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Softening a Sarbanes-Oxley Thorn
SEC Makes Progress On Tweaking the Rules For Unpopular Provision
By Kara Scannell
The Wall Street Journal
Thursday, April 5, 2007

WASHINGTON -- Federal securities regulators approved guidance staff should follow when paring back a provision of the Sarbanes-Oxley law to change how companies and auditors comply with accounting provisions unpopular with many businesses.

The Securities and Exchange Commission, in an unusual meeting, voted to support four staff recommendations to work with the Public Company Accounting Oversight Board, the author of auditing standards, in what it said were the remaining issues that needed to be hammered out to approve a final guidance and rule in time for 2007 audits.

Section 404 of Sarbanes-Oxley requires company management to develop processes to monitor internal controls over financial reporting, which is meant to ensure accurate financial statements, and test those controls.  The law also requires outside auditors to test managements' assessment of the company's internal controls.  The section has been under attack from business groups, lawmakers and others for being too expensive and irrational.

Since the fall, amid pressure from congressmen and business interests, SEC Chairman Christopher Cox has pledged that he would make compliance with Section 404 more cost-efficient for companies and their investors.  His goal was to make it more risk-based and a top-down review of the internal controls over financial statements, which could be scaled to companies of different sizes and complexities.  In December the SEC proposed management guidance and the PCAOB proposed a new auditing standard, designated AS-5.

Yet, some officials within the SEC didn't think the AS-5 wording went far enough and that has resulted in somewhat of a power struggle between the regulators, with the SEC having the final authority to adopt auditing standards.  Officials with both agencies have played down any differences and say they are working cooperatively toward a common goal.  The purpose of yesterday's meeting, Mr. Cox said, was to "keep us on track" and adhere to what lawmakers and others have urged for a more flexible implementation of the rule.

While SEC and PCAOB officials are in agreement that some fixes need to be made, it isn't clear how easily that will be accomplished.

Mark Olson, chairman of the PCAOB, said at the SEC meeting yesterday that the PCAOB did "anticipate" making some changes to the auditing standard.  However, he added, "It is premature to say how the board will act on a particular issue, nor to commit to any course of action."

The pressure is on as Democrat and Republican members of Congress have called for swift changes to the law's implementation to make it less costly.  Small-business advocates and some members of Congress have pushed for an exemption for small companies, which the SEC has refused to grant.

Investor advocates caution that any loosening of the standards could erode the auditors' role and reduce avenues meant to root out fraud.  The auditing profession has fought against scaling back some of the standard out of fear it could increase litigation for firms if they miss red flags.  Others say they are trying to preserve high fees they earn from Section 404 compliance.

Among the issues the SEC voted to support yesterday are better alignment between the SEC's management guidance and the PCAOB's auditing standard on key definitions, and greater use of a principles-based rather than a check-the-box list when testing managements' assessments.  Other issues include making the entire auditing standard scalable to companies based on size and complexity with the standard providing some examples in how to accomplish that.

"It's not a retrenchment on anything that's occurring," said Zoe-Vonna Palmrose, a deputy chief accountant at the SEC.  "It's rationalization of our rules and standards."

Write to Kara Scannell at