[Federal Register Volume 68, Number 102 (Wednesday, May 28, 2003)]
[Rules and Regulations]
[Pages 31820-31830]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-13095]



[[Page 31819]]

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

Part IV





Securities and Exchange Commission





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



17 CFR Part 240



Improper Influence on Conduct of Audits; Final Rule

  Federal Register / Vol. 68, No. 102 / Wednesday, May 28, 2003 / Rules 
and Regulations  

[[Page 31820]]


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

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release Nos. 34-47890; IC-26050; FR-71; File No. S7-39-02]
RIN 3235-AI67


Improper Influence on Conduct of Audits

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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

SUMMARY: As directed by section 303 of the Sarbanes-Oxley Act of 2002, 
we are adopting rules to prohibit officers and directors of an issuer, 
and persons acting under the direction of an officer or director, from 
taking any action to coerce, manipulate, mislead, or fraudulently 
influence the auditor of the issuer's financial statements if that 
person knew or should have known that such action, if successful, could 
result in rendering the financial statements materially misleading.

EFFECTIVE DATE: June 27, 2003.

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

SUPPLEMENTARY INFORMATION: We are redesignating rule 13b2-2 of 
Regulation 13B-2 \1\ as rule 13b2-2(a) and adding new rules 13b2-2(b) 
and (c).
---------------------------------------------------------------------------

    \1\ 17 CFR 240.13b2-1 et seq.
---------------------------------------------------------------------------

I. Executive Summary

    On July 30, 2002, the Sarbanes-Oxley Act of 2002 (the ``Act'') \2\ 
was enacted. Section 303(a) of the Act states:
---------------------------------------------------------------------------

    \2\ Pub. L. 107-204, 116 Stat. 745 (2002).

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

    As mandated by the Act, the Commission is adopting rules to 
implement section 303(a).\3\ The rules, in combination with the 
existing rules under Regulation 13B-2, are designed to ensure that 
management makes open and full disclosures to, and has honest 
discussions with, the auditor of the issuer's financial statements. 
These rules prohibit officers or directors of an issuer, or persons 
acting under their direction, from subverting the auditor's 
responsibilities to investors to conduct a diligent audit of the 
financial statements and to provide a true report of the auditor's 
findings.
---------------------------------------------------------------------------

    \3\ Section 303 of the Act states:
    (a) RULES TO PROHIBIT. It shall be unlawful, in contravention of 
such rules or regulations as the Commission shall prescribe as 
necessary or appropriate in the public interest and for the 
protection of investors, for any officer or director of an issuer, 
or any other person acting under the direction thereof, to take any 
action to fraudulently influence, coerce, manipulate, or mislead any 
independent public or certified accountant engaged in the 
performance of an audit of the financial statements of that issuer 
for the purpose of rendering such financial statements materially 
misleading.
    (b) ENFORCEMENT.--In any civil proceeding, the Commission shall 
have exclusive authority to enforce this section and any rule or 
regulation issued under this section.
    (c) NO PREEMPTION OF OTHER LAW.--The provisions of subsection 
(a) shall be in addition to, and shall not supersede or preempt, any 
other provision of law or any rule or regulation issued thereunder.
    (d) DEADLINE FOR RULEMAKING.--The Commission shall--
    (1) propose the rules or regulations required by this section, 
not later than 90 days after the date of enactment of this Act; and
    (2) issue final rules or regulations required by this section, 
not later than 270 days after that date of enactment.
---------------------------------------------------------------------------

II. Discussion of Final Rules

A. Introduction

    The new rules supplement the rules currently in Regulation 13B-2, 
which address the falsification of books, records and accounts \4\ and 
false or misleading statements, or omissions to make certain 
statements, to accountants.\5\ New rule 13b2-2(b)(1) specifically 
prohibits officers and directors, and persons acting under their 
direction, from coercing, manipulating, misleading, or fraudulently 
influencing (collectively referred to herein as ``improperly 
influencing'') the auditor of the issuer's financial statements when 
the officer, director or other person knew or should have known that 
the action, if successful, could result in rendering the issuer's 
financial statements materially misleading.\6\ New rule 13b2-2(b)(2) 
provides examples of actions that improperly influence an auditor that 
could result in ``rendering the issuer's financial statements 
materially misleading.'' This paragraph also clarifies that such 
actions should not occur at any time that the auditor is called upon to 
exercise professional judgment related to the issuer's financial 
statements. New rule 13b2-2(c) applies similar provisions to audits of 
investment companies' financial statements.
---------------------------------------------------------------------------

    \4\ 17 CFR 240.13b2-1 states that no person shall, directly or 
indirectly, falsify or cause to be falsified, any book, record or 
account subject to section 13(b)(2)(A) of the Securities Exchange 
Act of 1934 (``Exchange Act''). Section 13(b)(2) of the Exchange Act 
states:
    Every issuer which has a class of securities registered pursuant 
to section 12 of this title and every issuer which is required to 
file reports pursuant to section 15(d) of this title shall (A) make 
and keep books, records, and accounts, which, in reasonable detail, 
accurately and fairly reflect the transactions and dispositions of 
the assets of the issuer. * * *
    \5\ 17 CFR 240.13b2-2 states that no director or officer of an 
issuer, in connection with an audit or examination of the issuer's 
financial statements or the preparation of any document or report to 
be filed with the Commission, directly or indirectly shall (a) make 
or cause to be made a materially false or misleading statement to an 
accountant or (b) omit to state, or cause another person to omit to 
state, any material fact necessary to make statements made, in light 
of the circumstances under which such statements were made, not 
misleading to an accountant. In redesignating Rule 13b2-2 as Rule 
13b2-2(a), technical changes have been made to clarify that the rule 
addresses false or misleading statements made ``to an accountant in 
connection with'' an audit, review or preparation of any document or 
report required to be filed with the Commission.
    \6\ The rules were proposed in Release Nos. 34-46685; IC-25773; 
File No. S7-39-02 (October 18, 2002) [67 FR 65325] (``proposing 
release'').
---------------------------------------------------------------------------

B. Discussion

    Definition of ``issuer.'' In the proposing release, we noted that 
the definition of the term ``issuer'' in section 3 of the Securities 
Exchange Act of 1934 (``Exchange Act'') would apply to the term as used 
in the rule. This definition includes, with certain exceptions, any 
person who issues or proposes to issue securities.\7\ One commenter 
noted that this definition would include all private issuers of 
securities and suggested that we use the definition of ``issuer'' in 
the Sarbanes-Oxley Act.\8\ The definition in that Act

[[Page 31821]]

generally would limit application of the rule to issuers whose 
securities are registered with the Commission under section 12 of the 
Exchange Act, that are required to file reports with the Commission 
under section 15(d) of the Exchange Act, or that have filed 
registration statements with the Commission that have not yet become 
effective and have not been withdrawn.\9\ We continue to believe that 
the definition of the term ``issuer'' in section 3 of the Exchange Act 
applies to the use of the term in the new rules.\10\ The term 
``issuer,'' as defined in the Exchange Act, has been used in Rule 13b2-
2 since it was adopted in 1979,\11\ and we believe that the amendments 
do not require a change in the meaning of the term. In addition, 
because the new rule specifically applies to improperly influencing 
auditors of issuers' financial statements ``that are required to be 
filed with the Commission,'' the commenter's concern that this 
definition would extend the scope of the rule to all private issuers of 
securities has been addressed. Accordingly, the term ``issuer'' in the 
new rule should be defined as stated in section 3 of the Exchange Act.
---------------------------------------------------------------------------

    \7\ The new rules are included in Regulation 13B-2 under the 
Securities Exchange Act of 1934 (``Exchange Act''). Section 3(a)(8) 
of the Exchange Act, 15 U.S.C. 78c(a)(8), defines ``issuer'' as 
follows:
    The term ``issuer'' means any person who issues or proposes to 
issue any security; except that with respect to certificates of 
deposit for securities, voting trust certificates, or collateral-
trust certificates, or with respect to certificates of interest or 
shares in an unincorporated investment trust not having a board of 
directors or of the fixed, restricted management, or unit type, the 
term ``issuer'' means the person or persons performing the acts and 
assuming the duties of depositor or manager pursuant to the 
provisions of the trust or other agreement or instrument under which 
such securities are issued; and except with respect to equipment-
trust certificates or like securities, the term ``issuer'' means the 
person by whom the equipment or property is, or is to be, used.
    \8\ Letter from Paul B. Uhlenhop, dated November 8, 2002.
    \9\ Section 2(a)(7) of the Act, which states:
    The term ``issuer'' means an issuer (as defined in section 3 of 
the Securities Exchange Act of 1934 (15 U.S.C. 78c)), the securities 
of which are registered under section 12 of that Act (15 U.S.C. 
78l), or that is required to file reports under section 15(d) (15 
U.S.C. 78o(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.
    \10\ The Commission has broad rulemaking authority to prescribe 
illegal acts that contribute to the falsification of financial 
statements or the issuance of false or misleading audit reports. 
See, e.g., sections 10, 10A and 23(a) of the Exchange Act, 15 U.S.C. 
78j, 78j-1 and 78s(a). See also section 3(a) of the Sarbanes-Oxley 
Act of 2002, which states, ``The Commission shall promulgate such 
rules and regulations, as may be necessary or appropriate in the 
public interest or for the protection of investors, and in 
furtherance of this Act.''
    \11\ Exchange Act Release No. 15570 (February 15, 1979) [44 FR 
10970].
---------------------------------------------------------------------------

    Definition of ``officer.'' New rule 13b2-2(b)(1) addresses 
activities by an officer or director of an issuer, or any other person 
acting under the direction of an officer or director.\12\ The 
Commission has defined the term ``officer'' to include the company's 
``president, vice president, secretary, treasurer or principal 
financial officer, comptroller or principal accounting officer, and any 
person routinely performing corresponding functions with respect to any 
organization whether incorporated or unincorporated.'' \13\ The term 
`executive officer' includes an issuer's chief executive officer and 
other officers who perform policy-making functions for the issuer.\14\
---------------------------------------------------------------------------

    \12\ The rule applies to foreign private issuers as well as 
domestic issuers. In applying the rule to foreign private issuers, 
the terms ``officer'' and ``director'' would indicate those 
performing equivalent functions under the local laws and corporate 
governance practices where the issuer is domiciled.
    \13\ Rule 3b-2 under the Exchange Act, 17 CFR 240.3b-2. A person 
may be an ``officer'' for purposes of Rule 3b-2 regardless of the 
person's title or the legal entity with which he or she is 
associated. For example, officers of wholly owned subsidiaries of 
public companies and promoters may be ``officers'' of public 
companies.
    The definition of ``director'' under the Exchange Act has a 
similar functional and flexible nature. See section 3(a)(7) of the 
Exchange Act, 15 U.S.C. 78c(a)(7), which states, ``The term 
`director' means any director of a corporation or any person 
performing similar functions with respect to any organization, 
whether incorporated or unincorporated.''
    \14\ Rule 3b-7 under the Exchange Act, 17 CFR 240.3b-7, states, 
``The term `executive officer,' when used with reference to a 
registrant, means its president, vice president of the registrant in 
charge of a principal business unit, division or function (such as 
sales, administration, or finance), any other officer who performs a 
policy making function or any other person who performs similar 
policy making functions for the registrant. Executive officers of 
subsidiaries may be deemed executive officers of the registrant if 
they perform such policy making functions for the registrant.''
---------------------------------------------------------------------------

    Some commenters suggested that the term ``officer'' should include 
all those responsible for corporate governance matters \15\ or who 
influence the preparation of an issuer's financial statements.\16\ 
Commenters also suggested that the definition include an issuer's 
general counsel or chief legal officer.\17\ We do not believe at this 
time that it is necessary to amend the existing definition of 
``officer'' or ``executive officer,'' or to write a new definition 
specifically for Regulation 13B-2. The existing definitions cover, 
among others, those who set corporate governance policies and legal 
policies for an issuer. Should we note that members of management not 
encompassed by the existing definitions of ``officer'' and ``executive 
officer'' are engaging in the conduct addressed in the rule, we may 
revisit this issue.
---------------------------------------------------------------------------

    \15\ Letter from the National Association of State Boards of 
Accountancy (``NASBA'') dated November 25, 2002.
    \16\ Letter from Transparency International--USA, dated November 
8, 2002.
    \17\ Letters from PricewaterhouseCoopers LLP (``PwC'') dated 
November 25, 2002 and Transparency International--USA, dated 
November 8, 2002.
---------------------------------------------------------------------------

    Definition of ``under the direction.'' As noted above, new rule 
13b2-2(b)(1) covers the activities of not only officers and directors 
of the issuer who engage in an attempt to misstate financial statements 
but also ``any other person acting under the direction thereof.'' 
Activities by such ``other persons'' currently may constitute 
violations of the anti-fraud or other provisions of the securities laws 
\18\ or aiding or abetting \19\ or causing \20\ an issuer's violations 
of the securities laws. Section 303(a) and the new rule provide the 
Commission \21\ with an additional means of addressing efforts by 
persons acting under the direction of an officer or director to 
improperly influence the audit process and the accuracy of the issuer's 
financial statements.
---------------------------------------------------------------------------

    \18\ See, e.g., Section 10(b) of the Exchange Act, 15 U.S.C. 
78j, and Rule 10b-5 thereunder, 17 CFR 240.10b-5.
    \19\ See, e.g., section 20(e) of the Exchange Act, 15 U.S.C. 
78t(e).
    \20\ See, e.g., section 21C of the Exchange Act, 15 U.S.C. 78u-
3.
    \21\ Section 303(b) of the Act states, ``The Commission shall 
have exclusive authority to enforce this section and any rule or 
regulation issued under this section.''
---------------------------------------------------------------------------

    As noted in the proposing release, we interpret Congress' use of 
the term ``direction'' to encompass a broader category of behavior than 
``supervision.'' \22\ In other words, someone may be ``acting under the 
direction'' of an officer or director even if they are not under the 
supervision or control of that officer or director. Such persons might 
include not only the issuer's employees but also, for example, 
customers, vendors or creditors who, under the direction of an officer 
or director, provide false or misleading confirmations or other false 
or misleading information to auditors, or who enter into ``side 
agreements'' that enable the issuer to mislead the auditor.\23\ In 
appropriate circumstances, persons acting under the direction of 
officers and directors also may include not only lower level employees 
of the issuer \24\ but also other partners or employees of the 
accounting firm (such as consultants or forensic accounting

[[Page 31822]]

specialists retained by counsel for the issuer) and attorneys, 
securities professionals, or other advisers who, for example, pressure 
an auditor to limit the scope of the audit, to issue an unqualified 
report on the financial statements when such a report would be 
unwarranted,\25\ to not object to an inappropriate accounting 
treatment, or not to withdraw an issued audit report on the issuer's 
financial statements. In the case of a registered investment company, 
persons acting under the direction of officers and directors of the 
investment company may include, among others, officers, directors, and 
employees of the investment company's investment adviser, sponsor, 
depositor, administrator, principal underwriter, custodian, transfer 
agent, or other service providers.\26\
---------------------------------------------------------------------------

    \22\ See, e.g., Webster's Dictionary (9th edition), which 
defines ``direction'' to include not only guidance or supervision of 
action or conduct but also explicit instruction.
    \23\ See, e.g., In the Matter of Ronald G. Davies, Accounting 
and Auditing Enforcement Release No. (``AAER'') 1281 (June 29, 
2000), which states, in part,
    In early 1998, Davies learned information that should have 
alerted him to the fact that Hybrid's sales personnel had concealed 
the existence of the side letter from the Company's management and 
auditors. When Hybrid and its auditors, as part of the preparation 
of the Company's financial statements, sought confirmation that Ikon 
had received no right of return, Davies provided a misleading audit 
response to the Company. * * * Davies actions described above 
allowed Hybrid personnel to circumvent internal controls and make 
false statements to the Company's auditors, and caused Hybrid to 
make material misrepresentations and file inaccurate reports with 
the Commission. * * * Based on the foregoing, Davies caused 
violations of Sections 10(b), 13(a), 13(b)(5) of the Exchange Act 
and Rules 10b-5, 12b-20, 13a-13, 13b2-1, and 13b2-2 thereunder.
    \24\ See, e.g., In the Matter of John K. Bradley, AAER 1568 
(June 5, 2002).
    \25\ `An `unqualified opinion'' [or unqualified report] states 
that the financial statements present fairly, in all material 
respects, the financial position, results of operations, and cash 
flows of the entity in conformity with generally accepted accounting 
principles.'' AICPA, Statement on Auditing Standards No. (``SAS'') 
58, ``Reports on Audited Financial Statements,'' ] 10; Codification 
of Statements on Auditing Standards (``AU'') Sec.  508.10.
    \26\ Some of these individuals also would be covered under 
provisions of the rule tailored to investment companies. See section 
II.C. of this release, Issues Related to Investment Companies.
---------------------------------------------------------------------------

    Commenters on this discussion in the proposing release were 
divided. Some believe that some form of specific instruction or 
direction from an officer or director should be required before the 
rule should apply to ``other persons.'' \27\ Others expressed the 
opposite view that no specific direction should be required,\28\ that 
the conduct should be considered illegal whether or not the person was 
acting under the direction of an officer or director,\29\ and that the 
rule should apply to anyone who lies to or misleads the auditor \30\ 
and to all those who have responsibilities or activities relevant to 
the financial statements.\31\ Still others suggested that we neither 
define the term ``under the direction'' nor provide examples.\32\ As 
noted above, we continue to believe that ``direction'' encompasses a 
broader category of behavior than supervision, and may include the 
activities of third parties who participate in an effort to improperly 
influence the auditor when those third parties knew or should have 
known that the effect of their conduct would be to render an issuer's 
financial statements materially misleading.
---------------------------------------------------------------------------

    \27\ See, e.g., letters from Sidley Austin Brown & Wood dated 
December 30, 2002, BDO Seidman LLP dated November 25, 2002, Plains 
All American Pipeline L.P. dated November 25, 2002, Dechert dated 
November 25, 2002, National Association of Real Estate Investment 
Trusts dated November 25, 2002, and Compass Bancshares, Inc. dated 
November 25, 2002.
    \28\ See, e.g., letter from Transparency International--USA, 
dated November 8, 2002.
    \29\ See, e.g., letter from America's Community Bankers dated 
November 25, 2002.
    \30\ See, e.g., letter from the American Institute of Certified 
Public Accountants dated November 25, 2002.
    \31\ See, e.g., letter from PwC dated November 25, 2002.
    \32\ See, e.g., letters from the American Bar Association dated 
December 13, 2002 and The Business Roundtable dated November 29, 
2002.
---------------------------------------------------------------------------

    Some commenters were concerned that including customers, vendors 
and creditors in the discussion of those persons who, in appropriate 
circumstances, might be considered to be acting under the direction of 
an officer or director would have a chilling effect on communications 
between those persons and the auditors.\33\ Other commenters noted that 
this chilling effect would be enhanced by the Commission's position in 
the proposing release that negligently misleading the auditor was 
sufficient conduct to trigger application of the rule.\34\ In 
particular, some commenters noted that a misleading legal analysis 
should violate the rule only if accompanied by fraudulent or ``bad'' 
intent on the part of the attorney providing the analysis.\35\ These 
comments would appear to be based on the premise that in the past the 
Commission has not addressed the negligent communication of misleading 
information to auditors and that the new rule, therefore, would chill 
communications during the audit process and thereby lower the quality 
of the audit process. To the contrary, for many years we have initiated 
enforcement actions against those who, by negligently providing 
misleading confirmations to auditors, cause \36\ an issuer to violate 
the financial reporting or books and records provisions of the 
Securities Exchange Act of 1934.\37\ The new rule, by providing an 
additional means of addressing such conduct, should provide more 
credibility and integrity to the audit process. We believe that third 
parties providing information or analyses to an auditor should exercise 
reasonable attention and care in those communications.\38\ A primary 
purpose for enactment of the Sarbanes-Oxley Act is the restoration of 
investor confidence in the integrity of financial reports, which will 
require the cooperation of all parties involved in the audit process. 
We do not intend to hold any party accountable for honest and 
reasonable mistakes or to sanction those who actively debate accounting 
or auditing issues. We do believe, however, that those third parties 
who, under the direction of an issuer's officers or directors, mislead 
or otherwise improperly influence auditors when they know or should 
know that their conduct could result in investors being provided with 
misleading financial statements or a misleading audit report, should be 
subject to sanction by the Commission.\39\
---------------------------------------------------------------------------

    \33\ See, e.g., letters from Wells Fargo dated November 22, 
2002, Dorsey & Whitney dated November 25, 2002, Deloitte & Touche 
dated November 27, 2002, Sidley Austin Brown & Wood dated December 
30, 2002, America's Community Bankers dated November 25, 2002, and 
BDO Seidman LLP dated November 25, 2002.
    \34\ See, e.g., letter from Ernst & Young LLP dated November 25, 
2002.
    \35\ See, e.g., letters from Wells Fargo dated November 22, 
2002, American Bar Association dated December 13, 2002, America's 
Community Bankers dated November 25, 2002, National Association of 
Real Estate Investment Trusts dated November 25, 2002, Intel 
Corporation dated November 26, 2002, and Compass Bancshares, Inc. 
dated November 25, 2002.
    \36\ KPMG LLP v. Securities and Exchange Commission, 289 F. 3d 
109, 126 (D.C. Cir. 2002), which states, ``We affirm the 
Commission's determination that negligence is an appropriate basis 
for violations underlying a Section 21C cease-and-desist order. * * 
*'' See In the Matter of KPMG Peat Marwick LLP, AAER 1360 (January 
19, 2001), which states, ``We hold today that negligence is 
sufficient to establish ``causing'' liability under Exchange Act 
section 21C(a), at least in cases in which a person is alleged to 
``cause'' a primary violation that does not require scienter. 
Therefore, if Peat Marwick acted at least negligently with respect 
to whether its conduct would contribute to PORTA's violations, Peat 
Marwick is liable under Section 21C(a) as a cause of those 
violations.''
    \37\ See, e.g., In the Matter of Donald F. Marcus and In the 
Matter of Harry P. Adler, AAER 1715 (February 10, 2003); SEC v. John 
F. Mortell, et al., AAER 1569 (June 5, 2002); In the Matter of 
Ronald G. Davies, AAER 1281 (June 29, 2000); and In the Matter of 
Terry R. Kuntz and Richard J. Scheer, AAER 720 (September 26, 1995), 
which states, in part,
    Kuntz and Scheer knew or should have known that their conduct 
contributed to the fraudulent activities of Assix management. The 
September 13, 1991 letter supplied by Kuntz, coupled with the 
invoices provided by Scheer, assisted Assix in filing a materially 
false and misleading Annual Report and Quarterly Report with the 
Commission * * *.
    Accordingly, Kuntz's conduct in providing the September 13, 1991 
letter and Scheer's conduct in providing the invoices to the company 
caused Assix to violate Sections 10(b), 13(a) and 13(b) of the 
Exchange Act and Rules 10b-5, 12b-20, 13a-1, 13a-13 and 13b2-2 
thereunder. By falsifying these documents, Kuntz and Scheer also 
caused Assix's violation of Rule 13b2-1 and Section 13(b)(2)(A). 
Further, Kuntz and Scheer also caused Assix's controller to violate 
13b2-2 by providing materially false and misleading documents which 
were used by Assix's auditors * * *.
    In this instance, Kuntz and Scheer subverted the audit process 
by creating false documents which assisted Assix in filing 
materially false and misleading statements, recording false revenue, 
and lying to its auditors. The Commission will not tolerate conduct 
by third party vendors such as that described herein, which poses a 
very real threat to the integrity of the disclosure process.
    \38\ Id.
    \39\ See, e.g., In the Matter of Terry R. Kuntz and Richard J. 
Scheer, AAER 720 (September 26, 1995), which states, in part, ``The 
Commission will not tolerate conduct by third party vendors * * *, 
which poses a very real threat to the integrity of the disclosure 
process.''

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

[[Page 31823]]

    ``Fraudulently influence.'' New rules 13b2-2(b)(1) and (c)(2) 
address certain actions ``to coerce, manipulate, mislead, or 
fraudulently influence'' the auditor of the issuer's financial 
statements. Much of the conduct addressed by the rules, particularly 
efforts to ``manipulate or mislead'' the auditor, generally would be 
subject to other provisions of the securities laws and the Commission's 
regulations, including the existing rules in Regulation 13B-2.\40\ The 
new rules, however, would provide an additional means to address 
conduct to coerce, manipulate, mislead, or fraudulently influence an 
auditor during his or her examination or review of the issuer's 
financial statements, including conduct that did not succeed in 
affecting the audit or review.\41\
    In the proposing release, we noted that in the rule the word 
``fraudulently'' modifies influence but not coerce, manipulate or 
mislead. Several commenters suggested that the Commission should amend 
this interpretation and state that ``fraudulently'' modifies all four 
types of conduct.\42\ Some commenters indicated that intent to 
materially mislead the auditor should be required \43\ and others 
stated any attempt to purposely skew the issuer's disclosure should 
violate the rule.\44\ One commenter noted that fraudulent intent should 
not be required for officers, directors or employees, but should be 
required for third parties such as vendors and customers.\45\
---------------------------------------------------------------------------

    \40\ See, e.g., In the Matter of Donald F. Marcus and In the 
Matter of Harry P. Adler, AAER 1715 (February 10, 2003); SEC v. John 
F. Mortell, et al., AAER 1569 (June 5, 2002); In the Matter of 
Ronald G. Davies, AAER 1281 (June 29, 2000); and In the Matter of 
Terry R. Kuntz and Richard J. Scheer, AAER 720 (September 26, 1995).
    \41\ It is the act of coercing, manipulating, misleading, or 
fraudulently influencing the auditor, for the purpose of rendering 
misleading financial statements, that is unlawful. There is no 
requirement in section 303(a) of the Act that the purpose be 
achieved.
    \42\ See, e.g., letters from Wells Fargo dated November 22, 
2002, the American Bar Association dated December 13, 2002, Sidley 
Austin Brown & Wood dated December 20, 2002, BDO Seidman LLP dated 
November 25, 2002, and Dechert dated November 25, 2002.
    \43\ Letter from Dorsey & Whitney LLP dated November 25, 2002.
    \44\ Letter from Association for Investment Management and 
Research dated December 12, 2002.
    \45\ Letter from Ernst & Young dated November 25, 2002.
---------------------------------------------------------------------------

    We have decided not to amend our view that the word 
``fraudulently'' modifies only ``influence.'' To emphasize this point, 
we have reordered the words to place ``fraudulently influence'' at the 
end of the list instead of at the beginning.\46\ The new rule, 
therefore, reads that no officer or director or person acting under his 
or her direction ``shall directly or indirectly take any action to 
coerce, manipulate, mislead, or fraudulently influence'' any accountant 
engaged in the performance of an audit or review of an issuer's 
financial statements.
---------------------------------------------------------------------------

    \46\ See letter from Robert Waxman dated November 25, 2002.
---------------------------------------------------------------------------

    In the context of the new rule, the words ``coerce'' and 
``manipulate'' imply compelling the auditor to act in a certain way 
through pressure, threats, trickery, intimidation or some other form of 
purposeful action,\47\ and further modifiers are not necessary. 
Regarding the term ``mislead,'' pre-existing rule 13b2-2 for many years 
has prohibited officers and directors from directly or indirectly 
making or causing to be made materially misleading statements to 
auditors. Causing \48\ misleading statements to be made to auditors has 
included, and will continue to include, an officer or director entering 
into an arrangement with a third party to send a misleading 
confirmation or to provide other misleading information or data to the 
auditor of the issuer's financial statements.\49\ The new rule does not 
alter this approach. As noted above, a primary purpose for enactment of 
the Sarbanes-Oxley Act is the restoration of investor confidence in the 
integrity of financial reports. Such a purpose would not be served by 
imposing what would amount to a new scienter requirement on the pre-
existing provision prohibiting officers and directors from causing 
misleading statements or omissions to be made to auditors.
---------------------------------------------------------------------------

    \47\ See letter from Dorsey & Whitney LLP dated November 25, 
2002.
    \48\ KPMG LLP v. Securities and Exchange Commission, 289 F. 3d 
109, 126 (D.C. Cir. 2002), which states, ``We affirm the 
Commission's determination that negligence is an appropriate basis 
for violations underlying a Section 21C cease-and-desist order* * 
*.'' See In the Matter of KPMG Peat Marwick LLP, AAER 1360 (January 
19, 2001), which states, ``We hold today that negligence is 
sufficient to establish `causing' liability under Exchange Act 
section 21C(a), at least in cases in which a person is alleged to 
`cause' a primary violation that does not require scienter. 
Therefore, if Peat Marwick acted at least negligently with respect 
to whether its conduct would contribute to PORTA's violations, Peat 
Marwick is liable under Section 21C(a) as a cause of those 
violations.''
    \49\ See, e.g., In the Matter of Donald F. Marcus and In the 
Matter of Harry P. Adler, AAER 1715 (February 10, 2003); SEC v. John 
F. Mortell, et al., AAER 1569 (June 5, 2002); In the Matter of 
Ronald G. Davies, AAER 1281 (June 29, 2000); and In the Matter of 
Terry R. Kuntz and Richard J. Scheer, AAER 720 (September 26, 1995).
---------------------------------------------------------------------------

    Types of Conduct. As stated in the proposing release, types of 
conduct that the Commission believes could constitute improper 
influence (if the person engaged in that conduct knows or should know 
that the conduct, if successful, could result in rendering the issuer's 
financial statements materially misleading) include, but are not 
limited to, directly or indirectly:
    [sbull] Offering or paying bribes or other financial incentives, 
including offering future employment or contracts for non-audit 
services,
    [sbull] Providing an auditor with an inaccurate or misleading legal 
analysis,
    [sbull] Threatening to cancel or canceling existing non-audit or 
audit engagements if the auditor objects to the issuer's accounting,
    [sbull] Seeking to have a partner removed from the audit engagement 
because the partner objects to the issuer's accounting,
    [sbull] Blackmailing, and
    [sbull] Making physical threats.
    The facts and circumstances of each case would be relevant to 
determining whether the conduct would violate the new rule.
    Commenters had varied reactions to the illustrative list of the 
types of conduct that could be covered by the rule. Some commenters 
suggested that providing inaccurate or misleading information to 
internal auditors, as well as to independent auditors, should be deemed 
a violation of the rule.\50\ While we believe that an officer or 
director, or person acting under the direction of an officer or 
director, providing misleading information to an internal auditor would 
be relevant to the status of the issuer's internal accounting controls 
or disclosure controls, it would not appear to be related to the 
purpose of section 303 of the Act and the new rule, which is to protect 
and enhance the independent audit function.\51\
---------------------------------------------------------------------------

    \50\ See, e.g., letters from HarborView LLC dated October 29, 
2002 and Council of Institutional Investors dated November 22, 2002.
    \51\ To the extent that the work of the internal auditor is used 
by the independent auditor in conducting an audit or review of the 
issuer's financial statements, however, misleading or inaccurate 
information provided to the internal auditor may be deemed to be 
provided to the independent auditor.
---------------------------------------------------------------------------

    Other commenters suggested that, due to other safeguards in the 
Act, we should delete from the illustrative list the actions of 
offering future employment with the issuer \52\ and threatening to 
cancel audit or non-audit contracts for services.\53\ These commenters 
indicated that section 206 of the Act, which requires a one-year 
``cooling off'' period from the time certain officers of the issuer 
last participated as a partner or employee of

[[Page 31824]]

the accounting firm in an audit of the issuer's financial statements to 
the commencement of the audit,\54\ provides sufficient protection 
against offering employment as a means of improperly influencing the 
auditor. Similarly, commenters indicated that the provisions in 
sections 201 and 202 requiring audit committee pre-approval of audit 
and non-audit services should be an adequate safeguard against the use 
of such services to improperly influence auditors.\55\ Sections 201, 
202 and 206, as well as the remainder of Title II of the Act, are 
designed to enhance the independence of auditors. We believe, however, 
services and employment opportunities that would not impair an 
auditor's independence nonetheless could provide financial incentives 
used to improperly influence or otherwise deter auditors from 
performing an appropriate audit. Accordingly, such actions continue to 
be possible mechanisms, assuming the other criteria in the rule are 
met, for violating the new rule.
---------------------------------------------------------------------------

    \52\ See, e.g. letter from Deloitte & Touche dated November 27, 
2002.
    \53\ See, e.g. letters from Deloitte & Touche dated November 27, 
2002, European Commission dated November 25, 2002, and Ernst & Young 
dated November 25, 2002.
    \54\ Section 206 of the Act adds section 10A(l) to the Exchange 
Act, which states:
    It shall be unlawful for a registered public accounting firm to 
perform for an issuer any audit service required by this title, if a 
chief executive officer, controller, chief financial officer, chief 
accounting officer, or any person serving in an equivalent position 
for the issuer, was employed by that registered public accounting 
firm and participated in any capacity in the audit of that issuer 
during the 1-year period preceding the date of the initiation of the 
audit.
    \55\ Section 201 of the Act prohibits the auditor of the 
issuer's financial statements from providing certain non-audit 
services for that issuer and permits other non-audit services to be 
performed only if the service is pre-approved by the issuer's audit 
committee. Section 202 of the Act describes the pre-approval 
process.
---------------------------------------------------------------------------

    Some commenters suggested qualifying other examples in the list. 
For example, commenters indicated that canceling or threatening to 
cancel an audit or non-audit engagement should be within the purview of 
the rule only if the action was taken because the auditor objects to 
the issuer's accounting.\56\ One commenter expressed this notion in 
terms of a clear quid pro quo linking the offering of a contract for 
non-audit services with the intent to fraudulently influence the 
audit.\57\ We acknowledge that there may be many legitimate reasons to 
replace individuals on an audit or review engagement, or to award or 
cancel audit or non-audit services. Such actions alone do not violate 
the new rule. When such actions, however, become the consideration used 
by an officer or director, or person acting under the direction of an 
officer or director, to improperly influence the auditor, and that 
person knew or should have known that the result of his or her conduct 
could be materially misleading financial statements, then the actions 
fall within the scope of the rule.
---------------------------------------------------------------------------

    \56\ See, e.g., letter from America's Community Bankers dated 
November 25, 2002.
    \57\ Letter from KPMG LLP dated November 25, 2002.
---------------------------------------------------------------------------

    Still other commenters suggested adding to the list activities such 
as: knowingly providing to the auditor inadequate or misleading 
information that is key to the audit, \58\ transferring managers or 
principals from the audit engagement, \59\ and when predicated by an 
intent to defraud, verbal abuse, creating undue time pressure on the 
auditors, not providing information to auditors on a timely basis, and 
not being available to discuss matters with auditors on a timely 
basis.\60\ In the appropriate circumstances and upon satisfaction of 
the criteria in the rule, each of these actions could result in 
improper influence on the auditor.
---------------------------------------------------------------------------

    \58\ See, e.g. letter from Deloitte & Touche dated November 27, 
2002.
    \59\ See, e.g., letter from Robert Waxman dated November 25, 
2002.
    \60\ Letter from BDO Seidman LLP dated November 25, 2002.
---------------------------------------------------------------------------

    Finally, most commenters addressing the issue stated that the 
Commission should not place in the rule any examples of the types of 
conduct that might violate the rule, \61\ and we have not done so.
---------------------------------------------------------------------------

    \61\ See, e.g., letters from America's Community Bankers dated 
November 25, 2002, Software Finance & Tax Executives Council dated 
November 25, 2002, New York State Bar Association dated November 25, 
2002, KPMG LLP dated November 25, 2002, and the American Institute 
of Certified Public Accountants dated November 25, 2002.
---------------------------------------------------------------------------

    Definition of ``independent public or certified public 
accountant.'' The new rule addresses the improper influence of ``any 
independent public or certified public accountant'' engaged in the 
performance of an audit or review of an issuer's financial statements. 
\62\ Prior to the adoption of the Act, similar phrases commonly were 
used in the securities laws and the Commission's regulations to refer 
to the accountant providing audit and review services to a Commission 
registrant. Although the Act, in anticipation of accounting firms 
registering with the Public Company Accounting Oversight Board (the 
``Board''), \63\ changed several of these references, \64\ such terms 
continue to appear in certain sections of the securities laws \65\ and 
related schedules.\66\ We believe that section 303 of the Act includes 
all accountants \67\ engaged in auditing or reviewing an issuer's 
financial statements or issuing attestation reports \68\ to be filed 
with the Commission. Once firms are registered with the Board, the term 
``independent public or certified public accountant,'' as used in the 
new rule, would include registered public accounting firms \69\ and 
persons associated with such a public accounting firm, \70\ as defined 
in the Act. While some commenters expressed concern with the use of 
different definitions to describe the independent auditor, \71\ they 
generally

[[Page 31825]]

did not object to the use of the term in the new rule.\72\
---------------------------------------------------------------------------

    \62\ Section 303(a) uses the phrase ``independent public or 
certified accountant,'' which appears, for example, in items 25, 26 
and 27 of Schedule A to the Securities Act of 1933. 15 U.S.C. 
77aa(25), (26) and (27). Since the passage of the 1933 Act, however, 
the general reference to ``certified accountant'' has been replaced 
by ``certified public accountant.'' To avoid any possible confusion, 
we have used ``certified public accountant'' in the new rules.
    \63\ See section 102 of the Act, which provides that beginning 
180 days after the Commission determines that the Board, as 
established by Title I of the Act, is appropriately organized and 
has the capacity to carry out and enforce the requirements of that 
title, it shall be unlawful for any person that is not a registered 
public accounting firm to prepare any audit report with respect to 
any issuer.
    \64\ See, e.g., sections 205(b) and (c) of the Act.
    \65\ See, e.g., section 13(a) of the Exchange Act, 15 U.S.C. 
78m(a), and section 8(e) of the Securities Act of 1933 (the ``1933 
Act''), 15 U.S.C. 77h(e).
    \66\ See, e.g., items 25, 26 and 27 of Schedule A of the 1933 
Act, 15 U.S.C. 77aa(25), (26) and (27).
    \67\ The rule would apply regardless of whether the accountant 
was a certified public accountant. For example, some states require 
accountants to have years of experience before being deemed to be a 
CPA. Efforts to mislead such an individual during his or her 
performance of audit procedures would fall within the rules. In 
addition, the term ``independent public or certified public 
accountant'' includes accountants in foreign countries who engage in 
auditing or reviewing an issuer's financial statements or issuing 
attestation reports to be filed with the Commission, regardless of 
the title or designation used in those countries.
    \68\ See, e.g., section 404 of the Act, which mandates that the 
Commission prescribe rules that require (1) each annual report filed 
under sections 13(a) and 15(d) of the Exchange Act contain a 
management statement of responsibilities for, and assessment of the 
effectiveness of, the issuer's internal control structure and 
procedures for financial reporting, and (2) the auditor to attest 
to, and report on, the assessment made by management.
    \69\ Section 2(a)(12) of the Act defines ``registered public 
accounting firm'' to mean ``a public accounting firm registered with 
the Board in accordance with this Act.''
    \70\ Section 2(a)(9)(A) of the Act defines ``person associated 
with a public accounting firm'' (or with a ``registered public 
accounting firm'') to mean ``any individual proprietor, partner, 
shareholder, principal, accountant, or other professional employee 
of a public accounting firm, or any other independent contractor or 
entity that, in connection with the preparation or issuance of any 
audit report--(i) shares in the profits of, or receives compensation 
in any other form from, that firm, or (ii) participates as agent or 
otherwise on behalf of such accounting firm in any activity of that 
firm.'' The Board, in section 2(a)(9)(B) of the Act, is given 
limited authority to exempt persons performing only ministerial 
tasks.
    \71\ See, e.g., letters from Independent Community Bankers of 
America dated November 25, 2002 and Robert Waxman dated November 25, 
2002.
    \72\ See, e.g., letter from PwC dated November 25, 2002.
---------------------------------------------------------------------------

    ``Engaged in the performance of an audit.'' New rules 13b2-2(b)(1) 
and (c)(2) track the language in section 303(a) of the Act regarding 
the improper influence of an accountant ``engaged in the performance of 
an audit'' of the issuer's financial statements. Both the Commission 
\73\ and the accounting profession \74\ have recognized that the need 
for an auditor to maintain an independent and unbiased attitude begins 
when the accountant is selected to perform audit or review services and 
continues until there is a formal or informal public notification that 
the professional relationship has ended.\75\ To effectuate the intent 
of Congress, we believe the phrase ``engaged in the performance of an 
audit'' should be given a broad reading. We believe Congress intended 
that the phrase encompass the professional engagement period and any 
other time the auditor is called upon to make decisions or judgments 
regarding the issuer's financial statements, including during 
negotiations for retention of the auditor and subsequent to the 
professional engagement period when the auditor is considering whether 
to issue a consent on the use of prior years' audit reports. The new 
rules, therefore, would apply throughout the professional engagement 
and after the professional engagement has ended when the auditor is 
considering whether to consent to the use of, reissue, or withdraw 
prior audit reports. In limited circumstances, the new rules also may 
apply before the professional engagement period begins. For example, 
the new rules would apply if an officer, director, or person acting 
under the direction of an officer or director, offers to engage an 
accounting firm subject to a condition that could result in rendering 
the financial statements materially misleading, such as a condition 
that the firm issue an unqualified audit report on financial statements 
that do not conform with generally accepted accounting principles, or a 
condition that the firm limit the scope or performance of audit or 
review procedures in violation of generally accepted auditing 
standards.
---------------------------------------------------------------------------

    \73\ Rule 2-01(f)(5)(ii) of Regulation S-X, 15 CFR 210.2-
01(f)(5)(ii), which defines the ``professional engagement period'' 
to be: ``The period of the engagement to audit or review the audit 
client's financial statements or to prepare a report filed with the 
Commission,'' and states: ``(A) The professional engagement period 
begins when the accountant either signs an initial engagement letter 
(or other agreement to review or audit a client's financial 
statements) or begins audit, review, or attest procedures, whichever 
is earlier; and (B) The professional engagement period ends when the 
audit client or the accountant notifies the Commission that the 
client is no longer that accountant's audit client.''
    \74\ American Institute of Certified Public Accountants 
(``AICPA'') Code of Professional Conduct, ET Sec.  101.02, which 
states:
    The period of a professional engagement starts when the [AICPA] 
member begins to perform any professional engagement requiring 
independence for an enterprise, lasts for the entire duration of the 
professional relationship, which could cover many periods, and ends 
with the formal or informal notification of the termination of the 
professional relationship either by the member, by the enterprise, 
or by the issuance of a report, whichever is later. Accordingly, the 
professional engagement does not end with the issuance of a report 
and recommence with the signing of the following year's engagement.
    \75\ Changes in the principal auditor of an issuer's financial 
statements are reported under item 4 of Form 8-K, 17 CFR 249.308. 
See also item 304 of Regulation S-K, 17 CFR 229.304, and item 304 of 
Regulation S-B, 17 CFR 228.304.
---------------------------------------------------------------------------

    Commenters generally agreed with this approach.\76\ Some suggested 
that we define in the rule the phrase ``engaged in the performance of 
the audit.'' \77\ We believe, however, that the longer discussion in 
this release provides a better context to understand the meaning of the 
phrase.
---------------------------------------------------------------------------

    \76\ See, e.g., letters from Deloitte & Touche dated November 
27, 2002, Independent Community Bankers of America dated November 
25, 2002, the American Institute of Certified Public Accountants 
dated November 25, 2002, and Ernst & Young LLP dated November 25, 
2002.
    \77\ See, e.g., letters from America's Community Bankers dated 
November 25, 2002 and PwC dated November 25, 2002.
---------------------------------------------------------------------------

    ``Rendering financial statements materially misleading.'' One of 
the criteria that must be met in order for the improper influence on 
the auditor by officers, directors, or persons acting under their 
direction to be actionable under the new rule is that the improper 
influence, if successful, could result in ``rendering [the issuer's] 
financial statements materially misleading.'' \78\ Because the 
financial statements are prepared by management and the auditor 
conducts an audit or review of those financial statements, the auditor 
would not directly ``render [the] financial statements materially 
misleading.'' Rather, the auditor might be improperly influenced to, 
among other things, issue an unwarranted report on the financial 
statements,\79\ including suggesting or acquiescing in the use of 
inappropriate accounting treatments \80\ or not proposing adjustments 
required for the financial statements to conform with generally 
accepted accounting principles.\81\ An auditor also might be coerced, 
manipulated, misled, or fraudulently influenced not to perform audit or 
review procedures that, if performed, might divulge material 
misstatements in the financial statements. Other examples of activities 
that would fall within the rule would be for an officer, director, or 
person acting under an officer or director's direction, to improperly 
influence an auditor either not to withdraw a previously issued audit 
report when required by generally accepted auditing standards,\82\ or 
not to communicate appropriate matters to the audit committee.\83\ New 
rule 13b2-2(b)(2) makes it clear that subparagraph (b)(1) would apply 
in such circumstances. As noted, the rule is not limited to the audit 
of the annual financial statements, but would include, among other 
things, improperly influencing an auditor during a review of interim 
financial statements \84\ or in connection with the issuance of a 
consent to the use of an auditor's report.\85\ Conducting reviews of 
interim financial statements and issuing consents to use past audit 
reports are sufficiently connected to the audit process, and improper 
influences during those processes are sufficiently connected to the 
harms that the Act seeks to prevent, that they should be within the 
scope of the rule. The list of examples in the rule is only 
illustrative; other actions also could result in

[[Page 31826]]

rendering the financial statements materially misleading.
---------------------------------------------------------------------------

    \78\ There is no such requirement for Rule 13b2-1 or Rule 13b2-
2.
    \79\ See Report of the Committee on Banking, Housing, and Urban 
Affairs, To Accompany S. 2673, ``Public Company Accounting Reform 
and Investor Protection Act of 2002,'' 107th Cong., 2d Sess., (S.R. 
107-205), at 26 (Comm. Print, July 3, 2002), which states that 
section 303 makes it unlawful for any officer or director of an 
issuer, or any person acting under the direction of an officer or 
director, to fraudulently influence, coerce, manipulate, or mislead 
the auditor of the issuer's financial statements ``for the purpose 
of rendering the audit report misleading.'' (Emphasis added.)
    \80\ For example, an auditor might be fraudulently influenced to 
allow an issuer to correct material misstatements over time, or not 
to restate prior period financial statements, in violation of 
generally accepted accounting principles.
    \81\ See section 401(a) of the Act, which, among other things, 
adds section 13(i) to the Exchange Act, which requires that 
financial statements prepared in accordance with (or reconciled to) 
generally accepted accounting principles and filed with the 
Commission reflect all material correcting adjustments identified by 
a registered public accounting firm.
    \82\ See, e.g., SAS 1, ``Subsequent Discovery of Facts Existing 
at the Date of the Auditor's Report,'' AU Sec.  561.
    \83\ See, e.g., section 204 of the Act, which adds section 
10A(k) to the Exchange Act and requires each registered public 
accounting firm to report certain matters to the audit committee, 
and AICPA, SAS 61, ``Communication With Audit Committees'' (as 
amended by SAS 89 and SAS 90).
    \84\ See Rule 10-01(d) of Regulation S-X, 17 CFR 210.10-01(d).
    \85\ See, e.g., section 7(a) of the Securities Act of 1933, 15 
U.S.C. 77g, which states in part, ``If any accountant * * * is named 
as having prepared or certified any part of the registration 
statement, the written consent of such person shall be filed with 
the registration statement''; Rule 436 under the Securities Act of 
1933, 17 CFR 230.436.
---------------------------------------------------------------------------

    Many commenters indicated that the examples in paragraph (b)(2) 
were appropriate and should be retained.\86\ Some commenters suggested 
that the list of examples be expanded to include improperly influencing 
the auditor to permit the inconsistent use of generally accepted 
accounting principles (``GAAP'') or the use of ``non-preferable'' GAAP 
in the issuer's financial statements.\87\ Others suggested including 
improperly influencing an auditor in connection with the auditor's 
report on an issuer's assertions about its internal controls.\88\ 
Another commenter suggested that the examples be replaced with a 
statement that actions that could result in ``rendering the financial 
statements materially misleading'' include improperly influencing an 
auditor during the performance of any procedures by the auditor.\89\ We 
believe that the list of examples in paragraph (b)(2) is sufficiently 
broad to include the majority of instances, including under appropriate 
circumstances those addressed by commenters, where improperly 
influencing an auditor could result in the issuer publishing misleading 
financial statements. As noted above, the list of examples is not all-
inclusive. Other actions, in appropriate circumstances, could result in 
rendering the issuer's financial statements materially misleading.
---------------------------------------------------------------------------

    \86\ See, e.g., letters from National Association of State 
Boards of Accountancy dated November 25, 2002, Independent Community 
Bankers of America dated November 25, 2002, Plains All American 
Pipeline LP dated November 25, 2002, Ernst & Young LLP dated 
November 25, 2002, and PwC dated November 25, 2002. One commenter, 
however, suggested that the list of examples be removed. Letter from 
Intel Corporation dated November 25, 2002.
    \87\ Letter from Robert Waxman dated November 25, 2002.
    \88\ Letter from Transparency International--USA dated November 
8, 2002.
    \89\ Letter from Deloitte & Touche dated November 27, 2002.
---------------------------------------------------------------------------

    ``Knew or should have known.'' Section 303(a) states that conduct 
by an officer, director, or person acting under the direction of the 
officer or director designed to improperly influence an issuer's 
auditor is actionable if undertaken ``for the purpose of rendering [the 
issuer's] financial statements materially misleading.'' We proposed, 
however, the rule state that an officer, director, or person acting 
under the direction of the officer, who engaged in conduct to 
improperly influence an auditor would be culpable if he or she ``knew 
or was unreasonable in not knowing'' that the improper influence, if 
successful, could result in rendering financial statements materially 
misleading. In the proposing release we noted that we would consider 
changing this wording to another phrase to convey that proving a 
particular purpose or intent is not required. We are adopting in the 
final rule the phrase ``knew or should have known,'' which historically 
has indicated the existence of a negligence standard.\90\ As noted 
elsewhere in this release, this standard is consistent with the 
Commission's enforcement actions in this area.\91\
---------------------------------------------------------------------------

    \90\ See, e.g., section 21C(a) of the Exchange Act, 15 U.S.C. 
78u-3, which authorizes the Commission to order a person to cease 
and desist from committing or causing violations, or future 
violations, of the federal securities laws due to actions that the 
person ``knew or should have known'' would contribute to the 
violation, and KPMG LLP v. Securities and Exchange Commission, 289 
F. 3d 109, 126 (D.C. Cir. 2002), which states, ``We affirm the 
Commission's determination that negligence is an appropriate basis 
for violations underlying a Section 21C cease-and-desist order. * * 
*''
    \91\ See, e.g., In the Matter of Donald F. Marcus and In the 
Matter of Harry P. Adler, AAER 1715 (February 10, 2003); SEC v. John 
F. Mortell, et al., AAER 1569 (June 5, 2002); In the Matter of 
Ronald G. Davies, AAER 1281 (June 29, 2000); and In the Matter of 
Terry R. Kuntz and Richard J. Scheer, AAER 720 (September 26, 1995).
---------------------------------------------------------------------------

    Several commenters suggested that the rule should contain the 
statutory language, which they believe requires a fraudulent intent, 
instead of the proposed language, which they believe reflected a 
negligence standard.\92\ Other commenters, however, indicated that the 
proposed language should be adopted \93\ or that, at a minimum, a 
reasonableness standard is appropriate when evaluating the actions of 
officers and directors.\94\
---------------------------------------------------------------------------

    \92\ See, e.g., letters from Wells Fargo dated November 22, 
2002, Dorsey and Whitney LLP dated November 25, 2002, Sullivan & 
Cromwell dated November 25, 2002, The Business Roundtable dated 
November 29, 2002, America's Community Bankers dated November 25, 
2002, Steven Hazen dated November 25, 2002, New York State Bar 
Association dated November 25, 2002, KPMG LLP dated November 25, 
2002, and Plains All American Pipeline LP dated November 25, 2002.
    \93\ See, e.g., letters from the American Institute of Certified 
Public Accountants dated November 25, 2002 and the National 
Association of State Boards of Accountancy dated November 25, 2002.
    \94\ See, e.g., letter from Ernst & Young LLP dated November 25, 
2002.
---------------------------------------------------------------------------

    We believe that the adopted language, particularly in the absence 
of any private right of action under the rule,\95\ best achieves the 
purpose of restoring investor confidence in the audit process.\96\ For 
example, if an officer of an issuer coerces an auditor not to conduct 
certain audit procedures required by generally accepted auditing 
standards (``GAAS'') because the officer wants to conceal his 
embezzlement of funds from the issuer, then it is possible that his 
actions might not be found to be for the ``purpose of rendering the 
financial statements misleading.'' If that officer, however, knew or 
should have known that not performing the procedures could result in 
the auditor not detecting and seeking correction of material errors in 
the financial statements, then we believe the officer's conduct should 
be subject to the rule. Excusing this conduct from the scope of the 
rule would be inconsistent with the restoration of investor confidence 
in financial statements and in the integrity of the audit process.
---------------------------------------------------------------------------

    \95\ We believe that the mental state requirements of the rules 
generally should be construed consistently with the existing rules 
in Regulation 13B-2. Because there is no private right of action, 
among other reasons, the Commission believes that a lesser standard 
of liability is appropriate. See Release No. 34-15570 (February 15, 
1979); 44 FR 10970. See also, Report of the Committee on Banking, 
Housing, and Urban Affairs, To Accompany S. 2673, ``Public Company 
Accounting Reform and Investor Protection Act of 2002,'' 107th 
Cong., 2d Sess., (S.R. 107-205), at 26 (Comm. Print, July 3, 2002), 
which cites as a reason for enacting section 303 the testimony of 
witnesses who were concerned with addressing fraud and other 
``misconduct in the audit process.''
    \96\ See In the Matter of Terry R. Kuntz and Richard J. Scheer, 
AAER 720 (September 26, 1995), which states, in part, ``The 
Commission will not tolerate conduct by third party vendors * * *, 
which poses a very real threat to the integrity of the disclosure 
process.''
---------------------------------------------------------------------------

    Response to Other Significant Comments. In the proposing release, 
we asked if we should replace the statement in paragraphs (b)(1) and 
(c) of the rule that no person acting ``under the direction'' of an 
officer or director shall improperly influence the auditors of the 
issuer's financial statements, with a statement that no person acting 
``at the behest of'' or ``on behalf of'' an officer or director shall 
improperly influence the auditors. Although some commenters supported 
use of the phrase ``on behalf of,'' \97\ in general commenters opposed 
changing this aspect of the proposed rule.\98\ We agree that there may 
be circumstances where a person acting on behalf of an officer or 
director would be considered to be acting under the direction of that 
officer or director as contemplated by the rule. We believe, however, 
that the rule, as proposed and adopted, is sufficiently clear. 
Replacing

[[Page 31827]]

``under the direction of'' with ``on behalf of'' might be construed as 
narrowing the scope of the rule, and having both phrases in the rule 
might create confusion in the interpretation of the rule. Accordingly, 
we have adopted the rule as proposed.
---------------------------------------------------------------------------

    \97\ See, e.g., letters from Transparency International--USA 
dated November 8, 2002, National Association of State Boards of 
Accountancy dated November 25, 2002, and Independent Community 
Bankers of America dated November 25, 2002.
    \98\ See, e.g., letters from the American Bar Association dated 
December 13, 2002, The Business Roundtable dated November 29, 2002, 
the New York State Bar Association dated November 25, 2002, BDO 
Seidman LLP dated November 25, 2002, Ernst & Young LLP dated 
November 25, 2002, and the National Association of Real Estate 
Investment Trusts dated November 25, 2002.
---------------------------------------------------------------------------

    We also asked in the proposing release if we should replace the 
word ``fraudulently'' in paragraphs (b)(1) and (c)(2) of the rule with 
the word ``improperly'' or some other word to convey a mental state 
short of scienter. Although some commenters noted that there is a need 
for the Commission to adopt rules intended to enhance investor 
confidence in issuers' financial statements,\99\ commenters generally 
opposed this change as exceeding the purpose and scope of section 303 
of the Act.\100\ The new rule retains the statutory language of 
``fraudulently influence'' because we are concerned about a lack of 
specificity associated with the word ``improperly'' in the context of 
the rule. As discussed above, ``fraudulently'' modifies only influence 
and not ``coerce, manipulate or mislead.''
---------------------------------------------------------------------------

    \99\ See, e.g., letter from Association for Investment 
Management and Research dated December 12, 2002.
    \100\ See, e.g., letters from Wells Fargo dated November 22, 
2002, Eastman Kodak Company received on November 25, 2002, Sullivan 
& Cromwell dated November 25, 2002, the American Bar Association 
dated December 13, 2002, The Business Roundtable dated November 29, 
2002, America's Community Bankers dated November 25, 2002, the 
Software Finance & Tax Executives Council dated November 25, 2002, 
New York State Bar Association dated November 25, 2002, Independent 
Community Bankers of America dated November 25, 2002, Plains All 
American Pipeline LP dated November 25, 2002, Dechert dated November 
25, 2002, Intel Corporation dated November 25, 2002, Compass 
Bancshares Inc. dated November 25, 2002, and Robert Waxman dated 
November 25, 2002.
---------------------------------------------------------------------------

    Finally, commenters questioned whether an auditor would have an 
obligation to report violations of the new rule as ``illegal acts'' 
under section 10A(b) of the Exchange Act.\101\ Section 10A defines an 
``illegal act'' to be an act or omission that violates any law or any 
rule or regulation having the force of law.\102\ Accordingly, 
violations of the new rule are illegal acts within section 10A and 
should be dealt with as required by that section.\103\
---------------------------------------------------------------------------

    \101\ Letters from KPMG LLP dated November 25, 2002 and PwC 
dated November 25, 2002. Section 10A(a) of the Exchange Act, 15 
U.S.C. 78j-1(a), requires auditors to conduct procedures designed to 
provide, among other things, reasonable assurance of the detection 
of illegal acts that would have a direct and material effect on the 
determination of financial statement amounts. Section 10A(b) of the 
Exchange Act, 15 U.S.C. 78j-1(b), states that if the accountant 
becomes aware of information indicating that an illegal act has or 
may have occurred the accountant shall perform additional procedures 
to determine whether it is likely an illegal act has occurred and, 
if so, its possible effect on the financial statements, and report 
the act to management and assure that the issuer's audit committee 
is informed of the act. If the accountant concludes that the illegal 
act has a material effect on the financial statements, appropriate 
remedial actions are not taken, and the failure to take such actions 
is reasonably expected to warrant a modified audit report or 
resignation from the audit engagement, then the auditor must report 
his or her conclusions to the issuer's board of directors. If the 
board does not notify the Commission that it has received such a 
report, then the auditor must furnish to the Commission a copy of 
its report.
    \102\ Section 10A(f) of the Exchange Act, 15 U.S.C. 78j-1(f).
    \103\ One commenter also suggested ``technical corrections'' to 
the rule to include ``review'' in paragraph (a)(2)(i) and 
``reissue'' in paragraph (b)(2)(i). Letter from KPMG LLP dated 
November 25, 2002. We have made these corrections and a conforming 
change to paragraph (c)(1)(ii)(A).
---------------------------------------------------------------------------

C. Issues Related to Investment Companies

    In the case of registered investment companies and business 
development companies,\104\ the prohibition on improper influence on 
the conduct of audits covers not only officers and directors of the 
investment company itself, but also officers and directors of the 
investment company's investment adviser, sponsor, depositor, trustee, 
and administrator.\105\ These service providers perform virtually all 
of the management, administrative, and other services necessary to the 
investment company's operations, including preparation of the financial 
statements. We are also amending existing rule 13b2-2 to cover officers 
and directors of these entities.\106\
---------------------------------------------------------------------------

    \104\ Business development companies are a category of closed-
end investment companies that are not required to register under the 
Investment Company Act of 1940. See 15 U.S.C. Sec.  80a-2(a)(48) 
(defining business development companies).
    \105\ Rule 13b2-2(c)(2).
    \106\ Rule 13b2-2(c)(1).
---------------------------------------------------------------------------

    One commenter suggested expanding the scope of the persons covered 
by the prohibition, to include accounting personnel working for an 
investment company's service providers.\107\ Consistent with the 
language of section 303(a) and the scope of the rule for operating 
companies, we have not expressly included these persons, although we 
note that they would be covered by the rule if they are acting under 
the direction of an officer or director of the investment company or 
its investment adviser, sponsor, depositor, trustee, or administrator. 
By contrast, another commenter argued that the prohibition should 
extend to officers and directors of an investment company's investment 
adviser, because the investment adviser acts, in effect, in an 
executive capacity with a fund, but should not extend to other service 
providers.\108\ We have determined not to narrow the service providers 
covered by the new rule in this manner, because any of the investment 
adviser, sponsor, depositor, trustee, or administrator may have 
responsibility for preparation of an investment company's financial 
statements, and therefore its officers and directors may be in a 
position to exercise improper influence over the investment company's 
audit.
---------------------------------------------------------------------------

    \107\ Letter from PwC dated November 25, 2002.
    \108\ Letter from Dechert dated November 25, 2002.
---------------------------------------------------------------------------

III. Paperwork Reduction Act

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

IV. Costs and Benefits

    The new rules implement a Congressional mandate. We recognize that 
any implementation of the Act likely will result in costs and benefits 
and 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.
    The new rules prohibit officers and directors of an issuer, and 
persons acting under the direction of an officer or director, from 
taking any action to coerce, manipulate mislead, or fraudulently 
influence the auditor of the issuer's financial statements if that 
person knew or should have known that such action, if successful, could 
result in rendering the financial statements materially misleading.
    Some commenters were concerned that the rules could have a chilling 
effect on communications between the auditor and third parties,\109\ or 
dampen the debate on accounting issues between auditors and 
issuers.\110\ Such a chilling effect on communications between third 
parties and auditors, or between auditors and the issuer, could result 
in an added cost associated with the rule. We believe, however, that 
the conduct addressed by the new rules generally was prohibited under 
provisions of the securities laws that existed before enactment of the 
Sarbanes-Oxley Act.\111\

[[Page 31828]]

Because the new rule is consistent with previous law, rules, and cases 
\112\ we do not anticipate that the new rules will increase 
significantly costs for issuers or accounting firms.
---------------------------------------------------------------------------

    \109\ See, e.g., letters from Wells Fargo dated November 22, 
2002, Dorsey & Whitney dated November 25, 2002, Deloitte & Touche 
dated November 27, 2002, Sidley Austin Brown & Wood dated December 
30, 2002, America's Community Bankers dated November 25, 2002, and 
BDO Seidman LLP dated November 25, 2002.
    \110\ See, e.g., letter from New York County Lawyers' 
Association dated December 3, 2002.
    \111\ See, e.g., In the Matter of Donald F. Marcus and In the 
Matter of Harry P. Adler, AAER 1715 (February 10, 2003); SEC v. John 
F. Mortell, et al., AAER 1569 (June 5, 2002); In the Matter of 
Ronald G. Davies, AAER 1281 (June 29, 2000); and In the Matter of 
Terry R. Kuntz and Richard J. Scheer, AAER 720 (September 26, 1995).
    \112\ Id.
---------------------------------------------------------------------------

    Nonetheless, the Act and new rules might prompt some issuers to 
adopt procedures or guidelines that would assure additional care is 
used by an issuer's officers and directors, and others acting under 
their direction, in communicating with auditors of the issuer's 
financial statements. For example, some issuers might require that more 
discussions include members of senior management or the issuer's legal 
counsel. Because no particular procedures related to such 
communications are required, and the nature and scope of those 
procedures are likely to vary among issuers, it is difficult to provide 
an accurate cost estimate.
    As noted above, in some circumstances the new rules might apply 
before the professional engagement period begins. For example, the 
rules would apply if an officer, director, or person acting under the 
direction of an officer or director, offers to engage an accounting 
firm on the condition that the firm either issue an unqualified audit 
report on financial statements that do not conform with generally 
accepted accounting principles, or limit the scope or performance of 
audit or review procedures in violation of generally accepted auditing 
standards. We believe, however, that such conduct would not be 
permitted under existing laws and regulations and, accordingly, the 
rules should not result in a significant increase in costs for issuers.
    Potential benefits of the rules include increased investor 
confidence in the integrity of the audit process and, in turn, in the 
reliability of reported financial information. One of the most 
important factors in the successful operation of our securities markets 
is the trust that investors have in the reliability of the information 
used to make voting and investment decisions.\113\
---------------------------------------------------------------------------

    \113\ See Accounting Series Release No. 296 (Aug. 20, 1981), 
which states in part:
    (T)he capital formation process depends in large part on the 
confidence of investors in financial reporting. An investor's 
willingness to commit his capital to an impersonal market is 
dependent on the availability of accurate, material and timely 
information regarding the corporations in which he has invested or 
proposes to invest. The quality of information disseminated in the 
securities markets and the continuing conviction of individual 
investors that such information is reliable are thus key to the 
formation and effective allocation of capital. Accordingly, the 
audit function must be meaningfully performed and the accountant's 
independence not compromised.
---------------------------------------------------------------------------

    Section 303(a) and the new rules are designed to provide added 
assurance that the full-disclosure purposes of the securities laws are 
fulfilled,\114\ and to help restore the faith of America's investors in 
the integrity of the audit process and in the reliability of reported 
financial information. If section 303 of the Act and the new rules lead 
to increased investor confidence in financial reporting, they also 
might facilitate capital formation. An increased willingness of 
investors to participate in the securities markets could result in 
issuers being able to lower their cost of capital.
---------------------------------------------------------------------------

    \114\ See, e.g., H.R. Rep. No. 1383, 73rd Cong., 2d Sess., 11 
(1934), which states:
    Just as artificial manipulation tends to upset the true function 
of an open market, so the hiding and secreting of important 
information obstructs the operation of the markets as indices of 
real value. There cannot be honest markets without honest publicity.
    Manipulation and dishonest practices of the market place thrive 
upon mystery and secrecy.
    This House Report also includes a letter from the Executive 
Assistant of the Committee on Stock List for the New York Stock 
Exchange, which recognizes management's need for accurate financial 
information and then states:
    [U]nder the conditions of today, the next object in order of 
importance has become to give stockholders, in understandable form, 
such information in regard to the business as will avoid misleading 
them in any respect and as will put them in possession of all 
information needed, and which can be supplied in financial 
statements, to determine the true value of their investments * * *. 
The exchange is interested in the accounts of companies as a source 
of reliable information for those who deal in stocks. It is not 
sufficient for the stock exchange that the accounts should be in 
conformity with law or even that they should be conservative; the 
stock exchange desires that they should be fully and fairly 
informative.
    Id. at 12.
---------------------------------------------------------------------------

    Commenters generally agreed that the costs associated with the new 
rules are not significant.\115\ One commenter, however, indicated that 
increased costs might be associated with more litigation and increased 
liability exposure for accounting firms.\116\ Because there is no 
private right action under section 303 or the new rule,\117\ we expect 
that such costs will not be significant.
---------------------------------------------------------------------------

    \115\ See, e.g., letters from National Association of State 
Boards of Accountancy dated November 25, 2002 and PwC dated November 
25, 2002.
    \116\ Letter from Independent Community Bankers of America dated 
November 25, 2002.
    \117\ Section 303(b) of the Act states, ``In any civil 
proceeding, the Commission shall have exclusive authority to enforce 
this section and any rule or regulation under this section.''
---------------------------------------------------------------------------

V. Final Regulatory Flexibility Analysis

    This Final Regulatory Flexibility Act Analysis has been prepared in 
accordance with 5 U.S.C. 604. It relates to revised rule 13b2-2 of 
Regulation 13B-2, which implements the statutory prohibition on 
officers and directors of an issuer, and persons acting under their 
direction, improperly influencing the conduct of an audit or review of 
the issuer's financial statements.

A. Reasons for, and Objectives of, the Rules

    The purpose of the new rules is to implement section 303(a) of the 
Act. The rules prohibit officers and directors of issuers, including 
``small businesses,'' and persons acting under their direction, from 
improperly influencing an accounting firm's audit or review of the 
issuer's financial statements. Regardless of the application of section 
303(a) and the new rules, such conduct would violate the anti-fraud or 
other provisions of the securities laws or aid and abet or cause the 
issuer's violations of those sections. The new rules, and section 
303(a) of the Act, provide the Commission with an additional means to 
address such conduct and are intended to enhance the credibility of 
financial statements.

B. Significant Issues Raised by Public Comments

    Some commenters indicated that the cost of compliance with the 
rules is not significant and that there should be no differences in the 
rules for small companies.\118\ Another commenter stated that special 
rules are not necessary for small entities if the definitions of 
officer and director are sufficiently broad to include persons who 
normally have the responsibility for governance of an entity.\119\ As 
noted above, under the securities laws and the Commission's 
regulations, the definition of ``officer'' includes not only those with 
certain corporate titles but also those performing corresponding 
functions with respect to any organization,\120\ and the definition of 
``director'' includes not only directors of corporations but also those 
performing similar functions with respect to any organization.\121\ 
Such definitions are sufficiently broad to include persons responsible 
for governance of an entity.
---------------------------------------------------------------------------

    \118\ See, e.g. letters from PwC dated November 25, 2002 and 
Robert Waxman dated November 25, 2002.
    \119\ Letter from National Association of State Boards of 
Accountancy dated November 25, 2002.
    \120\ See Rules 3b-2 and 3b-7 under the Exchange Act, 17 CFR 
240.3b-2 and 240.3b-7.
    \121\ See section 3(a)(7) of the Exchange Act, 15 U.S.C. 
78c(a)(7).
---------------------------------------------------------------------------

    One comment letter, responding to the Commission's rule proposals 
related to sections 404, 406 and 407 of the Act, as well as section 
303, encouraged the Commission to exempt small companies

[[Page 31829]]

from the ``onerous and sometimes impossible rules for board 
membership.''\122\ These comments, however, would appear to address the 
requirements related to the disclosure of an ``audit committee 
financial expert'' under section 407 and not improperly influencing 
auditors under section 303. This commenter also suggested that we 
``nurture and encourage business formation and finance'' and not impose 
``insurmountable difficulties for the smaller companies.''\123\ We 
believe that enhanced investor confidence in the audit process will 
encourage capital formation by all companies and that the new rule, 
which addresses conduct that generally was unlawful prior to the 
enactment of the Act, does not place ``insurmountable difficulties'' on 
small companies.
---------------------------------------------------------------------------

    \122\ Letter from Nicholas Taylor dated November 8, 2002.
    \123\ Id.
---------------------------------------------------------------------------

    Another commenter stated that the Commission should be mindful of 
difficulties some smaller institutions face ``in seeking auditing firm 
alternatives and complying with other new regulatory requirements due 
to limited staff resources.''\124\ Although the rule might encourage 
some companies to exercise additional care in communicating with 
auditors, the rule does not impose any specific requirements on 
companies and should not result in the use of additional staff 
resources. Accordingly, we do not believe that it imposes significant 
costs on small entities.
---------------------------------------------------------------------------

    \124\ Letter from Independent Community Bankers of America dated 
November 25, 2002.
---------------------------------------------------------------------------

C. Small Entities Subject to the Rules

    The rules affect small registrants that are small entities. 
Exchange Act Rule 0-10(a) \125\ and 1933 Act Rule 157 \126\ define a 
company to be a ``small business'' or ``small organization'' if it had 
total assets of $5 million or less on the last day of its most recent 
fiscal year. We estimate that approximately 2,500 companies are small 
entities, other than investment companies.
---------------------------------------------------------------------------

    \125\ 17 CFR 240.0-10(a).
    \126\ 17 CFR 230.157
---------------------------------------------------------------------------

    For purposes of the Regulatory Flexibility Act, an investment 
company is a small entity if it, together with other investment 
companies in the same group of related investment companies, has net 
assets of $50 million or less as of the end of its most recent fiscal 
year.\127\ We estimate that approximately 225 investment companies meet 
this definition.
---------------------------------------------------------------------------

    \127\ 17 CFR 270.0-10.
---------------------------------------------------------------------------

D. Reporting, Recordkeeping and Other Compliance Requirements

    The enactment of section 303(a) of the Act and the adoption of the 
rules might result in some issuers adopting more detailed procedures 
for communications between the company and the accounting firm that 
audits the company's financial statements. These procedures might 
result in an insignificant increase in costs associated with compliance 
with the securities laws.
    We received no comments or data indicating the extent of burden 
that might be imposed on small entities. As noted above, we assume the 
burden would be minor for most issuers.

E. Agency Action To Minimize Effects 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 amendments, we considered the following 
alternatives:
    1. The establishment of differing compliance or reporting 
requirements or timetables that take into account the resources of 
small entities;
    2. The clarification, consolidation, or simplification of 
compliance and reporting requirements under the rules for small 
entities;
    3. The use of performance rather than design standards; and
    4. An exemption from coverage of the amendments, or any part 
thereof, for small entities.
    Section 303(a) of the Act does not provide an exemption for small 
businesses. The section does provide, however, that the rules adopted 
by the Commission should be ``as necessary and appropriate in the 
public interest and for the protection of investors.''
    We considered not applying the rules to small business issuers. We 
believe, however, that investors in small companies, just as investors 
in large companies, would want and benefit from the added confidence in 
reported financial information that comes from knowing that efforts to 
improperly influence the performance of the audit have been prohibited.
    We are using a performance standard rather than a design standard. 
In addition, Congress has dictated the timetable for this rulemaking.

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

    Section 23(a)(2) of the Exchange Act \128\ requires us, when 
adopting rules under the Exchange Act, to consider the impact on 
competition of any rule we adopt. Section 2(b) of the 1933 Act,\129\ 
section 3(f) of the Exchange Act,\130\ and section 2(c) of the 
Investment Company Act of 1940,\131\ require us, when engaging in 
rulemaking where we are required to consider or determine whether the 
action is necessary or appropriate in the public interest, to consider, 
in addition to the protection of investors, whether the action will 
promote efficiency, competition and capital formation.
---------------------------------------------------------------------------

    \128\ 15 U.S.C. 78w(a)(2).
    \129\ 15 U.S.C. 77b(b).
    \130\ 15 U.S.C. 78c(f).
    \131\ 15 U.S.C. 80a-2(c).
---------------------------------------------------------------------------

    The new rules prohibit improper influences on auditors in 
connection with their reviews and audits of financial statements filed 
with the Commission. The proposals, therefore, should enhance investor 
confidence in the audit process and in the quality of information 
available to them, and lead to a more efficient market.
    Because of the nature of the new rules, we do not believe that they 
would impose any burden on competition. They prohibit equally all 
officers and directors of public companies (and persons acting under 
their direction) from improperly influencing the auditor.
    As noted in the cost-benefit section, if section 303 of the Act and 
the new rules lead to increased investor confidence in financial 
reporting, they also may facilitate capital formation. An increased 
willingness of investors to participate in the securities markets might 
result in issuers being able to lower their cost of capital.
    We received no comments indicating that the rule would impact 
competition, efficiency or capital formation.

VII. Statutory Authority

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

Text of Rules and Amendments

List of Subjects in 17 CFR Part 240

    Securities.

[[Page 31830]]


0
In accordance with the foregoing, Title 17, Chapter II, of the Code of 
Federal Regulations is amended as follows:

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

0
1. The authority citation for Part 240 continues to read, in part, as 
follows:

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


0
2. Section 240.13b2-2 is revised to read as follows:


Sec.  240.13b2-2  Representations and conduct in connection with the 
preparation of required reports and documents.

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

    Dated: May 20, 2003.
    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-13095 Filed 5-27-03; 8:45 am]
BILLING CODE 8010-01-P