Washington, D.C. - A measure by the House Financial Services Committee that would exempt small and midsized companies from Sarbanes-Oxley audit requirements has drawn fire from a number of organizations, including the American Institute of CPAs, the Center for Audit Quality and the Association of Certified Fraud Examiners.

The Garrett-Adler Amendment, which last month passed through the committee by a margin of 37-32, would exempt public companies with market capitalizations below $75 million - defined as "small issuers," but making up more than half of all publicly traded companies - from Section 404(b), the provision of the Sarbanes-Oxley Act that requires an audit report on internal controls

The exemption comes despite a plea from Securities and Exchange Commission Chair Mary Schapiro, who wrote to lawmakers on the committee opposing the carve-out.

In addition, it requires the SEC and the Government Accountability Office to conduct a study to determine how the SEC can reduce the burden of complying with Sec. 404 for companies whose market cap ranges between $75 million and $250 million.

The Sec. 404 audit requirements for smaller companies' internal controls have been postponed several times by the SEC, but the commission had announced recently that it would no longer delay the mandate.

While SOX 404 compliance has been mandatory for a number of years for larger SEC issuers, small companies have long protested the disproportionate costs of Sec. 404 compliance as compared to entities with far larger market caps.

The amendment was part of the more expansive Investor Protection Act, which doubles the authorized funding for the SEC over five years and imposes stricter rules on broker-dealers and investment advisors.

The overall investor protection bill passed by a vote of 41-28. It includes a provision to close a loophole that had prevented the Public Company Accounting Oversight Board from examining the auditors of broker-dealers, particularly investment firms that also act as asset custodians, such as the one operated by jailed Ponzi schemer Bernard Madoff.The bill also would require that every financial intermediary that provides advice have a fiduciary duty toward their customers. Broker-dealers and investment advisers would have a harmonized standard of duty toward clients.

But critics zeroed in on the Sarbanes-Oxley exemption.

"The accounting profession supports the Sarbanes-Oxley Act and we believe that the Section 404(b) internal control provisions should apply to all public companies, not just large ones," said AICPA president and chief executive Barry Melancon. "We believe all investors should be entitled to the same protections under the act, regardless of company size. Sarbanes-Oxley improved the quality and reliability of financial reporting. Congress and the administration should adopt policies that serve to build jobs in America by strengthening our capital markets, not by weakening needed reforms."

The exemption provision also raised the ire of ACFE president James D. Ratley, who said that lawmakers need to reconsider the impact of potential fraud losses on organizations, investors, employees and taxpayers when weighing the cost of anti-fraud controls prescribed by SOX.

"At a time when the economic downturn has heightened the risk of fraud for organizations large and small, it simply does not make sense to weaken accounting rules that are in place to protect investors," he said. "The bottom line is that internal controls are one of the best fraud-prevention tools for any organization to have in place. Providing exemptions for some public companies from the SOX 404 requirements only leads to an increased risk of fraud."

In a report issued last year on fraud statistics, the Austin, Texas-based ACFE found that the implementation of anti-fraud controls has a measurable impact on an entity's exposure to fraud.

While the amendment to Sarbanes-Oxley would exempt organizations worth less than $75 million, the report found that companies of all sizes and industries are susceptible to fraud and rely on internal controls - second only to tips, in terms of discovery - for fraud detection and prevention.

Meanwhile, Cindy Fornelli, executive director at the CAQ, wrote a letter to the leaders of the congressional committee also criticizing the amendment: "We believe the reforms under SOX have contributed significantly to restoring investor confidence and, in particular, that Section 404 has played a critical role in promoting high-quality financial reporting, which is vital to the successful operation of our capital markets. Reporting under Section 404 provides investors with meaningful information regarding a company's internal control over financial reporting. In addition, we believe that the required independent audit of management's assessment of the effectiveness of ICFR, as required by SOX Section 404(b), has been integral to the achievement of the intended objectives of ICFR reporting under SOX Section 404."

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