SEC roundtable on Section 404

Strategic Finance, April, 2005 by Stephen Barlas

The fact that the Securities & Exchange Commission (SEC) scheduled a roundtable on Section 404 of Sarbanes-Oxley for April without initially setting a definite date for that confab reflects the pressure the SEC is under from the business community. Groups such as the U.S. Chamber of Commerce have been actively whispering in the ears of Bush administration officials that the internal controls requirements of Section 404 are too costly. SEC Chairman William H. Donaldson has been under pressure to respond. That explains the February 8, 2005, publication of the notice proclaiming that the roundtable is "tentatively scheduled for April 2005." Asked why no date had been specified, John Heine, an SEC spokesperson, said, without further clarification, "What you see is what you get."

Section 404 and the rules adopted by the SEC require all U.S. and non-U.S. entities that file annual reports to report on management's responsibilities to establish and maintain adequate internal controls over the company's financial reporting process. Each report must include management's assessment of the effectiveness of those internal controls.

Whenever the roundtable takes place, it will be the start of an analysis period that will last through spring, according to Donald T. Nicolaisen, the SEC's chief accountant. "The SEC and Public Company Accounting Oversight Board are committed to working closely together to determine ways to improve the crucial internal controls process without sacrificing investor protection," he says.

It's highly unlikely that the SEC will change its 404 rules in a major way. Cynthia A. Glassman, an SEC commissioner, says, "It may be too early to truly be able to assess the costs and benefits of Sarbanes-Oxley, especially when one of the final provisions has not been fully implemented, and the main intended benefit, restoring investor trust, will take time to be fully realized."

Treasury Gussies Up 401(k) Rules

With the Pension Benefit Guaranty Corporation (PBGC) possibly heading for stormy seas (as reported last month), it's no surprise that the Treasury Department is trying to make 401(k)s easier to fund and manage. That's the backdrop to the Department's final rule issued in late December on company administration of employee stock ownership plans (ESOPs), whose rules were last changed over a decade ago. Congress ordered Treasury to modernize the rules for ESOPs when it passed the Small Business Job Protection Act (SBJPA) of 1996. It has taken Treasury eight years to implement those reforms. The most substantial changes had to do with nondiscrimination tests that are based on either of two calculations: actual deferral percentage (ADP) or actual contribution percentage (ACP), depending on the kind of company stock plan involved. Those tests help a company determine whether enough lower-paid employees are in a particular plan, which is a threshold determination for allowing higher-salaried employees to both participate in a plan and, in some cases, exceed what they might otherwise contribute. Under the reforms, employers who find they have allowed higher-paid workers to contribute too much will have more flexibility in undoing their error. The new rules go into effect in 2006 for most companies.

Tax Panel Starts Deliberations

It is way too early to say whether the President's Advisory Panel on Federal Tax Reform will lead to legislation making significant changes in the tax code, but one thing is certain: The panel won't be restricting its review to individual taxes. Business taxes are up for grabs, too. Former Sen. John Breaux, the panel's co-chair (former Sen. Connie Mack is the chair), said at the panel's first meeting in mid-February, "Reform is not just about the possibility of eliminating mountains of paperwork--it's also about global competition. Now is the time to take a critical look at whether our tax code is an obstacle to U.S. businesses--both here at home and abroad."

IRS Budget

Speaking of a fairer tax system, President Bush thinks another way to get that done--besides a wholesale revision of the code--is to make sure everyone is paying what they owe under the current system. That's why he proposed boosting the IRS's enforcement budget from the $6.392 billion Congress approved for FY 2005 to $6.893 billion for fiscal 2006, which starts October 1, 2005.

One of the IRS's major enforcement efforts has been in the area of tax shelters. On February 15, the IRS designated "sale-in/lease-out" (SILO) arrangements as abusive tax avoidance transactions. SILO arrangements are designed to exploit the tax law by shifting tax benefits from a tax-indifferent party that can't use them to a taxpayer that can. Taxpayers entering into SILO arrangements can't claim tax benefits as the purported owners of property subject to the lease because they don't acquire tax ownership of the property. In the American Jobs Creation Act of 2004, Congress enacted limitations on the deductibility of losses from future SILO transactions. The IRS says that it will challenge the purported tax benefits claimed by taxpayers entering into earlier SILO transactions. It further states that it will consider SILOs to be "listed transactions," requiring taxpayers who enter into SILOs to disclose their participation to the IRS.