By Hank Bourg

Dec. 17 – The U.S. House of Representatives last Friday passed sweeping legislation that tightens government regulation of the financial markets in the U.S. including addressing predatory lending practices and unregulated financial derivatives.

Nestled in the various sections of the act, titled “The Wall Street Reform and Consumer Protection Act,” is an amendment to the Sarbanes-Oxley Act that would change compliance requirements for some companies. Sarbanes-Oxley, originally enacted in 2002, applies to companies that are required to file periodic reports with the Securities Exchange Commission and contains significant changes to reporting requirements and to the responsibilities of directors, officers, and auditors. With respect to foreign entities, the SOX not only applies to U.S.-based parent companies, but also to those subsidiaries organized outside the borders of the United States.

The recently passed act if enacted would amend the compliance requirements of Section 404 of SOX. Under Section 404 as originally enacted, issuers (U.S. Domestic Corporation that issue securities publically traded in the United States) and foreign private issuers (similar to issuers, but are incorporated outside U.S.) are required to include in their annual reports filed with the SEC a report of management, and an accompanying auditor’s attestation report, on the effectiveness of the company’s internal control over financial reporting (ICFR). The new legislation amends section 404 lifting the ICFR compliance for public companies with public float under US$75 million.

This change has significant implication for Chinese companies interested in gaining access to the U.S. capital markets through an IPO or a reverse merger. ICFR compliance is a daunting task that all newly public companies must comply within two years (45 days after the second annual report date). This can be burdensome both in the form of human resources devoted to the effort as well as financial resources required in the form of consulting and accounting fees. For such Chinese companies seeking financing below US$75 million will have much lower SEC reporting compliance costs.

The House legislation must also be approved by the U.S. Senate before being sent to President Obama for approval. However, the U.S. Senate is currently considering companion legislation and will likely not vote directly on the House’s bill. If the companion legislation is approved by the Senate, both pieces of legislation will go to a conference committee (made up of select members of both houses) to reconcile differing provisions. The final legislation (combined and reconciled) would go for final approval of both houses of Congress and then on to the president for final approval.

Hank Bourg is a U.S. certified public accountant and the head of the North American desk at Dezan Shira & Associates. For comments or inquiries, please contact him at tax@dezshira.com.