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SOX Requirement Targeted; Study Points to Risks of Weak Internal Controls

Criticism of the Sarbanes Oxley Act, enacted in the wake of the WorldCom and Enron scandals, has been increasing as the government seeks to roll back financial regulations.  A New York Times article recently discussed Congressional testimony delivered by critics of SOX, who say the law entails significant regulatory burdens and costs for companies and has not evolved with the financial markets. The Sarbanes Oxley Act requires, among other things, that an independent auditor attest to, and report on, management’s assessment of a company’s internal controls. Some critics say that in addition to the high cost, the financial reporting audit requirement does nothing to prevent fraud. However, the NYT story cited a recent study that examined whether and how weak internal controls increase the risk of financial reporting fraud by top managers at corporations. The study’s authors found a strong association between material weaknesses in companies’ financial reporting and future fraud revelation and theorized that this link could be attributable to weak internal controls giving company managers greater opportunity to commit fraud, or signaling a management characteristic that does not emphasize reporting quality and integrity.

Meanwhile, the IASB recently published guidance to encourage public companies to produce leaner, more useful financial statements. According to the global accounting authority. “The need for materiality judgments is pervasive in the preparation of financial statements.” According to a Reuters report, auditors in over 100 countries apply the IASB standards.