December 27, 2002
Mr. Jonathan G. Katz
File No. S7-46-02
Dear Mr. Katz:
We appreciate the opportunity to comment on the Commission's proposed rule, Retention of Records Relevant to Audits and Reviews (the "Proposed Rule"), issued pursuant to Section 802 of the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley"). We believe the overarching objective of the provisions of Sarbanes-Oxley, including Section 802, is one of furthering the public interest through improving audit quality. Adoption in final form of provisions in the Proposed Rule without consideration of the matters discussed in this letter, however, may result in unintended consequences that ultimately will undermine the spirit of furthering the public interest.
We respectfully present for your consideration our observations on the Proposed Rule, including suggestions that we believe will improve the overall quality and effectiveness of the final rule issued by the Commission, consistent with the letter and spirit of Sarbanes-Oxley. Our comments are limited to those matters that we believe require consideration by the Commission prior to releasing a final rule. These matters include the following: (1) Nature of Documents Retained, (2) Documents Retained Under Sections 103 and 802 of Sarbanes-Oxley, and (3) Foreign Auditor Implications. References to "SAS" in this letter refer to Statements on Auditing Standards included in the American Institute of Certified Public Accountants Codification of Statements on Auditing Standards.
Nature of Documents Retained
The Proposed Rule would require that the auditor retain workpapers and other documents that "form the basis of the audit or review of an issuer's financial statements, and memoranda, correspondence, communications, other documents, and records (including electronic records) that meet two criteria. The two criteria are that the materials (1) are created, sent or received in connection with the audit or review, and (2) contain conclusions, opinions, analyses, or financial data related to the audit or review." For purposes of the Proposed Rule, "nonsubstantive materials that are not part of the workpapers, however, such as administrative records, and other documents that do not contain relevant financial data or the auditor's conclusions, opinions or analyses would not meet the second of these criteria and would not have to be retained."
We note that the drafters of the Proposed Rule indicated that "retaining the materials created under SAS 22 and SAS 96, as well as other materials that might cast doubt on the conclusions reflected in the auditor's report, would be consistent with the letter and intent of the Sarbanes-Oxley Act." We believe that documentation addressing consultation on, and resolution of differences of professional judgment on, issues material to the issuer's financial statements would satisfy the intent of the Proposed Rule in reference to "other materials that might cast doubt..." Differences of professional judgment between engagement team members and between the engagement team and issuer on matters significant to the issuer's financial statements generally would be more extensively documented under this approach. The final rule, and if deemed necessary, auditing standards should be revised to more clearly articulate the nature and extent of documentation necessary to comply with the two criteria noted above.
Documents Retained Under Sections 103 and 802
We believe that the nature of documentation to be retained under Sections 103 and 802 of Sarbanes-Oxley should be consistent Clearly, the documents to be retained under both Sections overlap to a large extent. In order to avoid obvious and unavoidable confusion, duplication of effort and variation in practice, we believe it is imperative that rules regarding the nature of documents to be retained pursuant to Sections 103 and 802 of Sarbanes-Oxley be consistent. As noted above, we believe that documentation developed and retained pursuant to SAS 22 and SAS 96, including satisfactory documentation addressing consultations and resolution of differences in the conduct of an audit or review, is consistent with the spirit and intent of Section 802, and complies with the provisions of Section 103.
Foreign Auditor Implications
Standards for retention of audit workpapers and other documents vary from country to country, and include requirements issued by national statutory, regulatory and professional bodies, and are supported by well-established business practices. In some foreign jurisdictions, audit documentation may be subject to legal privilege between the issuer and auditor. The Proposed Rule may be contrary to existing practice or laws in foreign jurisdictions, and specific permission may be required from the issuer to permit the release of such information to the Commission, if requested. We believe that further consideration must be given to the ramifications in foreign jurisdictions of compliance with provisions of the final rule.
Audit documentation, which collectively forms the evidentiary matter and basis to support the auditors' report on financial statements, is generated throughout the audit process. Preliminary documentation is reviewed, revised, put in final form and the final documentation is retained to form the principal record of the work performed pursuant to generally accepted auditing standards. An audit is, by necessity, an interactive and iterative process. The imposition of requirements that might stifle the interactive and iterative qualities of the audit process clearly run contrary to an objective to improve audit quality.
We certainly appreciate the difficulty of developing an operational definition of "other documents" referred to in Sarbanes Oxley and thus the Proposed Rule. However, we believe the language in the Proposed Rule referring to "other documents," coupled with the notion of "cast doubt," is so broad and vague as to prohibit an operational definition of what should be retained pursuant to proposed Rule 2-06 of Regulation S-X. As a criminal statute, vague or ambiguous language which could be applied unfairly in hindsight must be avoided. In addition, we believe that a very real risk exists, without amendment to the Proposed Rule, that auditors will rely more on oral rather than written communication in the conduct of an audit. Oral communication generally involves less extensive analysis and is subject to greater misinterpretation than written communication. Accordingly, we believe the unintended consequence of a final rule consistent with the Proposed Rule would be a less interactive and thoughtful audit process. Clearly, such a result is not in the public interest of improving audit quality.
SAS 96, Audit Documentation, requires auditors to "document audit findings or issues that in his or her judgment are significant, actions taken to address them (including additional evidence obtained), and the basis for the final conclusions reached." In addition, an interpretation of SAS 22, Planning and Supervision, states that "...each assistant has a professional responsibility to bring to the attention of appropriate individuals in the firm, disagreements or concerns the assistant might have with respect to accounting and auditing issues that he believes are of significance to the financial statements or auditor's report..." Comprehensive and effective consultation and dispute resolution protocols should result in documentation of matters consistent with the "cast doubt" notion in the Proposed Rule. In order to achieve consistency in practice, we recommend that the final rule clearly articulate the nature and extent of documentation expected in the areas of consultation and dispute resolution in the conduct of an audit. In addition, auditing standards may be similarly amended, if deemed appropriate. Matters to consider for documentation include identification of the issue/matter, discussion of alternatives and applicable professional literature or guidance, consulted parties and nature of consultation(s), conclusions reached, and final resolution.
We believe the spirit and intent of Section 802 would be met under the following approach:
The standards for retention of audit workpapers and other documents vary from country to country, and include requirements issued by national statutory, regulatory and professional bodies, as well as common business requirements. In some foreign jurisdictions, audit documentation may be subject to legal privilege between client and auditor. The Proposed Rule may violate national practice or laws, and specific permission may be required from the issuer to permit the release of such information to the Commission, if requested. To the extent that audit workpapers contain personal information of client personnel, the requirement to release such information to the Commission is likely to be in conflict with the laws of those countries in the European Union, or where similar privacy laws govern. We believe that further consideration must be given to the ramifications of the final rule on applicability and compliance in foreign jurisdictions.
Most auditing firms will require some modification to existing systems, processes and procedures relative to record retention in order to comply with the provisions of a final rule. Accordingly, we recommend that compliance with provisions of the final rule be required for audits of fiscal years beginning on or after December 15, 2003 (including interim reviews conducted relative to such fiscal years). This effective date should allow auditing firms sufficient time to execute an orderly transition to comply with provisions of the final rule.
Professional auditing standards related to audit documentation currently result in auditors preserving records and documents which support the auditors' conclusions in an audit or review. Professional auditing standards presently provide discretion as to what records become part of the audit or review workpapers, however. Therefore, to meet the intent of Sarbanes-Oxley, it is appropriate to supplement existing professional standards with more specificity regarding final records or documents which constitute the principal record of the work performed in the area of material dispute resolution and consultations regarding material issues.
As drafted, the definition of "other documents" in Rule 2-06 (a) (1) and (2) of Regulation S-X and the "cast doubt" language now proposed are so broad and vague as to make it very difficult to determine what should be retained, and could conceivably capture any writing, no matter how preliminary, created in the course of performing an audit, adding significant burden and cost to the audit process, decreasing rather than increasing audit effectiveness, and discouraging a thoughtful audit process. Moreover, the "cast doubt" language can be applied unfairly in hindsight, creates unintended consequences, and will likely have a result that is exactly the opposite of the law's intent - i.e., it will likely reduce, not increase, robust and meaningful documentation of audit work and conclusions, and preservation of those documents for the necessary period. In short, the proposed rule creates a very significant risk of adversely impacting the quality of audits by reducing the level of documentation, discouraging a robust give and take in the audit process, and increasing costs.
Thus, adoption of the Proposed Rule without consideration of the matters discussed in this letter may result in unintended consequences that ultimately will undermine the spirit of furthering the public interest by improving audit quality. Most importantly, we believe that a very real risk exists, without amendment to the Proposed Rule, that auditors will naturally rely more on oral rather than written communication in the conduct of an audit. Oral communication generally involves less extensive analysis and is subject to greater misinterpretation than written communication. An audit is, by necessity, an interactive and iterative process. Changes in auditor behavior that run contrary to the interactive and iterative qualities of the audit process clearly are not consistent with the overarching objective of Sarbanes-Oxley to further the public interest by improving audit quality. We encourage the Commission to seriously consider the matters addressed in this letter when deliberating the final rule.
If you have any questions regarding the contents of this letter, please contact Sam Ranzilla at (212) 909-5837or Craig Crawford at (212) 909-5536.