Risk & Compliance

What’s Next for Section 404?

SEC chairman William Donaldson and PCAOB chairman William McDonough seem to suggest that they believe this provision of Sarbanes-Oxley goes too far.
Stephen TaubApril 14, 2005

Will Section 404 be scaled back?

Two of the most powerful securities regulators seemed to hint as much at yesterday’s Securities and Exchange Commission roundtable, which discussed the demands of that Sarbanes-Oxley provision calling for companies to document their internal controls over financial reporting.

Regulators can’t eliminate the rule themselves since it is mandated by Congress. However, if you listen closely to SEC chairman William Donaldson and to William McDonough, chairman of the Public Company Accounting Oversight Board, and you get a strong feeling that they believe the rule goes too far and has caused too many difficulties when balanced against the benefits of reining in potential fraud.

“I would be very disappointed if we didn’t find some things we could do,” Donaldson told reporters outside the meeting, according to Reuters. “The American people have been saying [404] is a very good idea, but it costs too much,” McDonough told reporters, the wire service also noted. “We have to be attentive to that.”

McDonough said the PCAOB will probably issue staff guidance within 30 to 45 days to help clarify some aspects of the rule, according to The Wall Street Journal, and would even consider reopening the rule if the guidance didn’t provide enough help.

These are precisely the kinds of words many attendees and critics wanted to hear.

In panel after panel, speakers at yesterday’s roundtable complained about how expensive, time consuming, rigid, and inconsistent they had found the rules on assessment and documentation of internal controls over financial reporting. Speakers also lamented that they couldn’t draw on their auditors for professional advice, thanks to new auditor independence rules.

CFO senior writer Tim Reason, who determinedly covered the all-day webcast from his Boston office in the CFO Blog, pointed out the testimony of Computer Sciences Corp. chief financial officer Leon Level, whose company tested 1,500 process controls and 1,300 information-technology general controls. “We really believe that additional guidance needs to be around scoping,” Level suggested, according to Reason’s account.

It’s no surprise that some groups — albeit a minority of critics — are calling for scrapping Section 404 or even the Sarbanes-Oxley Act in its entirety. In fact, earlier this week the Competitive Enterprise Institute asked Congress and President Bush to do just that.

“To deal with the problem of a few big business bad apples, Congress created a web of costs and mandates that are shackling innovation,” said the institute’s president Fred L. Smith Jr., president of the Competitive Enterprise Institute, in a statement. “These rules disproportionately hurt the innovative entrepreneurs who run small public companies. And they’ve turned out to be a form of corporate welfare for the accounting industry that many wanted to punish after the scandals.”

Don’t bet on Sarbox vaporizing any time soon, however.

As Reason pointed out during his blow-by-blow coverage of the roundtable, “there has been relatively little, nay, almost no concrete criticism of specific language in 404, AS No. 2, or any of the promulgated rules.”

True, 7.7 percent of companies have received “adverse opinions” on their internal controls so far, according to a recent report by Compliance Week. And dozens of companies have restated their year-end 2004 results as a result of their Section 404 assessments.

For these reasons, you may see some tinkering with Section 404 rules — especially for smaller companies, which have shouldered a disproportionately larger burden — but don’t bet on wholesale changes.