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How CIOs Should Prepare for Sarbanes-Oxley

Mar 02, 20048 mins
CSO and CISOData and Information Security

By Gartner Research Directors

Rich Mogull,

Debra Logan

and Lane Leskela

Sarbanes-Oxley is the most sweeping legislation to affect publicly traded companies since the reforms during the Great Depression. CIOs should follow Gartner’s four-phase approach to meet compliance requirements.

The U.S. Public Company Accounting Reform and Investor Protection Act of 2002, known as the Sarbanes-Oxley Act, is the most sweeping regulatory reform of publicly traded markets since the Securities and Exchange Act of 1934. Sarbanes-Oxley is designed to reduce fraud and conflicts of interests, while increasing financial transparency and public confidence in the markets. It is a response to the sensational corporate fraud cases of Enron and WorldCom. As with all new dramatic regulatory changes – especially those where rules are evolving and criminal penalties are possible – Sarbanes-Oxley has created fear and uncertainty, and enterprises lack clear road maps.

Although Sarbanes-Oxley doesn’t directly regulate information technology, IT is the backbone of the financial processes that the law regulates. Therefore, the CIO will play a critical role in achieving compliance.

A Sarbanes-Oxley Primer for CIOs

Few sections of Sarbanes-Oxley directly affect the CIO, but it’s important for CIOs to understand the requirements to most efficiently become compliant. Sections 302 and 404 are the primary drivers of compliance projects. Gartner expects that section 409 will affect IT projects within 12 months after 404 filing deadlines pass in 2004.

Section 302: Certification of Financial Reports

The CEO, CFO and an attesting public accounting firm must certify the accuracy of financial statements and disclosures in the periodic report, and that those statements fairly present in all material aspects the operations and financial condition of the issuer. Section 302 prescribes criminal penalties if CEOs or CFOs knowingly or willfully issue inaccurate statements. Section 302 also requires that material information that is used to generate periodic reports be retained and available to the public. In most enterprises, IT systems generate periodic reports and control e-mail, the primary tool for communicating this information internally. CIOs are being asked to ensure that these systems are secure and reliable. Because of the criminal penalties, CIOs also should expect to be asked to sign an internal attestation on their systems to further protect the enterprise in case of CIO negligence in maintaining these systems.

Section 404: Certification of Internal Controls

Section 404 is the largest driver of Sarbanes-Oxley compliance projects and the most significant section for IS organizations. It requires a statement of management’s responsibility for establishing and maintaining adequate internal control over financial reporting for the company, attested to by the company’s auditor. This statement includes an assessment of the controls and identification of the framework used for the assessment. Section 302 requires that financial statements be complete and accurate; section 404 requires that the process that is used to generate statements be accurate and meet an accepted industry standard (the Committee of Sponsoring Organizations of the Treadway Commission standard is the de facto standard).

Because the processes and internal controls are implemented principally in IT systems, section 404 audits involve a detailed assessment of these systems. Process changes to meet compliance must be documented and implemented by the IS organization. Although a completely paper-based organization could be compliant, most organizations make such extensive use of technology for financial reporting that the CIO plays a major role in auditing and compliance projects. Section 404 also requires reporting of material process changes every quarter. Thus, a new enterprise resource planning (ERP) system or any material change to a system could require a new 404 audit, attestation and report.

Section 409: Material Event Reporting

Public companies must disclose information on material changes in their financial condition or operations on a rapid and current basis. The goal of section 409 is to protect investors from delayed reporting of material events, increasing their losses. IT systems, as they support business operations and financial management, play a significant role in the detection and management of material events. Proactive use of IT enables earlier detection and mitigation of material events. The U.S. Securities and Exchange Commission (SEC) hasn’t issued final guidelines for section 409, but Gartner expects that IT systems will be affected by this section in 2004. The SEC has not defined “real time” from an enterprise information process perspective. Unless the SEC clarifies the time frame, the working guideline for section 409 is disclosure of changes, in addition to the report for that period.

Compliance Process and Role of the CIO

Public companies must meet section 302 requirements. Depending on their filing date, they must meet section 404 requirements by June 15, 2004 for large companies and April 15, 2005 for other filers, including foreign companies listed in the United States in 2004. Many enterprises are planning or have started their compliance projects. Although it seems daunting and complex, from a high level, the process is straightforward.

Phase 1: Discovery/Audit

Enterprises must pass section 302 and 404 audits before filing. Therefore, the first step in compliance is to begin audits to discover where changes need to be made. Gartner advises against “pre-attestation” projects to prepare for the audit by auditors or consultants other than the attesting auditor; these are a waste of resources (see “Don’t Put the Cart Before the Horse,” ). A good provision of Sarbanes-Oxley is that it limits the services that an attesting audit firm can offer to prevent conflicts of interests. Thus, the auditor that signs your financial statement can’t implement recommended changes through some future project. These audits are fairly intensive and involve the documentation of the enterprise’s financial process and all internal process controls. CIOs should expect to participate extensively in the audit process, usually as a member of a compliance committee. You may need to dedicate resources to support the examination of IT systems and financial data. Most auditing firms use technology that must be installed in the enterprise to document the process and results, and to communicate with management. This technology will be included as part of the project – you should never pay for it.

Phase 2: Gap Analysis

After the first pass of the audit, most enterprises will need to make a variety of process changes that must be reflected in technology. It may be as simple as adding a sign-off in a financial package or as complex as the complete retooling of an ERP system. CIOs should expect that most required changes will be to support non-IT process requirements, such as an accounts payable process, managed in IT systems. Gartner anticipates that more than 80 percent of changes will be updates to systems and will not require new technology. When new technology is required, it most likely will be a documentation and records management tool to document controls and manage records that are used to generate reports. Your attesting auditor should provide a complete list of requirements to meet compliance.

Phase 3: Compliance

With the gap analysis from your auditor in hand, implement required changes in IT systems. If you lack internal resources, consider hiring external consultants to assist you, but bound them by the requirements from your auditor to prevent “scope creep.” Understand that Sarbanes-Oxley compliance is a hard deadline with serious penalties. Thus, project timelines are more important than you may be used to, and you must leave enough time for a final audit and attestation by your auditor. Also remember that your attesting auditor can’t implement the required changes, but it can perform periodic evaluations to ensure that you are on track and should participate in any compliance project.

Phase 4: File and Prepare for the Future

Once your final audit and attestation are complete and your company has issued its periodic report, it’s time to prepare for the future. Sarbanes-Oxley has been described as “Y2K without an end date.” Not only will changes be made to the regulation, but it requires audits and attestations with every periodic report, and disclosures of material events as they occur. IT projects that possibly materially affect your financial process must be evaluated and reported quarterly. Thus, a new ERP project or financial upgrade will require new certification. In the short term, CIOs should document changes to systems that potentially change the financial process or internal controls, and report these changes to the CFO, CEO and risk management or compliance committee, if one exists. In the long term, CIOs should develop compliance management architectures to account for long-term compliance needs, with a particular emphasis on business process management and records management.

Bottom Line: Although Sarbanes-Oxley is a sweeping regulation with significant impact on IT, becoming compliant is straightforward. CIOs should work with their auditors to understand where their systems are non-compliant, then implement required changes. Brace yourself for possible unplanned expenses.

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