[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

[[Page 73391]]

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.
---------------------------------------------------------------------------

    (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.
---------------------------------------------------------------------------

    (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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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\
---------------------------------------------------------------------------

    \50\ See supra note 24.
    \51\ See, e.g., TIAA-CREF Letter, supra note 42.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \62\ Letter dated November 29, 1999 from David K. Owens, Edison 
Electric Institute.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    \65\ See, e.g., TIAA-CREF Letter, supra note 42.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \74\See, e.g., ASCS Letter, supra note 71.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

    \75\ 17 CFR 240.14a-101.
    \76\ 17 CFR 240.14c-101.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \77\ 17 CFR 249.310.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

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.''
---------------------------------------------------------------------------

    \80\ See Section III.A above.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

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