SEC Official Sounds Alarm on Decline in ‘Material Weaknesses’
December 8, 2013 Leave a comment
December 5, 2013, 4:15 PM ET
SEC Official Sounds Alarm on Decline in ‘Material Weaknesses’
Senior Editor
Public companies are disclosing fewer missteps in their internal controls over financial reporting. But it could be that they just aren’t looking hard enough, a securities regulator said on Thursday. The number of companies and their auditors reporting so-called “material weaknesses” over their internal control systems that work to prevent fraud and misstatements at public companies has declined precipitously over the past few years.“There are likely more material weaknesses in the system than are being reported,” says Brian Croteau, a deputy chief accountant in the Securities and Exchange Commission’s Office of the Chief Accountant.
Companies were required to begin testing for material weaknesses under the Sarbanes-Oxley Act of 2002 and have their auditors attest to their effectiveness. In the first year after the rule took effect, auditors reported some 629 material weaknesses, such as a failure in oversight over cash management or receivables, according to Audit Analytics. But that figure has declined every year since, and only 141 were reported in 2011.
When companies report material weaknesses today, Mr. Croteau said, they are generally accompanied by disclosures of material misstatements or restatements in financial results. That could indicate companies are not testing their controls properly or early enough to detect problems before they get out of hand.
Financial errors should not be “a precursor to there being a material weakness,” Mr. Croteau told the audience at a Baruch College auditing conference in New York.
A possible lack of rigor around material weakness testing appears to be showing up both in regular corporate correspondence with the SEC’s Division of Corporation Finance and auditor inspections by the Public Company Accounting Oversight Board.
The PCAOB sent out an alert in October about the need to improve auditing around internal controls, after its latest round of inspections found that in 15% of the 309 audits it examined, auditors failed to get enough evidence to support their opinions.
To be sure, many of the companies that first disclosed material weaknesses have implemented improvements to fix earlier problems and improved their effectiveness in controls over the years. But regulators, like Mr. Croteau, are unconvinced that companies are really experiencing so few weaknesses.
“This is an area that needs continued attention and perhaps more attention than it is getting today,” Mr. Croteau said.
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