(The news featured below is a selection from the news covered in SEC Today, which is distributed to subscribers of SEC Today.)

Glassman Wants SEC and PCAOB to Closely Monitor Internal Control Rules

While describing the Sarbanes Oxley Act section 404 internal control regime as conceptually worthwhile, SEC Commissioner Cynthia Glassman also warned against the significant possibility of unintended consequences that may result from its implementation. In remarks at a recent forum, she urged the SEC and the PCAOB to monitor the workings of the section 404 internal control rules and standards and refine them if appropriate to achieve their true intended purpose.

The SEC is hearing that the documentation and controls have gone beyond what is reasonable and what was intended, such as, for example, five officers of a company signing off on a purchase that was formerly approved by one. These concerns have reinforced Glassman's fear that the section 404 experience could turn into a check-the-box exercise rather than being incorporated into a vigorous risk management framework. The SEC is also hearing that adoption of its section 404 rules, along with the PCAOB's Auditing Standard Number 2, is improving corporate internal control processes. Prior to their adoption, investors really had no basis to judge whether a company had good internal controls.

Glassman said that internal control is a means to an end, not an end in itself. There is a spectrum of outcomes following a company's review of its internal controls, she explained, encompassing at one extreme a lack of clear controls, to controls that exist but are not well documented, to the opposite extreme of good controls that are well documented. Obviously, she said, the better a company's controls and documentation, the less likely that an inaccuracy will surface in its financial reports, either by accident or on purpose.

Recently, after near continuous discussions with the audit community during the summer and fall, the Commission gave accelerated filers with a public equity float of less than $700 million an extra 45 days from the due date of their 2004 annual report to file their internal control report and related auditor attestation. The filers that were given the extension represent over half of the accelerated filers. The Commission concluded that the extension was necessary to address the concern over resources, both at this group of companies as well as their auditors, which was making it difficult to meet the prior deadlines.

Even after granting this extension, the SEC is hearing that some companies may still have difficulty meeting the new deadline, and a number of companies may report material weaknesses that prevent their auditors from issuing a clean internal controls opinion. Glassman urged the markets to keep this new information in perspective, especially if the auditor has been unable to issue an unqualified opinion on the company's financial statements.

The companies and their auditors are still feeling their way on these requirements, she explained, and the process undoubtedly will need fine-tuning. Since this is the first year for section 404 reporting, there is a risk that the market will misinterpret internal control opinions. Material weaknesses in internal controls do not necessarily mean the financials are inaccurate, Glassman emphasized, but they do mean that the company has some process improvements to make.

Glassman encouraged corporate management to be up-front with investors in their disclosure. Management should tell investors what they are finding and what they are doing about it. She cautioned management that boilerplate disclosure is not sufficient.