NEW YORK — Complying with Section 404 of the Sarbanes-Oxley Act is turning out to be a heck of a headache, and an expensive one — especially for smaller-sized companies.
Section 404 requires managers of public companies to establish and maintain internal controls with regard to financial reporting. The section also requires the auditing firms to not only sign off on the financial reports, but attest that the management of the audited company made the necessary internal assessments.
According to a study published by Korn/Ferry International, complying with Section 404 cost companies an average of $5.1 million. Moreover, ongoing compliance to the law trims, on average, $3.7 million from a company’s bottom line.
“It’s a very expensive, very complicated thing,” said Laurence Leeds Jr., chairman of Buckingham Capital Management in New York. “The dollar amount, in addition to the time required to comply, has and will continue to affect the bottom line.”
In a separate study and survey by Financial Executives International, companies with sales of $5 billion or more spent an average of $4.4 million to implement Section 404, which is “39 percent more than they had budgeted. In addition, 94 percent of all respondents said the cost of compliance exceeded the benefits,” according to the National Retail Federation, citing the survey.
Compliance to Section 404 couldn’t come at a worse time. Retailers were caught off guard earlier this year when the Securities and Exchange Commission changed the way companies account for their leases.
The result of these two changes have caused dozens of companies to delay the filing of their annual reports.
Earlier this month, the NRF sent a letter to the SEC expressing its concerns while encouraging the commission to review the regulations.
“It has been too costly,” said Carleen Kohut, chief financial officer of the NRF. “We have heard talk of some companies wanting to delist as a result of the complexities of Section 404. I would imagine that for every hard dollar spent in complying, there are probably two soft dollars lost in terms of resources and staffing.”
Recent data supports the NRF’s claim. In a published study from the Wharton School of Business, 198 American companies had deregistered from exchanges in 2003. This is nearly three times as many deregistrations as in 2002, which was one year after Sarbanes-Oxley was passed.“We support the principles of sound and transparent financial reporting and the underlying importance of effective internal controls,” said NRF president and chief executive officer Tracy Mullin in a letter to SEC chairman William H. Donaldson. “We have concerns, however, that confusion about and inconsistent application of the act have undermined its objectives and effectiveness. We further question whether the initial intent of this act — to restore investor confidence — has been balanced against the cost of its implementation.”
In the letter to the SEC, the NRF urged the commission to lay out clearer guidance “to ensure consistency of Section 404 application by the public accounting firms,” while also providing “direction on the use of materiality when determining tests of controls, and allow independent auditors to place more reliance on internal audit and management’s internal control testing.”
The NRF went on in the letter that “auditors have long used risk-based assessment to determine the scope of a financial statement audit. The practice allows the auditor to focus on areas that have the greatest potential for misstatement, error or abuse.” This is the same approach used in the internal control assessment by the reporting company.
“Our members believe that independent auditors did not use this tool as effectively as possible in their compliance testing,” the NRF said in the letter. “Rather than focusing on the areas that posed the greatest level of risk — such as the ethical culture of the company, entity-wide controls, nonroutine transactions, new markets, areas of rapid growth or new technology implementation — auditors seemed to treat the entire business as a more risky venture and insisted on testing an inordinate number of medium- and low-risk controls.”
The NRF went on to say that the independent auditors “tested routine transactions at multiple locations with the same rigor and resources as those transactions or judgments that posed substantial financial statement risks.”
In short, the NRF believes the intention of Section 404 was to prevent material fraud, and that “it was not intended as a mechanism to identify and prevent every single error that could occur."
“My personal philosophy to beauty is paying attention to oneself. I love to be outdoors, lots of fresh air, trying to take care of yourself as best you can. I always notice that comes through,” says Felicity Jones, the global face of @shiseido-owned @cledepeaubeauteus, which launches today. Head to WWD.com to read more about the actress’ love for beauty and how she prepared for her new role in “The Basis of Sex,” playing the young Ruth Bader Ginsburg. #wwdbeauty (📷: @dandoperalski)
For men’s fall 2018, @giuseppezanotti drew on elements from streetwear, sport, biker, combat and rock ‘n’ roll. Pictured here are a pair of shoes from the collection, featuring zippers, rhinestones, and silver hardware. Head to WWD.com to see a roundup of the accessories from Milan’s men’s fall 2018 shows. #wwdfashion (📷: Andrea Delb)
To celebrate the 25th anniversary of @ralphlauren’s snowboarding collection, the brand is mining its archives. The iconic brand is reintroducing vintage styles and dropping new designs for a color capsule that will be available in Ralph Lauren stores and @openingceremony on January 25. The capsule will consist of 10 pieces, including the Snow Beach Pullover, pictured here, which is a collector’s item that rapper Raekwon wore in Wu-Tang Clan’s “Can It Be All So Simple” video. #wwdfashion (📷: Tom Gould)
For @rochasofficial’s pre-fall 2018 collection, creative director Alessandro Dell’Acqua channeled the sophisticated and intriguing Catherine Denevue in the film “Belle de Jour.” Polished collarless coats, midi skirts, suits and ’60s graphic motifs were all featured in the collection, adding a sense of discreet luxury. See the rest of the photos on WWD.com #wwdfashion
“We tried to produce clothing of that couture quality, but the most daunting part was that we only had a matter of days [to do it],” said costume designer Lou Eyrich, who recreated Gianni Versace’s iconic looks for @americancrimestoryfx. Eyrich searched online retailers and vintage shops for original pieces from the design house and for @penelopecruzoficial, who plays Donatella Versace. Head to WWD.com to read how she created the Versace world. #wwdfashion
Only three months after her stellar debut catwalk season, @kaiagerber has inked her first big design collaboration –– with @karllagerfeld. The collection blends Lagerfeld’s Parisian chic aesthetic and the model’s signature West Coast casual style via RTW, accessories, footwear and more. The #KarlLagerfeldxKaia collection will launch in September with a series of events. Get all the details on WWD.com. #wwdnews #wwdfashion
Harrods plans to remove the famous statue of Princess Diana and Dodi Al Fayed from the bottom of the Egyptian escalators and hand it back to Mohamed Al-Fayed. “We are very proud to have played our role in celebrating the lives of Diana, Princess of Wales and Dodi Al Fayed at Harrods and to have welcomed people from around the world to visit the memorial for the past 20 years,” said Michael Ward, Harrods managing director. “With the announcement of the new official memorial statue to Diana, Princess of Wales at Kensington Palace, we feel that the time is right to return this memorial to Mr. Al Fayed and for the public to be invited to pay their respects at the palace.” More on the news, with reporting by @loreleimarfil, at WWD.com. #wwdnews