[Federal Register Volume 67, Number 206 (Thursday, October 24, 2002)]
[Proposed Rules]
[Pages 65325-65331]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-27115]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release Nos. 34-46685; IC-25773; File No. S7-39-02]
RIN 3235-AI67


Improper Influence on Conduct of Audits

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: As directed by Section 303(a) of the Sarbanes-Oxley Act of 
2002, we are proposing rules to prohibit officers and directors of an 
issuer, and persons acting under the direction of an officer or 
director, from taking any action to fraudulently influence, coerce, 
manipulate or mislead the auditor of the issuer's financial statements 
for the purpose of rendering the financial statements materially 
misleading.

DATES: Comments should be received on or before November 25, 2002.

ADDRESSES: You should send three copies of your comments to Jonathan G. 
Katz, Secretary, U.S. Securities and Exchange Commission, 450 Fifth 
Street, NW, Washington, DC 20549-0609. You also may submit your 
comments electronically to the following address: [email protected]. Please use only one method of delivery. All comment 
letters should refer to File No. S7-39-02; this file number should be 
included in the subject line if you use electronic mail. Comment 
letters will be available for public inspection and copying at the 
Commission's Public Reference Room, 450 Fifth Street, NW, Washington, 
DC 20549-0102. We will post electronically-submitted comment letters on 
the Commission's Internet Web site (http://www.sec.gov). We do not edit 
personal identifying information, such as names or electronic mail 
addresses, from electronic submissions. Submit only information you 
wish to make publicly available.

FOR FURTHER INFORMATION CONTACT: Michael J. Kigin, Associate Chief 
Accountant, or Robert E. Burns, Chief Counsel, at (202) 942-4400, 
Office of the Chief Accountant, or Fiona A. Philip, Senior Counsel, or 
David M. Estabrook, Associate Chief Accountant, at (202) 942-4510, 
Division of Enforcement, U.S. Securities and Exchange Commission, 450 
Fifth Street, NW, Washington, DC 20549.

SUPPLEMENTARY INFORMATION: We are proposing to redesignate rule 13b2-2 
of Regulation 13B-2\1\ as rule 13b2-2(a) and to add new rule 13b2-2(b).
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    \1\ 17 CFR 240.13b2-1 et seq.
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I. Executive Summary

    On July 30, 2002, the Sarbanes-Oxley Act of 2002 (the ``Act'') \2\ 
was enacted. Section 303(a) of the Act states:
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    \2\ Pub. L. 107-204, 116 Stat. 745 (2002).

    It shall be unlawful, in contravention of such rules or 
regulations as the Commission shall prescribe as necessary or 
appropriate in the public interest and for the protection of 
investors, for any officer or director of an issuer, or any other 
person acting under the direction thereof, to take any action to 
fraudulently influence, coerce, manipulate, or mislead any 
independent public or certified accountant engaged in the 
performance of an audit of the financial statements of that issuer 
for the purpose of rendering such financial statements materially 
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misleading.

    As mandated by the Act, the Commission is proposing rules to 
implement section 303(a).\3\ The proposed rules, in combination with 
the existing rules under Regulation 13B-2, are designed to ensure that 
management makes open and full disclosures to, and has honest 
discussions with, the auditor of the issuer's financial statements. 
These rules prohibit officers or directors of an issuer,\4\ or persons 
acting under

[[Page 65326]]

their direction, from subverting the auditor's responsibilities to 
investors to conduct a diligent audit of the financial statements and 
to provide a true report of the auditor's findings.
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    \3\ Section 303 of the Act states:
    (a) RULES TO PROHIBIT.--It shall be unlawful, in contravention 
of such rules or regulations as the Commission shall prescribe as 
necessary or appropriate in the public interest and for the 
protection of investors, for any officer or director of an issuer, 
or any other person acting under the direction thereof, to take any 
action to fraudulently influence, coerce, manipulate, or mislead any 
independent public or certified accountant engaged in the 
performance of an audit of the financial statements of that issuer 
for the purpose of rendering such financial statements materially 
misleading.
    (b) ENFORCEMENT.--In any civil proceeding, the Commission shall 
have exclusive authority to enforce this section and any rule or 
regulation issued under this section.
    (c) NO PREEMPTION OF OTHER LAW.--The provisions of subsection 
(a) shall be in addition to, and shall not supersede or preempt, any 
other provision of law or any rule or regulation issued thereunder.
    (d) DEADLINE FOR RULEMAKING.--The Commission shall ``
    (1) propose the rules or regulations required by this section, 
not later than 90 days after the date of enactment of this Act; and
    (2) issue final rules or regulations required by this section, 
not later than 270 days after that date of enactment.
    \4\ The proposed rules would be included in Regulation 13B-2 
under the Securities Exchange Act of 1934 (``Exchange Act''). 
Section 3(a)(8) of the Exchange Act, 15 U.S.C. 78c(a)(8), defines 
``issuer'' as follows:
    The term ``issuer'' means any person who issues or proposes to 
issue any security; except that with respect to certificates of 
deposit for securities, voting trust certificates, or collateral-
trust certificates, or with respect to certificates of interest or 
shares in an unincorporated investment trust not having a board of 
directors or of the fixed, restricted management, or unit type, the 
term ``issuer'' means the person or persons performing the acts and 
assuming the duties of depositor or manager pursuant to the 
provisions of the trust or other agreement or instrument under which 
such securities are issued; and except with respect to equipment-
trust certificates or like securities, the term ``issuer'' means the 
person by whom the equipment or property is, or is to be, used.
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II. Discussion of Proposed Rules

A. Introduction

    The proposed rules would supplement the rules currently in 
Regulation 13B-2. The current rules address the falsification of books, 
records and accounts \5\ and false or misleading statements, or 
omissions to make certain statements, to accountants.\6\ Proposed rule 
13b2-2(b)(1), which substantially would mirror the language in section 
303(a) of the Act, specifically would prohibit officers and directors, 
and persons acting under their direction, from fraudulently 
influencing, coercing, manipulating or misleading the auditor of the 
issuer's financial statements for the purpose of rendering the issuer's 
financial statements misleading. Proposed rule 13b2-2(b)(2) would 
provide examples of actions that improperly influence an auditor that 
could result in ``rendering the issuer's financial statements 
materially misleading.'' This paragraph also would clarify that such 
actions should not occur at any time in connection with the 
professional engagement.
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    \5\ 17 CFR 240.13b2-1 states that no person shall, directly or 
indirectly, falsify or cause to be falsified, any book, record or 
account subject to section 13(b)(2)(A) of the Exchange Act. Section 
13(b)(2) of the Exchange Act states:
    Every issuer which has a class of securities registered pursuant 
to section 12 of this title and every issuer which is required to 
file reports pursuant to section 15(d) of this title shall (A) make 
and keep books, records, and accounts, which, in reasonable detail, 
accurately and fairly reflect the transactions and dispositions of 
the assets of the issuer.
    \6\ 17 CFR 240.13b2-2 states that no director or officer of an 
issuer, in connection with an audit or examination of the issuer's 
financial statements or the preparation of any document or report to 
be filed with the Commission, directly or indirectly shall (a) make 
or cause to be made a materially false or misleading statement to an 
accountant or (b) omit to state, or cause another person to omit to 
state, any material fact necessary to make statements made, in light 
of the circumstances under which such statements were made, not 
misleading to an accountant.
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B. Discussion

    Proposed rule 13b2-2(b)(1) would address activities by an officer 
or director of an issuer, or any other person acting under the 
direction of an officer or director. The Commission has defined the 
term ``officer'' to include the company's ``president, vice president, 
secretary, treasurer or principal financial officer, comptroller or 
principal accounting officer, and any person routinely performing 
corresponding functions with respect to any organization whether 
incorporated or unincorporated.'' \7\ The term ``officer'' includes an 
issuer's chief executive officer and other executive officers.\8\
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    \7\ Rule 3b-2 under the Exchange Act, 17 CFR 240.3b-2. A person 
may be an ``officer'' for purposes of Rule 3b-2 regardless of the 
person's title or the legal entity with which he or she is 
associated. For example, officers of wholly owned subsidiaries of 
public companies and promoters may be ``officers'' of public 
companies.
    The definition of ``director'' under the Exchange Act has a 
similar functional and flexible nature. See section 3(a)(7) of the 
Exchange Act, 15 U.S.C. 78c(a)(7), which states, ``The term 
`director' means any director of a corporation or any person 
performing similar functions with respect to any organization, 
whether incorporated or unicorporated.''
    \8\ Rule 3b-7 under the Exchange Act, 17 CFR 240.3b-7, states, 
``The term ``executive officer,'' when used with reference to a 
registrant, means its president, vice president of the registrant in 
charge of a principal business unit, division or function (such as 
sales, administration, or finance), any other officer who performs a 
policy making function or any other person who performs similar 
policy making functions for the registrant. Executive officers of 
subsidiaries may be deemed executive officers of the registrant if 
they perform such policy making functions for the registrant.''
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Should We Amend the Definition of ``Officer'' in Rule 3b-2 To Include 
Specific References to Additional Individuals and Entities Who May 
Perform ``Corresponding Functions''? Should We Amend Regulation 13B2 To 
Craft a Special Definition of a Public Company Officer for the Purposes 
of that Regulation? If We Amend Rule 3b-2 or Regulation 13B-2, Who 
Should Be Included or Excluded From the Definition of ``Officer''?
    As noted above, proposed rule 13b2-2(b)(1) would cover the 
activities of not only officers and directors of the issuer who engage 
in an attempt to misstate financial statements but also ``any other 
person acting under the direction thereof.'' Activities by such ``other 
persons'' currently may constitute violations of the anti-fraud or 
other provisions of the securities laws \9\ or aiding or abetting \10\ 
or causing \11\ an issuer's violations of the securities laws. Section 
303(a) and the proposed rule would provide the Commission \12\ with an 
additional means of addressing efforts by persons acting under the 
direction of an officer or director to improperly influence the audit 
process and the accuracy of the issuer's financial statements. We 
interpret Congress' use of the term ``direction'' to encompass a 
broader category of behavior than ``supervision.''\13\ In other words, 
someone may be ``acting under the direction'' of an officer or director 
even if they are not under the supervision or control of that officer 
or director. Such persons might include not only the issuer's employees 
but also, for example, customers, vendors or creditors who, under the 
direction of an officer or director, provide false or misleading 
confirmations or other false or misleading information to auditors, or 
who enter into ``side agreements.'' In appropriate circumstances, 
persons acting under the direction of officers and directors also may 
include other partners or employees of the accounting firm (such as 
consultants or forensic accounting specialists retained by counsel for 
the issuer) and attorneys, securities professionals, or other advisers 
who, for example, pressure an auditor to limit the scope of the audit, 
to issue an unqualified report on the financial statements when such a 
report would be unwarranted,\14\ to not object to an inappropriate 
accounting treatment, or not to withdraw an issued opinion on the 
issuer's financial statements. In the case of a registered investment 
company, persons acting under the direction of officers and directors 
of the investment company may include, among others, officers, 
directors, and employees of the investment company's investment 
adviser, sponsor, depositor, administrator, principal underwriter,

[[Page 65327]]

custodian, transfer agent, or other service providers.\15\
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    \9\ See, e.g., Section 10(b) of the Exchange Act, 15 U.S.C. 78j, 
and Rule 10b-5 thereunder, 17 CFR 240.10b-5.
    \10\ See, e.g., section 20(e) of the Exchange Act, 15 U.S.C. 
78t(e).
    \11\ See, e.g., section 21C of the Exchange Act, 15 U.S.C. 78u-
3.
    \12\ Section 303(b) of the Act states, ``The Commission shall 
have exclusive authority to enforce this section and any rule or 
regulation issued under this section.''
    \13\ See, e.g., Webster's Dictionary (9th edition), which 
defines ``direction'' to include not only guidance or supervision of 
action or conduct but also explicit instruction.
    \14\ ``An `unqualified opinion' [or unqualified report] 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, Statement on Auditing Standards No. (``SAS'') 
58, ``Reports on Audited Financial Statements,'' ] 10; Codification 
of Statements on Auditing Standards (``AU'') Sec.  508.10.
    \15\ Some of these individuals also would be covered under 
provisions of the rule tailored to investment companies. See section 
II.C. of this release, Issues Related to Investment Companies.
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Should We Define by Rule the Scope of ``Any Other Person Acting Under 
the Direction'' of an Officer or Director?
    Proposed rule 13b2-2(b)(1) addresses ``any action to fraudulently 
influence, coerce, manipulate, or mislead'' the auditor of the issuer's 
financial statements for the purpose of rendering the financial 
statements materially misleading. Much of the conduct addressed by this 
section, particularly efforts to ``manipulate or mislead'' the auditor, 
generally would be subject to other provisions of the securities laws 
and the Commission's regulations, including the existing rules in 
Regulation 13B-2. The proposed rule, however, would provide an 
additional means to address conduct to fraudulently influence,\16\ 
coerce, manipulate, or mislead an auditor during his or her examination 
or review of the issuer's financial statements, including conduct that 
did not succeed in affecting the audit or review.\17\ Types of conduct 
that the Commission believes might constitute improper influence 
include, but are not limited to, directly or indirectly:
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    \16\ We view ``fraudulently'' as modifying only ``influence.''
    \17\ It is the act of fraudulently influencing, coercing, 
manipulating, or misleading the auditor, for the purpose of 
rendering misleading financial statements, that is unlawful. There 
is no requirement in section 303(a) of the Act that the purpose be 
achieved.
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    [sbull] Offering or paying bribes or other financial incentives, 
including offering future employment or contracts for non-audit 
services,
    [sbull] Providing an auditor with inaccurate or misleading legal 
analysis,
    [sbull] Threatening to cancel or canceling existing non-audit or 
audit engagements if the auditor objects to the issuer's accounting,
    [sbull] Seeking to have a partner removed from the audit engagement 
because the partner objects to the issuer's accounting,
    [sbull] Blackmailing, and
    [sbull] Making physical threats.
    The facts and circumstances of each case, including the purpose of 
the conduct (as discussed below), would be relevant to determining 
whether the conduct would violate the proposed rule.
Should the Types of Conduct That Might Constitute Actions To 
Fraudulently Influence an Auditor Be Set Forth in the Rule? If so, 
Which Items Listed in the Preceding Paragraph Should Be Included or 
Excluded? What Additional Types of Conduct, if any, Should Be Included?
    Proposed rule 13b2-2(b)(1) would address the improper influence of 
``any independent public or certified public accountant'' engaged in 
the performance of an audit or review of an issuer's financial 
statements.\18\ Prior to the adoption of the Act, similar phrases 
commonly were used in the securities laws and the Commission's 
regulations to refer to the accountant providing audit and review 
services to a Commission registrant. Although the Act, in anticipation 
of accounting firms registering with the Public Company Accounting 
Oversight Board (the ``Board''),\19\ changed several of these 
references,\20\ such terms continue to appear in certain sections of 
the securities law \21\ and related schedules.\22\ We believe that 
section 303 of the Act includes all accountants \23\ engaged in 
auditing or reviewing an issuer's financial statements or issuing 
attestation reports \24\ to be filed with the Commission. Once firms 
are required to register with the Board, the term ``independent public 
or certified public accountant,'' as used in the proposed rule, would 
include registered public accounting firms \25\ and persons associated 
with such a public accounting firm,\26\ as defined in the Act.
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    \18\ Section 303(a) uses the phrase ``independent public or 
certified accountant,'' which appears, for example, in items 25, 26 
and 27 of Schedule A to the Securities Act of 1933. 15 U.S.C. 
77aa(25), (26) and (27). Since the passage of the 1933 Act, however, 
the general reference to ``certified accountant'' has been replaced 
by ``certified public accountant.'' To avoid any possible confusion, 
we have used ``certified public accountant'' in the proposed rules.
    \19\ See section 102 of the Act, which provides that beginning 
180 days after the Commission determines that the Board, as 
established by Title I of the Act, is appropriately organized and 
has the capacity to carry out and enforce the requirements of that 
title, it shall be unlawful for any person that is not a registered 
public accounting firm to prepare any audit report with respect to 
any issuer.
    \20\ See, e.g., sections 205(b) and (c) of the Act.
    \21\ See, e.g., section 13(a) of the Exchange Act, 15 U.S.C. 
78m(a), and section 8(e) of the Securities Act of 1933 (the ``1933 
Act''), 15 U.S.C. 77h(e).
    \22\ See, e.g., items 25, 26 and 27 of Schedule A of the 1933 
Act, 15 U.S.C. 77aa(25), (26) and (27).
    \23\ The rule would apply regardless of whether the accountant 
was a certified public accountant. For example, some states require 
accountants to have years of experience before being deemed to be a 
CPA. Efforts to mislead such an individual during his or her 
performance of audit procedures would fall within the proposed 
rules.
    \24\ See, e.g., section 404 of the Act, which mandates that the 
Commission prescribe rules that require (1) each annual report filed 
under sections 13(a) and 15(d) of the Exchange Act contain a 
management statement of responsibilities for, and assessment of the 
effectiveness of, the issuer's internal control structure and 
procedures for financial reporting, and (2) the auditor to attest 
to, and report on, the assessment made by management.
    \25\ Section 2(a)(12) of the Act defines ``registered public 
accounting firm'' to mean ``a public accounting firm registered with 
the Board in accordance with this Act.''
    \26\ Section 2(a)(9)(A) of the Act defines ``person associated 
with a public accounting firm'' (or with a ``registered public 
accounting firm'') to mean ``any individual proprietor, partner, 
shareholder, principal, accountant, or other professional employee 
of a public accounting firm, or any other independent contractor or 
entity that, in connection with the preparation or issuance of any 
audit report--(i) shares in the profits of, or receives compensation 
in any other form from, that firm, or (ii) participates as agent or 
otherwise on behalf of such accounting firm in any activity of that 
firm.'' The Board, in section 2(a)(9)(B) of the Act, is given 
limited authority to exempt persons performing only ministerial 
tasks.
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Should We Define by Rule the Phrase ``Independent Public or Certified 
Public Accountant''? The Rules Currently in Regulation 13B-2 Refer to 
``Accountant'' as Opposed to ``Independent Public or Certified Public 
Accountant.'' Should These Rules, or the Proposed Rules, be Changed To 
Refer to the Same Term? Which Term Should Be Used?
    Proposed rule 13b2-2(b)(1) tracks the language in section 303(a) of 
the Act regarding the improper influence of an accountant ``engaged in 
the performance of an audit'' of the issuer's financial statements. 
Both the Commission \27\ and the accounting profession \28\ have 
recognized that the need for an auditor to maintain an independent and 
unbiased attitude begins when the accountant is selected to perform 
audit

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or review services and continues until there is a formal or informal 
public notification that the professional relationship has ended.\29\ 
To effectuate the intent of Congress, we believe the phrase ``engaged 
in the performance of an audit'' should be given a broad reading. We 
believe Congress intended that the phrase encompass the professional 
engagement period and any other time the auditor is called upon to make 
decisions regarding the issuer's financial statements, including during 
negotiations for retention of the auditor and subsequent to the 
professional engagement period when the auditor is considering whether 
to issue a consent on the use of prior years' audit reports. The 
proposed rules, therefore, would apply throughout the professional 
engagement and after the professional engagement has ended when the 
auditor is considering whether to consent to the use of, reissue, or 
withdraw prior audit reports. In limited circumstances, the proposed 
rules also may apply before the professional engagement period begins. 
For example, the proposed rules would apply if an officer, director, or 
person acting under the direction of an officer or director, offers to 
engage an accounting firm on the condition that the firm either issue 
an unqualified audit report on financial statements that do not conform 
with generally accepted accounting principles, or limit the scope or 
performance of audit or review procedures in violation of generally 
accepted auditing standards.
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    \27\ Rule 2-01(f)(5)(ii) of Regulation S-X, 15 CFR 210.2-
01(f)(5)(ii), which defines the ``professional engagement period'' 
to be: ``The period of the engagement to audit or review the audit 
client's financial statements or to prepare a report filed with the 
Commission,'' and states: ``(A) 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 begins audit, review, or attest procedures, whichever 
is earlier; and (B) The professional engagement period ends when the 
audit client or the accountant notifies the Commission that the 
client is no longer that accountant's audit client.''
    \28\ American Institute of Certified Public Accountants 
(``AICPA'') Code of Professional Conduct, ET Sec.  101.02, which 
states:
    The period of a professional engagement starts when the [AICPA] 
member begins to perform any professional engagement requiring 
independence for an enterprise, lasts for the entire duration of the 
professional relationship, which could cover many periods, and ends 
with the formal or informal notification of the termination of the 
professional relationship either by the member, by the enterprise, 
or by the issuance of a report, whichever is later. Accordingly, the 
professional engagement does not end with the issuance of a report 
and recommence with the signing of the following year's engagement.
    \29\ Changes in the principal auditor of an issuer's financial 
statements are reported under item 4 of Form 8-K, 17 CFR 249.308. 
See also item 304 of Regulation S-K, 17 CFR 229.304, and item 304 of 
Regulation S-B, 17 CFR 228.304.
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Should Proposed Rule 13b2-2(b)(2) Provide a Specific Definition of 
``Engaged in the Performance of an Audit''?
    To be actionable under section 303 of the Act, the conduct must be 
``for the purpose of rendering [the issuer's] financial statements 
materially misleading.'' \30\ Because the financial statements are 
prepared by management and the auditor conducts an audit or review of 
those financial statements, the auditor would not directly ``render 
[the] financial statements materially misleading.'' Rather, the auditor 
might be improperly influenced to, among other things, issue an 
unwarranted report on the financial statements,\31\ including 
suggesting or acquiescing in the use of inappropriate accounting 
treatments \32\ or not proposing adjustments required for the financial 
statements to conform with generally accepted accounting 
principles.\33\ An auditor also might be fraudulently influenced, 
coerced, manipulated or misled not to perform audit or review 
procedures that, if performed, might divulge material misstatements in 
the financial statements. Other examples of activities that would fall 
within the proposed rule would be for an officer, director, or person 
acting under an officer or director's direction, to improperly 
influence an auditor either not to withdraw a previously issued audit 
report when required by generally accepted auditing standards,\34\ or 
not to communicate appropriate matters to the audit committee.\35\ 
Proposed rule 13b2-2(b)(2) would make it clear that subparagraph (b)(1) 
would apply in such circumstances. As noted, the proposed rule would 
not be limited to the audit of the annual financial statements, but 
would include, among other things, improperly influencing an auditor 
during a review of interim financial statements \36\ or in connection 
with the issuance of a consent to the use of an auditor's report.\37\ 
Conducting reviews of interim financial statements and issuing consents 
to use past audit reports are sufficiently connected to the audit 
process, and improper influences during those processes are 
sufficiently connected to the harms that the Act seeks to prevent, that 
they should be within the scope of the proposed rules. The list of 
examples in the proposed rule is only illustrative; other actions also 
could result in rendering the financial statements materially 
misleading.
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    \30\ There is no such requirement for Rule 13b2-1 or Rule 13b2-
2.
    \31\ See Report of the Committee on Banking, Housing, and Urban 
Affairs, To Accompany S. 2673, ``Public Company Accounting Reform 
and Investor Protection Act of 2002,'' 107th Cong., 2d Sess., (S.R. 
107-205), at 26 (Comm. Print, July 3, 2002), which states that 
section 303 makes it unlawful for any officer or director of an 
issuer, or any person acting under the direction of an officer or 
director, to fraudulently influence, coerce, manipulate, or mislead 
the auditor of the issuer's financial statements ``for the purpose 
of rendering the audit report misleading.'' (Emphasis added.)
    \32\ For example, an auditor might be fraudulently influenced to 
allow an issuer to correct material misstatements over time, or not 
to restate prior period financial statements, in violation of 
generally accepted accounting principles.
    \33\ See section 401(a) of the Act, which, among other things, 
adds section 13(i) to the Exchange Act, which requires that 
financial statements prepared in accordance with (or reconciled to) 
generally accepted accounting principles and filed with the 
Commission reflect all material correcting adjustments identified by 
a registered public accounting firm.
    \34\ See, e.g., SAS 1, ``Subsequent Discovery of Facts Existing 
at the Date of the Auditor's Report,'' AU Sec.  561.
    \35\ See, e.g., section 204 of the Act, which adds section 
10A(k) to the Exchange Act and requires each registered public 
accounting firm to report certain matters to the audit committee, 
and AICPA, SAS 61, ``Communication With Audit Committees'' (as 
amended by SAS 89 and SAS 90).
    \36\ See Rule 10-01(d) of Regulation S-X, 17 CFR 210.10-01(d).
    \37\ See, e.g., section 7(a) of the Securities Act of 1933, 15 
U.S.C. 77g, which states in part, ``If any accountant * * * is named 
as having prepared or certified any part of the registration 
statement, the written consent of such person shall be filed with 
the registration statement''; Rule 436 under the Securities Act of 
1933, 17 CFR 230.436.
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Is Subparagraph (b)(2) of the Proposed Rule Helpful or Necessary? 
Should it Be Deleted? If Subparagraph (b)(2) Should Be Adopted, are the 
Examples Appropriately Illustrative? Should More, or Fewer, Examples Be 
Included in the Rule? If so, What Examples Should be Added or Removed?
    Section 303(a) states that conduct by an officer, director, or 
person acting under the direction of the officer or director designed 
to improperly influence an issuer's auditor is actionable if undertaken 
``for the purpose of'' rendering the issuer's financial statements 
materially misleading. Under the proposed rule, an officer, director, 
or person acting under the direction of the officer who engaged in 
conduct to improperly influence an auditor would be culpable if he or 
she knew, or was unreasonable in not knowing, that the improper 
influence could, if successful, result in rendering financial 
statements materially misleading.\38\
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    \38\ We believe that the mental state requirements of the 
proposed rules generally should be construed consistently with the 
existing rules in Regulation 13B-2. Because there is no private 
right of action, among other reasons, the Commission believes that a 
lesser standard of liability is appropriate. See Release No. 34-
15570 (Feb. 15, 1979); 44 Federal Register 10970. See also, Report 
of the Committee on Banking, Housing, and Urban Affairs, To 
Accompany S. 2673, ``Public Company Accounting Reform and Investor 
Protection Act of 2002,'' 107th Cong., 2d Sess., (S.R. 107-205), at 
26 (Comm. Print, July 3, 2002), which cites as a reason for enacting 
section 303 the testimony of witnesses who were concerned with 
addressing fraud and other ``misconduct in the audit process.''
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    The Commission is considering strongly other wording changes to 
make the rule effective in preventing improper influences. There are 
several changes, individually or collectively, that could accomplish 
that objective, and we solicit comment on the best approach. For 
example:
    1. Should we replace the statement in subparagraphs (b)(1) and (c) 
that no person acting ``under the direction'' of an officer or director 
shall improperly influence the auditors of the issuer's financial 
statements, with a statement that no person acting ``at the behest of'' 
or ``on behalf of'' an officer or director shall improperly influence 
the auditors. Such language might better indicate that no specific 
direction by an officer or

[[Page 65329]]

director is required to violate the proposed rules.
    2. Should the word ``fraudulently'' in subparagraphs (b)(1) and 
(c)(2) be replaced with the word ``improperly'' or some other word to 
convey a mental state short of scienter?
    3. Should the phrase in subparagraphs (b)(1) and (c)(2) that ``if 
the person knew or was unreasonable in not knowing that such action 
could, if successful, result in rendering such financial statements 
materially misleading'' be replaced with ``for the purpose of, or have 
the effect of, rendering the financial statements materially 
misleading'' or some other phrase to convey that proving a particular 
purpose or intent is not required?

C. Issues Related to Investment Companies

    In contrast to other issuers, investment companies generally have 
contracts with service providers that perform virtually all of the 
management, administrative, and other services necessary to the 
investment company's operations, including preparation of the financial 
statements. These entities may include an investment company's 
investment adviser, sponsor, depositor, trustee, and administrator. For 
registered investment companies and business development companies,\39\ 
the proposed prohibition on improper influence on the conduct of audits 
would cover not only officers and directors of the investment company 
itself, but also officers and directors of the investment company's 
investment adviser, sponsor, depositor, trustee, and administrator.\40\ 
We are also proposing to amend existing rule 13b2-2 to cover officers 
and directors of these entities.\41\
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    \39\ Business development companies are a category of closed-end 
investment companies that are not required to register under the 
Investment Company Act of 1940. See 15 U.S.C. Sec.  80a-2(a)(48) 
(defining business development companies).
    \40\ Proposed rule 13b2-2(c)(2).
    \41\ Proposed rule 13b2-2(c)(1).
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Is it Necessary or Appropriate To Expressly Extend the Prohibition on 
Improper Influence on the Conduct of Audits, and Existing Rule 13b2-2, 
to Officers and Directors of the Investment Company's Service 
Providers? If so, Which Service Providers Should Be Covered?

III. General Request for Comments

    We invite any interested person wishing to submit written comments 
on the proposed rules to do so. We specifically request comments from 
investors, accounting firms and registrants. We solicit comment on each 
component of the proposal.

IV. Paperwork Reduction Act

    The Paperwork Reduction Act is not applicable to the proposed rules 
because they do not impose any collection of information requirements.

V. Costs and Benefits

    The proposed rules implement a Congressional mandate. We recognize, 
however, that any implementation of the Act likely will result in costs 
and benefits and have an effect on the economy.
    Because much of the conduct addressed by Section 303(a) and the 
proposed rules generally was prohibited under provisions of the 
securities laws that existed before enactment of the Sarbanes-Oxley 
Act, we do not anticipate that the proposed rules would increase 
significantly costs for issuers or accounting firms. Nonetheless, the 
Act and proposed rules might prompt some issuers to adopt procedures or 
guidelines that would assure additional care would be used by an 
issuer's officers and directors, and others acting under their 
direction, in communicating with auditors of the issuer's financial 
statements. For example, some issuers might require that more 
discussions include members of senior management or the issuer's legal 
counsel. Because no particular procedures related to such 
communications are required, and the nature and scope of those 
procedures are likely to vary among issuers, it is difficult to provide 
an accurate cost estimate.
    As noted above, in some circumstances the proposed rules might 
apply before the professional engagement period begins. For example, 
the proposed rules would apply if an officer, director, or person 
acting under the direction of an officer or director, offers to engage 
an accounting firm on the condition that the firm either issue an 
unqualified audit report on financial statements that do not conform 
with generally accepted accounting principles, or limit the scope or 
performance of audit or review procedures in violation of generally 
accepted auditing standards. We believe, however, that such conduct 
would not be permitted under existing laws and regulations and, 
accordingly, the proposed rules should not result in a significant 
increase in costs for issuers.
    Potential benefits of the proposed rules include increased investor 
confidence in the integrity of the audit process and, in turn, in the 
reliability of reported financial information. One of the most 
important factors in the successful operation of our securities markets 
is the trust that investors have in the reliability of the information 
used to make voting and investment decisions.\42\
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    \42\ See Accounting Series Release No. 296 (Aug. 20, 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.
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    Section 303(a) and the proposed rules are designed to provide added 
assurance that the full-disclosure purposes of the securities laws are 
fulfilled,\43\ and to help restore the faith of America's investors in 
the integrity of the audit process and in the reliability of reported 
financial information. If section 303 of the Act and the proposed rules 
lead to increased investor confidence in financial reporting, they also 
may facilitate capital formation. An increased willingness of investors 
to participate in the securities markets might result in issuers being 
able to lower their cost of capital.
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    \43\ See, e.g., H.R. Rep. No. 1383, 73rd Cong., 2d Sess., 11 
(1934), which states: Just as artificial manipulation tends to upset 
the true function of an open market, so the hiding and secreting of 
important information obstructs the operation of the markets as 
indices of real value. There cannot be honest markets without honest 
publicity. Manipulation and dishonest practices of the market place 
thrive upon mystery and secrecy.
    This House Report also includes a letter from the Executive 
Assistant of the Committee on Stock List for the New York Stock 
Exchange, which recognizes management's need for accurate financial 
information and then states: [U]nder the conditions of today, the 
next object in order of importance has become to give stockholders, 
in understandable form, such information in regard to the business 
as will avoid misleading them in any respect and as will put them in 
possession of all information needed, and which can be supplied in 
financial statements, to determine the true value of their 
investments. * * * The exchange is interested in the accounts of 
companies as a source of reliable information for those who deal in 
stocks. It is not sufficient for the stock exchange that the 
accounts should be in conformity with law or even that they should 
be conservative; the stock exchange desires that they should be 
fully and fairly informative. Id. at 12.
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VI. Initial Regulatory Flexibility Analysis

    This Initial Regulatory Flexibility Act Analysis has been prepared 
in accordance with 5 U.S.C. 603. It relates to the proposed revisions 
to rule 13b2-2 of Regulation 13B-2. The proposals would implement the 
statutory prohibition on officers and directors of an issuer, and 
persons acting under

[[Page 65330]]

their direction, improperly influencing the conduct of an audit or 
review of the issuer's financial statements.

A. Reasons for, and Objectives of, the Proposed Rules

    The purpose of the proposed rules is to implement section 303(a) of 
the Act. The proposed rules would prohibit officers and directors of 
issuers, including ``small businesses,'' and persons acting under their 
direction, from improperly influencing an accounting firm's audit or 
review of the issuer's financial statements. Today, it could be alleged 
generally that such conduct violated the anti-fraud or other provisions 
of the securities laws or aided and abetted or caused the issuer's 
violations of those sections. The proposed rules, and section 303(a) of 
the Act, would provide the Commission with an additional means to 
address such conduct and are intended to enhance the credibility of 
financial statements.

B. Legal Basis

    We are proposing the amendments under the authority set forth in 
sections 3(a) and 303 of the Act; Schedule A and sections 5, 6, 7, 8, 
10 and 19 of the 1933 Act; Sections 3, 10A, 12, 13, 14, 15, 17 and 23 
of the Exchange Act; and Sections 6, 8, 20, 30, 31 and 38 of the 
Investment Company Act of 1940.

C. Small Entities Subject to the Proposed Rules

    The proposals would affect small registrants that are small 
entities. Exchange Act Rule 0-10(a) \44\ and 1933 Act Rule 157 \45\ 
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 approximately 2,500 companies 
are small entities, other than investment companies.
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    \44\ 17 CFR 240.0-10(a).
    \45\ 17 CFR 230.157.
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    For purposes of the Investment Company Act, Rule 0-10 \46\ 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 approximately 225 investment companies meet this 
definition.
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    \46\ 17 CFR 270.0-10.
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D. Reporting, Recordkeeping and Other Compliance Requirements

    The enactment of section 303(a) of the Act and the adoption of the 
proposed rules might result in some issuers adopting more detailed 
procedures for communications between the company and the accounting 
firm that audits the company's financial statements. These procedures 
might increase costs associated with compliance with the securities 
laws.
    At this time, we cannot estimate the likely burden that would be 
incurred by small businesses, although we assume the burden would be 
minor for most issuers.

E. Duplicative, Overlapping or Conflicting Federal Rules

    We are not aware of any federal rules that conflict with the 
proposed rules. The improper conduct directly addressed in section 
303(a) and the proposed rules, however, also under certain 
circumstances may constitute violations of the existing rules in 
Regulation 13B-2 or other sections of the securities laws. We were 
directed by Congress to perform this rulemaking, and section 303(c) of 
the Act expressly states that rules adopted under the section are in 
addition to and do not preempt or supersede any other rule or 
regulation.

F. 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 rules 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.
    Section 303(a) of the Act does not provide an exemption for small 
businesses. The section does provide, however, that the rules adopted 
by the Commission should be ``as necessary and appropriate in the 
public interest and for the protection of investors.'' We are inclined 
to apply the proposals to small business issuers. We believe investors 
in small companies, just as investors in large companies, would want 
and benefit from the added confidence in reported financial information 
that comes from knowing that efforts to fraudulently influence the 
performance of the audit have been prohibited.
    We are using a performance standard rather than a design standard. 
In addition, Congress has dictated the timetable for this rulemaking.
    We request comment on whether it is feasible to further clarify, 
consolidate, or simplify the proposed rules for small entities.

G. Solicitation of Comments

    We encourage the submission of comments with respect to any aspect 
of this Initial Regulatory Flexibility Analysis. Specifically, we 
request comments regarding the number of small entities that may be 
affected by the proposed rules and the existence or nature of the 
potential impact on those small entities.
    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.

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,\47\ we are requesting information regarding the 
impact of the proposed rules on an annual basis. Commenters should 
provide empirical data to support their views.
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    \47\ Pub. L. 104-121, title II, 110 Stat. 857 (1996).
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    Section 23(a)(2) of the Exchange Act \48\ requires us, when 
adopting rules under the Exchange Act, to consider the impact on 
competition of any rule we adopt. Section 2(b) of the 1933 Act,\49\ 
section 3(f) of the Exchange Act,\50\ and section 2(c) of the 
Investment Company Act of 1940,\51\ require us, when engaging in 
rulemaking where we are required to consider or determine whether the 
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.
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    \48\ 15 U.S.C. 78w(a)(2).
    \49\ 15 U.S.C. 77b(b).
    \50\ 15 U.S.C. 78c(f).
    \51\ 15 U.S.C. 80a-2(c). to be filed with the Commission if that 
person knew or was unreasonable in not knowing that such action 
could, if successful, result in rendering such financial statements 
materially misleading.
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    The proposed rules would prohibit improper influences on auditors 
in connection with their reviews and

[[Page 65331]]

audits of financial statements filed with the Commission. The 
proposals, therefore, should enhance investor confidence in the audit 
process and in the quality of information available to them, and lead 
to a more efficient market.
    Because of the nature of the proposed rules, we do not believe that 
they would impose any burden on competition. They prohibit equally all 
officers and directors of public companies (and persons acting under 
their direction) from improperly influencing the auditor.
    As noted in the cost-benefit section, if section 303 of the Act and 
the proposed rules lead to increased investor confidence in financial 
reporting, they also may facilitate capital formation. An increased 
willingness of investors to participate in the securities markets might 
result in issuers being able to lower their cost of capital. The 
possible effects of the proposed rules on efficiency, competition, and 
capital formation, however, are difficult to quantify. We request 
comment on these matters in connection with our proposed rules.

VIII. Statutory Authority

    We are proposing the new rules under the authority set forth in 
sections 3(a) and 303 of the Act; Schedule A and sections 5, 6, 7, 8, 
10 and 19 of the 1933 Act; Sections 3, 10A, 12, 13, 14, 15, 17 and 23 
of the Exchange Act; and Sections 6, 8, 20, 30, 31 and 38 of the 
Investment Company Act of 1940.

Text of Proposed Rules and Amendments

List of Subjects in 17 CFR Part 240

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

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    1. The authority citation for part 240 continues to read, in part, 
as follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 
78w, 78x, 78ll, 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-
3, 80b-4 and 80b-11, unless otherwise noted.
* * * * *
    2. Section 240.13b2-2 is revised to read as follows:


Sec.  240.13b2-2  Issuer's representations and conduct in connection 
with the preparation of required reports and documents.

    (a) No director or officer of an issuer shall, directly or 
indirectly:
    (1) Make or cause to be made a materially false or misleading 
statement; or
    (2) Omit to state, or cause another person to omit to state, any 
material fact necessary in order to make statements made, in light of 
the circumstances under which such statements were made, not misleading 
to an accountant in connection with:
    (i) Any audit or examination of the financial statements of the 
issuer required to be made pursuant to this subpart; or
    (ii) The preparation or filing of any document or report required 
to be filed with the Commission pursuant to this subpart or otherwise.
    (b)(1) No officer or director of an issuer, or any other person 
acting under the direction thereof, shall directly or indirectly take 
any action to fraudulently influence, coerce, manipulate, or mislead 
any independent public or certified public accountant engaged in the 
performance of an audit or review of the financial statements of that 
issuer that are required to be filed with the Commission if that person 
knew or was unreasonable in not knowing that such action could, if 
successful, result in rendering such financial statements materially 
misleading.
    (2) For purposes of paragraphs (b)(1) and (c)(2) of this section, 
actions that ``could, if successful, result in rendering such financial 
statements materially misleading'' include, but are not limited to, 
actions taken at any time with respect to the professional engagement 
period to fraudulently influence, coerce, manipulate, or mislead an 
auditor:
    (i) To issue a report on an issuer's financial statements that is 
not warranted in the circumstances (due to material violations of 
generally accepted accounting principles, generally accepted auditing 
standards, or other standards);
    (ii) Not to perform audit, review or other procedures required by 
generally accepted auditing standards or other professional standards;
    (iii) Not to withdraw an issued report; or
    (iv) Not to communicate matters to an issuer's audit committee.
    (c) In addition, in the case of an investment company registered 
under section 8 of the Investment Company Act of 1940 (15 U.S.C. 80a-
8), or a business development company as defined in section 2(a)(48) of 
the Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(48)), no officer 
or director of the company's investment adviser, sponsor, depositor, 
trustee, or administrator (or, in the case of paragraph (c)(2) of this 
section, any other person acting under the direction thereof) shall, 
directly or indirectly:
    (1)(i) Make or cause to be made a materially false or misleading 
statement; or
    (ii) Omit to state, or cause another person to omit to state, any 
material fact necessary in order to make statements made, in light of 
the circumstances under which such statements were made, not misleading 
to an accountant in connection with:
    (A) Any audit or examination of the financial statements of the 
investment company required to be made pursuant to this subpart; or
    (B) The preparation or filing of any document or report required to 
be filed with the Commission pursuant to this subpart or otherwise; or
    (2) Take any action to fraudulently influence, coerce, manipulate, 
or mislead any independent public or certified public accountant 
engaged in the performance of an audit or review of the financial 
statements of that investment company that are required to be filed 
with the Commission if that person knew or was unreasonable in not 
knowing that such action could, if successful, result in rendering such 
financial statements materially misleading.

    Dated: October 18, 2002.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-27115 Filed 10-23-02; 8:45 am]
BILLING CODE 8010-01-P