The $120,000 Threshold Is Not Your Threshold: Item 404(d) for Smaller Reporting Companies

Every securities lawyer's outline, every governance training deck, every questionnaire template says the same thing: related-party transactions over $120,000 get disclosed. For a smaller reporting company with a light balance sheet, that number can be wrong, and wrong in the direction that produces omitted disclosure.

What threshold actually applies to a smaller reporting company?

Item 404(d) of Regulation S-K (17 CFR 229.404(d)) replaces the flat $120,000 trigger in Item 404(a) with the lesser of $120,000 or 1% of the average of the company's total assets at year-end for its last two completed fiscal years.

The mechanics matter:

• Total assets of $30 million and $20 million at the last two year-ends → average $25 million → 1% = $250,000 → threshold stays at $120,000 (the lesser).
• Total assets of $10 million and $6 million → average $8 million → threshold is $80,000.
• A clinical-stage biotech that burned down to $4 million and $2 million in assets → threshold is $30,000. A consulting arrangement with a director's spouse at $3,500 a month is now reportable.

The companies most likely to have a depressed threshold, cash-burning, asset-light, pre-revenue, are exactly the companies most likely to be transacting with insiders, because insiders are often the only available lenders, landlords, and consultants. That correlation is why this trap fires so often.

Before proxy season, run your last two audited balance sheets and your transaction list through the Related-Party & Item 404 Disclosure Checker at app.unfoldingvalues.com; it computes the 404(d) threshold and screens every transaction against it, rather than against the $120,000 figure your questionnaire was built on.

What else is different under Item 404(d) besides the dollar amount?

Three things, and each changes your drafting:

A two-year lookback. SRCs disclose covered transactions for the last two completed fiscal years, not just since the beginning of the last fiscal year. A reportable transaction from the prior year does not fall away after one proxy cycle.

Promoter and control-person disclosure. Item 404(d) picks up the Item 404(c) requirements for registrants filing certain registration statements, names of promoters, what they received from the company, and assets acquired from them with how the price was determined. Shell-origin and reverse-merger companies, take note: this is where your corporate pre-history gets disclosed.

No mandatory 404(b) narrative. SRCs are not required to provide the Item 404(b) description of review-and-approval policies. Most provide it anyway: Nasdaq Rule 5630 and NYSE American requirements mandate independent-director or audit-committee review of related-party transactions regardless, and omitting the narrative while your peers include it invites questions rather than avoiding them.

Does the lower threshold change what the auditors look at?

Not directly, and that's the second trap. Your auditor tests related-party identification and disclosure under PCAOB AS 2410 against ASC 850, which has no dollar threshold at all: financial-statement disclosure turns on materiality. So you face two independent screens with different definitions (ASC 850's "principal owners" starts at 10% ownership; Item 404's related-person definition starts at 5% holders) and different triggers. A transaction can require a footnote but no proxy disclosure, proxy disclosure but no footnote, or both. Reconciling the two lists side by side, which is precisely what the free Related-Party & Item 404 checker produces, is the only way to prove you considered each transaction under each regime rather than assuming one disclosure covered both.

What does an under-threshold miss look like when it surfaces?

Typically not in a vacuum. It surfaces when a new audit partner rotates in and re-runs the related-party population; when a D&O questionnaire response changes and someone asks why last year's answer was different; or when the SEC staff, reviewing a registration statement, cross-references your footnote against your Part III disclosure and finds a transaction in one but not the other. The remediation path is manageable when caught internally, amend the proxy or 10-K/A if material, fix the process, document the analysis. It is far worse when the staff finds it first: the SEC's 2023 Lyft order ($10 million penalty for one omitted related-person transaction in a Form 10-K, charged under Exchange Act Section 13(a) and Rule 13a-1) shows enforcement does not require fraud, materiality to the bottom line, or even shareholder harm allegations. A reporting-violation theory is enough.

How do I operationalize the 404(d) threshold without new headcount?

Four low-cost controls that survive audit scrutiny:

1. Recompute the threshold annually, in writing, as part of the proxy-drafting checklist, average the last two year-end total-asset figures, take 1%, compare to $120,000, and circulate the operative number to legal, accounting, and the audit committee.
2. Rebuild the questionnaire around the operative number. Asking directors about transactions "over $120,000" when your threshold is $80,000 guarantees a blind spot.
3. Screen AP and payroll against the related-persons list at the operative threshold divided by four, quarterly amounts aggregate, and "amount involved" aggregates related transactions and, for indebtedness, uses the largest principal outstanding during the period.
4. Keep the two-year file open. Because of the SRC lookback, last year's disclosure workpapers are this year's source documents.

FAQ

How do I calculate the Item 404(d) threshold?

Average your total assets as of the last two fiscal year-end balance sheets, take 1% of that average, and compare it to $120,000. The lesser of the two is your disclosure threshold for related-person transactions.

Do smaller reporting companies have to describe related-party approval policies under Item 404(b)?

No: Item 404(d) does not require the 404(b) policies-and-procedures disclosure for SRCs. But exchange listing standards still require the underlying review process, and most SRCs voluntarily include the narrative.

How far back do SRC related-party disclosures reach?

Two completed fiscal years, plus currently proposed transactions, versus the single-year lookback under Item 404(a) for larger registrants.

Can a transaction be too small for Item 404 but still need disclosure?

Yes. ASC 850 imposes no dollar threshold, so a transaction below your Item 404(d) trigger still requires a financial-statement footnote if it is material to the statements.