Sullivan & Cromwell
125 Broad Street
New York, New York 10004-2498
December 26, 2002
VIA E-MAIL: firstname.lastname@example.org
Mr. Jonathan G. Katz,
Securities and Exchange Commission,
450 Fifth Street, N.W.,
Washington, D.C. 20549-0609.
Dear Mr. Katz:
We are pleased to respond to Release No. 33-8151 (the "Proposing Release"), in which the Securities and Exchange Commission solicited comments on its proposed rule implementing the provision of the Sarbanes-Oxley Act of 2002 (the "Act") relating to retention of records relevant to audits and reviews.
We have set forth below specific aspects of the proposed rule that we believe, based on our review and on discussion with our clients, should be modified in order to promote the underlying statutory purposes of Section 802 of the Act.
I. General Comments
Section 802 of the Act provides for criminal liability in the event of a violation of either Section 802 or the rules promulgated by the Commission thereunder. Because an accountant could be faced with criminal liability for violation of the document retention rules, including imprisonment for up to ten years, the Commission should strive for clarity and certainty in application of Section 802. As noted below, we have serious concerns regarding the breadth of the proposed rule. We urge the Commission to sharpen the focus of the proposed rule and provide a more objective set of circumstances that may give rise to a violation in order to protect both accountants from unintended risk from inadvertent violations of the rule and their audit clients from any unnecessary adverse consequences and costs that may arise from application of the rule.
II. The "Cast Doubt" Standard Goes Well Beyond What Is Necessary or Appropriate to Prevent Destruction of Relevant Records.
Documents that would be required to be retained under the proposed rule include not only those documents that support conclusions reached by the auditor, but also any document or communication that "casts doubt" on those conclusions. We recognize and support the Commission's effort to preserve significant documents that reflect differing professional judgments and views on the accounting practices employed by an issuer; however, we believe that the term "cast doubt" is an overly broad and subjective standard, especially with respect to a rule whose violation can result in criminal liability.
Literally read, the proposed rule may reasonably be interpreted to apply to casual communications that, for example, simply seek clarification about the audit process or accounting practices or disclosures contemplated by the issuer as well as to more formal correspondence or records that may raise serious questions regarding the audit being conducted or the accounting principles or practices being applied by the issuer. With such a broad standard, we are concerned that reasonable auditors may disagree with respect to whether a document "casts doubt" and will have to spend significant time determining whether a document or communication should be retained. In addition, we note that as a normal part of the audit or review process, auditors on an engagement team discuss and debate various auditing procedures and accounting judgments. We are concerned that, to the extent that auditors may have legitimate questions, they will be deterred from raising such questions in an effective way because they may be concerned that such a communication may create a "record" that must be retained. To the extent that these communications reflect questions that are eventually resolved (particularly those that are resolved through informal discussions), such communications may fall within the purview of the proposed rule, as arguably, they would "cast doubt" on the auditor's conclusions.
We suggest that the relevant determination should require that the communication reflect a significant difference of opinion as to a matter that would be material to the issuer's financial statements or to the auditor's final conclusions regarding an audit or review. This more objective threshold should eliminate from the rule's scope those communications that merely inquire into the auditor's decision with respect to a particular accounting issue or that reflect an informal discussion regarding audit procedures. With such a standard, auditors would, in most instances, be able to determine objectively whether a document falls within a category requiring retention. In addition, documents retained as a result of the higher threshold would be more useful in the litigation and regulatory context, as those individuals reviewing the communications readily would be able to determine whether there were significant differences of opinion that were not resolved satisfactorily prior to the end of the audit. The documents required to be retained under the proposed alternative would represent the records most relevant to an investigation into a possible claim of wrongdoing or serious flaw in judgment with respect to an accounting issue.
If the proposed phrase "cast doubt" is retained in the final rule, for the reasons discussed above, we suggest that it be modified by some form of "significance" threshold that would prevent the rule from applying to any communication that merely questions the auditor's decision.
III. The Proposed Rule Should Clarify the Procedures to be Followed with Respect to Electronic Records that Fall Within the Rule's Scope.
The proposed rule would apply to certain memoranda, correspondence, communications, other documents and records, including electronic records. Neither the Proposing Release nor the proposed rule provides guidance on the scope of "electronic records" that would require retention. We strongly urge the Commission to define the term electronic records and to indicate to what extent such term would apply to email communications, voicemail communications, instant messenger and other developing forms of electronic communications.
We suggest that the rule apply only to formal documentation of disagreements with the auditor's conclusions and not to email, voicemail, instant messenger or other "real-time" or "near-time" communications. These types of communications generally are transitory in nature and analogous to face-to-face or telephone communications. Given the "back and forth" nature of such communications and the use of such means to obtain information or clarification, or even to resolve casual differences of opinion, and given the evolution of other forms of communication that are increasingly taking the place of oral communications, we believe that the rule would be overbroad in its application and likely would have a chilling effect on such communications, which are both useful to auditors and beneficial to investors. Because of the inherent difficulty of "policing" the nature of the communications made through these means, auditing firms and their issuer clients are likely to limit severely the use of these technologies if their use creates records within the purview of Section 802 of the Act and the rules thereunder. We believe that the Commission should not adopt a rule that would inhibit these developing forms of communication in light of the benefits that these forms of communication may bring to the audit process (particularly in the ability to obtain guidance or assistance from within the accounting firm).
We understand that the Commission may be concerned that auditors may be encouraged to avoid application of the rule by limiting communications that may reflect significant differences of opinion to communications that are in a form that is not covered by the rule. However, we believe that the Commission could mitigate this concern by encouraging the Public Company Accounting Oversight Board to establish specific guidelines requiring that significant differences of opinion be formally documented and retained for the requisite period of time.
The Commission has requested comment on whether auditors would have to implement significant changes to their retention policies or internal control processes and procedures, as well as system upgrades, to comply with the proposed rule. First, the Commission should be aware that many organizations have protocols to periodically "purge" all email and voicemail communications. Firms would have to develop new systems and procedures to identify communications that must be retained, and do so before the purge period ends. Second, firms may not currently have any system designed to identify voicemail or casual email required to be retained. Developing such systems, particularly for voicemail, could require major effort. Finally, to the extent that firms do not have in place systems to store these types of records for extended periods of time, they may have to implement significant changes to their communications systems. If the Commission determines that the rule would apply to such communications, the Commission should provide for a transition period to permit accounting firms to develop appropriate systems to identify and retain such records.
IV. The Rule Should Not Require Issuers to Retain Records.
The Commission requests comment on whether issuers should be required to keep copies of all correspondence with the auditors and copies of documents provided to the auditors. Any such addition would go significantly beyond Section 802, which applies only to those documents or communications that are created, sent or received in connection with an audit or review and contain conclusions, opinions, analyses or financial data relating to an audit or review. To the extent that certain communications or documents provided to auditors do not contain such conclusions, opinions, analyses or financial data, the proposed modification would go beyond what is required by Section 802 and indeed what is necessary to meet the central purpose of the section, which is to ensure that certain materials relating to an audit or review not be destroyed by an auditor in a manner that would obstruct justice or evade responsibility under the Act. The Commission also requests comment on whether the issuer should be required to retain records that the auditor reviewed but did not include in the audit workpapers. Section 802(a) of the Act specifically requires the auditor to retain all audit or review workpapers. The Commission should not require issuers to act as a "safety net" in the instance that an auditor fails to retain the materials required by the Act.
It is unclear from the language of Section 802 whether the provision applies to retention of documents by issuers or auditors. However, assuming that the Commission limits application of the rule to those documents required by Section 802, application to issuers would be duplicative, as any of these documents retained by the issuer would be required to be retained by the auditor as well. Furthermore, an accountant, who is familiar with the nature of the audit and review process generally and as applied to a particular issuer, would be in the best position to evaluate whether a particular record falls within the Act and the proposed rule (i.e., whether it contains conclusions, opinions, analyses or financial data related to the audit or review). Accordingly, we urge the Commission not to expand the rule to require issuers to retain audit-related materials.
* * *
We appreciate the opportunity to comment to the Commission on the proposed rule, and would be happy to discuss any questions the Commission may have with respect to this letter. Any questions about this letter may be directed to John T. Bostelman (212-558-3840), Robert E. Buckholz, Jr. (212-558-3876), David B. Harms (212-558-3882) or Scott D. Miller (650-461-5620).
Very truly yours,
SULLIVAN & CROMWELL
cc: Giovanni P. Prezioso
Jackson M. Day
Acting Chief Accountant
Alan L. Beller
Director, Division of Corporation Finance