Risk & Compliance

SEC: More Questions than Answers on 404

In its first response to public companies since a heated meeting last May, the SEC issues an extensive list of questions about Sarbox 404.
Marie LeoneJuly 11, 2006

Two months and one day after a contentious roundtable in which companies voiced their continuing displeasure with Section 404 of the Sarbanes Oxley Act, the Securities and Exchange Commission has responded, although primarily with more questions for public companies.

The concept release, published Tuesday, is intended by the SEC as a prelude to its forthcoming guidance related to Section 404. That is the Sarbox provision that addresses management’s assessment of company’s internal controls for financial reporting. The SEC is seeking public comment on the concept release by October, suggesting that it may be close to year end before any formal guidance is issued.

Entitled “Next Steps for Sarbanes-Oxley Implementation,” SEC officials characterize the release as a roadmap that will provide management the guidance, “that has been lacking since the law was enacted in 2002.” The guidance issued will likely be in the form of a new SEC rule, according to the document.

The topic areas covered by the concept release include, but are not limited to: Identifying risks to financial statement account and disclosure accuracy; objectives of the evaluation methods available to management to gather evidence to support its assessment; factors management should consider to determine the nature, timing, and extent of its evaluation procedures; and documentation requirements, including overall objectives and factors that might influence the requirements.

About half of the 28-page release includes specific questions about 404 that the SEC would like to see addressed in public comment letters. For example, the commission asks: Should guidance be limited to broad principles or should it be more detailed; what is the appropriate role of outside auditors; and should the SEC provide guidance about fraud controls?

The May 10 roundtable, hosted by the SEC and the Public Company Accounting Oversight Board (PCAOB), focused on second-year compliance experiences with Section 404. SEC Chairman Christopher Cox promised at the time that the SEC would issue a response to the roundtable relatively quickly. His predecessor, William Donaldson, resigned six weeks after a similar roundtable in April 2005 that focused on first-year experiences. His response to corporate complaints had been widely viewed by the business community as inadequate.

Participants at the roundtable in May, who comprised representatives from the corporate, investor, auditing, and academic sectors, generally testified that, despite some benefits, compliance with Section 404 was unduly costly, especially for smaller public companies — those with market capitalizations under $125 million.

“The public comment we receive in response to today’s Concept Release will help the SEC write meaningful guidance for all public companies — large, small, foreign, and domestic — for the benefit of all of their shareholders,” stated Cox.

The SEC also noted that it would continue to work with the PCAOB to make Auditing Standard No. 2 more workable in terms of efficiency. The PCAOB rule known as AS No. 2 implements Section 404 for auditors.