Sarbanes-Oxley – PCAOB still not living in a material world

Materiality is a dreaded word in any legal case and Sarbanes-Oxley has been no exception. The original documentation from the guardians of Sarbox, the PCAOB, talked about material and significant when referring to events likely to have an impact on a company’s financial returns and on the need for controls to avert these events.

However no guidance was given in their guidelines, Auditing Standard 2 (AS2), as to how to decide whether an event was material, significant or simply a minor event with no impact on the bottom line. The result was that auditors, already put in a difficult position regarding being potentially liable for any misrepresentation, took the simple way out. If in doubt classify it as material.

The PCAOB has made many statements in the past six months about requiring auditors to take a reasonable view of controls but has never helped them out by defining what material actually is. There is also cross-party pressure from the US Congress to define materiality, and there are many who want this to be a numeric calculation, i.e. a material failure is one that will impact a company’s profits by X%.

On June 7th, the PCAOB released a draft AS5 for public comment, designed to make Sarbanes-Oxley easier to implement. One week later, the SEC issued seven questions designed to structure discussion on AS5. The first question asks, "Is the standard of materiality appropriately defined throughout AS5 to provide sufficient guidance to auditors?"

Despite rewording by the PCAOB, the answer, according to many responding US bodies, is a firm "No". When challenged, the PCAOB said its new standard is "an inappropriate place to redefine or refine the meaning of materiality, which is a long-established concept in the federal securities laws" and that they wanted to create a standard that "relies more on general principles than detailed requirements".

Will materiality be defined? Can materiality be defined? Is doing so going against a "principles-based" interpretation of Sarbanes-Oxley? Can the PCAOB, like Madonna, ever join the material world?