Auditors to Be Told to Focus On Biggest Risks

Regulators next week will urge auditors to exercise better judgment and increase their reliance on the work of corporate employees as the audit firms pore over the systems companies have in place to prevent fraud.

The guidance is designed to respond to complaints from businesses that new rules are too expensive and time consuming. It was described by sources familiar with the recommendations who spoke only on the condition of anonymity because the directives are not yet public.

The Public Company Accounting Oversight Board, which oversees the work of auditing firms, plans to issue policy and technical directives Monday. The Securities and Exchange Commission also will release new guidance on the issue next week. Auditors have been criticized recently by corporate executives who said the auditors are concentrating on obscure details rather than the big picture when they assess their clients' risk of financial restatement.

For months, companies and industry trade groups have resisted rules mandated by the 2002 Sarbanes-Oxley Act. The law requires executives to vouch for the adequacy of financial controls, or checks and balances intended to prevent fraud and accounting errors. By some estimates, the reviews have cost more than $4 million per company -- far more than the SEC predicted. Investor advocates say the reviews help boost public confidence in corporate financial statements.

SEC Chairman William H. Donaldson and accounting board Chairman William J. McDonough said they would act quickly after a day-long roundtable discussion last month at which representatives of the New York Stock Exchange and Pfizer Inc., among others, expressed concern about how auditors are carrying out the control reviews. The law's sponsors say they have little interest in reopening debate in Congress this year. Instead they encouraged the SEC and accounting board to modify the rules where it is appropriate.

At a speech to financial officers in Washington yesterday, Donaldson said some of the costs may have resulted from "excessive or duplicative effort by management and auditors." Donaldson added that Section 404, the part of the law that refers to control reviews, "is too important not to get right."

The guidance scheduled to be issued Monday will encourage independent auditors to rely more on the work of corporate accounting staff to avoid duplication and busywork, according to people familiar with the documents. Regulators also will stress that auditors should consider the size of the client company and focus on the areas most at risk of requiring financial restatement when designing their reviews.

Next week's guidance and directives may not be the final word. Accounting oversight board leaders will devote two days of meetings with an outside advisory panel in June to the internal controls issue.

Barbara Roper, director of investor protection at the Consumer Federation of America, noted that auditors have been required to review controls for years but that they were often given short shrift by accountants and corporate managers before the 2002 law. "Whether 404 is meaningful or not is directly on the line right now," she said of the regulatory guidance, which she has not reviewed. "I'd like to see them encouraging auditors to do very thorough reviews of internal controls."

Thomas J. Lehner, director of public policy at the Business Roundtable, and David C. Chavern, director of the U.S. Chamber of Commerce's corporate governance initiative, said that they have not seen the new policies but that they think regulators have been sincere in hearing out business concerns.

"Our membership wants to make sure the costs don't become so high that they detract from productivity and risk-taking," Lehner said. Ten chief executives affiliated with the Business Roundtable met with Donaldson on Wednesday to talk about Sarbanes-Oxley and other corporate governance issues, he said.

Meanwhile, lobbyists continue to press regulators over several sensitive issues, including treating stock options as expenses. Technology companies have made heavy use of options, or the ability to purchase stock at a specific price within a certain period of time, to recruit and retain employees.

This week, Silicon Valley venture capitalist E. Floyd Kvamme and two partners launched a Web site called Expensing Stock Options Is Bad Accounting ( http://www.expensingisbadaccounting.com ) . Separately, Cisco Systems Inc. is talking with SEC officials about a new way of valuing options that could help decrease the expenses it must report.

In advance of the directive to expense options, which will take effect for companies with fiscal years that start after June 15, some companies have stopped issuing options to employees, a decision that Kvamme called "tragic."

"Ownership has been an important element of what made the tech industry the tech industry," said Kvamme, a co-chairman of President Bush's Council of Advisors on Science and Technology. Kvamme said he has met with SEC officials and members of Congress to address his concerns about options expensing and the Sarbanes-Oxley law.

Donaldson yesterday reaffirmed his support for options expensing and said the SEC would consider Cisco's approach, according to a spokesman.

On other issues, Donaldson has stood firm under pressure. He signaled that he would not retreat from aggressive enforcement efforts Thursday by naming longtime deputy Linda Chatman Thomsen chief of the SEC's enforcement division. The U.S. Chamber of Commerce has criticized the agency for what it called overreaching in its policing of the securities industry.

Agency observers and insiders say relations among the SEC's five commissioners are fragile. Democratic Commissioner Harvey J. Goldschmid recently said in a speech that the agency is "very delicately balanced right now." Donaldson frequently votes with two Democrats to form a majority on the commission, with Republicans Paul S. Atkins and Cynthia A. Glassman dissenting on issues such as stock market structure, hedge fund registration, and mutual fund governance.

That balance could shift when Goldschmid returns to teach at Columbia University in the fall. Goldschmid's replacement, who has yet to be proposed by Democratic senators, requires the approval of the White House and the Senate. The term of Democratic Commissioner Roel C. Campos also expires late this summer. Campos has said he would like to be renominated.