Insight - The big day delay

Previously, foreign companies registered with the SEC had to comply with section 404 for financial years ending on or after 15 July 2005. Now they have an extra 12-month breather, with compliance only required for financial years ending on or after 15 July 2006. The SEC has made this deadline extension in recognition of the work that is required, particularly for European companies that have simultaneously been grappling with the implications of applying international financial reporting standards for the first time.

Section 404 requires companies to include in their annual reports a report by management on the company’s internal control over financial reporting and an accompanying auditor’s report. The work involved in documenting controls and then testing them has been much bemoaned and commented upon. As the SEC’s chief accountant, Donald Nicolaisen, said when announcing the deadline extension: “Section 404’s requirements are among the most important part of the Sarbanes-Oxley Act and I encourage public companies to devote the necessary resources to make sure those requirements are implemented effectively. I don’t underestimate the effort this will require of smaller companies and foreign private issuers, but this extension will provide additional time for those users to take a good hard look at their internal controls, as the act contemplates.”

The SEC is seeing the compliance deadline extension as giving companies the chance to approach SarbOx more comprehensively rather than simply delaying their work on it. “Companies should use the extension not to delay but to improve the quality of their efforts,” says Alan Beller, director of the SEC’s division of corporation finance. “Section 404 reporting has the long-term potential to substantially improve the reliability of financial reporting.”

The word on the UK corporate street is that most companies needing to comply with section 404 agree with the SEC and are not planning to delay compliance. Resources Global Professionals, the international professional services firm that works with clients on a project basis, has been heavily involved with SarbOx compliance assignments. “The majority of our clients are saying they have to get this done,” confirms Chris Beer, Resources’ UK managing director. “They have a plan and resources in place. Only a small minority are saying they will stop what they are doing.”

The general consensus is that keeping going is the best option. “Having started the project it’s a lot better, if possible, to keep it going,” Beer says. “You have the resources and people in place. To lose momentum is more damaging than any value you may gain in stepping back – unless the organisation really doesn’t feel it has got its head round what it is trying to achieve.” One of the complications in SarbOx compliance, Beer points out, is that the Big Four accountancy firms aren’t necessarily giving the same advice about how to achieve compliance, and are interpreting the requirements differently. Given that many companies are using a firm that isn’t their auditor for SarbOx compliance consultancy, this can result in confusion.

Some of Resources’ clients are not actually stopping their SarbOx work, but are considering adjusting their methodology, for example, so that they spend more time on embedding their SarbOx-related processes effectively. “The whole concept behind Sarbanes-Oxley is that it is a recurring thing, with annual attestation,” explains Beer. “It isn’t going to go away. Our advice is to get as many people exposed to the project as possible. Get people involved and build that experience into the organisation.”

Apart from not wanting to lose momentum on their SarbOx projects, the pressure to compete with US rivals is also driving some UK companies on. “Some clients, particularly UK plcs that have US-listed organisations as competitors, have said they have to be seen to be as clean as their US competitors,” Beer explains. “The fact that their US competitors are complying means they have no option but to comply now too.” Failing to do so could damage their reputation in the marketplace.

Pushing ahead with SarbOx compliance does mean that any benefits should be felt sooner. That said, most UK companies are still feeling more pain than gain. “Most of my CFO clients are saying it’s too painful for them to be able to say there is some value there,” Beer says. “I think many more will see value post first-year compliance.

“Our own chief financial officer, who is going through this too, says that it’s too time-consuming and too labour-intensive to be able to quantify value at the moment.”

Hopefully, once the systems are embedded and control improvements completed, some benefits may start to be felt.