Data security and trust are paramount between businesses and their clients in the current digital landscape. With increasing concerns about privacy breaches and cyber threats, organizations must demonstrate their commitment to safeguarding sensitive information and providing reliable services for customers.
One way to provide this assurance is through System and Organization Controls (SOC) reports. These reports, issued by independent auditors, offer valuable insights into a company's internal controls related to security, availability, processing integrity, confidentiality, and privacy.
A SOC report results from a SOC audit, which is a deep dive into a service organization's internal control processes. It’s an attestation provided by third-party auditors that showcases how the organization manages data and ensures it’s secure and effective.
The American Institute of Certified Public Accountants (AICPA) has expanded SOC offerings to what is known as the SOC Suite of Services. This suite encompasses SOC for Service Organizations (SOC 1, SOC 2, and SOC 3), SOC for Supply Chain, and SOC for Cybersecurity.
What are the Different SOC Reports?
SOC 1 is a report on the design (Type 1) or design and operating effectiveness (Type 2) of controls at a service organization that affects the user entities’ Internal Control over Financial Reporting (ICFR). These reports are essentially all about financial reporting. They enable clients to assess how a service organization's controls could impact its financial statements.
Management, user entities, indirect user entities, and independent auditors primarily use SOC 1 reports. Auditors or CPAs also utilize SOC 1 reports in the planning and execution of financial statement audits.
SOC 2 is a report on the design (Type 1) or design and operating effectiveness (Type 2) of controls at a service organization related to its service commitments and system requirements based on the Trust Services Criteria (TSC).
The Trust Services Criteria are:
- Security
- Availability
- Processing integrity
- Confidentiality
- Privacy
Security is a mandatory component in each SOC 2 report and is often called the common criteria. However, many SOC 2 reports will include at least one additional TSC.
Like SOC1 reports, SOC2 reports are used by management, user entities, indirect user entities, regulators, and independent auditors.
Although SOC 1 and SOC 2 reports often cover many of the same controls, the primary focus is notably different. SOC2 reports cater to clients that require details and assurances about a service organization's controls.
SOC 3 reports are for general use and distribution, most like SOC 2 Type 2 reports. They report on the design and operating effectiveness of controls at a service organization.
SOC 3 reports are typically less detailed and considered summaries. They also use the TSCs but are utilized by clients who don’t need detailed information about the tests conducted and the execution methods.
Who Needs a SOC Audit?
How can a service organization determine if they need a SOC audit? If the following factors apply to your organization, you likely could use a SOC audit.
You are providing a service to clients.
SOC audits and reports are designed for service organizations. If your organization provides services to clients, especially services involving sensitive data or financial reporting, you will need a SOC audit.
Your clients will be interested in the control measures your organization implemented for their protection.
Your existing clients are asking for a SOC report.
If your existing clients are inquiring about SOC reports, it's likely because their financial auditors or information security team requested them.
Offering a SOC report highlights the existence of controls and certifies that a third party has examined them. The absence of a SOC report might prompt a client to send in their auditors to test for existing controls, or they may choose not to engage with your company at all.
When submitting a proposal to a new client, they ask if you have a SOC report.
Your service organization could be eliminated from a new client’s selection pool solely because it lacks a SOC report.
You want an edge over your competitors.
If you find your organization competing with another for a new client, possessing a SOC report could provide an advantage in securing the contract.
It’s an industry standard.
Some organizations must obtain a SOC report to meet the industry requirements of their client.
In healthcare and financial services industries, a SOC 2 audit is often a minimum requirement for doing business with hospitals or banks.
What SOC Report Do I Need?
As previously mentioned, SOC 1 and SOC 2 reports often cover many of the same controls. However, the differences between the two are much clearer when determining what report you need.
SOC 1 reports focus on a service organization’s internal controls around financial statements. SOC 2 reports focus on a service organization’s controls around the design and functional effectiveness against the TSCs.
A SOC 1 report is probably your best choice if you are a payroll processing company, given that payroll notably influences a client’s financial statements. However, a SOC 2 report would be the better choice if you are a data center, as direct financial impacts are unlikely, and the focus shifts to satisfying the TSCs.
Remember your client's requirements when deciding the report type your service organization needs. Clients might expressly state their preference for SOC 1, SOC 2, or SOC 3.
It's also worth noting that some clients opt for multiple reports (like both a SOC 1 and a SOC 2 report), which might be the most fitting solution in specific scenarios.
Are SOC Audits Required?
Legally speaking, no governing authority requires service organizations to undergo a SOC audit, and the absence of such an audit does not result in penalties or fines.
Nonetheless, a service organization might encounter a client or prospect requiring a SOC report to collaborate in business.
“Even though SOC audits are not mandatory, they play a crucial role in building customer trust and confidence with our client’s service offerings,” said Aaron Kerr, Director at Clearview Group.
“They provide a comprehensive review of the controls and processes in place, for example, ensuring the integrity, confidentiality, and privacy of client data.”
How Long is my SOC Report Good for?
SOC 1 and SOC 2, Type 1 report is for a specific point in time and is typically the first step for an organization to get a Type 2 audit. A Type 2 reports cover a specified period, typically up to 12 months. Once issued, the report remains relevant for that period.
"A SOC audit is typically considered ‘good for’ one year from the date of issuance. However, that assumes no major changes to your environment and your intent to have an annual audit completed,” said Kerr.
“There could also be nuances with some of your customers who expect an audit on a more frequent basis, so this is a key area to work through with your consultant or CPA firm to determine the best approach for your customer base.”
Though SOC audits and reports are not an annual requirement, service organizations should schedule a SOC audit every 12 months as a best practice. This cadence allows clients to expect annual assurance about the service organization's internal controls. It also helps maintain a consistent level of trust and transparency with stakeholders.
However, it's worth noting that the environment of internal controls can change, and thus, the relevance of a SOC report can diminish over time. An annual audit ensures that the service organization complies with its internal policies.
What Other Factors Affect a SOC Audit?
The need for a SOC audit depends more on the nature of your business and the expectations of your clients or stakeholders than the age of your business.
A SOC audit may not be necessary immediately for a newer business that is not facing high client demand. The need for SOC reports will increase as an organization grows and engages with larger clients or moves into regulated industries.
It's a good idea to be aware of SOC audits as a new business and understand the competitive advantage they could provide.
Business size is another factor that doesn’t directly indicate the need for a SOC report. However, larger businesses often have more complex environments and stakeholders, making them more likely to need or be requested to provide a SOC report.
Additionally, larger organizations might operate in multiple industries or regions where clients require such reports. Still, even smaller businesses need a SOC report when providing services where clients entrust an organization with data or if they play a crucial role in financial reporting.
What Type of Firms Offer SOC Audit Services?
A wide variety of firms offer SOC audit services, such as the Big 4, regional CPA firms, and firms that specialize in SOC audit and other external certification services.
Choosing the right firm for your situation is critical to the SOC audit process. While the ultimate objective is to obtain a SOC audit report, these reports can vary significantly in cost and quality.
SOC reports are crucial in demonstrating an organization's commitment to security, compliance, and operational excellence. Organizations can instill trust and confidence in their clients, partners, and stakeholders by undergoing SOC audits and obtaining SOC reports.
Additionally, understanding the distinctions between SOC 1, SOC 2, and SOC 3 reports empowers organizations to choose the most appropriate engagement to meet their specific needs and compliance requirements. When it comes to SOC audits and reports, it's better to have them than not.
