Statement by SEC Staff:
SEC's Proposed Interpretive Guidance to Management for Section 404 of Sarbanes-Oxley Act
U.S. Securities and Exchange Commission
SEC Open Meeting
May 23, 2007
Chairman Cox and Members of the Commission:
As Chairman Cox mentioned, the Commission proposed the interpretive guidance for management on the evaluation and assessment of internal control over financial reporting and related rule changes last December. The comment period for these proposals ended February 26th . My staff and I have been working very diligently to address the comments received and finalize the proposals. Today, we are here to present for your consideration our finalized interpretive guidance for management and the related rule changes.
An overall objective of Section 404 and the Commission's rules is to foster the preparation of reliable financial statements. Another objective is that the Commission's rules implementing Section 404 are intended to bring information concerning material weaknesses into public view. We believe the interpretive guidance we are presenting here today maintains both of those objectives. At the same time, the guidance provides a principles-based framework to management as to how they might complete their assessment in a more effective and efficient manner. We believe the guidance will be beneficial to companies of all sizes, but especially smaller companies, including those that have not yet completed their first evaluation.
The majority of the comment letters we received on our proposing release expressed overall support for the principles-based nature of the Commission's interpretive guidance. Many commenters believed that this guidance will encourage a healthy use of judgment and common business sense in formulating the procedures companies use to evaluate whether material weaknesses exist in their internal control systems. Further, over 70% of the commenters that were smaller companies or representatives of smaller companies expressed support for the guidance, with many indicating that the guidance would allow management to focus on the areas most important to reliable financial reporting. Also, commenters said that the guidance would allow management to tailor their evaluations to each company's facts and circumstances.
The interpretive guidance reiterates the Commission's position that management must bring its own experience and informed judgment to bear in order to design an evaluation process. The evaluation process needs to provide a reasonable basis for its annual assessment of whether ICFR is effective. The guidance is intended to allow management sufficient and appropriate flexibility to design such an evaluation process. Smaller public companies, which generally have less complex internal control systems than larger public companies, should use this guidance to scale and tailor their evaluation methods and procedures to fit their own facts and circumstances. We encourage smaller public companies to take advantage of the flexibility and scalability afforded in the guidance to conduct an evaluation of ICFR that is both efficient and effective at identifying material weaknesses.
The core principles of the interpretive guidance have not changed from our proposing release. However, we have made certain clarifications and modifications to the proposed guidance. In a moment, Zoe-Vonna Palmrose will overview the more significant changes made.
At this point, I would like to reiterate the Chairman's thanks to the staff who worked tirelessly on this effort. During this process we have worked closely with the PCAOB, and I would like to add my thanks to the Board and the staff of the PCAOB. We would also like to thank the Commissioners and their staff for the countless hours they have worked with us on this topic over the past months, providing their insight and guidance.
Finally, we believe that the interpretive guidance for management, when adopted by the Commission will provide for many years in the future a more effective and efficient ICFR evaluation process for existing and future public companies. The guidance will allow companies of all sizes to comply with our rules, while reassuring investors that material weaknesses in internal controls will be brought to light and disclosed. Stated simply, we believe that the interpretive guidance will play an important role in achieving the cost-benefit balance that must be brought to the section 404 compliance for all companies.
Now, I would like to turn it over to Zoe-Vonna Palmrose.