[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]]


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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: [email protected]. 
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

[[Page 45733]]

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