SEC-PCAOB Relationship Drives Internal Control Changes

By James Hamilton, J.D., LL.M.

We are approaching the time when the long-awaited SEC and PCAOB interpretations and guidance on the internal control mandates of section 404 of the Sarbanes-Oxley Act will attempt to provide relief to a long-suffering corporate community. Many have refrained from proposing legislative amendments to section 404 out of respect for what the SEC and the Board are expected to accomplish in ameliorating the internal controls mandate of that statute. The SEC and the Board have promised to coordinate their efforts.

Recently, at the fall meeting of the ABA’s Business Law section, John White, Director of the SEC’s Division of Corporation Finance, said one of the amendments to the PCAOB’s Auditing Standard No. 2 on internal controls will remove all of the guidance for management since the SEC has taken that issue back. The format may include both interpretive guidance and rules, he said, but the “guts” of the release will be interpretive.

Companies will not have to comply with the interpretive guidance, according to White. They can continue to follow the processes that they established since they began to comply with the management’s assessment requirement of section 404. The goal for the management guidance release is to have it proposed and adopted for companies to use in 2007. The PCAOB has the same goal with respect to the amendments to AS2.

These momentous happenings are coming against the backdrop of a SEC-PCAOB relationship that has not been adequately defined, in the view of some. In a recent speech, SEC Commissioner Paul Atkins said that the Sarbanes-Oxley Act made the PCAOB the Commission’s ward. Former PCAOB Chair William McDonough described the Board-SEC relationship as one of cousins. This issue is more than semantics. Because the Board is a ward, said Atkins, the Commission is overseeing the AS2 rewrite. In the past, he said, the SEC has taken too light a hand in the drafting of PCAOB audit standards. In his view, it is incumbent that the SEC ensures that the PCAOB does the job right on AS2 and to insist on modifications if it is not done right. He warned that getting AS2 right could involve the SEC's invoking as yet untried and somewhat unwieldy oversight powers.