[Federal Register Volume 61, Number 169 (Thursday, August 29, 1996)]
[Proposed Rules]
[Pages 45730-45735]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-21889]
[[Page 45729]]
_______________________________________________________________________
Part VII
Securities and Exchange Commission
_______________________________________________________________________
17 CFR Parts 210 and 240
Implementation of Section 10A of the Securities Exchange Act of 1934;
Proposed Rule
Federal Register / Vol. 61, No. 169 / Thursday, August 29, 1996 /
Proposed Rules
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 210 and 240
[Release No. 34-37594; IC-22162; File No. S7-20-96].
RIN 3235-AG70
Implementation of Section 10A of the Securities Exchange Act of
1934
AGENCY: Securities and Exchange Commission.
ACTION: Proposed Rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'' or
``SEC'') today is soliciting comments on proposed rule amendments to
implement the reporting requirements in section 10A of the Securities
Exchange Act of 1934 (the ``Exchange Act''). Section 10A requires,
among other things, that the auditor of a registrant's financial
statements report to the registrant's board of directors certain
uncorrected illegal acts of the registrant, and that the registrant
notify the Commission that it has received such a report. If the
registrant fails to provide that notice, the auditor is required by
section 10A to furnish directly to the Commission the report given to
the Board. The proposed amendments to the Commission's Exchange Act
Rules are intended to implement those reporting requirements. The
proposed amendment to Regulation S-X would conform the definition of
``audit'' in that regulation with the wording in section 10A.
DATES: Comments on the proposed amendments should be received on or
before October 28, 1996.
ADDRESSES: Comments should be submitted in triplicate to Jonathan G.
Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street,
N.W., Washington, D.C. 20549. Comments also may be submitted
electronically at the following E-mail address: rule-comments@sec.gov.
Comment letters should refer to File No. S7-20-96; this file number
should be included on the subject line if E-mail is used. All comments
will be available for public inspection and copying in the Commission's
Public Reference Room, 450 Fifth Street, N.W., Washington, D.C. 20549.
Electronically submitted comments may be posted on the Commission's
internet web site (http://www.sec.gov).
FOR FURTHER INFORMATION CONTACT: Robert E. Burns or W. Scott Bayless,
at (202) 942-4400, Office of the Chief Accountant, Mail Stop 11-3, and
for investment company issues, Kathleen Clarke, at (202) 942-0724,
Division of Investment Management, Mail Stop 10-6, Securities and
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.
SUPPLEMENTARY INFORMATION: The Commission is proposing to amend its
Exchange Act Rules, 17 CFR 240, by adding Rule 10A-1, and Regulation S-
X, 17 CFR 210, by revising Rule 1-02.
I. Background
Title III to the Private Securities Litigation Reform Act of 1995,
Public Law 104-67, enacted on December 22, 1995, added section 10A to
the Exchange Act. This section codifies certain professional auditing
standards and imposes expanded obligations on auditors 1 to report
in a timely manner certain uncorrected illegal acts 2 to a
registrant's board of directors. It further requires the registrant, or
if the registrant fails to do so then the auditor, to provide
information regarding the illegal act to the Commission.
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\1\ For the purpose of this release, the term ``auditor'' refers
to any independent public or certified public accountant who is
performing or has performed an audit of a registrant's financial
statements and whose audit report has or will be filed with the
Commission in accordance with the federal securities laws or the
Commission's regulations. See, e.g., sections 12(b)(1) (J) and (K),
13(a)(2), and 17(e) of the Exchange Act, 15 U.S.C. 78l(b)(1) (J) and
(K), 78m(a)(2), and 78q(e), and the Commission's Regulation S-X, 17
CFR Sec. 210. The term ``independent accountant'' is used in the
regulatory text in order to be consistent with existing provisions
in Regulation S-X.
\2\ Section 10A(f) defines the term ``illegal act'' broadly to
mean ``an act or omission that violates any law, or any rule or
regulation having the force of law.'' This definition is consistent
generally with Statement on Auditing Standards No. 54, ``Illegal
Acts by Clients,'' para.2 (January 1, 1989), AU Sec. 317.02, which
states, ``the term illegal acts . . . refers to violations of laws
or governmental regulations.''
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Section 10A(a) requires that audits of registrants' financial
statements include, ``in accordance with generally accepted auditing
standards, as may be modified or supplemented from time to time by the
Commission--''
1. Procedures designed to provide reasonable assurance of detecting
illegal acts that would have a direct and material effect on the
determination of financial statement amounts;
2. Procedures designed to identify related party transactions that
are material to the financial statements or otherwise require
disclosure therein; and
3. An evaluation of whether there is substantial doubt about the
registrant's ability to continue as a going concern during the ensuing
fiscal year.3
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\3\ Section 10A(a) (1), (2), and (3).
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Certain procedures in each of these three areas already are
required by generally accepted auditing standards (``GAAS'') 4 in
the United States and are further codified in the Statements on
Auditing Standards (``SAS'') 5 adopted by the Auditing Standards
Board (``ASB''), the senior technical body for auditing matters of the
American Institute of Certified Public Accountants (``AICPA'').6
The Commission staff historically has worked closely with the ASB. The
staff, among other things, attends ASB meetings, reviews and provides
the ASB with comments on draft Statements on Auditing Standards, and
has periodic meetings with ASB representatives to discuss items on the
ASB agenda and other matters of mutual concern. The Commission staff
plans to continue these practices.
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\4\ In February 1941, the Commission amended Rule 2-02 of
Regulation S-X, 17 CFR Sec. 210.2-02, to require that the
independent accountant state in his or her report ``whether the
audit was made in accordance with generally accepted auditing
standards. . . .'' Accounting Series Release No. 21 (February 5,
1941). In this release, the Commission defined ``generally accepted
auditing standards'' to mean the application of ``generally
recognized normal auditing procedures'' with professional competence
by properly trained persons. The Commission defined ``generally
recognized normal auditing procedures'' to be those normally
employed by skilled accountants and those prescribed by
authoritative bodies dealing with the subject of auditing, such as
accounting societies and governmental bodies having jurisdiction in
the area. Id. Following this addition to the Commission's rules, the
relevant professional committee at the time, the Committee on
Auditing Procedure, began a study to determine which auditing
standards should be included within ``GAAS.'' In 1948, the
membership of the predecessor organization to the American Institute
of Certified Public Accountants (``AICPA'') approved ten standards
as constituting GAAS. See, AICPA, Codification of Statements on
Auditing Standards, AU Sec. 150.02. These ten standards are
supplemented by Statements on Auditing Standards, which currently
are issued by the Auditing Standards Board of the AICPA.
\5\ Currently effective Statements on Auditing Standards are
published by the American Institute of Certified Public Accountants
in the Codification of Statements on Auditing Standards. Provisions
in the Codification are designated as ``AU Sec. .'' For standards
addressing those procedures mandated by section 10A, see SAS 54,
``Illegal Acts by Clients'' (January 1, 1989), AU Sec. 317; SAS 45,
``Related Parties'' (September 30, 1983), AU Sec. 334; and SAS 59,
64, and 77 reprinted in ``The Auditor's Consideration of an Entity's
Ability to Continue as a Going Concern'' (January 1, 1989), AU
Sec. 341. See also SAS 53, ``The Auditor's Responsibility to Detect
and Report Errors and Irregularities'' (January 1, 1989), AU
Sec. 316. The ASB is in the process of re-examining SAS 53, SAS 54,
and other auditing standards related to the detection and reporting
of financial fraud. References in this release are to auditing
standards in effect at the date of this release.
\6\ The ASB's 15 members serve on a part-time basis and are
appointed for one year terms that may be extended for up to three
years.
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In addition to the requirement in section 10A(a) that auditors
perform procedures designed to enhance the detection of fraudulent
financial reporting, section 10A(b) contains provisions that would
require an auditor to report directly to the Commission
[[Page 45731]]
certain detected illegal acts if the registrant fails to do so.
Under section 10A(b), if, while conducting the audit of the
registrant's financial statements, the auditor becomes aware of
information indicating that an illegal act (whether or not material to
the financial statements) has occurred or may have occurred, then the
auditor would be required, in accordance with GAAS, ``as may be
modified or supplemented from time to time by the Commission,'' to
determine whether it is ``likely'' that an illegal act has occurred
and, if so, its possible effect on the financial statements (including
any contingent monetary effects, such as fines, penalties, and
damages).7 The auditor would be required to inform the
registrant's management of the illegal act ``as soon as practicable.''
In addition, the auditor must assure him/herself that the registrant's
board of directors is adequately informed, by management or otherwise,
of any detected illegal act.8
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\7\ Section 10A(b)(1)(A). See, SAS 54, Paras. 10-15. AU
Sec. 317.10-.15. Paragraph 11 of SAS 54 sets forth additional audit
procedures that might be necessary once the auditor becomes aware of
a possible illegal act.
\8\ Section 10A(b)(1)(B). See, SAS 54, para. 17, AU Sec. 317.17.
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Although GAAS contains procedures for similar notification of
illegal acts to managements and boards of directors,9 section
10A(b) contains the additional requirement that these notifications
occur ``as soon as practicable.'' 10
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\9\ See, SAS 54, Paras. 10 and 17, AU Sec. 317.10 and .17.
\10\ The addition of this time period reflects the original
legislative efforts in this area to provide an earlier warning to
the SEC of registrants' potential illegal acts than may occur under
the current Form 8-K procedures, see note 20 infra, and in audit
reports. See H.R. Rep. No. 102-890, 102d Cong., 2d Sess. 3 (1992),
which contained the predecessor legislation to Section 10A and
stated:
This legislation amends the Securities Exchange Act of 1934
(Exchange Act) to improve fraud detection and disclosure with
respect to public companies by codifying auditing standards in
certain specified areas and by providing a mechanism for earlier
warning to the Securities and Exchange Commission of certain illegal
acts by registrants.
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After the auditor determines that the audit committee or the board
of directors has been adequately informed of an illegal act and the
auditor reaches three specified conclusions, the auditor is required by
section 10A(b)(2) to report those conclusions directly to the board of
directors ``as soon as practicable.'' The three conclusions set forth
in section 10A(b)(2) that trigger the auditor's obligation to report to
the board are that:
1. The illegal act has a material effect 11 on the
registrant's financial statements,
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\11\ The auditor should consider both the quantitative and
qualitative materiality of the act, including contingent liabilities
that might be created by the illegal act. See, e.g., SAS 54, para.
13, AU Sec. 317.13.
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2. Senior management has not taken, and the board of directors has
not caused senior management to take, timely and appropriate remedial
actions with respect to the illegal act, and
3. The failure to take remedial action is reasonably expected to
warrant either a departure from the auditor's standard audit
report,12 when made, or the auditor's resignation from the audit
engagement.13
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\12\ See, SAS 58, ``Reports on Audited Financial Statements,''
para. 10, AU Sec. 508.10, for a general discussion of the
circumstances that may require the auditor to depart from the
standard report and the types of opinions, other than the standard
report, that may be expressed by the auditor in various
circumstances.
\13\ Section 10A(b)(2)(A), (B), and (C). See generally, SAS 54,
Paras. 18-22, AU Sec. 317.18-.22.
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If the board of directors receives a report that the auditor has
reached these conclusions, then the board has one business day to
notify the Commission that it received such a report. If the auditor
does not receive a copy of the board's notice to the Commission within
that one business day period, then by the end of the next business day
the auditor is required to furnish directly to the Commission a copy of
the report given to the board (or the documentation of any oral report
14).15 The auditor's resignation from the audit engagement
does not negate the auditor's obligation to furnish his or her report
to the Commission in these circumstances.16
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\14\ For documentation requirements under GAAS, see, e.g., SAS
54, para. 17, AU Sec. 317.17, and SAS 61, ``Communication with Audit
Committees,'' para. 3 (January 1, 1989), AU Sec. 380.03.
\15\ Section 10A(b)(3).
\16\ Section 10A(b)(4).
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Section 10A(c) states that there is no private right of action
against auditors based on any findings, conclusions, or statements
expressed in their reports to the Commission. It should be noted,
however, that this section does not address private rights of action
based on, among other things, the auditor's failure to make the
required report, the auditor's failure to comply with GAAS or
Commission requirements during the conduct of its audit or other work,
or for the preparation of any other reports or statements filed with
the Commission.
Section 10A(d) subjects auditors to civil money penalties if the
Commission finds in a cease and desist proceeding 17 that the
auditor willfully failed to comply with the direct reporting provisions
in section 10A. Similar penalties may be imposed on any person who was
a cause of such a violation.18
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\17\ Under the Securities Enforcement Remedies and Penny Stock
Reform Act of 1990, Pub. L. 101-429, (the ``Remedies Act'') auditors
are subject to the Commission's cease and desist proceedings under
section 21C of the Exchange Act but not to civil money penalties
under section 21B. Under the Remedies Act, auditors are not subject
to temporary cease and desist orders as set forth in section 21C(c)
of the Exchange Act. Although failure to file a required report may
justify disciplinary proceedings under Rule 102(e) of the
Commission's Rules of Practice, 17 CFR Sec. 201.102(e), auditors are
not subject to civil money penalties in such proceedings.
\18\ Under section 10A(d), the determination to impose a civil
money penalty on auditors and those causing a violation of the
auditor's reporting requirements and the amount of such a penalty
are governed by section 21B of the Exchange Act.
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Section 10A(e) states that, except for the civil money provisions
in section 10A(d), nothing in section 10A shall be held to limit or
otherwise affect the authority of the Commission under the Exchange
Act.
II. Discussion of Proposed Rules
A. Proposed Rule 10A-1.
Proposed Rule 10A-1 is based on the premise that the notice and
reports under section 10A are to assist the Commission in performing
its enforcement responsibilities and, therefore, will be non-public.
Disclosure to the public of registrants' illegal acts will continue to
be made in modified audit reports 19 or, when the auditor has
resigned, been dismissed, or elected not to stand for re-election, on
Form 8-K 20
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under the Exchange Act and on N-SAR 21 under the Investment
Company Act of 1940 (the ``Investment Company Act''), among others.
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\19\ For the effect of illegal acts on the audit report, see,
SAS 53, Paras. 26 and 27, AU Sec. 316.26 and .27, and SAS 54,
Paras. 18-21, AU Sec. 317.18-.21. See generally, SAS 58, 64, and 79
reprinted in Reports on Audited Financial Statements (January 1,
1989), which describes the standard report and the various opinions
that may be reflected in the auditor's report. SAS 58, Paras. 7-10,
AU Sec. 508.07-.10.
\20\ Item 4 of Form 8-K, 17 CFR Sec. 249.308, Item 304 of
Regulation S-K, 17 CFR Sec. 229.304, and Item 304 of Regulation S-B,
17 CFR Sec. 228.304. In summary, these provisions state that a
registrant must file a Form 8-K, providing the information required
by item 4 of that form, within five business days of the date that
the registrant's auditor (or an independent accountant upon whom the
auditor expressed reliance in its audit report regarding a
significant subsidiary) resigns, declines to stand for re-election,
or is dismissed, and within five business days of the date a new
auditor is engaged. The registrant is to ask the former auditor to
provide the registrant with a letter indicating whether the former
auditor agrees with the disclosures in the Form 8-K that reports the
termination of the audit engagement and, if not, the respects in
which the auditor disagrees. This letter is to be filed with the
Commission as an exhibit by amendment to the registrant's Form 8-K
within 10 business days of the date that the Form 8-K was filed.
The registrant's Form 8-K must state, among other things:
whether the former auditor resigned, was dismissed, or declined to
stand for re-election and the date thereof; whether the auditor
modified his or her report on the registrant's financial statements
for either of the last two fiscal years and, if so, the nature of
the modification; whether the decision to change auditors was
recommended or approved by the audit committee or board of
directors; whether, in connection with the audits of the financial
statements for the two most recent fiscal years, and any subsequent
interim period, there were any disagreements between the auditor and
the registrant on any matter of accounting principles or practices,
auditing scope or procedure, or financial statement disclosure. The
Form 8-K also must provide disclosure of any instance within the
applicable time period where the former auditor advised the
registrant that (1) the internal controls necessary for the
registrant to develop reliable financial statements did not exist,
(2) information had come to the auditor's attention that led him or
her no longer to be able to rely on management's representations, or
that made the auditor unwilling to be associated with the
registrant's financial statements, (3) there was a need to expand
significantly the scope of the audit and, due to the auditor's
resignation or for any other reason, the scope was not expanded, or
(4) information had come to the auditor's attention affecting the
reliability of past audit reports or financial statements and the
issue had not been resolved to the auditor's satisfaction prior to
the auditor's resignation, dismissal, or declination to stand for
re-election.
\21\ Sub-item 77K of Form N-SAR, 17 CFR Sec. 274.101, requires
investment companies filing Form N-SAR to provide the information
required by item 4 of Form 8-K. Sub-item 77K of Form N-SAR notes
that notwithstanding the requirements in Form 8-K to file more
frequently, registrants need only file such information semi-
annually in accordance with the requirements of Form N-SAR.
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In testifying on prior bills that contained the same reporting
requirements, the Commission stated, ``[W]e anticipate that reports
filed under section 10A would be confidential and exempt from
disclosure under the Freedom of Information Act.'' 22 The
Commission further noted,
\22\ Testimony of Richard C. Breeden, Chairman, U.S. Securities
and Exchange Commission, Concerning H.R. 574, The Financial Fraud
Detection and Disclosure Act, Before the Subcommittee on
Telecommunications and Finance of the House Committee on Energy and
Commerce, 103d Cong., 1st Sess., 32 (February 18, 1993).
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Premature disclosure of the issuer and auditor reports could,
among other things, interfere with the Commission's investigation,
deprive the issuer or other persons of the right to a fair trial or
impartial adjudication, constitute an unwarranted invasion of
privacy, or disclose a confidential source. In addition, issuer and
auditor reports under Section 10A might contain confidential
commercial or financial information exempt from disclosure under
FOIA Exemption 4, 5 U.S.C. 552(b)(4).23
\23\ Id.,, at 32 n. 36.
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The Commission's testimony further states that the direct reporting
provisions in the bill might provide an earlier warning of certain
illegal acts that could allow the Commission to begin enforcement
investigations at an earlier date.24
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\24\ Id.,T1 at 31.
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Accordingly, the proposed rule provides that the reports of both
the board and the auditor would be non-public and exempt from
disclosure under the Freedom of Information Act to the same extent as
the Commission's investigative records.\25\
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\25\ See 5 U.S.C. 552(b)(7), which exempts from disclosure
certain ``records or information compiled for law enforcement
purposes.''
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Despite the confidential nature of the reports under section 10A,
these reporting requirements should improve the quality of public
disclosures in Forms 8-K and N-SAR and in audit reports on registrants'
financial statements, because it is unlikely that registrants and
auditors will make public disclosures that are incompatible with the
confidential reports made to the Commission. Also, the direct reporting
requirements in section 10A should give auditors additional leverage to
prompt management to correct illegal acts and to make appropriate
adjustments in their financial statements.
Proposed Rule 10A-1 designates the Commission's Office of the Chief
Accountant (``OCA'') as the appropriate office to receive the notice
provided by any registrant under section 10A(b)(3) and any reports
provided by auditors under section 10A(b)(3) or 10A(b)(4). OCA
expeditiously will forward copies of the notice or report to all
appropriate offices and divisions within the Commission. The notice or
report may be provided to other agencies, as appropriate.
Delivery of the notice or report to OCA may occur under proposed
Rule 10A-1 in any manner, provided the notice or report is received by
OCA within the statutory time period. Currently, the most timely manner
of delivery may be through submission of a facsimile,\26\ telegraph, or
personal delivery. In the future, procedures may be developed for
registrants and auditors to deliver confidential information directly
to OCA via electronic mail. Proposed Rule 10A-1 would permit use of
such means of delivery.\27\
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\26\ The phone number for OCA's facsimile machine currently is
(202) 942-9656. Such phone numbers, however, are subject to change
without notice and registrants and auditors should verify the
accuracy of the number before use.
\27\ A similar provision applies to auditors of broker-dealers.
See Rule 17a-5(h)(2) under the Exchange Act, 17 CFR Sec. 240.17a-
5(h)(2), which states that if, during the course of audit or interim
work, the auditor determines that any material inadequacies exist in
the accounting system, internal accounting control, procedures for
safeguarding securities, or certain other practices and procedures,
then the auditor shall call those inadequacies to the attention of
the chief financial officer of the broker-dealer, who has the
obligation to notify the Commission and the designated examining
authority within 24 hours thereafter. If the auditor does not
receive a copy of that notice within that 24 hour period, or if the
auditor disagrees with the statements in the notice, then the
auditor must inform the Commission and the designated examining
authority of the material inadequacy within the next 24 hours.
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Proposed Rule 10A-1 sets forth the required contents for a
registrant's notice to the Commission. This notice would be in writing
and identify the registrant and the auditor, state the date the auditor
made its report to the board, and provide a summary of the report. The
required summary would describe the act and the potential impact of
that act on the registrant's financial statements. This information is
consistent with the requirement under GAAS that the auditor's
communication with the registrant's audit committee ``should describe
the act, the circumstances of its occurrence, and the effect on the
financial statements.'' \28\ The proposed rule specifically would
permit a registrant to provide additional information regarding its
view of, and response to, the section 10A report it has received from
the auditor.
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\28\ SAS 54, para. 17, AU Sec. 317.17.
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Regarding reports filed by auditors, proposed Rule 10A-1 would
specify that if the report does not identify clearly both the
registrant and the auditor, then the auditor must attach that
information to the report submitted to OCA.
Proposed Rule 10A-1 makes it clear that providing the notice or
report in accordance with section 10A and the proposed rule does not,
in any way, affect the obligations of the registrant and the auditor to
file and make all applicable disclosures required by the Commission's
rules, including, without limitation, Forms 8-K and N-SAR, and of the
auditor to comply with GAAS reporting requirements.\29\ Similarly, the
proposed rule states that the confidential nature of the notice and the
report to the Commission does not diminish a registrant's or auditor's
obligations to make full disclosures required by the Commission's
rules, forms, reports, or disclosure items, or by applicable
professional standards.
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\29\ In addition, one of the membership requirements of the SEC
Practice Section of the AICPA is that members notify registrants in
writing of the cessation of an auditor-client relationship. The
member also is required to send a copy of that notification to the
Commission's Office of the Chief Accountant.
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B. Proposed Rule 1-02(d).
The proposed amendment would conform the definition of ``Audit (or
examination)'' in Rule 1-02(d) of Regulation S-X with section 10A, by
noting that audits of the financial statements of Commission
registrants should be performed in accordance with generally accepted
auditing standards as
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may be modified or supplemented by the Commission.
III. Investment Companies
Section 10A and proposed Rule 10A-1 apply to all audits required
pursuant to the Exchange Act, including those prepared on behalf of
investment companies that have reporting obligations under the Exchange
Act.30 The Commission requests comment whether the proposed
reporting requirements under Rule 10A-1 need to be modified to reflect
the operations of investment companies.
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\30\ See sections 13(a) and 15(d) of the Exchange Act, 15 U.S.C.
78m(a) and 78o(d), and section 30(a) of the Investment Company Act,
15 U.S.C. 80a-29(a). Form N-SAR requires investment companies to
file information with the Commission about their operations,
including audited financial information. Rule 30a-1 under the
Investment Company Act, 17 CFR Sec. 270.30a-1, provides that
investment companies filing annual reports on Form N-SAR are deemed
to have satisfied the reporting requirements of sections 13(a) and
15(d) under the Exchange Act and section 30(a) under the Investment
Company Act.
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IV. General Request for Comments
The Commission seeks comments from all interested persons wishing
to address any aspect of the proposed rules.
The Commission also is requesting comments on whether the proposed
amendments, if adopted, would have an adverse impact on competition or
would impose a burden on competition that is neither necessary nor
appropriate in furthering the purposes of the Securities Act of 1933
and the Exchange Act. Comments in this regard will be considered by the
Commission in complying with its responsibilities under section 23(a)
of the Exchange Act.31
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\31\ 15 U.S.C. 78w(a).
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V. Cost/Benefit Analysis
Comments are requested related to any costs or benefits associated
with the proposed rules. The costs of complying with proposed Rule 10A-
1, which is intended to carry out the purposes of new section 10A the
Exchange Act, are expected to be de minimis. Such costs for a
registrant may include converting the information in the auditor's
report to the board into a notice that conforms to the rule and
delivering that notice, via facsimile or otherwise, to the Commission's
Office of the Chief Accountant. Costs for the auditor may include
assuring that the report to the board identifies the registrant, as
required by the proposed rule, and the cost of delivering that report,
via facsimile or otherwise, to the Commission's Office of the Chief
Accountant.
Benefits would include an earlier warning to the Commission of
possible illegal acts by registrants and potential improvements in
public disclosures in Forms 8-K and N-SAR regarding changes in
registrants' auditors and in audit reports that are modified due to
registrants' illegal acts.
VI. Summary of Regulatory Flexibility Analysis
An Initial Regulatory Flexibility Analysis has been prepared in
accordance with 5 U.S.C. 603 concerning proposed Rule 10A-1. The
analysis notes that the proposed rule is intended to implement the
reporting requirements of section 10A of the Exchange Act.
As discussed more fully in the analysis, the proposed rule would
affect small entities, as defined by the Commission's rules, but would
affect small entities in the same manner as other registrants. The
analysis notes that alternatives that provide for different means of
compliance for small entities or which exempt small entities from the
proposed rules would not be consistent with the statutory requirements.
Moreover, the cost of complying with the proposed rule should be de
minimis, even for small registrants.
Written comments are encouraged with respect to any aspect of the
analysis. Such comments will be considered in the preparation of the
Final Regulatory Flexibility Analysis if the proposed rules are
adopted. A copy of the analysis may be obtained by contacting Robert E.
Burns, Chief Counsel, Office of the Chief Accountant, U.S. Securities
and Exchange Commission, Mail Stop 11-3, 450 Fifth Street, N.W.,
Washington, D.C. 20549.
VII. Paperwork Reduction Act
Proposed Rule 10A-1 contains ``collection of information''
requirements within the meaning of the Paperwork Reduction Act of 1995
[44 U.S.C. 3501 et seq.] and the Commission has submitted the proposed
rules to the Office of Management and Budget for review in accordance
with 44 U.S.C. 3507(d). The title for the collection of information is
``Amendments to Implement Exchange Act Section 10A.''
The Supporting Statement to the Paperwork Reduction Act submission
notes that the proposed rule is intended to implement the reporting
requirements found in recently enacted section 10A of the Exchange Act,
and that the proposed rule would have a negligible effect on the annual
reporting and cost burden of Commission registrants. As discussed
above, the notice provided by the registrant would contain the minimum
amount of information necessary to identify the registrant and the
auditor, indicate the date the auditor provided the report to the board
of directors as specified in section 10A, and summarize the report
given to the board. The summary would be based on information required
to be given to the board of directors under GAAS. The auditor's report,
furnished only in the event that the registrant does not fulfill its
reporting responsibilities, would consist only of the report given to
the board of directors and, if necessary, additional information to
identify clearly the registrant and the auditor.
Potential respondents are entities with reporting obligations under
the Exchange Act and their auditors, although it is anticipated that
the reporting requirements under section 10A rarely will be triggered.
On those rare occasions when the reporting requirement is triggered, it
is estimated that the total recordkeeping and reporting burden, beyond
that directly required by the statute, would not exceed one hour per
respondent.
As notices must be filed by a registrant within one day of
receiving a report from its auditor, and the auditor must file its
report (if necessary) the next day, there are essentially no
recordkeeping or retention requirements.
Filing the notices and reports, when necessary, is required by
section 10A of the Exchange Act and therefore is mandatory. As
explained above, however, the notices and reports will be kept
confidential while the Commission has an enforcement interest in the
information contained in those notices and reports.
Pursuant to 44 U.S.C. Sec. 3506(c)(2)(B), the Commission requests
comments concerning: whether the proposed collection of information is
necessary for the proper performance of the function of the Commission,
including whether the information shall have practical utility; on the
accuracy of the Commission's estimate of the burden of the proposed
collection of information; on the quality, utility, and clarity of the
information to be collected; and whether the burden of collection of
information on those who are to respond, including through the use of
automated collection techniques or other forms of information
technology, may be minimized.
Persons desiring to submit comments on the collection of
information requirements should direct them to the Office of Management
and Budget, Attention: Desk Officer for the Securities and Exchange
Commission,
[[Page 45734]]
Office of Information and Regulatory Affairs, Washington, D.C. 20503,
and also should send a copy of their comments to Jonathan G. Katz,
Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W.,
Washington, D.C. 20549 with reference to File No. S7-20-96. The Office
of Management and Budget is required to make a decision concerning the
collection of information between 30 and 60 days after publication, so
a comment to the Office of Management and Budget is best assured of
having its full effect if the Office of Management and Budget receives
it within 30 days of publication.
List of Subjects
17 CFR Part 210
Accounting, Reporting and recordkeeping requirements, Securities.
17 CFR Part 240
Reporting and recordkeeping requirements, Securities.
Text of Proposed Rulemaking Amendments
In accordance with the foregoing, Title 17, Chapter II of the Code
of Federal Regulations is proposed to be 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 is revised to read as
follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77aa(25),
77aa(26), 78j-1, 78l, 78m, 78n, 78o(d), 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 revising Sec. 210.1-02(d) to read as follows:
Sec. 210.1-02 Definitions of terms used in Regulation S-X (17 CFR part
210).
* * * * *
(d) Audit (or examination). The term audit (or examination), when
used in regard to financial statements, means an examination of the
financial statements by an independent accountant in accordance with
generally accepted auditing standards, as may be modified or
supplemented by the Commission, for the purpose of expressing an
opinion thereon.
* * * * *
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
3. The authority citation for Part 240 is revised to read as
follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77eee, 77ggg,
77nnn, 77sss, 77ttt, 78c, 78d, 78i, 78j, 78j-1, 78l, 78m, 78n, 78o,
78p, 78q, 78s, 78w, 78x, 78ll(d), 79q, 79t, 80a-20, 80a-23, 80a-29,
80a-37, 80b-3, 80b-4, and 80b-11, unless otherwise noted.
4. By adding Sec. 240.10A-1 to read as follows:
Sec. 240.10A-1 Notice to Commission of issuers' illegal acts.
(a)(1) If any issuer with a reporting obligation under the Act
receives a report requiring a notice to the Commission in accordance
with section 10A(b)(3) of the Act, 15 U.S.C. 78j-1(b)(3), the issuer
shall provide such notice to the Commission's Office of the Chief
Accountant within the time period prescribed in that section. The
notice may be provided by facsimile, telegraph, personal delivery, or
any other means, provided it is received by the Office of the Chief
Accountant within the required time period.
(2) The notice specified in paragraph (a)(1) of this section shall
be in writing and:
(i) Shall identify the issuer (including the issuer's name,
address, phone number, and file number assigned to the issuer's filings
by the Commission) and the independent accountant (including the
independent accountant's name and phone number, and the address of the
independent accountant's residence or principal office);
(ii) Shall state the date that the issuer received from the
independent accountant the report specified in section 10A(b)(2) of the
Act, 15 U.S.C. 78j-1(b)(2);
(iii) Shall provide a summary of the independent accountant's
report, including a description of the act that the independent
accountant has identified as a likely illegal act and the potential
impact of that act on all affected financial statements of the issuer
or those related to the most current three year period, whichever is
shorter; and
(iv) May provide additional information regarding the issuer's
views of and response to the independent accountant's report.
(3) Provision of the notice in paragraphs (a)(1) and (a)(2) of this
section does not relieve the issuer from its obligations to comply
fully with any other reporting requirements, including, without
limitation:
(i) The filing requirements of Form 8-K, Sec. 249.308 of this
chapter, and Form N-SAR, Sec. 274.101 of this chapter, regarding a
change in the issuer's certifying accountant and
(ii) The disclosure requirements of item 304 of Regulation S-B or
item 304 of Regulation S-K, Secs. 228.304 and 229.304 of this chapter.
(b)(1) Any independent accountant furnishing to the Commission a
copy of a report (or the documentation of any oral report) in
accordance with section 10A(b)(3) or section 10A(b)(4) of the Act, 15
U.S.C. 78j-1(b)(3) or 78j-1(b)(4), shall provide that report (or
documentation) to the Commission's Office of the Chief Accountant
within the time period prescribed by the appropriate section of the
Act. The report (or documentation) may be provided to the Commission's
Office of the Chief Accountant by facsimile, telegraph, personal
delivery, or any other means, provided it is received by the Office of
the Chief Accountant within the time period set forth in section
10A(b)(3) or 10A(b)(4) of the Act, 15 U.S.C. 78j-1(b)(3) or 78j-
1(b)(4), whichever is applicable in the circumstances.
(2) If the report (or documentation) provided to the Office of the
Chief Accountant in accordance with paragraph (b)(1) of this section
does not clearly identify both the issuer (including the issuer's name,
address, phone number, and file number assigned to the issuer's filings
with the Commission) and the independent accountant (including the
independent accountant's name and phone number, and the address of the
independent accountant's residence or principal office), then the
independent accountant shall place that information in a prominent
attachment to the report (or documentation) and shall provide that
attachment to the Office of the Chief Accountant at the same time and
in the same manner as the report (or documentation) is provided to that
Office.
(3) Provision of the report (or documentation) by the independent
accountant as described in paragraphs (b)(1) and (b)(2) of this section
does not replace, or otherwise satisfy the need for, the newly engaged
and former accountants' letters under items 304(a)(2)(D) and 304(a)(3)
of Regulation S-K, Secs. 229.304(a)(2)(D) and 229.304(a)(3) of this
chapter, respectively, and under items 304(a)(2)(D) and 304(a)(3) of
Regulation S-B, Secs. 228.304(a)(2)(D) and 228.304(a)(3) of this
chapter, respectively, and does not limit, reduce, or affect in any way
the independent accountant's obligations to comply fully with all other
legal or professional
[[Page 45735]]
responsibilities, including, without limitation, those under generally
accepted auditing standards and the rules or interpretations of the
Commission that modify or supplement those auditing standards.
(c) Notices and reports furnished to the Office of the Chief
Accountant in accordance with paragraphs (a) and (b) of this section
shall be non-public and exempt from disclosure pursuant to the Freedom
of Information Act to the same extent and for the same periods of time
that the Commission's investigative records are non-public and exempt
from disclosure under, among other applicable provisions, 5 U.S.C.
552(b)(7) and Sec. 200.80(b)(7) of this chapter. The preceding sentence
shall not relieve, limit, delay, or affect in any way, any issuer's or
independent accountant's obligations to provide all public disclosures
required by law, by any Commission disclosure item, rule, report, or
form, or by any applicable accounting, auditing, or professional
standard.
By the Commission.
Dated: August 22, 1996.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-21889 Filed 8-28-96; 8:45 am]
BILLING CODE 8010-01-P
