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The SEC has delayed the phase-in of management's annual report and auditor attestation in upcoming 10-Ks for accelerated filers[fn1] with market capitalization of less than $700 million. These accelerated filers will now have up to an additional 45 days to file an amendment to include in their 10-Ks management's report on internal control over financial reporting and the auditor's "attest" report on management's assessment of internal control over financial reporting.

New Exemptive Order

The SEC exemptive order (Release No. 34-50754) indicates that the SEC "has become increasingly concerned that many smaller accelerated filers may not be in a position to meet" the upcoming deadline required by rules under Section 404 of the Sarbanes-Oxley Act of 2002. Under that deadline, all accelerated filers with fiscal years ending on or after November 15, 2004 would have been required in their Form 10-K annual reports to include both a management report and auditor attestation report regarding the effectiveness of the issuer's internal control over financial reporting. However, under the SEC exemptive order, qualifying smaller accelerated filers with fiscal years ending between November 15, 2004 and February 28, 2005 will have an additional 45 days to satisfy these Section 404 requirements.

In order to take advantage of the exemptive order, accelerated filers must meet the following conditions:

• the market value of the accelerated filer's outstanding common equity held by non-affiliates must have been less than $700 million at the end of its second fiscal quarter in 2004.
• the accelerated filer must timely file all other information required to be in its 10-K within the usual 75 day filing period (or the extended period permitted if satisfying rule 12b-25, i.e. up to a further 15 calendar days)
• the accelerated filer must indicate in the filing that it has not filed the management report and auditor attestation report
• if before the 10-K is filed the accelerated filer or its auditor has identified a material weakness in its internal control over financial reporting, this material weakness must be disclosed in the 10-K
• an amendment to the 10-K must be filed to include the management report and auditor attestation report within 45 days after the end of the original 75 day filing period (regardless of whether Rule 12b-25 was relied on for an extension). No Rule 12b-25 extension is permissible for that 10-K amendment. Also for S-2 and S-3 eligibility purposes, until the 10-K amendment is filed the accelerated filer will not be considered to have timely filed all reports required to be filed by it under the Securities and Exchange Act of 1934, or ‘34 Act[fn2] .

What Companies Need to Know

The effect of the exemptive order simply gives eligible companies the ability to delay filing their 404 internal control reports (including auditors' attestations) for a further 45 days past the normal Form 10-K filing deadline and does not affect the need to file in accordance with the normal timeline a Form 10-K containing all other required information other than the internal control reports. Accelerated filers with fiscal year ends falling between November 15, 2004 and February 15, 2005 whose public equity float thresholds exceed $700 million are not affected by the exemptive order and will be required to complete their internal control work by the existing 10-K deadline. As a result, the exemptive order applies to only a small percentage of all accelerated filers because it is available for only those issuers whose public float is less than $700 million (at the end of the filer's second fiscal quarter in 2004) and that have fiscal years ending between November 15, 2004 and February 15, 2005.

For those issuers that qualify for exemptive relief, the order raises a number of issues. First, S-2 and S-3 eligibility will be lost[fn3] until the 10-K amendment has been filed if the issuer takes advantage of the 45-day extension, since the issuer will not be considered to have timely filed all '34 Act reports until the 10-K amendment has been filed. Second, although the exemptive order gives small capitalization issuers additional time to file their 404 internal control reports (including auditors' attestations), it has not changed the time period for the required evaluation of the effectiveness of the issuer's controls and procedures, which will still need to be performed as of the end of the issuer's fiscal year end, and not as of the end of the 45-day extension period. Accordingly, issuers are advised to continue to evaluate the state of their internal controls and procedures and to address remediation of any known material weaknesses and deficiencies by their fiscal year end, even if they are eligible for the relief provided by the exemptive order. Third, for issuers that have an identified material weakness, the order requires the material weakness to be disclosed in the original Form 10-K filing even if the issuer will take advantage of the 45-day extension. Moreover, if the material weakness is in existence, the issuer would be well advised to have addressed remedial measures to address this condition as of the end of its fiscal year. In addition, regardless of whether an issuer elects to rely upon the additional time for 404 compliance, the 10-K filing required to be made at the normal time will still include the audit firm's opinion and the issuer's required disclosure in the 10-K concerning assessment of controls and procedures as of the end of the issuer's fiscal year. Hence, in order to file the 10-K in a timely manner, the issuer will still need to address compensating procedures to address any identified material weakness or other significant deficiencies in its internal control environment.

Accordingly, although the order may provide additional time for some smaller issuers that are struggling to meet the current timetable for 404 compliance, substantial compliance requirements will still apply for the normal filing of the Annual Report on 10-K regardless of whether an issuer elects to rely upon the exemptive order for 404 compliance.

In conclusion, eligible issuers may be well advised to complete both their evaluation of their controls and procedures as of their fiscal year end and the implementation of compensating procedures to address any significant deficiencies or material weaknesses that are identified before the end of the year.

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Footnotes

1: Accelerated filers are issuers that have a public float of at least $75 million, have been subject to the SEC's periodic reporting requirements for at least 12 months and have filed one annual report, and are not eligible to use the SEC's small business reporting forms.

2: S-2 and S-3 registrants must have filed in a timely manner all reports required to be filed during the twelve calendar months and any portion of a month immediately preceding the filing of the registration statement and , if the registrants have used (during the twelve calendar months and any portion of a month immediately preceding the filing of the registration statement) Rule 12b-25(b) under the '34 Act with respect to a report or a portion of a report, that report or portion thereof must have actually been filed within the time period prescribed by the Rule.

3: If the exemptive order is being relied on by an issuer that has not yet filed but wishes to file a S-2 or S-3 registration statement, it will not be eligible to file and go effective on S-2 or S-3 until it has filed the necessary 10-K amendment. If the exemptive order is being relied on by an issuer that has an effective S-2 or S-3 registration statement, it will not be able to rely on the S-2 or S-3 during the period until it has filed the necessary 10-K amendment.