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PCAOB
Approves Remediation Standard for Material Weaknesses The proposed rule, Auditing Standard No. 4, “Reporting on Whether a Previously Reported Material Weakness Continues to Exist,” seemingly is a natural extension of Section 404 of the Sarbanes-Oxley Act. The section requires public companies to annually provide the investing public with an assessment of the company’s internal control over financial reporting. PCAOB Standard No. 2 requires the company’s auditor to attest to, and report on, management’s assessment. For accelerated filers, the deadline for compliance with Section 404 was Nov. 15, 2004, while the deadline for nonaccelerated filers—companies with less than $75 million in public equity—is July 15, 2006. Under the Securities and Exchange Commission’s rules, company management may not conclude that internal control over financial reporting is effective if one or more material weaknesses exist. The proposed standard, therefore, is a mechanism called for by companies, investors and professional organizations, including the New York State Society of CPAs, through which a company could notify and instill greater confidence in its investors that a previously reported material weakness no longer exists, as attested to by the company’s independent auditor. According to the standard, the decision by a company with a previously disclosed material weakness to engage its outside auditor for this purpose is voluntary. Furthermore, the engagement would be narrowly tailored to the reporting on the elimination of the previously disclosed weaknesses. If, in the course of the engagement, the auditor discovers a new material weakness while examining the old one, he is required to report it to the company’s board of directors. In a May 11 comment letter submitted to the PCAOB, the Society’s Auditing Standards and Procedures Committee expressed its support for the rule, noting that the standard could serve as a springboard to prompt action by issuers that don’t have a clean opinion on internal controls at their year-end audit. “I think it’s very important, because although it’s voluntary, many companies will have the incentive to correct the weakness as soon as they have the opportunity,” said Mark Mycio, chair of the committee. “It will bring in a transparent process of continuous improvement in internal controls rather, than it’s being a periodic type of process.” In addition to providing an incentive for early correction, the PCAOB also believes that outside auditor assurance that a material weakness no longer exists could also result in increased investor confidence. While this may be true, Mycio pointed out that the standard could have the reverse effect. “It’ll be a double-edged sword. Though voluntary, investors will feel reassured if a company corrects a material weakness very shortly after it is reported,” said Mycio, senior manager in quality review at American Express Tax and Business Services Inc. in Manhattan. “But then certainly companies that do not take that action expeditiously could be questioned, and it could actually erode investors’ confidence in those situations and raise the question of why aren’t they correcting it…Why wouldn’t they avail themselves of the opportunity.” The PCAOB notes that some companies with previously reported material weaknesses might determine that a voluntary engagement with the auditor is cost-prohibitive or not in its best interest. Mycio added that it would be “poor judgment” for a company to bring in its auditors if it hasn’t adequately addressed its internal control deficiencies. While Joel Quall, member of the Society’s Chief Financial Officers Committee, believes the standard could give a company a chance to “redeem” itself with the investing public, he’s reluctant to state what the net effect would be on stockholders. “Does someone really rely on Section 404? I’d like to see more statistics and evaluation of investor confidence in relation to the reporting of material weakness,” said Quall, CFO with MarketAxess in Manhattan. “I haven’t seen anything to indicate if a stock has been affected by reporting of material weakness.” As of July 26, the PCAOB authorized the proposed auditing standard for filing with the SEC, which has to approve the rule for it to take effect. That same day, the PCAOB adopted certain ethics and independence rules addressing tax services, contingent fees, and certain related general ethics and independence standards. These too need the SEC’s approval in order to take effect. For more information on these proposals, go to www.pcaobus.org. Associate Editor Simon Eskow contributed to this report. |
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