Is the end of SOX near? Businesses have long complained that the Sarbanes-Oxley Act is too costly and burdensome. How far will the SEC go to appease them and other critics?

Jim Clark, chairman of online photo company Shutterfly Inc., recently announced he was leaving the firm because of the Sarbanes-Oxley Act of 2002 (SOX). According to the Associated Press, Clark said the law has taken reform too far and was preventing him from leading the way he wanted to lead.

Clark, the founder of Netscape Communications, also owns 30 percent of Shutterfly's stock, making him its biggest shareholder.

According to a letter Clark wrote to the company's board of directors that was released to the media: "As I understand it, Sarbox dictates that I not chair any committee due to the size of my holdings, not be on the compensation committee because of the loan I once made to the company, not be on the governance committee, and it even dictates that some other board member must carry out the perfunctory duties of the Chairman. What's left is liability and constraints on stock transactions, neither of which excite me."

While other corporate leaders may empathize, the general public may scratch their heads and ask, "Isn't that what SOX is supposed to do?"

The answer is a resounding "yes"; however, the Securities and Exchange Commission (SEC), which enforces the law, lately seems to be going out of its way to quell criticism by making SOX more business-friendly. Anyone who has been paying attention to the words and actions of the commission over the past several months might believe that the sky is beginning to fall on the corporate reform law.

Is the end nigh for the five-year-old legislation that was enacted in an attempt to prevent another Enron debacle? From all indications, the world will find out soon; however, recent signs are not encouraging for SOX proponents.

Section 404 in the Crosshairs

Since SOX was passed almost five years ago, many businesses have been very vocal in expressing their opinion that the legislation--especially the internal-controls provision, Section 404--is too costly and time-consuming, thus negatively affecting their bottom-lines. But that is nothing new. What is different now is that the SEC and its sister agency, the Public Company Accounting Oversight Board (PCAOB), are not only listening to, but also are increasingly appeasing SOX critics.

For example, in late December 2006, the SEC extended the deadline for small public companies yet again, giving non-accelerated fliers--those with less than $75 million worth of shares held by the public--at least five extra months to file reports required by SOX's Section 404 and an additional year and a half for auditors to confirm the accuracy of their reports.

The commission also changed the internal report requirements for small public companies. Now they will not be required to submit a management assessment of internal controls with their annual report until the first fiscal year that ends on or after December 15, 2007. (The deadline had been July 15, 2007.) Also, the second SOX requirement for an outside auditor to confirm the managerial assessment of the firm's internal controls has been pushed back to 2008.

According to SEC reports published in the media, 7,402 smaller public companies account for 78.5 percent of the total number of public companies in the United States. That means nearly four out of five U.S. public companies do not have to report on their internal financial controls until the end of the year, at the earliest. These companies have not had to submit reports yet, as the SEC has given them a one-year extension in each of the past two years. And, according to several media reports, the SEC is already discussing further extensions.

But that's not all. The SEC has also proposed changes to the internal control provisions specified under SOX's Section 404 that would reduce the number of reports and outside accounting audits that are now required of companies. The proposals would not require every financial document to be reviewed, as is currently the case, and would give companies greater freedom to focus internal controls on addressing only the areas in which they face the biggest risks. Also, outside accounting auditors would need to submit only one opinion, instead of two, regarding the company's internal financial controls. Currently, SOX requires both management and outside auditors to approve a company's internal financial controls, which firms have criticized as both burdensome and expensive.

Many companies had been asking for exemption from Section 404. Instead, this proposal would help companies prevent auditors from engaging in what many executives considered costly and unnecessary audits. According to The New York Times, the SEC's proposed guidance would impose a "materiality standard" for the first time, meaning that executives could review the design of financial controls, and auditors would be advised to scrutinize only those controls that might affect financial statements. It is expected to encourage auditors to rely on previous years' work as a basis for testing controls and discourage them from testing the same controls multiple times, the Times reported. It will also encourage auditors to perform a risk assessment to focus just on the areas of greatest potential concern.

Regulators said the guidance proposes a "scaled" or flexible framework that will meet the needs of each company. For example, a small company with many financial issues would face more rigorous auditing of its controls than one of the same size with fewer issues.

"Companies of all sizes and complexities will be able to conduct their evaluations more effectively and efficiently by following the pro posed guidance," Christopher Cox, SEC chairman, told the Times. "As smaller companies have less complex internal control systems than larger companies, this approach enables smaller companies, in particular, to scale and tailor their evaluation methods and procedures to fit their own facts and circumstances."

Media reports said the SEC will consider public comments on the proposed SOX guidelines for 70 days after their January publication in the Federal Register. The guidelines could be adopted as early as late March.

Replacing AS No. 2

On the heels of that action came a new proposed auditing standard from the PCAOB in late December 2006. This guidance would require auditors to do less work when assessing internal controls over financial reporting and advocate a principles-based standard designed to focus auditors on issues that are most likely to cause a firm to misstate its financial results. According to an Investor Relations magazine report, it also provides direction for scaling audits for smaller companies, revises the definition of "strong indicators of material weakness," and permits the use of information obtained during previous audits.

The proposal's comment period will end February 26, after which the board will decide whether to adopt the final standard. If so, the standard will then be submitted for SEC approval. If approved, it will supersede SOX's Auditing Standard No. 2, which Cox called "unduly expensive and inefficient" in a recent press release.

Coincidentally or not, just a few days before the flurry of new proposals, the Justice Department announced it was imposing new limits on federal prosecutors in white-collar corruption cases. Its new guidelines restrict prosecutors' ability to crack down on companies that withhold confidential information in criminal fraud investigations. Specifically, they stipulate that prosecutors in the field must first get permission from senior officials before trying to get companies under investigation to waive their attorney-client privilege, according to the Times. The guidelines also state that prosecutors can no longer consider whether a company is paying the legal fees of an employee involved in the inquiry when considering whether to indict the company.

Under Legal Threat

All the proposed revisions to the law will be moot if SOX is ruled unconstitutional and struck down, and that all depends on the impending decision of a D.C. district court judge.

In December, Judge James Robertson heard arguments in the case, Free Enterprise Fund v. The Public Company Accounting Over sight Board, brought by the Free Enterprise Fund and Beckstead and Watts, a Nevada accounting firm currently under investigation by the PCAOB for auditing deficiencies, according to the Legal Times.

The plaintiffs claim that the PCAOB and the SOX provisions that created it violate the constitutional requirement that key executive branch officials be appointed by the president and, therefore, they infringe upon executive authority. The fund also argues that SOX has had negative consequences for the U.S. economy and is driving public companies out of the country.

The Legal Times reported that provisions of SOX cannot legally be severed from the law, so if the court decides that the provisions that established the board are unconstitutional, the entire law would be invalidated.

Michael Carvin, the fund's lawyer who argued in front of the Florida Supreme Court on behalf of George W. Bush in the 2000 Florida election recount case, argued that the PCAOB is a quasi-independent entity with broad powers that is unaccountable to the executive branch, the Legal Times reported.

The PCAOB's attorney, however, disagreed, saying that the board's members are subject to SEC supervision and oversight. Every decision the board makes is subject to SEC review and approval.

Even the government has come to the PCAOB's defense; a Justice Department official told the Legal Times that the board does not infringe executive power and said that the fund seems to be "looking for constitutional problems."