Let’s Hear it for Sarbanes-Oxley

Our fundamental responsibility is to provide oversight with respect to the financial reporting of our companies, not minimizing audit fees. For years, as an audit partner, I was frustrated in the lack of attention paid by audit committees to the importance of internal control. Fortunately, those days are gone.

Published in Darwin’s Online Magazine, November 2004.
Reprinted by benbradley.net: Let’s Hear it for Sarbanes-Oxley

Yep. You heard me. Sarbanes-Oxley – SarbOx, or SOx. By any name it’s the legislation passed by Congress in response to the recent spate of accounting scandals that everybody loves to hate. Since its inception, few words of praise have been written about it. It’s enough to give the poor legislation an inferiority complex. There must be something about SOx that we can learn to love.

This legislation first appeared to be just another knee jerk over kill on the part of Congress to show how tough they were getting with miscreants. SOx is clearly negative in its concepts and its message. As a result, everybody felt threatened and nobody was happy.

First in line to complain were the company CEOs and CFOs who are now required to sign off on their financial statements as being free of material error. The huge negative reaction begged the question of whether these executives were in fact aware of what was recorded in their own financial statements.

Next, the Auditing Profession felt the heat, some of it deserved, much of it not. The media, most of whom have no understanding of the audit process, have nevertheless labeled the accounting scandals “audit failures” as if the Auditing Profession caused them. Professional “failure” ranges from culpability to downright negligence, but the factor causing such failure was corporate malfeasance. Yet, it is the Profession that has been the primary focus of this legislation. Complain they will, but they might as well get used to it. For years, the Profession has fought to avoid any form of attestation with respect to internal controls. Such controls were considered so ill defined that any audit failure would be viewed as prima fascia evidence of internal control failure. Unfortunately, SOx has now put them in precisely in that position.

The SOx legislation has also replaced the Public Oversight Board with the far tougher Public Company Accounting Oversight Board or “PCAOB.” Having visited with the PCAOB, I believe that the Profession has cause for concern. The PCAOB’s strategy is to review completed audit engagements for evidence of failure and then confront the firms with the directive to fix it, whatever “it” is – “or else.” Considering the power of the PCAOB to invoke a death sentence to a firm, their concern is well founded.

The last group of unhappy campers is Registrant Boards of Directors, especially the Audit Committee members. The reaction from this group has been swift and intense. Much has been written about the difficulty of finding board members, especially audit committee members because of the heightened level of risk due to SOx requirements. They are also complaining about the substantial increase in audit fees related to the requirement to document corporate controls over the preparation of financial statements. Again, their ire is focused on the Profession as if it had caused the mess in the first place and had written the SOx legislation.

With all constituencies now on record with their perceived concerns, it is time to stop the collective whining and begin to understand the benefits of SOx. Let’s begin with understanding the point of the legislation. SOx wasn’t written to make CFOs, CEOs, their boards and their auditors happy. It was written to protect the credibility of the greatest capital formation process in the world, one that is key to our economic wellbeing, and one in which we all have a huge stake. It follows that its credibility must be restored at any reasonable cost. Now for the benefit. In the process of doing so, the ultimate winner will be you, me and everyone else who depends upon credible financial information.

So, first to CEOs and CFOs, stop your whining. SOx has only reaffirmed that which they well know – they are responsible for the fairness of their company’s reporting. So, why the problem in attesting to it? Are they suggesting that they lack the confidence to do so? Well, if they don’t trust their controls over the preparation of their financial reports, why should we? And why is it such a major effort to define and document corporate controls over the preparation of financial reports? Aren’t such controls in place now?

Next to step up the plate must be the Auditing Profession. For years, they have touted their expertise in risk management and internal control. Now is the time to prove it. What greater value could the Profession add than helping responsible companies improve the quality of their financial reporting?

While they are at it, they could clean up their own risk management processes. Their strategy must be to cooperate with the PCAOB to define, implement, monitor and improve those controls that ensure that audits are performed with the highest level of quality attainable. Sitting back and waiting for the PCAOB to “catch” them in a substandard audit is a risk that no responsible Firm CEO has the right to take. The last firm that was “caught” is now completing its liquidation.

Lastly, to my fellow board and audit committee members, I would remind you that our fundamental responsibility is to provide oversight with respect to the financial reporting of our companies, not minimizing audit fees. For years, as an audit partner, I was frustrated in the lack of attention paid by audit committees to the importance of internal control. Fortunately, those days are gone – thanks to SOx. To those complaining about the time it now takes to prepare for meetings and understand complex transactions, one would ask why they weren’t spending the time before. I am pleased to serve on boards where we understand the challenges and willingly address them. Those unwilling or unable to make a similar commitment have no alternative but to resign in favor of those who are.

As a thirty year veteran of the Auditing Profession and the member of several boards and audit committees, I applaud Sarbanes-Oxley. It has raised the awareness of responsibility on the part of all of us who, together, can restore public confidence in financial reporting.

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