SEC and PCAOB to Reform Internal Controls Mandate This Week

With Congress closely watching, the SEC and PCAOB are set this week to adopt a new risk-based, principles-based top down regime for disclosure of internal control over financial reporting pursuant to section 404 of the Sarbanes-Oxley Act. Section 404, of course, remains unchanged, but the rules, guidance, and standards promulgated pursuant to the statute will be reformed in response to concerns that internal controls compliance has been overly costly and harmful to the competitiveness of US financial markets. The reforms build on the guidance issued by the SEC and PCAOB in May of 2005. Further, while the SEC incorporated certain sections of the May 2005 staff guidance into the new interpretive guidance, the Commission has emphasized that the staff guidance remains relevant. Also, companies that have already completed one or more evaluations can continue to use their existing procedures to satisfy the evaluation required by our rules, or companies can choose to follow the guidance.

It is interesting to note that, because management is responsible for maintaining effective internal control over financial reporting, the interpretive guidance will most likely not specifically address the role of the board of directors or audit committee in a company’s evaluation and assessment of internal controls. However, in the proposed guidance, the SEC said that it expects a board of directors or audit committee, as part of its oversight duties for the company’s financial reporting, to be knowledgeable and informed about the evaluation process and management’s assessment, as necessary in the circumstances.