Grant Thornton LLP Position on SEC Proposed Section 404 Changes

Business Wire, April 7, 2006

CHICAGO -- Grant Thornton LLP has committed to playing an active role in shaping guidance to protect investors. Although ultimately serving the interests of investors, auditors must also aid audit committees and companies with ever-evolving compliance requirements. Rather than roll back Section 404 provisions of the Sarbanes-Oxley Act of 2002 (the Act), as recently recommended by the SEC's Advisory Committee on Smaller Public Companies (the Committee), we believe that these provisions should be given a chance to work through collaborative fine-tuning. In the process of "getting it right," it is vital to make sure that new guidelines protect investors without unduly burdening companies with excessive costs. Included in that broader charge is the implicit responsibility to maintain a level playing field.

Section 404 of the Act requires public companies to state in their annual reports whether there are adequate controls over the financial reporting processes. In other words, management must tell investors whether their internal procedures can reasonably be relied upon to produce complete and accurate financial statements. Section 404 also requires auditors of those public companies to attest to, and report on, the assessment made by management.

Although these requirements are reasonable, real-world execution has led to significant problems, chief among them costs. Responding to these concerns, on Dec. 14, 2005, the Committee recommended that the SEC: (1) fully exempt certain small companies from this requirement, and (2) exempt slightly larger companies from the requirement to have management's assessment audited. In effect, then, this recommendation would create three classes of public companies: one in which management would not have to assert the quality of their controls; another in which management would have to assert the quality of their controls (but their independent auditors would not audit that assertion); and, a final group of nonexempt public companies (i.e., those with public market capitalization of more than $700 million or revenues of more than $250 million), in which management would be required to issue an audited assertion regarding the quality of their internal controls. The creation of such a hierarchy would confuse investors and negatively affect audit committees, companies and capital markets.

If adopted, this recommendation would place investors in smaller companies at a disadvantage compared with investors in larger companies. Auditors of the nonexempt public companies would, by mandate, be able to perform more overall audit work than auditors of smaller public companies. As a result, investors would not be able to rely as much on the financial statements of smaller public companies as on those of larger public companies. Moreover, the relative quality of financial reporting processes would be less for smaller companies than if all companies were held to the same standard; i.e., everyone understands, up front, that all internal controls will be audited.

Historically, effective inspection has driven proper performance, and it would be unfair to smaller company investors to have their investments held to a lesser standard than those of investors in larger companies. Moreover, in the proposed scenario, smaller company audit committees would find it difficult to fulfill fiduciary responsibilities for ensuring proper internal controls, and management, having spent the time and money to ensure proper controls, would be left at greater risk without independent evaluation of them. The lack of such third-party affirmation represents a significant competitive disadvantage.

The proposed cutoff between the largest public companies and all other public companies would also increase concentration of audits in the largest accounting firms. Today, six large accounting firms audit 99 percent of public-company sales. Adopting the Committee's recommendations would force an increasingly unhealthy concentration of the skills, methodologies and tools for auditing internal controls within these six accounting firms. Accordingly, investors and audit committees would be further limited in their choices for qualified auditors as they attempt to match a public company with the skills and resources of the "best-fit" global, national or local accounting firm. Although Grant Thornton LLP is the U.S. member firm of a global accounting organization and is among these six firms, we do not believe that concentration is good for the profession or the capital markets.

The Committee's recommendations were born out of a fundamental disparity that does exist between larger and smaller public companies with respect to implementation costs, and that disparity must be addressed. The problem does not lie in Section 404 requirements, however, but rather in the lack of agreed-upon standards for good internal controls that are applicable in myriad business situations.

Every public company, regardless of size, should have good controls over their financial reporting processes. It follows, then, that management of every public company should be in a position to state, at least annually, that they have good controls over their financial reporting processes. If these two statements are true, then the accounting and auditing profession and regulators should be able to agree upon the criteria upon which management and auditors would base their conclusions on internal controls. They should also be able to develop reasonable audit procedures that would allow an auditor to state whether they agree with management's assessment.