[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]
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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
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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
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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.''
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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\
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\45\ Letter from K. Michael Conaway, Chair, NASBA, and David A.
Costello, President and CEO, NASBA, dated December 23, 2002.
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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\
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\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.
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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\
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\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.
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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\
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\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.
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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.
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\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.''
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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.
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\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.
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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.
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\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.
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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.
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\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.
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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.
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\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.
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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.
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\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.
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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\
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\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.
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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.
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\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.
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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.
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\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.
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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.
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\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).
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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 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.
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\76\ Letter from PricewaterhouseCoopers dated December 27, 2002.
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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.\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.
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\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).
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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.\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.
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\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