SEC Publishes Study on SOX 404 Compliance And Effects Of The 2007 Reforms


The Office of Economic Analysis (“OEA”) of the Securities and Exchange Commission (“SEC”) published its study of survey data and empirical evidence gathered on the compliance of Section 404 of the Sarbanes-Oxley Act (“SOX”) by public companies. The study also analyzed the effects of the SEC’s June 2007 Management Guidance, and the Public Company Accounting Oversight Board’s Accounting Standard No.5 (“AS5”) (collectively referred to as the “2007 Reforms”).

One objective of the study was to forecast the projected, incremental Section 404(b) compliance cost to filers with a public float below $75 million, since these filers must start complying with the Section 404(b) auditor’s attestation rule for their fiscal years ending after June 15, 2010. For companies that have to comply with Section 404(b), the largest component of the costs are attributed to internal labour, with auditor’s fees coming in second. The typical share of total audit fees perceived to have been allocated to Section 404(b) compliance ranges from 30 to 43 percent, with the bigger filers attributing smaller percents to such costs.

Evidence supports the theory that the costs for complying with Section 404 are inversely related to the size of a filer. However, experience gained from Section 404 compliance and the attenuation of non-recurring start-up costs seem to materially reduce compliance costs over a horizon of two to three years.

The survey results also suggest that there was an economically and statistically significant reduction in costs related to Section 404 compliance after the 2007 Reforms. The most notable changes in the costs, pre and post 2007 Reforms, are observed in the outside vendor fees and the percent of the total audit fees attributable to internal control over financial reporting (“ICFR”). Most respondents reported that they relied on the Management Guidance as clarification of Section 404 compliance requirements.

Over half of the respondents also believe that AS5 reduced the time necessary to complete the auditor’s attestation. This is true especially if the respondent has at least one year of prior experience in Section 404(b) compliance. Survey data indicates that following the 2007 Reforms, companies have devoted greater effort to structure the compliance process for Section 404(a) in order to expedite the auditor’s process for attestation. Several auditors also reported that companies have incorporated AS5 in their own assessment of ICFR and in turn maximized the auditor’s ability to rely on the company’s own work.

While the study reports that “the average perceived net benefits [by public companies with respect to Section 404 compliance] are uniformly and significantly negative, other than for a few large companies”, most external users of financial statements believe that Section 404 can discipline public companies in regards to the quality and reliability of their financial reporting, and in turn significantly impacted these users’ own confidence on such reports. Many users interviewed by the OAC also express that they believe the audit requirement to be a necessary discipline to the whole reporting process.

The study can be accessed online at

If you have questions about how to prepare for compliance with Section 404 of SOX, contact any member of Clark Wilson LLP’s Corporate Finance & Securities Group.