HOT TOPIC

INTERNAL CONTROLS


» Context

Did Sarbanes-Oxley 404 unleash a wave of administrative hell or a call to prudent business practices?
For that matter, what does “material weakness” mean anyway?

» In the News [please contact us for further archival references]
Feb08 Cornerstone Research Group and Stanford Law School Securities Clearinghouse, 2007: A Year in Review “Emerging academic literature suggests that managements have become more conservative and accurate in reporting financial results since Enron and Worldcom” [comment on trying to explain low shareholder class-action litigation rates in 2006 (creeping up again in 2007), related to an increase in restatements since 2002].
26Nov07 Compliance Week study of 9,700 companies indicated that disclosures of “material weaknesses” were down from 16.7% of respondents in calendar 2005, to 5.9% of respondents in the first six months of 2006.” “The findings support a growing view that the law (SOx) can no longer shoulder as much of the blame for capital flight (from NY to London or HK) as previously thought”.
Oct07 NASDAQ recommendations for refining AS5 include focusing on the effectiveness of an internal control program, not individual controls; establishing a clear policy against over-auditing, allowing companies with no material weaknesses to perform 404 audits on alternating years; and relief for smaller companies.
» Briefing Notes - © The Governance Counsel™ (2007)

Think about other initiatives for internal controls to facilitate more effective business – for example, just-in-time integration and quality management.
Not only within a corporate enterprise, but with the market place there are various national versions of GAAP [under review and updating], ISO [new standards under review].

SOx was intended to admonish the gatekeepers of financial accountability, the auditors and CFOs, and to remind directors of their fundamental obligations.
Financial reporting had started to obfuscate the loss of the occasional billion dollars here or there over time, or the odd million of petty cash losses per year. Reminded that “internal controls” ought to be a good thing, the accounting professions were caught in the awkward role of needing to be mindful of professional standards to use due skill, care and diligence, and the opportunity to increase fee revenues by 10-20%. The filters for “internal control audits” were set at $100 increments, for some multinational corporations by their auditors.

The Principle behind the Practice?
One principle is that good governance requires constant vigilance and renewal, and the regulatory component is no exception. A review of the SOx regulatory framework is underway – look for amendments in 2007. It would be nice to also look to the accounting professions for guidelines or standards on internal controls based on a balance of effective business and regulatory interests.

“Strategic oversight” is a concept which we promote as capturing the intent of good governance. Reflecting both legal duties and business principles, it involves the primary obligation of directors and councillors to look to the long term, make plans, periodically check on performance against assumptions and operational reality, and assess and update the strategic plans as necessary. The use of information technology is starting to allow decision-makers to spend more time thinking and less time looking for, or reacting after the fact to, information.