Explaining SOC 1, SOC 2, and SOC 3 Compliance

As businesses increasingly outsource core functions to service organizations, managers at service organizations are more likely to receive requests for a SOC audit to examine their internal control environment. Choosing between a SOC 1, SOC 2, and SOC 3 report can be a little confusing but understanding the differences between these types of audits will help your organization remain compliant with information protection and privacy standards. Here’s everything you need to know to differentiate the reports, select the right type of audit for your organization, and achieve SOC compliance. 

 

What are SOC Reports?

The System and Organization Controls (SOC) framework was developed by the American Insitute of Certified Public Accountants (AICPA) to keep pace with the developing need for confidentiality and privacy of information as more and more data is stored and processed in the cloud. The AICPA sets the standards for service organizations that offer data housing, cloud computing, software as a service and other outsourced functions. SOC audits are conducted by independent, licensed CPAs to examine system-level and entity-level controls at a service organization to provide assurance to their partners, clients, and other key stakeholders. However, there are multiple variations of SOC reports, each of which is designed to address a specific need in the industry. Understanding the different types of SOC audits and their relative uses will help you create a clear path toward compliance. 

 

Purpose of SOC Audits

Depending on the type of SOC report an organization requests and the extent of that specific report, auditors will examine the controls in place and determine whether they are well-designed and operating effectively to produce the desired outcome. This is particularly important for organizations that provide services such as payroll processing or cloud services like hosting, analytics, application migration, and storage where data is incredibly valuable and sensitive. SOC audits help to provide necessary assurances for the client, key stakeholders, and the service organization itself that every step is being taken to protect company and client information. 

 

Although SOC criteria might broadly describe what must be done to achieve compliance, individual organizations are on their own when it comes to designing, developing, and implementing controls for how they reach compliance. The variability of controls based on the specific services provided by the organization are part of what can make SOC audits a lengthy and complex process.

 

SOC 1

For organizations that process financial transactions or otherwise impact their clients’ financial statements, a SOC 1 report is particularly useful. SOC 1 reports, also known as Statement on Standards for Attestation Engagements (SSAE 18) have been available since 2011 and document a service organization’s internal controls that are relevant to a customer’s financial reporting. 

There are two types of SOC 1 reports. The Type 1 audit is a point-in-time report that examines the controls on a specific date whereas the Type 2 audit examines the controls over a period of time (typically one year). While the Type 1 report simply describes the organization’s systems, the Type 2 report tests and determine the operational effectiveness of those systems. 

Based on the type of SOC 1 report being created, an auditor might seek to answer key questions such as how the company defines its organizational structure, whether or not the organization performs formal risk assessments, and if the organization has developed policies and procedures that address all controls. 

 

SOC 2

Although some people might initially believe that SOC reports simply become more complex or extensive as they ascend in numbers, that’s not true. Unlike the SOC 1 report, the SOC 2 report has nothing to do with financial statements. In fact, SOC 2 audits focus on the protection and privacy of data. Auditors assess the system-level controls and compare them to the five Trust Services Categories as developed by the AICPA. The Trust Services Categories are as follows: 

Security: this criterion refers to the protection of system resources against unauthorized access to avoid the misuse of software, data theft, and improper disclosure of information. 

Availability: this criterion refers to the accessibility of the system in the context of network performance and incident handling. 

Processing Integrity: this criterion addresses whether or not the system achieves its purpose and ensures that data processing is complete, valid, accurate, timely, and organized. 

Confidentiality: this criterion refers to data that is restricted access and the ability to adequately safeguard information being stored or processed. 

Privacy: this criterion addresses the system’s collection, use, retention, disclosure, and disposal of personal information. 

Although the reports differ greatly in scope and focus, the SOC 2 report is similar to the SOC 1 report in that there are two types of reports. The Type 1 audit examines the design of an organization’s controls and the Type 2 audit includes all of the same information but also includes the auditor’s assessment that the controls were tested for implementation and effectiveness over a longer period of time. 

 

SOC 3

The SOC 3 report covers the same information that is presented in the SOC 2 report, however, the SOC 3 report is intended for public use and is therefore much less detailed. This means that the report does not contain any descriptions of the tests of controls or results of tests. Oftentimes, service organizations will choose to receive a SOC 3 report if they want to prove to potential clients, investors, and other key stakeholders that their organization adheres to the five Trust Services Categories without providing an overwhelming amount of information. The SOC 3 report is also an incredibly useful marketing tool because it can easily be displayed on your website to show your good standing with data security standards. 

 

How is Compliance Evaluated? 

To receive an unqualified (no significant exceptions found) SOC report, you will need to have a working knowledge of the standards by which the controls will be evaluated. There are a number of different categories of controls that an auditor will test to determine compliance, depending on the type of report being issued. Auditors will check internal controls to gain assurance that the processes meet certain requirements and are operating properly in accordance with certain expectations, laws, or policies. In general, there are four types of controls: manual controls; IT-dependent manual controls; application controls; and IT general controls. 

 

Manual Controls: these types of controls rely on human actions and require specific owners to ensure the consistency of operation. Examples of manual controls include having a supervisor sign off on a document or matching the amount of cash in a lockbox against the number stated on an account. 

 

IT-Dependent Manual Controls: they types of controls rely on manual processes from personnel but they also require some level of system involvement. For example,  system-generated report that lists users who have not logged into a particular system in a certain amount of time might require an administrator’s review prior to disabling certain accounts. 

 

Application Controls: these types of controls can be categorized as virtually any configuration setting in a system that’s used to prevent or detect problems. This includes common practices such as two-factor authentication or multi-factor authentication which locks a user out of the program if they enter the wrong password too many times. 

 

IT General Controls: these types of controls are the focus of most SOC audits because they are usually combinations of manual and application controls and they are comprised of policy management, logical access, change management, and physical security. One example is the process by which organizational changes are authorized, tested, approved, and implemented. 

 

From access control to quality assurance and performance monitoring to disaster recovery, controls exist to achieve objectives established by the service organization for the optimal protection of client information. SOC audits are a necessary component to ensuring the suitable, design, implementation, and effectiveness of an organization’s systems. 

 

SOC compliance should be regarded as the pinnacle of data security rather than an impediment because it confirms your organization’s ability to safely and securely handle sensitive customer data. To learn more about SOC reports or how your internal controls could be affecting your organization’s compliance, contact our experts at K Financial. Our team of licensed professionals can address any compliance concerns to help you establish more confidence with your customers.