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Securities

Printable Version

Recent Developments in Sarbanes-Oxley Implementation

June 2006

The Securities and Exchange Commission (SEC) recently announced a series of actions that it intends to take to improve the implementation of the Section 404 internal control requirements of the Sarbanes-Oxley Act of 2002 (SOX).1 The SEC expects to issue additional guidance to companies, as well as further postpone the requirements of Section 404 of SOX for the smallest company filers. Although some have speculated that the SEC would exempt small companies from the internal control reporting requirements, the SEC clearly stated that ultimately all public companies will be required to comply with the requirements of Section 404.

The SEC will also be working with the Public Company Accounting Oversight Board (PCAOB) on revisions of its internal control auditing standards.

The actions that the SEC expects to take include the following:

  • Guidance for Companies. The SEC intends to address requests for additional guidance for management by:
    • A Concept Release and Opportunity for Public Comment. The SEC expects to issue a Concept Release covering a variety of issues that might be the subject of SEC guidance for management, including the role of outside auditors in connection with the management assessment required by Section 404(a) of SOX, and the manner in which outside auditors provide the attestation required by Section 404(b). The Concept Release would solicit views on the management assessment process in order to ensure that the guidance the SEC ultimately proposes will address the needs and concerns of all public companies.
    • Consideration of Additional Guidance from COSO. The SEC anticipates that guidance from the Committee of Sponsoring Organizations of the Treadway Commission (COSO) relating to the needs of smaller companies will help organizations of all sizes to better understand and apply the control framework as it relates to internal control over financial reporting. The SEC will consider the extent to which the additional guidance that COSO provides is useful to smaller public companies in completing their Section 404(a) assessments.
    • Issuance of Guidance. The SEC currently anticipates providing guidance to management to assist in its performance of a top-down, risk-based assessment of internal control over financial reporting. The SEC intends such future guidance to be scalable and responsive to individual circumstances in order to ensure that the guidance will assist non-accelerated filers and smaller public companies. The guidance will also take into account the fact that many companies have already invested substantial resources to establish and document programs and procedures in order to perform their assessments.
  • Extension of Compliance for Non-Accelerated Filers. The SEC expects to issue a short postponement of the effective date of the rules implementing Section 404 for non-accelerated filers. This would permit these companies and their auditors to benefit from the management guidance that the SEC intends to issue and to have the opportunity to evaluate and implement the revisions that the PCAOB plans to make to Accounting Standard No. 2, as discussed below. Even with a postponement, the SEC anticipates to still require all filers to comply with the management assessment required by Section 404(a) of SOX for fiscal years beginning on or after December 16, 2006.
  • Cooperation with the PCAOB. The PCAOB announced that it intends to propose revisions to its Auditing Standard No. 2, An Audit of Internal Control Over Financial Reporting Performed in Conjunction with an Audit of Financial Statements (AS No. 2). Any final revision of AS No. 2 would be subject to SEC approval. The proposed revisions would:
    • Seek to ensure that auditors focus on areas that pose a higher risk of fraud or material error during integrated audits;
    • Incorporate key concepts contained in the guidance issued by the PCAOB on May 16, 2005; and
    • Revisit and clarify what, if any, role that an auditor should play in evaluating a company’s process of assessing internal control effectiveness.
  • In addition, the PCAOB recently announced that it would focus its 2006 inspections on whether auditors have achieved cost-saving efficiencies in the audits that they have performed under AS No. 2, and on whether auditors have followed the guidance that the PCAOB issued in May and November 2005 urging them to do so. As part of the SEC’s oversight of the PCAOB, the SEC staff reviews aspects of the PCAOB’s operations, including its inspection program. Upon completion of the PCAOB’s 2006 inspections, for example, the SEC staff will examine whether the PCAOB inspections of audit firms have been effective in encouraging implementation of the principles outlined in the PCAOB’s recent statement.

We will provide updates as the SEC and the PCAOB implement the foregoing actions. For more information, please contact a member of our Securities Group. We would be happy to talk to you in more detail about these changes and how they may affect your company.

 1 SEC Press Release No. 2006-75 (May 17, 2006).