Impact of Section 404
Implementation of Section 404 has had significant adverse effects not intended by Congress or anyone else. As every Member of Congress knows from talking to constituents, it has caused a tremendously expensive amount of paperwork and bureaucracy. The explicit and indirect costs are extremely high and disproportionately high for smaller companies. There are also major opportunity costs from the diversion of management and board focus from productive to unproductive, defensive, formalistic activities.
The public accounting firms have received unintended, windfall enrichment, but have become excessively risk-averse and reluctant to make professional judgments.
I believe the total costs far outweigh the possible benefits, especially for smaller companies. These costs are forced on the shareholders, who have no say in the matter, and who ostensibly are being “protected.”
- Can 404 Implementation be Improved?
Yes, without question.
Specific Actions
a. Make Section 404 voluntary, with explanation and disclosure, at a minimum for smaller companies.
b. Instruct the SEC and PCAOB to change the review standard from “remote likelihood” to “a material risk of loss or fraud.”
c. Clearly state that Congress understands that accounting is art, not science: that accounting is full of debatable theories, subjective judgments and estimates of the unknowable future. Therefore explicitly instruct public accounting firms that professional advice and judgment on the application of our complex accounting standards is expected and demanded.
d. Mandate a report from the SEC and PCAOB comparing and contrasting the British principles-based Turnbull Guidance to implementation of Sarbanes-Oxley.
Bring the PCAOB under Congressional authority as all regulatory agencies should be.
Enact a sunset or reauthorization requirement for Section 404 in 2011
Additional SEC Guidance?
I am not in favor of expanding a rules-based approach. Instead, the SEC should work on something similar to the principles-based Turnbull Guidance.
- Should the SEC and PCAOB Distinguish Between Companies Based on Size?
Yes, absolutely.
- Should They Issue More Guidance?
Yes, provided it is principles-based.
- Actions to Foster a More Risk-Based Approach
a. As stated above, I believe it is essential to change the risk assessment standard from the “remote likelihood” idea to something reasonable, viz.: “a material risk of loss or fraud.”
b. Also as stated above, the SEC and PCAOB should be required to study and then move to something like the principles-based Turnbull Guidance.
- Frequency of 404 Certifications
Once every two years would be better than every year. A voluntary approach, with explanation and disclosure, would be better still.
