SOX 404(b) Compliance and the 2020 Amendment to the SEC’s Accelerated Filer Definitions

Abstract

In 2020, the Securities and Exchange Commission exempted issuers with less than $100 million in annual revenue from the SOX Section 404(b) internal control audit requirement. We consider the implications of this change in two ways. First, we use a pre-amendment sample of issuers that would be exempt under the new rule to examine the effects of internal control audits on audit fees, internal control quality, internal control report quality, and financial reporting quality for such issuers. Using a fuzzy regression discontinuity design, we estimate that issuers with 404(b) audits in our sample pay 73 percent higher audit fees than exempt issuers. However, we find little evidence that internal control audits improve internal control reporting quality or financial reporting quality. Second, we use a post-amendment sample to evaluate issuer responses to the expanded compliance exemption. We find that 92.1 percent of newly exempted issuers opt not to voluntarily obtain an internal control audit. In fact, we observe low levels of voluntary compliance even within the subsample of issuers that received a 404(b) audit in the prior year, as 85.7 percent of these issuers dropped their audit of internal controls over financial reporting upon availability of the exemption. Together, our findings provide support for the SEC’s decision to exempt low-revenue issuers from the requirements of 404(b).

Keywords: SOX Section 404(b), Internal Control Audits, Compliance Costs, Compliance Benefits