• Section 404: Preparation Continues
  • June 2, 2004 | Author: Eric J. Skytte
  • Law Firm: Leonard, Street and Deinard, [incorporation phrase format]Professional Association - Minneapolis Office
  • Most accelerated filers with calendar year ends are finding themselves midway through the process provided in Section 404 of the Sarbanes-Oxley Act. Many breathed a sigh of relief when the rules for auditor's attestations issued by the Public Company Accounting Oversight Board (PCAOB), which are still subject to SEC approval, did not significantly alter the envisioned process. While much has been written on the topic, we note the following items that merit special consideration:

    • The Audit Committee Will Be Evaluated. Standards issued by the PCAOB require the auditor to evaluate the effectiveness of the audit committee. An ineffective audit committee can be considered a material weakness in internal control. As such, the audit committee should make every effort to demonstrate its competence and knowledge of the financial reporting process and respond to any concerns the auditor may have.

    • Know When Disclosure Obligations Arise. If the Section 404 preparation process discloses material weaknesses in internal controls over financial reporting, that fact will likely need to be reported in the next 10-Q. Regulation S-K Item 408(c) requires disclosure of any change in internal controls over financial reporting identified during the quarterly Section 302 certification process.

    • Make Sure the 404 Team Understands Your Governance Enhancements. The best internal controls in the world will not prevent fraud if the "Tone at the Top" is not conducive to accurate financial reporting. To that end, NYSE and NASDAQ issuers have implemented numerous governance requirements to strengthen the "Tone at the Top" to provide an effective check on management. Those preparing Section 404 documentation and interfacing with the audit staff should be aware of these requirements, so they can be communicated to the auditors, thereby enabling the auditors to draw comfort and fully assess the control environment.

    • Consider the Effect of Mergers and Acquisitions. If a company is acquired by a registrant, either the target's internal controls must be converted to the new parent's system or the target's systems must be analyzed and documented. Either way, there will be a significant effect on the Section 404 process. Large acquisitions toward year-end could further complicate the process.

    • Consider the Effect of Outsourcing. Some activities result in the effective outsourcing of internal controls. One example is payroll processing being provided by a service bureau. The effect of the outsourcing, and whether the service bureau's audit report can be relied upon, should be addressed early in the 404 process.