Section 404 of Sarbanes-Oxley Should Not Be Exempt For Smaller Companies

Section 404 of Sarbanes-Oxley Should Not Be Exempt For Smaller Companies

Section 404 should be expanded to include privately held companies with bank debt.

Section 4040 should be modified for smaller companies to delete the requirement for external auditors to attest to management’s report.

Background: What Is Section 404?
From the SEC’s Final Report: “SUMMARY: As directed by Section 404 of the Sarbanes-Oxley Act of 2002, we are adopting rules requiring companies subject to the reporting requirements of the Securities Exchange Act of 1934, other than registered investment companies, to include in their annual reports a report of management on the company’s internal control over financial reporting. The internal control report must include: a statement of management’s responsibility for establishing and maintaining adequate internal control over financial reporting for the company; management’s assessment of the effectiveness of the company’s internal control over financial reporting as of the end of the company’s most recent fiscal year; a statement identifying the framework used by management to evaluate the effectiveness of the company’s internal control over financial reporting; and a statement that the registered public accounting firm that audited the company’s financial statements included in the annual report has issued an attestation report on management’s assessment of the company’s internal control over financial reporting….”

When I was studying internal controls first for the Certified Internal Auditors exam and then for the CPA exam (both certificates earned) I learned the fundamental principles of internal control. One of the key tenants of an effective system of internal controls is management’s (owner’s) attitude toward how business is to be conducted. I also learned that if two or more people colluded, most systems of internal control could be successfully violated.

Bob Greifield, president of Nasdaq, in an editorial published in the Wall Street Journal on Monday March 6, 2006, discussing the anguish continuing over the burden of complying with SOX. He states:” when it comes to SOX, …the burden of compliance is onerous, the cost is significant and it falls disproportionately on smaller companies that are least able to pay.”

Mr. Greifield does not advocate abandoning SOX but agrees their should be and exemption for smaller companies. I completely disagree with any movement to allow and exemption. The core reason for an escalating cost of SOX compliance is the interpretation of outside experts including accounting firms and lawyers as to what is required to support their attestation opinion. Now before the public accountants and lawyers conclude that I am saying the cost of SOX is their fault, I am not at all. The accountants and lawyers are responding appropriately in a best effort to avoid litigation. Remove their responsibilities for Section 404 and place sole responsibility for the report with management where it belongs.

SOX legislation is fundamental internal controls practice. It is unfortunate that our government had to implement this legislation. From a practical point of view it has no choice considering the corporate scandals and huge financial losses from those scandals. However I have maintained for years that SOX should be a contributor to increased profits and not increased costs. Few agree but that is OK. Now I go further and advocate the expansion of SOX to privately held companies with material third party debt. I advocate SOX be amended to remove the outside auditor’s and outside lawyer’s responsibility for attestation for companies below a certain size if they are public.

Steve Pohlit is a CPA has his MBA and has been the CFO of several major domestic and international companies. Today Steve is an expert business consultant focused on helping companies improve their business performance including growing profits, revenues and customers. For a FREE 6 week mini course where you will receive 10 easy to implement action steps guaranteed to increase business revenue in profits by at least 30% in the next 90 days, please visit All articles published by Steve unless specifically restricted may be freely published with this resource box in tact.

Author: Steve Pohlit

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