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On the eve of the five-year anniversary of the Sarbanes-Oxley Act, the benefits of the legislation have been proven - among them greater transparency, accountability and improved corporate governance. Almost all of the complaints regarding Sarbanes-Oxley have their genesis in two short paragraphs -- 20 lines of text -- contained in Section 404.
NASDAQ believes incremental progress has been made to improve 404 via the PCAOB proposed Auditing Standard No. 5 (AS5), which addresses internal control auditing standards. However, NASDAQ believes AS5 has not provided the needed clarity or the tools to alleviate the root cause of unnecessarily onerous and costly auditing processes. To support the use of smart controls NASDAQ recommends the further refinement of AS5 prior to its implementation. Our recommendations are as follows:
1) Change the auditor's role to focus on evaluating the effectiveness of management's internal controls program, rather than the effectiveness of individual controls, which are the primary driver for auditor fees. NASDAQ believes management should have the responsibility to identify the internal controls over financial reporting and to execute a program to ensure that the identified controls are functioning.
2) A clearer, more workable definition of materiality needs to be established to assist management and auditors alike.
3) Establish an "Ombudsman" office in PCAOB to serve as an advocate for issuers who feel their internal controls are being over-audited.
4) Establish a clear policy against over-auditing including a fine schedule against auditors, if necessary. This would encourage auditors to take advantage of appropriate opportunities to reduce testing and other redundant activities, thereby minimizing the costs involved with their review. Providing a level of accountability would make the revised standards meaningful.
5) Allow companies with no material weaknesses to perform the auditor portion of 404 in alternate years. The management portion of 404 should be conducted every year.
6) Eliminate the notion that auditing firms need to focus on controls for interim financial statements; instead reaffirm the focus on annual reports, as required by the Sarbanes-Oxley Act.
7) Raise relief for smaller companies by focusing on "smaller" companies, not just "smaller and less complex" companies.
"Lack of clarity combined with the complexity of today's global capital markets creates a fundamental issue in applying Section 404 that has not been adequately addressed through Accounting Standard No. 5. We need to provide companies and accounting firms with the tools they need to make 404 more workable," said Bob Greifeld, President and Chief Executive Officer of NASDAQ. He continued, "We also believe companies should be able to voice claims of over-auditing. Currently there is no mechanism in place to do so. We are proposing an Ombudsman office at the PCAOB to provide such an outlet."
Michael G. Oxley, NASDAQ's Vice Chairman and co-author of Sarbanes-Oxley commented, "Good governance depends on good controls and bright line standards. While AS5 represents improvement over the previous standard, it does not go far enough to help decrease regulatory complexity and reduce the risk for overzealous auditing. We must take bolder steps to make our markets more attractive and competitive."
