April 25, 2013
Last month, the Securities and Exchange Commission (SEC) reported that the NASDAQ Stock Market LLC (NASDAQ) filed with the Commission a proposed rule change requiring that listed companies establish and maintain an internal audit function. The proposed rule states that to allow sufficient time for companies that do not have an internal audit function, each company listed on NASDAQ on or before June 30, 2013, will be required to establish such a function by no later than December 31, 2013. However, companies listed on NASDAQ after June 30, 2013, will be required to establish an internal audit function prior to listing.1
The proposed rule change was published for comment in the Federal Register on March 8, 2013. To date, the SEC has received 38 comments on the proposal. The comment letters are available at www.sec.gov/comments/sr-nasdaq-2013-032/nasdaq2013032.html.
The SEC has now decided to extend the 45-day time period for it to act on the proposed rule change. Given the resistance to the rule expressed in many of the comment letters (see discussion below), the Commission has concluded that a longer period is necessary to take action on the proposed rule change so that it has sufficient time to consider NASDAQ’s proposal, as described above, as well as the comments received. The Commission’s ruling may be found on its website at www.sec.gov/rules/sro/nasdaq/2013/34-69402.pdf.
The securities laws provide that, within 45 days of the publication of notice of the filing of a proposed rule change, the Commission must approve or disapprove the proposed rule change or institute proceedings to determine whether the proposed rule change should be disapproved. The securities laws further provide that the Commission may designate a longer period of up to 90 days if it concludes that such a longer period is appropriate. As the 45th day for comment on this proposal is April 22, 2013, the Commission designated June 6, 2013, as the date by which it should either approve or disapprove the proposed rule or institute further proceedings to determine whether to disapprove the proposed change. This gives the Commission time to consider the comments it has received to date as well as seek more comments.
A review of the comment letters indicates a variety of concerns about the NASDAQ proposal, with cost being the predominate issue raised. The letters include quite a few comments from CEOs, CFOs, GCs and CAEs of NASDAQ-listed companies, with CFOs being the strong majority. There are also commenters from the Biotechnology Industry Organization.
Many of the commenters reported that overall compliance costs already are significant in relation to their revenue base, and that this proposal would increase that burden. Companies with a small revenue base are especially sensitive to the cost issue, particularly if they qualify as an “emerging growth company.” To address this issue, some commenters proposed a “microcap” exemption based on a market capitalization threshold.
Other commenters expressed concern with the requirement to provide management and the audit committee with an ongoing assessment of the company's risk management process and system of internal controls, viewing it as inflexible. Still others asserted that an internal audit function is unnecessary if the business is not complex, e.g., low volume of transactions. An interesting perspective is the assertion by more than a few commenters that the proposal either would defeat the purpose of the Sarbanes-Oxley Section 404(b) exemption they currently have or would be redundant with their company’s current Section 404 compliance process.
Clearly, the SEC has decided it must sort through the comments it has received and provide additional time for further comments. While it is premature to attempt to read the tea leaves at this juncture as to what the Commission may decide, NASDAQ-listed companies that do not have a modest revenue base and are accelerated filers should continue to take this proposed rule seriously.
Protiviti (www.protiviti.com) is a global consulting firm that helps companies solve problems in finance, technology, operations, governance, risk and internal audit. Through our network of more than 70 offices in over 20 countries, we have served more than 35 percent of FORTUNE® 1000 and Global 500 companies. We also work with smaller, growing companies, including those looking to go public, as well as with government agencies.
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1See Protiviti SEC Flash Report, “SEC Seeks Comment on NASDAQ Proposed Rule Requiring Listed Companies to Have an Internal Audit Function,” dated March 11, 2013, available at www.protiviti.com. This Flash Report outlines the specifics of the proposal.