A recent fraud case caught my attention as it brought to life the concern I expressed in a November post (Small companies may get SOX audit relief). I wrote that “internal controls will always be a crucial piece of the business that streamlines financials and paves the way for airtight fraud prevention, regardless of audit requirements.”

Here we are less than two months later, and CFO Magazine is reporting on the fallout from a fraud case that could have been avoided with a better check on internal controls. The article cites the case of Koss Corporation, a small public company that was not subject to an internal controls audit and  which appears on the surface to have lacked sufficient segregation of duties — they paid dearly for it. A company Vice President is accused of skimming more than $4.5 million for personal expenditures over a two year period — a loss that a thorough audit of internal controls may well have uncovered or prevented.  As James D. Ratley, President of the Association of Certified Fraud Examiners indicated in the article, the fraud may have been prevented with the knowledge that auditors would be coming in to specifically audit internal controls.

This example will weigh heavily for those arguing against the permanent elimination of the audit requirement for non-accelerated public companies.

One of the most significant tasks introduced in 2009 was presented by new guidelines under the Massachusetts Privacy Law, which requires a slew of changes to administrative and security processes.  Compliance calls for a significant overhaul for many companies, and the deadline is just around the corner: March 1, 2010.  The marketplace has demonstrated an urgent need for a new standard of  information protection, so we do not expect a great deal of leniency for those that fall behind.  Companies need to take the new law seriously, gear up, and put appropriate defenses in place around the personal information of their employees and customers.

This is without question a daunting call to action, however the need for the law remains unquestioned.  In fact, a report published by the Office of Consumer Affairs and Business Regulation [PDF] notes that since 2007, over 1 million Massachusetts residents have been impacted by security breaches.  The report states that 495 incidents were criminal in nature, while 312 “generally demonstrated poor employee handling of residents’ personal information, including transporting sensitive data, either in disregard of company policies, or in an environment without sufficient policies in place to secure such information.”

A few additional findings from the report include:

- The OCABR received 807 notifications of security breaches

- Most breaches (76 percent) were electronic in nature

- It may have been expected that financial services breaches impacted the highest number of individuals (707,305), but it is perhaps a bit surprising to find that the second greatest impact was felt from incidents involving the education sector (130,161)

The law takes aim at improving defenses against the criminal element while shoring up process to reduce risk of negligent handling of data.  And most importantly, it applies to — by the letter of the law — all persons that “own or license” personal information from a resident of the Commonwealth, specifically any individual or company that “Receives, stores, maintains, processes, or otherwise is permitted access to personal information through its provision of goods or services directly to a person that is subject to this regulation.”

That means pretty much everyone.

The most important step to compliance might be the WISP - a Written Information Security Program (WISP) that ensures the security and confidentiality of personal information in both physical and electronic format. The actual scope and complexity of a WISP will vary depending on an organization’s size and scope of business, availability of resources, nature and quantity of data stored, and the need for security and confidentiality of both consumer and employee information.

There is of course much more to understand before diving in. We encourage you to take a look at this 2009 Perspectives article for more detail, including specific action items and consequences for failing to comply.

The anecdotal evidence was already there, but now the hard numbers are in from an SEC report that proves smaller companies are paying a disproportionately high cost to comply with Sarbanes Oxley.  As CFO Magazine reports in a recent story on audit fees:

Small companies’ perceived cost burden is important because it’s caused a series of delays in the deadline for full Sarbox compliance. The SEC has been dogged by small-business advocates wanting extensions to Sarbox since soon after the regulator first estimated that compliance would cost firms an average of $91,000. In late 2007, under pressure from members of Congress who called for specific cost-benefit dollar figures, then–SEC chairman Christopher Cox responded with the promise of the type of study that was completed [last] Friday.

The report notes that much of the cost is allocated to in-house work necessary to get internal controls in shape.  This is a topic we’re well familiar with, as we’ve spent a great deal of time battling to help small to mid-sized companies.  An article by our Managing Patrtner, Carl Famiglietti, discussed How CFOs Can Control Rising Audit Costs [pdf] and suggested that:

Given the powerful undertow of Section 404, it is of course easy to fall into acceptance of rising fees…but there are ways to take back control of the bottom line.  Companies can follow two distinct yet equally important lines of attack:  easing costs associated with non-audit CPA advisory services and mining governance initiatives for extended ROI.

In the spirit of Carl’s article, MFA is routinely on the front lines alongside the financial departments of small to midsized companies.  With the news last week that small companies received an extension for SOX compliance to on or after June 2010, we are encouraged that the additional time will help us and non-accelerated filers craft strategies that will keep their costs down and their return on investment up.