August 12, 2003

At yesterday’s “internal controls” session

At yesterday’s “internal controls” session at the ABA Annual Meeting, there was much discussion about the PCAOB’s July 29th Roundtable. Based on a review of the transcript of the Roundtable, it is clear that on many topics, companies and the FEI represented the minority viewpoint, while the PCAOB, the SEC staff, the audit firms and institutional investors were unified to advocate broader, deeper engagements for audit firms. However, conclusions were not reached on most issues.

Here are some of the highlights from the transcript:

– Although no specific timetable was mentioned, it has been clear that the PCAOB’s goal is to have final standards approved by the SEC by the end of 2003. As a result, the PCAOB could issue an exposure draft in the late August/September timeframe.

– As for documentation, most participants advocated “principles-based” rather than “rules-based” guidance. Although companies recognized that there is some necessary level of documentation, they largely favored leaving documentation to management’s discretion. By emphasizing the view that documentation is the foundation for controls, the audit firms seemed to be pushing for more documentation.

– There was much discussion on whether an audit committee that fails to comply with listing requirements should raise a presumption of material weakness in internal controls. Investors want this presumption.

– Corp Fin Director Alan Beller noted that there are 3 requirements in the SEC’s SOX 404 rules that work together: (1) Management must assess internal controls and disclose any material weaknesses at year-end; (2) Each quarter, management must assess changes in internal controls and disclose any change in internal control that has materially affected or is reasonably likely to materially affect internal controls; SEC specifically did not refer to “material weaknesses” but noted that if the change is due to the correction of a material weakness, then management must consider the need to disclose; (3) Management must report significant deficiencies and material weaknesses to the audit committee and external auditors that had or are likely to have a material effect on internal controls.

– As for auditor independence (long my pet peeve – see recent “50 Nuggets” webcast), the SEC staff reminded participants that management should direct the work to be done and that it is management’s job to make the assessment on internal controls – and the staff indicated it will soon release FAQs on this topic.

Yesterday, the ABA House of Delegates narrowly approved rule changes to the model confidentiality rules that will allow lawyers to turn in corporate clients that are committing fraud – today is the day that the House considers the “reporting up and out” framework (and based on this, the SEC will decide what to do with its outstanding proposal on “reporting out” sometime this fall).

For subscribers, we have posted an interview with Chris Herzeca on the Process of Board Evaluation.