Auditing

Panelist: SEC Deserves Failing Grade

A diverse final panel results in some testy exchanges as the regulators seek next steps for 404.
Tim ReasonMay 10, 2006


See our special report on “The 404 Debate.”

A wide range of positions in the Section 404 debate were represented in the final panel of the Securities and Exchange Commission’s second roundtable on 404, and the panelists made their differences known with some testy exchanges and criticisms.

In a particularly scathing critique, Alex Davern, CFO of National Instruments and chairman of the American Electronics Association committee on reform of Sarbanes-Oxley 404, said he was disappointed with the “tremendous amount of polite discussion” during this year’s roundtable. The SEC, he observed, “deserves a failing grade for implementation of 404,” adding that back in 2003, the SEC predicted a per-company implementation cost of “about $90,000” for companies of all sizes.

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Davern, who was also on the final panel at last year’s roundtable, noted: “I sat here last year and listened to predictions that external audit fees would drop by 40 percent.” Instead, he said, they have not gone down at all. “Investors already recognize that,” he added. “As CFO of a public company, I have never once been asked by an investor about 404 except ‘How much is it going to cost?’ and ‘When is [the cost] going to come down?’” And in a shot aimed at the many accounting-firm executives in the room, he said: “The elephant in the room that has not been addressed is that the GAO has determined that the Big Four [accounting firms] are an oligopoly with a significant amount of anticompetitive market power.”

Davern also defended the efforts of the SEC’s Advisory Committee on Smaller Companies, arguing that it is “very difficult to believe that a regulatory format that requires external attestation would ever be cost-effective” for microcap companies.

That was far from the first time the cause of smaller public companies was raised during the day. Although the roundtable was ostensibly devoted to the second-year compliance experiences of large companies, the contentious issue of applying 404 to smaller companies came up several times throughout the day and on the final panel.

Indeed, J. Michael Cook, who serves as audit-committee chairman for Burt’s Bees, Comcast, Eli Lilly, and International Flavors and Fragrances, called for an end — one way or another — to this, one of the hottest topics in the 404 debate. He urged the SEC to “call the question of whether or not these rules apply to smaller business.” That is a “lingering issue creating a lot of heat,” he said. “It needs to come off the front page.”

Another hot topic was whether to reopen Accounting Standard No. 2 (AS2), the Public Company Accounting Oversight Board’s standard on audit internal controls. After last year’s roundtable, the PCAOB issued guidance to help auditors and companies understand how AS2 should be applied. One of the recommendations frequently raised on Wednesday was the idea of formally inserting that guidance into AS2.

The guidance includes PCAOB pronouncements on several issues that are considered crucial to reducing the cost and effort that public companies devoted to 404 in 2004, including urging auditors to focus their efforts on controls that pose the greatest risk and to rely on testing done by others in their audit work.

The idea of formally adding that guidance to AS2 drew a variety of reactions from the panel. David Walker, the U.S. Comptroller General, noted that the guidance was important, “but does not have the same authoritative standing [as AS2]. It is important to recognize that reality and integrate it into an updated AS2.” Ann Yerger, executive director of the Council of Institutional Investors, agreed, noting “there’s certainly evidence that auditors have not understood the guidanceÂ…it is appropriate to embed it in AS2.”

Davern also agreed that AS2 should be amended but, like several of his fellow panelists, warned that amendments should not become effective until the current reporting year ends.

Nick Cyprus, former controller of Interpublic Group and a member of the Commission of Sponsoring Organizations of the Treadway Board, was not convinced that such a move was needed. “Be extremely cautious about making changes to AS2,” he warned the PCAOB moderators, arguing that companies and auditors were well aware of the guidance.

By far the strongest opposition came from Damon Silvers, associate general counsel of the AFL-CIO. Expressing concern about “the mischief that might follow” from reopening the standard, he said: “I’m inclined to hope the SEC and PCAOB can resist” calls to do so. But, he added, “Some of what’s gone on in the last few months in terms of efforts to gut Sarbox have impinged upon my natural hopefulness.”