Auditing can be an intimidating but necessary part of corporate governance, and businesses, especially publicly traded corporate giants in the US, cannot escape it. Many regulatory laws govern various auditing topics and industries; however, none are as recognized and applauded for financial transparency as Section 404 of the Sarbannes-Oaxley Act of 2002 (SOX 404). A foundational financial regulation, SOX 404, was implemented in reaction to corporate scandals that undermined investor confidence. It now affects how businesses document, manage, and report financial processes.
Compliance with SOX 404 is not only a legal requirement for companies, especially those publicly traded in the US, but also a crucial part of their operating structure. It requires stringent internal controls for financial reporting to stop and detect fraud and financial misstatements. Whether you are an executive, auditor, or compliance officer, it is essential to master the intricacies of SOX 404 compliance to ensure financial security and investor trust in your organization.
In this blog, we will provide a brief overview of SOX 404 and SOX ITGC compliance and who must comply with it, its compliance and internal controls requirements, and its key sections and benefits.
What is SOX 404 Compliance?
The Sarbannes-Oaxley Act (SOX) mandates publicly traded companies operating in the United States to establish financial reporting standards, including data security, tracking attempted breaches, logging electronic records for auditing, and demonstrating compliance. This is known as SOX compliance.
The legislation mandates internal controls for financial records, and the CEO and CFO must sign declarations attesting to the accuracy of financial reporting. The statute also increases penalties and jail time for filing false reports. Both requirements are designed to increase confidence in American corporate investment. The rules that have the most effects on an organization’s accounting procedures for financial documents. Auditors are also required to report on financial documents and SOX security controls at a higher standard.
Section 404 of SOX is the most expensive and complex aspect of the Sarbannes-Oaxley Act and is concerned with annual financial reporting. This section mandates that annual reports must include the company’s evaluation of its internal controls over financial reporting and an auditor’s certification and report on the company’s evaluation. The auditor must be an external third party and must demonstrate the reliability and security of the company’s internal controls.
SEC-registered businesses have to provide the following with their yearly filing in accordance with Section 404:
- an explanation of management’s obligation to create and maintain effective internal control over financial reporting;
- a declaration outlining the methodology used by management to assess the efficacy of internal controls;
- an evaluation of management’s internal control effectiveness at the conclusion of the business’s most recent fiscal year; and,
- a declaration that management’s evaluation has been verified by the company’s external auditor in an attestation report.
Now, let’s see who must comply with SOX 404 compliance.
Who Must Comply With SOX 404 Compliance?
There are eleven provisions in SOX, most of which apply to publicly traded American businesses or publicly traded foreign companies that conduct business in the United States. These companies must establish, maintain, and audit internal controls. A rotating, independent accounting firm assures high-quality reporting as part of its reporting and auditing needs. You are also required to report the actions taken off the balance sheet.
The ultimate goal is to get businesses to produce yearly reports for the general public to make their financial accounts clear and dependable. This increases stock sales and establishes the legitimacy of American markets while lessening financial fraud. In short, enterprises must comply with the SOX 404 compliance to gain investor trust.
To maintain a positive standing with the Public Company Accounting Oversight Board (PCAOB), audit firms must also abide by the rules. Continuing education on accounting ethics, standards, and the effects of SOX rules must be included for relevant practitioners.
Next, let’s understand the SOX 404 compliance and internal controls requirements.
What are SOX 404 Compliance and Internal Controls Requirements?
SOX 404 compliance is a four-step process that requires each of the following:
- Submitting financial statements to the SEC that have undergone a third-party audit;
- reporting significant alterations to the public;
- creating, assessing, and putting internal controls into practice; and
- Creating an annual report on internal controls and their effectiveness signed by management and subject to external audit.
The third criterion, which calls for improvements to an organization’s IT infrastructure to maintain financial data security, is the one that takes the longest for a business new to SOX regulatory compliance.
What are the SOX Internal General Controls (ITGC) Requirements?
The use of SOX at the IT level justifies managing internal controls in a digital SOX environment. This comprises the following sections:
- Access management
- Change administration
- Segregation of duties
- Backup programs
- Security and cybersecurity
There are numerous frameworks for tackling these issues from non-profit industry organizations, including the Control Objectives for Information and Related Technologies (COBIT) and the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Additionally, organizations like the National Institute of Standards and Technology (NIST) for federal institutions and ISO 27001, a globally acknowledged data security certification. While there is no SOX certification, there is SOX compliance.
These frameworks allow businesses to combine business and IT goals, create controls, establish targets, delegate duties, and track performance.
What is a SOX Internal Controls Audit?
Companies must install internal controls and have them audited, as per SOX Act Section 404. However, no set of SOX controls or a concept of SOX compliance applies to all organizations. Every aspect of IT, from backup systems to access control, will be examined during an audit of IT controls. For instance, businesses may test internal access management systems while examining access control and authentication management.
An audit begins with a risk analysis to determine the extent of the requirements for SOX compliance. These places where controls are required should be found using the PCAOB accounting rules. Before testing, identify the important controls and ensure they operate to stop breaches and are managed by the appropriate owner. When adopting a SOX framework to strengthen data security, these actions must be taken for each control individually.
While the SOX Act has eleven provisions, we will highlight the ones that impact compliance requirements most — sections 302 and 404. We will also highlight sections 806 and 906 since they deal with financial reporting and fraud.
Key Sections of SOX Compliance
The provisions of SOX compliance essential to financial reporting and transparency are:
Section 302: Corporate Responsibility for Financial Reports
This section states that Chief Executive Officers (CEOs) and Chief Financial Officers (CFOs) are directly accountable for the accuracy of financial reports. Internal controls must be established and maintained, serious flaws, fraud, and changes to internal controls must be disclosed, and signing officers must evaluate and approve the correctness of financial statements.
According to section 302, CEOs and CFOs may face civil or even criminal liability for errors in their company’s financial statements.
Section 404: Management Assessment of Internal Controls
This section states that all annual financial reports must include an Internal Control report that outlines management’s obligation to maintain an effective internal control framework, an evaluation of the framework’s effectiveness, and any gaps in those controls. Additionally, independent external auditors must attest to the integrity of the company’s claim that effective internal controls are in place.
The SOX 404 audit must be conducted by independent auditors, who employ professional skepticism and their judgment to assess the condition of internal controls at publicly traded corporations.
Two more provisions deal with financial responsibility and fraud. These are
Section 806: Protection for Employees of Publicly Traded Companies Who Provide Evidence of Fraud
This section protects company employees and officials who knowingly cooperate with investigators, provide information, testify during an investigation, or publicly publish information about a firm’s financial misconduct. It shields employees from termination, harassment, downsizing, suspension, and other forms of discrimination. Compensation damages for SOX violations are also described in Section 806.
Section 906: Corporate Responsibility for Financial Reports
Employees who violate SOX by submitting false or misleading reports face criminal consequences, including huge monetary penalties or up to 20 years in prison. Contractors, workers, agents, and executives are all included as having a responsibility in the complete form of SOX.
Benefits of SOX 404 Compliance
While companies found it challenging to manage the costs and resource expenditure when SOX compliance first came into the picture, most of them have seen their investment pay off in several significant ways, as highlighted below:
- Improved Corporate Governance
SOX improved corporate governance by subjecting audit committees to more regulation.
This legislation requires all publicly traded firms to have an audit committee of at least one financial professional and members who are not management employees. As a result, audit committees are more prepared than ever to deliver precise and honest financial reports. Financial reporting is governed further by independent audit committees, which have a separate role from other committees.
- Increased Responsibilities
Executives are held more accountable, and investors are protected by SOX compliance. Financial reports must be personally certified by executives, and harsh fines punish fraud-related offenses. Since Arthur Andersen, one of the biggest accounting firms at the time, was brought to its knees by the fraud scandals that fuelled Sarbannes-Oaxley, auditors also have a greater obligation to uphold integrity and independence.
- Greater Auditor Independence and Fewer Financial Restatements
SOX compliance improves auditor independence by forbidding audit firms from doing bookkeeping, actuarial, or management duties for the corporations they audit. In both appearance and reality, external auditors must maintain their independence. As a result, the audit becomes more rigorous and of higher quality.
Moreover, fewer financial record restates have been made since the SOX Act was passed.
- Better Risk Management and Cybersecurity Posture
Many of the best practices modern organizations use to comply with SOX, including IT General Controls, cross over with recommendations from cybersecurity frameworks like the NIST CSF. The need for strong, restricted access control and access management to safeguard sensitive systems and information from unauthorized access is one instance of this overlap; the NIST CSF strongly advises this as part of their “Protect” pillar, and the majority of SOX 404 audits require it for financially material information systems.
SOX ITGC Compliance Readiness with Akitra!
Establishing trust is a crucial competitive differentiator when courting new SaaS businesses in today’s era of data breaches and compromised privacy. Customers and partners want assurances that their organizations are doing everything possible to prevent disclosing sensitive data and putting them at risk, and compliance certification fills that need.
Akitra offers an industry-leading, AI-powered Compliance Automation platform for SaaS companies. Using automated evidence collection and continuous monitoring, together with a full suite of customizable policies and controls as a compliance foundation, our compliance automation platform and services help our customers become compliance-ready for SOX ITGC compliance framework, along with other security standards like SOC 1, SOC 2, HIPAA, GDPR, PCI DSS, ISO 27001, ISO 27701, ISO 27017, ISO 27018, NIST CSF, NIST 800-53, NIST 800-171, FedRAMP, CCPA, CMMC, and more such as CIS AWS Foundations Benchmark, etc. In addition, companies can use Akitra’s Risk Management product for overall risk management using quantitative methodologies such as Factorial Analysis of Information Risks (FAIR) and qualitative methods, including NIST-based for your company, Vulnerability Assessment and Pen Testing services, Trust Center, and AI-based Automated Questionnaire Response product to streamline and expedite security questionnaire response processes, delivering huge cost savings. Our compliance and security experts will provide customized guidance to navigate the end-to-end compliance process confidently.
The benefits of our solution include enormous savings in time, human resources, and cost savings, including discounted audit fees with our audit firm partners. Customers achieve compliance certification fast and cost-effectively, stay continuously compliant as they grow, and can become certified under additional frameworks using a single compliance automation platform.
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