Making Sarbanes—Oxley 404 work: Reducing cost, increasing effectiveness

• Published in: International journal of disclosure and governance 2006-03, Vol.3 (1), p.27-48
• Main Authors: Gupta, Parveen P, Leech, Tim
• Format: Article
• Language: English
• Subjects: Accounting; Accounting firms; Auditing standards; Auditors; Audits; Capital markets; Certification; Compliance; Costs; Feedback; Financial executives; Financial reporting; Financial statements; Internal controls; Management; Public companies; Public Company Accounting Reform & Investor Protection Act 2002-US; Risk assessment; SEC regulations
• ISSN: 1741-3591; 1746-6539
• DOI: 10.1057/palgrave.jdg.2040063

Section 404 of the Sarbanes-Oxley Act of 2002 is, perhaps, one of the shortest sections of the Act but it has generated the most controversy both domestically and internationally. Although no one disagrees with the overall goals of Section 404 - strengthening and tightening controls over financial reporting - there is considerable opposition, and even disagreement among the regulators, on how best to implement the intent of Section 404 in the most cost-effective manner. The opposition to the implementation of Section 404 was so intense that less than a month after the 15th March, 2005 due date for first-time Securities and Exchange Commission (SEC) accelerated filers, the SEC hosted a Roundtable on 13th April, 2005 to receive feedback on the implementation experiences of the SEC registrants. The urgency to act was also so strong that the SEC, along with the Public Company Accounting Oversight Board (PCAOB), released new guidance in the form of a Staff Statement, on 16th May, 2005, to provide some clarity and more direction to the registrants as well as their external auditors as they prepared for the year-two certification. In spite of this additional clarification, dissatisfaction with the 'how to do it' versus the 'why to do it' continues to run high. After briefly discussing the basic requirements imposed by Section 404 of the Sarbanes-Oxley Act of 2002 within the historical context of reporting on internal controls, this paper focuses on identifying and analysing the underlying fundamental problems that are causing the implementation of Section 404 to be so problematic. The authors believe that the SEC registrants and their external auditors will continue to struggle with similar issues even during the year-two certification process unless these fundamental problems are addressed. Massive cost, confusion and disagreements between registrants and their external auditors are only symptoms of the serious underlying problems with the current regulations. The paper concludes with a number of recommendations that, if followed, have the potential to make Section 404 compliance a value-adding activity that will cost-effectively achieve the goal of promoting transparency and accountability in the US capital markets. [PUBLICATION ABSTRACT]