On October 13, 2006, Todd Markus of Horn Murdock Cole gave a talk to attorneys on the risks and opportunities relating to Sarbanes-Oxley Section 404 (Section 404).
Section 404 relates to management’s assessment of internal controls over financial reporting. It involves assessing controls that have a direct impact on the financial statements. The process provides reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes.
There is no consideration of operational, legal, or regulatory controls if there are no financial statement consequences. Management must assess the effectiveness of internal controls every year.
For all accelerated filers, Section 404 management report and auditor attestation is required. For non-accelerated filers, Section 404 management report and auditor attestation is required for fiscal years ending July 15, 2007. For pre-IPO companies, a company is considered a non-accelerated filer until its first Form 10-K is filed, regardless of its market capitalization.
The Public Company Accounting Oversight Board oversees auditors of public companies. A company can best prepare for Section 404 by reading what auditors are reading when they are preparing for the Section 404 audits. Auditors are not part of the internal controls process. When an auditor finds an issue, it is usual that the company does not have effective internal controls. Financials would have gone out incorrectly if the auditor did not catch the mistake. Material weaknesses may lead to lawsuits. Material weaknesses based on revenues may impact a company’s stock price.
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