14 Jan 2010
Have Reforms Helped Companies Comply with Sarbanes-Oxley Section 404 More Efficiently?
The Study of the Sarbanes-Oxley Act of 2002 Section 404: Internal Control over Financial Reporting Requirements (the Study) was released by the Office of Economic Analysis of the US Securities and Exchange Commission (SEC) in September 2009. Its goal was to examine whether – and to what extent – companies are finding it more cost-effective to manage their compliance with the requirements of Sarbanes-Oxley Section 404 since the reforms contained in the Commission Guidance Regarding Management's Report on Internal Control over Financial Reporting Under Section 13(a) or 15(d) of the Securities Exchange Act of 1934, Interpretation (Management Guidance) issued by the SEC in June 2007, and the Public Company Accounting Oversight Board's Accounting Standard No. 5 (AS5).
Data for the Study was collected in the form of voluntary testimony from financial executives of companies with Section 404 experience between December 2008 and January 2009. It covered the following aspects of Section 404 compliance concerning internal controls over financial reporting (ICFR):
- factors that influence a company's compliance costs;
- trends in Section 404 compliance costs;
- compliance cost components;
- perspectives of corporate executives about the benefits of Section 404 compliance;
- perspectives of external financial statement users about the benefits of Section 404 compliance; and
- corporate procedures concerning Section 404 compliance since the 2007 reforms.
Factors that influence a company's compliance costs
The costs for a company to comply with Section 404 depend on its size, compliance history and compliance regime. Larger companies, in terms of their public float, tend to incur higher compliance costs in absolute dollar figures, while smaller ones are likely to incur higher scaled compliance costs as a component of their asset value. The study also suggests that companies incur some fixed start-up costs or recurring fixed costs, regardless of their size. Compliance costs also decline as companies gain greater compliance experience. Moreover, the compliance costs of companies – especially larger ones – have decreased since the 2007 reforms.
Trends in Section 404 compliance costs before and since the reforms
Generally speaking, the total costs of compliance with Section 404 fell between the year before and the year after the 2007 reforms. Average total compliance costs for large accelerated and accelerated filers were reduced from US$2.87 million to US$2.33 million, a 19% decline, while those for non-accelerated ones also dropped from US$769,000 to US$690,000. The reduction was more pronounced among medium and large companies that were already obliged to comply with both Section 404(a) and 404(b). There was no significant change in the costs of first time compliance during the year before and after the 2007 reforms. However, compliance costs for Section 404(b) were significantly lower after the 2007 reforms among companies that were complying for the second year.
Compliance cost components
The largest cost component for companies complying with both Section 404(a) and 404(b) was internal labour costs, which accounted for more than 50% of their total compliance costs. Among Section 404(b) companies, the fees paid for an independent audit of ICFR was the second-largest cost component, followed by outside vendor fees and non-labour costs. One objective of the 2007 reforms was to reduce Section 404 compliance costs; and in fact a downward trend has been observed in these costs relative to company size. Smaller companies (with a public float of less than US$75 million) have less Section 404 compliance experience; the decrease in their costs between the year before and the year after the 2007 reforms was less significant than that of medium and large companies.