenues really drive the complexity of your corporate structure," she said, noting that few biotech companies have revenues but might have high market caps. In fact, of the nearly 275 publicly listed biotech companies found in BioWorld Snapshots, about 80 percent have market caps under $787 million. "That tells you how we’re sort of disproportionately impacted," Choi added.
Noting that "this is a step in the right direction for us," she added that there still needs to be a clearer definition of revenue. BIO is stressing the use of product revenue, so companies that book partnership or licensing payments as revenue aren’t penalized for money they use to fund research and development. "We want to make sure that the committee, in its final report to the commission, comes up with some clarification about how revenues would be calculated."
The SEC commissioned the advisory committee more than a year ago to consider Sarbanes-Oxley reforms. A committee meeting scheduled for this week will include a vote on this draft, followed by a 30-day public comment period. A final report to the SEC is due by April 30, and Choi said BIO is hopeful that the SEC would act "swiftly" on it.
Opposition to Sarbanes-Oxley reforms has come from the four major accounting firms in the U.S., which have said that Section 404 audit costs would come down after a year, and some consumer groups.