Colleen [Cunningham, President of FEI] asked me to take a few minutes to give you my perspective on what happened in 2005, what is happening now, and what the Section 404 future looks like. Before I do that, I should note that the views I express are my own, and not necessarily those of the Board’s other members or staff.
The first year of internal control reporting was enormously challenging for all involved. Section 404 of the Sarbanes-Oxley Act prompted the biggest change in the auditor’s work in 70 years. In particular, both firms and issuers were challenged by –
At the same time, considering the complexity of the challenge, I think many things went right.
On May 16, the Board issued guidance in response to concerns about the cost and efficiency of the first year of accelerated filer Section 404 reporting. Basically, that statement makes five points:
The Board recognized that it was not enough to merely announce these principles -- which everyone seems to agree with. Instead, the Board has also addressed the problems more directly. Over the summer, we looked at the way the eight largest firms implemented the standard. That work is now done and the results have been conveyed to firm management. They are largely what you would expect. Although some auditors may have implemented the standard well, it is apparent that some auditors did not.
We have also taken some other steps to try to make sure that the philosophy of the May 16 guidance is part of the Year 2 audit process:
I anticipate that, before the end of November 2005, the Board will issue a public report on its Auditing Standard No. 2 inspection findings. And, in that context, we may also deal with some other interpretive points. For example, two issues that still seem to generate confusion are --
There is a certain “damned-if-you-do, damned-if-you-don’t” aspect to the problem of interpretive guidance. I hear often that Year 1 was hard because new guidance was emerging on a daily basis. I think that, if you go back and look at what we and the SEC actually issued, we were in fact quite circumspect. But, the comment illustrates the point that, every time you issue anything new in this area, hundreds of auditors and thousands of companies have to stop what they are doing, review the new pronouncement, and assess whether and how it affects them. There is a cost associated with that.
In the second reporting year, costs -- internal and external -- should fall. How much is unclear. For managements:
I also expect that in the second year:
Like everything else that emanates from Washington, we should expect Section 404 reporting to be able to meet a cost/benefit test. If not, something will have to change about the implementation or requirements. But, the costs tend to be upfront and the benefits spread over time. I think we are on the right track.