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Governance, Risk Management, and Compliance: It Can't Happen to Us—Avoiding Corporate Disaster While Driving Success by Richard M. Steinberg

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Do Effective Financial Reporting Controls Really Prevent Fraudulent Financial Reporting?

This is the big question, usually put forth in the context of the SOX 404 requirements. In answering, let's make one thing clear. Neither SOX nor any other legislation on the books or being considered—or for that matter, that can be conceived—will stop all fraud. There's no doubt in my mind that there will continue to be instances of major fraudulent financial reporting. The issue is not whether it will be stopped, but whether the likelihood has been reduced. To this I say, “Absolutely yes.”

With studies showing somewhat mixed results, let's look at the major features of SOX that really matter in dealing with reporting.

  • The audit committee. A well-qualified, capable, serious, and diligent audit committee undoubtedly is among the most important elements of preventing fraudulent financial reporting—or, for that matter, erroneous reports. Audit committees became more empowered, feeling the spotlight emanating from the major reporting failures, Sarbanes-Oxley, tighter stock exchange listing standards, and the like. With an audit committee armed with good knowledge of the business and carrying out its expanded oversight responsibilities with due care and focusing on the financial reporting process, there's less likelihood that improprieties in financial reporting will occur in the first place and greater likelihood that if they do occur they'll be noticed. While no guarantee exists, by taking their ...

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