January 24, 2005

Internal Controls: Where the Rubber Meets the Road

A number of members have been sending me their complaints about the internal controls process. Here are a handful:

– There appears to be a lot of fuzziness on the part of independent auditors regarding the lines between what is a material weakness versus significant deficiency.

– We’ve had a number of clients try to get us involved in their disputes with the independent auditors – for example, asking us to call the SEC, PCAOB and other accounting firms to try to check the positions being taken by their current auditors.

– When we ask the independent auditors about the specific basis for a determination of specific significant deficiencies or material weaknesses, they reply that it is part of “best practices.” It gives us pause that a failure to follow someone’s notion of best practices might be tantamount to a significant deficiency or material weakness.

– We just had a client tell us that their auditor told them that using the company’s in-house legal department/counsel as the recipient of “whistleblower” complaints is a significant deficiency. This doesn’t make sense (and it would cause a large percentage of companies to have a significant deficiency, since many companies use their GC or other in house counsel as the clearinghouse for whistleblower complaints).

– Our independent auditor just told us that we have significant deficiencies for failing to run a background investigation (covering education, employment
history and criminal records) for all senior management as well as all
employees who will be involved in accounting or financial reporting
oversight. In addition, they cited us for failing to have an internal audit function.
I think companies are going to feel sandbagged by these and other positions the accounting firms take and that they will be particularly upset if there isn’t some measure of consistency among the firms about what constitutes a significant deficiency.

– Regarding audit committee evaluations, one of our clients has been asked by their auditor to review any notes made during the board meeting during which the evaluation was discussed as well as the responses to the questionnaires. The auditors seemed more focused on the thoroughness of the process than on the substantive results.

Send me your gripes and I will post them anonymously in “Insights and Gripes about Internal Controls” in our “Internal Controls” Practice Area, where we still daily update our list of excerpts from SEC filings that identify material weaknesses and significant deficiencies – and we post many other resources (such as this new 48-page report from the Big 4 giving their perspectives on internal control reporting).

SEC and PCAOB Post FAQs on 404 Deadline Delay

On Friday, the SEC posted 10 FAQs regarding its November 30th exemptive order that provided a 404 delay for certain smaller companies. At the same time, the PCAOB issued one related FAQ.

In particular, note FAQs 4-6, which discuss the effect of reliance on the SEC exemption on a company’s eligibility to register securities on Forms S-2 and S-3 – and FAQ 7 discusses Form S-8 eligibility.

Quick Survey: Internal Control Delays and Auditor’s Evaluation of Audit Committees

In response to members asking me whether I have heard much talk about companies delaying the schedule for their Q4 earning announcements because of 404 uncertainty, I have posted this quick survey. It also addresses filing 10-Ks belatedly and the process of independent auditors evaluating audit committees.

And here are the results from the just completed survey on timing of option grants.