Internal control over financial reporting, as described in Section 404 of the Sarbanes-Oxley Act of 2002 (SOX 404), plays a critical role in the U.S. marketplace. A good internal control system is one of the most effective deterrents to fraud and a key factor in preventing financial misstatements. In the near future, investors will begin to see new types of reports from management and auditors about whether adequate internal control over financial reporting is in place. For these reasons and in order to give investors tools to improve their comprehension of the new internal control reporting, two investor resource guides were developed by Deloitte & Touche, Ernst & Young, KPMG and PricewaterhouseCoopers, collectively.

• Internal Control Over Financial Reporting: An Investor Resource
  
  This resource guide serves as a broad overview of SOX 404, providing the background and rationale for the internal control reports, a description of these new types of reports and a discussion of control deficiencies, management’s report and the independent auditor’s opinion.
  
  
• Perspectives on Internal Control Reporting: A Resource for Market Participants
  
  This resource guide provides a detailed discussion in question and answer format of specific topics related to SOX 404, including material weaknesses and potential implications of the new reporting.
  

The four firms issued these two investor resource guides to assist investors, brokers, analysts, rating agencies and other market intermediaries, both small and large, in understanding the new internal control reporting. Firms are encouraged to distribute these two guides to their clients.

On January 12, 2005, the Center's staff attended a conference called "Investors, the Stock Market, and Sarbanes-Oxley's New Section 404 Disclosure Requirements", which was sponsored by the four firms and Stanford Law School. The primary objective of the conference was to educate both retail and institutional investors regarding SOX 404. The conference was co-chaired by Joe Grundfest, Professor at Standford Law School and former SEC Commissioner, and Raymond Beier, Partner at PricewaterhouseCoopers. The speakers featured were Alan Beller, Director of Corporation Finance at the SEC; Douglas Carmichael, Chief Auditor at the PCAOB; Craig Crawford, Partner at KPMG; Nick Cyprus, Vice President, Controller and Chief Accounting Officer at The Interpublic Group of Companies; Steve Galbraith, Partner at Maverick Capital; Trevor Harris, Managing Director at Morgan Stanley; Elaine Harwood, Senior Manager at Cornerstone Research; Greg Jonas, Managing Director at Moody's Investors Services; Tom Knudsen, Partner at Ernst & Young; Bob Kueppers, Partner at Deloitte & Touche and Chairman of the Center's Executive Committee; Nell Minow, Editor at The Corporate Library; Don Nicolaisen, Chief Accountant at the SEC; Charles Niemeier, Board Member of the PCAOB and Colleen Sayther-Cunningham, President & CEO of Financial Executives International.

Below are some highlights from the conference:

1. SOX 404 is an evolving process which is new and full of uncertainties for all parties.
   
   
2. "Not all material weaknesses are created equal" – Some material weaknesses are worse than others from an investor perspective.
   
   
3. The stock market appears to be "smart" and able to differentiate between material weaknesses.
   
   
4. Issuers are smart to be candid about internal control problems identified and the steps being taken to fix them.
   
   
5. Issuers with greater complexity are most likely to have internal control problems. Some examples given were those companies with a history of mergers and acquisitions, diversity of operations in terms of both segments and geography (particularly international), and/or constrained resources, as well as those companies who got started on the SOX 404 process late.
   
   
6. A major concern is that the market place still does not understand that financial statements are not precise. Until that perception is corrected, there will not be satisfaction in the marketplace. The imprecision is the result of the judgment, estimates and choice of accounting methods necessary in financial statement preparation. In addition, there is a flawed perception that because billions of dollars are being spent on internal controls, the financial statements will be more precise as a result of SOX 404.
   
   
7. We are all still learning and it is too soon to draw any conclusions regarding the cost/benefit debate on SOX 404.
   
   
8. The regulatory process is still in a state of flux, as the regulators are still learning as well. The rules are likely to change with experience.