The biggest uncertainty is how a wave of companies reporting bad news about internal controls would affect the financial markets. In his speech to the Midwestern Financial Reporting Symposium, Nicolaisen noted that it shouldn't be surprising that some companies would have to report a material weakness in internal controls in this first year under 404. "Nor should it, by itself, necessarily be motivation for immediate or severe regulatory or investor reactions," he told the group, pointing out that it's possible for an external auditor to give a clean opinion on the company's financials even if the company reports a material weakness. (The auditor has to perform additional tests to ensure that the financials are accurate despite the weakness.)

Dan Langer, internal controls solution director at Jefferson Wells International Inc., which provides internal auditing services, says he wouldn't be surprised if it turns out that 20% of companies have to report a material weakness. "What I'm anxious about is if the market overreacts as they start seeing these [announcements] and shareholder value depreciates further than it really should," Langer says. He adds, though, that if large numbers of companies do report material weaknesses, sophisticated market participants may interpret it as a sign that accounting firms are being strict. "Large institutional investors are probably going to expect to some extent the Big Four are going to be conservative," Langer says, citing the influence of Arthur Andersen's demise on the remaining firms. "They may discount it somewhat and it may not have the market impact it otherwise might."

But will investors take time to sort through the details if a number of companies come out with reports of deficiencies? Nicolaisen cited an effort by Moody's Investors Service, the credit rating agency, to categorize types of material weaknesses. Greg Jonas, a managing director and leader of the accounting group at Moody's, says Moody's is considering dividing material weaknesses into two buckets: pervasive weaknesses and localized ones. Under the system Moody's is considering, a pervasive weakness not already included in the company's current rating and for which management did not have a credible plan to remedy would most likely result in a ratings downgrade, Jonas says. Of course, a raft of downgrades could also tank the equities market.

THE COST OF COMPLIANCE

Neri Bukspan, managing director and chief accountant at Standard & Poor's Corp., says S&P will consider each report of material weakness and its impact on the company's rating separately, looking at such factors as the nature of the problem and how serious the company is about mitigating the risk. Another factor is what the company will have to spend to remedy the material weakness, Bukspan says. "Your cost structure could substantially change on an ongoing basis."

Accounting experts say many of the weaknesses that companies identify as they comply with 404 are likely to be long-standing problems. Although the reports of material weaknesses focus the markets' attention on such problems, the 404 process means that the weaknesses are being fixed, says Moody's Jonas. "Arguably controls are only getting stronger. They're not weaker than in the past, they're stronger because of this scrutiny."