November 2, 2004

Warning Letters Regarding Internal Controls Status

Each of the Big Four auditing firms is in the process of notifying a significant number of their clients that the auditor believes the company is significantly behind schedule on their 404 work, and unless appropriate action is taken promptly, the auditor believes management will not be able to complete its assessment before the reporting deadline, or if completed, management’s assessment will likely not be completed in sufficient time for the auditor to complete its assessment.

It appears that two firms are providing warnings orally (and then tracking them internally) and two firms are providing warnings in writing. The most severe warning described above is known as a “red letter” or a “category 3 letter,” depending on the firm’s nomenclature. Based on anecdotal evidence, my guess is that 20-30% of companies are receiving red letters.

I hear that a much greater number of companies are receiving a “yellow letter” or “category 2 letter,” which still is a warning but less severe than a red letter. (Unfortunately, I have even heard from a few companies that they have been dropped by their Big 4 auditor due to “staffing issues” related to 404; another fallout for smaller companies as a result of Sarbanes-Oxley – see this press release from one company that got dropped.)

For the most part, those companies not receiving notification apparently are deemed to be on “green letter” or “category 1 letter” status – however, at least one of the Big 4 is providing letters to companies with this status. These companies have been determined to be “on track” to complete their 404 work on time.

With so many companies receiving written warnings from their auditor, the question remains – “what do I need to disclose if I receive a letter?” The possible answers – and sample disclosures – are in this new Disclosure about Internal Controls Status page that I have posted in our “Internal Controls Practice Area.”

New Competition for ISS and Glass Lewis

As we gear up for tomorrow’s webcast – “Another Wild Proxy Season? Forecast for 2005” – featuring Pat McGurn of ISS, Greg Taxin of Glass Lewis and David Drake of Georgeson – you should be aware that a new proxy advice service has been born. (Don’t forget to print off the Course Materials before tomorrow’s webcast!)

Learn more about PROXY Governance – which is a subsidiary of FolioFn, the company founded by former SEC Commissioner Steve Wallman – in my interview with Jim Melican on a New Kind of Proxy Advisory and Voting Service.

For Small Business Fans Only

Yesterday, the SEC posted a transcript of its Annual Government-Business Forum on Small Business Capital Formation, which was held back in September.