The Center for Audit Quality (CAQ or the Center), submitted comment letters to the SEC and PCAOB related to the internal control over financial reporting (ICFR) proposals for issuers and auditors, respectively. The Center supports the proposals, which encourage increased effectiveness and efficiency in implementing the provisions of Section 404 of the Sarbanes-Oxley Act of 2002 (the Act). We believe that these proposals will facilitate continued progress in upholding the investor protections that are so fundamental to the success of the Act and that any changes to the implementation of Section 404 should flow primarily from the desire to reinforce the significant benefits of Section 404 rather than a drive to cut costs.

Summary of CAQ's Comments to the SEC

The following is a summary of the CAQ's comments on the SEC's Proposed Interpretive Guidance- Management's Report on Internal Control Over Financial Reporting (File Number S7-24-06).

We expect that the SEC proposed management guidance, along with the proposed auditing standard of the PCAOB, will result in a reduction of total Section 404 efforts due to various specific positive changes such as 1) the ability of management to undertake or accelerate a controls rationalization process through the principles in the proposal to better focus its assessment on those controls that impact its financial statement reporting; and 2) the ability of an auditor to increase the use of the work of others, if certain conditions are met.

We are supportive of the following aspects of the SEC's proposal:

• Applying a principles-based approach to the internal control assessment that can be scaled based on the size and complexity of the issuer;
  
  
• A top-down risk-based approach to management's assessment of ICFR that requires testing of only those controls necessary to prevent or detect material misstatements in the financial statements; and
  
  
• Requirements that management test the operating effectiveness of those controls over financial reporting necessary to prevent or detect material misstatements each year.

The CAQ made the following comments intended to improve the proposed SEC guidance to meet the overall goal of making implementation of Section 404 more effective and efficient:

Interaction with the Independent Auditor

We recommended that the SEC guidance include a new section entitled Interaction with the Independent Auditor that would discuss, and provide examples, of how the audit scope may be affected by the level of work that management performs and its documentation. We believe that interaction between the auditor and management is crucial for the most effective and efficient overall ICFR process.

Consideration of Fraud

We recommended that the SEC guidance focus more attention on anti-fraud controls and procedures and clearly articulate the tools and techniques that should be considered by management and that may be implemented to help prevent, detect or deter fraud.

"Financial Reporting Risks" and "Significant Accounts and Relevant Assertions"

We recommended that the SEC consider the possible implications of using different terminology than what is used in the PCAOB proposed guidance and either align terminology or discuss whether the different terms are or are not intended to be synonymous (i.e., "financial reporting risks" and "significant accounts and relevant assertions").

Monitoring Activities

We recommended that guidance be provided to management specifically illustrating when monitoring activities are insufficient, making direct testing necessary. This guidance would be helpful to ensure that the COSO framework for monitoring activities is appropriately considered and addressed.

Documentation Requirements

We recommended that the SEC guidance consider including specific elements for management's documentation to enhance the effectiveness and efficiency of the overall process.

Entity-Level Controls (Company-Level Controls)

We recommended that the notion of precision as it relates to the "design" of entity-level controls be included in the guidance so that both precision relating to "evaluation" and "design" is emphasized to management.

Strong Indicators of a Material Weakness

We recommended that the SEC guidance on strong indicators of a material weakness be aligned with the description included within the PCAOB proposal. Conforming the two documents will help reduce potential confusion, inconsistencies, and possible inefficiencies that may occur as a result of differing evaluations by management and auditors of the same control deficiency.

The CAQ comment letter to the SEC can be accessed by clicking on the following link: CAQ Comment Letter on SEC File Number S7-24-06.