The number of companies reporting material weaknesses under Section 404 of Sarbanes-Oxley has dropped steadily since the first year of compliance in 2004, suggesting that accelerated filers have made improvements in their internal controls, according to a Securities and Exchange Commission staff member.
Among roughly 3,800 companies that filed reports in accordance with Section 404 through July 31, only 285—or 7.5 percent—reported material weaknesses. That’s down from 10.7 percent in Year Two and 16.3 percent in Year One, when 3,900 companies filed 404 reports.
“We are seeing significant improvement in internal controls for accelerated filers, which hopefully should result in improvements to the quality of financial reporting,” Josh Jones, professional practice fellow in the SEC Office of the Chief Accountant, said recently. Jones made his remarks in New York last week at a conference on Sarbanes-Oxley compliance sponsored by the Foundation for Accounting Education.
Twenty percent of the companies reporting material weaknesses this year also had ineffective internal controls over financial reporting during Years One and Two, he noted.
Among those companies reporting material weaknesses, some 60 percent had less than $500 million in revenue, a trend that Jones said has been consistent for all three years. The SEC staff will review all of the material weakness disclosures.
Jones noted that the material weakness disclosures related to areas of accounting that are “very technical [and] complex and require a lot of judgments.” Topping the list this year were financial statement elements related to income taxes (32 percent), liabilities and payables (25 percent), and revenue recognition (24 percent).
“As you are going through your assessments and audits next year, I’d encourage you to think long and hard about the areas that have the greatest complexity and require a lot of judgment … and place a lot of focus on these during the audit,” he said.
Jones also noted that the majority of material weakness disclosures are still “reactive,” discovered after an error is found. That is something the SEC hopes will change as a result of its efforts to improve the implementation of Section 404.
“We’re still seeing material weaknesses being disclosed on the basis of known errors, as opposed to the assessment of risk misstatements that may occur in future periods,” Jones said. He noted that this year, 68 percent of material weaknesses were disclosed after material or numerous auditor or year-end adjustments, while 25 percent involved restatements or non-reliance of company filings. “We hope to see those disclosures be more forward-looking than reactive,” he added.
Meanwhile, Jones noted that the SEC plans to put out a brochure tailored for smaller companies to serve as a quick reference on its management guidance. The Commission has also committed to conducting a cost-benefit analysis over the next year or two to look at the effect of its actions related to 404 implementation, he said.
Nasdaq Updates Listing Standards
Nasdaq has updated some of its listing standards to bring them more into line with Securities and Exchange Commission rules and comparable provisions of other exchanges.
The SEC recently approved two Nasdaq rule proposals. One allows Nasdaq listed companies to satisfy the annual report distribution requirement by posting their reports on their Web sites. The other eliminates a requirement that related-party transactions be approved by an independent board committee.
The rule change to allow issuers to post their annual reports online also requires companies to issue a press release announcing that the report is available online, and to make hardcopies available to shareholders for free upon request. The change aligns Nasdaq’s listing requirements with the “e-proxy” rules adopted earlier this year by the SEC, and with a rule change adopted last year by the New York Stock Exchange.
The rule change that eliminates a requirement that related-party transactions be approved by an independent board committee conforms to similar rules of the NYSE and the American Stock Exchange.
The revised rule still requires companies to conduct appropriate review and oversight of all potential conflicts of interest on an ongoing basis, either by the audit committee or another independent body of the board of directors. The SEC’s new rules relating to executive compensation and related party disclosure require companies to disclose their policies and procedures regarding related-party transactions.
FINRA Celebrates ‘Settlement Month'
If you’ve got a securities dispute to settle, now may be the time to do it. The Financial Industry Regulatory Authority is celebrating its ninth “Settlement Month” in October by offering lower rates to parties that mediate cases with the securities regulator.
During the month, hundreds of mediators will reduce their normal fees, and FINRA will reduce its normal mediation filing fees for all cases by half. FINRA says the number of cases where parties agree to mediate typically increases by 40 percent or more during the event.
The reduced rates and educational events on FINRA’s dispute resolution program are part of efforts to encourage mediation. In addition, the seventh annual Mediation Settlement Day is slated for Oct. 18, with a kick-off event on Oct. 2 at the New York City Bar Association.
For information about FINRA mediation and the Mediation Settlement Month events, visit www.finra.org.
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