On the last day of the 111th Congress, Senator Dick Durbin (D-Il) strongly defended the interchange fee reform provisions of Dodd-Frank Section 1075 against a growing chorus of concern and some criticism. Describing the current interchange system as a price-fixing scheme, the senator, who authored Section 1075, said that he is ``hunkered down and ready for the fight that is coming.’’ (Cong. Record, Dec. 22, 2010, S10995-10997).
Recently, Rep. Spencer Bachus (R-AL), incoming Chair of the Financial Services Committee, asked the Fed to proceed cautiously with the regulations under Section 1075 to allow Congress the opportunity to conduct its own review of the intent and impact of the changes. And thirteen US Senators, including leading members of the Banking Committee, have expressed concern with the consequences of replacing a market-based system for debit card acceptances with a government-controlled system pursuant to Section 1075.
According to Sen. Durbin, a Fed study revealed that it costs financial institutions between 7 and 12 cents to process a debit card transaction. But the Fed reported that large institutions and card networks charge merchants, retailers, charities, universities, and others an average debit interchange fee of 44 cents. The Fed has confirmed that consumers and retailers are being overcharged for each purchase made with a debit card. Merchants and their customers are being charged more than three times what the transactions cost.
The draft regulations under Section 1075 propose to cap the interchange fees at the largest financial institutions at 12 cents per transaction, give or take some conditions such as the prevention of fraud, which Dodd-Frank built into the law. With the 12-cent cap, the senator estimates a saving for businesses and consumers of about $10 billion in the first year.
Senator Durbin said that the interchange provisions rein in abusive fees by saying that if the large financial institutions are to let credit card networks fix fees on their behalf, the Federal Reserve should regulate those fees. The statute says that any debit interchange fee that is set by a card network and passed along to a large financial institution must be regulated by the Fed to ensure that the fee is reasonable and proportional to the actual cost of processing the transaction. That is the intent of Section 1075, explained the senator.
If a bank wants to charge its own fees to reflect the costs it bears, so be it since the Durbin Amendment does not regulate that so long as those fees are transparent and competitive. The result of Amendment, said the senator, is to squeeze the fat out of the interchange system. Banks will still be able to use interchange to pay for necessary
processing costs, but they won’t be able to use this interchange scheme to take excessive fees out of the pockets of merchants and their customers.
Section 1075 also says that if a financial institution takes steps to effectively reduce fraud in debit transactions it can get an increase in its interchange rate. The statute thus incentivizes financial institutions to reduce the amount of fraud that takes place. Section 1075 also says that credit card networks cannot require that their debit cards all use exclusively one debit network. Moreover, the Durbin provision states that card networks can no longer penalize merchants who try to offer certain discounts to consumers, like discounts for using debit instead of credit. This is a clear pro-consumer provision, emphasized the senator.
Responding to criticism that Section 1075 will hurt small banks and credit unions, Sen. Durbin pointed out that the provision ``bends over backward’’ to protect these small institutions. Nothing in Section 1075 enables merchants to discriminate against
cards issued by small banks and credit unions. Merchants are still required by contract to accept all cards regardless of the issuer. Further, Section 1075 exempts banks
with less than $10 billion in assets from interchange fee regulation. According to the senator, these small banks can continue to receive the same high interchange fees that they do today and they will actually receive higher fee rates than their larger competitors.
Sunday, January 2, 2011
Revised UK Corporate Governance Code Mandates Risk Management But Declines to Require Risk Committees
The revised UK Corporate Governance Code contains a new principle stating that boards are responsible for determining the nature and extent of the significant risks they are willing to take in achieving their strategic objectives. However, the establishment of a board risk committee is optional, with the audit committee assuming risk management functions for companies that do not set up risk committees. Where there is a risk committee, noted Financial Reporting Council Stephen Haddrill, CEO of the UK Financial Reporting Council, attention needs to be paid to its relationship with the audit committee. There is a danger of overlap or of issues getting missed entirely as each considers it to be the other’s responsibility. Various ways of managing this problem have been suggested, for example, common membership, common secretariat, joint meetings. The FRS has oversight of the Corporate Governance Code.
In recent remarks, the FRC chief said that the board and audit committee should not be involved in micromanaging the risk management and internal control system, but either directly or indirectly they need to know enough to assure themselves they are working effectively. The judgments boards and committees make can only be as good as the information on which they are based. Thus, he advised board and committee need to spell out to the senior company managers much more clearly what information they require. They must also satisfy themselves that there are internal assurance systems in place ensuring that information they receive is sound and robust. In turn, the board and audit committee must effectively report these issues to company shareholders.
Not mandating a separate board risk committee in the Code was effectively a rejection of a recommendation of Sir David Walker, who reasoned that risk management is essentially a forward looking process that does not fit well with the role of the audit committee, which is looking backwards, dealing with historical information. But the FRC was persuaded that the problems often stemmed from the board having not spent sufficient time assessing the risks, which is a weakness that would not be remedied by creating another committee. Thus, the Code leaves the decision of whether to have a separate risk committee to the individual companies.
In recent remarks, the FRC chief said that the board and audit committee should not be involved in micromanaging the risk management and internal control system, but either directly or indirectly they need to know enough to assure themselves they are working effectively. The judgments boards and committees make can only be as good as the information on which they are based. Thus, he advised board and committee need to spell out to the senior company managers much more clearly what information they require. They must also satisfy themselves that there are internal assurance systems in place ensuring that information they receive is sound and robust. In turn, the board and audit committee must effectively report these issues to company shareholders.
Not mandating a separate board risk committee in the Code was effectively a rejection of a recommendation of Sir David Walker, who reasoned that risk management is essentially a forward looking process that does not fit well with the role of the audit committee, which is looking backwards, dealing with historical information. But the FRC was persuaded that the problems often stemmed from the board having not spent sufficient time assessing the risks, which is a weakness that would not be remedied by creating another committee. Thus, the Code leaves the decision of whether to have a separate risk committee to the individual companies.
Saturday, January 1, 2011
Audit Firms Urge SEC Not to Extend 404(b) Exemption Beyond Dodd-Frank Relief for Companies with up to $75 Million Float
Citing the beneficial effect of PCAOB Audit Standard No. 5, global audit firms have urged the SEC not to recommend extending the exemption from Sarbanes-Oxley Section 404(b) auditor attestation of internal controls to companies with market capitalization between $75 and $250 million. While recognizing that there is a cost to conducting an audit of a company's internal controls, the audit firms believe that both issuers and investors have benefited from the auditor's involvement in reporting on internal controls. In letters to the SEC, they also noted that the cost of auditing internal controls has declined dramatically since the PCAOB’s adoption of AS 5, the Board’s guidance on audits of smaller companies, and the issuance of SEC guidance for companies conducting assessment of their internal controls. The Center for Audit Quality cautioned that permanently exempting another tier of companies from 404(b) beyond the Dodd-Frank $75 million float exemption could confuse investors and may even undermine their confidence in the quality of financial reporting.
Sarbanes-Oxley Section 404(a) requires companies to include in their annual reports management's assessment of the company's internal controls; Section 404(b) requires the company's auditor to attest to, and report on, management's assessment of the effectiveness of the internal controls. Section 989G of Dodd-Frank exempts companies with a public float of less than $75 million from 404(b) and requires the SEC to conduct a study and report to Congress on how the Commission can reduce the burden of complying with the auditor attestation requirement of 404(b) for companies whose public float is between $75 million and $250 million, while maintaining investor protections for such companies. The study must specifically determine if an expanded exemption would encourage companies doing an IPO to list on a US exchange.
In letters to the SEC, Ernst & Young and Deloitte & Touche said that reporting under Section 404 provides investors with meaningful information regarding a company's internal control over financial reporting. They also noted that the required independent audit of management's assessment of the effectiveness of ICFR has been integral to the achievement of the intended objectives of internal reporting under Sarbanes-Oxley. Deloitte cautioned that it would not be prudent to roll back existing internal control requirements for a population of issuers that are currently complying with Section 404(b).
The audit firms also observed that AS 5, which replaced the more prescriptive AS 2, has improved the audit of internal controls by better enabling auditors to focus their efforts on those areas that were critical to a company's internal controls, utilize their judgment in the design and performance of audit procedures, and tailor the audit to a company's particular facts and circumstances. In addition, the Committee of Sponsoring Organizations of the Treadway Commission (COSO) issued guidance related to the application of its internal control framework in smaller public companies. E&Y noted that investors have benefited from the auditor's involvement at companies with market capitalization between $75 and $250 million, which is particularly meaningful given that smaller public companies are typically more susceptible to financial reporting fraud.
Addressing congressional concerns about the impact of 404(b) on IPOs, Grant Thornton noted that any intention to increase IPOs in the U.S. by reducing the initial requirements for auditor attestation would negate the original intent and spirit of Section 404. In fact, continued GT, financial reporting crises often result in a debilitating impact on public listings on exchanges that are not grounded in sound and transparent financial reporting and governance standards.
In its letter to the SEC, the Center for Audit Quality (CAQ) spoke of the benefits and cost trends of Section 404(b), as well as concerns related to the Section 404(b) exemptions and recommendations to reduce the compliance burden. Grant Thornton fully supports the views expressed by CAQ that it would not be prudent to roll back existing internal control requirements that are currently being complied with by smaller public companies.
Section 404 says that management should be in a position to tell investors that it is responsible for internal control over financial reporting, and perform reasonable procedures to evaluate the effectiveness of those controls. It further indicates that independent auditors should be able to perform reasonable audit procedures to tell investors that, in their opinion, management’s assertions are accurate. In GT’s vierw, eliminating those reasonable expectations are not in the best interest of investors or companies. All companies that use the public’s money should give investors the confidence in their financial reporting systems that they demand and deserve. In this regard, GT strongly believes that the benefits of 404(B) outweigh the costs.
There was also a consensus among the audit firm community that a further benefit of 404(b) has been improvements to corporate governance. For example, CAQ noted that auditors are required to communicate to the audit committee all significant deficiencies and material weaknesses in internal controls that have been identified during the audit. PCAOB AS 5 enhances the ability of auditors to detect weaknesses and therefore have a basis to make such communications, specifically regarding significant deficiencies.
According to CAQ, rhis communication fosters important discussions about internal controls among management, the audit committee, and the auditor including any remediation efforts. In turn, these discussions enhance the audit committee’s oversight of the internal controls process, which fosters improvements to the quality of a company’s financial reporting.
Beyond AS 5 and existing Board guidance, the commenters set forth recommendations for further improvement. Ernst & Young noted that as a result of its inspections of 2007 audits, the PCAOB issued a report in 2009 related to its observations on the first year implementation of AS 5. As that report was focused only on the first year of implementation, E&Y urged the PCAOB to publish observations on how the implementation in 2008 and 2009 has progressed relative to its expectations when AS 5 was issued. Such information might enable auditors to continue to adjust their internal controls procedures to further improve the effectiveness and efficiency of the audit of internal controls.
CAQ urged the PCAOB to develop best practices on the auditing of internal controls. The Board is in a unique position where its inspection teams might identify efficient audit approaches that could be vetted with its standards-setting staff to identify best practices for AS 5 audits. If the PCAOB were to identify any best practices that both the standard-setting and inspection staffs agreed were in accordance with AS 5, said CAQ, auditors could make appropriate adjustments and refinements to their internal controls procedures.
Section 989G of Dodd-Frank was co-authored by Rep. Scott Garrett (R-NJ), the incoming Chair of the House Capital Markets Subcommittee. Rep. Garrett has expressed concern that the compliance burdens of Section 404(b) may be chilling IPOs on US exchanges.
Sarbanes-Oxley Section 404(a) requires companies to include in their annual reports management's assessment of the company's internal controls; Section 404(b) requires the company's auditor to attest to, and report on, management's assessment of the effectiveness of the internal controls. Section 989G of Dodd-Frank exempts companies with a public float of less than $75 million from 404(b) and requires the SEC to conduct a study and report to Congress on how the Commission can reduce the burden of complying with the auditor attestation requirement of 404(b) for companies whose public float is between $75 million and $250 million, while maintaining investor protections for such companies. The study must specifically determine if an expanded exemption would encourage companies doing an IPO to list on a US exchange.
In letters to the SEC, Ernst & Young and Deloitte & Touche said that reporting under Section 404 provides investors with meaningful information regarding a company's internal control over financial reporting. They also noted that the required independent audit of management's assessment of the effectiveness of ICFR has been integral to the achievement of the intended objectives of internal reporting under Sarbanes-Oxley. Deloitte cautioned that it would not be prudent to roll back existing internal control requirements for a population of issuers that are currently complying with Section 404(b).
The audit firms also observed that AS 5, which replaced the more prescriptive AS 2, has improved the audit of internal controls by better enabling auditors to focus their efforts on those areas that were critical to a company's internal controls, utilize their judgment in the design and performance of audit procedures, and tailor the audit to a company's particular facts and circumstances. In addition, the Committee of Sponsoring Organizations of the Treadway Commission (COSO) issued guidance related to the application of its internal control framework in smaller public companies. E&Y noted that investors have benefited from the auditor's involvement at companies with market capitalization between $75 and $250 million, which is particularly meaningful given that smaller public companies are typically more susceptible to financial reporting fraud.
Addressing congressional concerns about the impact of 404(b) on IPOs, Grant Thornton noted that any intention to increase IPOs in the U.S. by reducing the initial requirements for auditor attestation would negate the original intent and spirit of Section 404. In fact, continued GT, financial reporting crises often result in a debilitating impact on public listings on exchanges that are not grounded in sound and transparent financial reporting and governance standards.
In its letter to the SEC, the Center for Audit Quality (CAQ) spoke of the benefits and cost trends of Section 404(b), as well as concerns related to the Section 404(b) exemptions and recommendations to reduce the compliance burden. Grant Thornton fully supports the views expressed by CAQ that it would not be prudent to roll back existing internal control requirements that are currently being complied with by smaller public companies.
Section 404 says that management should be in a position to tell investors that it is responsible for internal control over financial reporting, and perform reasonable procedures to evaluate the effectiveness of those controls. It further indicates that independent auditors should be able to perform reasonable audit procedures to tell investors that, in their opinion, management’s assertions are accurate. In GT’s vierw, eliminating those reasonable expectations are not in the best interest of investors or companies. All companies that use the public’s money should give investors the confidence in their financial reporting systems that they demand and deserve. In this regard, GT strongly believes that the benefits of 404(B) outweigh the costs.
There was also a consensus among the audit firm community that a further benefit of 404(b) has been improvements to corporate governance. For example, CAQ noted that auditors are required to communicate to the audit committee all significant deficiencies and material weaknesses in internal controls that have been identified during the audit. PCAOB AS 5 enhances the ability of auditors to detect weaknesses and therefore have a basis to make such communications, specifically regarding significant deficiencies.
According to CAQ, rhis communication fosters important discussions about internal controls among management, the audit committee, and the auditor including any remediation efforts. In turn, these discussions enhance the audit committee’s oversight of the internal controls process, which fosters improvements to the quality of a company’s financial reporting.
Beyond AS 5 and existing Board guidance, the commenters set forth recommendations for further improvement. Ernst & Young noted that as a result of its inspections of 2007 audits, the PCAOB issued a report in 2009 related to its observations on the first year implementation of AS 5. As that report was focused only on the first year of implementation, E&Y urged the PCAOB to publish observations on how the implementation in 2008 and 2009 has progressed relative to its expectations when AS 5 was issued. Such information might enable auditors to continue to adjust their internal controls procedures to further improve the effectiveness and efficiency of the audit of internal controls.
CAQ urged the PCAOB to develop best practices on the auditing of internal controls. The Board is in a unique position where its inspection teams might identify efficient audit approaches that could be vetted with its standards-setting staff to identify best practices for AS 5 audits. If the PCAOB were to identify any best practices that both the standard-setting and inspection staffs agreed were in accordance with AS 5, said CAQ, auditors could make appropriate adjustments and refinements to their internal controls procedures.
Section 989G of Dodd-Frank was co-authored by Rep. Scott Garrett (R-NJ), the incoming Chair of the House Capital Markets Subcommittee. Rep. Garrett has expressed concern that the compliance burdens of Section 404(b) may be chilling IPOs on US exchanges.
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