A measure approved last week by the House Financial Services Committee to change Sarbanes-Oxley audit rules would lead to a higher incidence of fraud and an increase in the amount of fraud losses, said the Association of Certified Fraud Examiners.

James D. Ratley

The Garrett-Adler amendment exempts public companies with market capitalizations below $75 million — called “small issuers,” but making up just over half of all publicly traded companies — from Section 404(b), the provision of the Sarbanes-Oxley Act that requires an audit report on internal controls (see House Panel Exempts Small Companies from SOX Audits).

ACFE president James D. Ratley said that lawmakers need to reconsider the impact of potential fraud losses on organizations, investors, employees and taxpayers when weighing the cost of anti-fraud controls prescribed by Sarbanes-Oxley.

“At a time when the economic downturn has heightened the risk of fraud for organizations large and small, it simply does not make sense to weaken accounting rules that are in place to protect investors,” he said in a statement. “The bottom line is that internal controls are one of the best fraud prevention tools for any organization to have in place. Providing exemptions for some public companies from the SOX 404 requirements only leads to an increased risk of fraud.”

In a report last year on fraud statistics, the ACFE found that the implementation of anti-fraud controls has a measurable impact on an organization’s exposure to fraud. While the amendment to Sarbanes-Oxley would exempt organizations worth less than $75 million, the report found that companies of all sizes and industries are susceptible to fraud and rely on internal controls — second only to tips, in terms of discovery — for fraud detection and prevention.

The Center for Audit Quality wrote a letter last week to the leaders of the congressional committee also criticizing the amendment. “We believe the reforms under SOX have contributed significantly to restoring investor confidence and, in particular, that Section 404 has played a critical role in promoting high-quality financial reporting, which is vital to the successful operation of our capital markets,” wrote CAQ executive director Cindy Fornelli. “Reporting under Section 404 provides investors with meaningful information regarding a company’s internal control over financial reporting. In addition, we believe that the required independent audit of management’s assessment of the effectiveness of ICFR, as required by SOX Section 404(b), has been integral to the achievement of the intended objectives of ICFR reporting under SOX Section 404.”