A bipartisan group of senators has introduced a new bill, the Fostering Innovation Act of 2019 (S. 452), that would amend SOX to provide a temporary exemption from the auditor attestation requirements of Section 404(b) for low-revenue issuers, such as biotechs. The bill is designed to help those EGCs that will lose their exemptions from SOX 404(b) five years after their IPOs, but still do not report much revenue. For those companies, proponents contend, the auditor attestation requirement is time-consuming and expensive, diverting capital from other critical uses, such as R&D. According to the press release, the bill would provide “a very narrow fix that temporarily extends the Sarbanes-Oxley Section 404(b) exemption for an additional five years for a small subset of EGCs with annual average revenue of less than $50 million and less than $700 million in public float.” I know it’s Valentine’s Day, but does it also feel a bit like Groundhog Day? That’s because, in 2016, the House passed the Fostering Innovation Act of 2015—the very same bill. That bill went nowhere, but the question is: have we now reached an inflection point for SOX 404(b)?
You’ll recall that SOX 404(b) requires a public reporting company, other than a non-accelerated filer or emerging growth company, to obtain an auditor attestation regarding management’s assessment of the effectiveness of the company’s internal control over financial reporting. The new bill provides an exemption for each former EGC that ceased to be an EGC at the end of the five-year period after its IPO, had average annual gross revenues (defined as the total gross revenues of the company over its most recently completed three fiscal years divided by three) of less than $50 million as of the most recently completed fiscal year and is not a large accelerated filer (that is, a public reporting company that had a public float of $700 million or more, as of the last business day of its most recently completed second fiscal quarter). Under the bill, the company would lose the exemption on the earlier of the end of 10 years after its IPO, the last day of the fiscal year when its average annual gross revenues exceeded $50 million or the date when the company becomes a large accelerated filer.
The President of BIO (the Biotech Innovation Organization) observed in the press release that “[m]ost biotechnology companies remain pre-revenue for a decade or more until they receive their first product approval, long past the original five-year exemption from SOX 404(b) granted by the JOBS Act, causing a damaging diversion of capital from science to compliance. By extending this commonsense exemption of the JOBS Act to qualifying companies, emerging biotechnology innovators will be able to devote more of their limited resources to potentially lifesaving research and development activities.”
Obviously, the earlier version of this bill did not make it into law; whether the 2019 version will fare better remains to be seen. One difference might be the recent heightened clamor for relief from SOX 404(b), spurred in part by the deeply held belief of some that the decline in IPOs is attributable to regulatory overload, with the current bête noire of deregulation advocates being SOX 404(b). For example, in a 2018 report about expanding the number of IPOs and public companies, eight organizations—the American Securities Association, BIO, Equity Dealers of America, Nasdaq, National Venture Capital Association, Securities Industry and Financial Markets Association, TechNet and the U.S. Chamber of Commerce—recommended extending the JOBS Act exemption from SOX 404(b) from five years to ten years for EGCs that have less than $50 million in revenue and less than $700 million in public float. The report contended that costs associated with SOX 404(b) “have not been scalable for small and midsize public companies” and that there is “no evidence” that the JOBS Act exemptions from SOX 404(b) “have compromised investor protection or market confidence.” (See this PubCo post) Similarly, at a meeting of the Subcommittee on Capital Markets, Securities, and Investment of the House Financial Services Committee in 2017, witnesses lamented the SOX 404(b) requirement as time-consuming and expensive for smaller companies, diverting capital from other more important uses such as R&D. (On the other hand, another witness characterized internal control as “the backbone of the financial statements,” and observed that some auditors view the attestation as more important than the audit itself.) (See this PubCo post.)
The issue has also been considered at a meeting of the SEC Committee on Small and Emerging Companies, where one biotech CEO provided as an example a small public biotech with fewer than 60 employees and a public float of $85 million, where the cost of the controls audit added 1% to the company’s burn rate. He maintained that SOX 404(b) just did not make sense in those circumstances. (See this PubCo post.) And the Commissioners themselves have been divided on the advisability of retaining the SOX 404(b) requirement for smaller companies. To further consider that issue, Clayton last year directed the staff to come up with potential amendments to reduce the number of companies subject to SOX 404(b), while, of course, maintaining appropriate investor protections. Potential beneficiaries of relief, according to Clayton, are companies with little or no revenue, such as many biotechs. In those cases, he asserted, the money that would otherwise be used for the SOX 404(b) attestation “could instead be used to hire new scientists to advance life-enhancing or life-saving developments.” (See this PubCo post and this PubCo post.)
With so many eyes now trained on SOX 404(b), will it be the same-old same-old, or have we reached an inflection point?