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Atkins Discusses Section 404 and Stock Option Accounting

Commissioner Paul Atkins said that changes must be made to the conservative approach in which corporate managers and their auditing firms exercised their judgment in the first year of the Sarbanes-Oxley Act process. He said he has heard more complaints about the Public Company Accounting Oversight Board's Auditing Standard No. 2 than about the SEC's rule, but there is a general agreement that both auditors and management engaged in "overkill" in the first year.

Mr. Atkins said is it important to learn from the first year's experience with Section 404. The costs were greatly underestimated, he noted. Many of the costs may have been one-time startup expenses, but some of the costs will be recurring. The commissioner said it may take years to get the process right, and he does not believe that shareholders should accept the prospect of years of costs like the first year. Good internal controls are important and valuable to a company and its shareholders, Commissioner Atkins said, but it is not clear to him that documentation of internal controls would have prevented the type of collusive fraud by management that existed in some of the recent corporate failures.

Commissioner Atkins said the SEC and the PCAOB must provide assurance that they will allow professionals to use their judgment and that they will not be second-guessed. The recent SEC and PCAOB guidance acknowledged that more needs to be done in this area, he said, and that the current approach was not risk-based and failed to use a top-down strategy. He noted that he has conducted an internal control review and has seen first-hand how it can spin out of control by the impulse to document every process. He emphasized that the control process must provide reasonable assurance, the records must be maintained in reasonable detail, and the policies and procedures must provide reasonable assurance that transactions are recorded accurately in accordance with generally accepted accounting principles. Reasonable does not mean absolute or certain or perfect, he advised.

Internal controls are a tool to assist financial reporting, Mr. Atkins continued. They are not a standalone goal and they are not an insurance policy against fraud. He expressed concern about reports that companies or their auditors have found tens of thousands of controls. He also expressed concern about accounting firms that are making materiality determinations at the business segment and interim financial statement level. Materiality assessments should be made on an enterprise basis at the annual period level, according to the commissioner. He hopes that one day the rules will establish a groundwork in which the market favors companies that have sound internal controls and aggressive oversight programs. Mr. Atkins said the implementation of Section 404 relies to a great extent on the PCAOB, which is reason for the SEC to keep a close eye on its activities. The SEC should not simply rubber stamp the PCAOB's actions, he said.

He also addressed stock option accounting and his concern about valuation. He said he has not met many people who are truly confident in existing pricing models in providing sound estimates of employee stock option value. He is encouraged, however, by market participants who are working with the SEC to develop an options pricing model. The Financial Accounting Standards Board standard allows market-based models to determine the value of options, he added. If a functioning market determines a value, it would not have to be compared to a number that is derived from any other model. Market value is real, Commissioner Atkins said, while a model is just an estimate.