[Federal Register Volume 67, Number 229 (Wednesday, November 27, 2002)]
[Proposed Rules]
[Pages 71018-71025]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-30036]



[[Page 71017]]

-----------------------------------------------------------------------

Part III





Securities and Exchange Commission





-----------------------------------------------------------------------



17 CFR Part 210



Retention of Records Relevant to Audits and Reviews; Proposed Rule

  Federal Register / Vol. 67, No. 229 / Wednesday, November 27, 2002 / 
Proposed Rules  

[[Page 71018]]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 210

[Release Nos. 33-8151; 34-46869; IC-25830; File No. S7-46-02]
RIN 3235-AI74


Retention of Records Relevant to Audits and Reviews

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

-----------------------------------------------------------------------

SUMMARY: As directed by section 802 of the Sarbanes-Oxley Act of 2002, 
we are proposing rules requiring accounting firms to retain for five 
years certain records relevant to their audits and reviews of issuers' 
financial statements. Records to be retained would include an 
accounting firm's workpapers and certain other documents that contain 
conclusions, opinions, analyses, or financial data related to the audit 
or review.

DATES: Comments should be received on or before December 27, 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. S7-46-02; 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: Samuel L. Burke, Associate Chief 
Accountant, Robert E. Burns, Chief Counsel, or D. Douglas Alkema, 
Professional Accounting Fellow, at (202) 942-4400, Office of the Chief 
Accountant, U.S. Securities and Exchange Commission, 450 Fifth Street, 
NW., Washington, DC 20549-1103.

SUPPLEMENTARY INFORMATION: We are proposing to add rule 2-06 to 
Regulation S-X.

I. Executive Summary

    As mandated by section 802 of the Sarbanes-Oxley Act of 2002 
(``Sarbanes-Oxley Act'' or ``the Act''),\1\ we are proposing to amend 
Regulation S-X to require accountants who audit or review an issuer's 
financial statements to retain certain records relevant to that audit 
or review for a period of five years from the end of the fiscal year in 
which an audit or review was concluded. These records would include 
workpapers and other documents that form the basis of the audit or 
review, and memoranda, correspondence, communications, other documents, 
and records (including electronic records), which are created, sent or 
received in connection with the audit or review, and contain 
conclusions, opinions, analyses, or financial data related to the audit 
or review. Records described in the proposed rules would be retained 
whether the conclusions, opinions, analyses, or financial data in the 
records would support or cast doubt on the final conclusions reached by 
the auditor.
---------------------------------------------------------------------------

    \1\ Pub. L. 107-204, 116 Stat. 745 (2002).
---------------------------------------------------------------------------

II. Discussion of Proposed Rule

    Section 802 of the Sarbanes-Oxley Act \2\ is intended to address 
the destruction or fabrication of evidence and the preservation of 
``financial and audit records.'' \3\ We are directed under that section 
to promulgate rules related to the retention of records relevant to the 
audits and reviews of financial statements that issuers file with the 
Commission.
---------------------------------------------------------------------------

    \2\ Section 802 of the Sarbanes-Oxley Act, among other things, 
adds sections 1519 and 1520 to Chapter 73 of Title 18 of the United 
States Code. Section 1519 states, among other things, that anyone 
who knowingly alters, destroys, mutilates, conceals, covers up, 
falsifies, or makes a false entry in any record, document, or 
tangible object with the intent to impede, obstruct, or influence an 
investigation or proper administration of any matter within the 
jurisdiction of any department or agency of the United States or any 
case filed under the bankruptcy code, or in relation to or 
contemplation of any such matter or case, may be fined, imprisoned 
for not more than 20 years, or both.
    Section 1520(a)(1) specifies that: ``Any accountant who conducts 
an audit of an issuer of securities to which section 10A(a) of the 
Securities Exchange Act of 1934 applies, shall maintain all audit or 
review workpapers for a period of 5 years from the end of the fiscal 
period in which the audit or review was concluded.'' Section 
1520(a)(2) directs the Commission to promulgate, by January 26, 
2003:
    ``* * * such rules and regulations, as are reasonably necessary, 
relating to the retention of relevant records such as workpapers, 
documents that form the basis of an audit or review, memoranda, 
correspondence, communications, other documents, and records 
(including electronic records) which are created, sent, or received 
in connection with an audit or review and contain conclusions, 
opinions, analyses, or financial data relating to such an audit or 
review, which is conducted by an accountant who conducts an audit of 
an issuer of securities to which section 10A(a) of the Securities 
Exchange Act of 1934 (15 U.S.C. 78j-1(a)) applies. The Commission 
may, from time to time, amend or supplement the rules and 
regulations that it is required to promulgate under this section, 
after adequate notice and an opportunity for comment, in order to 
ensure that such rules and regulations adequately comport with the 
purposes of this section.''
    Section 1520 also provides that any person who knowingly and 
willfully violates subsection (a)(1), or any rule or regulation 
promulgated by the Securities and Exchange Commission under 
subsection (a)(2), may be fined, imprisoned for not more than 10 
years, or both. It further provides that nothing in section 1520 
shall be deemed to diminish or relieve any person of any other duty 
or obligation imposed by Federal or State law or regulation to 
maintain, or refrain from destroying, any document.
    \3\ Floor statement by Senator Leahy, 148 Cong. Rec. S7418 (July 
26, 2002).
---------------------------------------------------------------------------

    Section 802 states that the record retention requirements should 
apply to audits of issuers of securities to which section 10A(a) of the 
Securities Exchange Act of 1934 (``Exchange Act'') applies. The term 
``issuer'' in this context is defined in section 10A(f) of the Exchange 
Act to include certain entities filing reports under that Act and 
entities that have filed and not withdrawn registration statements to 
sell securities under the Securities Act of 1933.\4\ We also are 
proposing that the record retention requirements apply to any audit or 
review of the financial statements of any registered investment 
company.\5\ We believe that it is

[[Page 71019]]

important for these record retention requirements, like our other 
record retention requirements, to apply consistently with respect to 
all registered investment companies, regardless of whether they fall 
within the periodic reporting requirements of the Exchange Act.\6\
---------------------------------------------------------------------------

    \4\ Section 802 states that the record retention requirement 
applies to ``an audit of an issuer of securities to which section 
10A(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78j-1(a)) 
applies.'' Section 10A(a) of the Securities Exchange Act of 1934 
(``Exchange Act'') states, ``Each audit required pursuant to this 
title of the financial statements of an issuer by an independent 
public accountant shall include'' designated procedures. Section 
10A(f), which has been added to the Exchange Act by section 205(d) 
of the Sarbanes-Oxley Act, states: ``As used in this section the 
term `issuer' means an issuer (as defined in section 3 [of the 
Exchange Act]), the securities of which are registered under section 
12, or that is required to file reports pursuant to section 15(d), 
or that files or has filed a registration statement that has not yet 
become effective under the Securities Act of 1933 (15 U.S.C. 77a et 
seq.), and that it has not withdrawn.'' Section 3(a)(8) of the 
Exchange Act, 15 U.S.C. 78c(a)(8), states that, with certain 
exceptions, an ``issuer'' is ``any person who issues or proposes to 
issue any security* * *. ''
    Neither section 802 nor the proposed rules exempt auditors of 
foreign issuers' financial statements. Accordingly, the retention 
requirements would apply to domestic and foreign accounting firms 
conducting audits or reviews of foreign issuers' financial 
statements.
    Because investment advisers and broker-dealers are not 
necessarily issuers, audits of their financial statements required 
for regulatory purposes would not be subject to the proposed rules. 
In other words, only the audits of the financial statements of 
investment advisers and broker-dealers meeting the definition of 
``issuer'' in section 10A(f), or that are registered investment 
companies, would be subject to the retention requirements in the 
proposed rules.
    \5\ See section 8 of the Investment Company Act of 1940, 15 
U.S.C. 80a-8.
    \6\ Cf. rules 31a-1 and 31a-2 under the Investment Company Act 
of 1940, 17 CFR 270.31a-1 and 31a-2 (record-keeping and record-
retention requirements for registered investment companies).
---------------------------------------------------------------------------

Documents To Be Retained and Time of Retention

    Paragraph (a) of proposed rule 2-06 would identify the documents 
that must be retained and the time period for retaining those 
documents.\7\ In both instances, we have followed the guidance in 
section 802.
---------------------------------------------------------------------------

    \7\ The Commission's proposals are not intended to pre-empt or 
supersede any other federal or state record retention requirements.
---------------------------------------------------------------------------

    The proposed rule would require that the auditor \8\ retain 
workpapers and other documents that form the basis of the audit or 
review of an issuer's financial statements, and memoranda, 
correspondence, communications, other documents, and records (including 
electronic records) that meet two criteria. The two criteria are that 
the materials (1) are created, sent or received in connection with the 
audit or review, and (2) contain conclusions, opinions, analyses, or 
financial data related to the audit or review. The proposed rule, 
therefore, would require an auditor to retain any materials satisfying 
both criteria. Non-substantive materials that are not part of the 
workpapers, however, such as administrative records, and other 
documents that do not contain relevant financial data or the auditor's 
conclusions, opinions or analyses would not meet the second of these 
criteria and would not have to be retained.\9\
---------------------------------------------------------------------------

    \8\ Proposed rule 2-06 uses the term ``accountant,'' which is 
defined in rule 2-01(f)(1) of the Commission's auditor independence 
rules, 17 CFR 210.2-01(f)(1), to mean ``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 or public accountant is affiliated.'' In a comparison 
release, the Commission is proposing to amend this definition to 
include the term ``registered public accounting firm.'' We would 
apply the definition in rule 2-01(f)(1) to proposed rule 2-06. 
Because the definition would continue to reference certified public 
accountants and public accountants, the Commission could make the 
proposed rules effective before accounting firms register with the 
Public Company Accounting Oversight Board.
    \9\ Senator Leahy stated on the Senate floor, ``Non-substantive 
materials, however, which are not relevant to the conclusions or 
opinions expressed (or not expressed), need not be included in such 
retention regulations.'' 148 Cong. Rec. S7419 (July 26, 2002).
---------------------------------------------------------------------------

    The period for retention of these materials is five years after the 
end of the fiscal period in which an accountant audits or reviews an 
issuer's financial statements,\10\ which is the period prescribed by 
section 802.\11\
---------------------------------------------------------------------------

    \10\ The retention period is not based on the fiscal period 
covered by the financial statements being audited or reviewed, but 
when the audit or review occurs. For example, if a company has a 
calendar year-end fiscal year, for an audit of year 2002 financial 
statements that concludes in February or March 2003, the records 
would be required to be retained until January 1, 2009.
    \11\ See Statement of Senator Leahy on the Senate floor: ``[I]t 
is intended that the SEC promulgate rules and regulations that 
require the retention of such substantive material * * * for such a 
period as is reasonable and necessary for effective enforcement of 
the securities laws and the criminal laws, most of which have a 
five-year statute of limitations.'' 148 Cong. Rec. S7419 (July 26, 
2002).
---------------------------------------------------------------------------

    Section 103 of the Sarbanes-Oxley Act directs the Public Company 
Accounting Oversight Board (``the Board'') to require auditors to 
retain for seven years audit workpapers and other materials that 
support the auditor's conclusions in any audit report.\12\ There may be 
fewer documents retained pursuant to section 103, which focuses more on 
workpapers that support the auditor's conclusions, than under section 
802, which includes not only workpapers but also other documents that 
meet the criteria noted in this release. Many documents, however, may 
be covered by both retention requirements.
---------------------------------------------------------------------------

    \12\ The Board is required under section 103(a)(2)(A)(i) of the 
Sarbanes-Oxley Act to adopt an auditing standard that requires 
accounting firms registered with the Board to ``* * * maintain for a 
period of not less than 7 years, audit work papers, and other 
information related to any audit report, in sufficient detail to 
support the conclusions reached in such report.''
---------------------------------------------------------------------------

Workpapers Defined

    Section 802 is intended to require the retention of more than what 
traditionally has been thought of as an auditor's ``workpapers.''\13\ 
To clarify the distinction between workpapers and other materials that 
would be retained, paragraph (b) of the proposed rules would define the 
term ``workpapers.'' The legislative history to this section states 
that the term is to be used as it is ``widely understood'' by the 
Commission and by the accounting profession.\14\ We believe that the 
term is understood to refer to the documents required to be retained by 
generally accepted auditing standards (``GAAS'').
---------------------------------------------------------------------------

    \13\ Senator Leahy stated on the Senate floor that section 802 
``requires the SEC to promulgate reasonable and necessary 
regulations * * * regarding the retention of categories of 
electronic and non-electronic audit records, which contain opinions, 
conclusions, analysis or financial data, in addition to the actual 
work papers.'' 148 Cong. Rec. S7418 (July 26, 2002).
    \14\ Statement by Senator Leahy on the Senate floor, 148 Cong. 
Rec. S7418 (July 26, 2002).
---------------------------------------------------------------------------

    GAAS does not use the specific term ``workpapers'' \15\ but 
Statement on Auditing Standards No. 96, ``Audit Documentation,'' 
states, in part:
---------------------------------------------------------------------------

    \15\ American Institute of Certified Public Accountants 
(``AICPA''), Statement on Auditing Standards No. (``SAS'') 96, 
``Audit Documentation,'' at footnote 1, however, acknowledges that: 
``Audit Documentation also may be referred to as working papers''; 
Codification of Statements on Auditing Standards (``AU'') Sec.  339.

    The auditor should prepare and maintain audit documentation, the 
content of which should be designed to meet the circumstances of the 
particular audit engagement. Audit documentation is the principal 
record of the auditing procedures applied, evidence obtained, and 
conclusions reached by the auditor in the engagement.\16\
---------------------------------------------------------------------------

    \16\ SAS 96, at ] 1; AU Sec.  339.01. This paragraph also 
states: ``The quality, type, and content of audit documentation are 
matters of the auditor's professional judgment.'' The proposed rule 
does not include this sentence, but instead notes that the 
Commission or the Board may reexamine these requirements in the 
auditing standards.

    We have placed the body of this provision into paragraph (b) and 
stated that ``workpapers'' means ``documentation of auditing or review 
procedures applied, evidence obtained, and conclusions reached by the 
accountant in the audit or review engagement, as required by standards 
established or adopted by the Commission or by the Public Company 
Accounting Oversight Board.'' \17\ The proposed rule, therefore, 
recognizes that the Board, subject to Commission oversight, has the 
ability to review and change the nature and scope of the required 
documentation of procedures, evidence, and conclusions related to 
audits and reviews of financial statements.\18\
---------------------------------------------------------------------------

    \17\ Prior to the estblishment or adoption of auditing standards 
by the Board, ``workpapers'' would continue to mean the 
documentation of auditing or review procedures applied, evidence 
obtained, and conclusions reached by the accountant in the audit or 
review engagement as required by GAAS.
    \18\ See section 103(a) of the Sarbanes-Oxley Act.
---------------------------------------------------------------------------

Differences of Opinion

    SAS 96 states that audit documentation serves mainly to provide the 
principal support for the auditor's report and to aid the auditor in 
the conduct and supervision of the audit.\19\ In order to ensure that 
the purposes of the Act are fulfilled, we have included in paragraph 
(c) of the proposed rules the specific requirement that the materials 
retained under paragraph (a) would include not only those that support 
an auditor's conclusions about the financial statements but also those 
materials that may ``cast doubt'' on

[[Page 71020]]

those conclusions.\20\ Paragraph (c) is intended to ensure the 
preservation of those records that reflect differing professional 
judgments and views (both within the accounting firm and between the 
firm and the issuer) and how those differences were resolved. To better 
communicate what we intend by ``cast doubt'' on the auditor's 
conclusions, we have included in the proposed rule the example of 
documentation of differences of opinion concerning accounting and 
auditing issues.
---------------------------------------------------------------------------

    \19\ SAS 96, at ] 3; AU Sec.  339.03
    \20\ Senator Leahy stated on the Senate floor: In light of the 
apparent massive document destruction by Andersen, and the company's 
apparently misleading document retention policy, even in light of 
its prior SEC violations, it is intended that the SEC promulgate 
rules and regulations that require the retention of such substantive 
material, including material that casts doubt on the views expressed 
in the audit or review, for such a period as is reasonable and 
necessary for effective enforcement of the securities laws and the 
criminal laws, most of which have a five-year statue of limitations.
    148 Cong. Rec. S7419 (July 26, 2002).
---------------------------------------------------------------------------

    The auditor in a variety of contexts may create materials related 
to differences of opinion. For example, SAS No. 22, ``Planning and 
Supervision,'' states in part:

    The auditor with final responsibility for the audit and 
assistants should be aware of the procedures to be followed when 
differences of opinion concerning accounting and auditing issues 
exist among firm personnel involved in the audit. Such procedures 
should enable an assistant to document his disagreement with the 
conclusions reached if, after appropriate consultation, he believes 
it necessary to disassociate himself from the resolution of the 
matter. In this situation, the basis for the final resolution should 
also be documented.\21\

    \21\ SAS 22, ] 22 (as amended by SAS 47, 48 and 77); AU Sec.  
311.22. ``Assistants,'' in the context of the first sentence of the 
quoted paragraph, should be defined broadly and include other 
partners who are on the audit engagement team.
---------------------------------------------------------------------------

    An interpretation of this section issued by the AICPA's Auditing 
Standards Board emphasizes the professional obligation on each person 
involved in an audit engagement to bring his or her concerns to the 
attention of others in the firm and, as appropriate, to document those 
concerns. This interpretation states:

    Accordingly, each assistant has a professional responsibility to 
bring to the attention of appropriate individuals in the firm, 
disagreements or concerns the assistant might have with respect to 
accounting and auditing issues that he believes are of significance 
to the financial statements or auditor's report, however those 
disagreements or concerns may have arisen. In addition, each 
assistant should have a right to document his disagreement if he 
believes it is necessary to disassociate himself from the resolution 
of the matter.\22\
---------------------------------------------------------------------------

    \22\ ``Planning and Supervision: Auditing Interpretations of 
Section 311,'' AU Sec.  9311.37. ``Assistants,'' in the context of 
this interpretation, should be defined broadly and include other 
partners who are on the audit engagement team.

    In addition, SAS 96 states that the documentation for an audit 
should include the findings or issues that in the auditor's judgment 
are significant, the actions taken to address them (including any 
additional evidence obtained), and the basis for the final conclusions 
reached.\23\ For example, if a memorandum is prepared by a member of a 
large accounting firm's national office that is critical of the 
accounting used by an audit client, or of a position taken by the 
partner in charge of the audit of those financial statements, that 
memorandum should be retained.\24\ Another example would be 
documentation related to an auditor's communications with an issuer's 
audit committee about alternative disclosures and accounting methods 
used by the issuer that are not the disclosures or accounting preferred 
by the auditor.\25\
---------------------------------------------------------------------------

    \23\ SAS 96, ] 9; AU Sec.  339.09, which states: In addition, 
the auditor should document findings or issues that in his or her 
judgment are significant, actions taken to address them (including 
any additional evidence obtained), and the basis for the final 
conclusions reached.
    See also, SAS 96, ] 6; AU Sec.  339.06, which states: Audit 
documentation should be sufficient to (a) enable members of the 
engagement team with supervision and review responsibilities to 
understand the nature, timing, extent, and results of auditing 
procedures performed, and the evidence obtained; (b) indicate the 
engagement team member(s) who performed and reviewed the work; and 
(c) show that the accounting records agree or reconcile with the 
financial statements or other information being reported on.
    \24\ Such a memorandum might be prepared in connection with the 
consultation process that is part of an accounting firm's quality 
controls. See, e.g., Section 103(a)(2)(B)(ii) of the Sarbanes-Oxley 
Act. Superseded drafts or auditor review notes that do not reflect a 
difference of opinion, however, would not have to be retained.
    \25\ Section 204 of the Sarbanes-Oxley Act adds section 10A(k) 
to the Exchange Act and requires auditors to report certain matters 
to audit committees, including: ``(a) all critical accounting 
policies and practices to be used, (2) all alternative treatments of 
financial information within generally accepted accounting 
principles that have been discussed with management officials of the 
issuer, ramifications of the use of such alternative disclosures and 
treatments, and the treatment preferred by the registered public 
accounting firm; and (3) other material written communications 
between the registered public accounting firm and the management of 
the issuer, such as the management letter or schedule of unadjusted 
differences.''
---------------------------------------------------------------------------

    We believe that retaining the materials created under SAS 22 and 
SAS 96, as well as other materials that might cast doubt on the 
conclusions reflected in the auditor's report, would be consistent with 
the letter and spirit of the Sarbanes-Oxley Act.

Request for Comment

    [sbull] Are the ``workpapers'' and other documents that would be 
required to be retained under this proposed rule sufficiently 
described? If not, what changes should be made to provide for greater 
clarity? Are there alternative definitions that would better implement 
section 802?
    [sbull] Would auditors have to implement significant changes to 
their retention policies or internal control processes and procedures, 
as well as system upgrades, to ensure compliance with the proposed 
rule? If so, what types of changes most likely would be required? How 
can we minimize any required changes consistent with section 802?
    [sbull] Would auditors circumvent the proposed record retention 
requirements by, for example, replacing written communications with 
oral communications? If so, what additional measures should be taken?
    [sbull] Section 103 of the Sarbanes-Oxley Act directs the Public 
Company Accounting Oversight Board to adopt an auditing standard that 
requires each registered public accounting firm to retain for a period 
of not less than seven years audit workpapers and other information 
that support the conclusions in the auditor's report. Should the 
retention period in the proposed rules be extended to seven years to 
coincide with the retention period in section 103? Why?
    [sbull] Should the retention period be for some other appropriate 
period based on consideration of other factors, such as the utility of 
the records to investors, regulators or litigants, the cost of 
retaining the records, or the size of the accounting firm?
    [sbull] Audits of the financial statements of many investment 
advisers and broker-dealers would not be subject to the proposed rules 
because they are not ``issuers'' of securities. Should the proposals be 
amended to apply the retention period to audits of the financial 
statements of these entities? Why?
    [sbull] The proposed rules would incorporate the definition of 
``issuer'' in new section 10A(f) of the Exchange Act? Should ``issuer'' 
be defined more broadly to include any issuer of securities with 
respect to which a registration statement or report is filed with the 
Commission? Why?
    [sbull] Should there be a document retention requirement for 
issuers as well as auditors? If yes, what would be the scope and nature 
of that requirement? For example, should issuers be required to retain 
records that the auditor reviewed but did not include in the

[[Page 71021]]

audit workpapers? Should issuers be required to keep copies of all 
correspondence with the auditors and copies of documents provided to 
the auditors?
    [sbull] Section 32(c) of the Investment Company Act of 1940 
authorizes the Commission to adopt rules to require accountants and 
auditors to keep reports, work sheets, and other documents and papers 
relating to registered investment companies for such periods as the 
Commission may prescribe, and to make these documents and papers 
available for inspection by the Commission and its staff. Should we use 
our authority under this section to extend proposed rule 2-06 by 
requiring that audit workpapers and other documents required to be 
retained with respect to the audit or review of investment company 
financial statements be made available for inspection by the Commission 
and its staff?
    [sbull] The proposed rules would apply to foreign auditors. Are 
there statutes, rules or standards in foreign jurisdictions that govern 
the retention of records by foreign auditors that are different from 
and potentially conflict with the requirements of the proposed rules? 
If so, how is the foreign law incompatible with the specific provisions 
of the proposed rules?
    [sbull] Does the ``cast doubt on the final conclusions reached by 
the auditor'' provision in the proposed rules adequately capture the 
scope of the retention requirements under the Sarbanes-Oxley Act? 
Should the scope be narrower or broader? Would a different test be more 
appropriate, such as ``significant differences in professional 
judgment,'' or ``differences of opinion on issues that are material to 
the issuer's financial statements or to the auditor's final conclusions 
regarding any audit or review'?
    [sbull] Should the rules include other examples of materials that 
``cast doubt'' on auditors' conclusions? If so, what examples should be 
included?

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 issuers. We solicit comment on each 
component of the proposal.

IV. Paperwork Reduction Act

    Certain provisions of the proposed rules 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 
(``OMB'') 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 control number. Compliance with the proposed 
requirements would be mandatory. The proposed rules would require that 
accounting firms retain certain records for five years. Retained 
information would be kept confidential unless or until made public 
during an enforcement, disciplinary or other legal or administrative 
proceeding.
    The title for the collection of information is ``Regulation S-X--
Record Retention.'' We are applying for a new OMB Control Number for 
this collection.
    As mandated by section 802 of the Sarbanes-Oxley Act of 2002, we 
are proposing to amend Regulation S-X to require accountants who audit 
or review an issuer's financial statements to retain certain records 
relevant to that audit or review for a period of five years from the 
end of the fiscal year in which an audit or review was concluded. The 
proposed rules do not require accounting firms to create any new 
records.
    The records to be retained would include workpapers and other 
documents that form the basis of the audit or review, and memoranda, 
correspondence, communications, other documents, and records (including 
electronic records), which are created, sent or received in connection 
with the audit or review, and contain conclusions, opinions, analyses, 
or financial data related to the audit or review. Records described in 
the proposed rules would be retained whether the conclusions, opinions, 
analyses, or financial data in the records would support or cast doubt 
on the final conclusions reached by the auditor. The required retention 
of audit and review records should discourage the destruction, and 
assist in the availability, of records that may be relevant to 
investigations conducted and litigation brought under the securities 
laws.
    We estimate that approximately 850 accounting firms audit and 
review the financial statements of approximately 20,000 public 
companies and registered investment companies filing financial 
statements with the Commission.\26\ Each firm currently is required to 
perform its audits and reviews in accordance with generally accepted 
auditing standards (``GAAS''), which require auditors to retain certain 
documentation of their work.\27\ Accounting firms, therefore, currently 
make decisions about the retention of each record created during the 
audit or review. GAAS, however, currently does not require explicitly 
that auditors retain documents that may ``cast doubt'' on their 
opinions and GAAS does not set definite retention periods. As a result, 
the proposed rule might result in the retention of more records than 
currently required under GAAS, and might result in some accounting 
firms keeping those records for a longer period of time.
---------------------------------------------------------------------------

    \26\ These estimates are based on information in Commission 
databases. The number of public companies includes those filing 
annual reports and those filing registration statements to conduct 
initial public offerings. The same auditors also audit the financial 
statements of approximately 5,587 investment companies.
    \27\ See American Institute of Certified Public Accountants 
(``AICPA''), Statement on Auditing Standards No. (``SAS'') 96, 
``Audit Documentation'; Codification of Statements on Auditing 
Standards (``AU'') 339. GAAS does not specify a required retention 
period. The documents to be retained under SAS 96 include those 
indicating the auditing procedures applied, the evidence obtained 
during the audit, and the conclusions reached by the auditor in the 
engagement.
---------------------------------------------------------------------------

    The Commission, through its experience in matters pertaining to 
accounting firms, believes that many accounting firms retain records of 
audits and reviews of the financial statements of current clients for 
five or more years. Once an issuer is no longer a client, some firms 
currently may dispose of those records before the expiration of the 
five-year period. It is important to note, however, that the proposed 
rules do not require the creation of any record, they require only that 
existing records be maintained for the prescribed time period. It also 
is important to note that decisions about the retention of records 
currently are made as a part of each audit or review.
    We do not anticipate any significant increase in burden hours for 
accounting firms or issuers because the proposed rules do not require 
the creation of records, would not significantly increase procedures 
related to the review of documents, and minimal, if any, work would be 
associated with the retention of these records. The disposal of those 
records, which would occur in any event, merely would be delayed. In 
addition, because an already large and ever-increasing portion of the 
records required to be retained are kept electronically, we do not 
anticipate that the incremental increase in storage costs for documents 
would be significant for any firm or for any single audit client. To 
cover all increases in burden hours,

[[Page 71022]]

we estimate that, on average, the incremental burden on firms would be 
no more than one hour for each public company audit client, or 
approximately 15,000 hours.\28\
---------------------------------------------------------------------------

    \28\ This burden accounts for incidental reading and 
implementation of the proposed rule. Fifteen thousand burden hours 
should be sufficient to cover the audits and reviews of not only 
public companies but also registered investment companies. Because 
of the nature and scope of the audits of investment companies, there 
would be an even smaller and insignificant incremental burden 
imposed on those audits than on the audits of public companies.
---------------------------------------------------------------------------

    Pursuant to 44 U.S.C. 3506(c)(2)(B), 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 the Commission's estimates of the burden 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 
burden 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. S7-46-02. 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-
46-02, 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.

V. Cost--Benefit Analysis

    The record retention requirements that we propose would implement a 
congressional mandate. We recognize that any implementation of the 
Sarbanes-Oxley Act likely will result in costs as well as benefits and 
will have an effect on the economy.
    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 comments on all aspects of this cost-benefit analysis, 
including the identification of any additional costs or benefits. We 
encourage commenters to identify and supply relevant data concerning 
the costs or benefits of the proposed rules.

A. Background

    Under section 802 of the Sarbanes-Oxley Act, accountants who audit 
or review an issuer's financial statements must retain certain records 
relevant to that audit or review for a period of five years from the 
end of the fiscal year in which an audit or review was concluded. The 
proposed rules would implement this provision and indicate the records 
to be retained, but they do not require accounting firms to create any 
new records.
    The records to be retained would include workpapers and other 
documents that form the basis of the audit or review and memoranda, 
correspondence, communications, other documents, and records (including 
electronic records), which are created, sent or received in connection 
with the audit or review, and contain conclusions, opinions, analyses, 
or financial data related to the audit or review. Records described in 
the proposed rules would be retained whether the conclusions, opinions, 
analyses, or financial data in the records would support or cast doubt 
on the final conclusions reached by the auditor. The required retention 
of audit and review records should discourage the destruction, and 
assist in the availability, of records that may be relevant to 
investigations conducted under the securities laws.

B. Potential Benefits of the Proposed Rules

    The proposed rules would require that certain records relevant to 
the audit and review of an issuer's financial statements be retained 
for five years. To the extent that the proposals increase the 
availability of documents beyond current professional practices, the 
proposed rules may benefit investigations and litigation conducted by 
the Commission and others. Increased retention of these records may 
provide important evidence of financial reporting improprieties or 
deficiencies in the audit process.
    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. In addition to providing materials for investigations, the 
availability of the documents subject to the proposed rules might 
facilitate greater oversight of audits and improved audit quality, 
which, in turn, ultimately could increase investor confidence in the 
reliability of reported financial information.

C. Potential Costs of the Proposal

    We estimate that approximately 850 accounting firms audit and 
review the financial statements of approximately 20,000 public 
companies and registered investment companies filing financial 
statements with the Commission.\29\ Each firm currently is required to 
perform its audits and reviews in accordance with generally accepted 
auditing standards (``GAAS''), which require auditors to retain certain 
documentation of their work.\30\ Accounting firms, therefore, currently 
make decisions about the retention of each record created during the 
audit or review. GAAS, however, does not require explicitly that 
auditors retain documents that may ``cast doubt'' on their opinions and 
GAAS does not set definite retention periods. As a result, the proposed 
rule might result in the retention of more records than currently 
required under GAAS, and might result in some accounting firms keeping 
those records for a longer period of time.
---------------------------------------------------------------------------

    \29\ These estimates are based on information in Commission 
databases. The number of public companies includes those filing 
annual reports and those filing to conduct an initial public 
offering. The same auditors also audit the financial statements of 
approximately 5,587 investment companies.
    \30\ See American Institute of Certified Public Accountants 
(``AICPA''), Statement on Auditing Standards No. (``SAS'') 96, 
``Audit Documentation'; Codification of Statements on Auditing 
Standards (``AU'') 339.
---------------------------------------------------------------------------

    The Commission, through its experience in matters pertaining to 
accounting firms, believes that many accounting firms retain records of 
audits and reviews of the financial statements of current clients for 
five or more years. Once an issuer is no longer a client, some firms 
currently may dispose of those records before the expiration of the 
proposed five-year period. It is important to note, however, that the 
proposed rules do not require the creation of any record; they require 
only that existing records be maintained for the prescribed time 
period. It also is important to note that decisions about the retention 
of records currently are made as a part of each audit or review.

[[Page 71023]]

    We do not anticipate any significant increase in costs for 
accounting firms or issuers because the proposed rules do not require 
the creation of records, would not significantly increase procedures 
related to the review of documents, and minimal, if any, work would be 
associated with the retention of these records. The disposal of those 
records, which would occur in any event, merely would be delayed. In 
addition, because an already large and ever-increasing portion of the 
records required to be retained are kept electronically, we do not 
anticipate that the incremental increase in storage costs for documents 
would be significant for any firm or for any single audit client.
    For purposes of the Paperwork Reduction Act, we estimated the total 
burden to be 15,000 burden hours. Assuming an accounting firm's average 
cost of in-house staff is $110 per hour,\31\ the total cost would be 
$1,650,000.
---------------------------------------------------------------------------

    \31\ We estimate that associates would perform three-fourths of 
the required work, with a partner performing about one-fourth of the 
work. We also estimate that, on average, an associate's annual 
salary would be approximately $125,000 and a partner's annual 
compensation would be approximately $500,000. Based on these 
amounts, the in-house cost of an associate's time would be 
approximately $65 per hour, and the in-house cost of a partner's 
time would be approximately $250 per hour. The average hourly rate, 
therefore, would be about $110 per hour ([(3 x $65) + $250] / 4).
---------------------------------------------------------------------------

D. Request for Comments

    As noted above, we request comments on all aspects of this cost-
benefit analysis, including the 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. We 
request comments, including supporting data, on the magnitude of the 
costs and benefits mentioned in this section.
    [sbull] Are there any other costs or benefits that we have not 
identified? For example, would the cost of audits increase? Please 
describe any such costs and provide relevant data.
    [sbull] Are there additional costs related to the proposed rules? 
If there are, please identify them and provide supporting data.
    [sbull] Are there measures that the Commission should take, such as 
encouraging accounting firms to keep more records electronically, to 
lower storage costs?
    [sbull] We request comments on the reasonableness of the burden 
hours, cost estimates, and underlying assumptions related to the 
proposed disclosures.

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

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996,\32\ the Commission is requesting information regarding the 
potential impact of the proposals on the economy on an annual basis. 
Commentators should provide empirical data to support their views.
---------------------------------------------------------------------------

    \32\ Pub. L. No. 104-121, tit. II, 110 Stat. 857 (1996).
---------------------------------------------------------------------------

    Section 23(a)(2) of the Exchange Act \33\ requires the Commission, 
when adopting rules under the Exchange Act, to consider the anti-
competitive effects of any rule it adopts. In addition, Section 2(b) of 
the Securities Act of 1933,\34\ Section 3(f) of the Exchange Act,\35\ 
and Section 2(c) of the Investment Company Act \36\ require the 
Commission, when engaging in rulemaking that requires it to consider or 
determine whether an action is necessary or appropriate in the public 
interest, to consider whether the action will promote efficiency, 
competition, and capital formation.
---------------------------------------------------------------------------

    \33\ 15 U.S.C. 78w(a)(2).
    \34\ 15 U.S.C. 77b(b).
    \35\ 15 U.S.C. 78c(f).
    \36\ 15 U.S.C. 80a-2(c).
---------------------------------------------------------------------------

    We believe that the proposed rules would not have an adverse impact 
on competition. To the extent the proposed rules would increase the 
quality of audits and the efficiency of enforcement and disciplinary 
proceedings, there might be an increase in investor confidence in the 
efficacy of the audit process and the efficiency of the securities 
markets.
    We request comment on the anti-competitive effects of the 
proposals.
    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.

VII. Initial Regulatory Flexibility Act Analysis

    This Initial Regulatory Flexibility Act Analysis has been prepared 
in accordance with 5 U.S.C. 603. It relates to proposed revisions to 
Regulation S-X. The proposals would require the retention of certain 
audit and review documentation.

A. Reasons for the Proposed Action

    The proposed rules generally carry out a congressional mandate. The 
proposed rules, in general, would prohibit destruction for five years 
of certain records related to the audit or review of an issuer's 
financial statements.\37\ The proposed rules would not require 
accounting firms to create any new records.
---------------------------------------------------------------------------

    \37\ See section 802 of the Sarbanes-Oxley Act.
---------------------------------------------------------------------------

B. Objectives

    Our objectives are to implement section 802 of the Sarbanes-Oxley 
Act in order to increase investor confidence in the audit process and 
in the reliability of reported financial information. This would be 
accomplished by defining the records to be retained related to an audit 
or review of an issuer's financial statements. Having these records 
available should enhance oversight of corporate reporting and of the 
performance of auditors and facilitate the enforcement of the 
securities laws.

C. Legal Basis

    We are proposing amendments to Regulation S-X under the authority 
set forth in sections 3(a) and 802 of the Sarbanes-Oxley Act, and 
Schedule A and Sections 7, 8, 10, 19 and 28 of the Securities Act, 
Sections 3, 10A, 12, 13, 14, 17, 23 and 36 of the Exchange Act, 
Sections 5, 10, 14 and 20 of the Public Utility Holding Company Act of 
1935, and Sections 8, 30, 31, 32(c) and 38 of the Investment Company 
Act of 1940.

D. Small Entities Subject to the Proposed Rules

    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.\38\ 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 practice before the Commission. We request comment on the 
number of accounting firms with revenue under $6 million that audit 
issuers' financial statements.
---------------------------------------------------------------------------

    \38\ 13 CFR 121.201.
---------------------------------------------------------------------------

E. Reporting, Recordkeeping and Other Compliance Requirements

    Under the proposed rules,\39\ accountants who audit or review an 
issuer's financial statements must retain certain records relevant to 
that audit or review for a period of five years from the end of the 
fiscal year in which an audit or review was concluded. These records 
would include workpapers and other documents that form the basis of the 
audit or review and memoranda, correspondence, communications, other

[[Page 71024]]

documents, and records (including electronic records), which are 
created, sent or received in connection with the audit or review, and 
contain conclusions, opinions, analyses, or financial data related to 
the audit or review. Records described in the proposed rules would be 
retained whether the conclusions, opinions, analyses, or financial data 
in the records would support or cast doubt on the final conclusions 
reached by the auditor. The required retention of audit and review 
records should discourage the destruction, and assist in the 
availability, of records that may be relevant to investigations 
conducted under the securities laws.
---------------------------------------------------------------------------

    \39\ See section 802 of the Sarbanes-Oxley Act of 2002.
---------------------------------------------------------------------------

    The Commission, through its experience in matters pertaining to 
accounting firms, believes that many accounting firms retain records of 
audits and reviews of the financial statements of current clients for 
longer periods of time than for former clients.
    We do not anticipate any significant increase in costs for small 
accounting firms or small issuers because the proposed rules do not 
require the creation of records, would not significantly increase 
procedures related to the review of documents, and minimal, if any, 
work would be associated with the retention of these records. The 
disposal of those records, which would occur in any event, merely would 
be delayed. In addition, because an already large and ever-increasing 
portion of the records required to be retained are kept electronically, 
we do not anticipate that the incremental increase in storage costs for 
documents would be significant for any firm or for any single audit 
client.

F. Duplicative, Overlapping or Conflicting Federal Rules

    The Commission is not aware of any current rules that duplicate, 
overlap, or conflict with the proposed rules. The proposed rules 
contemplate that the Board will define ``workpapers,'' as required in 
section 103 of the Sarbanes-Oxley Act. Our proposal is designed to not 
conflict with the Board's rule.

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.
    The Sarbanes-Oxley Act provides the basis for the requirements and 
timetables for the proposed record retention rules. The proposed rules 
are designed to require the retention of those records necessary for 
oversight of the audit process, to enhance the reliability and 
credibility of financial statements for all public companies, and to 
facilitate enforcement of the securities laws.
    We considered not applying the proposals to small accounting firms. 
We believe, however, that investors would benefit if accountants 
subject to the proposed record retention rules, regardless of their 
size, audit all companies.
    Currently, we do not believe that it is feasible to further 
clarify, consolidate, or simplify the proposed rules for small 
entities. We invite comments, however, on whether the requirements 
could be simplified or clarified for small accounting firms.

H. 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. We also seek comments on how 
to quantify the number of small accounting firms that would be affected 
by the proposals, how to quantify the impact of the proposed rules on 
those firms, and how to lower the cost of record retention for small 
accounting firms.
    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.

VIII. Codification Update

    The Commission proposes to amend the ``Codification of Financial 
Reporting Policies'' announced in Financial Reporting Release No. 1 
(April 15, 1982):
    By amending section 602 to add a new discussion at the end of that 
section under the Financial Reporting Release Number (FR-XX) assigned 
to the adopting release and including the text in the adopting release 
that discusses the final rules, which, if the proposals are adopted, 
would be substantially similar to Section II of this release.
    The Codification is a separate publication of the Commission. It 
will not be published in the Code of Federal Regulations.

IX. Statutory Bases and Text of Proposed Amendments

    We are proposing amendments to Regulation S-X under the authority 
set forth in sections 3(a) and 802 of the Sarbanes-Oxley Act, and 
Schedule A and Sections 7, 8, 10, 19 and 28 of the Securities Act, 
Sections 3, 10A, 12, 13, 14, 17, 23 and 36 of the Exchange Act, 
Sections 5, 10, 14 and 20 of the Public Utility Holding Company Act of 
1935, Sections 8, 30, 31, 32 and 38 of the Investment Company Act of 
1940.

List of Subjects in 17 CFR Part 210

    Accountants, Accounting.

Text of Proposed Amendments

    In accordance with the foregoing, Title 17, Chapter II of the Code 
of Federal Regulations is proposed to be amended as follows:
    1. The authority citation for Part 210 is revised to read as 
follows:


    Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77aa(25), 
77aa(26), 78j-1, 78l, 78m, 78n, 78o(d), 78u-5, 78w(a), 78ll(d), 
79e(b), 79j(a), 79n, 79t(a), 80a-8, 80a-20, 80a-29, 80a-30, 80a-31, 
80a-37(a), unless otherwise noted.

    2. By adding Sec.  210.2-06 to read as follows:


Sec.  210.2-06  Retention of audit and review records.

    (a) For a period of five years after the end of the fiscal period 
in which an accountant concludes an audit or review of an issuer's 
financial statements to which section 10A(a) of the Securities Exchange 
Act of 1934 (15 U.S.C. 78j-1(a)) applies, or of the financial 
statements of any investment company registered under section 8 of the 
Investment Company Act of 1940 (15 U.S.C. 80a-8), the accountant shall 
retain workpapers and other documents that form the basis of the audit 
or review, and memoranda, correspondence, communications, other 
documents, and records (including electronic records), which:

[[Page 71025]]

    (1) Are created, sent or received in connection with the audit or 
review, and
    (2) Contain conclusions, opinions, analyses, or financial data 
related to the audit or review.
    (b) For the purposes of paragraph (a) of this section, 
``workpapers'' means documentation of auditing or review procedures 
applied, evidence obtained, and conclusions reached by the accountant 
in the audit or review engagement, as required by standards established 
or adopted by the Commission or by the Public Company Accounting 
Oversight Board.
    (c) Materials described in paragraph (a) of this section shall be 
retained whether the conclusions, opinions, analyses, or financial data 
in the materials support or cast doubt on the final conclusions reached 
by the auditor. For example, such materials shall include documentation 
of differences of opinion concerning accounting and auditing issues.
    (d) For the purposes of paragraph (a) of this section, the term 
``issuer'' means an issuer as defined in section 10A(f) of the 
Securities Exchange Act of 1934 (15 U.S.C. 78j-1(f)).

    Dated: November 21, 2002.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-30036 Filed 11-26-02; 8:45 am]
BILLING CODE 8010-01-P