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Conference Panelists Discuss Accounting, Auditing and Internal Controls

The Practising Law Institute's November 11-13 conference on securities regulation featured panel discussions on accounting, auditing and internal control over financial reporting. Garrett Stauffer, the corporate governance leader with the Florham Park, New Jersey office of PricewaterhouseCoopers, reported that companies are identifying more internal control weaknesses than they expected. The bar is relatively low for deficiencies, he explained. Since the rules are new, companies are trying to understand how to implement them, with assistance from the SEC and the PCAOB, both of which have provided guidance in the form of responses to frequently asked questions.

Companies should be almost done with implementation by now, he added, but he has seen some slippage. The process is taking longer than expected because of remediation efforts when deficiencies are discovered, he said. That pushes the time table backward. Some accounting firms are issuing letters to their clients as to where they stand with their internal controls plan. Every company will encounter deficiencies, in Stauffer's view.

SEC Chief Accountant Donald Nicolaisen maintained that there is nothing new here. Internal control over financial reporting has been talked about for years, he said. This is merely the first time that public reporting is required. Auditors have relied upon internal controls for decades in setting the scope of their work, he explained. Nicolaisen believes that the internal control requirement will have the most lasting, most significant impact on the accuracy of financial reporting of any other reform measures.

Nicolaisen acknowledged that it might take a few years before the internal control process is smooth and fully integrated. The SEC and the PCAOB understand the need to show a certain degree of understanding, he said. The SEC will be monitoring the process very closely, according to Nicolaisen. He hopes that no further initiatives will be delayed to allow for a smooth implementation of the internal controls requirements, but said the SEC will know in the coming weeks whether additional delays are necessary. The SEC wants this to be successful, he said.

Audit Committee Function

Ralph Ferrara, a partner in the Washington, D.C. office of Debevoise & Plimpton LLP, said that the SEC has strayed from its origins as a disclosure agency into corporate governance matters that have traditionally been left to the states. He highlighted the requirement that companies disclose whether they have a financial expert on their audit committees. Ferrara suggested that a failure to appoint a financial expert to the audit committee was tantamount to saying "we're dopes."

Ferrara also called the PCAOB's standard on internal controls mind boggling and said that companies are spending billions of dollars to comply. He said companies must know the nomenclature because "significant deficiency" and "material weakness" are very important concepts to understand. Ferrara characterized as epic the fact that a material deficiency will result in an automatic restatement.

Michael McAlevey, chief corporate and securities counsel for General Electric Co., said that if companies choose to establish preapproval policies and procedures for services that outside auditors may perform, they must be very specific. He said the company might want to impose a dollar limit as well that subjects a service to preapproval. McAlevey recommended that companies set a budget for each category of nonaudit service and monitor it.

McAlevey also cautioned companies to beware of foreign affiliates. There is no de minimis exception for nonaudit services, he explained. Audit committees should ask about remote or foreign sites. Also, he said to keep in mind that any preapproval is subject to trial in the court of shareholder opinion. McAlevey noted that the last chapter on the provision of tax services has not been written and the PCAOB appears to have concerns about this hot area.