JOnline: Managing Sarbanes-Oxley Section 404 Compliance in ERP Systems Using Information Security Control Reports 

 
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Globally, laws and regulations have been enacted and reinforced to ensure that entities comply with a particular society’s expectations for ethical behavior when conducting business.1, 2 Reflecting this premise, the US Sarbanes-Oxley Act of 2002 is a statutory compliance requirement that was enacted to improve corporate accountability by requiring publicly held companies to assess and report on the effectiveness of their internal control structure and procedures for financial reporting.3 Sarbanes-Oxley mandates consist of several sections that have been designed to improve the quality and integrity of financial reporting. However, the Sarbanes-Oxley section generally considered to be directly impacting IT control practices is section 404, Management Assessment of Internal Controls.

Sarbanes-Oxley section 404 suggests organizations registered as US Securities and Exchange Commission (SEC) filers annually report:
  • Management’s responsibility to establish and maintain adequate internal control over financial reporting
  • The framework used as criteria for evaluating the effectiveness of internal control over financial reporting
  • Management’s assessment of the effectiveness of internal control over financial reporting and disclosure of any material weaknesses

As part of Sarbanes-Oxley section 404 legal compliance assurance, an organization’s independent auditors need to attest management’s assessment of internal control over financial reporting. Consequently, organizations must ensure that appropriate controls, including IT controls, are operational. Furthermore, these organizations should provide their independent auditors with documented evidence of functioning controls and results of testing procedures.

Sarbanes-Oxley edicts have placed additional demands on US corporations and businesses worldwide that have initiated Sarbanes-Oxley related compliance measures. Directly related to enabling management’s responsibility to maintain adequate internal control over financial reporting is the Committee of Sponsoring Organizations (COSO) of the Treadway Commission’s Internal Control—Integrated Framework. Appropriate governance deployment that protects assets affecting investment and expenditure decisions is critical to achieving sustainable compliance. Sarbanes-Oxley has circumstantially required spending significant time and/or money on security technology, tools and resources to ensure Sarbanes-Oxley section 404 compliance.4 Thus, within this context, information security governance is playing an important role in meeting the new demands placed on businesses by Sarbanes-Oxley.

COSO indicates internal control is a process, directed by an entity’s board of directors, management and other personnel. Where applied, this process is designed to provide reasonable assurance regarding the achievement of objectives through subscribing to:5
  • Reliable financial reporting
  • Effective and efficient operations
  • Compliance with applicable laws and regulations

This paper addresses information security measures necessary for Sarbanes-Oxley section 404 compliance in enterprise resource planning (ERP) environments, the importance of information security control reports, and the procedures to be followed for creation and utilization of information security control reports for ERP systems.

General Overview of ERP Systems

Enterprise resource planning refers to the integration and extension of a business’s operational IT systems, with the end goals of making information flow within (and beyond) a company more immediate and dynamic; increasing the usefulness and shelf life of information; eliminating redundancy and automating routine processes; and making information system components more flexible. Departmental boundaries generally become softer, accessibility of data is increased for partner companies and customers, and the company’s ability to respond to the marketplace is generally enhanced.6

ERP software is typically used by organizations for seamless integration of various functional modules to ease the execution of business activities.7 Where deployed, this feature of ERP software brings to the forefront the necessities of segregation of duties, activity-based rules, active security monitoring, specific application controls and other related security issues.

Designing, developing, deploying and monitoring ERP systems requires an integrated approach to meet the requirements of various functional areas. Specifically, operational managers need to collaborate with IT managers to define processes for implementing a robust and secure ERP system, considering the organizational risks or challenges related to:8
  • Data integrity
  • User behavior
  • Data conversion
  • Application security
  • Business continuity
  • Business processes
  • System functionality
  • Business procedures
  • Industry environment
  • Business environment
  • Ongoing maintenance
  • Management behavior
  • Underlying infrastructure

Internal Control Structure Implications

IT is commonly an integrated service requiring consideration during an audit of financial statements. To prevent any laxity in information assets protection, organizations need to establish adequate IT controls within their internal control structure.9 Components of the organization’s internal control structure, as defined by COSO’s Internal Control—Integrated Framework, and their applicability to the IT infrastructure include the:10, 11

  • Control environment—The control environment sets the tone of an organization, influencing the control consciousness of its people. It is the foundation for all other components of internal control, providing discipline and structure. Control environment factors include management’s philosophy, operating style and direction provided by the board of directors. When establishing the control environment for an ERP system, senior management should make a commitment to IT service management and drive managerial direction by designing and deploying an IT policy.
  • Risk assessment—Risk assessments enable identification and analysis of relevant risk factors associated with the achievement of objectives, thus forming a basis for determining how risks should be managed.12 Because economic, industry, regulatory and operating conditions are in constant flux, mechanisms are needed to identify and deal with entity-centric risks associated with perceived impact of such changes. As for internal control, risks are more pervasive in the IT function than in other areas of a company. Therefore, senior management and IT personnel should gain a comprehensive understanding of ERP interdependencies to ensure service confidentiality, integrity, availability, compliance and reliability.
  • Information and communication—Pertinent information must be identified, captured and communicated in a form and time frame that enable people to carry out their responsibilities. Information systems produce reports containing operational, financial and compliance-related information that make it possible to run and control the business. In tandem, effective communication must occur in a broader sense, flowing down, across and up the organization’s hierarchy. All personnel should receive a clear message from top management that control responsibilities must be taken seriously. They also must understand their own role in the internal control system and how individual activities relate to the work of others.
  • Control activities—Control activities are the policies and procedures helping to ensure that management’s directives are carried out. They assist in ensuring necessary actions are taken to address risks associated with the organization’s objectives. Control activities occur throughout the organization at all levels and in all functions. They embrace a diverse range of activities such as approvals, authorizations, verifications, reconciliations, reviews of operating performance, protection of assets and segregation of duties. Control activities for an ERP system normally include, but are not limited to:
    – Change management
    – Incident management
    – Availability management
    – Service-level management
    – Configuration management
    – Information security management
  • Monitoring—Internal control structures need to be monitored as a process that assesses the quality of operational systems’ performance over time. With an IT system, sufficient monitoring of internal controls requires continuous vigilance, in-depth assessments, and internal and external audits.

Standards establish expectations and provide direction when an auditor is engaged to perform an audit of management’s assessment of the effectiveness of internal control over financial reporting. Under Sarbanes-Oxley, auditor adherence to defined standards is overseen by the Public Company Accounting Oversight Board (PCAOB)—a private-sector nonprofit corporation that oversees, regulates, inspects and disciplines accounting firms in their roles as auditors of public companies.13 However, the cost of complying with Sarbanes-Oxley section 404 impacts smaller companies disproportionately, as there is a significant fixed cost involved in completing the assessment. To prevent such disparity, the SEC and PCAOB issued specific guidance to ease the burden of expense.14, 15 The PCAOB approved Auditing Standard No. 5 for public accounting firms on 25 July 2007, so that section 404 audits and management evaluations are more risk-based and scalable to company size and complexity.16 As per the SEC, the following four features of Auditing Standard No. 5 provide the greatest impact:17

  • It is less prescriptive.
  • It makes the audit scalable (so it can change to fit the size and complexity of any company) by allowing the auditor to balance the amount of internal control testing required for audits of small and less-complex organizations. The standard also allows the auditor to consider alternative controls when there is limited segregation of duties. Moreover, when there is limited or no documentation trails, the auditor can decide to use inquiry along with other procedures, such as observation or reperformance, to provide supporting evidence of adequate controls.18
  • It directs auditors to focus on what matters most and eliminates unnecessary procedures from the audit. The standard;
    …Directs auditors to the areas that present the highest risk, such as the financial statement closing process and controls designed to prevent fraud by management. It emphasizes that the auditor is not required to scope the audit to find deficiencies that do not constitute material weaknesses. It also allows auditors to use knowledge accumulated in previous years’ audits to reduce testing. The new standard clarifies that management’s process is not the focus of the audit; rather, the audit focuses on the effectiveness of a company’s internal control over financial reporting. As a result, it will eliminate auditors requiring companies to do work that is not necessary.19
  • It includes a principles-based approach to determine when and to what extent the auditor can use the work of others.

Defining the Control Environment

The control environment construct is generally considered the most important component in the COSO-based audit framework. As discussed previously in this article, section 404 requires that management assess and report on the effectiveness of a company’s internal control structure.20 To this end, the control environment must be understood, evaluated and tested—first by management and then by the external auditors.

An organization’s control environment should exist as the pervasive foundational substructure affecting business processes. By most definitions, this foundational substructure is based on management’s integrity and ethical values, operating philosophy and commitment to organizational competence, as well as other factors. To enable section 404 compliance, appropriate employee and specific control-related policies, procedures, standards and rules should be provided by management and reviewed periodically.

Controls should be in place to check such items as accuracy, completeness, validity (e.g., proper authorization) and security (e.g., restricted access) for transactions. Technically, application safeguarding controls should be present during input, processing and output (see figure 1). To dispatch information reliability requirements, an information security manager should ensure that designated application owners identify, understand, test and document internal accounting security controls for relevant information assets. For instance, information-security-related application accuracy controls should include input, edit and validation routines ensuring that information integrity is assessed through deployed protection evaluations.

Figure 1

Security Measures for Section 404 Compliance of ERP Systems

The following detailed security measures can be applied to an ERP system for preventing a number of common gaps identified on the path to Sarbanes-Oxley section 404 compliance:21

  • Secure identity management—Generally, organizations understand the need to accommodate access to their data— as per the accepted requirements of employees, customers and partners—in real time. Simultaneously, there is also a need to provide sensitive data protection through effectively managing user identities. Consequently, an organization’s systems should remain secure, while the IT service supplies high-quality information.
  • Identity provisioning—Senior management should make provisions for quick and secure viewing, changing, auditing and reporting of all user profiles and access privileges granted to the users across the organization.
  • Policy-based access control—Policy-based access control should be exercised for programs and data security. Audits of access authorities at public, group, user and object levels should be performed at regular intervals, to augment other internal controls for Sarbanes-Oxley section 404 compliance.22 Furthermore, enabling strong authentication in client-server environments aids in ensuring the safety of sensitive business and process-related information.23
  • Data protection and integrity—If an ERP database contains sensitive customer information, activities of users who have unrestricted access to the database should be tracked to detect unauthorized modifications. This usually requires regular journaling of changes to database tables with periodic reviews of infrastructure audit trails and reviews of the database transactions. Reviewing the before and after images of the database records and verifying authorized approvals of those changes helps in tracking processing discrepancies. Additionally, users who have access to the production database should be required to change their password at least every 90 days, while assigned passwords should be strong enough to prevent compromise by random guessing or bruteforce attacks. The security team should perform a daily review of logs to discover irregular activities that may jeopardize data integrity. For operating system (OS) level security, application and device drivers should be checked on a regular basis to identify vulnerabilities and threats that can compromise effective database protection. Only approved and tested database patches should be applied, utilizing appropriate change management procedures.

ERP Internal Control Actions Supporting Section 404 Compliance

Administrative processes should rely on internal controls to remain in compliance with internal and external requirements. Adequate controls to mitigate risks need to exist in critical daily business procedures.24 Without the deployment of adequate internal controls, functions would be noncompliant, inefficient and costly to operate, and could ultimately fail.

Preventive controls are established to avoid undesirable circumstances and to maintain compliance with approved policies and procedures in financial and operational arenas.

For example, an organization can undertake the following preventive actions for Sarbanes-Oxley compliance:
  • Every department/functional head should be an authorized requestor for:
    – User profile creation
    – User profile activation
    – Menu access
    – User authority
    – Profile deletion
    – Report disablement

    The functional heads should be able to request access only for certain privilege levels/roles within their respective area/ access level.
  • As a collateral responsibility, requests should be documented on a form that mentions relevant details, such as the complete name of the user, department, user’s address book number, authorized requestor details (with signature of authorized requestor) and a clear mention of the request.
  • The IT support team should check the feasibility of the request before execution. If request fulfillment is not feasible, the authorized requestor should be informed about the policies and procedures prohibiting the execution of the request.
  • Upon notification of request denial, the authorized requestor should be permitted to submit a modified form or ask the IT support team to close the ticket.

Any security flaw already existing on the ERP system, and those that were not tracked as preventive actions, should be identified and mitigated by corrective actions. Detective controls are designed to identify irregular transactions or improper procedural events after they have occurred. Based on the deployment of detective controls, management can take proper corrective actions to remove material weaknesses. This can be enabled by generating information security control reports (see figure 2).

Figure 2

Procedures for Creation and Review of Control Reports

Information security control reports for ERP systems are a detective control that can be utilized quarterly to verify appropriate safeguarding deployment. These reports can be generated quarterly by querying the ERP system’s security files and journals. Business intelligence tools can be used as a report writing vehicle. Control reports can be run and printed midquarter and presented to the IT operations manager for review. Subsequently, all control reports should be reviewed and signed for accuracy and completeness by the IT operations manager every quarter of each year.

Based on the feedback from the functional heads, the IT operations manager should dispense directives to mitigate security weaknesses. Nevertheless, it is mandatory for security administration personnel to identify security gaps and, depending on their assigned responsibilities, take action to reduce, bridge or close security gaps.

The following steps show how security control reports can be used to manage Sarbanes-Oxley section 404 compliance in ERP systems:
  • Senior management, along with the IT operations manager and the functional heads, should develop standard procedures for normal business operations and review them on a quarterly basis for modifications and addendums.
  • The IT operations manager should complete a risk assessment of the ERP system and define new reporting needs.
  • The IT support team should create the security reports by querying the security files and required tables every quarter and save them in electronic form.
  • The IT support team should identify the security gaps and report them to the IT operations manager.
  • The IT operations manager, in consultation with the functional heads, should identify the actions to be taken to cover the security gaps and authorize the system administrator to take appropriate actions to remove the security gaps.
  • The system administrator and the IT support team should take necessary corrective action to cover the security gaps and archive the printed reports.
  • The IT operations manager should review and sign the security reports for conformity.
ERP control reports should be designed to cover all aspects of system security that are necessary to run a compliant Sarbanes-Oxley section 404 enterprise. The primary purpose of these reports is to identify possible gaps in security settings and to verify whether ERP system security is operating as directed per the organization’s policies. Various kinds of security reports can be developed and deployed based on the ERP system design. Some examples of associated control procedures for entity-centric designed information security reports are:
  • Reviewing logical security of existing user profiles
  • Identifying inappropriate and obsolete user profiles
  • Reviewing environment setup and user profiles that have access
  • Reviewing object authorization lists and identification of obsolete objects
  • Ensuring that user profiles have the appropriate password change frequency
  • Reviewing users who have not logged on to the system in the previous quarter
  • For an “all doors closed” security policy, verifying that sensitive objects are inaccessible through public profiles.

Conclusion

Sarbanes-Oxley has established additional standards for US corporate accountability by mandating that publicly held companies assess and report the overall effectiveness of internal control processes affecting financial reporting. As a result, Sarbanes-Oxley section 404 is applicable to IT services. In relation to IT services, without exception, qualifying organizations using ERP systems for their business are mandated to develop and document information security controls as well as process supporting financial reporting. Utilizing suitable report generation software is a simple, yet powerful, tool for extracting pertinent data from an ERP database and for uncovering security breaches. The combined affect of preventive controls and detective actions, based on superior information security control reports, enables a secured Sarbanes-Oxley section 404 compliant ERP system.

Endnotes

1 Brotby, Krag W.; Information Security Governance: Guidance for Boards of Directors and Executive Management, 2nd Edition, IT Governance Institute, 2006, p. 7
2 The Institute of Internal Auditors, “Common Misconceptions,” March 2005, www.theiia.org/periodicals/newsletters/tone-at-the-top/archives-by-topic/index.cfm?c=580
3 US Congress, Sarbanes-Oxley Act of 2002, HR 3763, January 2002, http://news.findlaw.com/hdocs/docs/gwbush/sarbanesoxley072302.pdf
4 Hewlett-Packard, “HP ITSM and HP OpenView: An Approach to Attaining Sarbanes-Oxley Compliance,” www.whitepapers.zdnet.co.uk/0,1000000651,260084722p,00.htm
5 Wikipedia, “Committee of Sponsoring Organizations of the Treadway Commission,” www.wikipedia.org
6 Robinson, Scott; “A Developer’s Overview of ERP,” Developer.com, www.developer.com/design/article.php/3446551
7 Mandal, Purnendu; Angappa Gunasekaran; “Issues in Implementing ERP: A Case Study,” European Journal of Operational Research, vol. 146, 2003, p. 274-283
8 ISACA, “Enterprise Resource Planning (ERP) Systems Review,” Information Systems Standards, Guidelines, and Procedures for Auditing and Control Professionals, p. 88–94, www.isaca.org/standards
9 Shang, Shari; Peter B. Seddon; “A Comprehensive Framework for Classifying the Benefits of ERP Systems,” University of Melbourne, www.unimelb.edu.au
10 Op cit, Committee of Sponsoring Organizations of the Treadway Commission
11 IT Governance Institute, IT Control Objectives for Sarbanes-Oxley, 2nd Edition, 2006, www.isaca.org
12 The Institute of Internal Auditors, “Applying COSO’s Enterprise Risk Management—Integrated Framework,” www.theiia.org
13 Op cit, US Congress
14 Public Company Accounting Oversight Board, “An Audit of Internal Control Over Financial Reporting That Is Integrated With an Audit of Financial Statements and Related Independence Rule and Conforming Amendments,” PCAOB Release No. 2007-005A, www.pcaob.org/Rules/Docket_021/2007-06-12_Release_No_2007-005A.pdf
15 Public Company Accounting Oversight Board, Auditing Standard No. 5, “An Audit of Internal Control Over Financial Reporting That Is Integrated With an Audit of Financial Statements,” www.pcaobus.org/Rules/Rules_of_the_Board/Auditing_Standard_No.5.pdf
16 Ethisphere, “SEC Approves PCAOB Auditing Standard No. 5 to Reduce Cost of SOX 404 Compliance,” 27 July 2007, http://ethisphere.com/sec-approves-pcaob-auditingstandard-no-5-to-reduce-cost-of-sox-404-compliance/
17 Ibid.
18 US Securities and Exchange Commission, “SEC Approves PCAOB Auditing Standard No. 5 Regarding Audits of Internal Control Over Financial Reporting; Adopts Definition of ‘Significant Deficiency’,” News Release, 25 July 2007, www.iasplus.com/usa/sec/0707as5secpr.pdf
19 Ibid.
20 Wikipedia, “Sarbanes-Oxley Act,” www.wikipedia.org
21 Wikipedia, “Sarbanes-Oxley 404 top-down risk assessment,” www.wikipedia.org
22 Soxlaw.com, “Sarbanes-Oxley Section 404,” www.soxlaw.com/s404.htm
23 Check Point Software Technologies, “Achieving Sarbanes-Oxley Act Section 404 Compliance With Check Point Solutions,” 2007, www.ventech.com/PDF/SOX_whitepaper.pdf
24 Karl Nagel & Company LLC, “Sarbanes-Oxley: Financial and Accounting Disclosure Information,” www.sarbanes-oxley.com

Abhik Chaudhuri, MCA, PMP
is an IBM-accredited senior IT specialist with work exposure as an IT security administrator. He has executed IT consulting projects in diverse environments. Chaudhuri can be reached at abhik.chaudhuri@gmail.com.

Dipanwita Chaudhuri, ACA (ICAI), MIIA
is a consultant auditor working as manager of management consultancy services with a reputed Chartered Accountants’ firm in Kolkata, India. She is a registered consultant with the Asian Development Bank. She can be reached at banerjee.dipanwita@gmail.com.

Robert E. Davis, CISA, CICA
is an independent auditor and management consultant, a Pleier Corp. author, and a Boson Software Inc. author and instructor. He has provided information systems (IS) auditing and data security consulting services to the US Securities and Exchange Commission, the United States Enrichment Corp., Raytheon Company, the US Interstate Commerce Commission, Dow Jones & Company, and Fidelity/First Fidelity (Wachovia) corporations. He can be reached at bobdcisa@yahoo.com.


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