[Federal Register Volume 64, Number 250 (Thursday, December 30, 1999)]
[Rules and Regulations]
[Pages 73389-73403]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-33849]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 210, 228, 229, and 240
[Release No. 34-42266; File No. S7-22-99]
RIN 3235-AH83
Audit Committee Disclosure
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: The Securities and Exchange Commission is adopting new rules
and amendments to its current rules to require that companies'
independent auditors review the companies' financial information prior
to the companies filing their Quarterly Reports on Form 10-Q or Form
10-QSB with the Commission, and to require that companies include in
their proxy statements certain disclosures about their audit committees
and reports from their audit committees containing certain disclosures.
The rules are designed to improve disclosure related to the functioning
of corporate audit committees and to enhance the reliability and
credibility of financial statements of public companies.
DATES: Effective Date: January 31, 2000.
Compliance Dates: Registrants must obtain reviews of interim
financial information by their independent auditors starting with their
Forms 10-Q or 10-QSB to be filed for fiscal quarters ending on or after
March 15, 2000. Registrants must comply with the new proxy and
information disclosure requirements (e.g., the requirement to include a
report of their audit committee in their proxy statements, provide
disclosures regarding the independence of their audit committee
members, and attach a copy of the audit committee's charter) for all
proxy and information statements relating to votes of shareholders
occurring after December 15, 2000. Companies who become subject to Item
302(a) of Regulation S-K as a result of today's amendments must comply
with its requirements after December 15, 2000. Registrants voluntarily
may comply with any of the new requirements prior to the compliance
dates.
FOR FURTHER INFORMATION CONTACT: Mark Borges, Attorney-Adviser,
Division of Corporation Finance (202-942-2900), Meridith Mitchell,
Senior Counselor, Office of the General Counsel (202-942-0900), or W.
Scott Bayless, Associate Chief Accountant, or
[[Page 73390]]
Robert E. Burns, Chief Counsel, Office of the Chief Accountant (202-
942-4400).
SUPPLEMENTARY INFORMATION: The Commission is adopting amendments to
Rule 10-01 of Regulation S-X,\1\ Item 310 of Regulation S-B,\2\ Item 7
of Schedule 14A \3\ under the Securities Exchange Act of 1934 (the
``Exchange Act''),\4\ and Item 302 of Regulation
S-K.\5\ Additionally, the Commission is adopting new Item 306 of
Regulation
S-K\6\ and Item 306 of Regulation S-B.\7\
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\1\ 17 CFR 210.10-01.
\2\ 17 CFR 228.310.
\3\ 17 CFR 240.14a-101.
\4\ 15 U.S.C. Sec. 78a et seq.
\5\ 17 CFR 229.302.
\6\ 17 CFR 229.306.
\7\ 17 CFR 228.306.
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I. Executive Summary
We are adopting new rules and amendments to current rules to
improve disclosure relating to the functioning of corporate audit
committees and to enhance the reliability and credibility of financial
statements of public companies.\8\ As more fully described in the
Proposing Release, the new rules and amendments are based in large
measure on recommendations made by the Blue Ribbon Committee on
Improving the Effectiveness of Corporate Audit Committees (the ``Blue
Ribbon Committee'').\9\ The new rules and amendments have been adopted
in most respects as proposed, with modifications discussed below.
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\8\ The new rules and amendments were proposed in Exchange Act
Release No. 41987 (Oct. 7, 1999) [64 FR 55648] (the ``Proposing
Release'').
\9\ See Report and Recommendations of the Blue Ribbon Committee
on Improving the Effectiveness of Corporate Audit Committees (1999)
(the ``Blue Ribbon Report''). The Blue Ribbon Report is available on
the internet at http://www.nasd.com and http://www.nyse.com.
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Audit committees play a critical role in the financial reporting
system by overseeing and monitoring management's and the independent
auditors' participation in the financial reporting process. We have
seen a number of significant changes in our markets, such as
technological developments and increasing pressure on companies to meet
earnings expectations,\10\ that make it ever more important for the
financial reporting process to remain disciplined and credible.\11\ We
believe that additional disclosures about a company's audit committee
and its interaction with the company's auditors and management will
promote investor confidence in the integrity of the financial reporting
process. In addition, increasing the level of scrutiny by independent
auditors of companies' quarterly financial statements should lead to
fewer year-end adjustments, and, therefore, more reliable financial
information about companies throughout the reporting year.
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\10\ See, e.g., Jack Ciesielski, Editorial, More Second-
Guessing: Markets Need Better Disclosure of Earnings Management,
Barrons, Aug., 24, 1998, at 47.
\11\ The Commission recently filed 30 enforcement actions
against 68 individuals and companies for fraud and related
misconduct in the accounting, reporting, and disclosure of financial
results by 15 different public companies. See SEC Press Release 99-
124 (Sept. 28, 1999).
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Accordingly, the new rules and amendments:
Require that companies' independent auditors review the
financial information included in the companies' Quarterly Reports on
Form 10-Q or 10-QSB prior to the companies filing such reports with the
Commission (see Section III.A below);
Extend the requirements of Item 302(a) of Regulation S-K
(requiring at fiscal year end appropriate reconciliations and
descriptions of any adjustments to the quarterly information previously
reported in a Form 10-Q for any quarter) \12\ to a wider range of
companies (see Section III.A below);
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\12\ 17 CFR 229.302(a).
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Require that companies include reports of their audit
committees in their proxy statements;\13\ in the report, the audit
committee must state whether the audit committee has: (i) Reviewed and
discussed the audited financial statements with management; (ii)
discussed with the independent auditors the matters required to be
discussed by Statement on Auditing Standards No. 61,\14\ as may be
modified or supplemented; and (iii) received from the auditors
disclosures regarding the auditors' independence required by
Independence Standards Board Standard No. 1,\15\ as may be modified or
supplemented, and discussed with the auditors the auditors'
independence (see Section III.B below);
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\13\ References in this release to proxy statements also include
information statements.
\14\ See Codification of Statements on Auditing Standards, AU
Sec. 380 (``SAS 61'').
\15\ Independence Standards Board Standard No. 1, Independence
Discussions with Audit Committees (``ISB Standard No. 1''). A copy
of ISB Standard No. 1 can be obtained at www.cpaindependence.org.
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Require that the report of the audit committee also
include a statement by the audit committee whether, based on the review
and discussions noted above, the audit committee recommended to the
Board of Directors that the audited financial statements be included in
the company's Annual Report on Form
10-K or 10-KSB (as applicable) for the last fiscal year for filing with
the Commission (see Section III.B below);
Require that companies disclose in their proxy statements
whether their Board of Directors has adopted a written charter for the
audit committee, and if so, include a copy of the charter as an
appendix to the company's proxy statements at least once every three
years (see Section III.C below);
Require that companies, including small business
issuers,\16\ whose securities are quoted on Nasdaq or listed on the
American Stock Exchange (``AMEX'') or New York Stock Exchange
(``NYSE''), disclose in their proxy statements whether the audit
committee members are ``independent'' as defined in the applicable
listing standards,\17\ and disclose certain information regarding any
director on the audit committee who is not ``independent''(see Section
III.D below); require that companies, including small business issuers,
whose securities are not quoted on Nasdaq or listed on the AMEX or NYSE
disclose in their proxy statements whether, if they have an audit
committee, the members are ``independent,'' as defined in the NASD's,
AMEX's or NYSE's listing standards, and which definition was used (see
Section III.D below); and
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\16\ ``Small business issuer'' is defined in Item 10(a)(1) of
Regulation S-B, 17 CFR 228.10(a)(1), as a company with less than $25
million in revenues and market capitalization.
\17\ The listing standrds of the National Association of
Securities Dealers (``NASD''), AMEX and NYSE are available on their
websites at: http://www.nasd.com, http://www.amex.com, and http://
www.nyse.com, respectively. See infra note 27 regarding recent
changes to the listing standards of the NASD, AMEX, and NYSE.
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Provide ``safe harbors'' for the new proxy statement
disclosures to protect companies and their directors from certain
liabilities under the federal securities laws (see Section III.E
below).
To provide companies with the opportunity to evaluate their
compliance with the revised listing standards of the NASD, AMEX, and
NYSE and to prepare for the new disclosure requirements, we are
providing transition periods for compliance with the new requirements
(see Section V below).
II. Background
As discussed in the Proposing Release, given the changes in our
markets, such as the increasing number of investors entering our
markets and changes in the way and speed with which investors receive
information, it is vitally important for investors to remain confident
that they are receiving the highest quality financial reporting. The
demand for reliable financial information appears to be at an all time
high, as technology makes information
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available to more people more quickly. The new dynamics of our capital
markets have presented companies with an increasingly complex set of
challenges. One challenge is that companies are under increasing
pressure to meet earnings expectations.\18\ We have become increasingly
concerned about inappropriate ``earnings management,'' the practice of
distorting the true financial performance of the company.\19\
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\18\ See, e.g., Carol J. Loomis et al., Lies, Damned Lies, and
Managed Earnings, Fortune, Aug. 2, 1999, at 74; Thor Valdmanis,
Accounting Abracadabra, USA Today, Aug. 11, 1998, at 1B; Bernard
Condon, Pick a Number, Any Number, Forbes, Mar. 23, 1998, at 124;
Justin Fox & Rajiv Rao, Learn to Play the Earnings Game, Fortune,
Mar. 31, 1997, at 76.
\19\ See, e.g., Arthur Levitt, Chairman, SEC, Address to the NYU
Center for Law and Business (Sept. 28, 1998). A copy of this speech
is available on the SEC's website at www.sec.gov.
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The changes in our markets and the increasing pressures on
companies to maintain positive earnings trends have highlighted the
importance of strong and effective audit committees. Effective
oversight of the financial reporting process is fundamental to
preserving the integrity of our markets. Audit committees play a
critical role in the financial reporting system by overseeing and
monitoring management's and the independent auditors' participation in
the financial reporting process. Audit committees can, and should, be
the corporate participant best able to perform that oversight function.
As discussed more fully in the Proposing Release, since the early
1940s, the Commission, along with the auditing and corporate
communities, has had a continuing interest in promoting effective and
independent audit committees. Most recently, the NYSE and NASD
sponsored the Blue Ribbon Committee in response to ``an increasing
sense of urgency surrounding the need for responsible financial
reporting given the market's increasing focus on corporate earnings and
a long and powerful bull market.'' \20\ The new rules and amendments
affirm what have long been considered sound practice and good policy
within the accounting and corporate communities.\21\
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\20\ Blue Ribbon Report, supra note 9, at 17.
\21\ See Advisory Panel on Auditor Independence (``Kirk
Panel''), Strengthening the Professionalism of the Independent
Auditor, Report by the Oversight Board of the SEC Practice Section,
American Institute of Certified Public Accountants (``AICPA'')
(Sept. 13, 1994) (the `'Kirk Panel Report''); see also Report of the
National Commission on Fraudulent Financial Reporting (Oct. 1987)
(the ``Treadway Report'').
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While almost all of the commenters that provided comment letters on
the Proposing Release \22\ supported our goals of improving disclosure
about audit committees and enhancing the reliability and credibility of
financial statements, many commenters suggested alternative approaches
to achieving those goals. Some commenters believed that we should
impose more rigorous requirements.\23\ Other commenters recommended
that we not adopt certain aspects of the proposals. In this regard, the
concern most frequently expressed was that as a result of the new
requirements to provide certain disclosures in a report, audit
committees may be exposed to additional liability, and that
consequently it may be difficult for companies to find qualified people
to serve on audit committees.\24\
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\22\ You may read and copy the comment letters in our Public
Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549.
Ask for File No. S7-22-99. You may view the comment letters that
were submitted by electronic mail at the Commission's web site:
www.sec.gov.
\23\ See, e.g., Letter dated November 8, 1999 from Sarah A.B.
Teslik, Executive Director, Council of Institutional Investors;
Letter dated October 14, 1999 from Robert B. Hodes, Willkie Farr &
Gallagher.
\24\ See, e.g., Letter dated November 29, 1999 from Stephanie B.
Mudick, General Counsel--Corporate Law, Citigroup Inc. (``Citigroup
Letter''); Letter dated November 22, 1999 from Michael L. Conley,
Executive Vice President and CFO, McDonald's Corporation.
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It is not our intention to subject audit committee members to
increased liability. We addressed concerns about liability by modifying
our initial proposals from the Blue Ribbon Committee's recommendations
and by providing safe harbor protections. Nevertheless, we appreciate
that many commenters continue to be concerned about the audit committee
report generally, and specifically the requirement that the audit
committee state whether anything has come to the attention of the
members of the audit committee that caused the audit committee to
believe that the audited financial statements included in the company's
Annual Report on Form
10-K or 10-KSB contain an untrue statement of material fact or omit to
state a material fact necessary to make the statements made, in light
of the circumstances under which they were made, not misleading.
In response, we have modified that disclosure item, which was the
subject of most of the commentary. We are adopting, instead, one of the
other alternatives proposed--the audit committee must state whether,
based on the review and discussion of the audited financial statements
with management and discussions with the independent auditors, the
audit committee recommended to the Board that the audited financial
statements be included in the company's Annual Report on Form 10-K or
10-KSB (as applicable) for the last fiscal year for filing with the
Commission. As we discussed in the Proposing Release, we do not believe
that improved disclosure about the audit committee and increased
involvement by the audit committee should result in increased exposure
to liability. Consequently, we believe that this modification, together
with the safe harbors, should further alleviate concerns about
increased liability exposure, while promoting our goal of improving the
financial reporting process.
Some commenters expressed concern about applying the new
requirements to small businesses, particularly the interim financial
review requirement. We have considered those comments carefully. We
think that improvements in the financial reporting process for
companies of all sizes is important for promoting investor confidence
in our markets.\25\ In this regard, because we have seen instances of
financial fraud at small companies as well as at large companies,\26\
we think that improving disclosures about the audit committees of small
and large companies is important. As discussed in the Proposing
Release, interim financial information generally may include more
estimates than annual financial statements, but interim financial
statements have never been subject to the discipline provided by having
auditors associated with these statements on a timely basis. Investors,
however, rely on and react quickly to quarterly results of companies,
large and small. Accordingly, we believe that it is appropriate to
require small business issuers to obtain reviews of interim financial
information. As discussed below, however, small business issuers are
not included in the expanded group of issuers subject to Item 302(a)
disclosure requirements. In addition, we think that the transition
period should help small businesses prepare for and adapt to the new
requirements.
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\25\ See, e.g., Letter dated November 19, 1999 from the New York
State Bar Association, Committee on Securities Regulation (``NYS Bar
Letter'') and Letter dated November 17, 1999 from KPMG LLP (``KPMG
Letter'') supporting application of the amendments and new rules to
companies of all sizes.
\26\ See supra note 11; see also Beasley, Carcello, and
Hermanson, Fraudulent Financial Reporting: 1987-1997, An Analysis of
U.S. Public Companies (Mar. 1999) (study commissioned by the
Committee of Sponsoring Organizations of the Treadway Commission)
(the ``COSO Report'').
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The Blue Ribbon Committee also made recommendations that call for
action by the NASD, the NYSE, and the AICPA. In response, the NASD and
NYSE proposed, and the Commission
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approved, changes to their listing standards,\27\ and the Auditing
Standards Board (``ASB'') recently proposed amendments \28\ to SAS 61
\29\ and SAS 71.\30\
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\27\ See Order Approving Proposed Rule Change by the NASD,
Exchange Act Release 42231, File No. SR-NASD-99-48; Order Approving
Proposed Rule Change by the NYSE, Exchange Act Release No. 42233,
File No. SR-NYSE-99-39. While the Blue Ribbon Committee's
recommendations were directed to the NYSE and the NASD, the AMEX
proposed, and the Commission approved, rule changes to AMEX's
listing standards. See Order Approving Proposed Rule Change by the
AMEX, Exchange Act Release No. 42232, File No. SR-Amex-99-38.
\28\ See Exposure Draft for Proposed Statement on Auditing
Standards: Amendments to Statements on Auditing Standard No. 61,
Communication with Audit Committees and Statements on Auditing
Standard No. 71, Interim Financial Information (Oct. 1, 1999) (``ASB
Exposure Draft''). A copy of the ASB Exposure Draft can be obtained
at www.aicpa.org/members/div/auditstd/drafts.htm.
\29\ SAS 61 requires independent auditors to communicate certain
matters related to the conduct of an audit to those who have
responsibility for oversight of the financial reporting process,
specifically the audit committee. Among the matters to be
communicated to the audit committee are: (1) Methods used to account
for significant unusual transactions; (2) the effect of significant
accounting policies in controversial or emerging areas for which
there is a lack of authoritative guidance or consensus; (3) the
process used by management in formulating particularly sensitive
accounting estimates and the basis for the auditor's conclusions
regarding the reasonableness of those estimates; and (4)
disagreements with management over the application of accounting
principles, the basis for management's accounting estimates, and the
disclosures in the financial statements.
\30\ See Codification of Statements on Auditing Standards, AU
Sec. 722. SAS 71 provides guidance to independent accountants on
performing reviews of interim financial information.
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III. Discussion of New Rules and Amendments
A. Pre-Filing Review of Quarterly Financial Statements; Item 302(a)
We are adopting, as proposed, amendments to Rule 10-01(d) of
Regulation S-X and Item 310(b) of Regulation S-B to require that a
company's interim financial statements be reviewed by an independent
public accountant prior to the company filing its Form 10-Q or 10-QSB
with the Commission.\31\ The amendments would require that independent
auditors follow ``professional standards and procedures for conducting
such reviews, as established by generally accepted auditing standards,
as may be modified or supplemented by the Commission.'' Under current
auditing standards, this means that the auditors would be required to
follow the procedures set forth in SAS 71, or such other auditing
standards that may in time modify, supplement, or replace SAS 71.
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\31\ In the Proposing Release, we solicited comment on whether
to require companies to disclose whether their quarterly financial
statements have been reviewed by independent auditors. We are not
adopting that requirement, but are retaining the current requirement
of Rule 10-01(d) of Regulation S-X, 17 CFR 210.10-01(d), that if a
company discloses that an independent auditor has performed a review
of interim financial information, it must file a copy of the
auditor's report. A conforming change to Item 310(b) has been made
as proposed.
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As noted above, we believe that more discipline is needed for the
quarterly financial reporting process.\32\ We believe that the reviews
required will facilitate early identification and resolution of
material accounting and reporting issues because the auditors will be
involved earlier in the year. Early involvement of the auditors should
reduce the likelihood of restatements or other year-end adjustments and
enhance the reliability of financial information. In addition, as a
result of changes in the markets, companies may be experiencing
increasing pressure to ``manage'' interim financial results.
Inappropriate earnings management could be deterred by imposing more
discipline on the process of preparing interim financial information
before filing such information with the Commission.
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\32\ In 1989, the Commission issued a concept release on whether
it should propose amendments to its rules to require more
involvement of the independent accountant in the preparation of
interim financial information. See Exchange Act Release No. 26949
(June 20, 1989) [54 FR 27023]. The Treadway Commission recommended
that the SEC require independent public accountants to review
quarterly financial data before a company releases it to the public.
Treadway Report, supra note 21, at 53.
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Many commenters supported the interim review requirement.\33\
Several commenters expressed concern, however, about the cost of
obtaining interim reviews, particularly for small business issuers.\34\
As discussed above, we believe that improving the interim reporting
process is important for companies of all sizes. As noted in the
Proposing Release, we understand that the five largest U.S. accounting
firms and other firms have policies to require that their clients have
reviews of quarterly financial statements as a condition to acceptance
of the audit.\35\ Consequently, those firms already have implemented
the new requirement for the companies that are audited by those firms.
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\33\ See, e.g., Letter dated November 29, 1999 from The Business
Roundtable (``We believe that a requirement for such a review would
not impose a substantial burden and would help to improve the
investor's comfort with interim statements''); Letter dated November
23, 1999 from Mark Wovsaniker, Vice President--Accounting Policy,
America Online Incorporated (``To promote the accuracy and the high
quality of the quarterly results, the auditor's regular involvement
throughout the year, not just once at the end of each year, is
necessary''); Letter dated November 22, 1999 from the Association
for Investment Management and Research--Advocacy Advisory Committee
(``AIMR Letter'') (``[The proposal] will require auditor involvement
throughout the year, which should help mitigate earnings management,
as well as reduce the likelihood of restatements or other year-end
adjustments'').
\34\ See, e.g., Letter dated December 3, 1999 from the American
Bar Association--Section of Business Law (``ABA Letter'').
\35\ One firm's policy apparently applies only to clients filing
selected quarterly financial data under Item 302(a) of Regulation S-
K, 17 CFR 229.302(a).
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In the Proposing Release, we solicited comment on whether, in light
of the proposal to require interim reviews, we should require all
companies to comply with Item 302(a) of Regulation S-K. Currently,
under Item 302(a) of Regulation S-K, larger, more widely-held companies
\36\ supplement their annual financial information with disclosures of
selected quarterly financial data. Item 302(a) requires appropriate
reconciliations and descriptions of any adjustments to the quarterly
information previously reported in a Form 10-Q for any quarter. The
selected financial data must be reviewed by the independent auditors in
accordance with SAS 71, but the review can occur at the end of the year
and as part of the audit of the annual financial statements. We are
amending Item 302(a) to extend the requirements to all companies \37\
(except small business issuers filing on small business forms) that
have securities registered under Sections 12(b) \38\ or 12(g) \39\ of
the Exchange Act regardless of the size of the company or public
float.\40\
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\36\ Prior to today's amendments, Item 302(a) required
registrants to provide Item 302(a) information if the registrant met
certain tests, but not limited to: (1) Two of the three following
requirements: (a) Shares outstanding have a market value of at least
$2.5 million; (b) the minimum bid price is at least $5 per share; or
(c) the registrant has at least $2.5 million of capital, surplus,
and undivided profits; and (2) the registrant and its subsidiaries:
(a) Have had net income after taxes but before extraordinary items
and the cumulative effect of a change in accounting of at least
$250,000 for each of the last three fiscal year; or (b) had total
assets of at least $200 million for the last fiscal year end.
\37\ See, e.g., KPMG Letter, supra note 25, supporting this
amendment.
\38\ 15 U.S.C. Sec. 78l(b).
\39\ 15 U.S.C. Sec. 78l(g).
\40\ We are eliminating the requirement for large, widely-traded
insurance companies, which file periodic reports solely pursuant to
Section 15(d) of the Exchange Act, to provide Item 302(a)
information. It is noted in this regard that other types of issuers
reporting solely pursuant to Section 15(d) are not required to
provide Item 302(a) information. The Item 302(a) amendments will
accord insurance companies the same treatment under Item 302(a) as
other issuers that report solely pursuant to Section 15(d).
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Regulation S-B does not require small business issuers to provide
Item 302(a) type disclosures. Today's amendments continue to exclude
small business issuers filing under Regulation S-B from
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those disclosure requirements,\41\ but we will continue to consider
whether and how such requirements should apply to small business
issuers.
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\41\ See Letter dated November 29, 1999 from Ernst & Young
recommending that the criteria for Item 302(a) compliance be based
on a company's market capitalization, such as above $25 million.
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We believe that the amendments to Item 302(a) are consistent with
the new requirement to obtain interim reviews. Both new measures should
add discipline to the process of preparing and reporting quarterly
financial information. Both should also encourage early identification
of accounting issues and resolution of those issues before they must be
subject to an auditor's review or a ``reconciling'' disclosure under
Item 302(a)(2). Because the information to be disclosed should be
readily available from each company's Form 10-Q filings, no additional
audit or review costs will be imposed by the amendments to Item 302(a).
B. The Audit Committee Report
We are adopting new Item 306 of Regulations S-K and S-B and Item
7(e)(3) of Schedule 14A that require the audit committee to provide a
report in the company's proxy statement. The required disclosure will
help inform shareholders of the audit committee's oversight with
respect to financial reporting, and underscore the importance of that
role.
Many commenters were concerned that a report by the audit committee
that indicates whether various discussions have occurred would expose
the audit committee members to increased scrutiny and liability.\42\ We
do not believe that will be the case. Under state corporation law, the
more informed the audit committee becomes through its discussions with
management and the auditors, the more likely that the ``business
judgment rule'' will apply and provide broad protection.\43\ Those
discussions should serve to strengthen the ``information and reporting
system'' that should be in place.\44\ Adherence to a sound process
should result in less, not more, exposure to liability.\45\
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\42\ See, e.g., Letter dated November 24, 1999 from Tommy
Chisholm, Secretary, Southern Company; Citigroup Letter, supra note
24. But see Letter dated November 26, 1999 from Peter C. Clapman,
Senior Vice President and Chief Counsel, Investments, Teachers
Insurance and Annuity Association College Retirement Equities Fund
(``TIAA-CREF Letter'').
\43\ See 1 American Law Institute, Principles of Corporate
Governance: Analysis and Recommendations 134-98 (1994); In re
Caremark Int'l Inc. Derivative Litig., 698 A.2d 959, 967-70 (Del.
Ch. 1996).
\44\ Caremark, 698 A.2d at 970 (boards must assure ``themselves
that information and reporting systems exist in the organization
that are reasonably designed to provide to senior management and to
the board itself timely, accurate information sufficient to allow
management and the board, each within its scope, to reach informed
judgments concerning both the corporation's compliance with law and
its business performance'').
\45\ See generally Report of the Public Oversight Board
(``POB''), ``Directors, Management, and Auditors: Allies in
Protecting Shareholder Interests,'' in which the POB discusses,
among other things, a recommendation of the Kirk Panel to require
audit committees to discuss with management and the auditors the
quality of the accounting principles and judgments used in preparing
financial statements. The POB notes its belief that compliance with
that recommendation would not increase the exposure of board members
to litigation because, among other things, the procedures will
reduce the possibility that the financial statements are in fact
misleading, thereby reducing the danger of finding directors at
fault, and the additional steps taken should be persuasive in
convincing courts and juries that the financial statements were
prepared with care.
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Accordingly, we are adopting, as proposed, the requirement that the
audit committee disclose whether the audit committee has reviewed and
discussed the audited financial statements with management and
discussed certain matters with the independent auditors.\46\ Under
paragraphs (a)(1), (a)(2), and (a)(3) of Item 306 (paragraph (a)(4) is
discussed separately, below), audit committees must state whether:
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\46\ At least in some measure, these discussions are already
prescribed by the auditing literature. See SAS 61. See, e.g., Letter
dated November 29, 1999 from America's Community Bankers and Letter
dated November 22, 1999 from the Massachusetts Financial Services
Company supporting the requirements of paragraphs (a)(1), (2) and
(3).
(1) The audit committee has reviewed \47\ and discussed the
audited financial statements with management;
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\47\ We recognized that the auditing literature defines the term
``review'' to include a particular set of required procedures. See
SAS 71. In using the term ``reviewed'' in the new disclosure
requirement, we are not suggesting that the audit committee members
can or should follow the procedures required of auditors performing
reviews of interim financial statements.
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(2) The audit committee has discussed with the independent
auditors the matters required to be discussed by SAS 61, as may be
modified or supplemented; \48\ and
---------------------------------------------------------------------------
\48\ See ASB Exposure Draft, supra note 28.
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(3) The audit committee has received the written disclosures and
the letter from the independent auditors required by ISB Standard
No. 1, as may be modified or supplemented, and has discussed with
the auditors the auditors' independence.
If the company does not have an audit committee, the board committee
tasked with similar responsibilities, or the full board of directors,
would be responsible for the disclosure.
The disclosure required by paragraph (a)(3) relates to written
disclosures, a letter from the independent auditors, and discussions
between the audit committee and the independent auditors required by
ISB Standard No. 1. The Commission has long recognized the importance
of auditors being independent from their audit clients.\49\ Public
confidence in the reliability of a company's financial statements
depends on investors perceiving the company's auditors as being
independent from the company.
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\49\ The federal securities law recognize the importance of
independent auditors. See, e.g., Items 25 and 26 of Schedule A of
the Securities Act and Sections 12(b)(1)(J) and 13(a)(2) of the
Exchange Act, 15 U.S.C. 78l(b)(1)(J) and 78m(a)(2).
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As noted above, paragraph (a)(4) was the subject of the most
criticism. Commenters expressed concern about increased liability
exposure, which they believed may result in qualified audit committee
members resigning or companies having difficulty recruiting qualified
members.\50\ Some commenters, on the other hand, were skeptical that
there would be increased liability exposure.\51\
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\50\ See supra note 24.
\51\ See, e.g., TIAA-CREF Letter, supra note 42.
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Because of concerns about liability, we did not propose the
disclosure requirement recommended by the Blue Ribbon Committee,\52\
but instead proposed that the audit committee indicate whether, based
on its discussions with management and the auditors, its members became
aware of material misstatements or omissions in the financial
statements. As discussed in the Proposing Release, we did not intend,
nor do we believe, that the proposed disclosure about the audit
committee and increased involvement by the audit committee would result
in increased exposure to liability. Because commenters continued to be
concerned, however, we are adopting an alternative contained in the
Proposing Release. We believe that the revised language, together with
the safe harbors, addresses those concerns.
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\52\ The Blue Ribbon Committee recommended that the audit
committee state that, in reliance on the review and discussions with
management and the auditors, the audit committee ``believes that the
company's financial statements are fairly presented in conformity
with Generally Accepted Accounting Principles (GAAP) in all material
respects.'' Blue Ribbon Report, supra note 9, at 35.
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As adopted, new paragraph (a)(4) requires the audit committee to
state whether, based on the review and discussions referred to in
paragraphs (a)(1) through (a)(3), it recommended to the Board of
Directors that the financial statements be included in the Annual
Report on Form 10-K or 10-KSB for the last fiscal year for filing with
the Commission.\53\ Because the new
[[Page 73394]]
language in paragraph (a)(4) focuses on the annual audited financial
statements and the filing of those financial statements with the
Commission, we believe that this requirement will provide investors
with a better understanding of the audit committee's oversight role in
the financial reporting process. The audit committee's recommendation
that the financial statements be used in Commission filings already is
implicit in, and is consistent with, board members signing the
company's Annual Report on Form 10-K or 10-KSB.\54\ Further, several
commenters preferred this alternative.\55\
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\53\ For closed-end investment companies, paragraph (a)(4)
clarifies that this requirement applies to financial statements
included in a fund's annual report to shareholders required by
Section 30(e) of the Investment Company Act of 1940 and rule 30d-1.
These reports must be filed with the Commission pursuant to Rule
30b2-1, 17 CFR 270.30b2-1, under the Investment Company Act of 1940.
Commenters disagreed about whether closed-end funds be excluded
altogether from the new proxy statement disclosure requirements.
See, e.g., ABA Letter, supra note 34; Letter dated November 29, 1999
from Stuart M. Strauss, Morgan Stanley Dean Witter; Letter dated
November 29, 1999 from Arthur Andersen LLP; Letter dated November 3,
1999 from the Investment Company Institute. We have concluded,
however, that the application of these requirements to closed-end
funds is warranted because of the critical role that audit
committees play in overseeing the financial reporting process.
\54\ The signature requirement is described in General
Instruction D of Form 10-K and General Instruction C of Form 10-KSB.
The Commission amended the signature requirements for Form
10-K in 1980 in order to ``enhance director awareness of and
participation in the preparation of the Form 10-K information.'' See
Securities Act Release No. 6176 (Jan. 15, 1980) [45 FR 5972].
\55\ See, e.g., Letter dated December 1, 1999 from Ira M.
Millstein, Weil Gotshal & Manges LLP, and John C. Whitehead. Messrs.
Millstein and Whitehead were co-chairmen of the Blue Ribbon
Committee; Letter dated November 29, 1999 from Deloitte & Touche
LLP; Letter dated November 29, 1999 from James E. Kelly, General
Counsel, Dime Bancorp, Inc.; Letter dated November 23, 1999 from
Michael A. Rocca, Senior Vice President, Chief Financial Officer,
Mallinckrodt Inc. (``This type of report better describes the audit
committee's oversight role * * *. Moreover, in our view this
alternative language would create a less significant litigation risk
to audit committees''); NYS Bar Letter, supra note 25; Letter dated
November 16, 1999 from Ernst & Young LLP. See also Letter dated
August 20, 1999 from Ernst & Young LLP to Harvey J. Goldschmid,
General Counsel, and Lynn E. Turner, Chief Accountant, SEC,
commenting on the recommendations of the Blue Ribbon Committee and
recommending a variation of this alternative.
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In addition, in performing its oversight function, the audit
committee likely will be relying on advice and information that it
receives in its discussions with management and the independent
auditors. Accordingly, the text of the new requirement acknowledges
that the audit committee had such discussions with management and the
auditors, and, based on those discussions, made decisions about the
financial statements and the filing of the company's Form 10-K or 10-
KSB. This approach is consistent with state corporation law that
permits board members to rely on the representations of management and
the options of experts retained by the corporation when reaching
business judgments.\56\ The Blue Ribbon Committee noted the
``impracticability of having the audit committee do more than rely upon
the information it receives, questions, and assesses in making this
disclosure.'' \57\
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\56\ Delaware General Corporation Law, for example, states that
board members are ``fully protected in relying on good faith upon
the records of the corporation and upon such information, opinions,
reports or statements presented to the corporation by any of the
corporation's officers or employees * * * or by any other person as
to matters the member reasonably believes are within such other
person's professional or expert competence * * *.'' Del. Code Ann.
tit. 8, Sec. 141(e).
\57\ See Blue Ribbon Report, supra note 9, at 34.
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We are adopting, as proposed, the requirement that the new
disclosure appear over the printed names of each member of the audit
committee.\58\ This requirement will emphasize for shareholders the
importance of the audit committee's oversight role in the financial
reporting process.
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\58\ This approach is consistent with the current treatment for
the report from the company's compensation committee. See
Instruction 9 to Item 402(a)(3) of Regulation S-K, 17 CFR
229.402(a)(3).
---------------------------------------------------------------------------
The disclosures are required in the company's proxy statement
because they could have a direct bearing on shareholders' voting
decisions, and because the proxy statement is actually delivered to
shareholders and is accessible on the SEC's web site. Companies must
provide the disclosure only in a proxy statement relating to an annual
meeting of shareholders at which directors are to be elected (or
special meeting or written consents in lieu of such meeting). The
disclosure needs to be provided only one time during the year (e.g., in
a proxy statement for an annual meeting at which directors are to be
elected, but not in proxy solicitation material used in a subsequent
election contest during that same year).
C. Audit Committee Charters
We are adopting, as proposed, the requirement that companies
disclose in their proxy statements whether their audit committee is
governed by a charter, and if so, include a copy of the charter as an
appendix to the proxy statement at least once every three years. The
requirement appears in new paragraph (e)(3) under Item 7 of Schedule
14A. The new disclosure regarding audit committees' charters should
help shareholders assess the role and responsibilities of the audit
committee.
We believe that audit committees that have their responsibilities
set forth in a written charter are more likely to play an effective
role in overseeing the company's financial reports. The amendments,
however, will not require companies to adopt audit committee charters,
or dictate the content of the charter if one is adopted.\59\
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\59\ We note, however, that the revised listing standards of the
NYSE, NASD, and AMEX require the audit committee to: (1) Adopt a
formal written charter that is approved by the full board of
directors and that specifies the scope of the committee's
responsibilities, and how it carries out those responsibilities,
including structure, processes, and membership requirements; and (2)
review and reassess the adequacy of the audit committee's charter on
an annual basis. See supra note 27.
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Several commenters expressed concern that the requirement to attach
the charter would result in boilerplate charters.\60\ We believe that
it is useful for shareholders to know about the responsibilities and
the duties of audit committees,\61\ and while it is inevitable that
some of the same provisions will appear in charters of different audit
committees, we encourage companies to tailor the charters to their
specific circumstances.
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\60\ See, e.g., Letter dated November 29, 1999 from William E.
Eason, Jr., Senior Vice President and General Counsel, Scientific-
Atlanta, Inc.; Letter dated November 29, 1999 from Paul V. Stahlin,
Senior Vice President and Comptroller, Summit Bancorp.
\61\ See, e.g., TIAA-CREF Letter, supra note 42.
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Consistent with some of the comments regarding the audit committee
report, some commenters recommended that the charter be attached to the
Form 10-K instead of the proxy statement because of concerns about
expanding the length of the proxy statement.\62\ We believe that
information about the responsibilities and the duties of audit
committees is most relevant to shareholders when they are electing
directors and reviewing their performance. Accordingly, we have
determined to require, as proposed, that the charter be attached to the
proxy statement every three years.
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\62\ Letter dated November 29, 1999 from David K. Owens, Edison
Electric Institute.
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D. Disclosure About ``Independence'' of Audit Committee Members
As early as 1940, the Commission encouraged the use of audit
committees composed of independent directors. As the Commission staff
stated in a report to Congress in 1978, ``[i]f the [audit] committee
has members with vested interests related to those of management, the
audit committee probably cannot function effectively. In some instances
this may be worse than having no audit committee at all by creating the
appearance of an effective
[[Page 73395]]
body while lacking the substance.'' \63\ Further, as the Blue Ribbon
Committee noted, ``* * * common sense dictates that a director without
any financial, family, or other material personal ties to management is
more likely to be able to evaluate objectively the propriety of
management's accounting, internal control and reporting practices.''
\64\
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\63\ Staff of the SEC, 95th Cong., 2d Sess., Report to Congress
on the Accounting Profession and the Commission's Oversight Role,
Subcommittee on Governmental Efficiency and the District of Columbia
of the Senate Committee on Governmental Affairs, at 97 (Comm. Print
July 1978). See also Blue Ribbon Report, supra note 9, at 22-23;
Treadway Report, supra note 21, at 40-41; In the Matter of McKesson
& Robbins, Accounting Series Release No. 19, Exchange Act Release
No. 2707 (Dec. 5, 1940).
\64\ Blue Ribbon Report, supra note 9, at 22.
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As noted in the Proposing Release, because of the importance of
having an audit committee that is comprised of independent
directors,\65\ we believe that shareholders should know about the
independence of the members. We believe that the new disclosures will
accomplish that goal.
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\65\ See, e.g., TIAA-CREF Letter, supra note 42.
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Under the revised listing standards of the NYSE, AMEX, and NASD,
under exceptional and limited circumstances, companies may appoint to
their audit committee one director who is not independent if the Board
determines that membership on the committee by the individual is
required by the best interests of the corporation and its shareholders,
and the Board discloses, in the next annual proxy statement subsequent
to such determination, the nature of the relationship and the reasons
for that determination. We are adopting, as proposed, the requirement
that companies whose securities are listed on the NYSE or AMEX or
quoted on Nasdaq that have a non-independent audit committee member
disclose the nature of the relationship that makes that individual not
independent and the reasons for the Board's determination to appoint
the director to the audit committee. Small business issuers are not
required to comply with this requirement.
In addition, companies, including small business issuers, whose
securities are listed on the NYSE or AMEX or quoted on Nasdaq, must
disclose whether the audit committee members are independent, as
defined in the applicable listing standards.\66\ While companies are
required to provide in their proxy statements certain disclosures that
relate to the independence of directors,\67\ we thought that it was
important to make the disclosure about all of the audit committee
members' independence explicit and clear for shareholders. For example,
if we required disclosure about only those audit committee members who
are not independent, there would have been an implication that all of
the other members are independent. Because of the importance of having
independent directors on the audit committee, shareholders should be
informed explicitly, rather than implicitly, of each member's status.
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\66\ The revised listing standards of the NASD and AMEX require
that small business issuers have at least two members of their audit
committee, a majority of whom must be independent. In responding to
the new disclosure requirement, small business issuers, of course,
can disclose that the listing standards of the NASD or AMEX do not
require that all members of their audit committee be independent.
See supra note 27.
\67\ Item 7 of Schedule 14A requires companies to provide the
disclosures required by Items 401 and 404(a) and (c) of Regulation
S-K.
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While we recognize that the new requirements of the NYSE, AMEX, and
NASD regarding independence of audit committees need not be complied
with for 18 months, we think that companies will be able to provide the
new disclosures in the first proxy season after year 2000 because, as a
practical matter, to meet the 18-month deadline, most companies will
elect new directors during the year 2000. For other companies, this
will show their progress in moving toward compliance with the listing
requirements.
We are also adopting, as proposed, the requirement that companies,
including small business issuers, whose securities are not listed on
the NYSE or AMEX or quoted on Nasdaq, disclose in their proxy
statements whether, if they have an audit committee, the members are
independent as defined in the NYSE's, AMEX's, or NASD's listing
standards, and which definition was used. These companies would be able
to choose which definition of ``independence'' to apply to the audit
committee members in making the disclosure. Whichever definition is
chosen must be applied consistently to all members of the audit
committee.
E. Safe Harbors
We are adopting, as proposed, ``safe harbors'' for the new
disclosures.\68\ The ``safe harbors'' would track the treatment of
compensation committee reports under Item 402 of Regulation
S-K.\69\ The safe harbors are in paragraph (c) in new Item 306 of
Regulations S-K and S-B and paragraph (e)(v) of Schedule 14A. Under the
``safe harbors,'' the additional disclosure would not be considered
``soliciting material,'' ``filed'' with the Commission, subject to
Regulation 14A or 14C (and, therefore, not subject to the antifraud
provisions of Rules 14a-9 or 14c-6) \70\ or to the liabilities of
Section 18 of the Exchange Act, except to the extent that the company
specifically requests that it be treated as soliciting material, or
specifically incorporates it by reference into a document filed under
the Securities Act or the Exchange Act.
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\68\ See Blue Ribbon Report, supra note 9, at 35, recommending a
safe harbor.
\69\ See Instruction 9 to Item 402(a)(3) of Regulation S-K, 17
CFR 229.402(a)(3).
\70\ The other antifraud provisions of the Exchange Act and
Securities Act of 1933 (the ``Securities Act''), however, would
continue to apply.
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Several commenters recommended that the Commission also provide a
safe harbor from private litigation.\71\ After careful consideration,
we do not believe an additional safe harbor is necessary or
appropriate. As discussed more fully above, in adopting the new rules
and amendments, we do not intend to subject companies or their
directors to increased exposure to liability under the federal
securities laws, or to create new standards for directors to fulfill
their duties under state corporation law. We do not believe that the
disclosure requirements will result in increased exposure to liability
or create new standards. We have modified the disclosure required in
Item 306 in response to commenters' concerns. To the extent the
disclosure requirements would result in more clearly defined procedures
for, and disclosure of, the operation of the audit committee, liability
claims alleging breach of fiduciary duties under state law actually may
be reduced. Accordingly, we believe that the safe harbors adopted are
appropriate and sufficient.
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\71\ See, e.g., Letter dated November 29, 1999 from Katherine K.
Combs, Deputy General Counsel and Corporate Secretary, PECO Energy
Company; Letter dated November 30, 1999 from the American Society of
Corporate Secretaries (the ``ASCS Letter'').
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IV. Applicability to Foreign Private Issuers and Section 15(d)
Reporting Companies
A. Foreign Private Issuers
We proposed to exclude from the new requirements foreign private
issuers with a class of securities registered under Section 12 of the
Exchange Act or that file reports under Section 15(d) of the Exchange
Act.\72\ Foreign private issuers currently are exempt from the proxy
rules, are not required to file Quarterly Reports on Form 10-Q or 10-
QSB,\73\ and are subject to different corporate governance regimes in
their
[[Page 73396]]
home countries. Accordingly, we do not believe it is appropriate to
extend the new requirements to foreign private issuers at this time.
The Commission, however, is continuing to consider how the periodic
reporting requirements for domestic companies should apply to foreign
private issuers.
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\72\ 15 U.S.C. Sec. 78o(d).
\73\ A ``foreign private issuer'' must file reports on Form 6-K
promptly after the information requried by the Form is made public
in accordance with the laws of its home country or a foreign
securities exchange. See 17 CFR 240.13a-16(b).
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B. Section 15(d) Reporting Companies
As noted in the Proposing Release, companies whose reporting
obligations arise solely under Section 15(d) of the Exchange Act are
not required to file proxy statements with the Commission. We solicited
comment on whether we should require those companies to provide the new
disclosures in their Form 10-Ks or some other filing. Because we
believe that the disclosures are most relevant to voting decisions on
the basis of disclosure in proxy statements, and because of the nature
of the market for the securities of such companies, we are not adopting
such a scheme. Accordingly, at this time we are not extending the proxy
statement disclosure requirements to Section 15(d) companies.
V. Compliance Dates
Several commenters requested that we provide a transition period to
allow companies time to consider the rules and to revise, if necessary,
any of their procedures.\74\ We agree, and have provided a transition
period for compliance with the new requirements. Registrants must
obtain reviews of interim financial information by their independent
auditors starting with their Forms 10-Q or 10-QSB to be filed for
fiscal quarters ending on or after March 15, 2000. Registrants must
comply with the new proxy and information disclosure requirements
(e.g., the requirement to include a report of their audit committee in
their proxy statements, provide disclosures regarding the independence
of their audit committee members, and attach a copy of their audit
committee's charter) for all proxy and information statements relating
to votes of shareholders occurring after December 15, 2000. Companies
who become subject to Item 302(a) as a result of today's amendments
must comply with its requirements after December 15, 2000. Registrants
voluntarily may comply with any of the new requirements prior to the
compliance dates.
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\74\See, e.g., ASCS Letter, supra note 71.
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VI. Paperwork Reduction Act
Earlier this year, the staff submitted the proposed amendments to
Regulations 14A and 14C to the Office of Management and Budget
(``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5 CFR
1320.11. Regulations 14A and 14C contain ``collection of information''
requirements within the meaning of the Paperwork Reduction Act of 1995
(44 U.S.C. Sec. 3501 et seq.). The titles for the collections of
information are: (1) Proxy Statements--Regulation 14A (Commission Rules
14a-1 through 14a-15) and Schedule 14A; and (2) Information
Statements--Regulation 14C (Commission Rules 14c-1 through 14c-7) and
Schedule 14C. Also, in accordance with the Paperwork Reduction Act, we
solicited comments on the accuracy of our burden estimates for
Regulations 14A and 14C. We did not receive any comments that address
specifically the estimated paperwork burdens associated with those
collections of information. The comments we received primarily
addressed the costs and benefits of the proposals in general terms, and
liability concerns, rather than issues relating to the collection of
information. Commenters' more generalized concerns about costs and
benefits of the amendments are addressed more fully in the cost-benefit
and other sections of this release.
We proposed and are adopting amendments that will require a company
to include additional disclosures in Schedules 14A and 14C, including
certain information about the company's audit committee. The audit
committee will have to disclose whether it had certain discussions with
management and the company's independent auditors. The substance of the
discussions would not be required to be disclosed. Companies will also
have to disclosure information regarding the independence of audit
committee members. The amendments would also require companies that
have adopted a written charter for their audit committee to include a
copy of the charter as an appendix to Schedules 14A and 14C at least
once every three years. The amendments do not require companies to
prepare charters.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a
currently valid control number. Schedule 14A (OMB Control No. 3235-
0059) \75\ and Schedule 14C (OMB Control No. 3235-0057) \76\ were
adopted pursuant to Sections 14(a) and 14(c) of the Exchange Act.
Schedule 14A prescribes information that a company must include in its
proxy statement to ensure that shareholders are provided material
information relating to voting decisions. Schedule 14C prescribes
information that a company must include in its information statement to
shareholders where votes are solicited by means other than proxies.
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\75\ 17 CFR 240.14a-101.
\76\ 17 CFR 240.14c-101.
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We solicited comments on whether we should require all companies to
comply with Item 302(a) of Regulation S-K. As discussed in previous
sections of the release, Item 302(a) of Regulation S-K currently
requires larger, more widely-held companies to supplement their annual
financial information with disclosures of selected quarterly financial
data. We are amending Item 302(a) to extend the requirements to all
companies (but not small business issuers filing on small business
forms and foreign private issuers) that have securities registered
under Section 12(b) or 12(g) of the Exchange Act. The Item 302(a)
information will continue to appear as a table in the Form 10-K.
Form 10-K under the Exchange Act (OMB Control Number 3235-0063)
\77\ is used by registrants to file annual reports. The title for this
collection of information is Form 10-K. Form 10-K provides a
comprehensive overview of the registrant's business and financial
condition. The Commission estimates that Form 10-K currently results in
a total annual compliance burden of approximately 17,886,463 hours. The
burden was calculated by multiplying the estimated number of entities
filing Form 10-K (approximately 10,381) by the estimated average number
of hours each entity spends completing the Form (approximately 1723
hours). The Commission based the number of entities that complete and
file Form
10-K on the actual number of filers during the 1998 fiscal year. The
staff estimated the average number of hours an entity spends completing
Form 10-K by contacting a number of law firms and other persons
regularly involved in completing the forms.
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\77\ 17 CFR 249.310.
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We estimate that the incremental burden of extending Item 302(a) to
all companies with securities registered under Sections 12(b) or 12(g)
of the Exchange Act (except small business issuers filing on small
business forms) will increase the total by approximately 2000 hours.
This burden was calculated by multiplying the estimated number of
entities that do not currently provide Item 302(a) information by the
number of additional hours it would take to provide the additional
information. The staff estimates that approximately 8000 Form 10-K
filers do not currently provide Item 302(a) information, and
[[Page 73397]]
that it would take a total of approximately .25 hours to include the
new disclosure in a Form 10-K. The Commission based the number of Form
10-K filers not currently providing Item 302(a) information on the
approximate number of companies in the Compustat database that
currently are required to file Item 302(a) information based on the
criteria set forth in Item 302(a) of Regulation S-K.
We believe that the amendments will promote investor confidence in
the securities markets by informing investors about the important role
that audit committees play in the financial reporting process and will
enhance the reliability and credibility of financial statements of
public companies.
Compliance with the disclosure requirements is mandatory. There
will be no mandatory retention period for the information disclosed,
and responses to the disclosure requirements will not be kept
confidential.
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits
comments to: (i) Evaluate whether the revised rule is necessary for the
proper performance of the functions of the agency, including whether
the information will have practical utility; (ii) evaluate the accuracy
of the Commission's estimate of the burden of the proposed collection
of information; (iii) determine whether there are ways to enhance the
quality, utility, and clarity of the information to be collected; and
(iv) evaluate whether there are ways to minimize the burden of the
collection of information on those who are to respond, including
through the use of automated collection techniques or other forms of
information technology.
Persons submitting comments on the collection of information
requirements for Form 10-K should direct the comments to the Office of
Management and Budget, Attention: Desk Officer for the Securities and
Exchange Commission, Office of Information and Regulatory Affairs,
Washington, DC 20503, and should send a copy to Jonathan G. Katz,
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW,
Washington, DC 20549-0609, with reference to File No. S7-22-99.
Requests for materials submitted to OMB by the Commission with regard
to these collections of information should be in writing, refer to File
No. S7-22-99, and be submitted to the Securities and Exchange
Commission, Records Management, Office of Filings and Information
Services. OMB is required to make a decision concerning the collection
of information between 30 and 60 days after publication of this
release. Consequently, a comment to OMB is assured of having its full
effect if OMB receives it within 30 days of publication.
VII. Cost-Benefit Analysis
The amendments are expected to improve disclosure related to the
functioning of the corporate audit committees and to enhance the
reliability and credibility of financial statements of public
companies. We believe that the amendments will promote investor
confidence in the securities markets by informing investors about the
important role that audit committees play in the financial reporting
process. As the Blue Ribbon Committee summarized:
Improving oversight of the financial reporting process
necessarily involves the imposition of certain burdens and costs on
public companies. Despite these costs, the Committee believes that a
more transparent and reliable financial reporting process ultimately
results in a more efficient allocation of and lower cost of capital.
To the extent that instances of outright fraud, as well as other
practices that result in lower quality financial reporting, are
reduced with improved oversight, the benefits clearly justify these
expenditures of resources.\78\
\78\ Blue Ribbon Report, supra note 9, at 19.
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As noted above, the amendments are part of a larger, coordinated
series of actions by the NYSE, NASD, AMEX, and the accounting
profession that were recommended by the Blue Ribbon Committee to
improve the financial reporting process. The Commission's rule
amendments and new rules complement and strengthen the efforts of the
NYSE, NASD, AMEX and the accounting profession. This cost-benefit
analysis concentrates only on the effect of the Commission's rules. The
benefits of the new requirements cannot be readily quantified.\79\
However, these measures should mitigate inappropriate earnings
management, enhance the reliability of financial information, improve
disclosure to investors, and could improve securities pricing
efficiency by encouraging the distribution of higher quality earnings
numbers on a more timely basis.
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\79\ OMB, Report to Congress on the Costs and Benefits of
Federal Regulation 21 (1998) (OMB has recognized that while it may
be difficult to quantify the benefits of disclosure requirements,
there is a strong consensus among economists that, in general,
disclosure-based regulatory schemes can improve the functioning of
markets and produce significant benefits for consumers).
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Reviews of Quarterly Financial Statements
We are requiring interim reviews of quarterly financial statements
filed on Form 10-Q or 10-QSB.\80\ Under the amendments, a company's
quarterly financial statements must be reviewed by independent auditors
using ``professional standards and procedures for conducting such
reviews, as established by generally accepted auditing standards, as
may be modified or supplemented by the Commission.'' Currently, that
means that the review would follow the procedures established by SAS
71. The amendments apply only to the financial information contained in
the company's Quarterly Reports on Form 10-Q or 10-QSB. Accordingly,
the amendments do not require any review of quarterly financial
information released to the public before the filing of the Form 10-Q
or 10-QSB, such as the so-called quarterly ``earnings release.''
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\80\ See Section III.A above.
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We believe that companies are under increasing pressure to meet
financial analysts' expectations, and that pressure can be even more
acute in the context of reports on quarterly earnings. We believe that
the participation of auditors in the financial reporting process at
interim dates will help to counterbalance that pressure and impose
increased discipline on the process of preparing interim financial
information.\81\ Auditor involvement in the financial reporting process
earlier in the year should facilitate timely identification and
resolution of significant and sensitive issues and result in fewer
year-end adjustments, which should reduce the cost of annual
audits.\82\ The increased focus and discipline imposed on the
preparation of interim financial statements should enhance the
efficiency of the capital markets by improving the reliability of
quarterly financial statements, although these benefits are difficult
to quantify.
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\81\ COSO Report, supra note 26, at 34 (``Close scrutiny of
quarterly financial information and a move toward continuous
auditing strategies may increase opportunities for earlier detection
of financial statement improprieties'').
\82\ See, e.g., AIMR Letter, supra note 33.
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We have prepared our best estimate of the incremental costs of
preparing a SAS 71 review for those companies not currently having them
performed. Our estimate of those incremental costs is based on data
provided to the staff by the SEC Practice Section of the AICPA
(``SECPS''), discussions with experienced practitioners, the
experiences of current SEC staff members, and data provided by
commenters.
Firms providing information to the SECPS indicated that the
procedures they currently use are similar, if not the same, as those
described in SAS 71. Most indicated that review reports are seldom
issued. The firms also indicated
[[Page 73398]]
that they are not aware of (and do not expect) clients switching
auditing firms because of their new policies.
The firms providing information to the SECPS identified several
unquantifiable benefits that they believe would result from the
reviews, including better interim reporting, earlier identification and
resolution of accounting issues, improvement in the quality of
accounting estimates, and improved communications between clients and
auditors. These benefits could also improve pricing efficiency of the
issuer's securities. Several comment letters from accounting firms
supported this view.\83\ Medium and smaller sized accounting firms,
however, indicated to the SECPS that SAS 71 reviews of small companies'
interim financial statements may cause delays in filing Forms 10-Q or
10-QSB, be relatively more costly for small companies, be hampered by
inadequate financial reporting processes, and would result in small
companies shifting work from the company to the CPA firm. One small
business commenter expressed concern that increased pressure to meet
the filing deadlines would require hiring another employee.\84\ Based
on staff experience and discussions with practitioners, we believe many
of the required review procedures can be performed simultaneously with
the preparation of the quarterly financial statements, and accordingly,
should not delay these filings. In addition, we believe that the same
management personnel who work with the auditors at year end should be
able to assist with the quarterly reviews.
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\83\ See, e.g., KPMG Letter, supra note 25 (``In our experience
that policy [of conducting SAS 71 reviews] has resulted in the
earlier identification of accounting and reporting issues and has
therefore enhanced the quality of interim financial reporting'').
\84\ Letter dated November 22, 1999 from Michael Dee.
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The firms responding to the SECPS generally indicated that the
costs of reviews of quarterly financial statements vary depending on
several factors, including: (i) The sophistication of the client's
accounting and reporting system; (ii) The quality of the client's
accounting personnel; (iii) The identification of ``fraud risk
factors;'' (iv) The client's industry; (v) The number and location of
the client's subsidiaries; (vi) The seasonality of the client's
business; (vii) The existence of contentious accounting issues; and
(viii) Whether there will be a staffing ``crunch'' at the firm to
handle the reviews each quarter.
The five largest U.S. accounting firms, the so-called ``Big 5,''
and some other firms, currently have in place policies that require
their clients to have interim reviews as a condition to acceptance of
an audit. Based on the Compustat database and information from the
SECPS and from commenters, we estimate that approximately 8,934
companies for calendar year 1998 retained auditors that require SAS 71
reviews. Based on a total of approximately 12,972 Forms 10-K and 10-KSB
filed in 1998, we therefore estimate that approximately 4,038 companies
are not currently subject to SAS 71 reviews.
Based on the data provided to staff by the SECPS, our experience,
and information from commenters, we estimate the incremental cost to
conduct a SAS 71 review will be nominal for those companies currently
audited by the Big 5 firms and for the remaining companies would range
from approximately $1,000 to about $4,000 \85\ per quarter. Multiplying
$7,500 (the midpoint of the average cost per firm of $3,000 to $12,000
per year) by 4038 produces an estimated $30 million a year cost for SAS
71 reviews.\86\ Obviously, if more companies are currently subject to
SAS 71 reviews, or if the cost of the reviews is offset by a reduction
in annual fees, the cost estimate would be smaller.
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\85\ One non-Big 5 accounting firm indicated in its comment
letter that the upper end of the range (i.e., about $4,000 per
quarter) comported with its experience for small to medium size
companies. Letter dated October 14, 1999 from Edward W. O'Connell,
Wiss & Company, LLP.
\86\ At the proposing stage, we used 2,150 companies to reach an
estimate of $16 million.
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Disclosure Related to the Functioning of the Audit Committee
The principal benefits of the proposals are improved disclosure
relating to the functioning of corporate audit committees and enhanced
reliability and credibility of financial statements. The benefits of
improved disclosure regarding the audit committee's communications with
management and the independent auditors are not readily quantifiable.
We believe, however, that they would include increased market
efficiency due to improved information and investor confidence in the
reliability of companies' financial disclosures. As discussed above,
most of the commenters supported the goals of improving disclosure
about audit committees, although some suggested alternative disclosure
requirements. Commenters' principal concern was that audit committees
may be exposed to additional liability, with the result that they would
find it more difficult to recruit qualified audit committee members;
others disagreed with that view. As discussed above, we modified the
Item 306 audit committee report requirement to respond to commenters'
concerns about liability.
We believe the costs associated with these amendments would derive
principally from the disclosure obligations--we are not placing any
substantive requirements on audit committees or their members. At the
proposing stage, we estimated that the additional disclosure
contemplated by the amendments would, on average, require less than
three-fourths of a page in a company's proxy statement, based on the
staff's experience with proxy statements, and analogous cost estimates.
A financial printing company informed the staff that this disclosure
would not likely increase the printing cost because up to three-fourths
of a page can normally be incorporated without increasing the page
length by reformatting the document. The printer reported that adding
one more page could increase costs by about $1,500 for an average sized
company.
Only a few commenters mentioned printing costs, with one stating
that the costs of printing the charter in the proxy statement ``could
be significant,'' but did not quantify the amount.\87\ We continue to
believe that the printing costs of the disclosures and charter \88\
would not be significant. The charter, for example, needs to be printed
only once every three years, so the cost has been averaged over three
years. We estimate the total average disclosure per year--the average
annual burden of printing the charter and the other disclosures--would
be one printed proxy statement page. Consequently, the annual aggregate
cost would be approximately $15 million.\89\
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\87\ See NYS Bar Letter, supra note 25.
\88\ Preparation of the charter is required by the NYSE, NASD,
and AMEX and not the Commission's rules.
\89\ The $15 million figure derives from one page at $1,500 per
page for approximately 10,145 companies.
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This amount, however, does not include possible ``start up'' costs
for some companies. First, some companies may have to set up procedures
to monitor the activities of their audit committee in order to collect
and record the information required by the amendments. In our view,
such monitoring costs are most likely to result from disclosing the
fact of the audit committee's discussions with management and the
independent auditors and receiving from the independent auditors
certain required disclosures and a letter from the
[[Page 73399]]
independent auditors. We believe such monitoring costs will be
insignificant.
Second, some companies may seek the help of outside experts,
particularly outside legal counsel, in formulating responses to the new
requirements.\90\ In some circumstances, for instance, the audit
committee may seek the advice of legal counsel before making the
required disclosure about the audited financial statements. Commenters
provided no cost data. We understand that many audit committees already
use outside experts, but do not know what, if any, incremental cost
there will be. As we modified our proposals to reflect better the
oversight role of audit committees and address liability concerns, we
anticipate that any costs attributable to the increased use of outside
experts to respond to the new disclosure requirements will be
negligible.
---------------------------------------------------------------------------
\90\ See, e.g., Letter dated November 19, 1999 from Patricia
Gallup, Chairman of the Board, PC Connection, Inc.
---------------------------------------------------------------------------
For purposes of the Paperwork Reduction Act, we estimated that our
required disclosures would, on average, impose one additional burden
hour, exclusive of printing costs, on each filer of Schedule 14A or
14C, or an aggregate annual total of 10,145 additional burden hours.
This estimate reflects the time companies would spend preparing the
additional disclosures in the proxy statement.\91\ The total annual
costs accordingly would be approximately $1 million.
---------------------------------------------------------------------------
\91\ The estimate does not include the amount of time the audit
committee would spend conducting the discussions with the
independent accountants and management to which new Item 306 of
Regulations S-K and S-B and the amendments to Item 7 of Schedule 14A
refer. The amendments would not require that the audit committee
hold the discussions, but merely that it disclose whether the
discussions have taken place.
---------------------------------------------------------------------------
These amendments are not intended to increase companies' or
directors' exposure to liability under federal or state law. A number
of commenters indicated that, in their assessment, the proposals would
have the effect of increasing the companies' and/or directors' exposure
to liability, with attendant costs, but provided no economic data. For
the reasons discussed in previous sections of this release, we believe
that the amendments will likely result in better and more reliable
financial reporting, but should not increase liability exposure. In
particular, we modified requirements to address this liability concern.
In addition, the amendments include liability ``safe harbors'' similar
to those that apply to compensation committee reports under current
rules.\92\
---------------------------------------------------------------------------
\92\ See Section III.E above.
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Item 302(a) of Regulation S-K
The Commission is requiring more companies to provide the
supplemental financial information described in Item 302 of Regulation
S-K. That information consists of selected quarterly financial data,
such as net sales and gross profit, for the prior two years. We
recognize that requiring all public companies (except Form S-B filers,
Section 15(d) reporting companies, and foreign private issuers) to
provide supplemental financial information under Item 302(a) of
Regulation S-K may have some incremental cost. Currently only certain
large, widely-held companies that meet certain tests (involving, among
other things, the number of security holders, stock price, and market
capitalization) must file supplemental financial information. Taking
into account that auditors will be performing SAS 71 reviews for these
companies, the incremental cost of preparing and presenting the
supplementary financial information is small.
Based on the staff's experience, we do not believe that it will
take company employees much time to pull the data from their prior
quarterly reports to prepare the supplementary financial information
for the Form 10-K. While the information will take up part of an
additional page in the Form 10-K, there are no printing costs
attributable to disclosure of this information since it is not
typically contained in the annual report that is printed and
distributed to investors.
We believe the supplementary financial information is a useful
resource for investors and justifies the cost of its collection and
filing. By tying the regulatory threshold to an existing, widely used
test (e.g., the definition of small business issuer in Regulation S-B),
the Commission is simplifying the regulatory scheme. Such
simplification is an additional benefit of the amendments.
VIII. Consideration of Impact on the Economy, Burden on
Competition, and Promotion of Efficiency, Competition, and Capital
Formation
Section 3(f) of the Exchange Act requires the Commission, when
engaging in rulemaking that requires it to consider or determine
whether an action is necessary or appropriate in the public interest,
also to consider whether the action will promote efficiency,
competition, and capital formation. We believe that the proposals will
promote investor confidence in the securities markets by improving the
transparency of the role of corporate audit committees and enhancing
the reliability and credibility of financial statements of public
companies. More reliable financial statements should help to lower the
costs of capital. Accordingly, the proposals should promote capital
formation and market efficiency.
Section 23(a) of the Exchange Act requires the Commission, when
adopting rules under the Exchange Act, to consider the impact on
competition of any rule it adopts. We do not believe that the proposals
would have any anti-competitive effects since the proposals should
improve the transparency, reliability, and credibility of companies'
financial statements. We requested comment on any anti-competitive
effects of the proposals. For the reasons discussed above, we have
decided to exclude foreign private issuers from these disclosure
requirements. Any competitive effect that may occur by requiring
domestic public companies to comply with these additional disclosure
requirements, compared to foreign private issuers, is necessary and
appropriate for the protection of investors.
IX. Final Regulatory Flexibility Analysis
This Final Regulatory Flexibility Analysis has been prepared in
accordance with the Regulatory Flexibility Act (``RFA''). It relates to
amendments to Rule 10-01 of Regulation S-X, Item 310 of Regulation S-B,
Item 302(a) of Regulation S-K, Item 7 of Schedule 14A under the
Exchange Act, and new Item 306 of Regulations S-B and S-K.
A. Need for the Rules and Rule Amendments
The new rules and amendments to current rules are designed to
improve disclosure relating to the functioning of corporate audit
committees and to enhance the reliability and credibility of financial
statements of public companies. The required disclosure will help
inform shareholders of the audit committee's role in overseeing the
preparation of the financial statements and underscore the importance
of the audit committee's participation in the financial reporting
process.
The required reviews of interim financial information should
facilitate early identification and resolution of material accounting
and reporting issues because the auditors will be involved earlier in
the year. More reliable interim financial information will be available
to investors, and early involvement of the auditors should reduce the
number of restatements or other year-end adjustments. We believe that
the disclosures will reinforce the audit
[[Page 73400]]
committee's awareness of its responsibilities, and make visible for
shareholders the audit committee's role in promoting reliable and
transparent financial reporting.
B. Significant Issues Raised by Public Comment
Many commenters were concerned that the proposed rules would expose
audit committee members to increased scrutiny and liability. As a
result, those commenters suggested that we amend certain disclosure
requirements and provide an additional safe harbor from private
litigation. We modified the required audit committee report to address
the liability concerns, and consequently, as discussed in previous
sections of this release, we do not believe additional safe harbors are
necessary or appropriate. We are adopting, as proposed, the same report
requirements and safe harbors for companies of all sizes.
The Commission requested comment on whether the scope of the
proposed rules should be narrowed to exclude companies under a certain
size. Some commenters questioned the need for interim reviews for small
entities,\93\ particularly in light of the additional costs. However,
we continue to believe that improving the interim reporting process is
important for small companies. Investors rely on and react quickly to
quarterly results of companies, large and small. Moreover, the COSO
Report found that the incidence of financial fraud was greater at small
companies.\94\ The COSO Report specifically noted that the
``concentration of fraud among companies with under $50 million in
revenues and with generally weak audit committees highlights the
importance of rigorous audit committee practices, even for smaller
organizations.'' \95\ In light of the COSO Report, we believe it would
be inconsistent with the purposes of the rule to exempt small business
issuers from the proposed requirement for interim reviews.
---------------------------------------------------------------------------
\93\ See ABA Letter, supra note 34.
\94\ See generally COSO Report, supra note 26. In fact, the COSO
Report specifically found that a ``regulatory focus on companies
with market capitalization in excess of $200 million may fail to
target companies with greater risk for financial statement fraud
activities.'' Id. at 4.
\95\ COSO Report, supra note 26, at 5.
---------------------------------------------------------------------------
We also solicited comment on whether we should require all
companies to comply with Item 302(a) of Regulation S-K. Commenters
generally agreed that we should extend the requirements to other
companies, but questioned the need to include small companies. We are
adopting the Item 302(a) requirement for all Section 12(b) and 12(g)
registered companies (except small business issuers reporting on small
business forms) to maintain the more simplified reporting format of the
regulatory scheme for small business issuers.
C. Small Entities Subject to the Rule
For purposes of the RFA, Exchange Act Rule 0-10 defines ``small
business'' as a company whose total assets on the last day of its most
recent fiscal year were $5 million or less.\96\ The rules will affect
small businesses that are required to file proxy materials on Schedule
14A or 14C and Quarterly Reports on Form 10-Q or 10-QSB under the
Exchange Act. We estimate that there are approximately 830 reporting
companies (that are not investment companies) with assets of $5 million
or less. The Commission bases its estimate on information from the
Insight database from Compustat, a division of Standard and Poors.
---------------------------------------------------------------------------
\96\ A ``small business issuer'' under Regulation
S-B, however, is a company with less than $25 million in revenues
and market capitalization.
---------------------------------------------------------------------------
D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
1. Reviews of Quarterly Financial Statements
The rules will require companies to engage their independent
auditors to conduct interim reviews of their quarterly financial
statements prior to the company filing its Forms 10-Q or 10-QSB. Based
on information provided to the Commission by the SECPS,\97\ it appears
that most companies already engage their independent auditors to
undertake some level of review of their quarterly financial statements.
---------------------------------------------------------------------------
\97\ See Section VII above.
---------------------------------------------------------------------------
Medium and smaller sized accounting firms indicated to the SECPS
that SAS 71 reviews of small companies' interim financial statements
may cause delays in filing Forms 10-Q or 10-QSB, be relatively more
costly for all companies, be hampered by inadequate financial reporting
processes, and would result in small companies shifting financial
responsibilities from the company to the CPA firm.
However, based on the SECPS survey, we believe that the costs of
compliance would be partially offset by a reduction in year-end audit
fees and would lead to earlier identification of accounting and
auditing issues and an improvement in the quality of the process used
for preparing interim financial reports.
2. Disclosure Related to the Functioning of the Audit Committee
Issuers, both large and small, will be required to provide certain
additional disclosure in their proxy statements regarding the company's
audit committee, including attaching every three years a copy of the
audit committee's charter, if they have one. Companies will be required
to include reports of their audit committees in which the audit
committee provides disclosure about whether certain discussions between
the audit committee and management and the auditors took place. No
disclosure of the substance of the discussions is required. The
increased disclosure will require all entities, large and small, to
spend additional time and incur additional costs in preparing
disclosures. In particular, smaller companies may incur additional
costs to set up procedures in order to respond to the new disclosure
requirements. Smaller companies may also incur additional costs in
seeking the help of outside experts, particularly outside legal
counsel, in formulating responses to the new requirements.
3. Disclosure Related to Independence
We are requiring that companies whose securities are listed on the
NYSE, AMEX, or traded on Nasdaq make certain disclosures about any
member of the audit committee who is not independent (small business
issuers are not subject to that requirement) and whether the audit
committee members are independent. Companies, including small business
issuers, whose securities are not listed on the NYSE or AMEX or quoted
on Nasdaq are required to disclose whether their members are
independent, but may choose which definition of independence to use and
must disclose which definition was used.
E. Agency Action To Minimize Effect on Small Entities
As required by Section 603 of the RFA, the Commission has
considered the following alternatives to minimize the economic impact
of the rules on small entities: (a) The establishment of differing
compliance or reporting requirements or timetables that take into
account the resources available to small entities; (b) the
clarification, consolidation, or simplification of compliance and
reporting requirements under the rules for small entities; (c) the use
of performance rather than design standards; and (d) an exemption from
coverage of the rules, or any part thereof, for small entities.
[[Page 73401]]
We continue to believe investors in smaller companies would want
and benefit from the disclosures about the audit committee and the
advantages of interim reviews just as much as investors in larger
companies. We have made some adjustments to the rules to decrease their
impact on small businesses. For example, we did not extend Item 302(a)
to small business issuers filing on small business forms.
In addition, small businesses not subject to the NASD's, AMEX's or
NYSE's listing standards can choose which definition of independence to
use, as long as it is used consistently. Further, small business
issuers are not required to state the reasons for including a non-
independent audit committee member, since under the listing standards,
they are not required to have all independent members on their audit
committees.
Finally, to provide companies with the opportunity to evaluate
their compliance with the revised listing standards of the NASD, AMEX,
and NYSE and to prepare for the new disclosure requirements, we are
providing transition periods for compliance with the new requirements,
which should benefit all companies, large and small.
X. Statutory Bases and Text of Amendments
We are adopting amendments to Rules 10-01 of Regulation S-X and
14a-101 (Schedule 14A), Item 310 of Regulation S-B, and Item 302(a) of
Regulation
S-K, and adopting new Item 306 of Regulations S-K and S-B, under the
authority set forth in Sections 2, 13, 14, and 23 of the Exchange Act.
List of Subjects
17 CFR Part 210
Accountant, Accounting, Reporting and recordkeeping requirements,
Securities.
17 CFR Part 228
Reporting and recordkeeping requirements, Securities, Small
businesses.
17 CFR Parts 229 and 240
Reporting and recordkeeping requirements, Securities.
Text of Amendments
In accordance with the foregoing, Title 17, Chapter II of the Code
of Federal Regulations is amended as follows:
PART 210--FORM AND CONTENT OF AND REQUIREMENTS FOR FINANCIAL
STATEMENTS, SECURITIES ACT OF 1933, SECURITIES EXCHANGE ACT OF
1934, PUBLIC UTILITY HOLDING COMPANY ACT OF 1935, INVESTMENT
COMPANY ACT OF 1940, AND ENERGY POLICY AND CONSERVATION ACT OF 1975
1. The authority citation for part 210 continues to read as
follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77aa(25),
77aa(26), 78j-1, 78l, 78m, 78n, 78o(d), 78u-5, 78w(a), 78ll(d),
79e(b), 79j(a), 79n, 79t(a), 80a-8, 80a-20, 80a-29, 80a-30, 80a-
37(a), unless otherwise noted.
2. By amending Sec. 210.10-01 by revising paragraph (d) to read as
follows:
Sec. 210.10-01 Interim financial statements.
* * * * *
(d) Interim review by independent public accountant. Prior to
filing, interim financial statements included in quarterly reports on
Form 10-Q (17 CFR 249.308(a)) must be reviewed by an independent public
accountant using professional standards and procedures for conducting
such reviews, as established by generally accepted auditing standards,
as may be modified or supplemented by the Commission. If, in any
filing, the company states that interim financial statements have been
reviewed by an independent public accountant, a report of the
accountant on the review must be filed with the interim financial
statements.
* * * * *
PART 228--INTEGRATED DISCLOSURE SYSTEM FOR SMALL BUSINESS ISSUERS
3. The authority citation for part 228 continues to read as
follows:
Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 77k, 77s, 77z-2,
77aa(25), 77aa(26), 77ddd, 77eee, 77ggg, 77hhh, 77jjj, 77nnn, 77sss,
78l, 78m, 78n, 78o, 78u-5, 78w, 78ll, 80a-8, 80a-29, 80a-30, 80a-37,
80b-11, unless otherwise noted.
4. Section 228.305 is added and reserved and Sec. 228.306 is added
to read as follows:
Sec. 228.305 [Reserved]
Sec. 228.306 (Item 306) Audit committee report.
(a) The audit committee must state whether:
(1) The audit committee has reviewed and discussed the audited
financial statements with management;
(2) The audit committee has discussed with the independent auditors
the matters required to be discussed by SAS 61, as may be modified or
supplemented;
(3) The audit committee has received the written disclosures and
the letter from the independent accountants required by Independence
Standards Board Standard No. 1 (Independence Standards Board Standard
No. 1, Independence Discussions with Audit Committees), as may be
modified or supplemented, and has discussed with the independent
accountant the independent accountant's independence; and
(4) Based on the review and discussions referred to in paragraphs
(a)(1) through (a)(3) of this Item, the audit committee recommended to
the Board of Directors that the audited financial statements be
included in the company's Annual Report on Form 10-KSB (17 CFR
249.310b) for the last fiscal year for filing with the Commission.
(b) The name of each member of the company's audit committee (or,
in the absence of an audit committee, the board committee performing
equivalent functions or the entire board of directors) must appear
below the disclosure required by this Item.
(c) The information required by paragraphs (a) and (b) of this Item
shall not be deemed to be ``soliciting material,'' or to be ``filed''
with the Commission or subject to Regulation 14A or 14C (17 CFR
240.14a-1 et seq. or 240.14c-1 et seq.), other than as provided in this
Item, or to the liabilities of section 18 of the Exchange Act (15
U.S.C. 78r), except to the extent that the company specifically
requests that the information be treated as soliciting material or
specifically incorporates it by reference into a document filed under
the Securities Act or the Exchange Act.
(d) The information required by paragraphs (a) and (b) of this Item
need not be provided in any filings other than a registrant proxy or
information statement relating to an annual meeting of security holders
at which directors are to be elected (or special meeting or written
consents in lieu of such meeting). Such information will not be deemed
to be incorporated by reference into any filing under the Securities
Act or the Exchange Act, except to the extent that the registrant
specifically incorporates it by reference.
5. By amending Sec. 228.310 by revising the introductory text of
paragraph (b) to read as follows:
Sec. 228.310 (Item 310) Financial Statements.
* * * * *
(b) Interim Financial Statements. Interim financial statements may
be unaudited; however, prior to filing,
[[Page 73402]]
interim financial statements included in quarterly reports on Form 10-
QSB (17 CFR 249.308b) must be reviewed by an independent public
accountant using professional standards and procedures for conducting
such reviews, as established by generally accepted auditing standards,
as may be modified or supplemented by the Commission. If, in any
filing, the issuer states that interim financial statements have been
reviewed by an independent public accountant, a report of the
accountant on the review must be filed with the interim financial
statements. Interim financial statements shall include a balance sheet
as of the end of the issuer's most recent fiscal quarter and income
statements and statements of cash flows for the interim period up to
the date of such balance sheet and the comparable period of the
preceding fiscal year.
* * * * *
PART 229--STANDARD INSTRUCTIONS FOR FILING FORMS UNDER SECURITIES
ACT OF 1933, SECURITIES EXCHANGE ACT OF 1934 AND ENERGY POLICY AND
CONSERVATION ACT OF 1975--REGULATION S-K
6. The authority citation for part 229 continues to read in part as
follows:
Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 77k, 77s, 77z-2,
77aa(25), 77aa(26), 77ddd, 77eee, 77ggg, 77hhh, 77iii, 77jjj, 77nnn,
77sss, 78c, 78i, 78j, 78l, 78m, 78n, 78o, 78u-5, 78w, 78ll(d), 79e,
79n, 79t, 80a-8, 80a-29, 80a-30, 80a-37, 80b-11, unless otherwise
noted.
* * * * *
7. By amending Sec. 229.302 by revising paragraph (a)(5) to read as
follows:
Sec. 229.302 (Item 302) Supplementary financial information.
(a) Selected quarterly financial data. * * *
(5) This paragraph (a) applies to any registrant, except a foreign
private issuer, that has securities registered pursuant to sections
12(b) (15 U.S.C. Sec. 78l(b)) (other than mutual life insurance
companies) or 12(g) of the Exchange Act (15 U.S.C. Sec. 78l(g)).
* * * * *
8. By adding Sec. 229.306 to read as follows:
Sec. 229.306 (Item 306) Audit committee report.
(a) The audit committee must state whether:
(1) The audit committee has reviewed and discussed the audited
financial statements with management;
(2) The audit committee has discussed with the independent auditors
the matters required to be discussed by SAS 61 (Codification of
Statements on Auditing Standards, AU Sec. 380), as may be modified or
supplemented;
(3) The audit committee has received the written disclosures and
the letter from the independent accountants required by Independence
Standards Board Standard No. 1 (Independence Standards Board Standard
No. 1, Independence Discussions with Audit Committees), as may be
modified or supplemented, and has discussed with the independent
accountant the independent accountant's independence; and
(4) Based on the review and discussions referred to in paragraphs
(a)(1) through (a)(3) of this Item, the audit committee recommended to
the Board of Directors that the audited financial statements be
included in the company's Annual Report on Form 10-K (17 CFR 249.310)
(or, for closed-end investment companies registered under the
Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.), the annual
report to shareholders required by Section 30(e) of the Investment
Company Act of 1940 (15 U.S.C. 80a-29(e)) and Rule 30d-1 (17 CFR
270.30d-1) thereunder) for the last fiscal year for filing with the
Commission.
(b) The name of each member of the company's audit committee (or,
in the absence of an audit committee, the board committee performing
equivalent functions or the entire board of directors) must appear
below the disclosure required by this Item.
(c) The information required by paragraphs (a) and (b) of this Item
shall not be deemed to be ``soliciting material,'' or to be ``filed''
with the Commission or subject to Regulation 14A or 14C (17 CFR
240.14a-1 et seq. or 240.14c-1 et seq.), other than as provided in this
Item, or to the liabilities of section 18 of the Exchange Act (15
U.S.C. 78r), except to the extent that the company specifically
requests that the information be treated as soliciting material or
specifically incorporates it by reference into a document filed under
the Securities Act or the Exchange Act.
(d) The information required by paragraphs (a) and (b) of this Item
need not be provided in any filings other than a company proxy or
information statement relating to an annual meeting of security holders
at which directors are to be elected (or special meeting or written
consents in lieu of such meeting). Such information will not be deemed
to be incorporated by reference into any filing under the Securities
Act or the Exchange Act, except to the extent that the company
specifically incorporates it by reference.
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
9. The authority citation for part 240 continues to read, in part,
as follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77eee,
77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78f, 78i, 78j, 78j-1, 78k,
78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 78w, 78x, 78ll(d),
78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4 and
80b-11, unless otherwise noted.
* * * * *
10. By amending Sec. 240.14a-101 by adding paragraph (e)(3) to Item
7 to read as follows:
Sec. 240.14a-101 Schedule 14A. Information required in proxy
statement.
* * * * *
Item 7. Directors and executive officers. * * *
(e) * * *
(3) If the registrant has an audit committee:
(i) Provide the information required by Item 306 of Regulation
S-K (17 CFR 229.306).
(ii) State whether the registrant's Board of Directors has
adopted a written charter for the audit committee.
(iii) Include a copy of the written charter, if any, as an
appendix to the registrant's proxy statement, unless a copy has been
included as an appendix to the registrant's proxy statement within
the registrant's past three fiscal years.
(iv)(A) For registrants whose securities are listed on the New York
Stock Exchange (``NYSE'') or American Stock Exchange (``AMEX'') or
quoted on Nasdaq:
(1) Disclose whether the members of the audit committee are
independent (as independence is defined in Sections 303.01(B)(2)(a)
and (3) of the NYSE's listing standards, Section 121(A) of the
AMEX's listing standards, or Rule 4200(a)(15) of the National
Association of Securities Dealers' (``NASD'') listing standards, as
applicable and as may be modified or supplemented); and
(2) If the registrant's Board of Directors determines in
accordance with the requirements of Section 303.02(D) of the NYSE's
listing standards, Section 121(B)(b)(ii) of the AMEX's listing
standards, or Section 4310(c)(26)(B)(ii) or 4460(d)(2)(B) of the
NASD's listing standards, as applicable and as may be modified or
supplemented, to appoint one director to the audit committee who is
not independent, disclose the nature of the relationship that makes
that individual not independent and the reasons for the Board's
determination. Small business issuers (17 CFR 228.10(a)(1)) need not
provide the information required by this paragraph (e)(3)(iv)(A)(2).
(B) For registrants, including small business issuers, whose
securities are not listed on the NYSE or AMEX or quoted on Nasdaq,
disclose whether, if the registrant
[[Page 73403]]
has an audit committee, the members are independent. In determining
whether a member is independent, registrants must use the definition
of independence in Sections 303.01(B)(2)(a) and (3) of the NYSE's
listing standards, Section 121(A) of the AMEX's listing standards,
or Rule 4200(a)(15) of the NASD's listing standards, as such
sections may be modified or supplemented, and state which of these
definitions was used. Whichever definition is chosen must be applied
consistently to all members of the audit committee.
(v) The information required by paragraph (e)(3) of this Item
shall not be deemed to be ``soliciting material,'' or to be
``filed'' with the Commission or subject to Regulation 14A or 14C
(17 CFR 240.14a-1 et seq. or 240.14c-1 et seq.), other than as
provided in this Item, or to the liabilities of section 18 of the
Exchange Act (15 U.S.C. 78r), except to the extent that the
registrant specifically requests that the information be treated as
soliciting material or specifically incorporates it by reference
into a document filed under the Securities Act or the Exchange Act.
Such information will not be deemed to be incorporated by reference
into any filing under the Securities Act or the Exchange Act, except
to the extent that the registrant specifically incorporates it by
reference.
(vi) The disclosure required by this paragraph (e)(3) need only
be provided one time during any fiscal year.
(vii) Investment companies registered under the Investment
Company Act of 1940 (15 U.S.C. 80a-1 et seq.), other than closed-end
investment companies, need not provide the information required by
this paragraph (e)(3).
* * * * *
Dated: December 22, 1999.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-33849 Filed 12-29-99; 8:45 am]
BILLING CODE 8010-01-U
