Grant Thornton LLP
December 27, 2002
VIA ELECTRONIC MAIL
Jonathan G. Katz, Secretary
File no. S7-46-02; SEC Release Nos. 33-8151; 34-46869 and IC-25830
Dear Mr. Katz:
Grant Thornton LLP appreciates the opportunity to comment on the U.S. Securities and Exchange Commission's proposed rule, Retention of Records Relevant to Audits and Reviews as presented in Release Nos. 33-8151, 34-46869 and IC-25830.
Consistent with Grant Thornton's five-point plan to restore public trust announced in February 2002, leaders of accounting firms must set a tone that once again places the firms' professional responsibilities ahead of all other business considerations. Grant Thornton's most valued principle has been, and will continue to be, our uncompromising commitment to professional excellence. We continue to be concerned about the impact of recent events on SEC registrants and the entire accounting profession, and we commend the Commission's progress in its recent rule-making efforts. We understand that Section 802 of the Sarbanes-Oxley Act (the "Act") directed the Commission to propose rules to address the destruction or fabrication of evidence and the preservation of "financial and audit records." Proposed Rule 210.2-06 is the Commission's response to that mandate. While Grant Thornton agrees that promulgating records retention rules will provide one step in helping restore public confidence, we believe that the proposal could be significantly improved in several respects.
We have limited our comments to critical issues that we have identified. First, we strongly believe that the ambiguous term "workpapers" should be replaced with "audit documentation" to be consistent with SAS 96, Audit Documentation ("SAS 96"). Second, we believe that the retention period in the proposed rules should be extended to coincide with the seven-year retention period required in Section 103 of Sarbanes-Oxley. Third, we believe that the requirement to retain materials that "cast doubt" on the final conclusions reached by the auditor is overly vague and could encompass a broad spectrum of records that would not advance the purposes of the Rule. Paragraph (c) of proposed Rule 2-06 should be revised to require documentation and retention of records reflecting significant differences in professional judgment on issues that are material to the financial statements or to the accountants' final conclusions regarding the audit or review.
Are the "workpapers" and other documents that would be required to be retained under this proposed rule sufficiently described? If not, what changes should be made to provide for greater clarity? Are there alternative definitions that would better implement section 802?
We believe that the term "workpapers" is not sufficiently described in the proposed rules. Further, there appears to be an inconsistency between the actual wording of the proposed Rule and the definition of "workpapers" in the Release. The proposed Rule 2-06(b) defines "workpapers" to mean:
The proposing Release acknowledges that the intent of Section 802 is to require the retention of more than what has traditionally been thought of as auditor's "workpapers." To clarify the distinction between workpapers and other materials that would be retained, the above paragraph was inserted into the proposed Rule. The proposing Release quotes SAS 96, acknowledging that the SAS does not use the specific term "workpapers," but that the body of paragraph .01 of SAS 96 was placed into the paragraph above. Therefore, it appears that the Commission is applying the concept and definition of "audit documentation" as defined in SAS 96 to the term "workpapers" as used in paragraph 2-06(b) of the proposed Rule. Paragraph .04 of SAS 96 states that:
While the proposed Rule appears to be consistent with SAS 96, the description of "workpapers" provided in the accompanying proposing Release extends the scope of the records considered "workpapers" beyond what appears in the proposed Rule. The Release states that:
Here, "workpapers" could be interpreted to include all electronic messages sent in connection with the audit, draft spreadsheets, draft memos and possibly even internal review notes. Further, the requirement to preserve communications that contain "financial data" "related to the audit" alone potentially swallows all other categories of records. The ambiguity in this language and its potentially vast scope will leave accounting firms struggling to interpret their obligations. For example, must all copies, paper and electronic, of all such "workpapers" be retained by every person copied? Must the staff retain scrap paper used to help prepare audit documentation? Must the staff retain a draft of a memo revised for clarity in response to comments from a more senior staff reviewer? Must the reviewer's comments be retained? More precision is necessary both to achieve the Commission's objectives and to provide the profession with full and fair notice of its obligations.
Articulation of the Rules' scope should not be left to the language of the Release. We believe that the final rules, not just the accompanying Release, should reflect as much detail as possible on the specific type of audit documentation that should be retained. The final rule, along with other final rules adopted, and to be adopted, will be the source for auditor compliance. It must be clear as to the nature of the items considered to be audit documentation and those that should be retained. Grant Thornton would like to make this point in general as to the Commission's many rule-making efforts. The final rules should fully reflect the compliance expectations of the Commission. Registrants and auditors may look to the proposing Release for background information and the Commission's rationale of the final Rule, but should not be required to look to the proposing Release for definitions or other clarifications needed for compliance. The final rules should stand on their own and provide the requirements in a clear and concise, yet comprehensive manner.
We believe it is critical that the final Rule be clarified as to the nature and extent of the documentation that must be retained. To do so, we suggest the Commission adopt the concept of "audit documentation" as defined and used in SAS 96, and rename the term "workpapers" in the proposed rules to "audit documentation." The definition of audit documentation in SAS 96 is widely accepted and understood by the profession. SAS 96 provides a workable definition of audit documentation. We believe that the definition of audit documentation under the SAS does not incorporate all correspondence and draft documents to support the auditor's opinion. Paragraph .03 of SAS 96 indicates that audit documentation serves mainly to:
An audit is a process that evolves over a period of time. Documents are created, edited and revised on a daily basis as part of the audit process, and are frequently communicated via electronic messages. The retention of documents other than what is contemplated under paragraph .04 of SAS 96 (for example, all electronic messages sent in connection with the audit and draft spreadsheets, memos and correspondence) would be overly burdensome and would not provide relevant principal support for the auditor's report. The retention requirements should apply to relevant records, which are the documents in final form, that are required to be retained by GAAS (including SAS 96) to support the accountants' report. We believe that requiring retention of relevant records will accomplish the Commission's objectives as stated in the accompanying Release.
We are concerned that an unintended consequence of a very broad and ambiguous definition of audit documentation could result in fewer review notes and a shift to verbal communications. Experienced auditors typically prepare review notes and mark drafts as a training medium for less experienced personnel and to comply with their firm's quality control processes. We believe the proposed rules will cause firms to reevaluate such processes and consider revising policies in this area. This effect would not improve audit or documentation quality and therefore we suggest the Commission make it clear in the final rules that review notes, draft memoranda, and routine communications are specifically eliminated from the definition of audit documentation.
To the extent the Commission believes it is necessary to expand the scope of retained records beyond relevant records, it should do so specifically. It should also consider whether it is sound public policy to insist on the preservation of records that do not support the auditors' conclusions, and whether such requirements may result in less, not more, audit documentation.
Would auditors have to implement significant changes to their retention policies or internal control processes and procedures, as well as system upgrades, to ensure compliance with the proposed rule? If so, what types of changes most likely would be required? How can we minimize any required changes consistent with section 802?
Extending the retention period to five or seven years will require revisions to our internal policies and will result in increased archive storage costs. The costs will increase dramatically if the Commission demands retention of all electronic messages sent in connection with the audit and draft versions of spreadsheets, memos, and correspondence. Compliance with this level of record retention would require extensive upgrades to our current server capacity and archive facilities. Additional staffing would also be required. The ultimate increase in costs is difficult to quantify as there are many variables that would affect the costs, such as size of emails (with or without attachments), number and frequency of messages sent or received in connection with the audit, and the number of, and revisions to, the other documents. Our information technology personnel inform us that the increased costs would be significant and there are also some technical difficulties that would need to be addressed, as electronic messages are not, at present, easily stored. It should be noted that these increased costs would ultimately have to be passed on to our clients, in the form of increased fees.
While increased costs are a major concern to the firm, ultimately Grant Thornton has the resources, technology and infrastructure to develop the policies, procedures and storage capacities that would be required to retain the electronic messages sent in connection with an audit. We believe, however, that this level of required records retention would place an enormous burden on the smaller accounting firms. The increased costs and difficulty in developing the technology and infrastructure to ensure compliance with the rule requirement could put some smaller firms out of the practice of auditing public clients. This would, in turn, make it difficult for smaller issuers to engage auditors that would be willing to accept a small audit engagement. Smaller issuers located in a small town would be further disadvantaged, since they may have to engage a larger firm outside of their local area, thus further increasing audit fees.
Would auditors circumvent the proposed record retention requirements by, for example, replacing written communications with oral communications? If so, what additional measures should be taken?
As previously stated, if the definition of workpapers in the final rule includes internal review notes and all correspondence between engagement team members generated during the audit engagement, we believe that reliance on written communications will diminish. This shift in form of communication may also occur as issues are researched and resolved during the audit process. The fear that every piece of written communication might later be misconstrued will impact the judgments made in determining the level and extent of later written audit documentation. Auditors may hesitate to commit initial evaluations and opinions to writing. The risk is that audit documentation serving as the basis for conclusions becomes weaker as a result of the rule requirements, instead of strengthened, as was the intent of Congress. We believe that the increased retention period on audit documentation (as defined in SAS 96), coupled with the criminal penalties imposed by Section 802, will strengthen practice in this area, and achieve the result desired by Congress.
Section 103 of the Sarbanes-Oxley Act directs the Public Company Accounting Oversight Board to adopt an auditing standard that requires each registered public accounting firm to retain for a period of not less than seven years audit workpapers and other information that support the conclusions in the auditor's report. Should the retention period in the proposed rules be extended to seven years to coincide with the retention period in section 103? Why?
Should the retention period be for some other appropriate period based on consideration of other factors, such as utility of the records to investors, regulators or litigants, the cost of retaining the records, or the size of the accounting firm?
The five-year retention period under Section 802 should be extended to correspond to the seven-year retention period mandated by Section 103 of the Act. We believe that most firms will adopt a policy of retaining all audit documentation for the longer period of seven years. The Release notes that there may be fewer documents retained pursuant to Section 103, which focuses more on workpapers that support the auditor's conclusions, than under Section 802, which includes not only workpapers but also other documents that meet the criteria noted in this Release. Many documents may be covered by both retention requirements. Given that many documents may be covered by both Sections of the Act, the costs of sorting through the documents after five years and deciding which documents fall under Section 802 and could be discarded, and which documents must be retained as required by Section 103, would appear to outweigh the storage costs that would be incurred to continue to archive all audit documentation. Also, firms may adopt the seven-year retention policy to avoid the risks of inadvertently destroying Section 103 workpapers after five years during the sorting process described above.
Audits of the financial statements of many investment advisers and broker-dealers would not be subject to the proposed rules because they are not "issuers" of securities. Should the proposals be amended to apply the retention period to audits of the financial statements of these entities? Why?
The proposed rules would incorporate the definition of "issuer" in new section 10A(f) of the Exchange Act? Should "issuer" be defined more broadly to include any issuer of securities with respect to which a registration statement or report is filed with the Commission? Why?
We believe that the proposed rules should apply to "issuers" as defined in the Act. To broaden the definition of issuer for some rules related to Sarbanes-Oxley, but not for certain other rules, would be confusing to registrants, auditors and investors.
The proposed rules would apply to foreign auditors. Are there statutes, rules or standards in foreign jurisdictions that govern the retention of records by foreign jurisdictions that govern the retention of records by foreign auditors that are different from and potentially conflict with the requirements of the proposed rules? If so, how is the foreign law incompatible with the specific provisions of the proposed rules?
We understand the Commission has received a letter commenting on the proposed rules from the European Commission (EC). In that letter, the EC noted that European Union (EU) auditors are already subject to equivalent Member State's retention requirements tailored to their specific legal environments. If the retention requirements of the (Sarbanes Oxley Act) were applied to EU auditors, this would put an additional second and third layer of differing retention requirements on EU auditors. While Grant Thornton has not studied the various retention requirements that are in effect outside the United States, we share the concern expressed by the EU, and we urge the Commission to consider the circumstances that apply to accounting firms organized outside the United States, not only in the area of retention of records, but in relation to other aspects of Rules that designed to implement the requirements of the Sarbanes Oxley Act as well.
Does the "cast doubt on the final conclusions reached by the auditor" provision in the proposed rules adequately capture the scope of the retention requirements under the Sarbanes-Oxley Act? Should the scope be narrower or broader? Would a different test be more appropriate, such as "significant differences in professional judgment," or "differences of opinion on issues that are material to the issuer's financial statements or to the auditor's final conclusions regarding any audit or review"?
Should the rules include other examples of materials that "cast doubt" on auditors' conclusions? If so, what examples should be included?
The proposed Rule requires retention of materials that "cast doubt on the final conclusions reached by the auditor." We strongly believe that this wording goes beyond the scope of the retention requirements of Sarbanes-Oxley. Moreover, the standard is ambiguous and would leave auditors uncertain about its scope. This paragraph should be revised to narrow the scope of the Rule to require only retention of records reflecting "significant differences in professional judgment on issues that are material to the financial statements or to the auditor's final conclusions regarding the audit or review." We believe that this wording would provide clear, concise guidance and would diminish the likelihood of misinterpreting paragraph (c).
One possible approach suggested in the Release is that auditors retain "documentation of differences of opinion concerning accounting and auditing issues." Recognizing that professional disagreements are already required to be retained as part of the audit documentation under SAS 22, Planning and Supervision, the Release notes:
The difficulty with this formulation is understanding just what the "other materials" are that must be retained. It seems to us that the intent of the rule is to preserve documents that express contrary opinions or alternatives. Such documents normally are created at the culmination of a consultative process in the form of a memorandum. We suggest the final rule specify that such memoranda are required to be retained in the audit documentation. If the Commission deems it necessary to keep the requirement broad, we think that it would be more informative to define these records or at least include examples of documents that the Commission would expect to be retained that are not already required by GAAS. The final rules should incorporate fully the compliance expectations of the Commission in a clear and concise manner, leaving little room for broad interpretation.
We thank you for the opportunity to comment and would be pleased to discuss any of our comments with the SEC or its staff. Please direct your questions to Karin French, National Director of SEC Regulations, at (703) 847-7533.