Suggesting that accounting firms may have become addicted to the fat audit fees associated with Sarbanes-Oxley compliance efforts, a spokesman for the nation's bankers warned that plans to streamline internal control reporting rules and issue new auditor guidance may not be enough to wean accountants away from wasteful and unnecessary SOX-related audit procedures."Reducing costs and streamlining efforts will only be achieved if the auditing firms have the incentive to make efficiency a priority," American Bankers Association spokesman Thomas Venables told a hearing of the Senate Committee on Small Business and Entrepreneurship.

The banking industry's concerns center on what he described as the "exorbitant costs attributable to audit firms' over-testing and evident misinterpretation" of the Public Company Accounting Oversight Board's rules implementing SOX Section 404 requirements for audits of internal controls.

Both the PCAOB and the Securities and Exchange Commission are working to streamline those standards and develop new guidance to help auditors avoid unnecessary testing and documentation procedures that have resulted in spikes in audit charges under SOX.

But those "efficiencies will only be successful if the auditing firms accept these streamlining efforts," Venables told lawmakers. The risk, he suggested, is that accountants may find SOX-related inefficiencies too profitable to abandon.

What "is the incentive for audit firms to forgo this additional revenue, even if many clients and shareholders view it as over-auditing?" he asked.


Concern that SOX is driving up audit expenses is particularly strong among small businesses, which are currently exempt from 404 internal control audit requirements that apply to public companies with assets of more than $75 million. Under the present schedule, however, those smaller corporations will be subjected to the internal control rules starting in 2007.

A recent report from the Government Accountability Office confirmed fears that small companies face disproportionately steep compliance costs under SOX. According to the GAO, firms with assets of $1 billion or more spend just 13 cents per $100 in revenue for audit fees, while small businesses are forced to spend more than a dollar per $100 in revenue to comply with the same rules.

Earlier this year, Senate Small Business Committee chair John Kerry, D-Mass., and ranking Republican Olympia Snowe of Maine wrote to PCAOB Chairman Mark Olson and SEC Chair Christopher Cox asking for a one-year postponement of the requirements governing small companies.

But the PCAOB has already ruled out a delayed Section 404 implementation, and during his testimony before Kerry's committee, Olson gave no indication that the board would reverse course on that issue.

Cox, however, left the door open a crack, noting that a delay in the rules governing small companies may be possible if standard-setters are unable to develop effective guidelines for scaling back on Sarbanes-Oxley-related audit procedures for small businesses.

At the same time, however, the SEC chairman said that delaying the implementation of SOX audit requirements for small companies is "not Plan A."

The regulator is "working diligently to provide both guidance for managements and a new auditing standard in time for companies and their auditors to use them in connection with annual reports to be filed in 2008," Cox told Congress. "We're pedal-to-the-metal on finishing this work, and we won't require smaller public companies to have a Section 404 audit until the new guidance and the new auditing standard are available."


Other witnesses at the Senate hearings, however, called on Congress to rethink imposing any new SOX auditing requirements on small companies.

Joseph Piché, founder and chief executive of Eikos Inc., a nanotechnology company based in Kerry's home state of Massachusetts, told the panel that SOX is making it difficult for many small companies to gain capital for expansion through public offerings. "The accounting costs specifically associated with taking a company public are now so large that they threaten to wipe out the funding that a company like Eikos would receive in its IPO," he testified.

His concerns were echoed by other witnesses, including Richard Wasielewski, chief financial officer for Nortech Systems, a Minnesota-based manufacturer of electronic parts. "Over the last five years, our compliance costs have more than doubled, from $376,000 in 2002, to $933,500 in 2006," he said. "We estimate that approximately 50 percent of this increase is a result of costs incurred from our Sarbanes-Oxley compliance and internal control initiatives."

The ABA's Venables testified that small community banks such as his in Franklin, Mass., are also being squeezed financially by SOX audit requirements. Bringing his bank into compliance with SOX required "2,214 hours during 2006 at a cost of $180,082," he explained. "In addition, we incurred an increase of internal audit costs of $113,080, information technology audit costs of $48,680, and additional external audit costs of $78,000, for a grand total of $419,842."

This extra expenditure equals 6.1 percent of the bank's total 2006 earnings and "has not improved our ability to manage the bank," he said.

For his part, Kerry offered sympathy to the small corporations facing higher audit expenses under SOX. "Too many small public companies who played by the rules are expected to clean up the mess made by Enron and other rogue companies," he said. "While it's important to protect investors through SOX, we also need to help small businesses comply with Sarbanes-Oxley by providing them with appropriate regulatory relief and additional time."

Separate from the hearings, other accounting-profession-centric groups weighed in on the 404 streamlining efforts. Cindy Fornelli, executive director of the Center for Audit Quality, a group affiliated with the American Institute of CPAs and large audit firms, said that her group supports changes that would streamline implementation of Section 404 for small businesses, "but not as long as efficiencies diminish its effectiveness." (For more, see "Investor confidence is easy to shake, hard to restore," page 6.)

"Currently, one in four U.S. investment dollars flows into small companies, and investors willing to put their money behind smaller public companies deserve the same level of reliability as when investing in larger entities," she said.

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