[Federal Register Volume 68, Number 20 (Thursday, January 30, 2003)]
[Rules and Regulations]
[Pages 4862-4872]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-2118]



[[Page 4861]]

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Part IV





Securities and Exchange Commission





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17 CFR Part 210



Retention of Records Relevant to Audits and Review; Final Rule

  Federal Register / Vol. 68, No. 20 / Thursday, January 30, 2003 / 
Rules and Regulations  

[[Page 4862]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 210

[Release Nos. 33-8180; 34-47241; IC-25911; FR-66; File No. S7-46-02]
RIN 3235-AI74


Retention of Records Relevant to Audits and Reviews

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: We are adopting rules requiring accounting firms to retain for 
seven years certain records relevant to their audits and reviews of 
issuers' financial statements. Records to be retained 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: Effective Date: March 3, 2003. Compliance Date: Compliance is 
required for audits and reviews completed on or after October 31, 2003.

FOR FURTHER INFORMATION CONTACT: Samuel L. Burke, Associate Chief 
Accountant, D. Douglas Alkema, Professional Accounting Fellow, or 
Robert E. Burns, Chief Counsel, 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 adding 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 amending 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. 
These records 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. To coordinate with 
forthcoming auditing standards concerning the retention of audit 
documentation, the rule requires that these records be retained for 
seven years after the auditor concludes the audit or review of the 
financial statements, rather than the proposed period of five years 
from the end of the fiscal period in which an audit or review was 
concluded. As proposed,\2\ the rule addresses the retention of records 
related to the audits and reviews of not only issuers' financial 
statements but also the financial statements of registered investment 
companies.
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    \1\ Pub. L. 107-204, 116 Stat. 745 (2002).
    \2\ These amendments were proposed in Securities Act Release No. 
8151 (November 21, 2002) (the ``Proposing Release'') [67 FR 71017 
(November 27, 2002)].
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II. Discussion of Final Rule

    Section 802 of the Sarbanes-Oxley Act \3\ is intended to address 
the destruction or fabrication of evidence and the preservation of 
``financial and audit records.'' \4\ 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.
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    \3\ 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.
    \4\ Floor statement by Senator Leahy, 148 Cong. Rec. S7418 (July 
26, 2002).
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    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.\5\ As adopted, the 
record retention requirements also apply to any audit or review of the 
financial statements of any registered investment company.\6\ We 
believe that it is 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.\7\
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    \5\ 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. * * *'' Accordingly, the definition of 
``issuer'' includes entities that have filed and not withdrawn a 
registration statement for an initial public offering.
    Because investment advisers and broker-dealers are not 
necessarily issuers, audits of their financial statements required 
for regulatory purposes are not subject to the rule. 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) are subject to the retention requirements in rule 2-06. One 
commenter suggested that investment advisers and broker-dealers be 
included within the scope of the rule. Letter from Lynette Downing, 
HLB Tautges Redpath, Ltd., dated December 27, 2002. Another 
commenter noted, however, that broadening some but not all rules 
under the Sarbanes-Oxley Act beyond ``issuers'' as defined in the 
Act would be confusing. Letter from Grant Thornton LLP dated 
December 27, 2002.
    \6\ See section 8 of the Investment Company Act of 1940, 15 
U.S.C. 80a-8.
    \7\ 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).
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    Neither section 802 nor the final rule exempts auditors of foreign 
issuers'

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financial statements. Commenters, including the European Commission, 
noted that application of the rule to foreign auditors would place 
additional and differing layers of retention requirements on those 
firms.\8\ However, none of the commenters identified any direct 
conflicts with foreign requirements.
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    \8\ Letter from the European Commission dated December 20, 2002; 
letter from PricewaterhouseCoopers dated December 27, 2002; letter 
from KPMG LLP dated December 27, 2002; letter from the American 
Institute of Certified Public Accountants dated December 27, 2002.
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    The availability of documents under this rule will assist in the 
oversight and quality of audits of an issuer's financial statements. 
Increased retention of identified records also may provide critical 
evidence of financial reporting impropriety or deficiencies in the 
audit process. In light of these benefits, and absent a direct conflict 
with foreign requirements, the retention requirements are to apply 
equally to domestic and foreign accounting firms auditing the financial 
statements of foreign issuers. Issues raised by commenters regarding 
Public Company Accounting Oversight Board (``the Oversight Board'') 
oversight of foreign accounting firms and access by the SEC and the 
Oversight Board to the records retained by foreign accounting firms, as 
provided by Section 106 of the Sarbanes-Oxley Act, will be the subject 
of further discussion among staff, the Commission and the Oversight 
Board.\9\
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    \9\ We also note that this rule is not intended to expand or 
restrict the Commission's exisiting authority to investigate cross-
border violations of the federal securities laws.
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    In restricting the application of the rule to the audits and 
reviews of the financial statements of issuers and registered 
investment companies, we are not condoning more liberal document 
destruction policies for the audits and reviews of financial statements 
of other entities. For example, we would expect that auditors of the 
financial statements of those investment advisers, broker-dealers, and 
entities subject to Municipal Securities Rulemaking Board regulations 
that are not subject to the rule would retain relevant audit and review 
records consistent with applicable laws, regulations, and professional 
standards.

Documents To Be Retained

    Paragraph (a) of rule 2-06 identifies the documents that must be 
retained and the time period for retaining those documents.\10\ The 
final rule requires that the auditor \11\ retain records relevant to 
the audit or review, including 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.
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    \10\ Rule 2-06 is not intended to pre-empt or supersede any 
other federal or state record retention requirements.
    \11\ 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 companion release, 
the Commission proposed to amend this definition to include the term 
``registered public accounting firm.'' We will apply the definition 
in rule 2-01(f)(1), as amended, to rule 2-06.
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    Paragraph (a) of the proposed rule did not contain the phrase, 
``records relevant to the audit or review.'' The proposal listed the 
records to be retained without a reference to the general notion of 
relevance to the audit or review. In response to commenters,\12\ and to 
track more closely the wording in section 802,\13\ we have added those 
words to the final rule.
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    \12\ See, e.g., letter from Deloitte & Touche dated December 27, 
2002, and letter from McGladrey & Pullen dated December 31, 2002, 
which states, in part, ``The key to promulgating record retention 
rules that enhance audit quality lies in the word `relevant'.''
    \13\ See note 3, supra.
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    In the Proposing Release, we stated that non-substantive materials 
that are not part of the workpapers, 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 the criteria in rule 2-06(a) and would not have to be retained. 
Commentators questioned whether the following documents would be 
considered substantive and have to be retained:
    [sbull] Superseded drafts of memoranda, financial statements or 
regulatory filings,\14\
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    \14\ See, e.g., letter from BDO Seidman, LLP, dated December 27, 
2002; letter from Ernst & Young LLP, dated December 27, 2002; letter 
from PricewaterhouseCoopers dated December 27, 2002.
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    [sbull] Notes on superseded drafts of memoranda, financial 
statements or regulatory filings that reflect incomplete or preliminary 
thinking,\15\
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    \15\ See letter from BDO Seidman, LLP, dated December 27, 2002.
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    [sbull] Previous copies of workpapers that have been corrected for 
typographical errors or errors due to training of new employees,\16\
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    \16\ See letter from Gelfond Hochstadt Pangburn, P.C. dated 
November 26, 2002.
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    [sbull] Duplicates of documents,\17\ or
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    \17\ See letter from Ernst & Young LLP, dated December 27, 2002, 
and letter from Gelfond Hochstadt Pangburn, P.C. dated November 26, 
2002.
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    [sbull] Voice-mail messages.\18\
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    \18\ Letter from Sullivan & Cromwell dated December 26, 2002.
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    These records generally would not fall within the scope of new rule 
2-06 provided they do not contain information or data, relating to a 
significant matter, that is inconsistent with the auditor's final 
conclusions, opinions or analyses on that matter or the audit or 
review.\19\ For example, rule 2-06 would require the retention of an 
item in this list if that item documented a consultation or resolution 
of differences of professional judgment.
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    \19\ 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).
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    Commenters also questioned whether all of the issuer's financial 
information, records, databases, and reports that the auditor examines 
on the issuer's premises, but are not made part of the auditor's 
workpapers or otherwise currently retained by the auditor, would be 
deemed to be ``received'' by the auditor under rule 2-06(a)(1) and have 
to be retained by the auditor.\20\ We do not believe that Congress 
intended for accounting firms to duplicate and retain all of the 
issuer's financial information, records, databases, and reports that 
might be read, examined, or reviewed by the auditor. Accordingly, we do 
not believe that the ``received'' criterion in rule 2-06(a)(1) requires 
that such records be retained.
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    \20\ See, e.g., letter from PricewaterhouseCoopers dated 
December 27, 2002.
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    Some commentators suggested that paragraph (a) of the proposed rule 
was overly broad and that the language in the rule, rather than 
following section 802 of the Sarbanes-Oxley Act, should conform to 
current auditing standards.\21\ It would appear, however, that by 
requiring the retention of documents in addition to audit workpapers 
required by generally accepted auditing standards (``GAAS'') Congress 
has rejected this approach. Congress intended that accounting firms 
retain substantive materials that are relevant to

[[Page 4864]]

the review or audit of financial statements filed with the Commission 
and enumerated the records described in the rule as being relevant to 
audits and reviews. Narrowing the scope of the rule to conform to the 
current auditing literature would be contrary to the apparent 
congressional purpose embodied in section 802.
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    \21\ See, e.g., letter from BDO Seidman, LLP, dated December 27, 
2002; letter from Deloitte & Touche dated December 27, 2002; letter 
from Ernst & Young LLP, dated December 27, 2002; letter from Grant 
Thornton LLP dated December 27, 2002; letter from KPMG LLP dated 
December 27, 2002. See the discussion of Statement on Auditing 
Standards No. 96, ``Audit Documentation,'' infra.
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Time of Retention

    The final rule states that records must be retained for seven 
years. We proposed that these materials be retained for five years 
after the end of the fiscal period in which an accountant audits or 
reviews an issuer's financial statements,\22\ which is the period 
prescribed by section 802.\23\ We also noted in the Proposing Release, 
however, that section 103 of the Sarbanes-Oxley Act directs the 
Oversight Board to require auditors to retain for seven years audit 
workpapers and other materials that support the auditor's conclusions 
in any audit report.\24\ 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.\25\
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    \22\ The proposed retention period was not based on the fiscal 
period covered by the financial statements being audited or 
reviewed, but when the audit or review would occur. 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, 
under the proposal, the records would have been required to be 
retained until January 1, 2009.
    \23\ 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).
    \24\ The Oversight 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 
Oversight Board to ``* * * prepare, and 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.'' The standard to be adopted by the 
Oversight Board, therefore, is to be both a documentation and 
retention standard.
    \25\ See, e.g., letter from KPMG LLP, dated December 27, 2002, 
which states, in part: ``Clearly, the documents to be retained under 
both Sections [103 and 802] overlap to a large extent.''
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    Some commenters suggested that we adopt a uniform seven-year 
retention period,\26\ while others indicated that the longer period 
would increase audit costs without any commensurate benefit.\27\ We 
anticipate that most accounting firms, for administrative convenience, 
would retain all relevant materials for the longer of the two periods 
prescribed by the Commission and by the Oversight Board.\28\ 
Incremental costs associated with requiring a seven-year retention 
period, therefore, should not be significant. We also believe that 
adopting a seven-year retention period would reduce inconsistencies 
between the forthcoming Oversight Board rules and the Commission's 
rules and lessen any potential confusion related to the calculation of 
retention periods.\29\ Accordingly, the final rule requires that 
auditors retain the required documents for seven years from the 
conclusion of the audit or review.
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    \26\ See, e.g., letter from Wendy Perez, President of California 
Board of Accountancy dated December 23, 2002; letter from Grant 
Thornton LLP dated December 27, 2002; letter from Lynette Downing, 
HLB Tautges Redpath, Ltd., dated December 27, 2002.
    \27\ See, e.g., letter form Donald G. DeBuck, Controller, 
Computer Sciences Corporation dated December 26, 2002; letter from 
PricewaterhouseCoopers dated December 27, 2002; letter from the 
American Institute of Certified Public Accountants dated December 
27, 2002.
    \28\ See e.g., letter from Grant Thornton LLP dated December 27, 
2002, which states, ``We believe that most firms will adopt a policy 
of retaining all audit documentation for the longer period of seven 
years.''
    \29\ Id.
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Workpapers Defined

    Section 802 is intended to require the retention of more than what 
traditionally has been thought of as auditor's ``workpapers.'' \30\ To 
clarify the distinction between workpapers and other materials that 
would be retained, paragraph (b) of the final rule defines the term 
``workpapers.'' The legislative history to section 802 states that the 
term is to be used as it is ``widely understood'' by the Commission and 
by the accounting profession.\31\ We believe that the term is 
understood to refer to the documents required to be retained by GAAS.
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    \30\ 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).
    \31\ Statement by Senator Leahy on the Senate floor, 148 Cong. 
Rec. S7418 (July 26, 2002).
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    GAAS does not use the specific term ``workpapers,'' \32\ but 
Statement on Auditing Standards No. 96, ``Audit Documentation,'' 
states, in part:
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    \32\ 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.\33\
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    \33\ 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 rule does not 
include this sentence, but instead notes that the Commission or the 
Oversight 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.'' \34\ The proposed rule, therefore, 
recognizes that the Oversight 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.\35\
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    \34\ Prior to the establishment or adoption of auditing 
standards by the Oversight 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.
    \35\ See section 103(a) of the Sarbanes-Oxley Act.
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    As noted by several commenters, there may be significant overlap of 
the documents falling within the definition of ``workpapers'' and the 
documents that would be retained pursuant to the description in 
paragraph (a) of the rule of ``other documents that form the basis of 
the audit or review, and memoranda, correspondence, communications, 
other documents, and records (including electronic records), which (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.'' \36\
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    \36\ See, e.g., letter from PricewaterhouseCoopers dated 
December 27, 2002.
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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.\37\ Section 802, however, is 
intended to

[[Page 4865]]

facilitate effective enforcement of the securities laws and criminal 
laws,\38\ which requires the retention of not only records that support 
the auditor's report (as required by SAS 96) but also records that 
would be inconsistent with, or otherwise challenge, the conclusions in 
the auditor's report. In order to ensure that the purposes of the Act 
are fulfilled, we proposed that paragraph (c) of the rule include 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 those conclusions.\39\ We stated in the Proposing Release 
that paragraph (c) was 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 intended 
by ``cast doubt'' on the auditor's conclusions, we included in the 
proposed rule the example of documentation of differences of opinion 
concerning accounting and auditing issues.
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    \37\ SAS 96, at ] 3; AU Sec.  339.03.
    \38\ See Statement of Senator Leahy on the Senate floor, 148 
Cong. Rec. S7419 (July 26, 2002).
    \39\ 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 statute of limitations.
    148 Cong. Rec. S7419 (July 26, 2002).
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    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.\40\
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    \40\ 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, is intended to 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 
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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.\41\
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    \41\ ``Planning and Supervision: Auditing Interpretations of 
Section 311,'' AU Sec.  9311.37. ``Assistants,'' in the context of 
this interpretation, includes 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.\42\ 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.\43\ 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.\44\
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    \42\ 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.
    \43\ 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.
    \44\ 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 continue to believe that retaining any materials that might cast 
doubt on the final conclusions reflected in the auditor's report, 
including those created under SAS 22 and SAS 96, would be consistent 
with the letter and spirit of the Sarbanes-Oxley Act. One commenter, 
the National Association of State Boards of Accountancy (``NASBA''), 
endorsed requiring the retention of documents that ``cast doubt'' on an 
auditor's audit or review because ``state attorneys' general staff 
members assigned to accountancy boards often have complained of 
receiving only those documents that support the final report.'' NASBA 
also noted, however, that the Commission promptly should revise the 
rule if it becomes too burdensome or otherwise unworkable.\45\
---------------------------------------------------------------------------

    \45\ Letter from K. Michael Conaway, Chair, NASBA, and David A. 
Costello, President and CEO, NASBA, dated December 23, 2002.
---------------------------------------------------------------------------

    Several commentators stated that the proposed ``cast doubt'' 
language was unworkable. They indicated that the phrase was 
pejorative,\46\ vague and unnecessary, and might be used to attribute 
doubt to virtually any remark made during an audit, regardless of its 
relevance or materiality.\47\ One accounting firm stated that the 
proposed rule ``could be read to require retention of every document 
reflecting an error however temporary--even typographical or addition 
errors made in preparing a workpaper. * * * It also could be read to 
require preservation of each and every exchange of differing views on 
any topic, however fleeting and trivial the differences.'' \48\ Another 
accounting firm stated that on many occasions correcting or redoing 
workpapers is not the result of differences of opinion but from on-the-
job training and a normal learning

[[Page 4866]]

process.\49\ One commenter stated that the ``cast doubt'' language in 
the proposed rule might deter auditors from asking legitimate 
questions.\50\
---------------------------------------------------------------------------

    \46\ Letter from Donald G. DeBuck, Computer Sciences 
Corporation, dated December 26, 2002.
    \47\ See, e.g., letter from BDO Seidman, LLP, dated December 27, 
2002; letter from Grant Thornton LLP dated December 27, 2002; letter 
from KPMG LLP dated December 27, 2002; letter from Deloitte & Touche 
LLP dated December 27, 2002.
    \48\ Letter from Ernst & Young LLP, dated December 27, 2002.
    \49\ Letter from Donald D. Pangburn, Director, Gelfond Hochstadt 
Pangburn, P.C., dated November 26, 2002.
    \50\ Letter from Sullivan & Cromwell dated December 26, 2002.
---------------------------------------------------------------------------

    Some commenters suggested language to replace the provision in 
subparagraph (c) that documents be retained if they ``cast doubt on the 
final conclusions reached by the auditor.'' For example, commenters 
suggested that records be retained only if they would constitute a 
reportable ``disagreement'' under Item 304 of Regulation S-K.\51\ Item 
304 indicates that a disagreement is reportable upon a change in an 
entity's principal accountant if, among other things, the disagreement 
occurs at the decision-making level on any matter of accounting 
principles or practices, financial statement disclosure, or auditing 
scope or procedure, which, if not resolved to the accountant's 
satisfaction, would cause the auditor to make reference to the matter 
in connection with his or her audit report.\52\
---------------------------------------------------------------------------

    \51\ See, e.g., letter from Ernst & Young LLP, dated December 
27, 2002; letter from PricewaterhouseCoopers dated December 27, 
2002; letter from Deloitte & Touche dated December 27, 2002.
    \52\ Item 304 of Regulation S-K, 17 CFR 229.304.
---------------------------------------------------------------------------

    We are reluctant, however, to follow Item 304 of Regulation S-K, 
which has a different purpose than the rule being adopted in this 
release. Item 304 requires disclosure to investors of potential 
``opinion shopping'' situations and provides a forum for the 
registrant, the newly engaged auditor, and the former auditor to 
provide their views of ``disagreements'' and other ``reportable 
events.'' New rule 2-06, on the other hand, addresses the retention of 
documents relevant to enforcement of the securities laws, Commission 
rules, and criminal laws.
    In the proposing release we asked if, in place of the ``cast 
doubt'' language, a different test for retention of documents would be 
appropriate. We specifically asked if such a test should be 
documentation of ``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.'' Several commenters supported using one or a 
combination of these tests.\53\
---------------------------------------------------------------------------

    \53\ See, e.g., letter from Sullivan & Cromwell dated December 
26, 2002; letter from Lynette Downing, HLB Tautges Redpath, Ltd. 
dated December 27, 2002; letter from Grant Thornton LLP dated 
December 27, 2002; letter from KPMG LLP dated December 27, 2002; 
letter from the American Institute of Certified Public Accountants 
dated December 27, 2002.
---------------------------------------------------------------------------

    In consideration of the comments received, we have revised 
paragraph (c) of the rule. We have removed the phrase ``cast doubt'' to 
reduce the possibility that the rule mistakenly would be interpreted to 
reach typographical errors, trivial or ``fleeting'' matters, or errors 
due to ``on-the-job'' training. We continue to believe, however, that 
records that either support or contain significant information that is 
inconsistent with the auditor's final conclusions would be relevant to 
an investigation of possible violations of the securities laws, 
Commission rules, or criminal laws and should be retained. Paragraph 
(c), therefore, now provides that the materials described in paragraph 
(a) shall be retained whether they support the auditor's final 
conclusions or contain information or data, relating to a significant 
matter, that is inconsistent with the final conclusions of the auditor 
on that matter or on the audit or review. Paragraph (c) also states 
that the documents and records to be retained include, but are not 
limited to, those documenting consultations on or resolutions of 
differences in professional judgment.
    The reference in paragraph (c) to ``significant'' matters is 
intended to refer to the documentation of substantive matters that are 
important to the audit or review process or to the financial statements 
of the issuer or registered investment company.\54\ Rule 2-06(c) 
requires that the documentation of such matters, once prepared, must be 
retained even if it does not ``support'' the auditor's final 
conclusions, because it may be relevant to an investigation.\55\ 
Similarly, the retention of records regarding a consultation about, and 
resolution of, differences in professional judgment would be relevant 
to such an investigation and must be retained. We intend for Rule 2-06 
to be incremental to, and not to supersede or otherwise affect, any 
other legal or procedural requirement related to the retention of 
records or potential evidence in a legal, administrative, disciplinary, 
or regulatory proceeding.
---------------------------------------------------------------------------

    \54\ SAS 96 requires the auditor to document findings or issues 
that in his or her judgment are significant. It states that 
``significant audit findings or issues'' include:
    [sbull] ``Matters that both (a) are significant and (b) involve 
issues regarding the appropriate selection, application, and 
consistency of accounting principles with regard to the financial 
statements, including related disclosures. Such matters often relate 
to (a) accounting for complex or unusual transactions or (b) 
estimates and uncertainties and, if applicable, the related 
management assumptions.
    [sbull] ``Results of auditing procedures that indicate that (a) 
the financial statements or disclosures could be materially 
misstated or (b) auditing procedures need to be significantly 
modified.
    [sbull] ``Circumstances that cause significant difficulty in 
applying auditing procedures that the auditor considered necessary.
    [sbull] ``Other findings that could result in modification of 
the auditor's report.'' SAS 96, ] 9, AU Sec.  339.09 (Footnote 
omitted.)
    This literature may provide helpful guidance as to the scope of 
the term ``significant.'' However, the term significant as used in 
this rule is not limited to items identified in SAS 96. Moreover, we 
do not intend for the auditor's subjective judgment of whether a 
matter is significant to be determinative. Instead, we believe that 
the more objective test of what may be significant to a reasonable 
investor should be applied in evaluating whether information is 
``significant.''
    \55\ See letter from Deloitte & Touche dated December 27, 2002, 
quoting Statement of Senator Orrin Hatch before the Senate Judiciary 
Committee (April 25, 2002): ``I anticipate that the SEC will 
exercise its discretion to promulgate only those rules and 
regulations that are necessary to ensure that documents material to 
an audit or review, as well as any future investigation, are 
retained.''
---------------------------------------------------------------------------

    Finally, we recognize that audits and reviews of financial 
statements are interactive processes and views within an accounting 
firm on accounting, auditing or disclosure issues may evolve as new 
information or data comes to light during the audit or review. We do 
not view ``differences in professional judgment'' within subparagraph 
(c) to include such changes in preliminary views when those preliminary 
views are based on what is recognized to be incomplete information or 
data.

Response to Other Significant Comments

    In response to our request in the Proposing Release, commenters 
addressed whether issuers and registered investment companies should be 
required to retain documents that the auditor examines, reviews or 
otherwise considers during the audit or review but are not made part of 
the auditor's records. Commenters generally opposed such a 
requirement.\56\ One commenter indicated that it was unclear whether 
section 802 of the Sarbanes-Oxley Act applies to such records and that, 
if such a requirement was imposed, it would go beyond those documents 
that are relevant to the audit or review or that contain the auditor's 
conclusions, opinions, or analyses.\57\ An accounting firm similarly 
stated that it was not practical for an issuer to keep track of the 
documents examined by the auditor and then apply the retention

[[Page 4867]]

requirements to those documents.\58\ An issuer commented that, due to 
the host of documents, databases, and other material provided to an 
auditor, it is impossible for an issuer to determine what, if any, 
documents provided to the auditor were relevant to the auditor or 
provided the basis for the auditor's conclusions.\59\ Accordingly, we 
are not instituting such a requirement at this time.
---------------------------------------------------------------------------

    \56\ One commenter supported such a requirement. Letter from 
Lynette Downing, HLB Tautges Redpath, Ltd. dated December 27, 2002.
    \57\ Letter from Sullivan & Cromwell dated December 26, 2002.
    \58\ Letter from BDO Seidman, LLP dated December 27, 2002. See 
also letter from the American Institute of Certified Public 
Accountants dated December 27, 2002.
    \59\ Letter from Mr. Donald G. DeBuck, Computer Sciences 
Corporation, dated December 26, 2002.
---------------------------------------------------------------------------

    We also requested comments on whether a transition period was 
necessary or appropriate in implementing the rule. Accounting firms 
\60\ and a law firm \61\ noted that time may be required to develop 
systems related to the retention of documents (particularly electronic 
documents) and to train people to use them. Accordingly, we have 
indicated in the beginning of this release that accounting firms should 
comply with the rule no later than October 31, 2003.
---------------------------------------------------------------------------

    \60\ See, e.g., letter from BDO Seidman, LLP dated December 27, 
2002 and letter from KPMG LLP dated December 27, 2002.
    \61\ Letter from Sullivan & Cromwell dated December 26, 2002.
---------------------------------------------------------------------------

    Several items were raised in the comment letters that may be 
addressed more appropriately by the Public Company Accounting Oversight 
Board. For example, one commenter suggested that the Commission adopt 
the standard promulgated by the General Accounting Office, or a 
previously proposed draft auditing standard, related to the form and 
content of audit workpapers.\62\ This commenter also suggested that the 
Commission adopt standards requiring accounting firms to: Document 
differences of opinion on issues that are material to the audit; have 
written documentation and destruction policies; document significant 
relationships regarding the auditor and issuer; and have auditors 
performing audit or review work related to the issuer's subsidiaries or 
foreign affiliates document all work performed and certify in writing 
that such documentation is complete and available for inspection.\63\ 
These matters are more appropriately within the purview of setting 
auditing standards and should be addressed, in the first instance, by 
the Oversight Board.\64\
    The same commenter suggested that the Commission provide that if 
audit work is not documented in the workpapers then the burden of proof 
shifts to the auditor to prove by a preponderance of evidence that the 
work in fact was performed.\65\ We note that the retention requirements 
under SAS 96, as discussed above, and new rule 2-06 should provide 
documentation of all significant matters considered during the audit. 
If such work is performed but not documented, the auditor generally 
would violate GAAS or new rule 2-06.
---------------------------------------------------------------------------

    \62\ Letter from Wendy S. Perez, President, California Board of 
Accountancy, dated December 23, 2002.
    \63\ Id.
    \64\ Sections 103(a) and 103(c) of the Sarbanes-Oxley Act 
empower the Oversight Board to establish auditing standards, 
including, to the extent it determines appropriate, adopting 
standards proposed by professional groups of accountants or by 
expert advisory groups convened by the Oversight Board.
    \65\ Id.
---------------------------------------------------------------------------

    Another commenter suggested that the Commission require that all 
accounting firms registered with the Public Company Accounting 
Oversight Board comply with consultation requirements, and related 
documentation requirements, currently prescribed by the SEC Practice 
Section of the American Institute of Certified Public Accountants for 
large accounting firms.\66\ We believe these matters relate to quality 
control standards within the scope of the Oversight Board's standard 
setting authority and we encourage the Oversight Board to consider 
adoption of such requirements. This commenter also suggested that the 
Commission address the application of rule 2-06 to documents prepared 
for a firm's internal inspection or outside peer review.\67\ Such 
documents generally would not be considered to be created, sent or 
received in connection with an audit or review engagement and, 
therefore, would not be within the new rule. We would encourage the 
Oversight Board to consider, however, whether there are circumstances 
in which certain of the records prepared for inspection purposes may be 
considered part of the audit or review workpapers.
---------------------------------------------------------------------------

    \66\ Letter from BDO Seidman, LLP dated December 27, 2002. See 
Section 1000.08(q) of the SECPS membership requirements. This 
section requires large firms to have policies on internal 
consultations and to document: the matter, the action taken to 
address the matter, and the basis for the final conclusion reached. 
Under this provision, the auditor must either follow the position 
taken by the person consulted or appeal any disagreement to a higher 
level of authority within the firm for ultimate resolution.
    \67\ Id.
---------------------------------------------------------------------------

III. Paperwork Reduction Act

    Certain provisions of rule 2-06 contain ``collections of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995 (``PRA'') (44 U.S.C. 3501 et seq.), and the 
Commission 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. The title for the collection of information is ``Regulation S-
X--Record Retention.'' The request for approval of the rule's 
collection of information requirements is pending at OMB.
    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. Rule 2-06 requires that accounting 
firms retain certain records for seven years. Retained information 
would be kept confidential unless or until made public during an 
enforcement, disciplinary or other legal or administrative proceeding.
    The final rule, which is included in Regulation S-X, requires 
accountants to retain certain records for a period of seven years after 
the accountant concludes an audit or review of an issuer's or 
registered investment company's financial statements. The proposed 
rules do not require accounting firms to create any new records. It 
also is important to note that decisions about the retention of records 
currently are made as a part of each audit or review.
    The records to be retained include records relevant to the audit or 
review, including 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 rule are to be retained 
whether the conclusions, opinions, analyses, or financial data in the 
records support the final conclusions reached by the auditor, or 
contain information or data, relating to a significant matter, that is 
inconsistent with the final conclusions of the auditor on that matter 
or the audit or review. 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, Commission 
rules or criminal laws.
    In the proposing release, we estimated that approximately 850 
accounting firms audit and review the financial statements of 
approximately 20,000 public companies and registered

[[Page 4868]]

investment companies filing financial statements with the 
Commission.\68\ 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.\69\ 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 do not support their opinions and GAAS does not 
set definite retention periods. As a result, rule 2-06 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.
---------------------------------------------------------------------------

    \68\ 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.
    \69\ 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.
---------------------------------------------------------------------------

    To cover all increases in burden hours, we estimated in the 
proposing release 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.\70\
---------------------------------------------------------------------------

    \70\ This burden accounts for incidental reading and 
implementation of the 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.
---------------------------------------------------------------------------

    We received comments on the proposed collection of information 
requirements indicating that, in view of the possible breadth of the 
proposed rule, the estimated burden hours appeared to be low.\71\ These 
commenters suggested that this burden would be mitigated by revising 
the portion of the proposed rule related to the retention of records 
that ``cast doubt'' on the final conclusions reached by the auditor on 
the audit or review.\72\ In view of the revisions made to the rule and 
the clarifications in this release provided in response to commenters' 
concerns, we believe that the estimated burden is reasonable.
---------------------------------------------------------------------------

    \71\ See letter from Lynette Downing, HLB Tautges Redpath, Ltd. 
dated December 27, 2002; letter from PricewaterhouseCoopers dated 
December 27, 2002; letter from Deloitte & Touche dated December 27, 
2002.
    \72\ See letter from PricewaterhouseCoopers dated December 27, 
2002 and letter from Deloitte & Touche dated December 27, 2002.
---------------------------------------------------------------------------

IV. Cost--Benefit Analysis

    The record retention requirements in rule 2-06 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, in the Proposing Release, we 
identified certain costs and benefits of the proposed rule.

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. Rule 2-06 implements this provision 
and indicates the records to be retained, but it does not require 
accounting firms to create any new records.
    The records to be retained would include those relevant to the 
audit or review, including 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 
rule would be retained whether the conclusions, opinions, analyses, or 
financial data in the records support the final conclusions reached by 
the auditor, or contain information or data, relating to a significant 
matter, that is inconsistent with the final conclusions of the auditor 
on that matter or the audit or review. 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, Commission rules or criminal laws.

B. Potential Benefits of the Retention Requirements

    Rule 2-06 requires that accountants retain certain records relevant 
to an audit or review of an issuer's or registered investment company's 
financial statements for seven years. To the extent that the rule 
increases the availability of documents beyond current professional 
practices, the rule may benefit investigations and litigation conducted 
by the Commission and others. Increased retention of these records will 
preserve evidence reflecting significant accounting judgments and 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 rule 2-06 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

    In the proposing release, we estimated 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.\73\ 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.\74\ 
Accounting firms, therefore, currently make decisions about the 
retention of each record created during the audit or review. GAAS 
explicitly requires that auditors retain documents that support their 
audit reports, but it does not set definite retention periods. As noted 
above, to ensure the purposes of the Act are achieved, the final rule 
requires the retention of materials that not only support the auditor's 
report but also records that are inconsistent with that report, and 
sets a seven-year retention period. As a result, rule 2-06 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.
---------------------------------------------------------------------------

    \73\ 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.
    \74\ 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.
---------------------------------------------------------------------------

    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

[[Page 4869]]

the retention of records currently are made as a part of each audit or 
review.
    In the proposing release, we estimated that adoption of the rule 
would not result in any significant increase in costs for accounting 
firms or issuers because the rule would 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. We indicated that 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 stated that 
the incremental increase in storage costs for documents would not be 
significant for any firm or for any single audit client. We recognize, 
however, that firms may incur some cost to retain access to older 
technologies as electronic storage technology advances.
    For purposes of the Paperwork Reduction Act, we estimated in the 
proposing release the total burden to be 15,000 burden hours. We 
further estimated that, assuming an accounting firm's average cost of 
in-house staff is $110 per hour,\75\ the total cost would be 
$1,650,000.
---------------------------------------------------------------------------

    \75\ 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).
---------------------------------------------------------------------------

    We received comments indicating that, based on the proposed rule, 
our cost estimate was low. Due to revisions made to the rule the cost 
estimates provided by the commenters, however, may no longer be 
accurate. For example, a large accounting firm stated that if it would 
be required to retain all financial data ``received'' from the issuer 
in the course of the audit, its current document retention costs of 
approximately $4.5 million would double.\76\ This firm questioned 
whether all of the issuer's financial information, records, databases, 
and reports that the auditor examines on the issuer's premises, but are 
not made part of the auditor's workpapers or otherwise retained by the 
auditor, would be deemed to be ``received'' by the auditor and subject 
to the retention requirements in rule 2-06. As noted previously in this 
release, we do not believe that Congress intended for accounting firms 
to duplicate and retain all of the issuer's financial information, 
records, databases, and reports that might be read, examined, or 
reviewed by the auditor. Accordingly, we do not believe that the 
``received'' criterion in rule 2-06(a)(1) requires that auditors retain 
such records and the firm's anticipated document retention costs, 
therefore, should be significantly reduced.
---------------------------------------------------------------------------

    \76\ Letter from PricewaterhouseCoopers dated December 27, 2002.
---------------------------------------------------------------------------

    Another accounting firm indicated that administrative costs of 
retaining records, based on the proposed rule, could include a one-time 
cost of $1 million and ongoing annual costs of $500,000 to $1 
million.\77\ This firm also estimated that increased litigation costs 
associated with complying with discovery requests and payment of 
damages would increase annual audit costs by at least five percent and 
perhaps as much as fifteen to twenty percent.\78\ As noted above, we 
believe that revisions to the rule in response to commenters' concerns 
should lessen the administrative costs anticipated by this commenter. 
Regarding the commenter's cost estimates related to potential 
litigation, we recognize that one purpose of section 802 is to 
facilitate investigations of potential violations of securities laws 
and criminal laws,\79\ which could impact a firm's litigation costs. 
Nonetheless, the firm's estimate would appear to be speculative. If the 
retention requirements lead to more efficient oversight of the 
accounting profession then they may result in improved audit quality 
and enhanced investor confidence in the profession.
---------------------------------------------------------------------------

    \77\ Letter from BDO Seidman, LLP dated December 27, 2002.
    \78\ Id.
    \79\ 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.* * *'' 148 Cong. Rec. 
S7419 (July 26, 2002).
---------------------------------------------------------------------------

    Other accounting firms noted that many variables would affect the 
costs related to the rule, and that the ultimate increase in costs is 
difficult to quantify.\80\ One commenter indicated that the amount of 
changes to be made to current record retention systems, and the related 
costs, depends on whether the accounting firm has a good record 
management system already in place.\81\ For those firms with 
established records management programs, this commenter indicated that 
the rule would require a review and possibly fine-tuning of the firms' 
existing policies and procedures. This commenter also noted that 
adopting the proposed five-year retention requirement would have been 
more costly than adopting the seven-year retention requirement that is 
consistent with the forthcoming auditing standard to be promulgated by 
the Public Company Accounting Oversight Board. In this commenter's 
view, having two retention periods would have increased costs 
associated with processing the records.\82\
---------------------------------------------------------------------------

    \80\ See, e.g., letter from Grant Thornton, dated December 27, 
2002.
    \81\ Letter from Lynette Downing, HLB Tautges Redpath, Ltd., 
dated December 27, 2002. This commenter estimated that, depending on 
the information systems and staff currently in place, to maintain 
electronic records ``an investment of $100,000 to $250,000 for each 
$5 million in net fees is likely with ongoing annual expenses of 
$50,000 to $100,000.''
    \82\ Id.
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V. Consideration of Impact on the Economy, Burden on Competition, and 
Promotion of Effeciency, Competition, and Capital Formation

    Section 23(a)(2) of the Exchange Act \83\ 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,\84\ Section 3(f) of the Exchange Act,\85\ 
and Section 2(c) of the Investment Company Act \86\ 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.
---------------------------------------------------------------------------

    \83\ 15 U.S.C. 78w(a)(2).
    \84\ 15 U.S.C. 77b(b).
    \85\ 15 U.S.C. 78c(f).
    \86\ 15 U.S.C. 80a-2(c).
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    We believe that rule 2-06 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.
    One commenter agreed that the rule should have no adverse effect on 
competition.\87\ This commenter also noted that those firms with good 
records management systems should have more efficient services and more 
secure information.\88\
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    \87\ Letter from Lynette Downing, HLB Tautges Redpath, Ltd., 
dated December 27, 2002.
    \88\ Id.
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    In any event, to the extent the rule has any anti-competitive 
effect, or impacts efficiency, competition, or capital formation, we 
believe those effects are necessary and appropriate in

[[Page 4870]]

furtherance of the goals of implementing section 802 of the Sarbanes-
Oxley Act.
    We received no comments indicating that the rule would impact 
efficiency or capital formation.

VI. Final Regulatory Flexibility Act Analysis

    This Final Regulatory Flexibility Act Analysis has been prepared in 
accordance with 5 U.S.C. 604. It relates to new rule 2-06 of Regulation 
S-X, which requires auditors to retain certain audit and review 
documentation.

A. Reasons for and Objectives of the New Rule

    The rule generally carries out a congressional mandate. The rule, 
in general, prohibits the destruction for seven years of certain 
records related to the audit or review of an issuer's or registered 
investment company's financial statements.\89\ The rule, however, would 
not require accounting firms to create any new records.
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    \89\ See section 802 of the Sarbanes-Oxley Act.
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    The objective of the rule is 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 is 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.

B. Significant Issues Raised by Public Comments

    One commenter anticipated that the record retention requirements, 
if adopted as proposed, would have placed an ``enormous'' burden on 
small accounting firms, and could have resulted in some firms deciding 
to no longer audit public companies.\90\ The final rule, however, 
contains several revisions designed to lower the costs on all firms, 
including smaller accounting firms. These revisions include removing 
the ``cast doubt'' language from the rule, which commenters generally 
viewed as requiring the auditor to retain virtually all documents 
generated or reviewed during an audit or review, regardless of their 
relevance or materiality.\91\ We have replaced this language with 
language that focuses on documents that contain information or data 
relating to a significant matter that are inconsistent with the 
auditor's final conclusions regarding that matter or the audit or 
review. We also have adopted a seven-year retention period to coincide 
with a forthcoming retention requirement to be promulgated by the 
Public Company Accounting Oversight Board, which, according to one 
commenter, should reduce processing costs associated with the rule.\92\ 
Also, as noted above, we have clarified in this release that the 
auditor need not retain every document read, examined or reviewed as 
part of the audit or review process. As a result of these revisions and 
clarifications, we believe that implementation of the revised rule 
should be less costly for accounting firms than anticipated by the 
commenters.
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    \90\ Letter from Grant Thornton LLP, dated December 27, 2002.
    \91\ See, e.g., letter from BDO Seidman, LLP, dated December 27, 
2002; letter from Grant Thornton LLP dated December 27, 2002; letter 
from KPMG LLP dated December 27, 2002; letter from Deloitte & Touche 
LLP dated December 27, 2002.
    \92\ Letter from Lynette Downing, HLB Tautges Redpath, Ltd., 
dated December 27, 2002.
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    Furthermore, one commenter noted that records management procedures 
for smaller accounting firms should be the same as they are for larger 
firms.\93\ This commenter indicated that ``the cost of implementing a 
[formalized records management] program at any-sized firm will be 
surpassed by the benefits received and the future cost savings.''\94\
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    \93\ Letter from Lynette Downing, HLB Tautges Redpath, Ltd., 
dated December 27, 2002.
    \94\ Id.
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C. Small Entities Subject to the Rule

    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.\95\ 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.
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    \95\ 13 CFR 121.201.
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    In the Initial Regulatory Flexibility Analysis we requested comment 
on the number of firms with less than $6 million in revenue in order to 
determine the number of small firms potentially affected by the rule, 
but we received no response.

D. Projected Reporting, Recordkeeping and Other Compliance Requirements

    Under the new rule,\96\ accountants who audit or review an issuer's 
or registered investment company's financial statements must retain 
certain records for a period of seven years from conclusion of the 
audit or review. The records to be retained include records relevant to 
the audit or review, such as 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 
rule would be retained whether the conclusions, opinions, analyses, or 
financial data in the records support the final conclusions reached by 
the auditor, or contain information or data, relating to a significant 
matter, that is inconsistent with the final conclusions of the auditor 
on that matter or the audit or review. 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.
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    \96\ See section 802 of the Sarbanes-Oxley Act of 2002.
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    In the Proposing Release, we estimated that adoption of the rule 
would not result in any significant increase in costs for accounting 
firms or issuers because the rule would 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. We indicated that 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 stated that 
the incremental increase in storage costs for documents would not be 
significant for any firm or for any single audit client.
    For purposes of the Paperwork Reduction Act, we estimated in the 
proposing release the total burden to be 15,000 burden hours. We 
further estimated that, assuming an accounting firm's average cost of 
in-house staff is $110 per hour,\97\ the total cost would be 
$1,650,000.
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    \97\ 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).
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    We received comments indicating that, based on the proposed rule, 
our cost estimate was low. Due to revisions made to the rule the cost 
estimates

[[Page 4871]]

provided by the commenters, however, may no longer be accurate. For 
example, a large accounting firm stated that if it would be required to 
retain all financial data ``received'' from the issuer in the course of 
the audit, its current document retention costs of approximately $4.5 
million would double.\98\ This firm questioned whether all of the 
issuer's financial information, records, databases, and reports that 
the auditor examines on the issuer's premises, but are not made part of 
the auditor's workpapers or otherwise retained by the auditor, would be 
deemed to be ``received'' by the auditor and subject to the retention 
requirements in rule 2-06. As noted previously in this release, we do 
not believe that Congress intended for accounting firms to duplicate 
and retain all of the issuer's financial information, records, 
databases, and reports that might be read, examined, or reviewed by the 
auditor.\99\ Accordingly, we do not believe that the ``received'' 
criterion in rule 2-06(a)(1) requires that the auditor retain such 
records and the firm's anticipated document retention costs, therefore, 
should be significantly reduced.
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    \98\ Letter from PricewaterhouseCoopers dated December 27, 2002.
    \99\ See letter from Deloitte & Touche dated December 27, 2002, 
quoting Statement of Senator Orrin Hatch before the Senate Judiciary 
Committee (April 25, 2002): ``I anticipate that the SEC will 
exercise its discretion to promulgate only those rules and 
regulations that are necessary to ensure that documents material to 
an audit or review, as well as any future investigation, are 
retained.''
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    Another accounting firm indicated that administrative costs of 
retaining records, based on the proposed rule, could include a one-time 
cost of $1 million and ongoing annual costs of $500,000 to $1 
million.\100\ This firm also estimated that increased litigation costs 
associated with complying with discovery requests and payment of 
damages would increase annual audit costs by at least five percent and 
perhaps as much as fifteen to twenty percent.\101\ As noted above, we 
believe that revisions to the rule in response to commenters' concerns 
should lessen the administrative costs anticipated by this commenter. 
Regarding the commenter's cost estimates related to potential 
litigation, we recognize that one purpose of section 802 is to 
facilitate investigations of potential violations of securities laws, 
Commission rules and criminal laws,\102\ which could impact a firm's 
litigation costs. Nonetheless, the firm's estimate would appear to be 
speculative. If the retention requirements lead to more efficient 
oversight of the accounting profession then they may result in improved 
audit quality and enhanced investor confidence in the profession.
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    \100\ Letter from BDO Seidman, LLP dated December 27, 2002.
    \101\ Id.
    \102\ 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 * * *.'' 148 Cong. Rec. 
S7419 (July 26, 2002).
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    Other accounting firms noted that many variables would affect the 
costs related to the rule, and that the ultimate increase in costs is 
difficult to quantify.\103\ One commenter indicated that the amount of 
changes to be made to current record retention systems, and the related 
costs, depends on whether the accounting firm has a good record 
management system already in place.\104\ For those firms with 
established records management programs, this commenter indicated that 
the rule would require a review and possibly fine-tuning of the firms' 
existing policies and procedures. This commenter also noted that 
adopting the proposed five-year retention requirement would have been 
more costly than adopting the seven-year retention requirement that is 
consistent with the forthcoming auditing standard to be promulgated by 
the Public Company Accounting Oversight Board. In this commenter's 
view, having two retention periods would have increased costs 
associated with processing the records.\105\
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    \103\ Letter from Grant Thornton, dated December 27, 2002.
    \104\ Letter from Lynette Downing, HLB Tautges Redpath, Ltd., 
dated December 27, 2002. This commenter estimated that, depending on 
the information systems and staff currently in place, to maintain 
electronic records ``an investment of $100,000 to $250,000 for each 
$5 million in net fees is likely with ongoing annual expenses of 
$50,000 to $100,000.''
    \105\ Id.
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E. Agency Action To Minimize Effect on Small Entities

    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 record retention rules. The rule is 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. We do not believe that it is feasible to 
further clarify, consolidate, or simplify the proposed rules for small 
entities.

VII. Codification Update

    The ``Codification of Financial Reporting Policies'' announced in 
Financial Reporting Release No. 1 (April 15, 1982) is amended as 
follows:
    By amending section 602 to add a new discussion at the end of that 
section under Financial Reporting Release Number 66 (FR-66) that 
includes the text in 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.

VIII. Statutory Bases and Text of Amendments

    We are adopting 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 Amendments

    In accordance with the foregoing, Title 17, Chapter II of the Code 
of Federal Regulations is 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,

[[Page 4872]]

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 seven years after 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 records relevant to the 
audit or review, including 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:
    (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) Memoranda, correspondence, communications, other documents, and 
records (including electronic records) described in paragraph (a) of 
this section shall be retained whether they support the auditor's final 
conclusions regarding the audit or review, or contain information or 
data, relating to a significant matter, that is inconsistent with the 
auditor's final conclusions regarding that matter or the audit or 
review. Significance of a matter shall be determined based on an 
objective analysis of the facts and circumstances. Such documents and 
records include, but are not limited to, those documenting a 
consultation on or resolution of differences in professional judgment.
    (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)).

    By the Commission.

    Dated: January 24, 2003.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-2118 Filed 1-29-03; 8:45 am]
BILLING CODE 8010-01-P