August 19, 2002
Mr. Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549-0609
File No. S7-21-02
Proposed Rule: Certification of Disclosure in Companies' Quarterly and Annual Reports
Release Nos. 34-46079; 34-46300
Dear Mr. Katz:
We appreciate the opportunity to comment on the Commission's proposed rule, Certification of Disclosure in Companies' Quarterly and Annual Reports, Release No. 34-46079, as supplemented by Release No. 34-46300 (the Proposed Rule).
Passage by Congress of the Sarbanes-Oxley Act of 2002 (the Act) has necessitated significant revision to the Commission's original proposals, and any final rule promulgated by the Commission must, by law, incorporate the provisions of the Act. Accordingly, we believe it to be a critical part of our commentary on the Proposed Rule to address certain of the inconsistencies and possible implementation issues that have arisen in our efforts to reconcile the requirements under the Proposed Rule, the Act, and existing professional standards. We hope the following comments will assist the Commission in designing a reporting regimen that incorporates executive officer certifications with respect to a company's system of internal controls that will provide benefit to investors and companies alike, without costly redundancy, and thereby contribute to the strength of and confidence in the U.S. capital markets.
- The separate certifications required by Section 302 of the Act (Section 302) in the Proposed Rule and Section 906 of the Act (Section 906) should be harmonized. We understand that it was the U.S. Congress' intent to satisfy differing objectives with each certification. However, the Commission should explore a means by which the Section 302 and Section 906 certifications could be combined. If combining the certifications is not acceptable or appropriate, the Commission should consider conforming the certifications to the extent possible so as to facilitate investor understanding of what is covered by the certifications and why each certification is required. One could reasonably interpret the Section 302 certification to be limited to financial information included in the report, whereas the Section 906 certification refers merely to "information" contained in the report. We do not understand the purpose of distinguishing financial information from other information contained in an annual or quarterly report for purposes of the certification, given that investors and other users of the reports are presumed to use the entire report.
- The manner in which all certifications should be filed with the Commission should be clarified and standardized. To promote consistency among filings and facilitate investor review of the certifications, it would be helpful if the Commission would specify how and where in each filing each certification should be provided.
- The meaning of "fairly presents" as it is used in the certifications should be clarified. It is unclear whether the language "fairly presents" is intended to be understood in the context of generally accepted accounting principles (GAAP), or if the Commission intends some other meaning. Clarification that the language is meant in the context of GAAP would eliminate any potential inconsistencies with current professional standards.
- Cash flows should be identified as part of the certified financial information. Regulation S-X and GAAP require a statement of cash flows as part of periodic quarterly and annual financial statements. It is unclear why a reference to cash flows should be excluded from the Section 302 and Section 906 certifications.
- Applicability of the certification requirements to certain reports filed under the Exchange Act of 1934 should be clarified. Sections 302 and 906 do not specify if, or how, the certification provisions apply to: Forms 8-K and 6-K, amendments to periodic reports on Forms 10-Q, 10-QSB, 10-K, 10-KSB, 20-F and 40-F, transition reports, and employee benefit plan annual reports on Form 11-K. To implement the requirements, companies need information about how the Proposed Rule affects these filings or submissions, or specific identification of those filings for which the certification provisions apply.
Internal Control Certifications
- The location within the filing in which each internal control certification will be included should be clarified and standardized. Similar to our comment above regarding the certifications, and in consideration of expected future rule-making regarding management's assessment of internal controls described in Section 404 of the Act, it would be helpful if the Commission would specify how and where in each filing each internal control certification should be provided.
- The Commission should clarify whether terms like "significant deficiencies" and "material weaknesses" have the same meaning as those terms are defined in current U.S. auditing standards (AU Section 325). It is unclear whether or not the Commission intends the terms "significant deficiencies" and "material weaknesses," as they are used in the Proposed Rule and Section 302, to have the same meaning as generally understood in the context of generally accepted auditing standards (GAAS), or if the Commission intends some other meaning. Clarification that the language is meant in the context of GAAS would eliminate potential inconsistencies with current professional standards and facilitate implementation of the Proposed Rule.
- The 90-day timeframe in which the evaluation of the effectiveness of internal controls must take place should be clarified. If the Commission intends for the evaluation of internal controls to cover the periods in which transactions that form the basis for the financial statements included in the report are recorded and processed, the evaluation should be required within 90 days of the date of the most recent balance sheet included in the filing.
- Companies should be allowed to design their own systems of internal control as appropriate under their own circumstances. We agree with the Commission's intention to not require any particular procedures for conducting the evaluation of internal controls. The Commission has indicated that it will rely on each company to develop a process that is consistent with its business and internal management and supervisory practices. Consistent with that conclusion, we question the necessity for specifying the members of a recommended "committee" that would be responsible for considering the materiality of information and determining disclosure obligations on a timely basis. A recommendation may be viewed as a de facto requirement.
Registered Investment Companies
The Commission should clarify if, and how, the Proposed Rule will apply to registered investment companies. The proposing release seeks comment on how to apply the Section 302 requirements to registered investment companies. If certifications are required for registered investment companies, the certifications should cover the financial statements included in annual and semiannual reports filed with the Commission under Section 30 of the Investment Company Act of 1940.
While they do not have a direct bearing on the Proposed Rule, we believe it appropriate for the Commission to also be mindful of how future rule making to comply with Sections 103 and 404 of the Act may interface with the Proposed Rule provisions. In general terms, we recommend that a common definition of "internal control" be adapted in implementing Sections 302 and 404 of the Act. The Commission should seek the greatest degree of consistency possible among the internal control requirements embedded in the Act, including, if possible, consistent effective dates of the various provisions and requirements.
If you have any questions about our comments please contact Sam Ranzilla at (212) 909-5837 or Melanie Dolan at (202) 533-4934.
Very truly yours,
/s/ KPMG LLP