June 7, 2005
The Origin of the SEC/PCAOB Rules on Section 404
For those wondering how the SEC/PCAOB drafted the Rules implementing Section 404 that have proven to be so difficult to apply (they still do not apply to small business and foreign filers) the history is revealing. Two trade organizations of auditors, one called the Treadway Commission's Committee of Sponsoring Organizations (COSO) and the other the IT Governance Institute (COBIT) wrote a set of recommendations on internal controls over ten years ago. COSO offered recommendations on financial controls and COBIT offered recommendations on information technology controls. The SEC and PCABO used these trade committtee reports as the basis for their requirements. Note the problems here. First the controls were written by accountants and auditors, in part to drum up business. They were voluntary; they were recommendations; they not intended to be binding. [Technically the SEC requires the use of rules "established by a body of experts"; the COSO rules are not the exclusive rules that may be used, but in practice they are the ones used.] Second, American business organizations were not represented in the formation of the recommendations. They were written by the accounting and auditing professionals. This is like barbers writing recommendations on how often to get a haircut and Congress making the recommondations into binding law. COSO has representatives of the American Accounting Association, the American Institute of Certified Public Accountants, the Financial Executives Internation, the Institute of Internal Auditors and the Institute of Management Accountants. COBIT relied heavily on PriceWaterHouseCoopers, Deloitte, and KPMG for authorship of the recommendations. Third, the recommendations were written with the country's largest firms in mind. They were not written for smaller companies and they were not written for foreign issuers. Fourth, they were not written in operational detail. They were best practice recommendations not rules. Now the the PCAOB and SEC have turned them into legal rules, a task for which they were not designed, we have a mess on our hands.
June 7, 2005 | Permalink
TrackBack URL for this entry:
Listed below are links to weblogs that reference The Origin of the SEC/PCAOB Rules on Section 404: