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Mortgage Bankers Request Relief

Mortgage Bankers Request ReliefMBA sends letter to SEC about high cost of complying with Sarbanes-Oxley Act

March 7, 2005


Mortgage lenders, frustrated with the high cost of complying with the Sarbanes-Oxley Act of 2002, have warned the Securities and Exchange Commission that investors, employees and American competitiveness may all suffer if compliance requirements don’t ease up.

The Mortgage Bankers Association’s chief executive Jonathan Kempner sent a letter to SEC secretary Jonathan Katz in an effort to seek assistance for the industry in reducing costs that result from complying with a section of the Sarbanes-Oxley Act of 2002.

“Our members are so concerned about the high costs of complying with Section 404 that they have requested that I convey their observations to you, along with a request that they be given the opportunity to discuss them with SEC staff and the staff of the Public Company Accounting Oversight Board,” Kempner wrote.

The Washington, D.C.-based association reportedly solicited the views of member companies that are subject to the act regarding the law’s impact on the industry and, more specifically, whether the MBA should support calls for appeal or amendment of sections in the legislative piece.

Among other things, the act places accountability on chief executive and chief financial officers and requires that companies employ a formal structure for management and their auditors to judge the effectiveness of the internal control structure, according to MBA.

While MBA reportedly found that members unanimously supported the act’s objectives of promoting greater integrity and responsibility in corporate financial reporting and disclosure, it also found members agreed that the way in which Section 404, Management assessment of internal controls, has been implemented in the industry, has undermined those goals by “unnecessarily reducing” investors’ investment returns.

“The high cost of reporting on internal control is sapping mortgage banking companies’ resources to the detriment of investors who will experience lower investment returns and, thus, declines in the values of their investments,” Kempner said.

MBA said the high cost of complying with the section was primarily due to the excessive amount of testing and documentation required by Auditing Standard No. 2, An Audit of Internal Control Over Financial Reporting Performed in Conjunction with An Audit of Financial Statements. The guidance in A2, which was released by the PCAOB last March, and the increased penalties for inaccurate financial reporting imposed by the act “have created an atmosphere of ‘near paranoia’ where auditors generally conclude that more testing and documentation is always better than less, regardless of cost/benefit considerations.” This, to avoid possible future criticism of their scope of testing.

Kempner noted that A2 does not “explicitly” require the extent to which testing and documentation is performed in internal control audits, yet it effectively mandates the amount of work being done with the “extensive array of factors and overlapping myriad of highly ambiguous terms” such as “remote likelihood,” “more than inconsequential,” “reasonable assurance,” and “material weakness.”

“Taken as a whole, the guidance in the standard effectively puts management and their auditors on notice that they must ascertain with near certainty whether fraud or an error in reporting could ever, possibly occur or go undetected by the internal control structure,” he added. “The amount of testing being performed within our industry appears to be aimed at providing almost ‘absolute assurance’ that no fraud or errors could ever occur, which, by the PCAOBs own admission is an illusory concept given inherent limitations in internal control.”

One solution suggested by a member was to allow management, in consultation with their auditors, to define materiality as a threshold, formula or amount and to require disclosure of such in management and audit reports.

Other observations of members regarding their experiences with A2 were reportedly the following: auditing firms, including the Big Four, can differ substantially in the interpretation of the rules; auditors are reluctant to advise about proper interpretation and application of GAAP, or Generally Accepted Accounting Principles; management feels discouraged from communicating with auditors and shareholders regarding proper application of accounting rules, or any change or note in financial statements prior to quarterly audits due to concerns that it may be viewed as an internal controlled deficiency or reportable “material weakness” or event; reasonableness in testing has been lost; and levels of testing in internal technology and operational areas are excessive.

Members also noted that the “point in time” requirement to have management assessments and auditor opinions on internal controls tested causes operation challenges with management, finance and auditors since all have conflicting year-end priorities, according to the letter.

And while there is an issue of “unproductive” excessive testing and documentation activities, member lenders also note that there is also a limited pool of individuals with the experience necessary to perform audits. Particularly, the ability of external auditors to perform quality audit process has been reduced due to the requirement to perform “what amounts to two separate engagements,” one for financial statements and the other for internal control, according to MBA.

The last observation listed in the letter was that PCAOB guidance is still evolving, making it difficult to plan and execute engagement.

Kempner said that the MBA believed that if internal control reporting costs were not reduced, compliance with Section 404 will undermine economic growth and reduce the competitive position of US public companies versus their private and foreign counterparts. Also, emerging companies, which are a source of new jobs and economic growth, may decide not to go public to avoid incurring the costs associated with such compliance.

“Ultimately,” he continued, “every cent spent on Section 404 compliance represents one cent less in earnings available for reinvestment in research, capital equipment, and new jobs which underlie our country’s future economic growth. Our members also believe that, over time, companies will not be able to secure the “best and brightest” to be a CFO of the company because their main responsibility has evolved from analyzing and improving business performance to filling out checklists and designing and testing compliance with numerous procedural internal processes.”

The MBA said it believed highly publicized instances of corporate accounting fraud and abuse that gave rise to the act “were due to ‘tone-at-the-top issues’ and not process-level errors of the type being focused on under Section 404.”

It recommended for the SEC to analyze the reasons for past material errors or improprieties in financial reporting and change the guidance to focus on areas of greatest risk. The MBA additionally suggested that the SEC promote more cooperation between management and auditors in determining reasonable levels of testing, as well as reminders to auditors that cost/benefit considerations are an important aspect of planning and performing internal control engagements.

Coco Salazar is an assistant editor and staff writer for

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