Auditors at the gate: Section 404 of the Sarbanes–Oxley Act and the increased role of auditors in corporate governance

Abstract

Section 404 of the Sarbanes–Oxley Act of 2002 is one of the most far-reaching components of recent US securities reforms. Under Section 404, management must prepare an annual report assessing the effectiveness of their company's internal control over financial reporting and the company's auditors must attest to, and report on, managements assessment. After examining the basic requirements of Section 404, this paper focuses on the extensive review required by auditors under Section 404 and related auditing standards, which require the auditor to monitor certain fundamental aspects of corporate governance. The paper then considers the impact of Section 404 on the auditor-company relationship, and the increased rigidity and formalisation that is likely to result from Section 404's implementation. Finally, the paper outlines the many uncertainties that surround Section 404. These uncertainties include questions concerning the implementation of Section 404 and the related Auditing Standard No. 2, the strains many European companies face as they attempt to comply with Section 404's requirements at the same time that they are transitioning to International Financial Reporting Standards and the potential new grounds for liability that both companies and auditors may confront.