[Federal Register Volume 67, Number 129 (Friday, July 5, 2002)]
[Proposed Rules]
[Pages 44964-45011]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-16539]



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Part III





Securities and Exchange Commission





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17 CFR Parts 210 and 229



Framework for Enhancing the Quality of Financial Information Through 
Improvement of Oversight of the Auditing Process; Proposed Rule

  Federal Register / Vol. 67, No. 129 / Friday, July 5, 2002 / Proposed 
Rules  

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 210 and 229

[Release Nos. 33-8109; 34-46120; 35-27543; IA-2039; IC-25624; File No. 
S7-24-02]
RIN 3235-AI41


Framework for Enhancing the Quality of Financial Information 
Through Improvement of Oversight of the Auditing Process

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (``SEC'' or 
``Commission'') is proposing rules designed to restore investors'' 
faith in the financial information that they rely on for their 
investment decisions. The proposed rules reform oversight and improve 
accountability of auditors of public companies, thereby enhancing the 
reliability and integrity of the auditing and financial reporting 
processes. Under the proposed rules, a registrant's financial 
statements will not comply with the requirements of the securities laws 
and Commission rules and regulations thereunder unless the registrant's 
independent accountant is a member of a Public Accountability Board 
(``PAB''), and the registrant engaging the accountant to audit or 
review financial statements or prepare attestation reports that are 
filed with the Commission is an adjunct member of the same PAB to which 
the accountant belongs.
    To improve oversight of and investor confidence in the quality of 
financial reports filed with the Commission, the Commission will not 
recognize a PAB unless the PAB meets certain conditions and performs 
certain functions. A PAB must have a Board that is dominated by persons 
who are not members of the accounting profession and must be subject to 
the Commission's oversight. A PAB must be committed to improving the 
quality of financial statements relied on by investors and the 
professional conduct of accountants by, among other things, directing 
periodic reviews of accounting firms' quality controls over their 
accounting and auditing practices and, when appropriate, disciplining 
accountants. A PAB also would set, or rely on and oversee designated 
private sector bodies to set, audit, quality control, and ethics 
standards. Disclosure would be required in Commission filings if an 
executive officer, director, or director nominee of a registrant has 
been sanctioned as a member accountant by a PAB within the last five 
years and the sanction has not been reversed, suspended, or vacated.

DATES: Comments should be received on or before September 3, 2002.

ADDRESSES: Comments should be submitted in triplicate to Jonathan G. 
Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, 
NW., Washington, DC 20549-0609. Comments also may be submitted 
electronically at the following electronic mail address: [email protected]. All comment letters should refer to File No. S7-24-
02. This file number should be included in the subject line if 
electronic mail is used. Comment letters will be available for public 
inspection and copying in the Commission's Public Reference Room, 450 
Fifth Street, NW., Washington, DC 20549. Electronically submitted 
comment letters will be posted on the Commission's Internet website 
(http://www.sec.gov).\1\
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    \1\ We do not edit personal identifying information, such as 
names or electronic mail addresses, from electronic submissions. You 
should submit only information that you wish to make available 
publicly.

FOR FURTHER INFORMATION CONTACT: Samuel L. Burke, Associate Chief 
Accountant, Bert W. Mehrer, Assistant Chief Accountant, or Robert E. 
Burns, Chief Counsel, Office of the Chief Accountant, at (202) 942-
4400, U.S. Securities and Exchange Commission, 450 Fifth Street, NW, 
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Washington, DC 20549-1103.

SUPPLEMENTARY INFORMATION: We are proposing to amend rule 1-02 \2\ and 
rule 2-01 \3\ of Regulation S-X, add new rules 13-01 through 13-07 to 
Regulation S-X,\4\ and amend item 401 \5\ of Regulation S-K.
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    \2\ 17 CFR 210.1-02.
    \3\ 17 CFR 210.2-01.
    \4\ 17 CFR 210.13-01-13.07.
    \5\ 17 CFR 229.401.
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I. Executive Summary

    Congress, through the federal securities laws, imposed on public 
companies the obligation to disclose complete and accurate financial 
information. Cognizant of the lessons of history, however, Congress 
built into the securities laws a significant safeguard: requirements 
that a public company's financial information filed with the Commission 
be audited by certified or public accountants that are independent of 
that company.
    The investing public and the Commission must rely on the 
competence, ethics, and independence of accountants who certify the 
financial statements of public companies. People invest their savings 
in the securities of public companies and thereby make capital 
allocation decisions in reliance on the financial statements of those 
companies. If investors lack confidence in the reliability of the 
information presented, the fundamental purposes of the federal 
securities laws--to protect investors and promote efficient markets--
are thwarted.
    Effective oversight of the accounting profession is critical to 
quality financial information and trust in and reliance on that 
information. By having effective oversight, investors are assured that 
skilled, disinterested professionals operating under high ethical 
standards and strict quality control procedures are auditing financial 
statements. Strong oversight helps to strengthen audit practice and to 
detect and deter weaknesses that could detract from an accountant's 
ability to fulfill the goal of having financial statements audited by 
competent, independent accountants. Further, when oversight is 
compromised, the quality of financial information can be affected, and 
investors' trust in the quality of financial information is compromised 
as well.
    The current system of oversight has not produced a credible result. 
Flaws in the system have contributed to the confluence of several 
factors that have undermined investor confidence in financial 
information and market efficiency.\6\ Those factors include:
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    \6\ See, e.g., Matt Krantz and Greg Farrell, Fuzzy accounting 
raises flags, USA Today, June 22, 2001, at 1B (quoting an individual 
investor, ``I almost don't believe any numbers I read anymore''); 
Rebecca Byrne, Audit Business Nearing Crisis of Faith, 
TheStreet.com, Dec. 10, 2001.
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     The dramatic and sometimes sudden reversals of public 
companies' financial conditions, with corresponding significant 
financial losses by investors and pensioners;
     Revelations of accounting irregularities at public 
companies, including large and seemingly well-regarded companies;
     The number of restatements of financial information by 
public companies;
     Increasing pressures on company management and auditors in 
today's economic environment;
     Continuing concerns about the oversight of the accounting 
profession, including issues regarding the independence and 
effectiveness of the current peer review and disciplinary processes; 
and
     The ineffectiveness of the Public Oversight Board 
(``POB'') that had overseen the peer review system of public 
accountants.

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    These factors highlight longstanding deficiencies in the regulatory 
system used to oversee the quality of the audits and reviews of 
financial statements that are filed with the Commission and relied on 
by investors and the Commission. These factors, among others, have 
contributed to a consequent decline in investor confidence, and provide 
the impetus for the Commission's proposals.
    We are proposing a new system of independent private sector 
regulation designed to improve oversight of the auditing process and 
strengthen investor confidence in financial information. The accounting 
profession would not and could not control or dominate the proposed 
system. Rather, instead of a body that functions under the aegis of the 
American Institute of Certified Public Accountants (``AICPA''), which 
represents the accounting profession, we propose to create a framework 
for a new independent, private sector body (or bodies) that we have 
termed a ``Public Accountability Board'' (``PAB'').\7\
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    \7\ Under our proposals, more than one PAB could be formed. For 
purposes of this release, however, we will refer to PABs in the 
singular.
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    Among other things, a PAB would discipline accounting firms and 
individual accountants for unethical or incompetent conduct or other 
violations of professional standards. A PAB would also direct periodic 
reviews of accounting firms' quality controls for their accounting and 
auditing practices. A PAB would supplement, not supplant, our 
enforcement efforts. We would continue vigorously to investigate and 
pursue instances of accounting misconduct. The new system would expand 
the opportunities to detect and remedy ethical lapses or deficiencies 
in competence, or violations of professional standards, thereby 
complementing our enforcement efforts.
    Based on public input we have received to date, and our own 
experience, we have identified certain key elements of a new framework 
to improve oversight of the accounting profession. We believe that 
these elements will promote investor confidence in the financial 
reporting process.\8\ The following elements, as well as others 
discussed in more detail below, are the foundation of our proposals:
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    \8\ See, e.g., Transcripts from the public Roundtables that the 
Commission sponsored on Assuring Adequate Oversight of Auditing 
Function held on March 4, and 6 and April 4, 2002, in New York, 
Washington, DC and Chicago, respectively (``SEC Roundtables''). 
Transcripts of the SEC Roundtables are available through the 
Commission's web site: www.sec.gov. Participants included: On March 
4, Robert Mundheim (moderator), William Allen, Warren Buffet, James 
Copeland, David Shedlarz, Melvyn Weiss; on March 6, Judge Stanley 
Sporkin (Ret.) (moderator), Robert Glauber, Neil Lerner, Professor 
Jonathan Macey, Ted White; on April 4, J. Carter Beese, Jr. 
(moderator), Ken Bertsch, Davis Costello, Professor Dan Fischel, 
Barbara Franklin, and Edward Nusbaum. The Commission also held an 
Investor Summit (``Investor Summit'') at which it received valuable 
input. The webcast of the Investor Summit is available at 
www.connective.com/events/secsummits/.
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     Private Sector System of Regulatory Oversight. The 
accounting profession would be subject to a private sector system of 
regulatory oversight directed by representatives of investors and 
issuers, not self-regulation by the profession.
     Requirements as to Financial Statements. To assure that 
the benefits of the oversight process extend to investors in all public 
companies:
     An SEC registrant's financial statements would not comply 
with Commission requirements unless the registrant's accountants who 
audited or reviewed those statements were members of a PAB; and
     An SEC registrant's financial statements would not comply 
with Commission requirements unless the registrant were a member of, 
and thereby bound to cooperate in any review or proceeding commenced 
by, the same PAB as its accountants.\9\
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    \9\ As we discuss in detail below, a PAB will require a 
registrant's cooperation only to the extent necessary to further a 
PAB's reviews or proceedings regarding the registrant's accountant. 
A PAB will not conduct ``roving'' investigation of registrants and 
will not sanction registrants.
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     Independent Board. To ensure independence from the 
accounting profession that it would oversee, a PAB would be a diverse 
board, dominated by persons who are not associated with the accounting 
profession.
     Independent and Dependable Funding Source. To assure 
continuity and independence, a PAB would have a dependable, 
uninterrupted funding source and not be voluntarily or solely funded by 
members of the accounting profession. A PAB's operations would be 
funded through the assessment of fees on accounting firms who are 
members of the PAB and on the audit clients of those firms--a funding 
mechanism that is not controlled by the accounting profession.
     SEC Oversight. Because a PAB would serve an important 
public function, a private entity could not serve as a PAB unless it 
was recognized by the Commission after Commission review of, among 
other things, the entity's proposed structure, its charter, by-laws, 
budget, and proposed board members. Conditions of a PAB's recognition 
by the Commission would include a PAB's irrevocable consent to the 
continuous oversight function by the Commission.
     Cooperation with a PAB. To remain in ``good standing,'' 
accounting firms, individual accountants, companies, and companies' 
management would cooperate with PAB quality control reviews, 
supplemental reviews, and disciplinary proceedings.
     PAB Quality Control Reviews. A PAB would perform quality 
control reviews of audit procedures and practices. To maintain high 
standards of auditing, ethics, and quality control among its members, a 
PAB would perform periodic quality control reviews of its member 
accounting firms. In conducting reviews, a PAB would ensure that 
accounting firms have quality control policies and procedures 
regarding, among other things: (i) independence, integrity, and 
objectivity; (ii) personnel management; (iii) acceptance and 
continuation of clients; (iv) audit performance; (v) audit methodology; 
and (vi) consultation and resolution of differences of professional 
opinion. A PAB would perform annual reviews of large accounting firms.
     PAB Disciplinary Powers. A PAB would conduct public 
disciplinary proceedings and would have the ability to discipline 
accountants for unethical or incompetent conduct or other violations of 
professional standards. A PAB would be able to impose a wide range of 
disciplinary or remedial sanctions, including:
     Fines;
     Censures;
     Required remediation;
     Removal of an individual or termination of a firm from an 
audit engagement;
     Limitations on certain activities; and
     Suspension or disbarment from membership in a PAB.
     Audit Standard Setting. A PAB should have responsibility 
for assuring high standards of ethics, auditing, and quality controls 
for its members. A PAB should either set such standards or oversee any 
private sector bodies designated to set standards.

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II. The Pressing Need To Improve Oversight of, and Restore Confidence 
in, the Auditing and Financial Reporting Processes

A. The Federal Securities Laws Contemplate, and Their Effective 
Application Depends Upon, the Existence of Mechanisms for Adequate 
Oversight of the Auditing Component of the Financial Disclosure Process

    It is no mystery what problem Congress intended to remedy--and 
believed it was remedying--by seeking to insure that issuers provide 
investors with ``complete information relative to the financial 
condition of the issuer.'' \10\ As the Senate Report on the Securities 
Exchange Act of 1934 (``Exchange Act'') described:
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    \10\ S. Rep. No. 73-792, 1934 WL 1289 at *10 (Apr. 17, 1934) 
(Senate Report on Securities Exchange Act of 1934).

    The committee has repeatedly heard testimony illustrating the 
evasions, suppressions, distortions, exaggerations, and outright 
misrepresentations practiced by corporations with intent to cloak 
their operations and to present to the investing public a false or 
misleading appearance as to financial condition. The chairman of the 
committee on stock list of the New York Stock Exchange testified 
that *  *  * [in one case] practically all the assets of the company 
consisted of notes receivable, good will, and licenses arbitrarily 
valued at grossly exaggerated figures. The testimony also 
established that within a period of a few days the assets of the 
company were written up 100 percent in value. In another case 
brought to the attention of the committee, the assets of a company 
were marked up from $4,000,000 to $24,000,000. A memorandum prepared 
by a corporate official was introduced in evidence which discussed 
the alternatives of preparing the corporation's annual report in 
either the `standard' or the `understandable'; form, the decision 
being in favor of the former. Many other instances of `window 
dressing' were observed, where inexcusable methods were employed to 
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inflate assets, obscure liabilities, and conceal deficits.\11\

    \11\ Id. at 11.
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    We begin from the premise that, through the securities laws' 
requirements related to financial disclosure, Congress intended to 
address these issues directly and forcefully. Congress did so by 
prescribing certain general statutory requirements and delegating to 
the Commission the regulatory flexibility to implement those 
requirements and to adopt regulations in furtherance of the statutes' 
purposes.
    Those statutory prescriptions include requirements that public 
companies' financial information filed with us be certified by 
independent public or certified public accountants.\12\ Without an 
unqualified audit opinion from an accounting firm,\13\ a Commission 
registrant or issuer in an initial public offering has not satisfied 
and cannot satisfy the statutory and regulatory requirements for 
audited financial statements, its filings are deficient under the 
securities laws, and it cannot sell securities to the public or file 
its annual reports in conformity with Commission rules. Furthermore, 
without an accounting firm's review of a registrant's quarterly 
financial statements,\14\ a registrant cannot not file its quarterly 
reports in conformity with Commission rules.\15\ Accounting firms also 
must prepare attestation reports related to the internal controls of 
certain broker dealers,\16\ investment companies,\17\ transfer 
agents,\18\ and others.\19\
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    \12\ For example, Items 25 and 26 of Schedule A to the 
Securities Act of 1933 (``Securities Act''), 15 U.S.C. 77aa(25) and 
(26), and Section 17(e) of the Securities Exchange Act of 1934 
(``Exchange Act''), 15 U.S.C. 78q(e), expressly require that 
financial statements be audited by independent public or certified 
accountants. Sections 12(b)(1)(J) and (K) and 13(a)(2) of the 
Exchange Act, 15 U.S.C. 78l(b) and 78m(a)(2), Sections 5(b)(2)(H) 
and (I), 10(a)(1)(G), and 14 of the Public Utility Holding Company 
Act of 1935 (``PUHCA''), 15 U.S.C. 79e(b), 79j(a)(1)(G), and 79n, 
Sections 8(b)(5) and 30(e) and (g) of the Investment Company Act of 
1940 (``ICA''), 15 U.S.C. 80a-8(b)(5) and 80a-29, and Section 
203(c)(1)(D) of the Investment Advisers Act of 1940 (``Advisers 
Act''), 15 U.S.C. 80b-3(c)(1)(D), authorize the Commission to 
require the filing of financial statements that have been audited by 
independent public accountants.
    \13\ ``An unqualified opinion states that the financial 
statements present fairly, in all material respects, the financial 
position, results of operations, and cash flows of the entity in 
conformity with generally accepted accounting principles.'' AICPA, 
Statements on Auditing Standards (``SAS'') No. 58, Codification of 
Statements on Auditing Standards (``AU'') Sec. 508.10.
    \14\ The proposed rules would define ``review'' in this context 
to mean a review of financial statements in accordance with 
generally accepted auditing standards (``GAAS''), as may be modified 
or supplemented by the Commission. A review includes procedures that 
are less in scope than an audit, and consists generally of inquiries 
and analytical procedures, rather than research and verification 
procedures. See, SAS No. 71, AU Sec. 722 (as revised by SAS No. 90).
    \15\ Rule 10-01(d) of Regulation S-X, 17 CFR 210.10-01(d), which 
states in part, ``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 conducing such reviews, as established 
by generally accepted auditing standards, as may be modified or 
supplemented by the Commission.''
    \16\ 17 CFR 240.17a-5(g), (h), and (j).
    \17\ Form N-SAR, item 77B; 17 CFR 274.101.
    \18\ 17 CFR 240.17Ad-13.
    \19\ See, e.g., Exchange Act Release No. 16900 (June 17, 1980), 
45 FR 41920 (June 23, 1980) regarding clearing agencies and Exchange 
Act Release No. 24216 (Mar. 13, 1987), 52 FR 8998 (Mar. 20, 1987) 
regarding depository trust companies.
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    Under the statutory scheme, accountants are the only professionals 
that Commission registrants and issuers must engage before making a 
public offering of or having a public market for their securities. That 
alone is a significant indication of legislative intent concerning the 
critical role of the auditing process, but Congress did not stop by 
describing the required professionals merely as ``accountants.'' 
Rather, the securities laws qualify that term so that accountants 
auditing the financial statements of public companies are both subject 
to oversight intended to facilitate a high level of competence--
reflected in the statutory requirement to be ``certified public'' or 
``public''--and disinterested in any outcome of the audit process other 
than getting reliable information to the public--reflected in the 
statutory requirement to be ``independent.'' \20\ The securities laws 
supplement those safeguards by giving the Commission significant 
flexibility to make rules and regulations bearing on public companies' 
financial disclosures, including the methods and forms employed in 
making those disclosures.
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    \20\ The Supreme Court has recognized and underscored the 
significant and unique role in which the securities laws cast 
accountants that audit public companies. In declining to extend to 
accounting firms certain confidentiality protections available to 
attorneys representing a client and preparing for trial, the Court 
emphasized that:
    [a]n independent certified public accountant performs a 
different role. By certifying the public reports that collectively 
depict a corporation's financial status, the independent auditor 
assumes a public responsibility transcending any employment 
relationship with the client *  *  * [and] owes ultimate allegiance 
to the corporation's creditors and stockholders, as well as to the 
investing public.
    United States v. Arthur Young & Co., 465 U.S. 805, 817-18 
(1984). The Court further noted that, pursuant to the securities 
laws, ``The SEC requires the filing of audited financial statements 
in order to obviate the fear of loss from reliance on inaccurate 
information, thereby encouraging public investment in the Nation's 
industries.'' Id. at 819 n.15.
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    The Commission relies on certified financial statements, and 
consequently on the competence, ethics, and independence of 
accountants, to protect its processes and carry out its mandate.\21\ 
While our staff reads and

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comments on a great many filings, it does not, cannot, and should not 
perform the extensive audit or review procedures that auditors must 
perform under GAAS. In addition, the volume of financial information 
filed with us far exceeds what the Commission staff can meaningfully 
review. We, therefore, must rely heavily on the accounting profession, 
as Congress intended, to ensure and enhance the integrity of the large 
volume of financial information that forms the cornerstone of our full 
disclosure system.\22\
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    \21\ In this regard, the Commission adopted Rule 102(e) of our 
Rules of Practice to protect the integrity of Commission processes. 
17 CFR 201.102(e). See, e.g., Touche Ross & Co. v. SEC, 609 F.2d 
570, 582 (2d Cir. 1979) (upholding the predecessor to Rule 102(e) as 
``reasonably related'' to the purposes of the securities laws, in 
part because the rule ``provides the Commission with the means to 
ensure that those professionals, on whom the Commission relies 
heavily in the performance of its statutory duties, perform their 
tasks diligently and with a reasonable degree of competence'').
    To protect its own processes, and by extension the investing 
public, the Commission vigorously pursues violations of professional 
standards. We have initiated Rule 102(e) proceedings when auditors 
failed to adhere to professional standards. For example, we 
sanctioned auditors under Rule 102(e) for not appropriately 
responding to warning signals pointing to client fraud (see, e.g., 
In the Matter of Nanette Miller, Accounting and Auditing Enforcement 
Release No. (``AAER'') 1241 (Mar. 29, 2000); In the Matter of 
Laubscher and Griffin, AAER 1082 (Sept. 29, 1998)), and when they 
have failed to obtain the specialized knowledge necessary to perform 
an audit (see, e.g., In the Matter of Ruzicka, AAER 1155 (Aug. 24, 
1999).
    \22\ The courts have recognized this regulatory regime. Touche 
Ross, 609 F.2d at 581.
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    In sum, investors and the Commission rely on accountants to assure 
disclosure of accurate and reliable financial information. As a result, 
``[b]reaches of professional responsibility jeopardize the achievement 
of the objectives of the securities laws and can inflict great damage 
on public investors.'' \23\ Effective oversight of the accounting 
profession therefore is critical to protecting the public interest and 
preventing this ``great damage'' to investors.
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    \23\ Id.
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    We are concerned that we are today facing some of the same problems 
that Congress sought to address in the 1930s when the federal 
securities laws were enacted. Certainly there is evidence of a public 
perception that these problems are recurring with disconcerting, and 
unacceptable, frequency.\24\ It falls to the Commission to try to 
identify the causes of the problem, and, to the extent possible, craft 
solutions consistent with its statutory mandate.
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    \24\ See, e.g., Nanette Byrnes, Accounting Failures Aren't New--
Just More Frequent, Bus. Wk., Jan. 28, 2002, at 46.
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    We have carefully considered the causes. For the reasons described 
below, we believe that the oversight mechanism for insuring that public 
companies have their financial statements audited by skilled, 
disinterested professionals operating under high ethical standards and 
strict quality control procedures is not working as intended. We are 
concerned that the deficiencies in that mechanism frustrate the 
financial disclosure purpose of the securities laws, undermine investor 
confidence in financial disclosures, and contribute to inefficient 
capital allocation in the markets.

B. Current Oversight Mechanisms Do Not Meet Their Objectives

    Several factors lead us to consider whether the accounting 
profession's self-regulatory oversight mechanisms, on which the markets 
and we have previously been willing to rely, do not meet the necessary 
objectives. For the reasons described below, we conclude that the self-
regulatory mechanisms are not producing credible results, and that this 
failure may be linked to features that cannot realistically be expected 
to change through further self-regulation or minor changes to the 
current oversight mechanism.
    The factors that concern us include the recent increases in the 
number of public companies restating their financials, revelations of 
serious financial difficulties at a variety of companies, a closed-door 
professional disciplinary process, and serious questions related to the 
current system of firm-on-firm ``peer reviews'' as a check on 
accountants' quality control processes.\25\ The need for significant 
structural reforms in the oversight process to protect the public has 
been suggested by several people.\26\
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    \25\ During the initial stages of the Commission's consideration 
of these issues, the profession's vehicle for oversight of the peer 
review system was the POB, until it voted to disband, and as of 
April 30, 2002, ceased official operations. The AICPA's SEC Practice 
Section (for firms that audit financial statements filed with the 
Commission) (``SECPS'') has indicated that, notwithstanding the 
POB's decision to terminate operations, the SECPS will continue its 
peer review and QCIC programs until such time as a new regulatory 
model replaces them. The SECPS also has indicated that it will 
continue to fund the oversight operations of the POB staff (now 
called the Transition Oversight Staff, or TOS) during this 
transition period. Letter from Robert J. Kueppers, Chair, to Robert 
K. Herdman, Chief Accountant (Feb. 15, 2002). See also SEC Press 
Release No. 2002-40 (Mar. 19, 2002) regarding the TOS's continuing 
review of certain accounting firms' quality control systems for 
assuring compliance with auditor independence requirements.
    \26\ See generally Section II.C. below.
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    As noted, one indication of the need for an enhanced regulatory 
structure is the increase in the number of restatements in recent 
years. According to a recent study, in the last three years more than 
700 companies have restated earnings.\27\ While there are many reasons 
for these restatements, we are concerned that they contribute to 
investor confusion and weaken investor confidence in the financial 
reporting process.
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    \27\ One recent study identified 234 restatements in 1999, 258 
restatements in 2000, and 305 restatements in 2001. Huron Consulting 
Group, A Study of Restatement Matters: For the Five Years Ended 
December 31, 2001, at 8 (June 11, 2002). See also Jim McTague, 
Fixable Flaws, Barron's, Jan. 7, 2002, at 16.
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    Through the 1990s, such restatements, as well as allegations of 
accounting irregularities at companies such as Miniscribe and Phar-Mor, 
and more recently at companies such as Rite-Aid, Cendant, 
MicroStrategy, Sunbeam, McKesson HBOC, Waste Management, and Xerox have 
caused increasing concern. The bankruptcy of Enron Corporation last 
year, which was the largest bankruptcy in history and resulted in 
substantial financial losses to investors and pensioners, has 
dramatically heightened the public attention given to those concerns, 
posing a critical threat to investor confidence in financial 
information generally.\28\
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    \28\ During the 19909s, federal banking regulators reviewed the 
performance of accounting firms in relation to the savings and loan 
crisis of the late 1980s and early 1990s. Accounting firms' 
settlements of actions pending before the Office of Thrift 
Supervision included, among other things, increased training 
requirements for individuals working on audits of financial 
institutions, work paper retention requirements, additional 
consultation procedures within the firms, and the payment of 
significant restitution to the Federal Deposit Insurance Corporation 
and Resolution Trust Corporation. See In the Matter of Ernst & 
Young, OTS Order No. AP 92-127 (Nov. 23, 1992); In the Matter of 
Deloitte & Touche, OTS Order No. AP 94-13 (Mar. 14, 1994); In the 
Matter of KPMG Peat Marwick, OTS Order No. AP 94-37 (Aug. 9, 1994); 
In the Matter of Grant Thornton, L.L.P., OTS Order No. AP 96-30 
(Oct. 3, 1996).
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    To the extent that restatements and accounting irregularities 
suggest a failure of those in the accounting profession to perform 
consistently with sufficient skill and competence,\29\ we are concerned 
that inherent limitations in the existing oversight mechanism prevent 
that mechanism from doing all that is required to curb such lapses. For 
example, the existing self-regulatory mechanism has not through its 
system of peer review uncovered significant deficiencies in competence, 
and it does not, and probably cannot, include the power to suspend 
incompetent individuals altogether from providing audit, review, or 
attest services to public companies.
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    \29\ See Janet Whitman, For Competence, Accounting Gets ``D'' in 
New Poll, Wall St. J., Apr. 10, 2002, at A7; Accounting Faces Crisis 
of Competence, Not Integrity; ``Andersen-itis'' Isn't What Ails the 
Industry, Newstream.com, Apr. 10, 2002 (surveyed companies indicated 
accountants lack competence in certain technical areas).
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    While some aspects of the existing system are plainly beneficial, 
including, for example some portions of the Quality Control Inquiry 
Committee (``QCIC'') process,\30\ the profession's

[[Page 44968]]

ability to discipline or remedy incompetent or unethical conduct has 
been a persistent concern.\31\ The profession's disciplinary program 
continues to suffer from several inherent weaknesses, including:
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    \30\ Under the membership requirements of the SECPS, after 
receiving service of a complaint in any litigation against the firm 
or its personnel, or the commencement of any publicly announced 
regulatory investigation, that alleges deficiencies in the conduct 
of an audit of the financial statements of a Commission registrant, 
the firm must not only review the engagement to evaluate the 
performance of senior personnel with respect to the specific issues 
contained in the complaint but also report the matter to the QCIC. 
SECPS, Requirements of Members, at k; SECPS, Appendix M--Procedures 
in Connection with an Alleged Audit Failure, SECPS Sec. 1000.46. The 
QCIC will review the matter and, if appropriate, refer it to the 
AICPA Professional Ethics Division, which will evaluate whether the 
matter warrants investigation.
    \31\ See, e.g., David S. Hilzenrath, Auditors Face Scant 
Discipline, Wash. Post, Dec. 6, 2001, at A01; See, e.g., John C. 
Burton, The Evolutionary Revolution in Public Accounting, 52 Brook. 
L. Rev. 1041, 1046-47 (1987) (Mr. Burton, former Chief Accountant to 
the SEC, commenting on the POB, has stated that ``[w]hile the 
structure created was highly promising and the development of a 
regular process of peer review is very desirable, my own judgment is 
that the results have fallen short of expectations. In the first 
place, the emphasis on process and remedial actions has been too 
limiting. Peer reviews need to go beyond process to look at 
application of procedures and to develop a significant disciplinary 
process'').
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     Peer reviews may not consistently be as thorough as 
necessary. Peer review is the process by which other accountants assess 
and test compliance with quality control systems for the accounting and 
auditing practices of SEC Practice Section (``SECPS'') members. The 
objectives of peer review are to determine whether the reviewed firm: 
(i) designed its system to meet Quality Control Standards established 
by the AICPA; (ii) complied with its quality control system to provide 
reasonable assurance of complying with professional standards; and 
(iii) complied with SECPS membership requirements. Upon the completion 
of a review the peer reviewer prepares a report and a letter of 
comments, which may recommend improvements to the firm's system of 
compliance. On occasion, firms have received ``clean'' peer review 
reports despite well-publicized problems within a firm. For example, a 
report published by an independent consultant noted one firm had 
numerous violations of the auditor independence rules,\32\ yet the next 
peer review report on the firm mentioned neither the need for 
improvements in the firm's quality controls in this area nor the 
efforts the reviewed firm had underway to make those improvements. Our 
staff has provided the POB with comments on peer reviews with the goal 
of improving the process and achieving more understandable 
communications to the public of peer reviewers' findings.\33\ For many 
years, we had stated in our Annual Report that the peer review and QCIC 
processes resulted in accounting firms ``focusing on and achieving the 
important goal of maintaining and improving effective quality control 
systems.''\34\ Because of our growing concerns, however, we 
intentionally did not include that statement in our 1999, 2000, and 
2001 Annual Reports.
---------------------------------------------------------------------------

    \32\ See SEC Press Release No. 2000-4 (Jan. 6, 2000).
    \33\ See, e.g., SEC, Annual Report 2001, at 90; SEC, Annual 
Report 1999, at 91. The SEC staff oversees the peer review and QCIC 
processes by periodically selecting at random a sample of peer 
reviews and evaluating working papers and POB oversight files 
related to those reviews. Our staff also reviews QCIC closed case 
summaries and related POB oversight files.
    \34\ See, e.g., SEC, Annual Report 1998, at 74.
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     The disciplinary process is voluntary. The disciplinary 
program is conducted within the auspices of the AICPA, which is a 
voluntary private sector organization dominated by accounting firms.
     There is no independent and dependable funding source. 
During discussions about the POB's reviews of the firms' systems of 
quality controls over auditor independence, the SECPS took the 
unprecedented step of threatening to halt the funding for the POB's 
reviews.
     The disciplinary process relies solely on information 
gathered from accountants. The process is generally limited to 
reviewing information obtained from the accountants and does not 
include obtaining information from third parties, such as management of 
the audit client. As Norman R. Walker, former chairman of an AICPA 
disciplinary panel has said, ``Basically we're confined to looking at 
the [public] record and the information that the [member] is able to 
provide and willing to provide.''\35\
---------------------------------------------------------------------------

    \35\ David S. Hilzenrath, Auditors Face Scant Discipline, supra 
note 31.
---------------------------------------------------------------------------

     Sanctions are weak. The most stringent sanction in an 
AICPA proceeding is expulsion from the AICPA, which does not directly 
affect an accountant's ability to practice before the Commission or 
elsewhere.\36\
---------------------------------------------------------------------------

    \36\ AICPA, Official Releases: Organizational Structure and 
Functions of the SEC Practice Section of the AICPA Division for CPA 
Firms, J. Acct., Nov. 1977, at 113, 115.
---------------------------------------------------------------------------

     The disciplinary proceedings are not public. AICPA 
disciplinary proceedings are conducted behind closed doors and, while 
improvements have been made in the public reporting of sanctions, 
limited information is available regarding the results of its 
proceedings.

C. The Need for Reform Is Widely Recognized

    Investor confidence in the quality of financial information is 
critical, and it is directly linked to investor confidence in the 
quality of audits.\37\ As a participant in the Commission's Roundtables 
stated:
---------------------------------------------------------------------------

    \37\ See Relationships Between Registrants and Independent 
Accountants, Accounting Series Release No. 296 (Aug. 20, 1981), 46 
FR 43181 (Aug. 27, 1981), which states in part:
    [T]he capital formation process depends in large part on the 
confidence of investors in financial reporting. An investor's 
willingness to commit his capital to an impersonal market is 
dependent on the availability of accurate, material and timely 
information regarding the corporations in which he has invested or 
proposes to invest. The quality of information disseminated in the 
securities markets and the continuing conviction of individual 
investors that such information is reliable are thus key to the 
formation and effective allocation of capital. Accordingly, the 
audit function must be meaningfully performed and the accountant's 
independence not compromised.

    [T]he public should have real confidence that their interest is 
being looked after in the mechanism for regulating the profession, 
and disciplining the members of the profession, setting professional 
standards. All of those. They want to know that the way that this is 
done is going to look after their interests, and not just the 
interests of the body of the individuals who practice in that 
---------------------------------------------------------------------------
profession.\38\

    \38\ EC Roundtables, supra note 8, at 37 (Mar. 6, 2002) 
(statement of Neil Lerner, Head of Risk Management (U.K.), KPMG).
---------------------------------------------------------------------------

    Because of the above-described concerns, calls for improved 
oversight of the accounting profession have become more urgent.
    Congress, the Commission, and many others have questioned whether 
weaknesses inherent in the profession's self-regulatory process limit 
its ability to improve sufficiently the performance of audits of public 
companies. More generally, strong public sentiment has emerged calling 
for more effective oversight. The connection between that oversight and 
investor confidence has never been as pronounced as it is today.
    The need for reform has been highlighted by President George W. 
Bush. On March 7, President Bush announced a ten-point plan to improve 
corporate disclosure, make corporate officers accountable, and develop 
a stronger and more independent audit system. In discussing the latter 
point, President Bush stated:

    An independent regulatory board should ensure that the 
accounting profession is held to the highest ethical standards. 
Under this proposal, an independent regulatory board would be 
established, under the supervision of the SEC, to develop standards 
of professional conduct and competence. This board would have the 
ability to monitor, investigate, and where needed, enforce its

[[Page 44969]]

ethics principles by punishing individual offenders.\39\

    \39\ Specifics on the President's Ten-Point Plan (Mar. 7, 2002) 
are available at http://www.whitehouse.gov/news/releases/2002/03/20020307.html.
---------------------------------------------------------------------------

    In addition, the Commission recently held the SEC Roundtables to 
discuss a variety of issues relating to the financial reporting 
process, including auditor oversight and held an Investor Summit.\40\ 
Participants in our Roundtables represented a variety of 
constituencies. Participants provided us with the benefit of extensive 
and diverse insights into the issues confronting the profession's self-
regulatory programs and how those programs should be improved.\41\ For 
example, Mr. Ken Bertsch, Director, Corporate Governance, at Teachers 
Insurance and Annuity Association College Retirement Equities Fund 
(``TIAA-CREF''), noted his organization's lack of confidence in the 
current peer review process. Others, such as Mr. David Shedlarz, Chief 
Financial Officer, Pfizer Inc., offered constructive outlines of the 
attributes and duties for a new regulatory body. While our proposals 
are not identical to any one participant's suggested approach, the 
discussions at the Roundtables were very valuable in helping us to 
identify issues, consider alternatives, and frame the positions 
contained in our proposed rules.
---------------------------------------------------------------------------

    \40\ See supra note 8 regarding the SEC Roundtables and Investor 
Summit.
    \41\ Id.
---------------------------------------------------------------------------

    Beyond our Roundtables, others have voiced concerns with the 
current self-regulatory system and called for reform. For example, the 
Consumer Federation of America has called for a complete overhaul of 
the profession's self-regulatory system.\42\ The Financial Executives 
International (``FEI'') also has recommended the creation of a new 
oversight body for the accounting profession.\43\ The FEI has indicated 
that a majority of the new oversight body's board should be executives 
with knowledge in accounting and finance, but should not be drawn from 
the audit profession. FEI further has stated that the new body's 
principal tasks should be oversight of audits and discipline.\44\
---------------------------------------------------------------------------

    \42\ Accounting and Investor Protection Issues Raised by Enron 
and Other Public Companies: Hearing Before the Senate Comm. on 
Banking, Housing, and Urban Affairs, at 6 (Mar. 20, 2002) (statement 
of Senator Howard M. Metzenbaum (Ret.), Chairman, Consumer 
Federation of America).
    \43\ FEI, FEI Observations and Recommendations: Improving 
Financial Management, Financial Reporting and Corporate Governance 
(Mar. 2002).
    \44\ Id. at 3.
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    Many other observers and members of the accounting profession have 
lost confidence in the efficacy of the SECPS programs overseen by the 
POB and have encouraged the development of a stronger body that plays a 
more active role in the oversight of quality control reviews and 
professional discipline. Former SEC Chairman Arthur Levitt also has 
called for a new oversight body. In his testimony before the Senate 
Committee on Governmental Affairs, he supported a ``truly independent'' 
non-governmental oversight body that has the power to conduct timely 
investigations and to discipline accountants. He also stated that the 
new body should operate in public--not behind closed doors--and, to 
preserve its integrity, the accounting profession should not fund the 
body.\45\
---------------------------------------------------------------------------

    \45\ The Fall of Enron: How Could It Have Happened?: Hearing 
Before the Senate Comm. on Governmental Affairs (Jan. 24, 2002) 
(statement of Arthur Levitt, Chairman, Securities and Exchange 
Commission, 1993-2000).
---------------------------------------------------------------------------

    In addition, Harold Williams, who was the Chairman of the 
Commission at the time the SECPS and POB were created, stated in recent 
testimony before the Senate Committee on Banking, Housing, and Urban 
Affairs:

    Self-regulation, aggressively overseen, can be much more 
effective in enforcing the spirit of the rules than can a policing 
agency of government. However, it is evident that the existing 
structure is not adequate to the task and needs to be redesigned and 
strengthened * * *.
    The Public Oversight Board was created by the profession during 
my chairmanship as an effort at self-regulation. We expressed 
concern at the time whether the peer review process administered by 
the profession would be adequate. But, as believers in the principle 
of self-regulation, we concluded that the Board should have the 
opportunity to prove itself. In my opinion, the events over the 
intervening years have demonstrated that it does not meet the needs 
and is not adequate * * *. A system needs to be established which is 
independent of the accounting profession, transparent and able to 
serve both effective quality control and disciplinary functions.\46\

    \46\ Accounting and Investor Protection Issues Raised by Enron 
and Other Public Companies: Oversight Hearing Before the Senate 
Comm. on Banking, Housing, and Urban Affairs (Feb. 12, 2002) 
(statement of The Honorable Harold M. Williams, Chairman, Securities 
and Exchange Commission, 1977-81).
---------------------------------------------------------------------------

    At the same hearing, former SEC Chairman David Ruder called for a 
new private sector regulatory system to oversee the accounting 
profession. In describing the deficiencies in the current system, he 
said:

    [A]lthough the POB's powers have been strengthened, it does not 
have sufficient budget to allow it to function effectively. It does 
not have the power to force accounting firms to provide the 
documents necessary to complete investigations * * *. It is forced 
to rely upon the accounting profession itself to engage in 
enforcement activities. Most important, its connection to the AICPA 
creates an appearance of control by that body.\47\
---------------------------------------------------------------------------

    \47\ Accounting and Investor Protection Issues Raised by Enron 
and Other Public Companies: Oversight Hearing Before the Senate 
Comm. on Banking, Housing, and Urban Affairs, at 8 (Feb. 12, 2002) 
(statement of David S. Ruder, Chairman, Securities and Exchange 
Commission, 1987-89)

    Former SEC Chief Accountants and other leaders of the accounting 
profession also have stated publicly that a new regulatory body is 
needed.\48\ Mr. James Turley, Chairman of Ernst & Young LLP, recently 
stated in an op-ed article in The Wall Street Journal:
---------------------------------------------------------------------------

    \48\ Accounting and Investor Protection Issues Raised by Enron 
and Other Public Companies: Oversight of the Accounting Profession, 
Audit Quality and Independence, and Formulation of Accounting 
Principles: Hearing Before the Senate Comm. on banking, Housing, and 
Urban Affairs (Feb. 26, 2002) (statement of Michael H. Sutton, Chief 
Accountant, Securities and Exchange Commission, 1995-98) which 
states: ``Regulatory processes that will build confidence in the 
auditing profession will be truly independent; they will be open; 
they will actively engage, inform, and involve the public; they will 
be adequately resourced and empowered to accomplish their mission; 
and they will be amendable to change as events dictate. I believe 
that the critical ingredients of an effective regulatory process 
that can restore and maintain pubic trust include:
     Timely and thorough investigations of circumstances 
that may involve fraudulent financial reporting.
     Objective and fair assessments of the role and 
performance of the auditor.
     Timely and meaningful discipline of auditors and firms 
that violate acceptable norms of conduct.
     Regular oversight and periodic examinations of the 
policies and performance of independent auditors.
     Timely and responsive changes in professional standards 
and guidance when a need for improvements is identified.''

    [W]e should create a new regulatory body for the profession. It 
should have its own funding, offices and staff. It should have 
direct power over the profession's disciplinary and audit quality 
control programs, replacing the current ``peer review'' process in 
which firms review each other. To ensure maximum public credibility, 
this oversight should come from a body other than the American 
Institute of Certified Public Accountants, because many believe it 
has not maintained its historic focus on professional 
---------------------------------------------------------------------------
responsibility.\49\

    \49\ James S. Turley, How Accounting Can Get Back Its Good Name, 
Wall St. J., Feb. 4, 2002, at A16.
---------------------------------------------------------------------------

    Similarly, PricewaterhouseCoopers LLP, in letters to certain audit 
clients that are Commission registrants, stated, ``[T]here is no 
question that the current regulatory structure is in need of reform.'' 
\50\ It stated that changes that are especially critical include having 
oversight come from outside the accounting profession and involve more 
participative reviews by staff that is independent of the accounting 
firms. It

[[Page 44970]]

also stated that the regulatory structure ``needs teeth'' and, ``if an 
independent oversight body finds quality procedures lacking, it must 
have the right to revoke an individual's or firm's right to practice.'' 
\51\
---------------------------------------------------------------------------

    \50\ Letters from Samuel A. DiPiazza, Jr., Chief Executive 
Officer, PricewaterhouseCoopers LLP to selected audit clients (Jan. 
to Feb. 2002).
    \51\ Id.
---------------------------------------------------------------------------

    Congress has introduced several bills that would create bodies 
similar to, but in some respects different than, a PAB. Numerous 
committees in both the Senate and House have held hearings to explore 
reform of the accounting regulatory structure. A common theme in these 
hearings was the need for improvements in the manner in which 
accountants are regulated, and, in particular, the need for effective 
private-sector regulation of the accounting profession.\52\
---------------------------------------------------------------------------

    \52\ See H.R. 3763, the Corporate and Auditing Accountability, 
Responsibility, and Transparency Act of 2002: Hearing Before the 
House Comm. on Financial Services (Apr. 9, 2002) (statement of 
Richard C. Breeden, Former Chairman, U.S. Securities and Exchange 
Commission 1989-93) (``[T]here is only one governmental `regulator' 
for the accounting industry, and that regulator is now and should 
remain the SEC. The SEC has the history, the culture and the 
institutional strength to be able to stand up to any wrongdoer. 
However, private sector groups working under the SEC's aegis can 
extend the reach of supervision in a healthy fashion.''); Accounting 
and Investor Protection Issues Raised by Enron and Other Public 
Companies: Hearing Before the Senate Comm. on Banking, Housing, and 
Urban Affairs (Feb. 14, 2002) (statement of Paul A. Volcker, 
Chairman of the Trustees of the International Accounting Standards 
Board and Former Chairman, Board of Governors of the Federal Reserve 
System) (``[E]xperience strongly suggests that governmental 
oversight, with investigation and enforcement powers, is necessary 
to assure discipline * * *. [T]his committee will want to explore 
means for providing more ``backbone'' for industry oversight, either 
through legislation or by encouraging exercise of SEC regulatory 
authority. Better means of identifying professional misconduct, with 
the possibility of meaningful fines and withdrawal of professional 
licenses, appears essential.''); Accounting and Investor Protection 
Issues Raised by Enron and Other Public Companies: Hearing Before 
the Senate Comm. on Banking, Housing, and Urban Affairs (Mar. 5, 
2002) (statement of Joel Seligman, Dean and Ethan A.H. Shepley 
University Professor, Washington University School of Law) (``I 
believe at this time a new auditing self-regulatory organization is 
necessary. It should replace not just the POB, but a byzantine 
structure of accounting disciplinary bodies which generally have 
lacked adequate and assured financial support; clear and undivided 
responsibility for discipline; and an effective system of SEC 
oversight.''); Accounting and Investor Protection Issues Raised by 
Enron and Other Public Companies: Hearing Before the Senate Comm. on 
Banking, Housing, and Urban Affairs (Mar. 6, 2002) (statement of 
Shaun O'Malley, Chair of the 2000 Public Oversight Board Panel on 
Audit Effectiveness, and Former Chair, Price Waterhouse LLP) (``I am 
in favor of the creation of an organization to oversee the 
accounting profession, whether it is created by regulation or by 
legislation.'').
---------------------------------------------------------------------------

    We intend to continue to work with Congress on these and other 
bills, and will monitor the progress of pending legislation. We will 
implement any legislation that is enacted. The Commission must proceed 
with its proposal under its existing statutory mandate, however, to 
strengthen investor confidence in the oversight of the auditing process 
and assure investors of comprehensive reform in the event that no 
legislation is passed.

D. The History of Audit Oversight Mechanisms Suggests the Need for a 
Different Type of Oversight Mechanism

    Over the years the accounting profession has been subject to 
various forms of oversight with varying degrees of success. As a 
foundation for understanding the elements of the new oversight 
mechanism that we propose, we believe that it is useful to examine the 
history of the present system.
    The current self-regulatory mechanism was developed as a result of 
concerns expressed during congressional hearings in the mid to late 
1970s. These hearings investigated unexpected failures by major 
corporations and questioned why auditors failed to detect, and 
financial statements failed to reflect, illegal payments made by United 
States companies to foreign officials. During these hearings, the 
accounting profession's competence to detect and deter such problems 
was a significant issue. The question was asked, ``Where was the 
independent auditor?'\53\ And bills were introduced that would have 
created a new regulatory structure for the profession.\54\
---------------------------------------------------------------------------

    \53\ Staff of Subcomm. on Reports, Accounting, and Management of 
the Senate Comm. on Government Operations, 95th Cong., Report on the 
Accounting Establishment: A Staff Study, 7 (Subcomm. Print Mar. 31, 
1977).
    \54\ See, e.g., H.R. 13175, 95th Cong. (1978).
---------------------------------------------------------------------------

    The hearings in the House of Representatives focused on how several 
federal agencies used the regulatory powers granted by Congress.\55\ 
After considering the work of accounting firms that audit registrants' 
financial statements, the Subcommittee on Oversight and Investigations 
of the House Committee on Interstate and Foreign Commerce found that 
the ``SEC's reliance on the private accounting profession alone to 
assure that corporate records are examined by independent auditors has 
been insufficient to protect public investors and to accomplish the 
objectives of the Federal securities laws.''\56\
---------------------------------------------------------------------------

    \55\ See Staff of Subcomm. on Oversight and Investigations of 
the House Comm. on Interstate and Foreign Commerce, 94th Cong., 
Report on Federal Regulation and Regulatory Reform, 1 (Subcomm. 
Print Oct. 1976). (also known as the ``Moss Report'').
    \56\ Id. at 38.
---------------------------------------------------------------------------

    The Senate hearings began with a staff study prepared for the 
Subcommittee on Reports, Accounting, and Management that was critical 
of the accounting profession. The staff study stated, ``Reforms are 
needed to restore public confidence in the accuracy and reliability of 
financial and other information reported by publicly-owned 
companies.''\57\ During the several months that followed, the 
Subcommittee gathered extensive information from accounting firms, the 
Commission, and others. At the conclusion of the hearings, the Senate 
Subcommittee Report stated, ``Self-initiated action by the private 
sector in cooperation with the SEC is the method of reform preferred by 
subcommittee members.''\58\
---------------------------------------------------------------------------

    \57\ Staff of Subcomm. on Reports, Accounting, and Management of 
the Senate Comm. on Government Operations, 95th Cong., Report on the 
Accounting Establishment: A Staff Study, 20 (Subcomm. Print Mar. 31, 
1977).
    \58\ Staff of Subcomm. on Reports, Accounting, and Management of 
the Senate Comm. on Governmental Affairs, 95th Cong., Report on 
Improving the Accountability of Publicly Owned Corporations and 
Their Auditors 4 (Subcomm. Print Nov. 4, 1977).
---------------------------------------------------------------------------

    The Commission's involvement in issues related to the AICPA's self-
regulatory processes, which included the establishment in 1977 of the 
POB, increased during and after these congressional hearings. The 
Commission undertook to oversee, and annually report to Congress on, 
the profession's response to Congressional concerns.\59\ The 1977 self-
regulatory system is described in more detail in Appendix A.
---------------------------------------------------------------------------

    \59\ Accounting and Auditing Practices and Procedures: Hearing 
Before the Subcomm. on Reports, Accounting and Management of the 
Senate Comm. on Governmental Affairs (June 13, 1977) (statement of 
Harold M. Williams, Chairman, U.S. Securities and Exchange 
Commission).
---------------------------------------------------------------------------

    As concerns about the quality of financial reports has increased in 
recent years, the POB, the Commission and others began to call for an 
update to the governance mechanisms of the POB, which were adopted soon 
after it was formed in 1977. While intended to be autonomous (the POB 
could set its own budget, establish its own operating procedures, and 
appoint its own members, chairperson, and staff), the POB relied for 
its funding on voluntary dues paid by AICPA firms that audited public 
companies and belonged to the AICPA section composed of such firms--
SECPS. In addition, the POB lacked the ability to organize and 
implement its own quality control reviews. And, the POB was not given 
any authority to sanction auditors for deficiencies or incompetence 
noted during quality control reviews.

[[Page 44971]]

    Discussions among the Commission staff, POB, SECPS, AICPA, 
accounting firms, and others, culminated in the adoption of a new POB 
charter in February 2001. The principal features of the new charter 
included:
     Oversight of the SECPS and, for the first time, oversight 
of the Auditing Standards Board and the now-defunct Independence 
Standards Board;
     Expanded responsibility for improving communications among 
various bodies involved in the profession's regulatory processes;
     Expanded responsibilities to undertake special reviews and 
projects; and
     Increased funding from the SECPS.\60\
---------------------------------------------------------------------------

    \60\ POB, Annual Report 2000, at 5. The POB charter is available 
at http://www.publicoversightboard.org/charter.htm.
---------------------------------------------------------------------------

    Even under the new charter, however, the POB lacked the express 
authority to direct the review of a firm's quality control system or to 
discipline a firm, or persons in a firm, for noncompliance with 
professional standards or the SECPS membership requirements. The new 
charter also provided that the SECPS would continue to be the sole 
source for the POB's funding, and required the SECPS to approve funding 
for the POB's special or unanticipated projects and for any amount 
above the $5.2 million annual limit set forth in the charter.\61\
---------------------------------------------------------------------------

    \61\ The new POB charter also fell short of instituting all of 
the recommendations of the Panel on Audit Effectiveness. For 
example, the Panel had recommended that the POB should approve all 
appointments to the Auditing Standards Board and SECPS Executive 
Committee, that the POB oversee the AICPA's evaluations, 
compensatory hiring and promotion decisions with respect to the 
staff of the AICPA committees it was to oversee, and the 
establishment of ``no strings attached'' funding for the POB. The 
Panel on Audit Effectiveness, Report and Recommendations 140 (Aug. 
31, 2002).
---------------------------------------------------------------------------

E. A New System of Private Sector Oversight Will Address Current 
Problems and Increase Investor Confidence

    The private sector framework we are proposing would provide 
reasonable assurance to investors and to the Commission that accounting 
firms' audit, review, and attest procedures, which are required by the 
securities laws and Commission regulations, fulfill their statutory and 
regulatory purposes, and thereby will increase assurances that 
financial reporting, also required by the securities laws and 
Commission regulations, meet applicable legal and regulatory 
requirements. While no system of private sector or government 
regulation can ensure one hundred percent compliance with professional 
standards, we believe that this system would enhance investors' 
confidence that accounting firms are performing their public 
responsibilities and that, therefore, the financial information 
published by registrants and issuers is reliable.
    After full consideration of the weaknesses of the present system 
and how it can be improved, we have based our proposed rules on the 
position that a PAB should reflect eight core principles:
    1. A PAB should be separate from, and independent of, the AICPA--
Despite the POB's oversight, significant failures in the auditing 
process continue to exist. In addition, there is a perceived conflict 
between the AICPA's dual roles of serving the best interests of its 
membership and serving investors. To restore confidence in the system, 
we believe that it is necessary for a new PAB to be established, 
operated, and overseen completely outside of the profession.
    2. Requirements as to financial statements--To assure that the 
benefits of the oversight process extend to investors in all public 
companies, the financial statements of an SEC-registered company would 
not comply with Commission requirements unless the company's 
accountants were members of a PAB and the company was a member of, and 
thereby bound to cooperate in any review or proceeding commenced by, 
the same PAB as its accountants. In the Commission's view this is 
necessary to assure cooperation and access necessary to carry out its 
reviews, quality control, and disciplinary activities over the 
accounting profession.
    3. A PAB should operate under the SEC's oversight--The SEC's 
relationship with the POB was based on the desire of the profession and 
the POB to provide assurance to Congress and to the public that the 
peer review process and related programs were working well. The SEC had 
limited ability to affect the work of the POB or the peer review 
program. Under the new framework, the Commission would recognize a PAB 
after reviewing, and being satisfied with, among other things, the 
entity's charter, by-laws, proposed budget, and proposed board members. 
The SEC would have the ability to review, alter, modify, or abrogate 
any PAB rule and to review any PAB disciplinary action.
    4. Public members should dominate a PAB--To be credible, it must be 
clear that the PAB is an independent organization and places the public 
interest and the interest of investors above all else. A PAB would be a 
diverse board, dominated by persons who are not associated with the 
accounting profession and who are in the position to make all 
significant decisions on quality control and disciplinary issues.
    5. A PAB should have an independent and dependable funding source--
A PAB must have an independent and dependable funding source. The POB 
was funded by the AICPA, which called into question its ability to act 
totally separate from the profession. To assure continuity and 
independence, a PAB should be neither controlled nor principally funded 
by members of the accounting profession. A PAB's operations should be 
funded on a non-voluntary basis through the assessment of fees on 
accounting firms who are members of the PAB and on those firms' audit 
clients, the reliability of whose financial reporting would be 
presumptively benefited by the activities of the PAB.\62\
---------------------------------------------------------------------------

    \62\ See, e.g., SEC Roundtables, supra note , at 38 (Mar. 6, 
2002) (statement of Ted White, Corporate Governance Director, 
California Public Employees' Retirement System) (``I would suggest 
some of the key tenets be * * * a board that consisted of 
independent members with solely independent funding'').
---------------------------------------------------------------------------

    6. For larger firms, annual PAB-directed reviews of firms' quality 
controls for accounting, auditing, and auditor independence should 
replace triennial firm-on-firm peer reviews--While individuals within 
accounting firms generally regard firm-on-firm peer reviews as serious 
events that can affect their careers, investors and critics of the 
program often consider such reviews among the limited number of large 
firms to be a ``one hand washes the other'' approach to regulation.\63\ 
In addition, the triennial reviews are too infrequent for large 
firms.\64\
---------------------------------------------------------------------------

    \63\ See, e.g.,Editorial, Watching the Watchers, Wash. Post, May 
21, 2002, at A16; SEC Roundtables, supra note , at 55-56 (Mar. 4, 
2002) (statement of William Allen, New York University Law School) 
(suggesting that the public perception of the current peer review 
process is an ``I scratched your back, you scratch my back 
organization'').
    \64\ See Letter from Robert J. Kueppers, Chair, SECPS Executive 
Committee, to Managing Partners of SECPS Member Firms, (Mar. 21, 
2002), which announces new requirements for member firms with more 
than 500 SEC clients to undergo annual review procedures during each 
of the years between triennial peer reviews.
---------------------------------------------------------------------------

    7. A PAB should have the ability to discipline firms and 
individuals and be able to impose a wide range of sanctions, including 
the ability to require an accountant to no longer audit a particular 
public company--A primary criticism of the current system is that it 
does not include effective disciplinary proceedings. The strongest 
sanction issued by the AICPA is expulsion from that organization, which 
does not remove the individual or firm

[[Page 44972]]

from practice before the Commission. We believe that we should continue 
to pursue violations of the securities laws and disciplinary actions 
under Rule 102(e). We also believe, however, for a PAB's quality 
control system to have ``teeth'' the PAB should have the ability to 
discipline its member accountants for incompetent, unethical, or other 
deficient conduct discovered during a quality control review or that 
otherwise comes to its attention, and that it must be able to sanction 
accounting firms for deficient quality control systems. The public must 
be assured that a PAB would be expected to and able to take appropriate 
and meaningful action to address incompetent or unethical conduct and 
violations of professional standards.
    8. A PAB should issue public reports of its activities--Although 
the POB issued an annual report, the SECPS has not issued a separate 
public report since 1997. To promote the understanding of its processes 
and to inform the public of the results of its programs and 
proceedings, a PAB should issue reports to the public at least annually 
and, to the extent possible, on a real time basis, that describe the 
PAB's quality control and disciplinary activities, contain the PAB's 
audited financial statements, explain the fees it has imposed on its 
members, and other information.
    The Commission invites comments on these factors, including 
suggestions for alternative or additional factors that should lay the 
foundation for our rules. In addition, the Commission invites and 
encourages persons who would consider forming a PAB to begin a dialogue 
with the Commission as soon as possible. The Commission will make 
itself available for meaningful dialogue to further and facilitate the 
timely establishment of a PAB.

III. Discussion of Proposed Rules

    We are proposing to amend and add rules to Regulation S-X. To 
assure that the benefits of the oversight process extend to investors 
in all public companies:
     An SEC registrant's financial statements would not comply 
with Commission requirements unless the accountants who have audited or 
reviewed those statements are members of a PAB. Attest reports would 
not comply with Commission requirements unless prepared by outside 
accountants who are members of a PAB; and
     An SEC registrant's financial statements and attestation 
reports contained in or accompanying an SEC registrant's reports or 
registration statements would not comply with Commission requirements 
unless the registrant is a member of the same PAB as its accountants, 
and thereby is bound to cooperate in that PAB's reviews or proceedings 
regarding the registrant's accountant.
    For the Commission to recognize a PAB, a PAB would have to meet 
certain conditions and perform certain functions. We also are proposing 
to require disclosure if an executive officer, director, or person 
nominated to become a director of a public company has been sanctioned 
as a member accountant by a PAB within the last five years.

A. Regulation S-X Definitions

    Rule 1-02 contains the general definitions for terms used 
throughout Regulation S-X.\65\ Although the terms ``review'' and 
``attest'' are common to accountants, they have never been defined 
within Regulation S-X. Because those terms are used in the rules we are 
proposing in this release, and in other rules within Regulation S-
X,\66\ we are proposing to define them in rule 1-02(d). Each proposed 
definition codifies the current common understanding of the term by 
referring to GAAS and to Statements on Standards for Attestation 
Agreements,\67\ as may be modified by the Commission.
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    \65\ 17 CFR 210.1-02.
    \66\ See e.g., Rule 10-01(d) of Regulation S-X, 17 CFR 210.10-
01(d), which requires that quarterly financial statements in Forms 
10-Q be reviewed by an independent accountant prior to a registrant 
filing its Form 10-Q with the Commission.
    \67\ See generally SAS No.71, AU Sec. 722 (as revised by SAS No. 
90). See also Attestation Standards: Revision and Recodification, 
Statement on Standards for Attestation Engagements No. 10 (Jan. 
2001).
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    We solicit comments on the above definitions. Do the definitions of 
``review'' and ``attest'' capture the understanding of the words common 
to accountants? Should the definitions differ from those in GAAS? If 
so, why and in what way? Are there reasons why we should not define 
``review'' or ``attest'' in the rule? Should we narrow or broaden the 
definitions? If so, how?

B. Requirements for Financial Statements and Attestation Reports

Qualifications of Accountants
    Existing Commission regulations state that accountants are not 
qualified to practice before the Commission unless they are licensed 
under the laws of the place of their residence or principal office, and 
are independent from their audit clients.\68\ As a practical matter, 
however, it has long been recognized that, in addition to these two 
qualifications, auditing a public company requires special 
expertise.\69\ The foundation for that expertise has been developed 
over many generations of accountants practicing before us and is 
embodied in professional standards for auditing, attestations, quality 
controls, ethics, and other areas. These standards guide accountants in 
their daily work of examining the accuracy and completeness of 
financial information disclosed by management to investors. It is 
imperative, therefore, that auditors reach reasoned decisions that are 
well grounded in these professional standards.
---------------------------------------------------------------------------

    \68\ 17 CFR 210.2-01.
    \69\ See generally SECPS membership requirements. See also SAS 
No. 1, Sec. AU 210.
---------------------------------------------------------------------------

    Further, as we stated when we revised our auditor independence 
rules in 2000, auditor independence is instrumental to the financial 
reporting process and to investor confidence in financial 
statements.\70\ Investors will commit their savings to an impersonal 
securities market only if they know that unbiased auditors take a 
critical look at managements' decisions and processes used to prepare 
the financial statements and that those auditors will place the 
concerns and interests of investors above not only the company's 
interests but above the accountant's self-interest as well.\71\
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    \70\ Revision of the Commission's Auditor Independence 
Requirements, Securities Act Release No. 33-7919 (Nov. 21, 2000), 65 
FR 76008 (Dec. 5, 2000).
    \71\ Relationships Between Registrants and Independent 
Accountants, Accounting Series Release No. 296 (Aug. 20, 1981), 46 
FR 43181 (Aug. 27, 1981).
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    Strong oversight of the profession helps to (and one goal of a PAB 
is to) strengthen firms' audit practices and to detect and deter 
weaknesses that might detract from an accountant's ability to fulfill 
professional standards of ethics and competence and requirements of 
auditor independence. In performing quality control reviews and through 
the disciplinary process, a PAB would play an important role in 
identifying and addressing competency, ethics, independence, and other 
professional practice issues.\72\
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    \72\ The securities laws require, or authorize the Commission to 
require, that registration statements and reports include financial 
statements that have been audited by an independent public or 
certified public accountant. See supra note 12.
---------------------------------------------------------------------------

    In recognition of the critical importance in having auditors well-
versed in professional standards operating under effective quality 
control systems, proposed rule 2-01(a)(2) would state that the 
Commission would not recognize any accountant to be a ``certified 
public accountant'' or ``public accountant,'' or as ``independent'' 
with respect to an audit client if, during the

[[Page 44973]]

professional engagement period, that accountant is not a member in good 
standing of a PAB (see below for discussion of the definition of 
``member accountant in good standing''). A PAB's oversight of 
accountants, particularly as to independence issues, will in some cases 
require a PAB to consider information that can be supplied only by the 
audit client. We therefore believe that the purposes of the statutory 
requirements will be advanced significantly if an audit client is a 
member of the same PAB as its accountant, and thereby agrees to supply 
information in connection with that PAB's reviews and proceedings 
regarding the accountant. Accordingly, the proposed rule contemplates 
that an audit client be an adjunct member of the same PAB of which its 
accountant is a member.
Registrants' Reports and Registration Statements
    Under the same reasoning as discussed above, proposed rule 13-01(a) 
requires reports and registration statements filed with the Commission 
that contain financial statements \73\ be audited or reviewed by an 
accountant that: (1) Is a member in good standing of a PAB of which the 
registrant \74\ filing the report or statement is an adjunct member in 
good standing, and (2) satisfies all other requirements prescribed by 
the federal securities laws and the rules and regulations thereunder 
concerning an accountant that audits, reviews, or prepares such report 
or registration statement.
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    \73\ See, e.g., Section 13(b)(1) of the Exchange Act, 15 U.S.C. 
78m(b)(1), which states, ``The Commission may prescribe, in regard 
to reports made pursuant to this title, the form or forms in which 
the required information shall be set forth *  *  *. Regulation S-X, 
17 CFR 210, prescribes the form and content of financial statements 
filed with the Commission.
    \74\ ``Registrant'' is defined in rule 1-02(t) of Regulation S-
X, 17 CFR 210.1-02(t), to mean ``the issuer of the securities for 
which an application, a registration statement, or a report is 
filed.'' As discussed above, for purposes of proposed amendments to 
Sec. 210.2-01, adjunct membership requirements would also extend to 
``audit clients.'' Accordingly, throughout the discussion in this 
release, any reference to ``registrant'' should also be understood 
to encompass ``audit client'' where the context requires.
---------------------------------------------------------------------------

    We request comment on proposed rules 2-01(a)(2) and 13-01(a), 
including the approach and structure of those rules for the filing with 
the Commission of financial statements and attestation reports. Are the 
definitions appropriate? Will they further the goals of enhanced 
oversight of the financial reporting process and enhanced quality of 
financial information? We request comment on the aspect of the proposed 
rule regarding registrant membership. Should registrants be adjunct 
members? Could our objectives be accomplished other than by having 
registrants be adjunct members--for example, by simply requiring 
registrants to participate in funding a PAB and to cooperate with a 
PAB's reviews and proceedings? Why or why not? We solicit comment on 
alternative frameworks to accomplish our goals. For example, if 
registrants can demonstrate that their accountants have an alternative 
system or process that meets the objectives of our rules (e.g., through 
third-party reviews or other organizations), should the registrants be 
exempted from the operation of the rules, in particular Rules 2-
01(a)(2) and 13-01? Should such systems or processes be required to 
operate with our approval and under our oversight? In addition, we 
solicit comment on what role, if any, exchanges and the National 
Association of Securities Dealers (``NASD'') should play with respect 
to a PAB.
    Investment advisers, certain broker-dealers, transfer agents and 
certain other entities that file audited financial statements with us 
are not considered to be ``registrants'' under Regulation S-X because 
they are not issuers of securities and, therefore, would not fall 
within Article 13. Nonetheless, because the auditor independence rules 
discuss ``audit clients'' and not registrants, auditors of such 
entities' financial statements, and the entities, would be subject to 
the proposed rules. Is this appropriate? Should entities that are not 
registrants be outside the scope of the proposed rules? Should 
accountants that audit only entities that are not issuers of securities 
be outside the scope of the rules?
    The proposals utilize the definition of ``audit client'' that is 
contained in Rule 2-01(f)(6) of Regulation S-X. That definition 
includes affiliates of the audit client. We request comment on the 
application of that definition to the rules proposed in this release. 
Should the definition of ``audit client'' include affiliates for 
purposes of the proposed rules? Why or why not? Are there special 
concerns in the investment company, investment adviser, or broker-
dealer context that are raised because of the inclusion of affiliates?

C. Definitions for Article 13

    In addition to providing definitions for use throughout Regulation 
S-X, the proposed rules would provide certain definitions of terms that 
would have a specific meaning for the purposes of Article 13 and a PAB.
    Accountant. Proposed rule 13-02(a) would define ``accountant'' for 
the purposes of Article 13. This definition has two important 
characteristics. First, it encompasses both accounting firms and 
individual accountants. Second, it limits the term ``accountants'' to 
those public or certified public accountants and firms engaged in 
auditing or reviewing financial statements, or preparing attest 
reports, that are filed with the Commission. The definition is similar 
to the definition of ``accountant'' in our auditor independence 
rules.\75\
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    \75\ Rule 2-01(f)(1) of Regulation S-X, 17 CFR 210.2-01(f)(1), 
which states, ``Accountant * * * means a certified public accountant 
or public accountant performing services in connection with an 
engagement for which independence is required. References to the 
accountant include any accounting firm with which the certified 
public accountant or public accountant is affiliated.''
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    Is this definition appropriate? Is it appropriate for the 
definition to include both accounting firms and individual accountants? 
Would the goals of the proposed rules be better or more appropriately 
accomplished if only one or the other was required to be a PAB member? 
Does this definition raise practical problems for firms that have 
partners who specialize in tax or other non-audit services, but also 
may be consulted briefly during an audit? For example, a firm might 
wish to have a tax partner consult for a very brief time with an audit 
engagement partner about a company's tax accrual. Would requiring such 
partners to be members of a PAB pose an unnecessary burden on the 
partners or accounting firms? If there would be an unnecessary burden, 
what would that burden be and is there any empirical data that would 
quantify such a burden?
    Adjunct member in good standing. Under proposed rule 13-02(b), an 
entity is an ``adjunct member in good standing,'' when the entity is an 
adjunct member of a PAB and is not delinquent (as defined in proposed 
rule 13-02(c)) in paying fees assessed by the PAB, or in appropriately 
responding to a PAB's request for documents and testimony relevant to a 
PAB quality control review, supplemental review, or disciplinary 
proceeding concerning the adjunct member's accountant. With respect to 
documents and testimony, the adjunct member's ``good standing'' would 
turn on whether it has produced documents that a PAB has requested from 
the adjunct member or its management, provided testimony that a PAB has 
requested from the adjunct member or its management, and used best 
efforts to cause its agents and non-management employees to supply any 
documents and testimony requested

[[Page 44974]]

from it by the PAB.\76\ In defining ``good standing,'' the proposed 
rule provides only for ``best efforts'' by an adjunct member with 
respect to non-management employees and agents. While such employees 
may often have documents and knowledge relevant to a PAB review or 
disciplinary proceeding, we are concerned about making the good 
standing of every public company turn on its ability to preclude any 
single employee from refusing to cooperate with a PAB review or 
proceeding. Rather, an adjunct member will remain in good standing as 
long as it uses its best efforts to cause those employees and other 
agents to comply with PAB requests for testimony, and so long as the 
adjunct member and its management provide all requested documents and 
testimony and the adjunct member is timely in paying fees assessed by 
the PAB.
---------------------------------------------------------------------------

    \76\ As discussed with respect to the definition of 
``delinquent,'' below, we expect that a PAB will adopt reasonable 
practices and procedures for dealing fairly with good faith 
assertions of legal objections to document and testimony requests.
---------------------------------------------------------------------------

    We invite comments on alternative approaches. Are there other, 
preferable, ways to define or condition an audit client's good standing 
that are sufficient to achieve the goals of PAB funding and PAB access 
to information relevant to its mission? Should the good standing of an 
adjunct member be contingent on willingness of management to testify? 
How should former management be treated? How, if at all, should 
``management'' be defined for these purposes? Should more than 
management be covered by the requirement? For example, our auditor 
independence rules use the defined term ``accounting role or financial 
reporting oversight role.'' \77\ Should the proposed rule include all 
or any of the individuals covered by that definition? Should the rule 
cover directors? With respect to non-management employees and agents, 
is it appropriate for the rule to require only that the adjunct member 
make best efforts to secure from them any documents or testimony 
requested by the PAB, or should the adjunct member's good standing 
depend upon the adjunct member actually causing the employee or agent 
to supply the documents and testimony? Is there an appropriate 
intermediate approach to addressing that issue? Alternatively, should 
the standard be ``reasonable efforts'' instead of ``best efforts.''
---------------------------------------------------------------------------

    \77\ Rule 2-01(f)(3) of Regulation S-X, 17 CFR 210.2-01(f)(3).
---------------------------------------------------------------------------

    Delinquent. Under proposed rule 13-02(c), a member or adjunct 
member of a PAB is ``delinquent'' when a PAB has provided public notice 
(consistent with proposed section 13-04(d)(11)) that the member or 
adjunct member has failed to pay the fees assessed by the PAB, or has 
failed to produce required documents or provide required testimony 
after any good faith legal objection to the request for documents or 
testimony has, in accordance with the PAB's rules, been resolved in the 
PAB's favor. An adjunct member may also be determined to be delinquent 
if it fails to use best efforts to cause its non-management employees 
and agents to supply requested documents or testimony.
    A PAB's ability to obtain fees, documents, and testimony from 
members and adjunct members would be critical to the PAB's ability to 
carry out the purposes of the proposed rules. Accordingly, becoming 
delinquent in paying or responding to a PAB request, in accordance with 
a PAB's rules, automatically terminates the good standing of a member 
or adjunct member.
    Under proposed rule 13-04(d)(11), discussed below, a PAB must 
devise a rule for advance public notice of the danger of a delinquency, 
sufficient to give audit clients an opportunity to prepare for such a 
delinquency and the consequent potential loss of good standing by their 
accounting firm.
    In addition, proposed rules 13-04(d)(7) and 13-04(d)(11) condition 
a PAB's Commission recognition on the PAB having fair procedures for 
requesting documents and testimony and for resolving any disputes 
concerning those requests or concerning fees. We would expect a PAB to 
take seriously the need for full and fair procedures before making a 
delinquency determination as to a member or adjunct member asserting a 
good faith legal basis for objecting to any request for documents or 
testimony.\78\
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    \78\ We would expect that, with respect to good faith assertions 
of privilege, a PAB would adopt a reasonable approach comparable to 
that of other private organizations or similarly situated private 
parties. Cf. D.L. Cromwell Investments, Inc. v. NASD Regulation, 
Inc., 279 F.3d 155, 161-63 (2d Cir. 2002) (interview demand issued 
by private membership organization to a member lacked sufficient 
nexus to government inquiry to trigger Fifth Amendment protection, 
since organization was not state actor and interview demand was not 
result of collusion with government) (citing Desiderio v. National 
Association of Securities Dealers, Inc., 191 F.3d 198, 206 (2d Cir. 
1999), cert. denied, 531 U.S. 1069 (2001) (rejecting constitutional 
challenges to NASD action because ``NASD is a private actor, not a 
state actor'') and United States v. Solomon, 509 F.2d 863, 867-71 
(2d Cir. 1975) (rejecting Fifth Amendment challenge to New York 
Stock Exchange inquiry of member because New York Stock Exchange is 
not government actor)). We would specifically expect, however, that 
a PAB would not honor any assertion of an accountant-client 
privilege. An accountant client privilege is not recognized under 
federal law. See United States v. Arthur Young & Co., 465 U.S. 805 
(1984); Couch v. United States, 409 U.S. 322 (1973). Further, the 
recognition of such privilege by a PAB would significantly impair 
its ability to further the goals and purposes of federal securities 
laws reflected in the proposed rules.
---------------------------------------------------------------------------

    We request comment on the proposed definition of delinquent. Are 
the proposed notice provisions appropriate? Are there other additional 
circumstances when a member or adjunct member of a PAB should be 
considered delinquent? What are they? Should the rule explicitly 
identify specific privileges or categories of privileges that a PAB may 
not invade? If so, what are they?
    Foreign Accountant. We have proposed in rule 13-02(d) to define 
``foreign accountant'' to mean an accountant: \79\ (1) Having a place 
of residence and principal office outside the United States and its 
territories, and (2) not licensed in the United States or its 
territories. If an accountant resides, practices, or is licensed in the 
United States, that accountant would be subject to the proposed rules. 
In this regard, if a foreign-licensed accountant resides in the United 
States as a result of a temporary assignment to work at a U.S. firm, he 
or she might be subject to the proposed rules. We intend for the PAB, 
however, to consider such issues and the many variations of working 
relationships that may arise in the operation of the firms' 
international organizations and, if considered necessary or 
appropriate, to interpret this provision, adopt related rules, or 
request amendments to the Commission's definition.
---------------------------------------------------------------------------

    \79\ As noted previously, under proposed rule 13-02, the term 
``accountant'' includes both individuals and firms, but is limited 
to those auditing or reviewing financial statements or preparing 
attestation reports filed with the Commission.
---------------------------------------------------------------------------

    Is the proposed definition of ``foreign accountant'' appropriate? 
Is the requirement that both the residence and principal place of 
business be outside the United States and its territories unduly 
restrictive, or not restrictive enough? Are there other factors that 
should be included in the definition? Is the intent to permit a PAB to 
consider this issue appropriate? Does the proposed definition provide 
sufficient flexibility for a PAB to consider these issues?
    Member accountant in good standing. Proposed rule 13-02(e) 
describes the requirements that an accountant must satisfy to be a 
member accountant in good standing with a PAB. First, the accountant 
must be a member of the PAB, a status that would be obtained through 
enrollment procedures devised by a PAB pursuant to proposed rule 13-
04(d)(1). In addition, status as a member

[[Page 44975]]

accountant in good standing involves two further elements that must be 
satisfied. The first element is satisfied if the accountant has not 
been barred, suspended, or otherwise sanctioned by a PAB. 
Alternatively, if the accountant has been barred, suspended or 
otherwise sanctioned, the first element is satisfied if the accountant 
has been reinstated by the PAB after having been barred or suspended, 
or if the accountant has not been cited by the PAB in a public notice 
as being noncompliant with the terms and conditions of any other 
sanction imposed by the PAB. The second element is rooted in the need 
to ensure funding of, and cooperation with, a PAB, and so is similar to 
the requirements to be an adjunct member in good standing, described 
above. Specifically, an accountant satisfies the second element if the 
accountant is not delinquent in paying fees or supplying required 
documents and testimony. The documents and testimony that must be 
supplied at a PAB's request in order for the accountant to remain in 
good standing are the accountant's documents and testimony and the 
documents and testimony of any of the accountant's employees, or other 
agents.\80\ Should the rule prescribe different limits on the documents 
and testimony that an accountant must provide to maintain good 
standing? Are there other factors that the rule should take into 
account for purposes of determining ``good standing?''
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    \80\ As discussed above with respect to the definition of 
``delinquent,'' we expect that a PAB will adopt reasonable practices 
and procedures for dealing fairly with good faith assertions of 
legal objections to document and testimony requests.
---------------------------------------------------------------------------

    Public Accountability Board. Proposed rule 13-02(f) would define 
the term ``Public Accountability Board'' or ``PAB'' to mean an entity 
that is organized in accordance with, and for the purposes described 
in, proposed Article 13, and that is recognized by the Commission.
    Professional Engagement Period. Both proposed rule 2-01(a)(2) and 
proposed rule 13-01 operate by reference to the ``professional 
engagement period.'' Under the operation of those rules, if either the 
accountant or the audit client is not a member in good standing with a 
PAB for any portion of the professional engagement period, the 
financial statements and attestation reports included in or 
accompanying that audit client's filings with the Commission will not 
be acceptable. We consider it important that any failure of good 
standing during the professional engagement period have significant 
consequences since auditors must be independent during the professional 
engagement period, and we do not want to permit any gamesmanship with 
respect to cooperating with the PAB.
    The term ``professional engagement period'' is defined in proposed 
rule 13-02(g) to begin when an accountant either signs an engagement 
contract to review or audit financial statements or to prepare an 
attestation report, or begins audit, review, or attest procedures, 
whichever is earlier. The period ends when the registrant or accountant 
notifies the Commission that the registrant is no longer the 
accountant's audit client.\81\ This definition parallels the definition 
of the same term in the auditor independence rules.\82\
---------------------------------------------------------------------------

    \81\ Such notice may occur under item 4 of Form 8-K, 17 CFR 
249.308.
    \82\ 17 CFR 210.2-01(f)(5)(ii)(A) and (B).
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    Does the proposed definition capture the appropriate period? Is 
there a different beginning point that would be more appropriate? Would 
a different end point be appropriate?
    Professional Standards. Proposed rule 13-02(h) defines 
``professional standards'' to include accounting,\83\ auditing,\84\ and 
attestation standards,\85\ the Commission's auditor independence 
regulations,\86\ the standards of the Independence Standards Board, and 
any other standards related to the audit, review, or preparation of 
financial statements filed with the Commission. These standards would 
include those set, or designated as authoritative, by a PAB, including 
auditing, quality control, or ethics standards. Does this definition 
capture all of the standards and regulations that are needed and 
appropriate?
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    \83\ The Financial Accounting Board (``FASB'') and other sources 
establish generally accepted accounting principles (``GAAP'') used 
to prepare financial statements filed with the Commission. For the 
``hierarchy of GAAP,'' see SAS No. 69, AU Sec. 411.
    \84\ The AICPA's Auditing Standards Board (``ASB'') issues SAS. 
Under Rule 202 of the AICPA's Rules of Professional Conduct, AICPA 
members must adhere to these standards or be prepared to justify any 
departures from them. The ASB's Audit Issues Task Force is assigned 
the responsibility to provide timely guidance on the application of 
the ASB's pronouncements.
    \85\ The AICPA's ASB issues Statements on Standards for 
Attestation Engagements, or SSAEs.
    \86\ 17 CFR 210.2-01.
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    SEC clients. Proposed rule 13-03(i) defines the term ``SEC 
clients.'' We have defined this term, which is distinct from 
``registrant,'' for the very limited purpose of identifying the 
dividing line (by reference to the number of ``SEC clients'') between 
those accounting firms that will be subject to an annual quality 
control review and those (with fewer SEC clients) that will be subject 
to a triennial quality control review. For consistency, we have 
incorporated into the proposed rule the definition of ``SEC clients'' 
that is found in the AICPA's bylaws and resolutions,\87\ but we have 
provided a PAB with the ability to amend the definition to add entities 
that the PAB believes should be considered to be SEC clients for the 
purpose of this rule. Under the AICPA definition, SEC clients include 
issuers in initial public offerings and registrants filing periodic 
reports under the Exchange Act (except broker-dealers filing only 
because of section 15(a) of that Act \88\) or the Investment Company 
Act. With respect to SEC clients, should companies whose reporting 
obligations arise solely under Section 15(d) of the Exchange Act be 
included within the definition of SEC clients?
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    \87\ AICPA Bylaw section 230R, Implementing Resolutions Under 
Section 2.3.5 for Definition of ``SEC Client'' (As adopted by 
Council Jan. 8, 1990), which states:
    That for purposes of section 2.3, an SEC Client is
     An issuer making an initial filing, including 
amendments, under the Securities Act of 1933.
     A registrant that files periodic reports (for example, 
forms N-SAR and 10-K) with the SEC under the Securities Exchange Act 
of 1934 (except brokers or dealers registered only because of 
Section 15(a) of that Act) or the Investment Company Act of 1940.
    \88\ 15 U.S.C. 78o(a).
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    We also generally request comment on all of the definitions in the 
proposed rule, including the proposed scope of those definitions, and 
whether there are additional definitions that should be added or 
proposed definitions that should not be included in any final rules?

D. Commission Recognition of Public Accountability Boards

    A PAB must be an organization that places the interests of 
investors above all else. To assure the ability and desire of an entity 
to represent investors and promote high quality financial reporting, 
the Commission would study carefully each organization before 
determining whether to recognize it as a PAB under the proposed rules. 
In this regard, proposed rule 13-03(a) would require that each entity 
desiring to become a PAB make a submission to the Commission containing 
the representations and materials necessary for the Commission to 
determine the entity's ability to carry out the functions and to 
accomplish the purposes that are described in Article 13. As noted in 
proposed rule 13-03(b), the Commission may ask the entity to supplement 
its submission with additional information.
    Proposed rule 13-03(b) also indicates that the Commission would, 
consistent

[[Page 44976]]

with the public interest and for the protection of investors, decide 
whether to recognize an entity as a PAB based on the entity's 
commitment and capacity to carry out the functions and accomplish the 
purposes of the proposed rules. The Commission would make its 
determination by issuance of a Commission order.
    We request comment on the procedures for Commission recognition of 
a PAB. In particular, is the standard for recognition of a PAB 
appropriate? Should we base our determination on factors other than or 
in addition to the entity's commitment and capacity to carry out the 
functions and to accomplish the purposes of the proposed rules? What 
other factors should the Commission consider?
    Proposed rule 13-03(c) sets forth the information to be submitted 
to the Commission by an entity seeking recognition as a PAB. Under 
proposed rule 13-03(c)(1), the entity's submission must include its 
organizational structure, proposed budget, and proposed board members 
and terms of board membership. This information must be sufficient for 
the Commission to determine that the entity will satisfy the 
requirements set out in proposed section 13-04(b), and discussed below. 
Under proposed rule 13-03(c)(2), the proposed PAB must submit its 
charter and bylaws. Specific criteria that the charter and bylaws must 
satisfy are set out in proposed section 13-04(c) and discussed below. 
We solicit comment on the materials that a PAB should submit to the 
Commission when seeking recognition as a PAB. Are these materials 
appropriate for the Commission to require? Are there other materials 
regarding the organization of an entity seeking recognition as a PAB 
that the Commission should require or review to inform its 
determination of whether to recognize a PAB? For example, should we 
require an entity seeking to be recognized to submit its rules, 
membership requirements, and descriptions of its systems and procedures 
for our review before we make a determination about recognition?
    In seeking recognition as a PAB, under proposed rule 13-03(c)(3), 
an entity would represent that it would pursue certain goals, such as 
to work to improve the quality of member firms' audits and reviews; 
work to improve member firms' quality controls and compliance with 
auditor independence and ethics requirements; enhance investor 
confidence in the audit process; and foster cooperation and 
coordination among private sector standard-setting bodies.
    Proposed rule 13-03(c)(4) requires an entity seeking Commission 
recognition as a PAB to represent that it would establish rules, 
membership requirements, systems and procedures designed to further the 
goals described in proposed rule 13-03(c)(3) and sufficient to 
accomplish, at a minimum, the further objectives described in proposed 
section 13-04(d), and discussed below. With regard to proposed rules 
13-03(c)(3) and (4), are these appropriate representations for the 
Commission to require? More generally, are there additional 
representations or information that an entity should be required to 
provide to aid the Commission's determination of whether to recognize 
the entity as a PAB?
    Finally, proposed rule 13-03(c)(5) would require an entity seeking 
recognition as a PAB to represent that it would study and monitor 
quality control developments in other countries and report periodically 
to the Commission on whether the exemption for foreign accountants in 
proposed rule 13-07, discussed below, should be withdrawn. A PAB may 
recommend that the exemption be maintained, withdrawn in whole or part, 
or modified to place conditions on the receipt of the exemption. 
Although not stated in our proposed rules, a PAB also may choose to 
participate in efforts to develop and improve international or foreign 
national auditing, quality control or ethics standards. With regard to 
proposed rule 13-03(c)(5), is this an appropriate and useful study for 
a PAB to conduct? What should be the time frame of the study? Are there 
other areas that we should require a PAB to study and report on to the 
Commission?

E. Conditions of Commission Recognition of Public Accountability Boards

    Proposed section 13-04 sets conditions to ongoing Commission 
recognition of a PAB. An entity seeking recognition as a PAB under 
proposed section 13-03 must meet certain of these requirements, 
specifically those contained in subsections (b) and (c), at the time of 
its initial request for recognition. For continued recognition by the 
Commission, the criteria in this section must be met on an ongoing 
basis. For the reasons described below, we believe that these 
conditions are necessary to ensure that a PAB acts in the public 
interest, consistently with the rules.
Organizational Structure, Board Membership, and Budget
    To improve investor confidence in the integrity of the oversight 
process, a PAB must be, and must be perceived by investors to be, 
dominated by representatives of investors and issuers, or ``public 
members,'' as opposed to representatives of the accounting profession. 
Proposed rule 13-04(b) sets forth several requirements for the 
structure, membership, and budget of a PAB designed to ensure that 
public board members dominate all aspects of a PAB's activities. First, 
proposed rule 13-04(b)(1) would require that a PAB have a fixed number 
of board members, none of whom are, or have been at any time in the 
previous two years, an employee of an accountants' professional 
organization.\89\ Additionally, no more than one-third of the members, 
and in no event more than three of the members, may be, or have been at 
any time in the ten year period preceding his or her PAB term: (1) An 
accountant; (2) a partner, principal, shareholder, or managerial 
employee of an accounting firm; or (3) a retired partner, principal, 
shareholder, or managerial employee of an accounting firm.
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    \89\ One of our core principles for a PAB is that it be outside 
the auspices of the AICPA or similar association or organization 
that has a purpose of serving the interests of ``accountants,'' as 
defined in Article 13. If an employee of such an organization served 
on a PAB, he or she would be obligated to serve both accountants and 
investors. While the interests of accountants and investors often 
are the same, they also may differ at times. To avoid real conflicts 
and the appearance of conflicts of interest, we have proposed that 
no employee of such an association or organization be a PAB board 
member and that there be a two-year period between working for such 
an organization and serving on a PAB. Because members of state 
boards of accountancy, which are state governmental agencies 
assigned the mission of protecting the public, would not face such 
conflicts, being a member or employee of a state board would not 
disqualify an individual from serving on a PAB.
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    The proposed rule does not set the number of PAB board members, but 
rather leaves this to a PAB's discretion. In this regard, however, 
because of the variety of functions to be performed by the PAB, we 
suggest that a PAB consisting of nine members likely could meet the 
objectives of the rule.
    We believe that having a small minority of accountants on a PAB 
would be appropriate because of the functions we anticipate a PAB would 
perform. Under the previous self-regulatory system, the POB had five 
members who had not been, or had not recently been, members of the 
accounting profession. That regulatory system also contained, however, 
the SECPS Executive Committee, the Peer Review Committee, and the QCIC, 
which were comprised entirely of active or retired accountants. We 
envision a PAB taking over the work of not only the prior POB but also 
much, if not all,

[[Page 44977]]

of the work of these committees. Because the PAB would be more involved 
than the POB had been in evaluating each review report, determining the 
appropriateness of attendant recommendations for improvements in 
quality controls, directing reviews of larger firms, and performing 
similar functions, we believe that some minimal professional 
representation on the PAB is appropriate. We have taken the added 
precaution, in proposed rule 13-04(g)(5), however, of stating that only 
public board members, and not any accountant or retired accountant 
board members, may participate in any vote on whether to institute a 
disciplinary proceeding, or any vote on the findings or sanctions to be 
imposed in any such proceeding.
    Under the proposed rule, the remainder of the PAB board members 
would be public members. A PAB may have as many public members as it 
believes are appropriate and necessary to fulfill its duties under 
Article 13. Public members should represent the interests of individual 
investors, institutional investors, and issuers. We anticipate that the 
public members may include, among others, former public officials, 
lawyers, bankers, institutional investors, securities industry 
executives, academics, economists, and business executives.
    Each public member should have a background that permits him or her 
to make a contribution to the operations of the PAB. Having been, at 
some point in his or her career, an accountant who audited or reviewed 
financial statements that were filed with the Commission, or a partner 
or employee of an accounting firm that performed those functions, would 
not necessarily preclude a person from being a public member. To assure 
that such a member is, and is perceived as a public member, the 
proposed rule would require that he or she not have practiced as an 
accountant or been a partner or employee of an accounting firm for at 
least the ten-year period immediately before joining the PAB. We 
believe that an individual with such a prolonged separation from 
practice and from accounting firms, and with the intervening 
experiences gained in other professional endeavors, should not be 
presume to be a representative of the accounting profession.
    We request comment on the composition of the board. Should the 
proposed rule set the number of board members? If so, what number is 
appropriate to accomplish the goals of the rules? We also request 
comment on the board membership requirements. Should we revise the 
criteria or ratios set forth above? Is the two-year parameter regarding 
employees of an accountant's professional organization appropriate? 
Would revising the criteria result in a board dominated by public 
members? Is the rule setting the ten-year parameter appropriate to 
ensure that the board has appropriate representation to fulfill the 
goals of the proposals? Are there other qualifications or restrictions 
on board members that ought to be addressed by Commission rule?
    Does the rule appropriately define accountant members and public 
members or is some other definition more appropriate? We have indicated 
a person may be a ``public'' member of a PAB if he or she has not been 
an accountant within the last ten years. Is ten years too long? If a 
different period is appropriate, what period should it be?
    We solicit comment on allowing a small number of accountants to be 
on a PAB. Should we require, rather than permit, that a certain 
percentage of board members be accountants? Whether mandatory or 
permissive, is the one-third standard appropriate, too high, or too 
low? Why? Is it appropriate to limit the number of accountants to 
three, no matter how large the board? Should there be no accountants 
permitted to be on a PAB, or is their expertise necessary for a PAB to 
carry out its mission?
    Under proposed rule 13-04(b)(2) members would serve staggered terms 
in order to ensure continuity of operations. The proposed rule does not 
set the duration of terms or impose term limits on members. While the 
proposed rule leaves these matters to the PAB's discretion, we believe 
that three-year terms with some term limit, perhaps nine years, is 
appropriate. Such a term limit would allow new members with fresh ideas 
to make a contribution. We solicit comment on board terms. Should terms 
be staggered? Why or why not? Should the rule specify term limits and 
length of terms? If so, what would be an appropriate term and limit. 
For example, would a three-year term and nine-year limit further the 
goals of the rules?
    Serving on a PAB would be a serious and time-consuming task. We 
have proposed in rule 13-03(b)(3) that a PAB's Chairman and Vice 
Chairman would be selected from among the public members and that at 
least one of these individuals would serve on a full-time basis. We 
envision that the remaining PAB members would devote approximately 20 
to 25 percent of their professional time to PAB activities. A PAB's 
rules could provide for additional full-time members.
    We solicit comment on the proposal to require that the Chairman and 
the Vice-Chairman be public board members and that at least one of them 
serve on a full-time basis. Is this requirement appropriate? Is it 
appropriate to limit the chairmanship and vice-chairmanship to the 
public members? Is it necessary or appropriate to accomplishing the 
purposes of a PAB that the Chairman or the Vice-Chairman be required to 
serve full time? Should more than one board member be required to serve 
full time, and if so, does it matter which board member(s)? Should we 
require the PAB to monitor and report to us on the time spent by PAB 
board members on PAB matters? Should requirements short of full-time 
service be placed on the percentage of time some or all the remaining 
board members devote to a PAB?
    Another essential attribute for any entity applying to be a PAB, as 
reflected in proposed rule 13-03(b)(4), would be adequate staff and 
facilities, and the ability to hire consultants or advisers, necessary 
to carry out the purposes of Article 13. We anticipate that the 
professional staff of a PAB would include accountants with extensive 
experience in auditing and in the structure and operation of firms' 
quality control systems. These individuals must be able to assess the 
quality of audits and detect flaws in complicated quality control 
systems. They must be able to structure plans for reviewing firms' 
quality controls, put those plans into action, and conduct or supervise 
reviews that yield tangible improvements in the audit process. We also 
envision a PAB having a sufficient legal staff to facilitate effective 
disciplinary proceedings and provide sound advice on legal, procedural, 
and regulatory matters.
    We solicit comment on the proper make-up of a PAB's staff. Should 
the proposed rules provide additional requirements regarding a PAB's 
staff or the means, capacity, and plans to hire that staff? Should a 
PAB be required to report to the Commission with respect to staff 
resource issues? If so, how often, and what should the reports entail? 
We have designed the composition of the board to provide assurance that 
a PAB would administer competently the proposed rules and that the 
public members would dominate the activities of a PAB. We request 
comment on all aspects of our proposed structure for the composition of 
a PAB, and on whether a PAB, as proposed, would be able to carry out 
its mandate effectively.
    During our Roundtable discussions, Neil Lerner, a partner in the 
United Kingdom (``U.K.'') KPMG accounting

[[Page 44978]]

firm, discussed the professional oversight system recently adopted in 
that country.\90\ The UK system uses a series of boards, each having a 
majority of non-accountant members, to oversee the setting of 
professional standards and to discipline inappropriate professional 
conduct. We solicit comment on this and similar comprehensive 
regulatory approaches and the extent to which such systems may be the 
basis for the regulatory system used in the United States.
---------------------------------------------------------------------------

    \90\ SEC Roundtables, supra note 8, at 40-41 (Mar. 6, 2002) 
(statement of Neil Lerner, Head of Risk Management (U.K.), KPMG).
---------------------------------------------------------------------------

Charter and Bylaws
    Proposed rule 13-04(c) sets certain requirements for a PAB's 
charter and bylaws. First, to limit the potential for excessive or 
unnecessary fees, proposed rule 13-04(c)(1) requires the charter and 
bylaws to provide that the entity will be a not-for-profit entity. 
Second, to assure that recusals, vacancies, or other factors do not 
result in a shift of voting power among the PAB members that would 
defeat public board member control of a PAB, proposed rule 13-04(c)(2) 
states that the entity's charter or bylaws must include quorum 
provisions ensuring that the public members can control the outcome of 
each vote by PAB members. Third, under proposed section 13-04(c)(3), in 
order to obtain Commission recognition, a PAB's charter and bylaws must 
provide that it will be subject to, and act in accordance with, 
Commission oversight as described in proposed section 13-04(i). 
Finally, proposed rule 13-04(c)(4) provides that a PAB's charter and 
bylaws must provide for immediate effectiveness of any changes that the 
Commission makes to the PAB's rules. As discussed below, proposed rule 
13-04(i)(1) allows the Commission, by rule, to abrogate, add to, and 
delete from the rules of a PAB. In order for any such Commission 
rulemaking to operate efficiently, the PAB's charter or bylaws must 
make these changes effective with or without further action by the PAB.
    We request comment on our proposals concerning a PAB's charter and 
bylaws. Should a PAB be required to be a not-for-profit entity? Could a 
for-profit entity achieve the purposes and goals of proposed Article 13 
as well as, or better than, a not-for-profit entity? Are the other 
proposed requirements for a PAB's charter and bylaws necessary or 
appropriate to achieve the purposes and goals of proposed Article 13? 
Are there more appropriate and effective means for addressing these 
issues other than through a PAB's charter and bylaws? Are there other 
items that we should require a PAB to have in its charter and bylaws?
Rules, Membership Requirements, Systems, and Procedures
    Proposed rule 13-04(d) describes certain rules, membership 
requirements, systems, and procedures that a PAB must have in place to 
be recognized by the Commission. A PAB would need to have these 
requirements in place, at a minimum, in order to achieve the goals set 
forth in proposed section 13-03(c). These rules, requirements, systems, 
and procedures would accomplish the following:
    Enrollment Procedures. Proposed rule 13-04(d)(1) would require a 
PAB to provide for membership enrollment procedures that: (1) minimize 
the administrative burden on individual accountants by maximizing the 
extent to which an accounting firm could satisfy the requirements on 
behalf of its individual accountants, and (2) require members and 
adjunct members to agree to be bound by a PAB's rules and membership 
requirements. The proposed rule allows a PAB latitude to determine the 
best approach to enrolling accountant-members, consistent with our 
requirement to minimize any burden on individual accountants. We expect 
that a PAB could adopt enrollment procedures that allow an accounting 
firm to enroll automatically all of its individual accountants by 
providing a PAB with a list of their names. This would eliminate any 
administrative burden on individual accountants. The proposed rule also 
reflects our intention that all members and adjunct members be made 
aware of their obligation to comply with a PAB's rules and membership 
requirements.
    We solicit comment on our proposals concerning PAB enrollment 
procedures. Should our rules allow a PAB more or less flexibility in 
this area? Are there ways to reduce further administrative burden that 
could be specified in our rules? Should an entity that is an audit 
client of a PAB member accountant be required to file an application or 
other information with a PAB?
    Quality Control Systems. Proposed rules 13-04(d)(2)-(4) concern a 
PAB's quality control system requirements for its members. Under 
proposed rule 13-04(d)(2), a PAB's rules would require member-
accountants to maintain a system of quality controls for their 
accounting and auditing practices designed to meet requirements set or 
designated by a PAB. At a minimum, a PAB would set or designate quality 
control requirements that would encompass those described in proposed 
section 13-04(e), discussed below. Under proposed rule 13-04(d)(3), a 
PAB would require its member-accountants to comply with their quality 
control systems in a way that provides reasonable assurance of 
conforming with professional standards. A PAB would also, under 
proposed rule 13-04(d)(4), develop and administer a continuing quality 
control review program for its members concerning accounting and 
auditing practices, and adherence to Commission and professional 
auditor independence requirements. The requirements for the quality 
control review program are set out in proposed rule 13-04(f), discussed 
below.
    We solicit comments on the proposed rules concerning a PAB's 
requirements for members concerning quality control systems. Should a 
PAB have any other rules in place concerning its members' quality 
control systems?
    Retention of Documentation Related to Audits and Reviews. It will 
be critical for a PAB to be able to review documents relating to audits 
performed and accordingly, it will be important for a PAB to have clear 
and effective requirements regarding record retention. Under proposed 
rule 13-04(d)(5), Commission recognition of a PAB would be conditioned 
on a PAB having in place rules, membership requirements, systems, or 
procedures that would direct each member firm to retain documentation 
related to the firm's audit and review engagements for a set period of 
time after completion of the engagement, and in accordance with such 
other policies as a PAB may establish. The records to be kept would 
include those required by the professional auditing literature,\91\ and 
records that otherwise document the procedures performed and the 
resolution of material issues during the engagement. Record retention 
policies and the period of time for the records to be kept would be 
determined by a PAB under its rulemaking process.
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    \91\ See generally, SAS No. 96, AU Sec. 339 (as revised 2002).
---------------------------------------------------------------------------

    We request comment on the requirement for a PAB to direct its 
member firms to retain certain documents. Are the categories of records 
the proposed rules would require a PAB to direct its members to retain 
appropriate? Should we be more specific in our rules with respect to 
either which documents must be retained or for how long? If so, please 
be specific about the types of documents and the length of time.
    Supplemental Reviews, Disciplinary Proceedings, and Dispute 
Resolution Procedures. Under proposed rule 13-

[[Page 44979]]

04(d)(6), Commission recognition of a PAB would be conditioned on a PAB 
having rules and procedures for conducting supplemental reviews and 
disciplinary proceedings in accordance with the criteria set out in 
proposed rule 13-04(g), discussed below. Under proposed rule 13-
04(d)(7), a PAB would need to provide procedures for requesting 
documents and testimony relevant to any PAB review or proceeding as 
described in proposed rules 13-04(f) and 13-04(g). We expect that a PAB 
will adopt rules and procedures in this area that are fair to all 
concerned while appropriately reflecting the need for strong 
enforcement mechanisms.
    We solicit comments on our proposals regarding PAB procedures for 
disciplining and sanctioning member accountants, and resolving disputes 
with members and adjunct members. Should our rules provide more or less 
flexibility for a PAB in this area? Should we specify procedures for a 
PAB to resolve disputes with its members and adjunct members about 
fees, documents or testimony? Should we specify procedures, in addition 
to those described in proposed rule 13-04(g) below, for disciplining 
and sanctioning member accountants? If so, what specific procedures 
would be appropriate?
    Conflicts of Interest. Under proposed rule 13-04(d)(8), a PAB would 
adopt appropriate policies to address any conflicts or potential 
conflicts of interest that may arise involving the PAB's board members, 
employees, contractors, and professional representatives. Even the 
appearance of a conflict of interest can damage investor confidence. 
Accordingly, we expect a PAB to devote careful attention to this area, 
and adopt policies that reassure investors that the PAB is acting in 
the public interest.
    We solicit comments on our proposal concerning a PAB's conflict of 
interest policies. What conflicts of interest are likely to arise? Will 
a PAB be able to adopt policies to address these conflicts? Do we need 
to be concerned about an appearance of conflict? If so, should we 
revise the proposed rules to address better eliminating perceived 
conflicts of interest? Should we require a PAB to adopt specific rules 
in this area or should we allow a PAB to develop its own rules? What 
specific rules, if any, should we require?
    Funding for a PAB. As noted above, a mandatory and continuous 
source of funds is critical to the independence and viability of a PAB. 
A PAB should not be dependent solely on the accounting profession for 
its funds or it may be viewed as beholden to, and influenced by, the 
profession. Accordingly, under proposed rule 13-04(d)(9)(i), a PAB 
would impose fees on both member accounting firms and on registrants 
who are adjunct members, to fund the operations and administration of 
the PAB. A PAB would be encouraged to adopt schedules that provide for 
different classes of firms and registrants to pay different fees, such 
that the fees would not impose unfair or disproportionate burdens on 
any one firm or registrant. We also would expect that the fee structure 
would not result in the PAB being overly reliant on any class of firms 
or registrants for its revenues. The PAB would determine the most 
appropriate method for collecting the fees.
    Each accounting firm, however, should bear the cost of its own 
quality control reviews. Proposed rule 13-04(d)(10), therefore, would 
provide for each firm to pay fees to the PAB, separate and apart from 
the fees determined according to the schedules discussed in the 
preceding paragraphs, that are sufficient for the PAB to recover its 
costs and expenses related to each quality control review of that firm 
pursuant to proposed rule 13-04(f). The review of a large firm's 
quality controls may cost in excess of a million dollars. It would be 
inappropriate, in our view, to have smaller or competing firms shoulder 
part of those costs.
    We request comment on our proposals concerning funding for a PAB. 
Are there alternative funding mechanisms that would better achieve the 
goals and purposes for which a PAB would be established? The proposed 
rules permit a PAB to impose fees on its members and adjunct members, 
but the proposed rules do not describe in detail how such fees should 
be set or collected. Should we be more specific, or should such matters 
be left to the discretion of the PAB?
    The proposed rules would require a PAB to impose fees on each 
member firm to reimburse it for the costs associated with the quality 
control review of the firm. Under our proposals, firms with 70 or fewer 
SEC Clients might undergo quality control reviews performed by other 
accounting firms. The PAB would impose fees on the reviewed firm 
related to the PAB's evaluation and oversight of the review. The 
reviewed firm, however, might pay the reviewer directly. Is the fee 
provision appropriate? Should each firm bear the approximate cost of 
its own quality control reviews, or should these costs be spread evenly 
among firms? Are there advantages or disadvantages to a system in which 
each firm bears the costs of its own reviews? Are there particular 
approaches to billing and payment arrangements that would work best? 
Should our rules more specifically prescribe those arrangements? Should 
adjunct members contribute to the funding of these reviews?
    Funding for the FASB. Proposed rule 13-04(d)(9)(ii) indicates that 
a PAB would collect fees sufficient not only to fund its own operations 
but also to fund the operation and administration of an accounting 
standards-setting body endorsed by the Commission as the primary source 
for generally accepted accounting principles. Today that body is the 
FASB.
    The FASB currently receives most of its funding from two sources--
sales of its publications and the receipt of voluntary donations.\92\ 
Because accounting firms and corporations purchase a significant 
portion of FASB's publications and make the majority of the voluntary 
donations to the FASB, these two groups have significant influence over 
the funds available to the FASB. By reducing donations, or by reducing 
the volume of their purchases, they have the potential to impact the 
funds available to the FASB.
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    \92\ Financial Accounting Foundation, High-Quality Financial 
Reporting: 2001 Annual Report, at 29, which indicates FASB received 
net contributions of $5,113,000 and subscription and publication 
sales of $14,818,000; its direct costs of sales was $1,586,000.
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    During debates of controversial accounting proposals, perceptions 
may arise that a corporation or accounting firm, or groups of 
corporations or firms, could use donations and sales volume to 
influence the FASB's decisions on substantive accounting issues.\93\ To 
remove such possibilities, and to increase the stature, neutrality, and 
perceived independence of the FASB, we have proposed that the FASB, 
through fees paid to a PAB, have a mandatory and continuous source of 
funds.
---------------------------------------------------------------------------

    \93\ See, e.g., Stephen Barr, FASB Under Siege, CFO Magazine, 
Sept. 1994, at 34, 46; Dean Foust, It's Time to Free the FASB Seven, 
Bus. Wk., May 3, 1993, at 144.
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    Accordingly, we anticipate that a PAB would receive a proposed 
budget from the FASB and the PAB would include the amount required to 
fund the FASB in determining the fees to be collected from accounting 
firm members and registrant-adjunct members. After collection, a PAB 
would pass those funds to the FASB.\94\ We anticipate that the 
Financial Accounting Foundation (``FAF''), which is a private sector 
body

[[Page 44980]]

comprised of representatives of the business, professional, and 
academic communities that selects FASB members and handles financial 
matters for the FASB,\95\ would continue to play a significant 
oversight role in determining the FASB's budget.\96\
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    \94\ In the event that more than one entity obtains Commission 
recognition as a PAB, as we anticipate that the FASB would receive 
funding through each PAB according to a formula that takes fair 
account of any significant difference in the size of the various 
PAB's membership.
    \95\ The FAF is comprised of 16 Trustees representing a broad 
range of professional backgrounds. The FAF currently has 
responsibilities for FASB and the Government Accounting Standards 
Board (``GASB''), and for their Advisory Councils, including 
oversight of the standard-setting process, selection of FASB and 
GASB members, and arrangmenets for financing.
    \96\ Further discussion of the history of the Commission's 
endorsement and oversight of FASB can be found in Appendix B.
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    We request comment on our proposal concerning funding for the FASB. 
Should fees collected by a PAB be used to fund the FASB? How would an 
appropriate amount of fees for such a purpose be determined? Is it 
sufficient to rely on the FAF to assist in the preparation of the 
FASB's budget or should the FASB be required to submit an annual budget 
to the PAB? Our proposal anticipates full funding for the FASB, with 
the FASB appropriately reducing or eliminating the cost of its 
publications. Should the FASB, however, continue to generate revenues 
from the sale of its publications, and replace only the donations it 
receives with fees collected by a PAB? Would a PAB collect fees to fund 
the FASB in a different manner than the fees used to fund the PAB's 
operations and, if so, how should the fees to fund the FASB be 
collected? Should registrants and accounting firms be required to join 
the FAF so that the FAF may directly impose fees to fund the FASB?
    In addition to raising funds for the FASB, the FAF raises funds for 
the GASB, which sets financial accounting and reporting standards for 
state and local governmental entities. Financial reports prepared under 
GASB may be the basis for investment, credit, and regulatory decisions. 
Because GASB has not been in existence as long as FASB, more of its 
funding is derived from private contributions. Costs associated with 
GASB are discussed in the Cost-Benefit Section of this Release. Should 
a PAB collect fees to fund GASB as well as FASB?
    Fair Dispute Resolution Procedures and Notices of Delinquencies. 
Under proposed rule 13-04(d)(11), Commission recognition of a PAB would 
be conditioned on the PAB having fair procedures for disciplining and 
sanctioning accountants and for resolving disputes with member 
accountants and adjunct members concerning fees, document requests and 
requests for testimony. As discussed above in connection with the 
definition of ``delinquent,'' we would expect a PAB to take very 
seriously the need for fair procedures to resolve any good faith 
disputes.
    The proposed rule also specifies the need for a PAB to have 
procedures for providing appropriate notice to member accountants, 
adjunct members, the Commission, and the public, of any action that 
could result, or has resulted, in suspension or bar of a member 
accountant, or any other loss of good standing by a member accountant 
or an adjunct member. The PAB's rules and procedures should be designed 
to balance a member or adjunct member's legitimate interest in keeping 
certain disputes nonpublic (such as may occur during a nonpublic PAB 
supplemental review) with the need to provide the public, including an 
accountant's audit clients, with sufficient notice of an accountant's 
potential loss of good standing before actually revoking good standing. 
In addition, it is pursuant to this proposed rule that a PAB must have 
procedures for providing actual notice that a member accountant or 
adjunct member has been determined to be delinquent.
    We request comments on our proposals regarding these notices. 
Should the proposed rules be more specific about when these notices 
would be required, or about the content of the notices? If so, when 
should the notices be required? For example, would it be appropriate to 
require a 90-day notice period before a PAB makes a public 
determination that a member or adjunct member is delinquent? What 
should the notices say?
    Professional Standards. For a PAB to be effective, it must be able 
to address not only personnel and systems failures in accounting firms, 
it must be able to address poor quality or vague standards that lead to 
deficient audits. When a PAB sees a need for new or revised standards, 
it must have a means to assure those standards are adopted and that 
other standard-setters, to the extent appropriate, conform their 
standards to facilitate the correction of the problem. Accordingly, a 
PAB, under proposed rule 13-04(d)(12), would either set, or designate 
private sector bodies to set, audit, quality control, and ethics 
standards. If it chooses to designate private sector bodies to set such 
standards, then a PAB would oversee the designated bodies by attending 
meetings, commenting on proposed standards, meeting as needed with each 
body, and, requesting that items be added to the private sector 
standard-setters' agendas and notifying the Commission when any such 
request is made.
    Under proposed rule 13-04(d)(13), a PAB would also request that 
matters be added to the agendas of private sector bodies that set 
accounting or independence standards, and similarly notify the 
Commission of each such request. Under proposed rule 13-04(d)(14), a 
PAB also would sponsor meetings with and among private sector standard-
setting bodies to coordinate their activities and to promote the 
sharing of information and effective communications.\97\ These meetings 
would include not only the bodies involved in setting audit, quality 
control, and ethics standards, but also accounting standard-setting 
bodies, the Commission staff, and any other persons that the PAB 
considers appropriate.
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    \97\ See, e.g., The Panel on Audit Effectiveness, Report and 
Recommendations, at 141 (Aug. 31, 2000), which emphasizes the need 
for effective communications among standard-setting bodies and the 
bodies involved in disciplining accountants and conducting reviews 
of accounting firms' quality control systems.
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    We request comments on our proposals regarding professional 
standards. What is the proper role of a PAB in standard setting? Should 
a PAB have the ability to set standards? Should it have the ability to 
designate which bodies would be considered authoritative? We request 
comment on the proposed role of a PAB in contributing to the agenda of 
private sector bodies that set accounting or independence standards and 
in coordinating among standard-setting bodies. Are these appropriate 
and useful roles for a PAB to play in satisfying the goals and purposes 
sought through proposed Article 13? Are there more specific or 
additional roles that a PAB ought to play in this regard? Should the 
Commission approve the bodies designated by a PAB before those bodies 
are considered authoritative?
    Open and Deliberative Process. A PAB's process for amending 
governing documents, rules, membership requirements, and procedures 
would include an open and deliberative rulemaking process with open 
meetings and publication for public comment of draft rules, 
requirements and procedures. Allowing for public input would enhance 
public confidence in a PAB's process, and improve the quality of a 
PAB's governing documents, rules, membership requirements, and 
procedures. Accordingly, we have addressed the need for such processes 
in proposed rule 13-04(d)(15).
    We request comment on the importance of an open and deliberative 
rulemaking process for a PAB. What

[[Page 44981]]

goals does it serve in the context of a PAB? Should our rules specify 
the types of procedures that a PAB should employ in rulemaking, or is 
this better left to a PAB to decide? What matters should a PAB be 
required to address only through an open process? Are there 
circumstances we should provide for under which issues concerning the 
amendment of governing documents, rules, membership requirements, and 
procedures should be handled other than through such open processes?
    Full Faith and Credit. Under proposed rule 13-04(d)(16), a PAB 
would give ``full faith and credit'' to the sanctions and good standing 
requirements of another PAB. This would be necessary, if more than one 
PAB is formed, to prevent an accountant from attempting to avoid a 
sanction by one PAB by resigning and joining a different PAB. This 
provision also notes that a registrant may not avoid a finding that it 
is in violation of a PAB's good standing requirements (due to not 
paying fees assessed by the PAB or not providing requested testimony or 
documents) simply by firing its current accountant and engaging another 
accountant that is a member of a different PAB. In such circumstances, 
the new PAB would consider the registrant to be not in good standing 
until the registrant remedied the nonpayment of fees or delinquency in 
providing testimony or documents.
    We request comment on the proposed requirement to extend full faith 
and credit to another PAB. How would this requirement work in practice? 
Will a requirement to extend full faith and credit prevent attempts to 
avoid sanction by resigning from one PAB and joining a different PAB? 
Should our rules be more specific?
    Training. A key to maintaining professional competence is continued 
training throughout an accountant's career. Business and financial 
transactions, as well as audit practices, change with ever-increasing 
speed. Accountants need to be able to keep abreast of these 
developments and adapt their skills. Under proposed rule 13-04(d)(17), 
therefore, we condition the Commission's recognition of a PAB on the 
PAB providing training for, or imposing appropriate training 
requirements on, its member accountants in matters relating to 
accounting, auditing, attestation, assurance, ethics, independence, and 
quality controls. A training requirement should increase investor 
confidence that audits are being performed effectively and competently.
    We request comment on the proposed requirement that a PAB provide 
or require training. Should we specify the particulars of a required 
training program? What would be the components of such a program? 
Should our proposed rules require a specific amount of training per 
year? How much training should be required?
    Other Duties or Requirements. Under proposed rule 13-04(d)(18), a 
PAB's rules, membership requirements, systems, and procedures would 
specify that the PAB would perform such other duties or functions as 
the Commission determines are necessary or appropriate in the public 
interest or for the protection of investors and to carry out the 
purposes of proposed Article 13. This provision would allow the 
Commission to oversee effectively a PAB's activities to make sure that 
the PAB is operating in accordance with the proposed rules, and would 
allow for the possibility of marshalling a PAB's resources for special 
projects that fall within its realm of responsibility. For example, in 
the past ten years, we asked the former POB to study accounting firms' 
quality control systems related to auditor independence, recent changes 
in audit techniques and practices, and various issues related to 
professionalism and independence.\98\ We solicit comment on this 
provision.
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    \98\ These projects are noted in Appendix A.
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    More generally, we solicit comment on these rules and requirements. 
Should we include other requirements necessary for the proper 
functioning of a PAB as we describe it? Are any of the proposed 
requirements too onerous? Why?
Quality Control Requirements
    Proposed rule 13-04(e) conditions Commission recognition of a PAB 
on the PAB ensuring that its member accountants maintain a quality 
control system designed to meet the requirements of quality controls 
set or designated as authoritative by the PAB. These controls should 
encompass at least the current AICPA quality control elements: 
independence, integrity, and objectivity; personnel management; 
acceptance and continuance of clients and engagements; engagement 
performance; and monitoring.\99\ In addition, the proposed rule 
conditions Commission recognition on a PAB requiring its members to 
maintain certain specific quality controls, many of which are current 
SECPS membership requirements.\100\ A PAB may supplement or otherwise 
modify the quality control elements and specific requirements with 
other elements and requirements it deems appropriate.
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    \99\ AICPA, System of Quality Control for a CPA Firm's 
Accounting and Auditing PRactice, ] 7, Quality Control (``QC'') 
Sec. s20.07.
    \100\ See generally, SECPS, Requirements of Members, items, e, 
f, h, i, k, m, n, o, and p. The membership requirements are 
available online at htt://www.aicpa.org/members/div/secps/require.htm.
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    ``Independence, integrity, and objectivity'' policies address the 
firm's relationships with its clients. ``Personnel management'' refers 
to the criteria for the hiring, development, continuing education, 
advancement, and assignment of personnel. The element related to the 
``acceptance and continuance of clients and engagements'' is designed 
to provide reasonable assurance that the likelihood of associating with 
a client's management that lacks integrity is minimized. ``Engagement 
performance'' policies are intended to provide reasonable assurance 
that the firm complies with applicable professional standards and 
regulatory requirements. And ``monitoring'' involves an ongoing 
evaluation of the relevance of the firm's policies, the appropriateness 
of the firm's guidance materials and practice aids, the effectiveness 
of professional development activities, and compliance with the firm's 
policies and procedures.\101\ We believe that these elements continue 
to be essential to high quality accounting and auditing practice and 
should continue to be required.
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    \101\ See supra note 99, QC Secs. 20.07-20.20 (description of 
each quality control eleemnt).
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    We request comment on conditioning Commission recognition on a PAB 
requiring that its member accountants maintain a quality control 
system. We stated that the controls should encompass at least the 
current AICPA elements and certain SECPS membership requirements. Are 
these elements appropriate to address the concerns discussed in the 
release? Are there other elements that we should require a PAB to 
include as part of its quality control system?
    The specific quality controls that should continue to guide 
accounting firms' accounting and auditing practices include:
     Rotating the partner in charge of an audit engagement at 
least once every seven years; \102\
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    \102\ SECPS, Requirements of Members, at item e.
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     Having a second-partner (one other than the partner in 
charge of the audit engagement) independently review the audit report 
and the financial statements,\103\ unless the PAB authorizes 
alternative procedures where

[[Page 44982]]

this requirement cannot be met because of the size of the firm;
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    \103\ Id. at item f.
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     Ensuring policies and procedures are in place to comply 
with auditor independence requirements and to refrain from providing to 
audit clients consulting services that are inconsistent with 
Sec. 210.2-01 and conducting public opinion polls and merger and 
acquisition assistance for a finder's fee; \104\
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    \104\ Id. at item h and o.
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     Reporting to the audit client and the SEC when the firm 
resigns, declines to stand for reelection, or is dismissed; \105\
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    \105\ Id. at item m.
---------------------------------------------------------------------------

     Seeking to have foreign associated firms adopt policies 
and procedures consistent with the objectives of the proposed rules, 
and notifying the Commission when any such firms have done so; \106\ 
and
---------------------------------------------------------------------------

    \106\ Id. at item n. As discussed elsewhere in this release, 
foreign accountants would be exempt from the coverage of the 
proposed rules. The provisions in this section is intended only to 
continue current practices, under the SECPS membership requirements, 
of encouraging foreign firms to improve their quality control 
systms.
---------------------------------------------------------------------------

     Ensuring the firm has policies and procedures for 
reporting litigation or government investigations or proceedings to the 
PAB,\107\ with a copy of the report to the Commission's Office of the 
Chief Accountant.
---------------------------------------------------------------------------

    \107\ Id. at items k and p.
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    We request comment on each of these items. Is a requirement to 
rotate a partner every seven years, for example, the appropriate time 
frame? Should a PAB be permitted to make any exceptions to these 
requirements in some cases? If so, under what circumstances?
    In addition to the current SECPS membership requirements, other 
practices currently enhance investors' confidence and contribute to 
improved audit quality. Under proposed rule 13-04(e), Commission 
recognition of a PAB depends on the PAB requiring its members' quality 
control systems to encompass these practices as well. For example, 
proposed rule 13-04(e)(4) essentially restates the requirement in 
Independence Standard No. 1 regarding communications on auditor 
independence issues between an accountant and the audit committee of 
its audit client.\108\
---------------------------------------------------------------------------

    \108\ Independence Standards Board, Independence Discussions 
with Audit Committes, Independence Standard No. 1 (Jan. 1999), which 
requires the auditor to disclose to the audit committee, in wiritng, 
relationships that the auditor believes may reasonably be thought to 
bear on auditor independence, confirm in the letter its 
independence, and discuss its independence with the audit committee.
---------------------------------------------------------------------------

    Another example of a beneficial practice is maintaining a central 
office function that has expertise in accounting and financial 
reporting matters, and having policies and procedures in place for: (1) 
Engagement partners and others to consult with that office, and (2) the 
resolution of differences of opinions between that office and 
engagement partners. Proposed rule 13-04(e)(8) would condition 
Commission recognition of a PAB on the PAB ensuring that member firms 
maintain such a central office function, but a PAB could authorize 
alternative procedures for firms that could not meet this requirement 
because of their size. We solicit comment on the central office 
function requirement. Would this requirement place a burden on those 
firms that do not already maintain a central office function? Would 
conditioning recognition on the maintenance of a central office 
function pose any competitive concerns?
    Finally, proposed rule 13-04(e)(9) would condition Commission 
recognition of a PAB on the PAB ensuring that its members incorporate 
many of the procedures discussed by the Independence Standards Board in 
Independence Standard No. 3, Employment with Audit Clients.\109\ This 
standard requires an accounting firm, when an audit client employs a 
former firm professional, to take steps to eliminate the risk that the 
firm's former partner or employee could, by reason of his or her 
knowledge of or relationships with the firm, adversely influence the 
quality or effectiveness of the audit.\110\
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    \109\ See Independence Standards Board, Employment with Audit 
Clients, Independence Standards No. 3 (July 2000).
    \110\ Id.
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    We request comment on the quality control elements and specific 
requirements we have included in the proposed rule. Should we require 
these items, or should we defer to a PAB's discretion to devise quality 
control elements and requirements or to designate another entity's as 
authoritative? If they should be retained, should any be omitted or 
should additional procedures be added? Which ones? For example, should 
all partners who participate in a portion of the audit of a 
registrant's financial statements be rotated periodically? Are there 
other circumstances when we should require reporting to the audit 
client, a PAB, and/or the SEC? What are they? Should the Commission 
provide greater or lesser direction regarding the content of 
requirements set or adopted by a PAB?
Quality Control Review Program
    In section 13-04(f), we propose to build on the most successful 
parts of the SECPS's peer review process and membership requirements to 
create a stronger, more diligent and independent system. Proposed rule 
13-04(f) conditions Commission recognition of a PAB on the PAB having a 
continuing program for the review and inspection of member accountants' 
compliance with the PAB's rules and membership requirements and 
professional standards.
    The frequency of the reviews of a firm's quality control system 
under proposed rule 13-04(f)(1) would vary based on the number of the 
firm's SEC clients. For each member firm with more than 70 SEC clients, 
or such other number of SEC clients as the PAB may determine, the 
proposed rule would require a PAB to conduct an annual review of the 
firm's quality control system. For all other member firms, a review 
would be conducted at least once every three years.
    According to a recent computer run of SECPS members, ten accounting 
firms have more than 70 SEC clients.\111\ We have chosen 70 SEC clients 
for the dividing line to ensure that those accountants who audit the 
vast majority of registrants will be subject to very frequent scrutiny 
by a PAB. We recognize that the number of firms with more or less than 
70 SEC clients, and the need to review more or fewer firms on an annual 
basis, may change over time. Proposed rule 13-04(f)(1), therefore, 
would provide a PAB with the discretion to change the number of SEC 
clients that would trigger an annual, as opposed to a triennial, 
review.
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    \111\ The same data, derived from a list obtained from the 
SECPS, indicates that ten firms have between 30 and 75 SEC clients 
and approximately 800 firms have fewer than 30 SEC clients.
---------------------------------------------------------------------------

    Should a PAB conduct reviews more or less often than annually for 
the larger firms? Will triennial reviews for small firms meet the goals 
of the proposed rules? Should a PAB have the discretion to alter these 
frequency requirements based on experience over time with the review 
process? If so, in what way, if any, should that discretion be guided 
by Commission rules?
    We also request comment on whether 70 SEC clients is the 
appropriate trigger for an annual review or whether a larger or smaller 
number of SEC clients would be more appropriate. Additionally, we 
request comment on the proposal to provide a PAB with discretion to 
alter the 70 SEC client trigger/standard. Should a PAB have that 
discretion? If it does not, how should developments over time and a 
PAB's experience with the review process be factored into or accounted 
for in adjusting the trigger, as

[[Page 44983]]

may be appropriate? If a PAB is granted discretion to change the 
trigger, are there factors the Commission should identify to guide the 
exercise of that discretion?
    Proposed rule 13-04(f)(2) would permit a PAB to direct its member 
firms to make and keep records that are necessary for the conduct of 
the reviews. Proposed rule 13-04(f)(3) would make clear our expectation 
that a PAB would establish the policies and procedures for conducting 
reviews, establish reporting requirements, and maintain public files. 
Under proposed rule 13-04(f)(4), a PAB would monitor each review to 
ensure that it is conducted in a fair and impartial manner and that 
appropriate procedures are recommended and implemented to correct any 
noted deficiencies in a timely and effective manner.
    We request comment on all aspects of our proposals regarding 
quality control reviews, including on the elements of a strong quality 
control review program. How can a PAB best assess compliance of its 
members with rules of a PAB and with professional standards? How can a 
PAB best assess compliance of individual accountants associated with a 
firm?
    If a PAB program would be compared to the peer review program that 
currently is conducted under the auspices of the AICPA, we would expect 
that the PAB and its staff would perform the functions related to peer 
reviews that currently are performed by the Peer Review Committee,\112\ 
the SECPS Executive Committee,\113\ and until recently the POB and the 
POB staff,\114\ to the extent those functions are deemed necessary by a 
PAB.
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    \112\ The Peer Review Committee administers the peer review 
program, establishes standards for conducting peer reviews, 
establishes standards for reports on peer reviews and publication of 
such reports, requests the SECPS Executive Committee to appoint a 
hearing panel when it believes that sanctions should be imposed on a 
member firm for failure to comply with membership requirements, 
keeps records of peer reviews, and establishes and maintains a 
public file for each member firm, which includes the firm's three 
most recent annual reports, the latest peer review report, the 
reviewer's letter of comments, and the firm's response. See AICPA, 
Governing Bodies at: http://www.aicpa.org/members/div/secps/bodies/index.htm.
    \113\ The SECPS Executive Committee, among other things, 
establishes requirements for membership in the SECPS and determines 
sanctions to be imposed on member firms for failure to comply with 
the SECPS's membership requirements, ordinarily through the 
appointment of hearing and appeals panels. Id.
    \114\ The POB and the POB staff, among other things, monitored 
and evaluated the effectiveness of the Peer Review Committee and the 
SECPS Executive Committee and determined whether the Peer Review 
Committee was ascertaining that firms were taking appropriate action 
as a result of findings during peer reviews. Id.
---------------------------------------------------------------------------

    Under proposed rules 13-04(f)(5) a PAB would direct and make all 
key decisions related to each review of a firm that has over 70 SEC 
clients, or such other number of SEC clients as the PAB may determine. 
For firms with 70 or fewer SEC clients, a PAB may permit the reviews to 
be conducted by non-PAB staff, but only if the PAB: (1) Approves the 
review program; (2) establishes policies and procedures for the reviews 
as well as for reporting the results of the reviews; (3) maintains 
public files related to the reviews; (4) monitors the program to insure 
that reviews are conducted in a thorough and impartial manner; and (5) 
evaluates each review to gain assurance that appropriate procedures are 
being recommended and implemented to correct any noted deficiencies in 
a timely and effective manner.
    We request comment on whether a PAB should be permitted to use 
approved review programs. The five items listed should help to make 
sure that such programs operate effectively. Are there any other 
requirements that should be added to this list before a PAB may permit 
reviews under a review program? If review under a program is permitted, 
should a PAB, as part of its oversight of such a program, have control 
or veto power over the reviewer?
    Under proposed rule 13-04(f)(5)(i), in performing a PAB-directed 
review, the PAB may engage accountants from one or more non-associated 
firms to work on the review. As noted above, however, all key decisions 
must be made by the PAB. We are proposing to allow the PAB to engage 
such accountants to assist in doing the ``leg work'' of the reviews, so 
that a PAB may decide whether to hire a larger permanent staff or to 
contract for additional support on reviews as needed. Any accountants 
engaged to assist the PAB in conducting the reviews would perform only 
assigned functions and be supervised by the PAB or its staff.
    Should a PAB be permitted to engage accountants to work on a 
review? If so, what is the scope of functions that accountants engaged 
to assist a PAB in conducting reviews should be permitted to perform? 
Should there be other limitations or requirements on the accountants 
that may be engaged to assist a PAB in conducting a review? Would it be 
practical, and would a PAB be able to obtain the necessary expertise, 
if it had to conduct all or a significant portion of reviews 
exclusively with its own staff? Should a PAB direct the reviews, and 
make all key decisions for all reviews? In a PAB-directed review, 
should a PAB be permitted to engage, on a contract basis, employees of 
firms that are not affiliated with the firm being reviewed to do the 
``leg work'' on the review? We have proposed that firms with 70 or 
fewer SEC clients may have quality control reviews conducted under a 
review program approved by a PAB. Should firm-on-firm reviews be 
allowed? If firm-on-firm peer reviews are allowed, should a PAB, as 
part of its oversight of such a program, have veto power over a firm's 
selection of its reviewer? Should these reviews be conducted by teams 
of persons from one accounting firm or should the teams include members 
from several firms? What are the advantages and disadvantages of either 
team composition? Should firms employ staff members dedicated, at least 
on a part-time basis, to PAB quality control reviews?
    Proposed rule 13-04(f)(6) provides that a PAB or approved reviewer 
would examine various offices and personnel within the firm. It also 
would require a PAB or reviewer to determine whether the firm's quality 
control system is appropriate, whether adequate documentation and 
communication of quality control policies and procedures exists within 
the firm, and whether those policies and procedures provide reasonable 
assurance of compliance with the Commission's rules, the PAB's rules 
and membership requirements, and professional standards. Under proposed 
rule 13-04(f)(7), a PAB or reviewer would prepare a report of its 
findings and comments during each review. Each report and any response 
provided by the reviewed firm would be available to the public.
    We solicit comments on the appropriate scope of a review and the 
type of report and access to the report that should be established by 
the rules.
Supplemental Reviews and Disciplinary Proceedings
    In proposed rule 13-04(g) we have created the framework for a 
disciplinary process that for the first time would add teeth to the 
quality control review process. Under this proposal, the PAB could 
suspend or bar an individual or firm from being a member of a PAB or 
impose other remedial or disciplinary sanctions, as it believes 
appropriate. Such a proceeding might be based on an individual 
accountant's incompetent or unethical conduct, other acts or omissions 
that constitute a failure to comply with professional standards, or for 
violations of the PAB's rules or membership requirements. A proceeding 
against a firm might be based on the issuance of an adverse

[[Page 44984]]

review report, which indicates that the firm's quality controls, or 
compliance with those controls, are deficient and fail to provide 
reasonable assurance that the firm is complying with professional 
standards during its audit, review, or attest engagements. A PAB could 
also institute disciplinary proceedings against a firm or an individual 
for conduct that comes to the attention of a PAB other than through the 
quality control review.
    Proposed rule 13-04(g)(1) conditions Commission recognition of a 
PAB on the PAB having rules, membership requirements, systems, and 
procedures, incorporating the criteria described in this section, 
pursuant to which it could institute public disciplinary proceedings to 
determine whether an accountant has violated PAB rules or membership 
requirements, or professional standards, and to impose sanctions. Prior 
to making a determination to institute a disciplinary proceeding, under 
proposed rule 13-04(g)(1)(ii) a PAB may, on the basis of information 
suggesting such a violation, engage in a nonpublic ``supplemental 
review'' process of gathering information relevant to its determination 
of whether to institute a disciplinary proceeding.
    The supplemental review process would be an important part of the 
PAB's mission. We would expect a PAB to pursue a supplemental review on 
the basis of any information suggesting the possibility of the type of 
violation described above, whether that information comes to a PAB 
through a routine quality control review or otherwise. Some 
supplemental reviews might be very brief, with PAB staff satisfying 
itself in the course of a single interview that there is no basis for 
inquiring further, while other supplemental reviews could be complex, 
requiring careful consideration of a large amount of information to 
make a responsible decision about whether to institute a disciplinary 
proceeding. Proposed rule 13-04(g)(4) provides that a PAB may request 
relevant testimony and documents from any person in connection with a 
supplemental review or a disciplinary proceeding.
    We request comment on the proposed supplementary review and 
disciplinary mechanisms. Under what circumstances should a PAB exercise 
this power? Should a PAB have the power to suspend or bar an individual 
or firm from being a PAB member? Should the rules set forth detailed 
requirements regarding the procedures that a PAB should employ before 
exercising disciplinary powers? What procedures, limitations, and 
controls should apply to a PAB's exercise of its disciplinary powers? 
Should the rule provide more specific limits on the circumstances in 
which a PAB may pursue a supplemental review?
    If a PAB becomes aware of information indicating that a violation 
of the securities laws has, or is likely to have, occurred, then under 
proposed rule 13-04(g)(2) the PAB would notify the Commission. As noted 
above, we intend to continue to address instances of violations of the 
securities laws and other conduct through our enforcement efforts, 
including enforcement of Rule 102(e) of our Rules of Practice. 
Violations of the securities laws and other actionable conduct should 
not go unaddressed because they are detected during a quality control 
review as opposed to coming to light through another means. While we 
recognize that some may fear that such a referral procedure could have 
a chilling effect on the review process, to provide otherwise would be 
contrary to our mandate under the securities laws. In light of the 
balance between these interests, we request comment on whether we 
should require that a PAB notify the Commission of information 
indicating that a violation of the securities laws has or is likely to 
have occurred. Would this referral procedure affect the review process? 
If so, how?
    Further, to ensure that there is not unnecessary duplication of 
effort or burden on a party, and to retain the Commission's control 
over the enforcement of the securities laws, we propose that a PAB 
could only institute a disciplinary proceeding regarding that 
information after notifying and consulting with the Commission. We 
solicit comment on whether the Commission should prohibit a PAB's 
institution of a disciplinary proceeding in this manner. Are there 
alternative ways to achieve the purposes of this limitation? Should a 
PAB have broader discretion and disciplinary powers to conduct 
proceedings related to violations of the securities laws?
    Under proposed rule 13-04(g)(3), a PAB must establish fair 
procedures for supplemental reviews and disciplinary proceedings. The 
rule also would require a PAB's disciplinary proceeding to be public 
unless otherwise ordered by the PAB with the prior approval of the 
Commission. We intend for a PAB's disciplinary proceedings to be open 
and transparent to the same extent that our Rule 102(e) proceedings are 
open to the public.\115\
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    \115\ See 17 CFR 201.102(e)(7). In 1988, the Commission amended 
Rule 102(e) to state that proceedings shall be public unless the 
Commission otherwise directs, and stated that the reasons supporting 
public proceedings against accountants include that disciplinary 
proceedings against broker-dealers and other market professionals 
are public, that private proceedings create an incentive for delay, 
that there is considerable public and professional interest in such 
proceedings, and that public proceedings are more favored in the law 
than are closed proceedings. See Disciplinary Proceedings Involving 
Professionals Appearing or Practicing Before the Commission, Release 
No. 33-6783 (July 7, 1988), 53 FR 26427 (July 13, 1988).
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    We request comment on the requirement that a PAB establish 
procedures for disciplinary proceedings. Should our rules be more 
specific with respect to the procedures a PAB must establish, such as 
specifically providing for appropriate burdens of proof or evidentiary 
rules? We request comment on the ability of a PAB to institute 
disciplinary proceedings and supplemental reviews, and on the 
procedures proposed for those proceedings and reviews. Under the 
proposal, disciplinary proceedings would be public. Are there reasons 
that all disciplinary proceedings, certain categories of disciplinary 
proceedings, or certain portions of disciplinary proceedings should not 
be public, or as to which a PAB should have discretion to make them 
non-public? Is providing a PAB discretion to close a disciplinary 
proceeding, but only with prior Commission approval, an appropriate 
response to these situations, given that it may not be possible to 
foresee all possible contingencies?
    We are not proposing to prescribe the details of the hearing 
process. A PAB, if it chooses, may have independent, non-accountant 
hearing officers conduct a hearing and recommend findings and sanctions 
to the PAB, in a manner not dissimilar to the process used by the NASD. 
Alternatively, it may require a panel of PAB members, with the advice 
of legal counsel, to conduct the hearings, or it may adopt rules and 
procedures for other suitable proceedings. Should we require a 
particular process in this area?
    At a minimum, however, under proposed rule 13-04(g)(3), a PAB 
should provide its members with procedural safeguards similar to those 
required by statute in proceedings conducted by the securities 
exchanges and the NASD. These include notice of specific charges, an 
opportunity to defend against the charges, a record of the proceedings, 
and an explanation of the grounds for any sanction imposed.\116\ As 
noted above, we believe that to have a credible process and protect the 
interests of both investors and accountants, these proceedings should 
be public to the

[[Page 44985]]

same extent as our Rule 102(e) proceedings.
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    \116\ See, e.g., 15 U.S.C. 78o-3(h).
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    We request comment on which safeguards, if any, a PAB should 
provide to its members. Are there additional safeguards that any final 
rules should require a PAB to provide? Are there safeguards that we 
propose that are unnecessary and would impede a PAB's ability to 
accomplish the goals and purposes of Article 13? Should the Commission 
provide more guidance or detail regarding the safeguards it proposes or 
may adopt in this proposed rule?
    Under proposed rule 13-04(g)(4), Commission recognition of a PAB is 
also conditioned on the PAB having rules pursuant to which it may 
request that any person provide documents or testimony relevant to any 
supplemental reviews or disciplinary proceeding. We have not proposed 
any provisions pursuant to which a PAB could require production or 
testimony from anyone who is not a member or adjunct member of the PAB.
    Are there appropriate mechanisms that could be included in the rule 
to increase the PAB's ability to obtain documents and testimony? Should 
the rule limit the circumstances under which, or the methods by which, 
a PAB should be permitted to seek documents and testimony?
    Proposed rule 13-04(g)(5) states that PAB board members who are not 
public members would not vote on any disciplinary matters (but could be 
consulted in connection with supplemental reviews and disciplinary 
proceedings). Placing the outcome of disciplinary matters solely in the 
hands of representatives of investors and issuers would serve to 
enhance investor confidence that their interests are being protected.
    Is this proposed restriction on voting in disciplinary matters to 
the public board members appropriate in light of the importance of 
assuring investor confidence in these proceedings? Are there 
circumstances when the accountant board members should be able to vote? 
Should further or other limitations be placed on the participation of 
accountant board members with regard to disciplinary proceedings or 
supplemental reviews? For example, should consultation be prohibited as 
well? If so, why?
    Under proposed rule 13-04(g)(6), if a PAB finds in a disciplinary 
proceeding that an accountant has violated rules or membership 
requirements of a PAB or professional standards, it could, among other 
sanctions, revoke or suspend the accountant's membership in, or expel 
the accountant from, the PAB; impose limitations on an accountant's 
activities, including requiring resignation from a specific audit, 
review, or attest engagement; suspend or bar an accountant from 
participating in any SEC audit, review, or attest engagement; impose 
fines and censures; and impose any other appropriate sanction.
    The Commission requests comment on whether these are appropriate 
sanctions. Should our rules be more or less specific with respect to 
the sanctions and remedial actions a PAB could take? If so, how?
    To provide heightened transparency in the disciplinary process, 
proposed rule 13-04(g)(7) would provide for a PAB to issue a public 
written report whenever it imposes a sanction. Copies of the report 
would be provided to the Commission and to any state or foreign 
financial regulatory authorities, with which the individual or firm is 
licensed, registered, or certified to practice public accounting. Each 
report would name the accountant being sanctioned, describe the acts or 
omissions on which the sanction is based, describe the nature of the 
sanction, and contain such other information as the PAB deems 
appropriate. We request comment on the persons to whom the report 
should be sent, whether it should be public, and what information it 
should contain. In addition, we solicit comment on whether public 
reports, either on a case-by-case basis or otherwise, should be 
provided when a PAB determines that no sanction should be imposed, and, 
if so, what those reports ought to include.
    Under proposed rule 13-04(g)(8), if a PAB is unable to complete a 
proceeding because of the refusal of any person to provide testimony or 
documents or otherwise to cooperate with the PAB, then the PAB would 
report that refusal to the Commission. Further, where the uncooperative 
party is a registrant, the PAB would additionally report the refusal to 
any market or exchange on which that registrant's securities are 
traded. Under this proposed rule, a PAB also may refer any other matter 
to the Commission that it deems appropriate.
    We solicit comments on the reporting and referral provisions in 
proposed rule 13-04(g)(8). Among other matters, should the Commission 
provide guidance or details regarding the timing and content of those 
reports and referrals. Are there other circumstances when a PAB should 
report to the Commission or to an exchange or market on which a 
registrant's securities are traded?
    Proposed rule 13-04(g)(9) addresses the situation where a firm 
employs a person who is subject to a PAB sanction, order, or ruling. 
Because many accounting firms provide diverse and varied services, it 
is possible for a firm to retain an individual to perform services that 
are unrelated to audits, reviews, or attest services for Commission 
registrants. Under this provision, however, the firm would notify the 
PAB of its relationship with the sanctioned individual and undertake 
procedures to make sure the terms of the sanction, order, or ruling are 
not violated. We request comment on these proposed requirements. Is it 
necessary or appropriate to the accomplishment of the goals and 
purposes of Article 13 for a member accounting firm to provide notice 
if the individual is not going to perform any audit, review, or attest 
services for registrants? Should the requirement to provide notice take 
into account whether the sanctioned person would perform services 
unrelated to audits of Commission registrants? Should the firm's 
requirement to notify a PAB of its relationship with the sanctioned 
person be a one-time or continuous requirement?
    Rule 102(e)(2) of the Commission's Rules of Practice states that 
any person whose license to practice as an accountant has been revoked 
or suspended in any state, and any person who has been convicted of a 
felony or a misdemeanor involving moral turpitude, shall be forthwith 
suspended from appearing or practicing before the Commission.\117\ 
Should proposed rule 13-04(g)(9), if adopted, include a provision that 
any person barred, suspended, or expelled from membership in a PAB 
shall be forthwith suspended from appearing or practicing before the 
Commission? Should we include such a provision in Rule 102(e)(2)?
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    \117\ 17 CFR 201.102(e)(2).
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Public Reporting
    To facilitate our oversight and to provide transparency regarding a 
PAB's operations and processes, we would encourage a PAB to make as 
much information available on a ``real-time'' basis as possible. Under 
proposed rule 13-04(h), a PAB would report to the Commission and the 
public at least annually, and where practicable on a current basis:
     A description of its quality control review and 
disciplinary activities;
     Annual audited financial statements;
     An explanation of fees and charges imposed on member 
accountants and adjunct members;
     A summary of issues discussed in the PAB-sponsored 
meetings with, or in

[[Page 44986]]

connection with its oversight of, private sector standard-setting 
bodies;
     A list of matters referred to each private sector 
standard-setter that were not placed on the standard-setter's agenda 
within 90 days of the referral; and
     Other matters as the PAB or the Commission deems 
appropriate.
    Transparency is essential if a PAB is going to be a credible 
private sector regulatory body, develop the trust of both accountants 
and government bodies, and enhance the confidence of investors in the 
audit process and in the integrity of the information that fuels our 
securities markets. Public reports are one means of providing that 
transparency.
    We request comment on our proposed public reporting provisions. 
Should we be more specific? Will the specified reports achieve an 
adequate level of transparency? If not, on what other types of 
reporting should we condition a PAB's Commission recognition? We also 
request comment on the appropriate timing and the scope of the reports.
Commission Oversight
    As discussed above, under proposed section 13-04(i), Commission 
recognition is conditioned on a PAB's charter and bylaws providing that 
it will be subject to, and act in accordance with, Commission 
oversight. Our oversight authority under proposed section 13-04(i) is 
substantial. We expect to monitor closely the activities of any PAB and 
exercise particular aspects of our oversight authority whenever the 
public interest so requires. Among other things, under these proposed 
rules, the Commission may make changes to a PAB's rules, inspect and 
monitor a PAB's operations, review PAB disciplinary proceedings and 
modify or reverse any sanctions imposed, remove PAB board members under 
certain circumstances, redirect fees paid to a PAB that fails to comply 
with the conditions of recognition, and, ultimately, withdraw 
recognition. We believe that the system of private regulation proposed 
by the release, coupled with Commission oversight, is the best way to 
achieve our goals of improving audit quality and financial disclosure.
    We envision a more thorough and extensive oversight of a PAB's 
processes than existed under the prior self-regulatory structure. We 
would intend to have full access to the process so that we would be 
able to determine to our satisfaction whether a PAB is operating in the 
interests of investors and working diligently to improve firms' quality 
control systems, including sanctioning or removing from practice before 
the Commission incompetent or unethical individuals.
    The proposed rule allows a PAB to set auditing, ethical and quality 
control standards, perform quality control and supplemental reviews, 
and impose disciplinary sanctions. As discussed elsewhere in this 
release, these powers are necessary in order for a PAB to improve audit 
quality and enhance public confidence in our markets. Because a PAB's 
influence on financial reporting will be significant, Commission 
oversight is necessary to ensure that a PAB exerts its influence 
exclusively in the public interest.
    We request comment on the structure and scope of Commission 
oversight provided in the proposed rules. Would our goals better be 
served by a system of oversight that was less extensive? Why or why 
not? Should our rules set forth detailed criteria with respect to when 
the Commission would exercise its oversight? What should those criteria 
be?
    Although we would not approve a PAB's rules before they take 
effect, as we do for the securities exchanges and others, one of the 
conditions of Commission recognition of a PAB would be, as set out in 
proposed rule 13-04(i)(1), that the PAB consent to and act in 
compliance with any Commission rule that abrogates, adds to, or deletes 
from the rules of a PAB. Using this provision, we could, by rule, amend 
a PAB's rules to remove inconsistencies, assure compliance with the 
securities laws or our regulations, and otherwise fulfill the purposes 
of Article 13. We would notify a PAB of our intention to take such 
action before we commenced a rulemaking proceeding. We also would 
follow our normal rulemaking process under the Administrative Procedure 
Act,\118\ including publication of the proposed changes in the Federal 
Register, to solicit a wide range of comments on the proposed 
amendments. As discussed above, a PAB's charter and bylaws would 
provide that any changes we make to a PAB's rules would be immediately 
effective without further action by a PAB. We request comment on this 
provision. Should we review or approve of a PAB's rules before they 
take effect? Should the Commission amend a PAB's rules or should we 
only suggest or require that changes be made by the PAB itself? We 
request comment on our requirement that a PAB provide that any changes 
we make to a PAB's rules would be immediately effective. Does this 
requirement raise any concerns in light of state law requirements in 
the areas of fiduciary duty and business judgment?
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    \118\ See 5 U.S.C. 553 et seq.
---------------------------------------------------------------------------

    Under the self-regulatory structure, a 1982 memorandum of 
understanding (``MOU'') among the Commission, the SECPS Peer Review 
Committee, the SECPS Executive Committee, and the POB significantly 
limited our oversight. For example, the MOU provided for the Commission 
staff to have access to POB staff workpapers, but only to certain 
workpapers of the peer reviewers on a random selection basis. The MOU 
also stated that the Commission staff was not permitted to retain or 
make copies of POB or reviewer workpapers.
    Under proposed rule 13-04(i)(2), a totally different approach is 
proposed that would give the Commission the requisite involvement and 
oversight of a PAB's activities. Under the rule, our staff periodically 
may monitor and inspect the operations, records, and results of a PAB 
to ensure it is operating in the public interest and fulfilling the 
purposes of the Commission's rules. We intend that our staff would, in 
fact, regularly inspect the PAB's operations, records, and results, and 
would meaningfully monitor the PAB's operations. Among other things, we 
expect that monitoring to include our staff's attendance at meetings 
between a PAB and firms in connection with closing conferences at the 
completion of quality control reviews. The rule also requires a PAB to 
make and keep records that the Commission staff deems necessary for its 
inspections of the PAB's quality control reviews, supplemental reviews, 
and disciplinary activities.
    We solicit comment on the approach to oversight in the proposed 
rules and on Commission involvement of a PAB's activities. How 
extensive should the involvement be of our staff in meetings between a 
PAB and a firm being reviewed? At what stage of the oversight process 
would our staff's involvement be most productive?
    Because a PAB may limit or suspend an accountant's practice before 
the Commission, an adversely affected firm or individual should have 
the opportunity to seek Commission review of a PAB disciplinary 
decision. In addition, any member or adjunct member who is found 
delinquent in paying fees, producing documents or providing testimony 
should have an opportunity to seek Commission review of that 
determination. Under proposed rule 13-04(i)(3)(i), a PAB member 
accountant or adjunct member would have 30 days from the date the 
member accountant or adjunct member was

[[Page 44987]]

notified by the PAB of the sanction or delinquency determination to 
file an application with the Commission for review. The Commission also 
could review a PAB sanction or delinquency determination on its own 
motion. A Commission review, however, would not stay the operation of 
the sanction unless the Commission so orders.
    We seek comment on Commission review of a PAB disciplinary or 
delinquency action. Under the proposed rules, a PAB member or adjunct 
member would have 30 days to file an application for review. Is 30 days 
sufficient time to file an application? Should an application for 
review stay the operation of the sanction?
    Under 13-04(i)(3)(ii), a Commission proceeding for review of a 
PAB's final disciplinary action against a member accountant would allow 
for notice and an opportunity for a hearing. The hearing may consist 
solely of consideration of the record before the PAB and opportunity 
for the presentation of supporting reasons to affirm, set aside, or 
modify the sanction. Under the proposed rule, the Commission would make 
a finding determining whether the member accountant engaged in the acts 
or omissions that the PAB found the accountant to have engaged in; 
whether those acts or omissions violated the provisions of the 
securities laws or rules thereunder, rules or membership requirements 
of the PAB, or professional standards that the PAB specified; and 
whether those provisions are, and were applied in a manner, consistent 
with proposed Article 13. If the Commission makes those findings, the 
Commission would by order so declare, and affirm or modify the sanction 
or, where appropriate, remand it to the PAB for further proceedings. If 
the Commission does not make those findings, it would set aside the 
sanction and, if appropriate, remand it to the PAB. We are not 
proposing that the Commission, during such a review, be able to 
increase the sanction imposed on the accountant. If the Commission 
deems a greater sanction to be necessary, it would initiate its own 
civil, administrative, or disciplinary proceedings.
    Proposed rule 13-04(i)(3)(iii) sets forth similar procedures for 
Commission review of a PAB delinquency determination against a member 
or adjunct member. In proposed rule 13-04(i)(3)(iv), we have expressed 
specifically our authority to cancel, reduce, or require remission of a 
sanction or to cancel a delinquency determination, if we find that the 
sanction or delinquency determination imposes an unnecessary burden on 
competition or is excessive or oppressive.
    We request comment on the Commission proceeding to review a PAB's 
disciplinary actions or delinquency determinations. What should such a 
hearing entail? Should the rule allow for us to increase the sanction 
imposed on an accountant when appropriate? Under the proposed rules, we 
may cancel, reduce or require remission of a sanction or cancel a 
delinquency determination if it would impose an unnecessary burden on 
competition or is excessive or oppressive. Are these the appropriate 
instances when we should take such action? Are there other 
circumstances when we should act to ameliorate a sanction? What are 
they?
    Proposed rule 13-04(i)(4) allows us, by order, to remove from 
office or censure any PAB board member if we find, after notice and 
opportunity for hearing that the member has (1) willfully violated any 
provision of the securities laws, rules or regulations thereunder, or 
the rules of the PAB; (2) willfully abused his or her authority; or (3) 
without reasonable justification or excuse failed to enforce a PAB 
member's compliance with any such provision or professional standards. 
In addition, under proposed rule 13-04(i)(5), if the Commission finds 
that a PAB is failing or has failed to comply with any of the 
conditions of recognition in proposed rule 13-04, we could withdraw 
recognition of the PAB and direct that PAB fees be deposited into 
escrow pending either correction of the PAB's failing or redirection of 
the funds to another PAB with which the formerly recognized PAB's 
members have enrolled.
    Does our proposal set forth the appropriate circumstances for when 
we would remove from office or censure a PAB board member? We solicit 
comment on the redirection of funds to another PAB. Are there other 
circumstances that would warrant such action by the Commission? Are 
there alternative approaches for resolving or correcting a PAB's 
failure to meet the conditions of ongoing recognition?
    We request comment on all aspects of Commission oversight of a PAB. 
Are there important aspects of Commission oversight that we have not 
identified? What are they? We request comment on our proposed rule that 
would allow us to withdraw recognition of a PAB.

F. Confidentiality and Immunity

    Proposed rule 13-05(a) contains the Commission's finding that it is 
in the public interest for reports, memoranda, and other information 
prepared by, and deliberations of, the PAB and its agents to receive 
appropriate confidential treatment under applicable law. We also find 
it in the public interest for a PAB to claim such protection, except to 
the extent that such information is requested by the Commission, any 
other Federal agency or department, any state licensing or criminal law 
authorities, and any foreign governmental or foreign financial 
regulatory authorities.
    The Commission anticipates and intends that a PAB vigorously will 
claim confidentiality for its quality control review files, 
supplemental review files, and other files to the full extent permitted 
under law. Courts have recognized the strong public interest in 
allowing non-governmental entities entrusted with enforcing rules of 
conduct to minimize disclosure of investigative materials.\119\ In Ross 
v. Bolton, the court noted the danger in ``making NASD files fair game 
for any of the thousands of private securities fraud litigants across 
the country who wish to shortcut their own discovery efforts and 
instead to reap the benefits of the Association's ongoing, statutorily 
governed work.'' \120\
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    \119\ See Fiero Bros. v. Mishkin, No. 95-08203 JLG, 1999 WL 
1747410 (S.D.N.Y. Dec. 8, 1999); Apex Oil Co. v. DiMauro, 110 F.R.D. 
490, 496 (S.D.N.Y. 1985); Ross v. Bolton, 106 F.R.D. 22, 23 
(S.D.N.Y. 1985).
    \120\ Ross, 106 F.R.D. at 24.
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    Those who possess information may be less forthcoming in responding 
to a PAB inquiry if they believe that the information they provide will 
be made public or made available to private litigants.\121\ The PAB's 
efforts to improve audit quality accordingly would be hindered.\122\ 
Additionally, we believe that in most instances a plaintiff's 
legitimate interest in obtaining discovery from a PAB will be slight at 
best. This particularly will be the case where the PAB is not a party 
to the litigation or where a PAB inquiry is not the subject of a 
plaintiff's claims.\123\ Moreover, a plaintiff generally will be able 
to obtain the information it seeks from sources other than a PAB. 
Accordingly, a PAB's files should receive significant protection from 
compelled disclosure. The scope of

[[Page 44988]]

this protection, however, should not be so broad as to permit a PAB to 
deny Commission access to the PAB's materials, nor should it permit a 
PAB to deny access to the other governmental authorities described 
above.
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    \121\ See Apex Oil, 110 F.R.D. at 496.
    \122\ Additionally, as with our own proceedings, substantial 
harm may occur to individuals, accounting firms, or registrants if 
materials are released either prematurely or after a determination 
has been made that allegations or suspicions of misconduct have not 
been substantiated sufficiently to warrant instituting a PAB 
disciplinary proceeding. Absent such confidentiality, the reputation 
of innocent professionals could be tarnished irreparably and the 
price of a registrant's securities could suffer based on unfounded 
suspicion or rumor.
    \123\ See Apex Oil, 110 F.R.D. at 497.
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    We request comment on our proposal that the Commission find that 
information prepared by a PAB receive confidential treatment. Should 
such information be treated confidentially? Why or why not? Our 
proposal sets forth exceptions to confidentiality, such as information 
requested by a federal agency. Should our rules provide for other 
exceptions? We seek comment on the effect that discovery requests in 
private actions would have on a PAB inquiry. Would those who possess 
information be less willing to share information if the information 
could be subject to discovery in a private action? Is there some other 
way to address this concern besides a PAB maintaining confidentiality 
of the information?
    In proposed Section 13-05(b), the Commission finds that public 
policy dictates that a PAB, its staff, contractors, and professional 
representatives should be immune from liability in a private civil suit 
for any action or failure to act in connection with the PAB's 
responsibilities under Article 13. We anticipate, and intend, that a 
PAB and its members and employees will claim and be entitled to 
immunity from private civil liability for any action or failure to act 
in connection with a PAB's responsibilities under the proposed 
rules.\124\ Common law provides immunity for non-governmental actors 
who perform public functions such as the ``development and promulgation 
of interpretations of statutory and regulatory requirements, the 
dissemination and implementation of these interpretations, and the 
provision of information to government agencies.'' \125\ Accordingly, 
self-regulatory organizations (``SROs''), for example, have been held 
to enjoy immunity for actions taken within the scope of their duties as 
SROs, including interpretive, enforcement, adjudicatory, and referral 
activities.\126\ Immunity from civil liability attaches because of, 
among other things, the likelihood of recriminatory lawsuits against 
SROs and the safeguards against abuse provided by the Commission's 
oversight.\127\
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    \124\ We do not intend anything in this rule to suggest that a 
PAB would or should be immune from civil law enforcement actions.
    \125\ See D'Alessio v. New York Stock Exchange Inc., 125 F. 
Supp. 2d 656, 658 (S.D.N.Y. 2000), aff'd, 258 F.3d 93 (2d Cir. 
2001).
    \126\ See D'Alessio v. New York Stock Exchange Inc., 258 F.3d 
93, 106 (2d Cir. 2001).
    \127\ See Barbara v. New York Stock Exchange Inc., 99 F.3d 49, 
59 (2d Cir. 1996); Austin Municipal Securities, Inc. v. National 
Assoc. of Securities Dealers, Inc., 757 F.2d 676, 692 (5th Cir. 
1985).
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    Although we are proposing the framework for a private sector 
regulatory organization that is not self-regulatory in nature, a PAB 
and its employees should be immune for activities within the scope of 
their duties under these rules. Like an SRO, the PAB will further the 
purposes of the federal securities laws by setting standards, enforcing 
compliance, and providing the Commission with information. A PAB will 
perform critical public functions as it fulfills its mission to ensure 
reliable financial information and enhance public confidence in our 
markets. A PAB will, to the same extent as an SRO, be susceptible to 
lawsuits that could hamper its important public mission or discourage 
public-spirited persons from serving on a PAB. Finally, a PAB will be 
subject to Commission oversight to guard against abuses. Accordingly, a 
PAB and its employees should be immune from civil liability to the same 
extent as the SROs.\128\
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    \128\ The distinction between private regulation and self-
regulation is important because under these rules the accounting 
profession will not be responsible for regulating itself. Rather, a 
private sector entity not controlled or dominated by accountants 
will assume this role. We do not believe, however, that distinction 
is relevant for the purposes of determining whether a PAB will be 
immune from civil liability.
---------------------------------------------------------------------------

    We solicit comment on our proposed finding that a PAB be immune 
from private liability. Should we make such a finding? Would immunity 
be appropriate, as our proposed finding suggests, for staff, 
contractors, and professional representatives of a PAB? Are there 
reasons we should not find that such immunity is appropriate?

G. Exemptions

    The Commission's broad exemptive authority \129\ is reflected in 
proposed rule 13-06(a). Under this provision, on our own motion or upon 
an application by any interested party, we may exempt, conditionally or 
unconditionally, in whole or in part, any registrant, accountant, or 
class of registrants or accountants, from the operation of Article 13 
and proposed rule 2-01(a)(2) of Regulation S-X.
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    \129\ See, e.g., Section 36 of the Exchange Act, 15 U.S.C. 78mm.
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    In proposed rule 13-06(b), we would use our authority and exempt 
from the operation of Article 13 and proposed rule 2-01(a)(2) of 
Regulation S-X those accountants who do not audit or review financial 
statements filed with the Commission on a recurring basis and whose 
audit reports are filed with us only in accordance with Rule 3-05 of 
Regulation S-X.\130\ Rule 3-05 requires that the audited financial 
statements of certain businesses acquired, or to be acquired, by 
registrants be filed with the Commission. An audit of a private 
business that subsequently is acquired by a registrant, therefore, 
would not, by itself, require the accountant performing the audit to 
become a member of a PAB.
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    \130\ 17 CFR 210.3-05.
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    Under proposed rule 13-06(c), the Commission may relieve a PAB from 
any of its obligations under Article 13 to enforce rules or membership 
requirements of a PAB or professional standards with respect to any 
accountant, adjunct member, or class of accountants or adjunct members. 
We believe this proposal is appropriate to clarify our ability to 
address unintended consequences or unforeseen events that may occur and 
result in a need to suspend or alter the functions performed by a PAB.
    We request comment on the proposed use of our exemptive authority. 
Should the Commission grant exemptions for accountants whose reports 
are filed only pursuant to Rule 3-09, regarding the financial 
statements of certain unconsolidated subsidiaries and ``50 percent or 
less owned persons,'' or Rule 3-10, regarding the financial statements 
of certain guarantors and issuers of guaranteed securities?

H. Foreign Accountants

    Under proposed rule 13-07(a), foreign accountants that audit or 
review financial statements filed with the Commission, and foreign 
issuers that engage foreign accountants for such services, would be 
exempt from the operation of Article 13 and proposed rule 2-01(a)(2) of 
Regulation S-X.\131\ As noted above, under proposed section 13-
03(c)(5), a PAB would study the quality control systems of foreign 
accountants and periodically report to us on whether the exemption 
provided to foreign accountants should be withdrawn. We would expect a 
PAB, at an appropriate time, to recommend that all or various classes 
of foreign accountants, conditionally or unconditionally, should be 
subject to proposed Article 13 and proposed rule 2-01(a)(2) of 
Regulation S-X.
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    \131\ This proposed exemption would not preclude the Commission 
from initiating Rule 102(e) proceedings or other appropriate 
proceedings when warranted.
---------------------------------------------------------------------------

    In the meantime, we would require, under proposed section 13-
04(e)(6), that domestic firms that are associated with foreign firms 
continue the current

[[Page 44989]]

practice of encouraging their international organizations and 
individual foreign associated firms to improve their quality control 
policies and procedures, in a manner consistent with the objectives of 
Article 13.\132\ We also would expect that domestic firms would 
continue to urge their foreign associated firms to adopt policies and 
procedures that are at least as rigorous as those set forth in Appendix 
K to the current SECPS Membership Requirements.\133\ These policies and 
procedures are intended to provide a mechanism for persons 
knowledgeable in United States accounting, auditing, and auditor 
independence requirements to assist foreign accountants in the 
performance of audits of financial statements included in filings with 
the Commission. Appendix K also addresses policies and procedures 
related to an annual inspection process that would include the review 
of a sample of audit engagements performed by foreign associated firms 
for clients that are Commission registrants.\134\ We would require 
under proposed rule 13-04(e)(6) that domestic accountants would report 
to a PAB, as they currently report to the SECPS, the name and country 
of the foreign associated firms, if any, that have advised the domestic 
accountant that such policies and procedures have been put in 
place.\135\
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    \132\ The Commission staff also will continue to seek comfort 
regarding a foreign accountant's knowledge of United States 
accounting, auditing, and auditor independence requirements as part 
of its review of filings or in anticipation of being requested to 
exercise its judgment in the public interest to accelerate the 
effectiveness of registration statements.
    \133\ Appendix K is available at http://www.aicpa.org/members/div/secps/inmere.htm.
    \134\ Persons knowledgeable in U.S. GAAP, GAAS and independence 
requirements and Commission regulations (the ``inspection 
reviewers'') would review the engagements. The inspection reviewers 
would determine whether anything came to their attention to cause 
them to believe that: (1) Either the financial statements did not 
comply with U.S. GAAP or the required reconciliation to U.S. GAAP 
did not include appropriate treatment of material reconciling items; 
(2) the audit engagement was not performed in accordance with U.S. 
GAAS; (3) the foreign associated firm did not comply with U.S. 
auditor independence requirements; and (4) the foreign associated 
firm did not comply with procedures for having Commission filings 
reviewed by a person knowledgeable in U.S. GAAP, U.S. GAAS, U.S. 
auditor independence requirements, and Commission regulations. See 
Id.
    \135\ SECPS, Requirements of Members, at n.
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    In this regard, under proposed rule 13-07(b), during a review of a 
member firm's quality controls, a PAB or other reviewer would examine 
the procedures performed by the firm related to documents filed with 
the Commission that contain audit reports prepared by the firm's 
foreign associated firms.
    We request comments on our proposal regarding foreign accountants. 
Is the exemption for foreign accountants appropriate? There may be 
situations where, for example, a foreign company has the majority of 
its assets and operations in the United States and as a result it 
engages a U.S. firm to conduct the audit of the foreign company's 
financial statements. Should the exemption be broadened to include such 
a foreign issuer? Are there situations in which a U.S. firm's audit 
work for public companies is limited to companies that are foreign 
issuers? If so, should the exemption be broadened to include those 
issuers, but not broadened to include foreign issuers whose U.S. 
accounting firm also provides audit services to domestic issuers, and 
would therefore be required to be a PAB member anyway? Should we 
include an explicit provision to prevent domestic issuers from avoiding 
the PAB requirement by engaging a foreign accounting firm as their 
principal auditor?

I. Disclosure by Directors, Executive Officers, Promoters, and Control 
Persons

    Under our proposed addition to item 401(f) of Regulation S-K,\136\ 
disclosure would be required if, during the past five years, any 
director, person nominated to become a director, or executive officer 
was, in his or her capacity as a PAB member accountant, sanctioned by a 
PAB for violations of professional standards or the PAB's rules or 
membership requirements and that sanction has not been subsequently 
reversed, suspended, or vacated.
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    \136\ 17 CFR 229.401(f).
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    Item 401 currently requires disclosure of similar sanctions, such 
as court orders or judgments by federal or state authorities barring or 
limiting the right of the person to engage in activities related to, 
among other things, commodity trading, any type of business practice, 
or the purchase or sale of any securities.
    A PAB sanction would be designed to protect investors from 
incompetent or unethical conduct or other failures to comply with 
professional standards. Such a sanction would be considered to be 
sufficiently serious that investors should be notified of the sanction 
for consideration in connection with investment or voting decisions.
    We request comment on our proposal regarding disclosure. The 
disclosure requirement has been placed in Regulation S-K but not in 
Regulation S-B in order not to increase the compliance burden on small 
business issuers. We are considering, however, placing the requirement 
in Regulation S-B as well. Should small business issuers make this 
disclosure? Assuming disclosure is required of PAB sanctions that have 
been imposed on executive officers, directors, or director nominees, 
should disclosure also be required of sanctions that have been imposed 
against such individuals in disciplinary actions under Rule 102(e) of 
the Commission's Rules of Practice? Should disclosure be required for 
sanctions that were imposed longer than five years ago?

J. Transition Period

    We are considering the appropriate timing for the implementation of 
final rules, if any are adopted, and how best to allow for an orderly 
transition to the new rules. We are considering what, if any, delay 
would be necessary or appropriate in this case.
    We could set a transition or compliance date that would allow 
additional time for a PAB to be established, recognized by the 
Commission, and in a position to begin accepting members. We anticipate 
that one or more entities seeking to be a PAB will submit appropriate 
information to the Commission soon after the final rules are published. 
We further anticipate that we would review that information promptly 
and, if practicable, issue an order recognizing a PAB by January 2003. 
Even though such a PAB might not be in a position for several months to 
begin conducting quality control reviews or disciplinary proceedings, 
it could begin accepting members soon after it conducts a rulemaking 
project related to the content and processing of accounting firms' 
applications.
    One alternative, therefore, may be for a transition or compliance 
date to be based on the public issuance of the Commission's Order 
recognizing a PAB. For example, the compliance date could be 90 days 
after the public release of a Commission Order recognizing a PAB. 
Another alternative, which would encourage entities desiring to be a 
PAB to submit information to us promptly, might be to set a date 
certain or specific period of time after the effective date for full 
compliance with the rules.
    We solicit comments on the appropriate timing for compliance with 
the proposed rules. Would a period of time beyond the effective date be 
necessary or appropriate for compliance with the rules? How should such 
a date be determined?

IV. General Request for Comments

    We invite any interested person wishing to submit written comments 
on

[[Page 44990]]

these proposed rules to do so. We specifically request comments from 
investors, accounting firms, and registrants and other audit clients. 
We solicit comment, both general and specific, on each component of the 
proposals.

V. Paperwork Reduction Act

    Certain provisions of the proposed amendments to Regulation S-X and 
Regulation S-K contain ``collection of information'' requirements 
within the meaning of the Paperwork Reduction Act of 1995 (``PRA'') (44 
U.S.C. 3501 et seq.), and the Commission has submitted them to the 
Office of Management and Budget for review in accordance with 44 U.S.C. 
3507(d) and 5 CFR 1320.11. 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 OMB control number. The titles for 
the collections of information are ``Framework for a Public 
Accountability Board--PAB,'' ``Framework for a Public Accountability 
Board--Accountants and Audit Clients,'' and ``Regulation S-K'' (OMB 
Control No. 3235-0071). Compliance with the collection of information 
requirements would be mandatory. There would be no mandatory retention 
period for the information, except as provided below. Responses to the 
disclosure requirements would not be kept confidential. The collections 
of information are necessary to provide assurance that audit, review, 
and attest services performed by accountants fulfill their statutory 
and regulatory purpose and enhance the confidence of investors in the 
audit and review processes and in reported financial information.

Information Provided by a PAB

    We are proposing a collection of information entitled ``Framework 
for a Public Accountability Board--PAB'' for information that would be 
provided by a PAB to the Commission, the public and others. The 
respondents to this collection of information would be PABs and 
entities seeking Commission recognition as PABs. As discussed below, we 
estimate solely for the purposes of the PRA that only one PAB would 
respond to this collection of information. This collection of 
information is necessary to allow the Commission to oversee a PAB to 
ensure that it is operating in the public interest. In addition, the 
collection of information would provide the public with important 
information concerning a PAB's activities. Finally, the information is 
necessary to ensure that the proposed rules operate effectively. This 
collection of information encompasses:
     An initial submission to the Commission;
     Notices concerning the loss of good standing;
     Requests to add items to agendas of standard-setters and 
related notices to the Commission;
     Publication of rules;
     Foreign accountants' quality controls report;
     Quality control review reports and files;
     Referrals to the Commission, markets, and exchanges;
     Notices of charges in disciplinary proceedings;
     Reports of sanctions;
     Public reports; and
     Record retention.
    Initial Submission to the Commission. Under proposed rule 13-03, an 
entity seeking Commission recognition as a PAB must make a submission 
to the Commission that would include its charter, bylaws, 
organizational structure, proposed budget, proposed board members and 
terms of board membership, and representations that it would perform 
certain functions and have rules, membership requirements, systems, and 
procedures to accomplish certain tasks. After evaluating this 
information and such other information as the Commission might request, 
the Commission would determine whether to recognize a PAB.
    We estimate solely for the purposes of the PRA that only one entity 
would apply to be a PAB \137\ and that it would prepare a charter, 
bylaws, and other governing documents for the purpose of incorporation 
under state law. While we would carefully scrutinize an entity's 
submission in order to determine its commitment and capacity to carry 
out the functions and to accomplish the purposes of a PAB, we do not 
believe that the submission would be onerous to prepare. As a result, 
for purposes of the PRA, we estimate it would take approximately 240 
hours to prepare a submission to be filed with the Commission.
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    \137\ We use this assumption, which we make solely for the 
purposes of the PRA, throughout this discussion of the information 
collection requirements that would be imposed by the proposed rules. 
Thus, wherever an estimate of the number of PABs is necessary to 
calculate an estimated paperwork burden, we assume that there will 
be only one PAB.
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    Notices Concerning the Loss of Good Standing. Under proposed rule 
13-04(d)(11), a PAB would have in place rules to provide notices to the 
member or adjunct member, the Commission, and the public of (1) any 
action that could result in a member or adjunct member's loss of good 
standing in the PAB, and (2) the loss of good standing by a PAB member 
or adjunct member. The notice requirements could be triggered by a 
failure to pay fees, produce documents or provide testimony, or by 
noncompliance with a PAB sanction.\138\ We expect that such notices 
would be rare. Accordingly, for the purposes of the PRA, we estimate 
that a PAB would provide 15 such notices each year. The paperwork 
burden involved in preparing the notice would be minimal because the 
notice would consist only of a short, factual statement. Accordingly, 
we estimate that each notice would require one hour to prepare, and 
that 15 burden hours per year would be spent on preparing these 
notices.
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    \138\ As discussed below, proposed rule 13-04(d)(11) also 
requires notice when the PAB takes action that could result, or 
results, in a suspension or bar from the PAB. The burden that would 
result from these notices is discussed in the section entitled 
``Notices of Charges in Disciplinary Proceedings,'' below.
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    Requests to Add Items to Agendas of Standard-Setters and Related 
Notices to the Commission. Under proposed rule 13-04(d)(12), a PAB 
would either set audit, quality control and ethics standards or 
designate private sector bodies' standards as authoritative. If it 
chooses the latter, it would notify the Commission any time it requests 
that a private sector standard-setter add an item to its agenda. 
Proposed rule 13-04(d)(13) would require a similar notice to the 
Commission any time a PAB requests that a private sector body that sets 
accounting or independence standards add an item to its agenda.
    For purposes of the PRA, we estimate that, after it completes its 
quality control review cycle, a PAB would make approximately five 
requests to standard-setting bodies to add several items to each body's 
agenda reflecting concerns that arose during the quality control review 
process.\139\ Each request would necessitate a letter to the 
appropriate standard-setting body, and would require a PAB to consider 
carefully any requests it would make. We therefore estimate, for 
purposes of the PRA, that each such request letter would require 
approximately 40 burden hours. The required notice to the Commission 
could simply include a copy of the request and an appropriate cover 
letter. As a result, the notice to the Commission would result in 
little additional burden. We estimate for

[[Page 44991]]

purposes of the PRA that such a notice would require approximately one 
burden hour. Accordingly, we estimate that this aspect of the proposed 
rules would impose 205 burden hours per year.
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    \139\ We estimate that a PAB might make one request regarding 
each of the five types of standards enumerated in the proposed 
rules.
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    Publication of Rules. Under proposed rule 13-04(d)(14), a PAB would 
provide an open and deliberative rulemaking process that would include 
publication of draft rules for notice and comment. We expect that a PAB 
would publish a large number of rules during its first year after 
recognition. In later years, we expect that a PAB would publish fewer, 
if any, new rules per year. Thus, we estimate, for the purposes of the 
PRA, that, on average, a PAB will publish approximately ten new rules 
per year. We expect that a PAB would expend significant time and effort 
in developing appropriate rules and requirements for its members. We 
also expect that a PAB would make its rules available to its members. 
Therefore, we estimate for purposes of the PRA that a PAB would spend, 
on average, approximately 200 burden hours for each rule it publishes. 
Accordingly, we estimate that this aspect of the proposed rules would 
impose approximately 2,000 burden hours per year.
    Foreign Accountants' Quality Controls Report. Under proposed rule 
13-03(c)(5), a PAB would study and periodically report to the 
Commission on matters related to the quality controls of foreign 
accountants. Foreign accountants are not covered by the proposed rules. 
A PAB would, however, periodically review whether foreign accountants 
should be subject to the rules, and report to the Commission on that 
issue. This proposed rule might require foreign travel, an analysis of 
various foreign legal and regulatory requirements, an analysis of 
foreign professional standards, and other items. We therefore estimate 
for the purposes of the PRA that this aspect of the collection of 
information may require 1,000 burden hours.
    Quality Control Review Reports and Files. Under the proposed rules, 
a PAB would issue a report at the end of each PAB-directed quality 
control review. A PAB-directed review would be required each year for 
accounting firms with more than 70 SEC clients. We estimate that there 
are currently approximately ten firms with more than 70 SEC 
clients;\140\ a PAB would therefore issue approximately ten such 
reports each year. We estimate that under the current SECPS system, a 
report requires approximately 40 burden hours to prepare. We expect 
that preparing a PAB quality control review report should take 
approximately the same amount of time. We therefore estimate, for 
purposes of the PRA, that a PAB would require approximately 400 burden 
hours per year to complete reports of quality control reviews.
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    \140\ We make this assumption based on a list of SECPS member 
firms compiled by the SECPS. See supra note 111.
---------------------------------------------------------------------------

    Under the proposed rules, a PAB also would maintain public files of 
all quality control review reports and any responses to the reports by 
the reviewed accounting firms. According to our records, there are 
approximately 850 domestic accounting firms that currently perform 
audits for SEC registrants. Accordingly, we estimate that approximately 
850 accounting firms would be members of a recognized PAB under the 
proposed rules. Ten of these firms would undergo a PAB-directed quality 
control review each year. The remaining 840 firms would be reviewed at 
least every three years. We therefore estimate that each year, a PAB 
would create or add to 290 public files of quality control review 
reports.\141\ Making the reports publicly available by maintaining them 
in a public file would not impose a significant burden. As a result, we 
estimate for purposes of the PRA that publicly maintaining one report 
would require one burden hour. Thus, 290 burden hours would be expended 
per year on this aspect of the proposed rule.
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    \141\ We derived this number by assuming that each year, one-
third of the accounting firms not subject to an annual PAB-directed 
review will be reviewed under a PAB-approved program. Thus, 280 of 
these firms would be reviewed per year. In addition, each year a PAB 
would review the ten firms with more than 70 SEC clients. As a 
result, the PAB would create or add to 290 public files per year.
---------------------------------------------------------------------------

    Referrals to the Commission, Markets and Exchanges. Under proposed 
rule 13-04(g)(2), a PAB would report information indicating a violation 
of the securities laws to the Commission. Under proposed rule 13-
04(g)(8), a PAB would similarly refer matters to the Commission anytime 
it is unable to conduct or complete a supplemental review or a 
disciplinary proceeding because of the refusal of any person to 
cooperate. If an uncooperative party is a registrant, the PAB would 
also report the registrant's lack of cooperation to the relevant market 
or exchange. A PAB would also refer any other matter it deems 
appropriate to the Commission. Although we cannot estimate with 
precision how frequently a PAB would make such a referral, for purposes 
of the PRA we estimate that a PAB would make 20 such referrals per 
year. These reports would likely be fact specific, and not result in 
significant burdens. The reports might be oral or written, and might be 
accompanied by such information that indicates a violation or non-
cooperation. We estimate that these reports will require approximately 
two burden hours each, and therefore that 40 burden hours per year 
would be required to comply with this requirement.
    Notices of Charges in Disciplinary Proceedings. Under proposed rule 
13-04(g)(3), a PAB would notify a member of specific charges in any 
disciplinary proceeding. We anticipate that this notice would be 
similar to a complaint or an order instituting administrative 
proceedings. Based on our experience with disciplinary proceedings 
against accountants, we estimate that a PAB might initiate 
approximately 75 disciplinary proceedings per year.\142\ This notice 
would require careful formulation and, possibly, legal review. 
Additionally, under proposed rule 13-04(d)(11), any disciplinary 
proceeding that could result in suspension or bar of a member 
accountant would trigger a requirement that a PAB provide notice, in 
addition to the member accountant, to the Commission, and to the 
public. Solely for the purposes of the PRA, we estimate that a PAB also 
would provide notice under 13-04(d)(11) each time it institutes 
disciplinary proceedings against an accountant. We estimate for the 
purposes of the PRA that approximately 30 burden hours would be 
required to complete both notices, and that a PAB would therefore 
expend 2,250 hours per year on this aspect of the proposed rules.
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    \142\ The Commission initiates approximately 100 cases per year 
related to deficient financial reporting. See, e.g., SEC, Annual 
Report 2001, at 134. We estimate that approximately one-half of 
these cases involve disciplinary actions against accountants. 
Because of its ability to detect issues during its reviews, we 
expect that a PAB would initiate at least as many actions as, and 
possibly more than, the Commission. Accordingly, we estimate that a 
PAB may initiate 75 disciplinary proceedings per year.
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    Reports of Sanctions. Under proposed rule 13-04(g)(7), anytime a 
PAB imposes a disciplinary sanction on an accountant, the PAB would 
report the sanction to the Commission, the public, and the appropriate 
state or foreign authorities. These reports would include the name of 
the accountant being sanctioned, a description of the acts or omissions 
upon which the sanction is based, the nature of the sanction, and such 
other information as a PAB deems appropriate. Based on our experience 
with disciplinary proceedings against accountants, we anticipate that a 
PAB may make approximately 50 such reports each year. Assuming for 
purposes of the PRA

[[Page 44992]]

that preparation and internal legal review of one report would require 
approximately 50 burden hours, there would be an annual burden of 
approximately 2,500 hours imposed by this requirement.
    Public Reports. Under proposed rule 13-04(h), a PAB would report to 
the public and the commission at least annually, and where practicable 
on a current basis, detailed descriptions of its activities, annual 
audited financial statements, explanations of its fees and charges, a 
summary of issues discussed with private sector standard-setting 
bodies, a list of matters referred to each standard-setter that were 
not placed on the standard-setter's agenda within 90 days, and such 
other information as a PAB considers appropriate or that the Commission 
requires by order. All of the information required would be readily 
available to a PAB. Nevertheless, some time would be required to 
compile the information and put it into usable form. We estimate for 
purposes of the PRA that 200 burden hours per year would be associated 
with the preparation of these reports. Burdens associated with 
preparation of the reports might be minimized if a PAB creates a 
website and updates information on that website on an ongoing basis.
    Record Retention. Under proposed rule 13-04(i)(2), a PAB would be 
required to make and keep records that the Commission staff deems 
necessary for its inspection of the PAB's quality control review 
activities, supplemental reviews, and disciplinary proceedings. A PAB 
would adopt a record retention policy that would be approved by the 
Commission. The policy would provide for the retention of records until 
the Commission has either inspected them or informed the PAB that they 
no longer need to be retained. In addition, under proposed rule 13-
04(g)(3), a PAB would keep a record of its disciplinary proceedings. We 
estimate for purposes of the PRA that 1,000 burden hours would be 
associated with these recordkeeping requirements.
    We therefore estimate for purposes of the PRA that a total of 
approximately 10,140 burden hours would be imposed on a PAB by this 
collection of information. We estimate that approximately 25% of these 
hours would be expended by a PAB's outside lawyers, while the rest 
would be incurred in-house. Assuming a cost of $300 per hour for 
outside legal expenses, the cost associated with the burden hours 
incurred by a PAB's outside counsel would be $760,500.

Information Provided by Accountants and Audit Clients

    The proposed rules would require accountants that are members of a 
PAB to provide certain information to the Commission, a PAB, the 
public, and others. A primary focus of the proposed rules is on the 
thoroughness of the quality control reviews and disciplinary 
proceedings resulting from these reviews. For the most part, the 
information to be provided by accountants currently is reported to the 
SECPS, or is otherwise required under professional standards. We assume 
that, if the proposed rules are adopted, the SECPS would no longer 
impose any requirements that would be duplicative of PAB requirements. 
In many instances, therefore, the proposed rules would simply require 
that information be directed to a PAB rather than the SECPS. 
Accordingly, most of what the proposed rules would require from 
accountants is usual and customary and would not impose a new 
burden.\143\
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    \143\ See 5 CFR 1320.3(b)(2) (``The time, effort, and financial 
resources necessary to comply with a collection of information that 
would be incurred by persons in the normal course of their 
activities (e.g., in compiling and maintaining business records) 
will be excluded from the `burden' if the agency demonstrates that 
the reporting, recordkeeping, or disclosure activities needed to 
comply are usual and customary.'').
---------------------------------------------------------------------------

    We estimate, however, that approximately 80 accounting firms that 
are not currently members of the SECPS would likely become members of a 
PAB under the proposed rules.\144\ These firms are, we believe, smaller 
firms with one or two SEC clients that chose not to join the SECPS. 
Under the proposed rules, however, these firms would likely join a PAB 
in order to maintain those SEC clients. These firms would incur new 
paperwork burdens under the proposed rules, and we have estimated these 
burdens below, along with new burdens that would be imposed on all PAB-
member accounting firms, regardless of membership in the SECPS.
---------------------------------------------------------------------------

    \144\ We estimate that the audit reports of approximately 850 
domestic accounting firms are filed with the Commission, and that 
approximately 770 of these firms are SECPS members.
---------------------------------------------------------------------------

    This information collection is necessary to enhance investor 
confidence that auditors of public companies are acting in the public 
interest and in furtherance of the purposes of the federal securities 
laws. The information would be used by a PAB, accounting firms, 
registrants, and the public to monitor accountants' compliance with the 
federal securities laws, PAB rules, and professional requirements. The 
respondents to this collection of information would be accountants and, 
extremely rarely (resulting in no more than approximately 15 burden 
hours, as discussed below), audit clients. As discussed below, we 
estimate that approximately 850 accounting firms would respond per year 
to the proposed collection of information requirements. In addition, up 
to approximately 53 individual accountants and 3 audit clients per year 
might respond to the collection of information requirements, depending 
on circumstances.\145\ The title for this collection of information is 
``Framework for a Public Accountability Board--Accountants and Audit 
Clients.'' The collection of information would encompass:
---------------------------------------------------------------------------

    \145\ Individual accountants and audit clients could, in rare 
cases, be subject to this collection of information. First, as 
discussed below, individual accountants could provide a notice upon 
beginning employment discussions with an audit client. Because such 
notices are already required, however, individual accountants would 
incur no new burden with respect to this usual and customary 
activity. Second, as discussed below, we estimate that as many as 53 
individual accountants and 3 audit clients per year might file 
applications for Commission review of PAB disciplinary sanctions or 
delinquency determinations.
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     Enrollment procedures;
     Auditor independence reports;
     Reports concerning the termination of an auditor-client 
relationship;
     Notices upon beginning employment discussions;
     Reports concerning foreign associated firms;
     Reports concerning litigation and government 
investigations or proceedings;
     Applications for Commission review;
     Quality control review reports;
     Record retention; and
     Notices concerning the hiring or retention of sanctioned 
individuals.
    Enrollment Procedures. Under proposed rule 13-04(d)(1), a PAB would 
provide for membership enrollment procedures that would minimize the 
administrative burden on individual accountants by maximizing the 
extent to which the enrollment requirements could be satisfied by an 
accounting firm on behalf of its individual accountants. A PAB would 
develop its own procedures under this proposed rule. We expect, 
however, that most likely a PAB would require each member accounting 
firm to provide at least a list of the individual accountants working 
for the firm. We believe that accounting firms will have this 
information, and the other information a PAB might require, readily 
available. For the purpose of the PRA, we estimate that each member-
accounting firm might expend five burden hours per year on enrollment 
in a PAB and any updating requirements.

[[Page 44993]]

Above, we estimated that approximately 850 accounting firms would be 
members of a PAB under the proposed rules. Accordingly, we estimate 
that accounting firms might expend 4,250 hours on enrollment 
procedures.
    Auditor Independence Reports. Under proposed rule 13-04(e)(4), each 
accounting firm that is a member of a PAB would disclose at least 
annually to the audit committee of each audit client that is a 
Commission registrant all relationships between the accountant and its 
related entities that may bear on auditor independence, and confirm 
that it is independent of the registrant. Reports such as these have 
been required since 1999 by Independence Standards Board Standard No. 
1.\146\ Accordingly, all accounting firms that would be members of a 
PAB already make such reports. Thus, these reports are usual and 
customary and no new burden would be imposed.
---------------------------------------------------------------------------

    \146\ Independence Standards Board, Independence Discussions 
with Audit Committees, Independence Standard No. 1 (Jan. 1999).
---------------------------------------------------------------------------

    Reports Concerning the Termination of an Auditor-Client 
Relationship. Under proposed rule 13-04(e)(5), when an accountant's 
relationship with a Commission registrant ends, a PAB member accountant 
would report this fact to the registrant and the Commission. The 
proposed rule simply codifies a long-standing SECPS requirement.\147\ 
Accordingly, all accountants that are members of the SECPS already are 
making such reports. Therefore, these reports are a usual and customary 
activity for SECPS members, and no additional burden would be imposed 
on them.
---------------------------------------------------------------------------

    \147\ SECPS, Requirements of Members, at m. These requirements 
are available at www.aicpa.org/members/div/secps/require.htm.
---------------------------------------------------------------------------

    As discussed above, we estimate that approximately 80 accountants 
that are not currently members of the SECPS would be members of a PAB 
under the proposed rules. These firms would most likely be smaller 
firms, with longstanding personal relationships with their one or two 
SEC clients. We believe that each year only a few of these firms would 
be required to provide notice of the termination of a relationship with 
a Commission registrant. We estimate, therefore, for the purposes of 
the PRA that approximately 6 of the 80 accountants that are not members 
of the SECPS would be required to make one of these reports each year. 
The report should require no more than one or two sentences and should 
not take more than one-half hour. We therefore estimate for purposes of 
the PRA that this requirement would impose 3 burden hours on 
accountants.
    Notices Upon Beginning Employment Discussions. Under proposed rule 
13-04(e)(9), a PAB would ensure that its member accounting firms have 
policies requiring prompt notification to the firm when an individual 
accountant who is a partner or employee of the firm begins employment 
discussions with an audit client. Under Independence Standards Board 
Standard No. 3,\148\ all accounting firms that would be members of a 
PAB are already required to make such reports. Accordingly, this is a 
usual and customary activity and no new burden would be imposed.
---------------------------------------------------------------------------

    \148\ Independence Standards Board, Employment with Audit 
Clients, Independence Standard No. 3, (July 2000).
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    Reports Concerning Foreign Associated Firms. Under proposed rule 
13-04(e)(6), PAB member accountants would report at least annually the 
name and country of any foreign associated firms that have notified the 
PAB member in writing that they have adopted policies and procedures 
that are consistent with proposed Article 13. Currently, accounting 
firms make such reports to the SECPS; these reports are therefore a 
usual and customary practice.\149\ Having such reports directed to a 
PAB instead of to the SECPS would impose no additional burden.\150\
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    \149\ SECPS, Requirements of Members, at n.
    \150\ We expect that none of the approximately 80 smaller firms 
that are not members of the SECPS but would be members of a PAB 
would have foreign associated firms.
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    Reports Concerning Litigation and Government Investigations and 
Proceedings. Under proposed rule 13-04(e)(7), a PAB would adopt a rule 
requiring its member accounting firms to have policies or procedures in 
place to report to the PAB, with a copy to the Commission, litigation 
or any proceeding or investigation by a government agency alleging 
deficiencies in an audit or review or violations of the securities 
laws. Currently, these reports are made to the SECPS QCIC.\151\ 
Accordingly, the proposed rule should not increase the burden of this 
usual and customary activity for accounting firms that are members of 
the SECPS.
---------------------------------------------------------------------------

    \151\ SECPS, Requirements of Members, at k.
---------------------------------------------------------------------------

    This proposed rule, however, would impose a new paperwork burden 
for any of the approximately 80 accounting firms that are not members 
of the SECPS but would be members of a PAB. We expect that litigation 
or government investigations or proceedings involving these firms would 
be relatively rare. Accordingly, we estimate that two of these 80 firms 
would report litigation or government investigations or proceedings 
once per year. We expect that a firm could satisfy the reporting 
requirement by sending the PAB and the Commission a copy of the 
complaint (or other relevant document) with a short cover letter. We 
therefore estimate for purposes of the PRA that one burden hour would 
be required to satisfy the proposed requirement, and that accounting 
firms would therefore incur two burden hours per year under this aspect 
of the proposed rules.
    Applications for Commission Review. Under proposed rule 13-
04(i)(3), any final PAB disciplinary action or determination of a loss 
of good standing as a result of a failure to pay fees, produce 
documents, or provide testimony is subject to Commission review upon 
application by any person aggrieved by the action. An application for 
review would not need to be lengthy or burdensome. We therefore 
estimate for purposes of the PRA that such an application would require 
approximately 5 burden hours.
    We estimated above that a PAB might sanction approximately 50 
accountants per year. Assuming, for purposes of the PRA, that each 
sanctioned accountant requests Commission review, accountants would 
file 50 applications each year. These accountants could include 
individual accountants as well as accounting firms. We estimated above 
that a PAB might issue 15 notices per year that a member or adjunct 
member might lose, or has lost, good standing as a result of either: 
(1) Failing to pay fees, produce documents, or provide testimony, or 
(2) not complying with a PAB sanction other than a suspension or a bar. 
We expect that few of these notices would result from an actual loss of 
good standing as a result of a failure to pay fees, produce documents, 
or provide testimony. Accordingly, we estimate for purposes of the PRA 
that 3 accounting firms, individual accountants, or adjunct members 
would make one request each for Commission review of such a good 
standing determination per year. Thus, for purposes of the PRA, we 
estimate that this aspect of the proposed rules would impose 265 burden 
hours. Up to fifteen of these hours could be incurred by audit clients, 
depending on the circumstances.
    Quality Control Review Reports. As discussed above, the proposed 
rules would require all members of a PAB to undergo quality control 
reviews. A PAB would direct the reviews of all members

[[Page 44994]]

with more than 70 SEC clients.\152\ Reviews of PAB members with 70 or 
fewer SEC clients could be conducted under a review program approved 
and monitored by the PAB.
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    \152\ The burden imposed by the reports at the conclusion of 
these reviews is included in the information collection entitled 
``Framework for a Public Accountability Board--PAB'' discussed 
above.
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    Under the SECPS system, accountants already prepare reports at the 
conclusion of reviews. Preparation of such reports, therefore, is a 
usual and customary activity for accountants. We expect that the SECPS 
will no longer require reviews if our proposed rules are adopted. While 
we expect that our proposed quality control review system would provide 
increased confidence in the reliability of audited financial 
statements, we do not expect that the preparation of the reports would 
require more burden hours than is currently required. While we estimate 
that there are approximately 1,250 SECPS members (some of whom do not 
in fact audit financial statements of public companies), we have 
estimated that approximately 850 accounting firms would be members of a 
PAB. Accordingly, no new burden would be imposed by this aspect of the 
proposed rules.
    Record Retention. Under proposed rule 13-04(d)(5), a PAB would 
adopt rules or membership requirements that direct member accounting 
firms to make and keep for specified periods of time records that are 
required by professional standards or that otherwise document 
procedures performed and the resolution of material issues during audit 
and review engagements. Additionally, proposed rule 13-04(f)(2) would 
require a PAB to direct its members to make and keep, for such periods 
as the PAB determines necessary, records that are necessary for the 
conduct of quality control reviews. The creation and retention of such 
records already is required by GAAS and, therefore, is a usual and 
customary activity within the accounting profession.\153\ Accordingly, 
accounting firms would not incur a new paperwork burden associated with 
this proposed rule. We do not know whether a PAB might impose rules 
requiring longer retention periods than are currently in place at 
accounting firms. Any such requirement, and resulting incremental 
burden, would be a function of PAB rules.
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    \153\ See generally, SAS No. 96, AU Sec. 339 (as revised 2002).
---------------------------------------------------------------------------

    Notices Concerning the Hiring or Retention of Sanctioned 
Individuals. Finally, under proposed rule 13-04(g)(9), a member firm 
would notify a PAB if the firm employs or becomes associated with an 
individual during any period in which that person is subject to a 
sanction, order, or ruling issued by a PAB. This notice would alert the 
PAB to consider, during quality control reviews, whether the firm and 
individual are in compliance with the PAB sanction. We anticipate that 
the notice would be relatively short and identify the individual, firm, 
sanction, and public report announcing the sanction. Such a report 
should take less than an hour to prepare. We estimate that no more than 
10 such reports would be made in any year. Accordingly, compliance with 
this provision would require approximately 10 burden hours.
    Thus, member-accounting firms would incur a total of approximately 
4,530 burden hours.\154\ We estimate that approximately 25% of these 
4,530 hours would be expended by outside lawyers, while the rest would 
be incurred in-house. Assuming a cost of $300 per hour for outside 
legal expenses, the cost associated with the burden hours incurred by 
outside counsel would be $339,750.
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    \154\ As described in the section entitled ``Applications for 
Commission Review,'' above, we estimate that up to 265 of these 
hours might instead be incurred by up to 53 individual accountants, 
and up to 15 of these hours might instead be incurred by up to three 
audit clients, depending on the circumstances.
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Information Disclosed by Registrants

    We have proposed an amendment to item 401 of Regulation S-K\155\ 
that would require disclosure if, within the last five years, any 
director, person nominated to be a director, or executive officer was 
sanctioned by a PAB for violations of professional standards or the 
PAB's rules or membership requirements and that sanction has not been 
subsequently reversed, suspended, or vacated. This information is 
necessary to alert investors of violations of PAB membership 
requirements or professional standards by directors, persons nominated 
to be directors, and executive officers. Investors would use this 
information to help them make informed investment decisions. The 
potential respondents are registrants. Below, we estimate that 
approximately 10 registrants per year would make one disclose each 
under the proposed amendment.
---------------------------------------------------------------------------

    \155\ 17 CFR 229.401.
---------------------------------------------------------------------------

    The title for the collection of this information is ``Regulation S-
K'' (OMB Control No. 3235-0071). This regulation was adopted pursuant 
to the Securities Act and the Exchange Act and sets forth disclosure 
requirements for annual and quarterly reports, registration statements, 
and proxy and information statements filed by registrants to ensure 
that investors are informed. The proposed disclosure requirement would 
provide investors with important information regarding executive 
officers, directors, and director nominees. The hours and costs 
associated with preparing, filing, and sending these disclosures 
constitute reporting and cost burdens imposed by each collection of 
information. Regulation S-K, however, historically has carried only one 
response and one burden hour because the burdens associated with the 
items within Regulation S-K are reflected in the estimated burdens 
assigned to each form, report, or registration statement.
    For disclosure to occur under the proposed amendment, an individual 
would have to be sanctioned by a PAB, not have that sanction reversed, 
suspended, or vacated, and within five years from the date of the 
sanction become an executive officer, director, or director nominee of 
a public company. We anticipate that these circumstances will occur 
infrequently. We estimated above that approximately 50 accountants 
might be sanctioned by a PAB per year. It is difficult to estimate, 
however, how many of these sanctioned individuals might be engaged to 
serve as an executive officer or director of a public company. Solely 
for the purpose of the PRA, we estimate that this disclosure would 
occur approximately ten times per year. It most likely would appear in 
a Form S-1 (OMB Control No. 3235-0065), Schedule 14A (OMB Control No. 
3235-0059), or Form 10-K (OMB Control No. 3235-0063).\156\ Such 
disclosure may be no more than a few lines that include a citation to 
the sanction and clarifying information, if any. Because it may be a 
relatively brief disclosure, printing and dissemination costs should be 
inconsequential. We estimate that no more than three burden hours would 
be required to prepare and review such disclosure, for a total burden 
of 30 hours. This burden would be divided evenly among Form S-1, 
Schedule 14A, and Form 10-K. Our proposal would therefore increase the 
burden hour inventory for Form S-1 from 196,846 to 196,856, the burden 
hour inventory for Schedule 14A from 98,868 to 98,878, and the burden 
hour inventory for Form 10-K from 12,309,462 to 12,309,472.
---------------------------------------------------------------------------

    \156\ Item 401, Regulation S-K disclosures are required by, 
among other provisions, item 11(k) of Form S-1, item 10 of Form 10-
K, and item 7 of Schedule 14A; 17 CFR 239.11, 240.14a-101, and 
249.310 respectively.

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[[Page 44995]]

Solicitation of Comments

    Pursuant to 44 U.S.C. 3506(c), we solicit comments to: (1) evaluate 
whether the proposed collections of information are necessary for the 
proper performance of the functions of the agency, including whether 
the information will have practical utility; (2) evaluate the accuracy 
of our estimates of the burdens of the proposed collections of 
information; (3) determine whether there are ways to enhance the 
quality, utility, and clarity of the information to be collected; and 
(4) evaluate whether there are ways to minimize the burdens of the 
collections 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 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. S7-24-02. 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-
24-02, 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.

VI. Cost-Benefit Analysis

    We are sensitive to the costs and benefits imposed by our rules, 
and we have identified certain costs and benefits of these proposals. 
We request comment on all aspects of this cost-benefit analysis, 
including identification of any additional costs or benefits. We 
encourage commenters to identify and supply relevant data concerning 
the costs or benefits of the proposed amendments.

A. Background

    In the wake of recent corporate failures that caused significant 
losses to investors and pensioners, Congress, the Commission, and 
others have been examining longstanding deficiencies in the accounting 
profession's self-regulatory programs. During this examination, the 
POB, which had overseen the profession's programs since 1977, voted to 
disband.
    Many of the criticisms of the accounting profession that existed 
when the current self-regulatory process was created in 1977 continue 
to exist today. Congressional hearings held in the first half of 2002, 
reminiscent of those held approximately 25 years before, considered why 
major corporations have failed without adequate warning in the 
companies' financial reports. Witnesses during those hearings expressed 
a lack of confidence in the self-regulatory system and the need for 
change.\157\
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    \157\ See, e.g., Accounting and Investor Protection Issues 
Raised by Enron and Other Public Companies: Hearing Before the 
Senate Comm. on Banking, Housing, and Urban Affairs (Mar. 19, 2002). 
For discussion of the profession in 1977, see, e.g., Staff of 
Subcomm. on Reports, Accounting, and Management of the Senate Comm. 
on Government Operations, 95th Cong., Report on the Accounting 
Establishment: A Staff Study, 7 (Subcomm. Print Mar. 31, 1977).
---------------------------------------------------------------------------

    Our proposals would create the framework for a new private sector 
regulatory structure for accountants that audit or review financial 
statements, or prepare attestation reports, that are filed with the 
Commission. Under the proposed rules, these accountants would be 
members of a Public Accountability Board, or PAB. A Commission 
registrant engaging an accountant to perform such services would be an 
adjunct member of the same PAB to which the accountant belongs.
    As discussed in detail above, our objective is to lay the 
foundation for a new, stronger system of private sector regulation that 
would enhance investor confidence in the audit process and in the 
reliability of the financial information used to make investment and 
voting decisions.
    A PAB would oversee the quality of financial statements relied on 
by investors by, among other things, directing periodic reviews of 
accounting firms' quality controls over their accounting and auditing 
practices and, when appropriate, disciplining accountants for 
deficiencies noted during those quality control reviews or otherwise 
coming to a PAB's attention. We focused on the need for a PAB to be 
able to remedy any deficiencies in standards that it may detect during 
quality control or disciplinary proceedings. The rules provide, 
therefore, that a PAB also would set, or rely on designated private 
sector standard-setting bodies to set, audit, quality control, or 
ethics standards, and would facilitate communications among these 
bodies and others.
    A PAB would be required to meet the conditions specified in the 
proposed rules to be recognized by the Commission. These conditions 
include Commission oversight and a board dominated by persons who are 
not members of the accounting profession. To ensure that result, our 
rules would set a maximum number of accountant-board members. A PAB, 
with a significant majority of public members, a diligent quality 
control review process, effective disciplinary proceedings, the ability 
to set standards or influence standard setters, and close oversight by 
the Commission, should be in a position to make meaningful improvements 
in the quality of audits and enhance the confidence of investors in 
both the audit process and in the reliability of financial information.
    The proposal addresses the need for all accountants providing 
audit, review or attest services to Commission registrants to have a 
strong, effective organization that could operate in the public 
interest without fear of losing its funding. We therefore included in 
our framework provisions regarding membership in such an organization, 
continuous and involuntary funding, and an effective disciplinary 
mechanism. The proposal also would allow a PAB to collect fees from its 
members and adjunct members to fund not only its own administration and 
operations, but also the administration and operations of an accounting 
standard-setting body recognized by the Commission, which currently is 
the FASB. We have included funding for the FASB in our proposal because 
that body currently collects funds primarily through donations from, 
and by selling its publications to, accounting firms and corporations. 
There is a perception that such funding may be increased or decreased 
based on the reaction of accounting firms or companies to proposed 
accounting standards.\158\ To remove this perception, a PAB would 
establish a mandatory and continuous source of funding for the FASB. A 
PAB would collect sufficient fees from its

[[Page 44996]]

members and adjunct members to fund the FASB and then transfer those 
funds to it.
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    \158\ See, e.g., Stephen Barr, FASB Under Siege, CFO Magazine, 
Sept. 1994, at 34, 46, which states that the FASB reported reduced 
contributions during the debate over the accounting for employee 
stock options, and Dean Foust, It's Time to Free the FASB Seven, 
Bus. Wk., May 3, 1993, at 144, which states: ``It's time to free the 
FASB Seven [board members] from this outside influence--beginning 
with their financial support. . . Critics contend that some 
executives have threatened to withhold support if FASB doesn't vote 
their way. A good solution is to require that corporations filing 
documents with the SEC pay a small sum each time to create a 
permanent endowment for FASB.''
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    Our proposal would keep the requirements under the current system 
that we believe increase the quality of audits. Our proposal would 
place these requirements, however, in a stronger system that is more 
independent from the profession, more transparent, more closely 
overseen by the Commission, more willing and able to discipline its 
members, and more efficient in coordinating the efforts of the various 
participants in the regulatory process. In addition, we are adding 
features to the current system, such as public disciplinary proceedings 
by a PAB, increased frequency of reviews of the largest firm's quality 
control systems, and requiring maintenance of a central office function 
with expertise in accounting and financial reporting matters.
    Congressional proposals, suggestions made during the SEC 
Roundtables, the U.K. system of regulation of the accounting 
profession, and recommendations submitted by others, all of which are 
discussed above, have provided numerous alternatives for the regulation 
of the accounting profession. Based on that input, we considered 
alternative frameworks that would include, among other things:
     Different mixes of accountant and ``public'' 
representatives on a PAB's governing board;
     Membership for accounting firms only, and not for 
individual accountants or registrants;
     Different funding sources and more specific methods of 
collecting fees assessed by a PAB;
     Funding that did not include the FASB;
     No standard-setting responsibilities;
     More disciplinary authority, including the authority to 
compel the production of documents and testimony from persons who are 
neither members nor adjunct members of a PAB; and
     Foreign accountants as members.
     An increased level of Commission oversight over the 
current self-regulatory system.
    Of the alternatives considered, we believe that our proposal would 
best protect investors.

B. Potential Benefits of the Proposed Rules

    Potential benefits to the proposed rule amendments include 
increased investor confidence in the audit process and in the 
reliability of reported financial information, and enhanced corporate 
governance resulting from more disclosure about directors and officers. 
Accountants and registrants also may benefit from a more streamlined 
and efficient regulatory process.
    The benefits of a stronger, more transparent, and more efficient 
regulatory system for the accounting profession should translate into 
increased investor confidence in the audit process and in the financial 
information provided to our securities markets. If the rule amendments 
lead to increased investor confidence in financial reporting, they also 
may encourage investment and facilitate capital formation. Issuers, 
therefore, may be able to lower their cost of capital, or raise capital 
where they might have been unable to do so. Additionally, the benefits 
of enhanced disclosure by directors, director nominees, and officers 
should translate into enhanced corporate governance in registrants. 
These benefits flow from the following six points, as well as other 
features of our proposal:
    1. Independence from the accounting profession and assured funding. 
A PAB established under our framework would be outside the realm of the 
AICPA. Representatives of investors and issuers, not accountants, would 
dominate a PAB's governing board, would actively participate in 
directing quality control reviews of large accounting firms, and would 
evaluate the quality control reviews of smaller firms. Funding, instead 
of being dependent on the AICPA, would be mandatory and flow from both 
accountants and registrants. Continuous and mandatory funding also 
would be provided for the FASB, which sets accounting standards.
    2. Periodic reviews. The current ability of an accounting firm to 
avoid periodic reviews of its quality control system, simply by 
deciding not to join a regulatory organization, would be removed. 
Reviews of quality control systems would occur more often for some 
firms and for the first time for some firms that were not previously 
members of the SECPS. Because registrants would be adjunct members, the 
payment of fees by registrants and the cooperation by registrants in a 
PAB's quality control reviews and disciplinary proceedings, would be 
assured.
    3. Enhanced quality of audit, review, and attest services. High 
quality audit, review, and attest services form a cornerstone of the 
Commission's full disclosure system. A PAB, after conducting an 
appropriate disciplinary process, could suspend individuals and firms 
from conducting audits and reviews of financial statements and from 
preparing attestation reports filed with us, or impose other 
appropriate remedial or disciplinary sanctions. By disciplining 
incompetent and unethical practices, a PAB would improve the overall 
quality of the audit, review, and attest services.
    4. Improved transparency regarding the regulatory system. In order 
for a PAB to earn investors' trust, investors must be able to view the 
PAB's regulatory system at work. Our proposals would not only encourage 
``real-time'' reporting by the PAB of its regulatory activities, they 
also would open a PAB's disciplinary proceedings to the public to the 
same extent that our Rule 102(e) proceedings are public.\159\ Open 
proceedings would shed light on a professional disciplinary process 
that the AICPA has conducted behind closed doors.
---------------------------------------------------------------------------

    \159\ 17 CFR 201.102(e)(7).
---------------------------------------------------------------------------

    5. Enhanced disclosure by corporate officers, directors, and 
director nominees of PAB sanctions. We are proposing that investors be 
informed if an executive officer, director, or person nominated to 
become a director has been sanctioned as a member accountant by a PAB 
within the last five years. We anticipate that a PAB would initiate 
disciplinary proceedings in cases of incompetence, unethical behavior, 
or serious breaches of professional standards. Sanctions imposed 
following these proceedings, therefore, would be of interest to 
investors making investment or voting decisions.
    6. Improved cooperation among standard-setting bodies. As noted by 
the Panel on Audit Effectiveness and others, one of the limitations of 
the current system is a lack of effective communications among the 
various entities involved in oversight of the audit process.\160\ That 
Panel recommended that the profession's system of governance be united 
under a POB that oversees standard setting, monitoring, discipline, and 
supplemental reviews.\161\ Our proposals reflect the need for greater 
communication and coordination among the participants of the regulatory 
system. Under our proposed rules, a PAB would either set, or rely on 
designated private bodies to set, audit, ethics, and quality control 
standards. To the extent that a PAB relies on others to set these 
standards, a PAB would oversee their efforts and encourage 
communication and coordination among them. In addition, a PAB would 
conduct periodic meetings with these bodies and include in those 
meetings the bodies that set accounting principles

[[Page 44997]]

and other standards affecting the accounting profession. The primary 
purpose for these meetings would be to facilitate an understanding of 
one another's projects, which may lead to better coordinated and more 
efficient standard-setting within the profession.
---------------------------------------------------------------------------

    \160\ The Panel on Audit Effectiveness, Report and 
Recommendations, at 138-41 (Aug. 31, 2000).
    \161\ Id.
---------------------------------------------------------------------------

    We request comment on each of the items identified above. Would 
they result in higher quality audits? Would they result in enhanced 
investor protection and investor confidence? Would the proposed rules, 
if adopted, yield other benefits? Is it possible to quantify the 
benefits of the proposed rules?
    Accountants and registrants also may benefit from a more 
coordinated and efficient regulatory process. As noted, our proposals 
would centralize into one independent body the quality control review 
functions previously performed by the POB and its staff, the SECPS's 
Peer Review Committee, the SECPS Executive Committee, the QCIC, and 
portions of the AICPA's disciplinary program. This body also would 
facilitate communications among various standard-setting bodies. We 
believe that a more efficient and leaner regulatory system, and a more 
coordinated standard-setting process, would benefit all participants in 
the financial reporting process. Among other things, we believe that 
these changes would reduce uncertainty about the regulatory and 
disciplinary system and would increase compliance.
    The Commission seeks comment on the benefits of the proposed rule. 
What methods are available to estimate the benefits to investors and 
others that would result from a private sector regulatory scheme for 
accountants? We request comment, including supporting data if 
available, on these benefits, and commenters with quantitative or 
empirical data on these issues are invited to provide that data for our 
consideration.

C. Potential Costs of the Proposed Rules

    We are sensitive to the costs that might result from our rules. We 
believe that the costs related to the proposals in this release would 
fall within three general categories: costs that are similar to costs 
currently borne, incremental costs, and costs that will be 
redistributed among market participants. We recognize that 
redistributed costs are not mutually exclusive of costs already borne.
    The proposal may result in costs similar to those already 
exisiting. SECPS member accounting firms already bear significant costs 
related to quality control reviews and to the POB-SECPS regulatory 
structure that administers and oversees those reviews. We assume that 
those firms will cease to pay the SECPS to perform those functions once 
a PAB is in place and that the costs attendant to our proposals will be 
offset by that cost savings.\162\ The proposed framework may result in 
incremental costs to small accounting firms that do not currently 
undergo quality control reviews, to Commission registrants, and to 
other accounting firms. Incremental costs could result from the 
performance of functions by a PAB that are performed today by no one. 
Finally, the proposal may result in redistributed costs. Funding for 
the FASB, for example, would not likely increase as a result of the 
proposals, but the burden might be redistributed from registrants and 
firms that make voluntary contributions to the FASB, or those that 
purchase a significant number of its publications, to all registrants 
and accounting firms that benefit from FASB's standards.\163\
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    \162\ Because a PAB would have discretion in determining the 
nature and extent of procedures to be performed each year, we cannot 
reliably estimate what those additional costs may be.
    \163\ We recognize that some portion of the voluntary 
contributions may be derived from fees paid by registrants to their 
auditors. Direct payment by registrants may lead to reduced audit 
fees or a decrease in the rate of audit fee increases. To that 
extent, our proposals should have no redistributive effects.
---------------------------------------------------------------------------

    We discuss each category of costs in more detail below in relation 
to the costs needed to fund a PAB (and the FASB), the imposition of 
costs on accounting firms and registrants, and the costs of preparing 
disclosure.
    The proposed rules would entail costs to a PAB for its operations. 
Our proposals would leave many facets of a PAB's operations to its 
discretion. It is difficult, therefore, to estimate the budget that 
would be required to fund a PAB's full range of activities. 
Nonetheless, to estimate the funds that a PAB may require, we examined 
the budgets of other accounting regulatory bodies. The FAF, for 
example, has approximately 140 employees and reported 2001 net 
operating revenues of $22,137,000. The POB was smaller, with five part-
time board members, a permanent staff of five full-time professional 
employees, seven part-time professional employees, and two 
administrative employees. The POB's annual budget, without special 
projects, was approximately $3,500,000, although under the February 
2001 charter, the POB could have increased its budget to $5,200,000 per 
year. The POB Chairman received $70,000 per year, the Vice Chairman 
$60,000, and members $50,000.
    The ISB, which from 1997 to 2001 undertook the development of 
auditor independence standards, had a part-time board of eight members, 
three full-time staff and one administrative employee. The annual 
budget for the ISB was approximately $2,000,000 to $2,200,000.
    The SECPS has an annual budget of less than $1,000,000, most of 
which relates to travel and lodging expenses. SECPS members are not 
compensated for their time, and except for a $300,000 per year charge 
that the SECPS pays to the AICPA, the AICPA pays for the SECPS staff. 
The AICPA annual report, however, does not specifically provide the 
cost of its peer review program.\164\
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    \164\ The AICPA notes expenses related to ``professional 
examinations'' of $12,121,000, but it is unclear what amounts are 
included in this category. AICPA, Annual Report 2000-2001, at 26.
---------------------------------------------------------------------------

    We recognize that a proposed PAB would not be identical to any of 
these organizations. They provide guidance, however, to the cost of a 
comparably-sized organization within the accounting profession. The 
FAF, for example, funds standard-setting organizations that conduct 
neither on-site reviews of the performance of accounting firms nor 
disciplinary proceedings. The FAF budget, however, might provide some 
evidence of the revenues needed to run an organization within the 
accounting regulatory system that has 125 to 150 employees and 
permanent facilities. The amounts paid to the FASB Chairman and FASB 
members also might provide an indication of the amount of compensation 
required to attract a full-time Chairman or Vice Chairman to a PAB.
    The POB's budget undoubtedly would be too small to fund a PAB, due 
to the more ``hands-on'' approach that we believe a PAB would take when 
directing large firms'' reviews, evaluating smaller firms' reviews, 
conducting supplemental reviews, conducting disciplinary proceedings, 
and improving communications and coordination among various standard-
setting bodies. Even when the funds budgeted to the SECPS are added to 
the POB's budget, the total amount might underestimate the amount 
required for a PAB due to the SECPS's reliance on volunteers from the 
accounting firms and on the payment of certain expenses by the AICPA. 
We anticipate that the cost of a PAB would be at least as much as the 
cost to run the POB and the SECPS, plus the cost of services provided 
to those organizations by volunteers. Moving these costs to a PAB would 
not result in an incremental cost.

[[Page 44998]]

Incremental costs may occur, however, from the performance of 
additional functions. Because our proposal leaves the identification 
of, and procedures for, these functions to the discretion of a PAB, we 
cannot quantify those costs.
    We anticipate that quality control reviews by a PAB would entail 
greater costs than those for quality control reviews by the POB. A PAB, 
for example, may incur significant costs to visit the offices of 
accounting firms during quality control reviews. If a PAB were 
directing a review, a PAB member or staff would conduct on-site visits 
to numerous and widely-dispersed offices of the accounting firm. Even 
if a PAB were not directing a quality control review but monitoring the 
review for its thoroughness and impartiality, we expect that a PAB or 
its staff would attend conferences between the reviewer and the firm 
being reviewed, and conduct on-site inspections during the conduct of 
the review. Fees to recover these costs, however, would be assessed 
separately from the more general fees imposed on all registrants and 
firms. As noted, we have proposed that each firm pay the cost of its 
own quality control reviews, as they do under the SECPS peer review 
system. To the extent that the cost of a PAB directed or approved 
quality control review exceeded both the cost of a peer review under 
the current SECPS peer review system and the cost of professional 
services donated to the SECPS and its committees, it would be an 
incremental cost. At this point, however, we are unable to quantify 
that cost. We also anticipate that incremental costs may result from a 
PAB conducting disciplinary hearings, preparing records of proceedings, 
and monitoring compliance with sanctions.
    A PAB may incur costs attendant to an open and deliberative 
standard-setting process. These costs may include hiring staff who are 
experts not only in a given subject area, but also experts in drafting 
standards. These costs may also include hiring staff for the 
preparation and publication of standards. If a PAB elects not to set 
standards but to designate other private sector bodies to set them, a 
PAB would incur costs related to its oversight of those bodies, 
including costs related to reviews of their standards and other 
documents.
    Finally, a PAB would have costs associated with our oversight. The 
preparation of an initial application and ongoing public reports, 
keeping quality control review records for our inspection, and 
preparing reports and records of disciplinary proceedings so we may 
review the sanctions imposed by a PAB, among other things, would add to 
a PAB's costs.
Costs To fund the FASB Through a PAB
    Our rules would impose costs on a PAB to fund the FASB. The 
revenues and expenses of the FASB are generally known. According to the 
2001 Annual Report published by the FAF, the FASB received 
contributions of $5,113,000, sold subscriptions and publications for 
$14,818,000, and had direct costs of sales of $1,586,000. The FASB, 
therefore, had revenues of $19,931,000 and revenues minus costs of 
sales equal to $18,345,000. The FASB and the GASB, also overseen and 
financed through the FAF, had combined net operating income of 
$22,137,000. The FAF Annual Report does not break out expenses between 
the FASB and GASB, but it reports total program expenses of $18,345,000 
and total support expenses of $4,883,000, for total expenses of 
$23,228,000 and a combined operating loss (i.e., revenues minus 
expenses) of $1,091,000. The FAF Annual Report also notes a decline in 
investments and unrestricted net assets of $2,342,000, from $28,812,000 
to $26,470,000. The FAF has indicated to our staff that it has 141 
employees, with 65 assigned to the FASB, 25 assigned to the GASB, and 
51 assigned as FAF administrative support staff for both the FASB and 
GASB. We understand that the FASB Chairman is paid $535,000 per year 
and that each of the other six full-time FASB members receive $435,000 
per year.
    An estimate of the funds that a PAB would have to collect each year 
for the FASB, therefore, might range from $20 million to $24 million. 
Some registrants and accounting firms (the two groups that would pay 
fees to fund the FASB under our proposals) already bear these costs 
through voluntary contributions and purchases of FASB publications. The 
proposals, however, might result in a more even redistribution of these 
costs among all registrants and accounting firms, not simply those 
wishing to make contributions or purchase large volumes of 
publications. We believe that by spreading the costs more evenly, we 
would enhance investor confidence by promoting a system whereby those 
with an interest in the system do not have a larger role in funding it. 
In any event, the fees an accounting firm or registrant would pay to a 
PAB to fund the FASB would be largely offset by reductions in 
contributions to the FASB and the elimination of costs for FASB's 
publications.\165\
    We invite comment and data on estimated revenues needed by a PAB to 
conduct the programs described in this release and our proposed rules. 
Are our estimates correct? We also seek comment on the extent to which 
those costs would be incremental costs, and the extent to which the 
funding costs may be redistributed among various market participants. 
We request comment on the costs that would be imposed on a PAB to fund 
the FASB. Are our estimates correct?
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    \165\ Our proposal anticipates full funding for the FASB, with 
the FASB appropriately reducing or eliminating the cost of its 
publications. We have requested comment, however, regarding whether 
the FASB should continue to generate revenues from the sale of its 
publications, and replace only the donations it receives with fees 
collected by a PAB.
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Imposition and Distribution of Costs Incurred by Accounting Firms and 
Registrants
    This section of the cost-benefit analysis discusses how the costs 
imposed by the proposal would be distributed among accounting firms and 
registrants. Under our proposal, the costs to fund a PAB and the FASB 
would be paid through fees assessed by a PAB. We expect a PAB to assess 
such fees according to schedules that apportion fees based on relative 
size of accounting firms and registrants such that fees would not be 
significant to any one entity. We also expect each accounting firm to 
continue to pay the costs of its own quality control reviews.
    As noted, accounting firms and registrants currently bear the costs 
associated with the self-regulatory system. Both accounting firms and 
registrants make contributions to the FASB and buy FASB publications. 
Accounting firms pay fees to the SECPS and other organizations to fund 
the current peer review and professional standard-setting processes, 
and they pay the costs of their own peer reviews. Registrants pay 
increased audit fees to compensate accounting firms for conducting peer 
reviews and for other professional expenses. To the extent that a 
registrant or accounting firm makes donations to the FASB or purchases 
FASB publications, a reduction in those amounts would offset the new 
fees paid to a PAB. To the extent that the SECPS and other 
organizations no longer would perform peer reviews or conduct similar 
programs after a PAB begins operations, the reduction in costs 
associated with the SECPS self-regulatory system would offset new costs 
imposed by the PAB. These offsets would reduce the net or incremental 
cost of a PAB-based system.
    Not all SECPS members would be members of a PAB. Of approximately 
1,250 SECPS members, we estimate that

[[Page 44999]]

approximately 850 audit the financial statements of Commission 
registrants and approximately 400 do not. All 1,250 firms now 
contribute to the SECPS budget of approximately $1 million and to the 
POB's budget of approximately $3.5 million. Because 400 of the SECPS 
member firms would not be required to join a PAB, any amounts paid by 
those 400 firms might have to be borne by accounting firm and 
registrant members of a PAB, to the extent a PAB performs similar 
functions.
    We also estimate that approximately 80 domestic small accounting 
firms that audit the financial statements of Commission registrants are 
not members of, and do not pay fees to, the SECPS or the AICPA. Amounts 
paid by these 80 firms to a PAB, therefore, would not be offset by 
reduced payments to the SECPS or AICPA. We expect, as noted, that a PAB 
would assess fees based on an entity's size or other relevant criteria. 
These firms, however, for the first time, may incur costs related to 
the conduct of quality control reviews. Because of the relatively small 
size of these firms, we anticipate that large, automated quality 
control systems would not be necessary. Nonetheless, the incremental 
costs of establishing controls and preparing and paying for reviews may 
be significant to a small firm. Some of these costs might be passed on 
or redistributed to the firm's audit clients that are Commission 
registrants, but such a redistribution would not affect the aggregate 
incremental cost of these firms' reviews.
    In addition to the approximately 850 accounting firms that would be 
members of a PAB, approximately 16,242 public companies and 5,587 
investment companies, as adjunct members, would pay fees to a PAB.\166\ 
By creating a base of at least 20,000 paying adjunct members,\167\ a 
PAB should be able to construct a fee schedule that is fair and 
equitable. Assuming that the FASB and a PAB each would require $20 
million to fund its administrative functions and operations, an average 
of approximately $2,000 per member and adjunct member would be 
assessed. Larger registrants and firms would be assessed significantly 
larger amounts; smaller firms and registrants would pay less.
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    \166\ According to OMB Active Information Collections as of 
April 30, 2002, the following number of responses are submitted 
annually on the following forms: Form 10-K--10,381; Form 10-KSB--
3,641; Form 11-K--774; Form S-1--3,617. We estimate that only 40 
percent of the filers on Form S-1 will include financial statements 
and that the remainder are reporting companies making repeat 
filings. Therefore, to avoid duplication in determining the number 
of registrants filing financial statements with the Commission, we 
have reduced this number to 1,446 (3,617 x .4).
    \167\ If the Commission determines to include the approximately 
865 investment advisers, 8,100 broker-dealers, 950 transfer agents, 
and the auditors of their financial statements within the scope of 
the rules, this base may be significantly expanded. In addition, a 
PAB might determine to assess fees to investment companies based on 
the numbers of portfolios, in the case of mutual funds and unit 
investment trusts other than insurance company separate accounts, 
and sub-accounts, in the case of insurance company separate 
accounts. Currently, there are approximately 8,364 portfolios of 
open-end management investment companies, 14,451 sub-accounts of 
insurance company separate accounts, and 9,940 portfolios of unit 
investment trusts other than insurance company separate accounts.
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    Finally, we believe that certain firms would face costs in 
maintaining a central office function. Many firms already have 
procedures for consultation with a central office and resolution of 
differences of opinion between the central office and other offices. 
The rule would require a PAB to ensure that member firms maintain this 
function. Those firms that do not currently do so, therefore, could 
face costs to establish and maintain a central office function that 
would likely not be offset from any other source.
    We solicit comments on the potential costs that would be imposed on 
registrants and accounting firms. What types of additional costs might 
be incurred? For example, if an accounting firm currently does not have 
a central office function, what would be the costs associated with 
creating and maintaining one? We seek comment on our assumptions about 
which costs would be offset and which would be incremental costs. Is it 
possible to quantify the costs discussed? We solicit quantitative data 
to assist in our assessment of the compliance costs related to a PAB.
    Our proposal would result in differences in the timing and conduct 
of quality control reviews of those accounting firms with more than 70 
SEC Clients and those with 70 or fewer SEC Clients. From a cost-benefit 
perspective, is this an appropriate dividing line? If not, what should 
be the cutoff, if any? We solicit any quantitative data that may be 
helpful in making this determination. We also request data on whether 
such costs would be costs that already are being borne by the 
accounting profession or others, incremental costs, or a redistribution 
of costs among market participants.
Costs of Complying With Collections of Information
    The proposed rules would impose costs associated with disclosure, 
record retention, notice, and other information collection 
requirements. For purposes of the Paperwork Reduction Act, we estimated 
the number of burden hours that would be incurred by a PAB, 
accountants, audit clients, and registrants as a result of the proposed 
rules. This ``paperwork burden'' is described in detail in Section V. 
of this release.
    A PAB would incur costs as a result of complying with the 
information collection requirements in the proposed rules. These 
requirements are discussed in detail in Section V., above. Solely for 
the purposes of the Paperwork Reduction Act, we estimated that a PAB 
would incur 10,140 burden hours as a result of the proposed rules. 
Certain of these burden hours, specifically those associated with an 
initial submission to the Commission would be non-recurring costs for 
any PAB. All other burden hours would recur annually. We estimate that 
of the total burden hours, 75% of them would be incurred by the in-
house staff of a PAB and 25% of them would be incurred by outside 
counsel. Assuming a rate of $100 for in-house staff, a PAB would incur 
a cost of $760,500 for in-house work. Assuming a rate of $300 for 
outside counsel, a PAB would incur a cost of $760,500 for work 
performed by outside counsel. Under these assumptions, a PAB would 
therefore expend approximately $1,521,000 on paperwork requirements.
    Accountants also would incur costs as a result of complying with 
collection of information requirements that would be imposed by the 
proposed rules. These requirements are discussed in detail in Section 
V, above. Solely for purposes of the PRA, we estimated that accountants 
would incur 4,530 burden hours as a result of our proposed rules. As 
discussed above, we estimated that as many as approximately 15 of these 
hours might be incurred by audit clients as opposed to accountants. We 
estimate that 75% of the 4,530 hours would be incurred in-house, and 
that 25% would be incurred by outside counsel. Based on staff 
experience, we estimate that the hours expended in-house by accountants 
would cost approximately $100 per hour. We estimate that outside legal 
work would cost $300 per hour. Under these assumptions, the in-house 
hours would result in a cost of $339,750 and the hours incurred by 
outside counsel would result in a cost of $339,750. Thus, the cost to 
accountants of information collection requirements would be $679,500.
    Finally, registrants would incur costs in complying with a new 
disclosure requirement under the proposed rules. Registrants would be 
required to make disclosure if a director, person nominated to be a 
director, or executive

[[Page 45000]]

officer was, in his or her capacity as a PAB member accountant, 
sanctioned by a PAB for violations of professional standards or the 
rules or membership requirements of the PAB within the previous five 
years, and that sanction has not been subsequently reversed, suspended, 
or vacated. For purposes of the PRA, we estimated that registrants 
would incur 30 burden hours per year in connection with this proposed 
rule. Thus, registrants would incur a cost associated with the 30 hours 
per year spent on the proposed disclosure requirement. We solicit 
comments on the costs of complying with the collections of information 
requirements that would be imposed by the proposed rules.

D. Request for Comments

    We request comment on all aspects of this cost-benefit analysis. 
Would the primary benefits of the proposal be enhanced investor 
confidence and corporate governance? Are there other significant 
benefits we have not discussed? Are we correct in our assumption that 
the proposal would entail costs similar to those already incurred, 
incremental costs, and redistributed costs? Are there other categories 
of costs we have not discussed? To assist the Commission in its 
evaluation of the costs and benefits that may result from the proposed 
rules discussed in this release, we request that commenters provide 
views and data relating to any costs and benefits associated with the 
proposed rules. Is it possible to quantify the costs and benefits 
discussed? What methods should we employ in attempting to place values 
on the costs and benefits?

VII. Consideration of Impact on the Economy, Burden on Competition, and 
Promotion of Efficiency, Competition, and Capital Formation

    For the purposes of the Small Business Regulatory Enforcement 
Fairness Act of 1996,\168\ we are requesting information regarding the 
potential impact of the proposals on the economy on an annual basis. 
Commenters should provide empirical data to support their views.
---------------------------------------------------------------------------

    \168\ Pub. L. No. 104-121, tit. II, 110 Stat. 857 (1996).
---------------------------------------------------------------------------

    Section 23(a)(2) of the Exchange Act requires us, when adopting 
rules under the Exchange Act, to consider the impact on competition of 
any rule we adopt. The proposed rules are intended to create a 
framework for a new, independent, private-sector regulatory structure 
for oversight of accountants who audit or review financial statements, 
or prepare attestation reports, filed with the Commission. We have 
identified two possible areas where the proposed rules could place a 
burden on competition. A possible impact on competition could occur as 
a result of: (1) Accountants and registrants being members and adjunct 
members, respectively, of a PAB in order to satisfy conditions 
necessary to make financial statements and attestation reports 
acceptable for filing with the Commission, and (2) new costs placed on 
small accounting firms that currently are not subject to periodic 
quality control reviews. To the extent that a PAB uses fee schedules 
based on the relative size of registrants and accounting firms, we 
would expect that there would not be a significant burden imposed on a 
substantial number of small accounting firms and small registrants.
    Any competitive impact stemming from membership of accountants in a 
PAB in order to provide audit, review, or attest services to a 
Commission registrant must be balanced against the need for investors 
to have confidence in the quality of audits and in the integrity of the 
financial information that fuels our securities markets. As noted 
above, accountants are assigned critical roles under the securities 
laws and our regulations, including reviewing and certifying financial 
statements and reporting their opinions on those statements directly to 
investors. If investors do not believe in the integrity and competence 
of the accountants providing those opinions, then investors might lose 
faith in the integrity of reported financial information and lose 
confidence in our markets. Our rule proposals are intended to provide a 
structure for a regulatory system that would foster the confidence of 
investors.
    As noted in our cost-benefit analysis, firms that currently do not 
undergo periodic quality control reviews would have additional costs 
related to those reviews.\169\ We estimate that this could occur for 
approximately 80 audit firms who are not currently members of the 
SECPS. These additional costs might also lead to an impact on 
competition. Under our proposals, these same audit firms with 
relatively few SEC clients would be members of a PAB. The imposition of 
PAB-related costs might lead to higher audit fees by these firms, 
eroding their ability to compete for the provision of audit services 
with larger audit firms. Alternatively, these audit firms with 
relatively few SEC clients may choose to withdraw providing services to 
SEC registrants in order to avoid these additional costs. This may also 
result in less competition for the provision of audit services to some 
set of smaller SEC registrants.
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    \169\ As noted in our cost-benefit analysis, even firms that 
currently undergo SECPS reviews may incur incremental costs 
associated with PAB quality controls. Because a PAB would have 
discretion in determining the nature and extent of procedures to be 
performed each year, we cannot reliably estimate what those 
additional costs may be.
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    We request comment regarding the degree to which our proposal would 
have harmful competitive effects on such small firms. We also request 
comment on any indirect effects on these firms' audit clients, 
including whether these costs might discourage some companies from 
making an initial public offering or entering our securities markets.
    Section 2(b) of the Securities Act,\170\ section 3(f) of the 
Exchange Act,\171\ and section 2(c) of the ICA,\172\ require us, when 
engaging in rulemaking that requires us to consider or determine 
whether an action is necessary or appropriate in the public interest, 
to consider, in addition to the protection of investors, whether the 
action will promote efficiency, competition, and capital formation. We 
believe that the proposed rules would promote market efficiency and 
capital formation by enhancing confidence in the financial information 
provided by registrants and examined or reviewed by accountants. 
Investors would have more confidence that: (1) Accounting firms' 
quality control systems reasonably assure the performance of high 
quality audit, review, and attest services and that individual 
accountants are adhering to those systems; (2) incompetent or unethical 
accountants are being identified and appropriately disciplined; and (3) 
there are direct lines of communication between quality control 
reviewers who discover problems with audit, quality control, ethics, or 
other standards and the body or bodies that can change those standards.
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    \170\ 15 U.S.C. 77b(b).
    \171\ 15 U.S.C. 78c(f).
    \172\ 15 U.S.C 80a-2(c).
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    The possible effects of our rule proposals on efficiency, 
competition, and capital formation are difficult to quantify. We 
request comment on these matters in connection with our proposed rules.

VIII. Initial Regulatory Flexibility Act Analysis

    This Initial Regulatory Flexibility Act Analysis has been prepared 
in accordance with 5 U.S.C. 603. It relates

[[Page 45001]]

to proposed revisions to rule 1-02 \173\ and rule 2-01 \174\ of 
Regulation S-X, the proposed addition of Rules 13-01 through 13-07 to 
Regulation S-X, and proposed revisions to Item 401 of Regulation S-
K.\175\ The proposals would create the framework for a new private 
sector regulatory structure for oversight of accountants that audit or 
review financial statements, or prepare attestation reports, that are 
filed with the Commission.
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    \173\ 17 CFR 210.1-02.
    \174\ 17 CFR 210.2-01.
    \175\ 17 CFR 229.401.
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A. Reasons for the Proposed Action

    In the wake of recent corporate failures that caused significant 
losses to investors and pensioners, Congress, the Commission, and 
others have been examining longstanding deficiencies in the accounting 
profession's self-regulatory programs. During this examination, the 
POB, which had overseen the profession's programs since 1977, voted to 
disband, leaving the profession without its ``conscience and critic.'' 
\176\ The consequences of not remedying the problems we have outlined 
in more detail above are significant to the quality of the audit 
process and the reliability of the financial information disseminated 
to investors. We have continuing concerns about the oversight of the 
accounting profession, including the effectiveness of the quality 
control review process. Without rules such as those we are proposing 
today, we are concerned that effective oversight will not be 
accomplished.
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    \176\ Accounting and Investor Protection Issues Raised by Enron 
and Other Public Companies: Hearing Before the Senate Comm. on 
Banking, Housing, and Urban Affairs (Mar. 19, 2002) (statement of 
Charles A. Bowsher, Chairman, Public Oversight Board, Former 
Comptroller General of the United States).
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B. Objectives

    Our objective is to lay the foundation for a new, stronger system 
of private sector regulation that would enhance investors' confidence 
in the audit process and in the reliability of the financial 
information used to make voting and investment decisions. Our 
proposals, among other things, would facilitate the formation of a 
stronger and more independent system of private sector regulation that 
would enhance investors' confidence in the quality of the audit process 
and in the integrity of reported financial information. The system, 
among other things, would:
     Move the system of regulation outside the AICPA and place 
it within the control of the representatives of public;
     Provide for more Commission oversight of the audit quality 
control process;
     Subject to periodic quality control reviews accounting 
firms that audit or review registrants' financial statements or provide 
attestation reports;
     Establish a consistent source of funds for the regulatory 
and accounting standard-setting processes, which is not dependent on 
voluntary contributions by the accounting profession;
     For larger firms, replace ``firm-on-firm peer reviews'' 
with PAB-directed reviews and assure that reviews of smaller firms' 
quality controls are conducted under programs that, among other things, 
are approved by a PAB, use a PAB's procedures, and provide for a PAB 
evaluation of each review; and
     Give the PAB the ability to discipline, in a public forum, 
accounting firms and individual accountants for incompetent or 
unethical conduct, or other violations of professional standards, and 
to discipline accounting firms for not having sufficient quality 
control systems or not complying with them.
    Under the proposed rules, an SEC registrant's financial statements 
would not comply with Commission requirements unless the accountant who 
audited or reviewed those statements is a member of a PAB. Attestation 
reports would not comply with Commission requirements unless prepared 
by outside accountants who are members of a PAB. Furthermore, an SEC 
registrant's financial statements and attestation reports contained in 
or accompanying an SEC registrant's reports or registration statements 
would not comply with Commission requirements unless the registrant is 
an adjunct member of, and thereby bound to cooperate in any review or 
proceeding commenced by, the same PAB as its accountant.
    A PAB would oversee the quality of financial statements relied on 
by investors by, among other things, administering a program of 
periodic reviews of accounting firms' quality controls and, when 
appropriate, disciplining accountants for deficiencies noted during 
those quality control reviews or that otherwise come to a PAB's 
attention. A PAB also would set, or rely on designated private sector 
standard-setting bodies to set audit, quality control, and ethics 
standards, and to facilitate communications among these bodies and 
others. To be recognized by the Commission, a PAB would be required to 
meet the conditions specified in the proposed rules, including having a 
board dominated by individuals who are not members of the accounting 
profession, and being subject to the Commission's oversight.
    Disclosure would be required in Commission filings if an executive 
officer, director, or director nominee had been, in his or her capacity 
as a PAB member accountant, sanctioned as a member accountant by a PAB 
within the previous five years and that sanction had not been reversed, 
suspended, or vacated.

C. Legal Basis

    We are proposing the rule amendments and new rules under the 
authority set forth in Schedule A and Sections 2, 4, 5, 6, 7, 8, 10, 
11, 19, and 28 of the Securities Act; Sections 2, 3, 9, 10, 10A, 12, 
13, 14, 15, 17, 23, and 36 of the Exchange Act; Sections 5, 10, 14, and 
20 of the PUHCA; Sections 304, 305, 307, 308, 309, 310, 314, and 319 of 
the Trust Indenture Act of 1939 (``Trust Indenture Act''); Sections 6, 
8, 20, 30, 31, and 38 of the ICA; and Sections 203, 206A and 211 of the 
Advisers Act.

D. Small Entities Subject to the Proposed Rules

    The proposals would affect small registrants and small accounting 
firms that are small entities. Exchange Act Rule 0-10(a) \177\ and 
Securities Act Rule 157 \178\ define a company to be a ``small 
business'' or ``small organization'' if it had total assets of $5 
million or less on the last day of its most recent fiscal year. We 
estimate that, as of February 20, 2002, approximately 2,500 companies 
were small entities, other than investment companies.
---------------------------------------------------------------------------

    \177\ 17 CFR 240.0-10(a).
    \178\ 17 CFR 230.157.
---------------------------------------------------------------------------

    For purposes of the ICA, Rule 0-10 \179\ defines ``small business'' 
to be an investment company with net assets of $50 million or less as 
of the end of its most recent fiscal year. We estimate that, as of May 
17, 2002, approximately 225 investment companies met this 
definition.\180\
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    \179\ 17 CFR 270.0-10.
    \180\ See Proposed Amendments to Investment Company Advertising 
Rules, Release No. 33-8101 (May 17, 2002), at n.142, 67 FR 36712 
(May 24, 2002).
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    Our rules do not define ``small business'' or ``small 
organization'' for purposes of accounting firms. The Small Business 
Administration defines small business, for purposes of accounting 
firms, as those with under $6 million in annual revenues.\181\ We have 
only limited data indicating revenues for accounting firms, and we 
cannot estimate the number of firms with less than $6 million in 
revenues that

[[Page 45002]]

practice before the Commission. We request comment on the number of 
accounting firms with revenue under $6 million.
---------------------------------------------------------------------------

    \181\ 13 CFR 121.201.
---------------------------------------------------------------------------

    Our rules do not define ``small business'' or ``small 
organization'' in terms of private sector regulatory organizations such 
as a PAB. Because no such entity exists at this time, we cannot 
reliably estimate its revenues or expenses. In addition, we cannot know 
in advance whether more than one PAB would exist, and if so, whether 
one PAB may be a small entity while another would not be a small 
entity. A PAB, however, would collect fees to fund not only its own 
operations but also approximately $20 to $24 million to fund the FASB. 
It would appear, therefore, that based on its revenues and scope of 
operations a PAB would not be a small entity.
    We request comment on whether a PAB would be a small entity. What 
criteria should be used to make this determination? If more than one 
PAB is formed and recognized by the Commission, is it likely that there 
would be both small and large PABs?

E. Reporting, Recordkeeping and Other Compliance Requirements

    The proposed rules would affect small accounting firms and small 
audit clients of accounting firms.
Registrants
    The proposed rules would impose minor reporting, recordkeeping, and 
compliance requirements on small entity registrants related to the 
operations of a PAB.
    Registrants would provide testimony and documents, upon request, to 
a PAB. The proposed rules do not direct a registrant, however, to keep 
or prepare documents or to maintain them in any specific form. Any 
burden under the proposals would relate to releasing documents and 
providing testimony to the PAB in supplemental reviews and disciplinary 
proceedings against the registrant's accountant. Although we cannot 
estimate at this time how often these events would occur, we do not 
expect this burden to have a significant economic impact on a 
substantial number of small entities.
    Registrants would pay fees assessed by a PAB and, through increased 
audit fees, might pay for increased costs incurred by accounting firms, 
as discussed below. We anticipate that a PAB would impose fees based on 
the relative size of registrants and accounting firms, such that the 
fees would not be significant to any one entity. Possible increases in 
audit fees also should not be significant. As noted below, and in our 
cost-benefit analysis, many accountants already undergo periodic 
quality control reviews. For small firms currently participating in 
these programs, the incremental costs should not be significant. For 
small accounting firms not currently participating in these programs, 
the incremental costs may be greater and a firm may attempt to pass 
these costs to a registrant-audit client. Even these firms, however, as 
explained below, currently must have a quality control system in place. 
The direct and indirect incremental fees imposed on small registrants, 
therefore, should not have a significant economic impact on a 
substantial number of small registrants.
    We also have proposed a disclosure requirement in Regulation S-K 
for registrants with an executive officer, director, or director 
nominee who, in his or her capacity as a PAB member accountant, was 
sanctioned by a PAB during the past five years. The information 
required to make this disclosure, when necessary, would be readily 
available from the individual and from a PAB's public reports. The 
proposed rules, therefore, would impose very low incremental costs, if 
any, for the collection and retention of information. In addition, in 
the relatively rare instances where the information would be disclosed, 
we anticipate that it would consist of no more than a few lines in a 
document and that drafting, reviewing, filing, printing, and 
dissemination costs, therefore, would be insignificant.
    In addition, we have not added this disclosure requirement to 
Regulation S-B,\182\ which, in lieu of Regulation S-K, is the source of 
disclosure requirements for ``small business issuers.'' \183\ A small 
business issuer is one that has revenues of less than $25 million, is a 
U.S. or Canadian issuer, is not an investment company, and, if a 
majority owned subsidiary, has a parent that also is a small business 
issuer.\184\ Accordingly, the disclosure requirement should not impose 
a significant economic impact on a substantial number of small 
registrants.
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    \182\ 17 CFR 228.
    \183\ 17 CFR 228.10.
    \184\ 17 CFR 228.10(a)(1).
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    We request comment on the reporting, recordkeeping, and other 
compliance requirements applicable to small entity registrants. Please 
quantify, if possible, what the likely burden would be.
Accountants
    The proposed rules might impose incremental costs on some small 
accounting firms. These costs may be offset, however, by reductions in 
costs currently paid to the SECPS and AICPA and amounts donated and 
paid to the FASB. In addition, many of these costs already are incurred 
to comply with requirements under GAAS to have an adequate quality 
control system.\185\
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    \185\ See SAS No. 25, AU Sec. 161.
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    As noted in our cost-benefit analysis, the vast majority of firms 
practicing before the Commission already are involved in a peer review 
program. For these firms, any costs imposed by the proposed rules of 
maintaining quality control systems and having quality control reviews 
should be offset to a large degree by reductions of fees paid to the 
SECPS or to others for such reviews.
    We have estimated, however, that approximately 80 domestic small 
accounting firms that audit the financial statements of Commission 
registrants are not members of the SECPS and do not participate in the 
SECPS peer review program. To the extent that such a firm does not 
participate in a peer review conducted by another organization, it may 
incur costs for the first time related to the conduct of quality 
control reviews. Because of the relatively small size of these firms, 
however, we anticipate that large, automated quality control systems 
would not be necessary.\186\ We also note that these firms already 
likely incur costs related to the establishment and maintenance of a 
quality control system as required by GAAS, which states:
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    \186\ See, AICPA, System of Quality Control for a CPA Firm's 
Accounting and Auditing Practice, at 4, QC Sec. 20.04, which states:
    A firm's system of quality control encompasses the firm's 
organizational structure and the policies adopted and procedures 
established to provide the firm with reasonable assurance of 
complying with professional standards. The nature, extent, and 
formality of a firm's quality control policies and procedures should 
be appropriately comprehensive and suitably designed in relation to 
the firm's size, the number of its offices, the degree of authority 
allowed its personnel and its offices, the knowledge and experience 
of its personnel, the nature and complexity of the firm's practice, 
and appropriate cost-benefit considerations.

    A firm of independent auditors needs to comply with the quality 
control standards in conducting an audit practice. Thus, a firm 
should establish quality control policies and procedures to provide 
it with reasonable assurance of conforming with generally accepted 
auditing standards in its audit engagements. The nature and extent 
of a firm's quality control policies and procedures depend on 
factors such as its size, the degree of operating autonomy allowed 
its personnel and its practice offices, the nature of its practice, 
---------------------------------------------------------------------------
its organization, and appropriate cost-benefit considerations.\187\

    \187\ SAS No. 25, AU Sec. 161.02 (as revised by SAS No. 96, Apr. 
2002).

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[[Page 45003]]

    Nonetheless, we recognize that the costs of preparing and paying 
for reviews may be significant to a small firm. To address this 
concern, our proposals indicate that smaller firms would be required to 
have a review only once every three years, instead of the annual 
reviews required of larger firms.
    We invite comments on the anticipated incremental costs to small 
firms of participating in the quality control review program discussed 
in this release. What would the reporting, recordkeeping, and other 
compliance costs be? Please quantify, if possible, any likely burden on 
small accounting firms.
    In addition to paying costs associated with quality control 
reviews, accounting firms would pay fees imposed by a PAB to fund not 
only the PAB's operations but also the operations of the FASB. We 
expect, however, that a PAB would assess fees according to schedules 
based on an entity's size or other relevant criteria, such that the 
fees paid would not be significant to any one entity.
    An accounting firm or individual accountant also might incur costs 
if the firm or individual becomes the subject of, or is required to 
participate in, a PAB's disciplinary proceedings. At this time, 
however, we cannot estimate the likely burden that would fall on small 
accounting firms as a result. In any case, we believe that they will 
not have a significant economic impact on a substantial number of small 
entities. We request comment on any likely burden that would result 
from disciplinary proceedings.

F. Duplicative, Overlapping, or Conflicting Federal Rules

    We are not aware of any federal rules that duplicate, overlap, or 
conflict with the proposed rules.

G. Significant Alternatives

    The Regulatory Flexibility Act directs us to consider significant 
alternatives that would accomplish the stated objective, while 
minimizing any significant adverse impact on small entities. In 
connection with the proposed amendments, we considered the following 
alternatives:
    1.The establishment of differing compliance or reporting 
requirements or timetables that take into account the resources of 
small entities;
    2. The clarification, consolidation, or simplification of 
compliance and reporting requirements under the rule for small 
entities;
    3. The use of performance rather than design standards; and
    4. An exemption from coverage of the proposed amendments, or any 
part thereof, for small entities.
    Congressional proposals, suggestions made during the SEC 
Roundtables, the U.K. system of regulation of the accounting 
profession, and recommendations submitted by others have provided 
numerous alternatives for the regulation of the accounting profession.
    After full consideration, we have included provisions in our 
proposed rules specifically designed to reduce the impact on small 
entities. We have provided for:
     A PAB to tailor fees based on a registrant's or accounting 
firm's size or other relevant criteria;
     Small firms to have triennial, as opposed to annual, 
quality control reviews; and
     Disclosure to be made by registrants complying with 
Regulation S-K, but not by small business issuers under Regulation S-B.
    In drafting requirements for a PAB, we have made use of certain 
standards that set performance goals. A PAB would have the ability to 
design its rules, membership requirements, policies, and procedures to 
best achieve the goals discussed in this release.
    Additional alternatives would be to exclude small entities from the 
rules or to provide an extended period of time for them to adhere to 
the rules. Because of the importance of high quality audits for all 
Commission registrants, we believe that small as well as large firms 
who audit public companies should be covered under the proposed 
rules.\188\ We have not provided delayed implementation dates just for 
small firms because most firms currently are participating in a review 
program. We also believe that some time would be required for a PAB to 
be formed, adopt the appropriate rules and procedures, and hire the 
needed staff to begin to conduct reviews. This should give smaller 
firms sufficient time to prepare for those reviews.
---------------------------------------------------------------------------

    \188\ See, e.g., Mark S. Beasley, Joseph V. Carcello, and Dana 
R. Hermanson, Fraudulent Financial Reporting, 1987-1997, An Analysis 
of U.S. Public Companies (1999); Mark S. Beasley, Joseph V. 
Carcello, and Dana R. Hermanson, Fraud Related SEC Enforcement 
Actions Against Auditors: 1987-1997 (2000).
---------------------------------------------------------------------------

H. Solicitation of Comments

    We encourage the submission of comments with respect to any aspect 
of this Initial Regulatory Flexibility Analysis. Specifically, we 
request comment regarding the number of small entities that may be 
affected by the proposed amendments, the existence or nature of the 
potential impact on those small entities, how to quantify the number of 
small accounting firms that would be affected by the proposals, and how 
to quantify the impact of the proposed amendments.
    Commenters are requested to describe the nature of any impact and 
provide empirical data supporting the extent of the impact. Such 
comments will be considered in the preparation of the Final Regulatory 
Flexibility Analysis, if the proposed rules are adopted, and will be 
placed in the same public file as comments on the proposed rules.

IX. Codification Update

    The Commission proposes to amend the ``Codification of Financial 
Reporting Policies'' announced in Financial Reporting Release No. 1 
(April 15, 1982):
    By adding a new section 700, captioned ``Matters Relating to a 
Public Accountability Board,'' to include the text in the adopting 
release that discusses the final rules, which, if the proposals are 
adopted, would be substantially similar to Section III of this release.
    The Codification is a separate publication of the Commission. It 
will not be published in the Code of Federal Regulations.

X. Statutory Authority

    We are proposing the rule amendments and new rules under the 
authority set forth in Schedule A and Sections 2, 4, 5, 6, 7, 8, 10, 
11, 19, and 28 of the Securities Act; Sections 2, 3, 9, 10, 10A, 12, 
13, 14, 15, 17, 23, and 36 of the Exchange Act; Sections 5, 10, 14, and 
20 of the PUHCA; Sections 304, 305, 307, 308, 309, 310, 314, and 319 of 
the Trust Indenture Act; Sections 6, 8, 20, 30, 31, and 38 of the ICA; 
and Sections 203, 206A and 211 of the Advisers Act.

Text of Proposed Amendments

List of Subjects

17 CFR Part 210

    Accountants, Accounting, Reporting and recordkeeping requirements, 
Securities.

17 CFR Part 229

    Reporting and recordkeeping requirements, Securities.

    In accordance with the foregoing, Title 17, Chapter II of the Code 
of Federal Regulations is proposed to be amended as follows:

[[Page 45004]]

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, INVESTMENT ADVISERS 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, 77z-3, 
77aa(25), 77aa(26), 78c, 78j-1, 78l, 78m, 78n, 78o(d), 78q, 78u-5, 
78w(a), 78ll, 78mm, 79e(b), 79j(a), 79n, 79t(a), 80a-8, 80a-20, 80a-
29, 80a-30, 80a-37(a), 80b-3, 80b-11, unless otherwise noted.
* * * * *
    2. Section 210.1-02 is amended by:
    a. Removing the authority citation following Sec. 210.1-02;
    b. Redesignating paragraph (d) as paragraph (d)(1);
    c. Removing the period at the end of newly redesignated paragraph 
(d)(1) and in its place adding a colon; and
    d. Adding paragraphs (d)(2) and (d)(3).
    The revision and additions read as follows:


Sec. 210.1-02  Definition of terms used in Regulation S-X (17 CFR part 
210).

* * * * *
    (d)(1) Audit (or examination). * * *
    (2) Review. The term review, when used in regard to financial 
statements, means a review of the financial statements by an 
independent accountant in accordance with generally accepted auditing 
standards, as may be modified or supplemented by the Commission.
    (3) Attest or attestation. The term attest or attestation, when 
used in regard to a report filed with the Commission pursuant to the 
securities laws or the rules or regulations thereunder, means a report 
by an independent accountant, on a written assertion that is the 
responsibility of another party, in accordance with Statements on 
Standards for Attestation Engagements, as may be modified or 
supplemented by the Commission, for purposes of issuing a report 
thereon.
* * * * *
    3. Section 210.2-01 is amended by redesignating paragraph (a) as 
paragraph (a)(1) and adding paragraph (a)(2) to read as follows:


Sec. 210.2-01  Qualifications of accountants.

* * * * *
    (a)(1) * * *
    (2) The Commission will not recognize any accountant as a certified 
public accountant or a public accountant, or as independent with 
respect to an audit client, if, during the professional engagement 
period, the accountant is not a member accountant in good standing of a 
Public Accountability Board or if the audit client is not an adjunct 
member in good standing of the same Public Accountability Board, as 
those terms are defined in Sec. 210.13.
* * * * *
    4. Section 210 is amended by adding an undesignated center heading 
and Secs. 210.13-01 through 210.13-07 to read as follows:

Article 13--Public Accountability Boards

Sec.
210.13-01   Financial statements and attestation reports.
210.13-02   Definitions.
210.13-03   Commission recognition of Public Accountability Boards.
210.13-04   Conditions of Commission recognition of Public 
Accountability Boards.
210.13-05   Confidentiality and immunity.
210.13-06   Exemptions.
210.13-07   Foreign accountants.

Article 13--Public Accountability Boards


Sec. 210.13-01  Financial statements and attestation reports.

    (a) Audited or reviewed financial statements or attestation reports 
contained in or accompanying reports or registration statements filed 
with the Commission must be audited or reviewed, in the case of 
financial statements, or prepared, in the case of attestation reports, 
by an accountant that, throughout the professional engagement period:
    (1) Is a member accountant in good standing of a Public 
Accountability Board of which the registrant filing the report or 
statement is an adjunct member in good standing; and
    (2) Satisfies all other requirements prescribed by the federal 
securities laws and the rules and regulations thereunder concerning an 
accountant that audits, reviews, or prepares such a statement or 
report.
    (b) [Reserved]


Sec. 210.13-02  Definitions.

    For the purposes of this Sec. 210.13:
    (a) Accountant means an independent public or certified public 
accountant that audits or reviews financial statements filed with the 
Commission, or that prepares attest reports filed with the Commission 
pursuant to the securities laws or the rules or regulations thereunder. 
References to the accountant include any accounting firm with which the 
certified public accountant or public accountant is affiliated.
    (b) Adjunct member in good standing means an entity that is an 
adjunct member of a PAB and:
    (1) Is not delinquent in the payment of fees assessed by such PAB;
    (2) Is not delinquent in the production of documents of the adjunct 
member or of the adjunct member's management employees, requested by 
such PAB and relevant to a review or proceeding by such PAB as 
described in Secs. 210.13-04(f) through (g);
    (3) Is not delinquent in providing testimony of the adjunct member 
or of the adjunct member's management employees, requested by such PAB 
and relevant to a review or proceeding by such PAB as described in 
Secs. 210.13-04(f) through (g); and
    (4) Is not delinquent in using its best efforts to cause its non-
management employees and agents to provide to such PAB any documents or 
testimony requested by such PAB and relevant to a review or proceeding 
by such PAB as described in Secs. 210.13-04(f) through (g).
    (c) A member or adjunct member of a PAB is delinquent when a PAB 
has provided public notice, in accordance with PAB rules consistent 
with Sec. 210.13-04(d)(11), that:
    (1) With respect to payment of fees assessed by a PAB, the member 
or adjunct member has failed to pay the fees; or
    (2) With respect to producing documents or providing testimony 
requested by a PAB and relevant to a review or proceeding by such PAB 
as described in Secs. 210.13-04(f) through (g):
    (i) In the case of a PAB request made to a member accountant, the 
member accountant has failed to produce the documents or provide the 
testimony after any good faith legal objection to the request has, in 
accordance with such PAB's rules, been resolved in such PAB's favor; 
and
    (ii) In the case of a PAB request made to an adjunct member, the 
adjunct member has failed to produce the documents or provide the 
testimony, or has failed to use its best efforts to cause any of its 
non-management employees or agents to produce the documents or provide 
the testimony, after any good faith legal objection to the request has, 
in accordance with such PAB's rules, been resolved in such PAB's favor.
    (d) Foreign accountant means an accountant, including associated 
entities of United States domiciled accountants:
    (1) Whose place of residence and principal office is outside the 
United States and its territories; and

[[Page 45005]]

    (2) Who is not licensed by any state or territory of the United 
States.
    (e) Member accountant in good standing means an accountant that is 
a member of a PAB and:
    (1) Either:
    (i) Has not been barred, suspended, or otherwise sanctioned by a 
PAB; or
    (ii)(A) Has been reinstated by the PAB after having been barred or 
suspended from membership with the PAB; or
    (B) Has not been cited in a public notice by the PAB as being 
noncompliant with the terms and conditions of any remedial or 
disciplinary sanction, other than suspension or bar, imposed by the 
PAB; and
    (2) Is not:
    (i) Delinquent in the payment of fees assessed by the PAB of which 
it is a member;
    (ii) Delinquent in the production of documents of the accountant, 
or of any of the accountant's employees or agents, requested by such 
PAB and relevant to a review or proceeding by such PAB as described in 
Secs. 210.13-04(f) through (g); or
    (iii) Delinquent in providing testimony of the accountant, or of 
any of the accountant's employees or agents, requested by such PAB and 
relevant to a review or proceeding by such PAB as described in 
Secs. 210.13-04(f) through (g).
    (f) Public Accountability Board, or PAB, means an entity organized 
in accordance with, and for the purposes described in, this Sec. 210.13 
that the Commission recognizes pursuant to Secs. 210.13-03 and 210.13-
04.
    (g) Professional engagement period means the period of the 
engagement to audit or review the registrant's financial statements or 
to prepare a report filed with the Commission. The professional 
engagement period begins when the accountant either signs an initial 
engagement letter (or other agreement to review or audit a client's 
financial statements or to prepare an attestation report to be filed 
with the Commission) or begins audit, review, or attest procedures, 
whichever is earlier. The professional engagement period ends when the 
registrant or the accountant notifies the Commission that the 
registrant is no longer the accountant's audit client.
    (h) Professional standards means generally accepted accounting 
principles, generally accepted auditing standards, generally accepted 
standards for attestation engagements, the Commission's auditor 
independence regulations, the standards of the Independence Standards 
Board, and any other standards related to the audit, review or 
preparation of financial statements or accountant's reports that 
accompany or are contained in filings made with the Commission, 
including auditing, quality control and ethics standards issued by a 
PAB or by a standard-setting body designated as authoritative by a PAB, 
as may be modified or supplemented by the Commission.
    (i) SEC clients means issuers making initial public offerings, 
registrants filing periodic reports with the Commission under the 
Securities Exchange Act of 1934 (except broker-dealers registered only 
because of section 15(a) of that Act (15 U.S.C. 78o(a)) or the 
Investment Company Act of 1940, and any other Commission registrant 
that a PAB, by rule, may include within that category for the purposes 
for which the term is used in this Sec. 210.13.


Sec. 210.13-03  Commission recognition of Public Accountability Boards.

    (a) To obtain Commission recognition as a PAB, an entity must 
submit for Commission review representations and materials on the basis 
of which the Commission can make a determination as to the entity's 
commitment and capacity to carry out the functions and to accomplish 
the purposes of a PAB as described in this Sec. 210.13. Such submission 
shall include, at a minimum, the representations and materials 
described in paragraph (c) of this section.
    (b) After receiving any submission pursuant to paragraph (a) of 
this section, the Commission shall, by order, determine whether the 
entity making the submission shall be recognized as a PAB. The 
Commission shall, consistent with the public interest and for the 
protection of investors, make its determination on the basis of the 
entity's commitment and capacity to carry out the functions and 
accomplish the purposes of a PAB as described in this Sec. 210.13. 
Before making its determination, the Commission may ask the entity to 
supplement its submission with such materials, representations, or 
written answers to questions as the Commission determines are necessary 
for the Commission to make an appropriate determination in the public 
interest and for the protection of investors.
    (c) Any submission pursuant to paragraph (a) of this section must 
include:
    (1) The entity's organizational structure, proposed board members 
and terms of board membership, and proposed budget, sufficient to 
determine that the entity will satisfy the requirements set out in 
Sec. 210.13-04(b);
    (2) The entity's charter and bylaws, which shall satisfy the 
criteria described in Sec. 210.13-04(c);
    (3) Representations that the entity shall undertake to:
    (i) Improve the quality of audit, review and attest services 
provided by its member accountants;
    (ii) Improve the quality controls over member firms' accounting 
practices, auditing practices, and compliance with auditor independence 
and ethics regulations;
    (iii) Enhance investors' confidence in the audit process; and
    (iv) To the extent it relies on private sector bodies to set 
auditing, ethics or quality control standards, foster cooperation and 
coordination among such private sector bodies, both domestic and 
international, and among those private sector bodies and private sector 
bodies that set standards for accounting and independence;
    (4) Representations that the entity shall put in place rules, 
membership requirements, systems and procedures designed to further the 
goals described in paragraph (c)(3) of this section and sufficient to 
accomplish, at a minimum, the objectives described in Sec. 210.13-
04(d); and
    (5) A representation that the entity will study matters concerning 
the quality control systems of foreign accountants and periodically 
report to the Commission on whether, or under what conditions, the 
exemption concerning foreign accountants in Sec. 210.13-07(a) should be 
withdrawn.


Sec. 210.13-04  Conditions of Commission recognition of Public 
Accountability Boards.

    (a) Conditions of recognition. Commission recognition of a PAB is 
conditioned upon the PAB satisfying the criteria described in 
paragraphs (b) through (i) of this section.
    (b) Organizational structure, board membership, and budget. A PAB 
shall:
    (1) Have a fixed number of board members:
    (i) None of whom may be, or have been at any time in the two-year 
period immediately preceding his or her PAB term, an employee of any 
accountants' professional organization;
    (ii) No more than one-third of whom, and in any event no more than 
three of whom, may:
    (A) Be, or have been at any time in the ten-year period immediately 
preceding his or her PAB term, an accountant or a partner, principal, 
shareholder, or managerial employee of an accounting firm; or
    (B) Be a retired partner, principal, shareholder, or managerial 
employee of

[[Page 45006]]

an accounting firm, eligible to receive benefits under an accounting 
firm's partner retirement plan or a comparable plan; and
    (iii) The remainder of whom shall be designated as ``public board 
members;''
    (2) Have staggered terms for board members;
    (3) Have a Chairman and Vice Chairman who are selected from among 
the public board members, and at least one of whom shall serve on a 
full-time basis; and
    (4) Have the means, capacity and plan to obtain the resources to 
employ a professional staff that includes a sufficient number of 
professionals with expertise in the audit process and quality control 
reviews to structure and supervise the quality control reviews required 
under paragraph (f) of this section, to conduct the supplemental 
reviews and disciplinary proceedings described in paragraph (g) of this 
section, and to engage consultants and other representatives and 
advisers necessary to carry out the purposes of this Sec. 210.13.
    (c) Charter and bylaws. A PAB's charter and bylaws shall:
    (1) Provide that the entity shall be a not for profit entity;
    (2) Include quorum provisions that insure that the public board 
members will have the ability to control the outcome of any matter 
submitted to a vote of the board;
    (3) Provide that the entity shall be subject to and shall act in 
accordance with Commission oversight as described in paragraph (i) of 
this section; and
    (4) Provide that, immediately upon the effective date of any 
Commission rule abrogating, adding to, or deleting from the entity's 
rules, the entity's rules shall be deemed, without further action, to 
be amended as provided by such Commission rule.
    (d) Rules, membership requirements, systems, and procedures. A PAB 
shall have in place rules, membership requirements, systems, and 
procedures designed to further the goals described in Sec. 210.13-
03(c)(3), and sufficient to accomplish, at a minimum, the following:
    (1) Provide for membership enrollment procedures that:
    (i) Minimize the administrative burden on individual accountants by 
maximizing the extent to which the enrollment requirements, and any 
periodic updating requirements, may be satisfied by an accounting firm 
on behalf of its individual accountants; and
    (ii) Require members and adjunct members to agree to be bound by 
the PAB's rules and membership requirements;
    (2) Require that member accountants maintain a system of quality 
control for the accountant's accounting and auditing practice designed 
to meet the requirements of quality controls set or designated as 
authoritative by the PAB, but encompassing, at a minimum, the 
requirements described in paragraph (e) of this section;
    (3) Require member accountants to comply with their own system of 
quality controls in a manner that provides reasonable assurance of 
conforming with professional standards;
    (4) Have a continuing program of review of each member firm's 
quality control systems concerning accounting practices, auditing 
practices, and adherence to Commission and professional auditor 
independence requirements; and administer that program according to the 
criteria described in paragraph (f) of this section;
    (5) Direct member firms to make and keep for specified periods of 
time records that:
    (i) Are required by professional standards in connection with each 
audit, review, or attest of a registrant's financial statements or 
reports; or
    (ii) Otherwise document the procedures performed and the resolution 
of material issues during each audit or review engagement;
    (6) Conduct supplemental reviews and disciplinary proceedings, in 
accordance with the criteria described in paragraph (g) of this 
section;
    (7) Provide procedures for requesting and obtaining documents and 
testimony relevant to a review or proceeding by such PAB as described 
in Secs. 210.13-04(f) through (g);
    (8) Adopt appropriate policies to address any conflicts or 
potential conflicts of interest that may arise involving the PAB's 
board members, employees, contractors, and professional 
representatives;
    (9) Collect from each registrant that is an adjunct member of the 
PAB, and from each member accounting firm, reasonable fees and charges, 
which fees may be assessed by the PAB according to schedules specifying 
different fees for different classes of registrants and accounting 
firms, sufficient:
    (i) To fund the operation and administration of the PAB; and
    (ii) To fund the operation and administration of an accounting 
standards-setting body endorsed by the Commission as the primary source 
for generally accepted accounting principles;
    (10) Collect from each member accounting firm reasonable fees and 
charges sufficient to recover the costs and expenses of conducting or 
overseeing quality control reviews of that firm as described in 
paragraph (f) of this section;
    (11) Provide fair procedures for disciplining and sanctioning 
accountants and for resolving disputes with member accountants and 
adjunct members concerning fees, document requests and requests for 
testimony, including procedures providing for appropriate notice to the 
member accountant or adjunct member, the Commission, and the public of 
any action that could result or has resulted in suspension or bar of a 
member accountant or a loss of good standing by a member accountant or 
adjunct member;
    (12) Set, or rely on designated private sector bodies to set, 
auditing, ethical or quality control standards for its members and, to 
the extent it relies on private sector bodies to set such standards, 
oversee such bodies and request that such matters as the PAB deems 
appropriate be added to the standard-setting agendas of such private 
sector bodies, and notify the Commission of each such request;
    (13) Request that matters be added to the agenda of private sector 
bodies that set accounting or independence standards, and notify the 
Commission of each such request;
    (14) Facilitate and participate in periodic meetings of 
representatives of the private sector bodies that set accounting, 
auditing, quality control, ethics and independence standards, 
representatives of the Commission, and such other persons as the PAB 
deems appropriate, for the purpose of furthering the coordination and 
cooperation among such bodies;
    (15) Provide that the PAB's process for amending governing 
documents, rules, membership requirements and procedures shall include 
an open and deliberative rulemaking process with open meetings, the 
publication for public comment of draft rules, requirements and 
procedures and substantive consideration of those comments;
    (16) Provide for extending full faith and credit to the sanctions 
and good standing requirements of any other PAB, such that an 
accountant sanctioned by, or an accountant or registrant in violation 
of the good standing requirements of, one PAB may not evade any 
sanction, inquiry, or failure of good standing by switching its 
membership to a different PAB;
    (17) Provide or require training for accountants in matters related 
to accounting, auditing, attestation,

[[Page 45007]]

assurance, ethics, independence, and quality controls; and
    (18) Perform such other duties or functions as shall be provided in 
any rule or order that the Commission may adopt or issue in furtherance 
of the public interest or for the protection of investors and to carry 
out the purposes of this Sec. 210.13.
    (e) Quality control requirements. A PAB shall require that each of 
its member accountants maintain a system of quality control for the 
accountant's accounting and auditing practice designed to meet the 
requirements of quality controls set or designated as authoritative by 
the PAB, including quality controls concerning independence, integrity, 
and objectivity; personnel management; acceptance and continuance of 
clients and engagements; engagement performance; and monitoring. The 
quality controls required by a PAB shall include, at a minimum:
    (1) Assigning a new audit engagement partner to be in charge of an 
audit engagement that has had another audit partner-in-charge for a 
period of seven consecutive years;
    (2) Establishing policies and procedures for a review of the audit 
report and financial statements by a partner other than the audit 
partner-in-charge of an audit engagement before issuance of an audit 
report on the financial statements and before the reissuance of such an 
audit report where performance of subsequent events procedures is 
required by professional standards, or alternative procedures that a 
PAB authorizes where this requirement cannot be met because of the size 
of the member firm;
    (3) Ensuring policies and procedures are in place to comply with 
applicable auditor independence requirements and to refrain from 
performing consulting services that are inconsistent with Sec. 210.2-
01, and to refrain from conducting public opinion polls or merger and 
acquisition assistance for a finder's fee;
    (4) At least annually, disclosing to the audit committee of each 
audit client that is a Commission registrant (or the board of directors 
if there is no audit committee), in writing, all relationships between 
the accountant and its related entities that in the accountant's 
professional judgment may reasonably be thought to bear on auditor 
independence; confirming in that letter that, in the accountant's 
professional judgment, it is independent of the registrant within the 
meaning of the securities laws, the rules and regulations thereunder, 
and professional standards; and discussing the accountant's 
independence with the audit committee (or board of directors);
    (5) When the member firm has been the auditor of the financial 
statements of a Commission registrant and has resigned, declined to 
stand for reelection, or been dismissed, promptly reporting in writing 
to the registrant, with a simultaneous copy to the Commission's Office 
of the Chief Accountant, the fact that the client-auditor relationship 
has ceased;
    (6) For member firms that are associated with international firms 
or international associations of firms:
    (i) Seeking the adoption of policies and procedures by the 
international organization or individual foreign associated firms that 
are consistent with the objectives of this Sec. 210.13; and
    (ii) Reporting annually, or more frequently as the PAB may 
prescribe, the name and country of the foreign associated firms, if 
any, for which the member firm has been advised in writing by its 
international organization or the individual foreign associated firms 
that such policies and procedures have been established;
    (7) Ensuring that the member firm has policies and procedures in 
place to report to the PAB, with a copy of the report to the 
Commission's Office of the Chief Accountant, litigation or any 
proceeding or investigation by a government agency alleging either 
deficiencies in the conduct of an audit or review of financial 
statements filed with the Commission by a present or former audit 
client, or any other violation of the securities laws, within 30 days 
of service of the first pleading in the matter on the accountant or on 
any partner or employee of a member accounting firm;
    (8) Ensuring that the member firm maintains a central office 
function that develops expertise in technical accounting and financial 
reporting matters, and has in place the following policies and 
procedures, or alternative procedures that a PAB authorizes where these 
requirements cannot be met because of the size of the member firm:
    (i) Polices and procedures requiring, as appropriate, consultations 
with that office by engagement partners and others within the member 
firm; and
    (ii) Policies and procedures for the resolution of differences of 
opinion between that central office and engagement partners; and
    (9) Ensuring that the member firm has policies and procedures that 
require:
    (i) Prompt notification to the firm when an individual accountant 
who is a partner or employee of the firm begins discussions with an 
audit client respecting possible employment; and
    (ii) Review of that accountant's work on engagements for that 
client to determine whether changes in the audit plan or audit team are 
necessary and to assure adherence to the Commission's auditor 
independence rules.
    (f) Quality control review program. A PAB shall administer and 
conduct a continuing program of quality control reviews and inspections 
of each member firm to assess compliance by such firm, and by 
individual accountants associated with such firm, with the rules and 
membership requirements adopted by the PAB, and professional standards, 
and shall administer such program according to the following criteria:
    (1) A PAB shall annually conduct such a quality control review of 
each member accounting firm that audits or reviews the financial 
statements of more than 70 SEC clients, or such other number of SEC 
clients as the PAB by rule may determine, and shall conduct such a 
quality control review of all other member accounting firms at least 
once every three years;
    (2) A PAB shall direct member firms to make and keep, for such 
periods as the PAB determines necessary, records that are necessary for 
the conduct of the quality control reviews required by this section;
    (3) A PAB shall establish policies and procedures for conducting 
the quality control reviews, establish procedures for reporting of the 
results of the quality control reviews, and maintain public files for 
each member accounting firm containing recent quality control review 
reports on the firm and the firm's response to each report;
    (4) A PAB shall provide for monitoring of the quality control 
reviews to ensure that they are conducted in a fair and impartial 
manner and for evaluating each quality control review and report to 
gain assurance that appropriate procedures are recommended and being 
implemented to correct noted deficiencies, if any, in a timely and 
effective manner;
    (5) A PAB or its staff shall plan and direct all such quality 
control reviews, make all key decisions related to such quality control 
reviews, and perform all tasks necessary to conduct such quality 
control reviews, except that:
    (i) A PAB may engage individual accountants from a firm or firms 
not associated with the firm being reviewed to assist in the conduct of 
such quality control reviews, provided that such accountants perform 
only assigned functions and are under the supervision of the PAB or its 
staff; and

[[Page 45008]]

    (ii) Quality control reviews of member accounting firms that audit 
or review the financial statements of 70 or fewer SEC clients, or such 
other number of SEC clients as the PAB by rule may determine, may be 
conducted pursuant to quality control review programs approved by the 
PAB, provided any such quality control review program follows the PAB's 
policies and procedures and the PAB administers the program and 
performs the functions described in paragraphs (f)(2) through (f)(4) of 
this section;
    (6) In conducting such quality control reviews, a PAB or, in the 
case of a quality control review program, the reviewer, shall review, 
among such other things as the PAB may determine, selected audit and 
review engagements performed at various offices and by various persons 
associated with the firm under review, and, in connection therewith, 
evaluate whether such firm's quality control system is appropriate, 
whether its policies and procedures are adequately documented and 
communicated to its personnel, and whether the firm is in compliance 
with such policies and procedures sufficient to provide reasonable 
assurance of conformity with Commission rules, PAB membership 
requirements and rules, and professional standards; and
    (7) In connection with each quality control review, a PAB or, in 
the case of a quality control review program, the reviewer, shall 
prepare a report of its findings and comments, and such report, 
accompanied by any letter of response from the member firm, shall be 
made publicly available as specified in paragraph (f)(3) of this 
section.
    (g) Supplemental reviews and disciplinary proceedings. (1) A PAB 
shall have rules, membership requirements, systems, and procedures, 
incorporating the criteria described in paragraphs (g)(2) through 
(g)(9) of this section, pursuant to which a PAB may:
    (i) Institute public proceedings (hereinafter ``disciplinary 
proceedings'') to determine whether an accountant has engaged in any 
act or practice, or omitted to act, in violation of the rules or 
membership requirements adopted by the PAB or professional standards, 
and to impose remedial or disciplinary sanctions for any such act, 
practice, or omission; and
    (ii) On the basis of information suggesting the possibility of any 
such act, practice, or omission, engage in a nonpublic practice of 
requesting and reviewing information (hereinafter ``supplemental 
reviews'') to determine whether to institute disciplinary proceedings;
    (2) If a PAB, at any time, becomes aware of information indicating 
that a violation of the securities laws has or is likely to have 
occurred, then the PAB promptly shall notify the Commission of that 
information. A PAB may initiate a disciplinary proceeding regarding 
that information only after notifying and consulting with the 
Commission;
    (3) A PAB shall establish fair procedures for supplemental reviews 
and for disciplinary proceedings. In any disciplinary proceeding, a PAB 
shall bring specific charges, notify such firm or person of those 
charges, give such firm or person an opportunity to defend against 
those charges, and keep a record. Disciplinary proceedings shall be 
public unless otherwise ordered by the PAB with the prior approval of 
the Commission;
    (4) For purposes of supplemental reviews or disciplinary 
proceedings, a PAB may request that any person provide testimony or 
documents relevant to the review or proceeding;
    (5) PAB board members who are not public board members may be 
consulted in connection with supplemental reviews and disciplinary 
proceedings but shall not have a vote in the PAB's determination 
whether to institute a disciplinary proceeding, what findings to make 
in a disciplinary proceeding, or what sanctions to impose;
    (6) If, as the result of a disciplinary proceeding, a PAB finds 
that an accountant has engaged in any act or practice, or omitted to 
act, in violation of the rules or membership requirements adopted by 
the PAB or professional standards, then the PAB may impose any 
appropriate disciplinary or remedial sanctions including revocation or 
suspension of membership, or expulsion from, the PAB; limitations on 
activities, functions, and operations, including requiring a member 
firm to resign a specific audit, review or attestation engagement; 
suspending or barring an accountant from participating in any way in 
any audit, review or attest engagement for any Commission registrant; 
fine; censure; or any other appropriate sanction;
    (7) Whenever a PAB imposes a disciplinary sanction against an 
accountant, the PAB shall report such sanction in writing to the 
accountant against whom the sanction is imposed, to the Commission, to 
the appropriate State or foreign financial regulatory authority or 
authorities with which such firm or such person is licensed, 
registered, or certified to practice public accounting, and to the 
public. Each PAB report shall include:
    (i) The name of the accountant against whom the sanction is 
imposed;
    (ii) A description of the acts or practices, or omissions to act, 
upon which the sanction is based;
    (iii) The nature of the sanction; and
    (iv) Such other information respecting the circumstances of the 
disciplinary action as the PAB deems appropriate;
    (8) In the event that a PAB is unable to conduct or complete a 
proceeding under this section because of the refusal of any person to 
testify, produce documents, or otherwise cooperate with the PAB, the 
PAB shall report such refusal to the Commission. If the uncooperative 
party is a registrant, the PAB shall also report such refusal to any 
market or exchange where the registrant's securities are traded or 
listed. A PAB may refer any other matter to the Commission, as the PAB 
deems appropriate; and
    (9) PAB rules shall require member accounting firms:
    (i) To notify the PAB in the event that the member firm employs or 
becomes associated with an individual accountant during any period in 
which that individual accountant is subject to a sanction, order or 
ruling issued by a PAB; and
    (ii) To undertake procedures to ensure that the individual 
accountant does not violate the terms of the sanction, order or ruling.
    (h) Public reporting. A PAB shall report to the Commission and to 
the public at least annually, and where practicable on a current basis, 
the following matters:
    (1) A detailed description of the quality control review and 
disciplinary activities of the PAB;
    (2) The annual audited financial statements of the PAB;
    (3) An explanation of the fees and charges imposed by the PAB on 
members and adjunct members;
    (4) A summary of the issues addressed in the PAB-sponsored periodic 
meetings with, or in connection with its oversight of, private sector 
standard-setting bodies;
    (5) A list of all matters the PAB referred to each private sector 
standard-setting body that were not placed on the agenda of that body 
within 90 days of the PAB's referral; and
    (6) Such other matters as the PAB deems appropriate or the 
Commission, by order, requires.
    (i) Commission oversight. A PAB shall consent to, and act in 
compliance with, Commission oversight as follows:
    (1) The Commission, by rule, may abrogate, add to, and delete from 
the rules of a PAB as the Commission deems necessary or appropriate to

[[Page 45009]]

ensure the fair and efficient administration of the PAB, to conform its 
rules to requirements of the securities laws or the rules and 
regulations thereunder, or otherwise in furtherance of the purposes of 
the securities laws. The Commission shall notify the PAB of any such 
action prior to publication of the notice of proposed rulemaking in the 
Federal Register;
    (2) The Commission staff periodically may inspect and monitor the 
operations, records, and results of a PAB to ensure the PAB is 
operating in the public interest and for the protection of investors 
and fulfilling the purposes of the Commission in adopting this 
Sec. 210.13. A PAB shall make and keep records, reports and summaries 
of its activities that the Commission staff deems necessary for its 
inspection of the PAB's quality control review activities, supplemental 
reviews, and disciplinary proceedings. A PAB shall adopt a policy, 
which shall be subject to Commission approval by order, identifying the 
categories of records, reports, and summaries that it shall retain. A 
PAB shall adopt a policy that provides for the retention of such 
materials until such time as the Commission has either inspected the 
materials or informed the PAB that it need no longer retain the 
documents;
    (3) The PAB shall, in accordance with paragraphs (g)(7) and (d)(11) 
of this section, promptly notify the Commission whenever it imposes any 
final disciplinary sanction on any member accountant or determines any 
member accountant or adjunct member to be delinquent. The Commission 
may review that sanction as follows:
    (i) Any final PAB disciplinary action or delinquency determination 
shall be subject to review by the Commission on its own motion at any 
time, or upon application by any person aggrieved thereby filed within 
thirty days after the date the notice required by paragraph (g)(7) or 
paragraph (d)(11) of this section was filed with the Commission and 
received by such aggrieved person, or within such longer period as the 
Commission, by order, allows. Application to the Commission for review, 
or the institution of review by the Commission on its own motion, shall 
not operate as a stay of such action unless the Commission otherwise 
orders, summarily or after notice and opportunity for hearing on the 
question of a stay (which hearing may consist solely of the submission 
of affidavits or presentation of oral arguments);
    (ii) In any Commission proceeding to review a final disciplinary 
sanction imposed by a PAB on a member accountant, after notice and 
opportunity for hearing (which hearing may consist solely of 
consideration of the record before the PAB and opportunity for the 
presentation of supporting reasons to affirm, modify, or set aside the 
sanction):
    (A) If the Commission finds that the member accountant has engaged 
in such acts or practices, or has omitted such acts, as the PAB has 
found the accountant to have engaged in or omitted, that such acts or 
practices or omissions to act are in violation of such provisions of 
the securities laws, the rules or regulations thereunder, the rules or 
membership requirements adopted by the PAB, or professional standards 
as have been specified in the determination of the PAB, and that such 
provisions are, and were applied in a manner, consistent with the 
purposes of this Sec. 210.13, then the Commission, by order, shall so 
declare and, as appropriate, affirm the sanction imposed by the PAB, 
modify the sanction in accordance with paragraph (i)(3)(iv) of this 
section, or, if appropriate, remand to the PAB for further proceedings; 
or
    (B) If the Commission does not make the finding set forth in 
paragraph (i)(3)(ii)(A) of this section, it shall, by order, set aside 
the sanction imposed by the PAB and, if appropriate, remand to the PAB 
for further proceedings; or
    (iii) In any Commission proceeding to review a PAB determination 
that a member accountant or adjunct member is delinquent, after notice 
and opportunity for hearing (which hearing may consist solely of 
consideration of the record before the PAB and opportunity for the 
presentation of supporting reasons to affirm, modify, or set aside the 
determination):
    (A) If the Commission finds that the member accountant or adjunct 
member has failed to comply with PAB rules or membership requirements 
concerning fee payments, requests for documents, or requests for 
testimony, that the PAB's determination is in accordance with the rules 
of the PAB, and that such rules are, and were applied in a manner, 
consistent with the purposes of this Sec. 210.13, the Commission, by 
order, shall so declare and, as appropriate, affirm the delinquency 
determination, cancel the delinquency determination in accordance with 
paragraph (i)(3)(iv) of this section, or, if appropriate, remand to the 
PAB for further proceedings; or
    (B) If the Commission does not make the findings set forth in 
paragraph (i)(3)(iii)(A) of this section, the Commission shall, by 
order, set aside the delinquency determination and, if appropriate, 
remand to the PAB for further proceedings; or
    (iv) If the Commission, having due regard for the public interest 
and the protection of investors, finds after a proceeding in accordance 
with this paragraph (i)(3) that a sanction imposed, or a delinquency 
determination made, by the PAB imposes any burden on competition not 
necessary or appropriate in furtherance of the purposes of the 
securities laws or is excessive or oppressive, the Commission may 
cancel such delinquency determination or may cancel, reduce, or require 
the remission of such sanction;
    (4) The Commission, by order, may remove from office or censure any 
board member of a PAB if the Commission finds, on the record after 
notice and opportunity for hearing, that such member has willfully 
violated any provision of the securities laws, the rules or regulations 
thereunder, or the rules of the PAB, willfully abused his or her 
authority, or without reasonable justification or excuse has failed to 
enforce compliance with any such provision or any professional standard 
by any accountant that is a member of the PAB.
    (5) If the Commission finds that a PAB has failed or is failing to 
comply with any of the conditions of recognition described in this 
Sec. 210.13-04, the Commission may, by order, withdraw recognition of 
such PAB and direct that any fees described in paragraphs (d)(9) and 
(d)(10) of this section and collected by, or due and owing to, such PAB 
shall be held in escrow pending:
    (i) Resolution or correction of such PAB's failings, satisfactory 
to the Commission; or
    (ii) A Commission order that such funds be paid to one or more 
other PABs that enroll members from the PAB that the Commission has 
ceased to recognize.


Sec. 210.13-05  Confidentiality and immunity.

    (a) Because a PAB's nonpublic proceedings and deliberations are 
subject to Commission oversight, and are governed by this Sec. 210.13 
in furtherance of the purposes of the securities laws, including the 
enforcement of certain standards, the Commission finds that, except to 
the extent that such information is requested by the Commission, any 
other Federal department or agency, the appropriate State licensing 
authority or authorities, State criminal law enforcement authorities, 
and foreign governmental authorities or foreign financial regulatory 
authorities, it is in the public interest for a PAB:
    (1) To be able to maintain the confidentiality of reports, 
memoranda

[[Page 45010]]

and other information prepared by it, and of its deliberations; and
    (2) To claim confidentiality protection for its nonpublic reports, 
memoranda, other information prepared by it, and of its deliberations, 
to the full extent allowed by law.
    (b) Because a PAB's activities are subject to Commission oversight, 
and are governed by this Sec. 210.13 in furtherance of the purposes of 
the securities laws, the Commission finds that it is in the public 
interest for the PAB and its board members, employees, contractors, and 
professional representatives:
    (1) To have immunity from private civil liability for any action or 
failure to act in connection with the PAB's responsibilities; and
    (2) To claim immunity from private civil liability, for any action 
or failure to act in connection with the PAB's responsibilities, to the 
full extent allowed by law.


Sec. 210.13-06  Exemptions.

    (a) The Commission, by rule or order, upon its own motion or upon 
application, may conditionally or unconditionally exempt in whole or in 
part any accountant or any Commission registrant, or any class of 
accountants or Commission registrants, from any or all of the 
provisions of Secs. 210.13 and 210.2-01(a)(2), if the Commission finds 
that such exemption is consistent with the public interest and the 
protection of investors.
    (b) Accountants that do not audit or review financial statements or 
prepare attestation reports filed with the Commission on a recurring 
basis and whose audit reports are filed with the Commission only in 
accordance with Sec. 210.3-05 are exempt from the requirements of this 
Secs. 210.13 and 210.2-01(a)(2).
    (c) The Commission, by rule or order, consistent with the public 
interest, the protection of investors, and the other purposes of the 
securities laws, may relieve a PAB of its responsibility to enforce 
compliance with any specified provision in Sec. 210.13, the rules or 
membership requirements adopted by a PAB, or professional standards, 
with respect to any accountant, Commission registrant, or any class of 
accountants or registrants.


Sec. 210.13-07  Foreign accountants.

    (a) Any foreign accountant that audits or reviews financial 
statements filed with the Commission, or prepares reports that are 
filed with the Commission, and any foreign issuer that engages a 
foreign accountant for such services, shall be exempt from compliance 
with Secs. 210.13 and 210.2-01(a)(2).
    (b) In reviewing the quality controls of any member firm that has 
associated entities that are foreign accountants, the PAB or reviewer 
should review the procedures performed by the member firm related to 
documents filed with the Commission that contain the reports or 
opinions of those foreign accountants.

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

    5. The general authority citation for part 229 continues to read as 
follows:

    Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 77k, 77s, 77z-2, 
77z-3, 77aa(25), 77aa(26), 77ddd, 77eee, 77ggg, 77hhh, 77iii, 77jjj, 
77nnn, 77sss, 78c, 78i, 78l, 78m, 78n, 78o, 78u-5, 78w, 78ll(d), 
78mm, 79e, 79n, 79t, 80a-8, 80a-29, 80a-30, 80a-31(c), 80a-37, 80a-
38(a), and 80b-11, unless otherwise noted.
* * * * *
    6. Section 229.401 is revised by adding paragraph (f)(7) before the 
Note to Paragraph (f) of Item 401 to read as follows:


Sec. 229.401 (Item 401)  Directors, executive officers, promoters and 
control persons.

* * * * *
    (f) * * *
    (7) Such person was sanctioned by a Public Accountability Board 
under Sec. 210.13 of this Chapter for violations of professional 
standards or the rules or membership requirements of that Public 
Accountability Board and that sanction has not been subsequently 
reversed, suspended or vacated.
* * * * *

    Dated: June 26, 2002.
    By the Commission.

Margaret H. McFarland,
Deputy Secretary.

    Note: Appendices A and B to the preamble will not appear in the 
Code of Federal Regulations.

Appendix A

Brief History of the Self-Regulatory System

    The self-regulatory system established in September 1977 
included the formation within the AICPA of a Division for CPA Firms 
and then the organization of that Division into two sections, one 
for those firms that audit financial statements filed with the 
Commission (the SECPS) and one for those that do not.\189\ Since its 
formation, the SECPS has imposed membership requirements on firms 
and required member firms to participate in two programs intended to 
promote effective quality control systems. The first is a peer 
review program, which in recent years has involved firm on firm 
reviews.\190\ The SECPS's Peer Review Committee administers the peer 
review program. The second program reviews allegations of audit 
failures involving Commission registrants that are contained in 
litigation filed against member firms. The QCIC conducts the second 
program.
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    \189\ The section for those firms that do not audit Commission 
registrants was formerly called the Private Companies Practice 
Section. The AICPA recently renamed its efforts for firms that 
provide services to private companies as ``Partnering for CPA 
Practice Success.''
    \190\ Although it is our understanding that ``firm on firm'' 
reviews are most prevalent, an SECPS member firm may choose a review 
team formed by a state CPA society (a committee-appointed review 
team, known as a CART review), or by an association of CPA firms 
authorized by the AICPA Peer Review Committee to assist its members 
by forming review teams to carry out peer reviews (an association 
review). See AICPA, Standards for Performing and Reporting on Peer 
Reviews at ] 15.
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    The September 1977 resolution of the AICPA Council that created 
the SECPS also provided for the establishment of the POB.\191\ This 
resolution indicated that the POB, among other things, would ``(a) 
Monitor and evaluate [the regulatory and sanction] activities of the 
Peer Review and [SECPS] Executive Committees to assure their 
effectiveness, (b) Determine that the Peer Review Committee is 
ascertaining that firms are taking appropriate action as a result of 
peer reviews, (c) Conduct continuing oversight of all other 
activities of the Section.''\192\
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    \191\ AICPA, Official Releases: Organizational Structure and 
Functions of the SEC Practice Section of the AICPA Division for CPA 
Firms, J. Acct., Nov. 1997, at 113, 114.
    \192\ See Division for CPA Firms SEC Practice Section, SECPS 
Reference Manual, at SECPS Sec. 100.23.
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    Operating under this resolution and related provisions, the POB 
oversaw the SECPS peer review and quality control inquiry programs 
and gradually expanded its scope to monitor and comment on other 
matters that affect public confidence in the integrity of the audit 
process.\193\ When the Commission was

[[Page 45011]]

concerned about the status of accounting firms' quality controls 
over auditor independence, it asked the POB to oversee a review of 
the firms' systems and procedures in this area.\194\ During 
discussions about the POB's reviews of the firms' systems of quality 
controls over auditor independence, the SECPS took the unprecedented 
step of threatening to halt the funding for the POB's reviews.\195\ 
The SECPS indicated that this step was part of its obligations to 
its member firms to exercise fiscal responsibility, but it was 
perceived widely as an indication of the POB's lack of financial 
independence from the AICPA.\196\
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    \193\ For example, in 1993 the POB issued a document entitled In 
the Public Interest: Issues Confronting the Accounting Profession, 
which contained recommendations designed to enhance the reliability 
of financial statements and improve the performance of auditors. In 
1994, in response to issues raised by then-SEC Chief Accountant 
Walter Schuetze, the POB sponsored a committee that published 
Strengthening the Professionalism of the Independent Auditor, which 
contained further recommendations in the areas of auditor 
independence, litigation reform, and the relationship of the 
accounting profession with various standard-setting and regulatory 
bodies, including the Commission. More recently, in response to the 
Commission's concerns about the impact of changes in audit 
procedures on the efficacy of the audit process, the POB formed the 
Panel on Audit Effectiveness (``Panel''). The Panel used a ``Quasi 
Peer Review'' (``QPR'') process to examine the audit processes of 
large SECPS member firms. The Panel on Audit Effectiveness, Report 
and Recommendations, at 211-17 (Aug. 31, 2000). Each QPR was 
conducted under the close supervision of the Panel staff, including 
at least one senior member of the Panel staff, and all of the 
reviewers had relevant industry experience. Id. at 213. The Panel 
also reviewed the relevant issues and held public hearings. In 
August 2000, the Panel issued a report containing recommendations 
for those involved in the audit process and for those who oversee 
that process. The Panel on Audit Effectiveness, Report and 
Recommendations (Aug. 31, 2000).
    \194\ The program is in progress and will be completed by the 
POB staff under the review of an independent party, Donald Kirk. See 
SEC Press Release No. 2002-40 (Mar. 19, 2002).
    \195\ Letter from David Brumbeloe, Director, SECPS, to Jerry D. 
Sullivan, Executive Director, POB (May 3, 2000), which states, in 
part: ``The SEC Practice Section (the ``Section'') will not approve 
nor authorize payment for invoices submitted by the Public Oversight 
Board (``POB'') or its representatives that contain charges for the 
special reviews until such time that the Section and POB determine 
that such reviews will take place, and accordingly, that the work 
plan is agreed to by all parties.''
    \196\ See, e.g., Accounting and Investor Protection Issues 
Raised by Enron and Other Public Companies: Hearing Before the 
Senate Comm. on Banking, Housing, and Urban Affairs (Mar. 19, 2002) 
(statement of Charles A. Bowsher, Chairman, Public Oversight Board, 
Former Comptroller General of the United States).
---------------------------------------------------------------------------

Appendix B

The Commission's Endorsement and Oversight of FASB

    We have ample authority to set accounting requirements for 
Commission registrants.\197\ Practically since the Commission's 
inception, however, we have looked to the accounting profession for 
leadership in establishing and improving the accounting principles 
used to prepare financial statements filed with the Commission and 
relied on by investors.\198\ These principles come from a variety of 
sources, and together form generally accepted accounting principles, 
or GAAP.\199\ Commission rules state that financial statements that 
do not follow GAAP will be presumed to be misleading, unless the 
Commission has directed otherwise.\200\
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    \197\ See, e.g., 15 U.S.C. 77s(a), 78c(b), and 78m(b)(1).
    \198\ See Accounting Series Release Nos. 4 (Apr. 25, 1938) and 
150 (Dec. 20, 1973).
    \199\ For a discussion of the various sources of GAAP and the 
hierarchy used to determine the most authoritative among conflicting 
principles or practices, see SAS No. 69 (for periods ending after 
Mar. 15, 1992), AU Sec. 411.
    \200\ Rule 4-01(a)(1) of Regulation S-X, 17 CFR 210.4-01(a)(1).
---------------------------------------------------------------------------

    In Accounting Series Release No. 150, which was published on 
December 20, 1973, the Commission endorsed the establishment of the 
FASB and stated that standards promulgated by the FASB would be 
considered to have ``substantial authoritative support'' and that 
those contrary to FASB pronouncements would be deemed to have no 
such support. The Commission, in making that decision, noted that 
the commitment of resources to the FASB by the private sector was 
``impressive'' and evidenced an intention on the part of the private 
sector to support the FASB in accomplishing its task of taking 
``prompt and reasonable actions flowing from research and 
consideration of varying viewpoints.'' \201\ In that release, the 
Commission acknowledged and endorsed the FASB as the primary source 
for GAAP.
---------------------------------------------------------------------------

    \201\ Accounting Series Release No. 150 (Dec. 20, 1973), which 
is reprinted in the Commission's Codification of Financial Reporting 
Policies, Sec. 101.
---------------------------------------------------------------------------

    The FASB operates under the Commission's oversight. That 
oversight reflects the fact that our staff, by virtue of its day-to-
day activities, often is among the first to identify emerging issues 
and areas of accounting that need attention. As the staff identifies 
issues, such as revenue recognition and accounting for business 
combinations, the staff refers them to the FASB for guidance. It is 
our expectation that, in response to such a referral, the FASB will 
add an item to its agenda to address the issue and will ensure that 
the item receives the priority requested by the Commission or by our 
staff.
    As the FASB conducts its deliberations, our staff monitors each 
project to ensure that the process is fair and deliberative, and 
that any final standard improves financial reporting for investors. 
The Commission staff, however, does not dictate final standards, but 
rather allows the private-sector standard setting process to work. 
Once a FASB project is completed, our staff evaluates the final 
product taken as a whole. We would expect to take action with 
respect to a FASB standard if we determine that the standard does 
not adequately protect the interests of investors.
    As companies adopt new FASB standards, our staff monitors 
implementation,\202\ addresses additional questions, and refers 
unique issues to the FASB's interpretative body, the Emerging Issues 
Task Force (``EITF''). Through this cycle, many EITF issues have 
been addressed at the request of the Commission staff because of 
implementation problems the staff observed in practice.
---------------------------------------------------------------------------

    \202\ In light of the SEC's unique role, it is critical that the 
SEC work closely with the FASB. However, no matter how good 
accounting standards are, there will be instances where answers will 
not be clear and additional guidance will be needed. In these 
instances, we have encouraged registrants and their auditors to 
discuss the issue with the staff prior to the filing of the 
registrant's financial statements. See Preliminary Note to 
Sec. 210.2-01; Staff Accounting Bulletin No. 99, General Comments 
(Aug. 13, 1999).

[FR Doc. 02-16539 Filed 7-3-02; 8:45 am]
BILLING CODE 8010-01-P