SEC Votes to Propose Interpretive Guidance for Management to Improve Sarbanes-Oxley 404 Implementation

The Securities and Exchange Commission today voted to propose for public comment interpretive guidance for managements regarding their evaluations of internal control over financial reporting. The Commission also proposed amendments to Rules 13a-15 and 15d-15 that would make it clear that a company choosing to perform an evaluation of internal control in accordance with the interpretive guidance would satisfy the annual evaluation required by those rules. Finally, the Commission proposed amendments to Regulation S-X to clarify the auditor's reporting requirement pursuant to Section 404(b) of the Sarbanes-Oxley Act.

An excerpt:

The proposed guidance is principles-based guidance that is organized around two important principles:

• First, management should evaluate the design of the controls that it has implemented to determine whether there is a reasonable possibility that a material misstatement in the financial statements would not be prevented or detected in a timely manner. This principle promotes efficiency by allowing management to focus on those controls that are needed to prevent or detect material misstatement in the financial statements.
  
• Second, management should gather and analyze evidence about the operation of the controls being evaluated based on its assessment of the risk associated with those control. The principle allows management to align the nature and extent of its evaluation procedures with those areas of financial reporting that pose the greatest risks to reliable financial reporting.

By following these two principles, we believe that companies of all sizes and complexities will be able to implement our rules more effectively and efficiently. As smaller public companies often have less complex internal control systems than larger public companies, this proposed approach would enable smaller public companies in particular to scale and tailor their evaluation methods and procedures to fit their own facts and circumstances.