Caterpillar and Internal Controls
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The May 10th hearing on Sarbanes-Oxley before the SEC/PCAOB is likely to hear demands to reduce the complexity and requirements of the legislation. Caterpillar for instance has called for less emphasis on low-level transactions and "checking signatures on transactions." Enron and WorldCom were not caused by low-level frauds but by management's unethical behaviour. What would be the effect on checking internal controls for Section 404? The primary source of guidance on internal controls effectiveness is the COSO Framework. In the framework 5 elements are identified as constituting and internal control. These are the control environment, risk assessment, control activities, monitoring, infformation and communications. COSO does not rank one element above others. An integrated and holistic approach has to be taken. Each control should be looked at individually. The Control Environment is akin to a wrapper around the entire set of internal controls. The central point of the element is that it is the management's role to set "the tone at the top". It is in this area that ethical behaviour and integrity is required. WorldCom is seen as a failure of the control environment. Bernie Ebbers (CEO) and other executives gave explicit instructions to accounting staff to falsify financial records. Another split in internal controls is between the entity-level and activity -level. Entity-level controls are those that underpin the business and allow others to operate. An example is the recruitment of honest non-fraudulent people, one could not trust fully transactions at the activity level. Caterpillar's representation that ethical behaviour should be more important. This would slant the weighting of the elements to the control environment. Most of the guidance from practitioners is that companies should concentrate on the entity-level controls anyway. Comments from senior SEC officers and the PCAOB have indicated that companies are gold-plating their compliance programs.
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