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Compliance : Sarbanes Oxley : Auditing : Thought Leader
Grant Thornton Position On SEC Proposed Section 404 Changes
By
Trent Gazzaway
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Trent Gazzaway
Managing Partner of National Corporate Governance
Grant Thornton
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Grant Thornton LLP has
committed to playing an active role in shaping guidance to protect investors. Although
ultimately serving the interests of investors, auditors must also aid audit committees and companies with ever-evolving compliance requirements.
Rather
than roll back Section 404 provisions of the Sarbanes-Oxley Act of 2002
(the
Act), as recently recommended by the SEC's Advisory Committee on Smaller
Public Companies (the Committee), we believe that these provisions
should be
given a chance to work through collaborative fine-tuning. In the process
of
"getting it right," it is vital to make sure that new guidelines protect
investors without unduly burdening companies with excessive costs.
Included
in that broader charge is the implicit responsibility to maintain a
level
playing field.
Section 404 of the Act requires public companies to state in their
annual
reports whether there are adequate controls over the financial reporting
processes. In other words, management must tell investors whether their
internal procedures can reasonably be relied upon to produce complete
and
accurate financial statements. Section 404 also requires auditors of
those
public companies to attest to, and report on, the assessment made by
management.
Although these requirements are reasonable, real-world execution has led
to
significant problems, chief among them costs. Responding to these
concerns,
on Dec. 14, 2005, the Committee recommended that the SEC:
(1) fully
exempt
certain small companies from this requirement, and
(2) exempt slightly
larger companies from the requirement to have management's assessment
audited.
In effect, then, this recommendation would create three classes
of
public companies: one in which management would not have to assert the
quality of their controls; another in which management would have to
assert
the quality of their controls (but their independent auditors would not
audit that assertion); and, a final group of nonexempt public companies
(i.e., those with public market capitalization of more than $700 million
or
revenues of more than $250 million), in which management would be
required
to issue an audited assertion regarding the quality of their internal
controls. The creation of such a hierarchy would confuse investors and
negatively affect audit committees, companies and capital markets.
If adopted, this recommendation would place investors in smaller
companies
at a disadvantage compared with investors in larger companies. Auditors
of
the nonexempt public companies would, by mandate, be able to perform
more
overall audit work than auditors of smaller public companies. As a
result,
investors would not be able to rely as much on the financial statements
of
smaller public companies as on those of larger public companies.
Moreover,
the relative quality of financial reporting processes would be less for
smaller companies than if all companies were held to the same standard;
i.e., everyone understands, up front, that all internal controls will be
audited.
Historically, effective inspection has driven proper performance, and it
would be unfair to smaller company investors to have their investments
held
to a lesser standard than those of investors in larger companies.
Moreover,
in the proposed scenario, smaller company audit committees would find it
difficult to fulfill fiduciary responsibilities for ensuring proper
internal
controls, and management, having spent the time and money to ensure
proper
controls, would be left at greater risk without independent evaluation
of
them. The lack of such third-party affirmation represents a significant
competitive disadvantage.
The proposed cutoff between the largest public companies and all other
public companies would also increase concentration of audits in the
largest
accounting firms. Today, six large accounting firms audit 99 percent of
public-company sales. Adopting the Committee's recommendations would
force
an increasingly unhealthy concentration of the skills, methodologies and
tools for auditing internal controls within these six accounting firms.
Accordingly, investors and audit committees would be further limited in
their choices for qualified auditors as they attempt to match a public
company with the skills and resources of the "best-fit" global, national
or
local accounting firm. Although Grant Thornton LLP is the U.S. member
firm
of a global accounting organization and is among these six firms, we do
not
believe that concentration is good for the profession or the capital
markets.
The Committee's recommendations were born out of a fundamental disparity
that does exist between larger and smaller public companies with respect
to
implementation costs, and that disparity must be addressed. The problem
does
not lie in Section 404 requirements, however, but rather in the lack of
agreed-upon standards for good internal controls that are applicable in
myriad business situations.
Every public company, regardless of size, should have good controls over
their financial reporting processes. It follows, then, that management
of
every public company should be in a position to state, at least
annually,
that they have good controls over their financial reporting processes.
If
these two statements are true, then the accounting and auditing
profession
and regulators should be able to agree upon the criteria upon which
management and auditors would base their conclusions on internal
controls.
They should also be able to develop reasonable audit procedures that
would
allow an auditor to state whether they agree with management's
assessment.
To date, we have not succeeded in accomplishing that goal. The Committee
of
Sponsoring Organizations (COSO) made a valiant attempt to draft guidance
for
smaller public companies, but COSO has not been afforded the resources
to
develop the type of case-study material required to address the
underlying
disparity.
We believe that the profession can develop appropriate guidance useful
to
both companies and auditors. Such guidelines would be authored most
appropriately by a body of professionals composed of auditors,
accountants
from industry, regulators and academics. This body could solicit
questions
from the field and develop case studies highlighting appropriate control
and
audit procedures relevant for a range of companies in varying
circumstances.
The resulting guidance could then be published on a Web site. Taking
this
approach would quickly eliminate the most egregious execution expense
for
all companies and gradually help the profession establish a point of
equilibrium in which every public company is held to an appropriate -
and
shared - standard of quality in financial reporting.
The application of Section 404 and its related auditing standard are
both
less than two years old. Clearly, early recommendations must be
scrutinized
for the consequences of implementation in all possible environments.
Before
making fundamental changes in underlying requirements, it is critical to
consider the implications for all interested parties. Any such changes
must
ultimately prove fair to all investors, audit committees and companies.
We
in the accounting profession should do everything possible to find ways
to
meet the needs and protect the investments of the varied businesses and
investor groups that make for robust capital markets.
To view a copy of Grant Thornton's comment letter to the SEC, go to
www.sec.gov/rules/other/265-23/grantthornton030706.pdf.
Grant Thornton LLP is the U.S. member firm of Grant Thornton
International,
one of the six global accounting, tax and business advisory
organizations.
Through member firms in 112 countries, including 50 offices in the
United
States, the partners and employees of Grant Thornton member firms
provide
personalized attention and the highest quality service to public and
private
clients around the globe.
Visit Grant Thornton LLP at
www.GrantThornton.com for more information
Trent Gazzaway
Managing Partner of National Corporate Governance
Grant Thornton
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