US accounting firms could lose an estimated $430 million in annual audit fees under an SEC proposal published on May 19 which would exempt nearly 1,600 public companies from independent auditor attestation of their internal financial controls.
The Securities and Exchange Commission is proposing to significantly narrow one of the principal audit requirements introduced after Enron. Public companies that do not meet a new $2 billion public-float threshold (up from $700 million), as well as newly listed companies — regardless of their size — that have been SEC reporting companies for less than five years, would generally no longer need to obtain an independent auditor’s attestation on their internal control over financial reporting.
The SEC estimates that 1,596 companies would become newly exempt from the auditor-attestation requirement under Section 404(b) of the Sarbanes-Oxley Act. That is 26.7% of SEC registrants and approximately 60% of companies currently subject to the requirement.
The proposal adds another piece to the broader reshaping of US audit oversight that Big4News has been tracking. Recent developments have focused on how the PCAOB inspects and enforces against audit firms, alongside the SEC’s creation of a specialist Financial Reporting and Accounting Unit. This proposal addresses a different part of the system: how many companies must obtain one of the central forms of independent assurance created by Sarbanes-Oxley.
SEC chair Paul Atkins has positioned the reforms as part of an effort to encourage more companies to enter and remain in US public markets. The SEC says that mounting regulatory requirements over recent decades have coincided with a decline in the number of public companies.
$430 million in audit fees
Companies expected to become exempt paid about $3.8 billion in audit fees last year, according to Ideagen Audit Analytics data cited by the Financial Times. Drawing on a Government Accountability Office study of the additional audit costs associated with Section 404(b), the FT estimates that roughly $430 million in annual audit fees could be at risk.
The figure is necessarily approximate. Section 404(b) work is embedded within the wider financial-statement audit and is not separately disclosed, and the SEC cautions that removing the attestation requirement may not produce an equivalent reduction in audit fees.
Audit firms have also argued that removing Section 404(b) would not eliminate all control-related audit work. Auditors would still need to obtain an understanding of internal controls as part of the financial-statement audit and, in some circumstances, test controls.
The Big Four push back
The Big Four have all opposed the rollback. The proposed five-year exemption for newly public companies — which would apply regardless of their size — has also drawn particular criticism from audit-industry groups.
The debate is not simply about audit fees.
Section 404(b) requires an independent auditor to provide assurance over management’s assessment of internal control over financial reporting. The SEC itself says the requirement is intended to encourage more complete identification and disclosure of material weaknesses and, in turn, more reliable financial reporting — although it also recognises the significant compliance costs involved.
Removing the requirement would not mean that the affected companies no longer need audited financial statements. Nor would management cease to be responsible for assessing internal controls under Section 404(a).
What disappears is the requirement for the auditor to provide the additional independent attestation over those controls.
That distinction places the proposal squarely within the wider changes now taking place in US audit regulation.
As Big4News has documented, the PCAOB is reconsidering how it inspects and enforces against auditors while the SEC is building greater specialist accounting and auditing enforcement capacity of its own. The Section 404(b) proposal adds another dimension: the regulatory architecture governing auditors is changing at the same time as the population of companies required to obtain this particular form of audit assurance could shrink by around 60%.
The proposal remains under consideration. The formal comment deadline was July 20.
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About the author: Claudine Cassar is the founder and editor of Big4News, covering audit, consulting, regulation and governance across Deloitte, PwC, EY and KPMG.