Measuring internal controls

As reported last week, the Las Vegas Sands said it has improved its internal controls. The board’s audit committee, according to the company, now believes the internal controls ‘do not represent a material weakness . . . over financial reporting.’

What do the FCPA’s internal controls require?

Issuers must ‘devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions are properly executed and recorded.’

So the measure for internal controls isn’t materiality but reasonableness.

The Sands, however, didn’t say it wrong. Internal controls have to provide reasonable assurance to management (and the audit committee). Otherwise, there’s a material weakness in the company’s financial reporting, whether or not the actual reporting is inaccurate.

A common misperception is that the internal controls provisions are about about the materiality of any inaccuracies that show up in the books and records. But it’s really about reasonable assurance that those inaccuracies won’t happen in the first place.

The Sands, after some repair work, now believes it has done enough to meet that standard.

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The full text of the internal controls provisions is here.

And here’s a shorthand way to say it:

The internal control provisions at 15 U.S.C. Section 78m(b)(2)(B) require issuers to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that–

(i) transactions are executed in accordance with management’s general or specific authorization;

(ii) transactions are recorded as necessary (I) to permit preparation of financial statements in conformity with generally accepted accounting principles or any other criteria applicable to such statements, and (II) to maintain accountability for assets;

(iii) access to assets is permitted only in accordance with management’s general or specific authorization; and

(iv) the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences.