WEBMASTER NOTE: This is the unedited transcript of the Roundtable Discussion on Implementation of Internal Control Reporting Provisions held on April 13, 2005, which we received directly from the court reporter. We are posting the transcript in this form to make it available as soon as possible. ================================================================================ 1 2 3 4 5 6 UNITED STATES SECURITIES AND EXCHANGE COMMISSION 7 8 9 10 11 ROUNDTABLE DISCUSSION ON 12 IMPLEMENTATION OF INTERNAL CONTROL 13 REPORTING PROVISIONS 14 15 16 17 Wednesday, April 13, 2005 18 9:00 a.m. 19 20 21 SEC Headquarters 22 450 Fifth Street, N.W. 23 Washington, D.C. 24 25 1 C O N T E N T S 2 PAGE 3 4 Opening Remarks . . . . . . . . . . . . . . . . . . . . . . 4 5 Chairman William H. Donaldson, U.S. 6 Securities and Exchange Commission 7 8 Chairman William J. McDonough 9 Public Company Accounting Oversight Board 10 11 Introduction and Panel One - The First Year . . . . . . . 15 12 Moderators: 13 Alan L. Beller, Division of Corporation Finance 14 Donald T. Nicolaisen, Office of the Chief Accountant 15 16 Panel Two - Reporting to the Public . . . . . . . . . . . 59 17 Moderators: 18 Alan L. Beller, Division of Corporation Finance 19 Carol A. Stacey, Division of Corporation Finance 20 21 Panel Three - Planning and Design . . . . . . . . . . . . 105 22 Moderators: 23 Andrew D. Bailey, Office of the Chief Accountant 24 Donald T. Nicolaisen, Office of the Chief Accountant 25 1 C O N T E N T S 2 PAGE 3 4 Lunch Break . . . . . . . . . . . . . . . . . . . . . . . 144 5 6 Panel Four - Documentation and Testing . . . . . . . . . 144 7 Moderators: 8 Andrew D. Bailey, Office of the Chief Accountant 9 Donald T. Nicolaisen, Office of the Chief Accountant 10 11 Panel Five - Using Judgment in . . . . . . . . . . . . . 195 12 Communication and Conclusions 13 Moderators: 14 Alan L. Beller, Division of Corporation Finance 15 Carol A. Stacey, Division of Corporation Finance 16 17 Panel Six - Next Steps . . . . . . . . . . . . . . . . . 238 18 Moderators: 19 Alan L. Beller, Division of Corporation Finance 20 Donald T. Nicolaisen, Office of the Chief Accountant 21 22 Conclusion . . . . . . . . . . . . . . . . . . . . . . . 281 23 24 25 1 P R O C E E D I N G S 2 (9:00 a.m.) 3 MR. BELLER: Good morning. Okay. Thank you all 4 for joining us, and I want to get started as close to on time 5 as we can. I'm Alan Beller, the director of the Division of 6 Corporation Finance. Don Nicolaisen, the Chief Accountant 7 for the Commission, is sitting on my right. 8 I'm going to ask the Commission chairman, William 9 Donaldson, to open the proceedings. Mr. Chairman. 10 OPENING REMARKS 11 COMMISSIONER DONALDSON: Thank you, Alan. Good 12 morning ladies and gentlemen. Thank you all for coming 13 today, and we welcome all of you on behalf of my fellow 14 commissioners sitting here, and on behalf of the Commission 15 itself. 16 I want to thank the panelists in particular for 17 their willingness to come to Washington, devote their energy 18 and constructive thinking to a topic of great importance to 19 the nation's public companies. 20 I'd also like to extend a particular welcome to 21 Chairman Will McDonough, sitting over there, and Directors 22 Kayley Gillan, Dan Goelzer, Bill Gradison, Charlie Niemeier, 23 all directors of the PCAOB, the Public Company Accounting 24 Oversight Board. 25 I think this is a great opportunity for all of us, 1 and in particular our two organizations, to work and learn 2 alongside each other. 3 And so we thought was a necessary and 4 understandable response to an unprecedented string of 5 corporate scandals, which were rooted in intolerable 6 governance, accounting and audit failures. 7 Section 404 of the Act requires that management 8 assess and report on the ineffectiveness of our internal 9 controls over financial reporting, and that the company's 10 external auditor report on both the internal controls and 11 management's assessment of these controls. 12 As I've said before, all of the provisions of the 13 Sarbanes-Oxley Act, the internal control requirements of 14 Section 404, may have the greatest potential to improve the 15 accuracy and reliability of financial reporting. 16 Strong controls are an important part of this goal, 17 because our capital markets run on the basic premise that 18 companies will present reliable and complete financial data 19 for investment and policy decisionmaking. 20 But we also understand that the process of 21 implementing the requirements of Section 404, as well as the 22 related SEC and PCAOB rules, has consumed considerable time, 23 energy, resources and has generated intense debate. 24 Our staff and the Commission and I have all heard 25 stories, as I'm sure many of you have, of substantial and 1 unanticipated expenses, including internal overhead, audit 2 fees and software expenses, companies pulling staff from 3 other strategic projects to help with internal control 4 reporting, management and auditors talking past one another, 5 and duplicative testing procedures with little or no reliance 6 on prior work. 7 With the distinguished and diverse group of 8 panelists we've assembled, this is an opportunity for us to 9 hear how the process really works for issuers in general. 10 Are these isolated instances or are they widespread? 11 Which of the problems encountered this year were 12 attributable to first-year growing pains, and which are 13 likely to reoccur each year? What are your suggestions for 14 improvement, and how can we help further? 15 We also want to know whether the steps we took to 16 ease the process, such as issuing staff guidance and delaying 17 compliance dates for some groups, were helpful. We'd like to 18 get an idea of how registrants and others feel they have 19 benefitted from the internal control reporting process. 20 We know that over 2,500 registrants have filed 21 their internal control reports by March 31st, approximately 22 eight percent reporting material weaknesses. But we also 23 heard from at least one accounting firm that within a group 24 of 225 registrants the firm audits, approximately 63,000 25 control deficiencies, that's an average of 275 per company, 1 were identified and most importantly, remedied. We look 2 forward to hearing more about these. 3 We also want to hear from investors. Was the 4 internal control information provided by companies helpful? 5 What was the investor community's reaction to reports of 6 material weaknesses? 7 This roundtable is an important vehicle for 8 gathering feedback on all aspects of the reporting process, 9 and as you can tell, I welcome the candid and constructive 10 feedback from each of our panelists, as do our Commissioners. 11 It's extremely important to me and our five 12 Commissioners, as well as the PCAOB board members, that we 13 hear the experiences and views of people who are familiar 14 with implementing the internal control reporting provisions 15 of Section 404. 16 We also want to make sure we're helping companies 17 and auditors accomplish the goals of Section 404 in the most 18 effective and efficient way. In addition to the information 19 we learned from this roundtable, we also will be considering 20 the written submissions we have received in response to our 21 request for feedback. 22 These submissions are available to the public on 23 the SEC website. The important work of the SEC Advisory 24 Committee on Smaller Public Companies, which had their first 25 meeting yesterday, also will inform our understanding of how 1 Section 404 can be implemented in a most sensible way for 2 smaller companies. 3 I'm going to keep my remarks brief, because we have 4 a lot to cover. Again, let me express my thanks to all of 5 the panels who agreed to be here today. We appreciate the 6 time that you're taking out of your very busy schedules, and 7 willingness to share your views with us. 8 We will be listening carefully, and I can assure 9 you that we intend to consider all of the different views 10 expressed today. I will have further comments at the end of 11 the roundtables regarding next steps. For now, I'd like to 12 give Bill McDonough, Chairman of the PCAOB, an opportunity to 13 say a few words before we get started. Bill? 14 MR. MCDONOUGH: Well, thank you, Bill. On behalf 15 of the Public Company Accounting Oversight Board, I would 16 like to extend our appreciation to you, your fellow 17 commissioners and the staff of the SEC for convening the 18 roundtable discussion today. 19 I know that we have all read many of the same 20 surveys about the implementation of Section 404, and that we 21 have all had occasion to meet and talk with issuers, with 22 corporate directors, and with the auditors who are on the 23 front lines of implementing the requirements of 404. 24 But this roundtable gives us an important 25 opportunity for public discussion of the specific issues that 1 companies and their auditors have confronted, as they work to 2 comply with the rigorous demands of this new law. 3 I expect, based on my own conversations, that this 4 will be a lively discussion. I hope that it will also be 5 constructive. 6 Although companies have been required to have 7 internal control over their accounting since the Congress 8 enacted the Foreign Corrupt Practices Act in 1977, there is 9 no doubt that the Sarbanes-Oxley Act's requirement for annual 10 assessments and auditor attestations to those assessments, 11 took corporate responsibilities to an entirely different 12 level. 13 At the same time that the board approved its 14 standard for audits of internal control over financial 15 reporting, my fellow board members and I acknowledged that 16 the standard would entail extra work and cost for public 17 companies. 18 We also did our best at the time of our vote and at 19 every opportunity in the year since the vote, to emphasize 20 the flexibility and judgment that we built into Auditing 21 Standard No. 2, including the provisions related to the 22 auditors' use of the work of others. 23 Unfortunately, we are hearing anecdotes that 24 auditors are not always using the flexibility available in 25 AS-2. Instead of using judgment to tailor audit programs to 1 the nature and size of an audit client, some auditors are 2 applying a checklist approach to all audit clients, 3 regardless of their complexity. 4 I will say again what I have said many times, there 5 is no one-size-fits-all approach to assessing company's 6 internal controls. Auditors should apply AS-2 in a manner 7 that is proportional to the quality of management's 8 monitoring of controls, as well as the complexity of the 9 company. 10 Untailored checklists to me are an early sign of 11 poor quality judgments, which can lead to poor quality 12 auditing. 13 On the other hand, I have no doubt that some of the 14 complaints being lodged about the assessment process being 15 too rigorous and too extensive are being lodged in response 16 to good auditors making hard decisions, auditors that are 17 putting pressure on exactly the points of poor quality 18 financial reporting that need to be squeezed. 19 Whatever actions we take, we must not undermine the 20 work of auditors who are using their best professional 21 judgment to drive exactly the kind of improvements in quality 22 financial reporting that the Act intended. 23 I have said before, we will use our inspections, 24 which begin this year in May, to assess the effectiveness of 25 registered firms' implementation of AS-2, including the 1 quality of the firm's judgments about planning audit programs 2 appropriate to the nature of their clients. 3 These inspections will provide the board with a 4 powerful opportunity to learn the substance behind the 5 anecdotes that we've been hearing. Undoubtedly, there is 6 more that we can do to encourage a smooth and reasonable 7 implementation of 404, and that is what we are here to learn 8 today. 9 It may be that some confusion or hardships in the 10 implementation of AS-2 can be addressed by additional 11 guidance. That would be the most rapid way to execute 12 changes and the most timely for companies and their auditors. 13 To the extent that what we hear today and read in 14 the comment letters causes us to believe that any of the 15 principles in AS-2 are fundamentally flawed, however, we 16 would undertake rulemaking to improve the principals. 17 In the end, no matter what action the board or the 18 Commission may take as a result of the information we gather 19 today, the ultimate responsibility for fulfilling the 20 requirements of Section 404 remains with the men and women 21 who lead and audit the companies that seek capital in our 22 securities markets. 23 The owners of those companies, investors, will 24 ultimately determine whether the benefit that inspired 25 Section 404, the increased reliability of company's financial 1 statements, is overshadowed by labor and costs that bear no 2 relationship to the goal of reassuring investors in our 3 capital markets. 4 Now with that in mind, I hope that we on the Board 5 and Commission can come away from today's discussion with 6 some very concrete ideas about specific actions that might 7 address any unintentional burdens of Section 404. 8 I also hope that participants in the roundtable 9 will share specific examples of how the closer examination of 10 internal controls has improved financial reporting, and 11 provided the confidence and assurance we are all seeking on 12 behalf of investors. I look forward to the discussion. 13 MR. BELLER: Thank you, Chairman Donaldson and 14 Chairman McDonough. We're going to dive right in here. Let 15 me lay out a couple of ground rules. I'm going to introduce 16 the panelists in a moment. 17 For the benefit of folks on the web who are 18 observing this, or listening to this via webcast, I am going 19 to tell you who's around the table and each of the other 20 moderators will do that at the beginning of the panels. 21 We have today the members of the Securities and 22 Exchange Commission, starting -- we'll do this in order. 23 Rowell Campos, Harvey Goldschmid, William Donaldson, Cynthia 24 Glassman and Paul Atkins. 25 We also have the members of the Public Company 1 Accounting Oversight Board. We're pleased to have you with 2 us this morning. Kayley Gillan, Charles Niemeier, William 3 McDonough, William Gradison and Dan Goelzer. Thank you for 4 joining us. 5 The ground rules are I think fairly simple. We 6 have a lot of subjects to cover. We have a large number of 7 panelists, because we want to get a large number of views. 8 We need all panelists to submit written statements and the 9 vast majority, if not all of them, where their organizations 10 have. 11 Those are on our public website in the file that 12 we've opened for this event, and the audience is encouraged 13 to, if they have not already, to look at them. But we are 14 going to ask panelists not to make opening statements as part 15 of today's activities. 16 There are too many of you, and we have too much 17 ground to cover. The moderators will take the liberty of 18 directing certain questions at certain members of panels, and 19 perhaps asking other members for specific follow-up. 20 On the other hand, we want this to be interactive 21 and we want this to be a discussion. We encourage panelists 22 who would like to add something with respect to any question, 23 to let us know. 24 We have over the years learned that we can learn a 25 lot from our European brethren. One of the things we've 1 learned is that the best way to run one of these things and 2 to seek to be recognized is to take your tent card and turn 3 it up on end like that. The moderators will see you. It's 4 much better than leaping out of your chair and raising your 5 hand. 6 We do want our panelists to not just echo other 7 answers that have been given, again for the sake of time. We 8 will recognize as many panelists as we can in the course of 9 the proceedings. 10 As Chairman McDonough already indicated, it would 11 be really helpful to the Commission and the board and their 12 respective staffs to have answers that are as specific as 13 possible. Also, concise and to the point. We are going to 14 try to keep this moving. We have a number of things we want 15 to cover. 16 We also very much encourage the members of the 17 Commission and the members of the board. You will have two 18 moderators here for each of these panels. Members of the 19 Commission staff, Don Nicolaisen and I, will do the first 20 panel. 21 But if any Commissioner or board member has a 22 subject that they think we're not getting to adequately or 23 has a question they want to raise, please let us know in the 24 same fashion and we will call on you and give you the floor. 25 Finally, because we are being webcast, including 1 audio, I think it's very helpful for our audience if people 2 before they speak could just identify themselves, tell us who 3 they are or tell the audience who they are. 4 With that, I'm going to introduce the first panel 5 and we're going to get started. 6 PANEL ONE - THE FIRST YEAR 7 From my left, the panel's right, the Honorable Mary 8 Bush, who's the president of Bush International and is also 9 the member and chair of an audit committee or two and a 10 director of a number of public companies. 11 To Ms. Bush's left, Michael Cook, who is also the 12 audit committee chair or a member of audit committees of a 13 number of public companies. 14 To Mr. Cook's left, Colleen Cunningham, who is the 15 president and CEO of Financial Executives International. 16 To Ms. Cunningham's left, Sam DiPiazza, who's the 17 global CEO of PriceWaterhouseCoopers. 18 Next in line, Randall Kroszner, who is a professor 19 of Economics at the University of Chicago. 20 Next to Mr. Kroszner, Bob Miles, who's the Senior 21 Vice President and Controller of Washington Mutual. 22 Next to Mr. Miles, Dr. Klaus Patzak, who is the 23 Corporate Vice President for Financial Reporting and 24 Controlling of Siemens, AG, and I want to thank Dr. Patzak 25 for coming across the Atlantic for us this morning to 1 participate. 2 To Dr. Patzak's left, Casey Sylla, who is the 3 chairman and president of Allstate Financial. 4 To Mr. Sylla's left, John Thain, who's the CEO of 5 the New York Stock Exchange. 6 And finally, to Mr. Thain's left, Lynn Turner, who 7 is with Glass, Lewis and Company, an advisory firm. 8 Thank you all for joining us this morning. I'd 9 like to start off with a rather open-ended and general 10 question. I promise you other questions in the course of the 11 day will be more pointed. But let's start with a broad one. 12 What in your view has been the most significant 13 impact of the internal control reporting requirement of 14 Section 404 in this, the first year of implementation? I 15 guess I'd like to ask Mr. Sylla to take the first crack at 16 that question. 17 MR. SYLLA: Thank you. As a sample of one fairly 18 large company, the short answer is the impact has been 19 positive. With respect to more specificity, not to suggest 20 that 2004 was the beginning of an internal control process 21 with an organization of our size. 22 But clearly, the impact of being able to increase 23 the amount of oversight and governance has been positive, 24 certainly looking at it in the long run. In the short run, 25 one could always conclude that there is a cost-benefit 1 analysis which may or may not be deemed positive. 2 However, the increased involvement -- I would list 3 two or three items very quickly. The increased involvement 4 on the part of senior management with respect to the 5 awareness of financial reporting has significantly increased. 6 There is no question about that. 7 Secondly, with respect to the awareness of 8 financial controls throughout the entire organization, on the 9 part of line managers, that awareness has increased 10 dramatically as well. 11 I would suggest finally that certainly informal 12 processes which in fact give you the ability to establish and 13 update a maintenance program will serve us well in the 14 future. 15 All of this, of course, is intended to create a 16 greater level of confidence, certainly by senior management. 17 It gives me a greater level of confidence, but more 18 importantly, with respect to our board, audit committee and 19 investors in general, we would put this very much on the 20 positive side. 21 MR. BELLER: Thank you very much. Mr. Miles, 22 what's your reaction? 23 MR. MILES: The most significant impact for our 24 organization was really the awareness that was created at the 25 senior level, senior management level throughout the 1 organization and down through the business lines. 2 Internal controls had always been a key part of our 3 structure, and certainly with the FDIC Improvement Act, banks 4 have been required to comply with an internal control 5 reporting framework for many years. 6 But I do think that this awareness was very 7 significantly strengthened, and also for the senior officers 8 that had to certify for Sections 906 and 302, this helped 9 them to have the confidence to make those assertions. 10 MR. BELLER: From the auditors' side, Mr. DiPiazzo, 11 what do you -- what would you underline as sort of the two or 12 three headline points of the overall impact in the first 13 year? 14 MR. DIPIAZZO: Mr. Chairman, I think you have to 15 reflect on the overall change of the environment that we're 16 facing today in the Sarbanes-Oxley. 17 Maybe the most significant change in behavior 18 within the capital markets, a dramatic shift of governance 19 from the executive suite to the board room, ownership by the 20 board around the issues of transparency and controls. 21 The auditors changed focus of an audit process 22 that's moving from analytics to a deeper sense of focus 23 around controls. 24 The auditor dealing with the fact that he's now 25 subject to oversight, and frankly the whole process for how 1 wide is the difficulty that our profession is having as it 2 transitioned from a self-regulated to a regulated profession. 3 Overall, I think the most significant impact coming 4 out of 404 is the transparency. Chairman Donaldson mentioned 5 60,000 deficiencies in just 200 of our clients. I think what 6 it shows is that controls were underfocused-upon. Now 7 they're owned by management, by the leadership of companies, 8 and I think significant progress is being made in remediating 9 those problems. 10 MR. BELLER: Mr. DiPiazzo mentioned transparency. 11 Mr. Turner, what's your take on the advantage that 404 has 12 brought to investors by virtue of increasing transparency 13 around the control process? 14 MR. TURNER: There's no question that investors now 15 have a better flavor for those companies who have high risk 16 with their financing reporting because of a lack of controls. 17 We've seen through the end of last Friday about 750 companies 18 actually report that they have problems. 19 The good news is that not only were investors now 20 able to determine whether those risks by NSS about what to do 21 with that, but they were also then in a number of instances 22 provided disclosures that indicated that the companies had 23 adequately dealt with those in a number of cases, which is a 24 very positive thing as well. 25 I think one of the things that's come out of this 1 process is that at the beginning of it, while there was maybe 2 a lack of awareness on the part of boards and corporate 3 executives, I think equally there was a lack of awareness 4 amongst investors, and investors really didn't know how to 5 react to this. 6 I think with the increased disclosures and 7 increased information, which is much better than what it was 8 before; we were never getting this type of disclosure about 9 weaknesses but now are, they are now able to differentiate 10 better between those companies where there's a problem that 11 they should impact the stock price, and those that aren't. 12 We are finding that the impact on the stock price 13 is very much company by company. There's no general trend. 14 MR. BELLER: Thank you. Turning this, rotating 15 this a little bit from the foreign private issuer, from the 16 non-U.S. issuer perspective, Dr. Patzak. I know your company 17 has been working very hard at implementation, even though you 18 have more time than some of the other companies represented 19 around the table this morning. 20 What would you say is different or special about 21 the impact or the experience for a foreign private issuer? 22 DR. PATZAK: I would think that the difference, 23 there is not a big difference between a foreign private 24 issuer and the U.S. company. It's more a difference between 25 an international company, a decentralized company, a company 1 doing business in a lot of industries, compared to a company 2 which is perhaps not so diverse and international. 3 For us being so diverse and fragmented was a huge 4 implementation effort. We started our 404 approach in late 5 2002. At that point of time we thought that we had to comply 6 with it at the end of our fiscal year '03. 7 Then we heard that there is a postponement, that we 8 would not have to comply at that point of time. So we 9 requested a first progress report from our auditor. Then we 10 expected to have that implementation done at the end of our 11 fiscal year '04. 12 There was another postponement, which gave us more 13 time. We requested again from our auditor a progress report 14 now based on Auditing Standard No. 2, and this standard 15 significantly changed the way how we implemented 404. 16 Now, as you know, we would even have one year more 17 time, but we are now right in the middle of the 18 implementation phase, and therefore we decided not to stop 19 our progress, and we are finishing all the implementation 20 work and testing work to be prepared for auditors to come in 21 and make their analysis. 22 As I mentioned earlier, the most significant 23 problem that we have companies all over the world. We 24 operating in 190 countries, and only -- and most of our 25 companies are insignificant by themselves, so we had to limit 1 it to companies which have revenues of 0.1 percent of our 2 consolidated revenues. 3 These companies are located in -- all over the 4 world. They are in the United States and Europe, of course, 5 and Germany. But also in India and Singapore, and that makes 6 it very costly and challenging for us to implement that. 7 MR. BELLER: I want to come back later, either to 8 this panel or later panels, at the point that Dr. Patzak has 9 identified, about both multiple locations and also the issue 10 of hundreds or dozens of smaller operations which 11 individually are not significant or material, and how they 12 have been dealt with in this process. 13 But having put that marker down, I guess Mr. 14 Koszner, I'd like to ask you. We've heard the problems of 15 people who've been on the front lines, both at the companies 16 and at the audit firms. 17 Basically benefits, perhaps more costs than 18 anticipated. What's your take on sort of the overall impact 19 and what we should be looking at in evaluating the first year 20 on both sides of the ledger. 21 MR. KROSZNER: I'm very pleased that the focus has 22 been on costs and benefits. I know that's sort of an old 23 song from economists, but it wasn't something that was always 24 part of the regulatory framework, and I praise both Chairman 25 McDonough and Chairman Donaldson and the members of the board 1 and the Commission for focusing on that issue, because that's 2 exactly how we have to think about these things, costs and 3 benefits. 4 In terms of the costs, certainly many of the 5 members of the panel have done studies by their institutions 6 to document the costs. But we have to remember that the 7 costs are not just simply based on business as usual in 2001 8 and 2000. 9 Things had to change, and the markets would have 10 changed things anyway. There would have been more emphasis 11 on internal controls, more emphasis on transparency and 12 conveying the stability and sturdiness of the internal work 13 to the outside world. 14 So we have to realize that costs would have gone up 15 under any circumstance, just by market forces, completely 16 independent of Section 404 or completely independent of 17 Sarbanes-Oxley. There have been a lot of private sector 18 responses in addition to just the internal audit pieces. 19 But the benefits are really where we have to focus 20 on now, and we're still in the early part of trying to 21 understand that. 22 There's been a lot of concern, I think, about legal 23 liability, which has gone to -- which has sometimes led to 24 extreme moves to protect against potential liability, even 25 though there may not be a great deal of substance that's 1 associated with that. 2 Mr. Turner mentioned something about market 3 reactions, and I think that's where we need to go and 4 continue to look at that much more carefully, because I think 5 that could provide very good guidance to the Commission and 6 to the board about where does the market thing that some sort 7 of deficiency is material or not. 8 Certainly there are thousands of potential 9 mistakes, problems that can come up, but many of them aren't 10 material. We shouldn't be putting our ammunition there. We 11 shouldn't be putting our costs there. We should be looking 12 at what the markets really think are important. 13 We're still in the very early stages of that. 14 We're just getting the revelations out, but I think that 15 would be a very valuable study for the Commission and the 16 board to do, for academics to continue to look at. 17 Also, as Mr. Miles had mentioned, the banking and 18 financial services industry has a good benchmark to look at 19 also, because since the FDIC Improvement Act of '91, there's 20 been an emphasis on internal controls, the so-called Basel II 21 new capital standards are really emphasizing these things 22 also. 23 So there's been a lot of work that's been done in 24 Basel on the bank regulators. It might be useful to begin a 25 discussion between the board, the Commission and the bank 1 regulators, to see where they have gone. 2 MR. BELLER: Thank you very much. Mr. Thain, you 3 talk to a lot of issuers, and I guess I'm curious as to your 4 perspective on the balance sheet at the end of the first 5 year. 6 MR. THAIN: Yes, thank you Alan. I do. My 7 perspectives here are different because I have input from 8 many of our listed companies. There are 2,760 companies 9 listed on the New York Stock Exchange. So I get input from 10 them. 11 So my comments are compilation of different views. 12 On the positive side of the ledger, and some of these 13 reflecting comments you've already heard. First, there's no 14 question that Sarbanes, actually broadly speaking, was 15 necessary and very crucial to restoring investor confidence 16 broadly. So I think that's a big plus. 17 I mean there's no question that boards are now more 18 independent of management. I think audit firms are also 19 taking a more independent posture with their clients. I 20 think there is definitely more of an awareness of internal 21 controls throughout companies. 22 I also think that both boards and senior management 23 have formalized their risk management policies, which is 24 good. I think the internal audit function has been given 25 greater importance in companies. 1 There's no question that documentation of 2 companies' policies and procedures has improved. I think 3 broadly speaking, the organizational tone at the top, the 4 emphasis on this subject has also improved. Again, all of 5 that's good. 6 Audit committees have been strengthened. I think 7 corporate behavior has in fact changed, and I broadly think 8 that the financial markets, confidence in the financial 9 markets, confidence in the integrity of financial statements 10 have all been improved. So that's on the plus side. 11 On the negative side, and I hear this a lot, and 12 this will be repetitive to what you've already said. There's 13 no question that the costs of 404 have been much higher than 14 companies had expected or I think pretty much anyone had 15 anticipated. 16 There's a lot of discussion about the cost and 17 benefits. I think there are many companies who would say 18 that they don't believe that the benefits achieved through 19 404 have been worth the costs. 20 I think a lot of what we should hope to get out of 21 today, is how can we, going forward, what things can we do to 22 keep all the benefits and all the positives, but try to 23 reduce some of the costs, try to reduce some of the 24 duplication of efforts, try to reduce some of the, what some 25 companies would say is an overly degree of focus on what they 1 would say are detailed transaction-level processes, rather 2 than bigger picture firmwide risk management issues. 3 MR. BELLER: Mr. Thain, thank you very much. I 4 want to come back to costs and spend a fair amount of time on 5 it. Before I do that, I want to continue this general theme 6 for just one more twist, and that is we have two members of 7 this panel who spend a lot of time sharing and working on 8 boards of directors and audit committees. 9 I want to ask first Ms. Bush, from the perspective 10 of an audit committee member, one of the things that 11 Sarbanes-Oxley was intended to accomplish and I believe has 12 accomplished is to increase the responsibility and importance 13 of audit committees, and particularly their direct 14 responsibility for what in plain English is sort of 15 supervising, hiring and firing external accountants. 16 From the perspective of an audit committee, and 17 with the particular question of the internal control 18 reporting requirement of 404 in mind, how do you see the 19 overall impact in the first year, and how do you see the 20 relationship between audit committee members and particularly 21 external auditors? 22 MS. BUSH: I think that formalizing the reporting 23 of external auditors to audit committees is probably a very 24 good thing. 25 I had the good fortune of having served on boards 1 and on audit committees, where we as members of the audit 2 committee always felt that we have very clear and open 3 communication with the outside auditors, and that even though 4 it's not a formal reporting relationship, that they indeed 5 did report to the audit committee. But as I say, the 6 formalization is a good thing. 7 What I find also has happened with regard to that 8 is that there is a lot more communication off line by me as 9 an audit committee chair, and by some of our other audit 10 committee members, with the outside auditors. That's also a 11 good thing. 12 That is not to say that we didn't have, as I said 13 earlier, frank and open conversations with the external 14 auditors earlier. I am accustomed for a number of years now 15 to always having the executive session with the outside 16 auditors. 17 Sometimes they are very short and sometimes they 18 take a little more time, because I personally, and some of my 19 colleagues on various audit committees, really take seriously 20 getting the views of the outside auditors on what's happening 21 internally, both with regard to the control process and the 22 financial statements. 23 Again, I think it's a good thing overall, and the 24 other point that I want to make is that the benefit from what 25 I have observed ranges the spectrum from company to company, 1 and the benefits of 404 overall. 2 I have seen some companies that -- where this was 3 probably really needed, that even though there were no 4 problems in the company, there were no problems with the 5 financial statements, the controls and the documentation of 6 the controls really were not up to par. 7 There are other companies at the other end of the 8 spectrum where the controls were in Triple A shape. Making 9 some tweaking in terms of documentation, but that was about 10 all that was required. 11 So I think that the benefits and therefore the 12 costs that somebody earlier was raising, really vary widely 13 over a wide spectrum. 14 MR. BELLER: Thank you very much. Mr. Cook, I 15 guess I'm curious as to your take on the same issues, but 16 also would ask you to address the question of whether the 17 internal control requirement has, in your view in any way 18 interfered with communications between audit committees and 19 their external auditors? 20 MR. COOK: Perhaps this is just the general view, I 21 also see and I'll try not to repeat what others have said, 22 see substantial benefits in 404. I think it would be true in 23 all companies, and the degree of benefit does vary. I agree 24 with Mary, considerably from company to company. 25 But I think a lot of folks are sort of measuring 1 the scorecard by how many people fail, as a measurement of 2 benefit. Perhaps that is at least one of the measures that's 3 appropriate. But there are a lot of excellent companies who 4 have Double A if not Triple A controls, who have 5 substantially improved their controls by the consequence of 6 the focus that's been given to controls. 7 I would suggest that the companies that I'm 8 directly involved with are fine companies; they have 9 excellent controls. I think they would have passed the 404 10 test the day Sarbanes-Oxley was passed. I think they would 11 have passed it a year ago, before the intense efforts of this 12 past year were put in. 13 But I would say each one of those companies 14 benefits from the attention that was given deficiencies that 15 were identified, improvements that were made, even though it 16 would not show up in a report, and would not necessarily be 17 evident and transparent to the investing community. 18 So I think that's an important consideration, but I 19 think -- and maybe we'll come back to this -- that may be a 20 benefit which is much more in the first year and not a 21 benefit that will be repeated as we go forward, which will 22 bring us to a different part of the cost-benefit analysis. 23 It has certainly changed what our committees do. I 24 think the audit committee agendas have been taken over. I 25 wouldn't say it's hostile, maybe not even unfriendly. But 1 there has been a takeover of our agenda during this past 12 2 to 18 months, with the focus on 404. 3 Unlike anything in my experience, all the way back 4 to the Y2K, when we spent almost all of our time at audit 5 committee meetings focused on Y2K for the best part of one to 6 two years, depending on when you got started and how long it 7 took you to finish. 8 We have spent a great deal of time on this subject, 9 and I think that's good. I think it's been good for audit 10 committee members. They have become much more aware of 11 controls. They've been educated about the controls in a way 12 that has been beneficial to them. 13 But at the same time, it has taken time away from 14 attention to other issues that are also very important, and I 15 don't think that can be continued at that level. I would say 16 my experience would be all of our audit committees have spent 17 the majority of their time during this past year -- whether 18 it's 55 percent or 65 percent of 75 percent I don't know -- 19 but somewhere over 50 percent of our time on matters related 20 to 404. 21 That's fine, but that has to go back in a different 22 direction going forward. There are important accounting and 23 financial reporting issues that need more time than they 24 received during this past year, with the level of focus on 25 404. 1 The issue about relationships with the external 2 auditing firms is interesting. We have certainly refereed as 3 many fee discussions -- I won't call them disputes -- heated 4 and spirited discussions about fees during this past year, 5 under the requirements of 404 and dealing with the costs of 6 implementing it. 7 As I have already experienced before, I don't think 8 anybody is happy with the outcome. I don't think the 9 corporate community writing the checks is happy. The 10 external auditors, despite the views of some I don't think 11 are particularly happy with the difficulties of dealing with 12 the cost issues and the client relationship issues that have 13 come from this. 14 The audit committees kind of referee, and the best 15 we can hope is that both parties will be equally unhappy at 16 the end of the day, and that's kind of the standard that we 17 aspire to. But I do think there have been -- 18 MR. BELLER: Sounds like shareholder proposal 19 season in the Division of Corporation Finance. 20 MR. COOK: But there have been some tensions around 21 this, to answer your question there. There have been real 22 tensions around this. It's been a tough go, and there have 23 been benefits achieved, but there have been a great deal of 24 effort go into this and I think my own view of it is that 25 there are lots of things that we can focus on in year one, 1 but most of them are important only as they relate to what we 2 do in the future and how we go forward from here. 3 We can spend a lot of time debating cost-benefit 4 without any clear answers, and my view is that if this has 5 achieved one of the important objectives, which is restoring 6 or enhancing investor confidence after some of the issues 7 that caused this legislation to be enacted, as they say in 8 the advertisement "that's priceless." 9 So if they have achieved that, if they have 10 achieved that, that certainly would justify a lot of the 11 costs. 12 MR. BELLER: Ms. Bush, you have your card up. I 13 guess I'd ask you to address one thing that Mike has left 14 with us, which is do you think and sort of how do you think a 15 lot of committees can refocus their attention on things other 16 than internal controls, to the extent that's a direction they 17 should be moving in? But also you sought the floor, so -- 18 MS. BUSH: I sought the floor, because I thought 19 there was one other point that I really should make, and this 20 is not an issue that I have had as an audit committee member 21 with the external auditors. 22 But I've heard several companies, the internal 23 audit staff and the finance staff, complain that the 24 relationship with the external auditor has really changed, 25 that they don't feel as free to consult with the external 1 auditor about accounting treatments for various things. 2 This, in my mind, is not good. I think that 3 managements of companies, finance staffs, have relied on that 4 in the past. Something needs to be done, so that those 5 communications can be freed up again. 6 I relate to that, because as an audit committee 7 member, I have always found it invaluable to be able to sit 8 there facing the outside auditors, and ask them very 9 pointedly about accounting treatment for some issues that 10 were questionable or that could have several different 11 treatments. What's the most conservative treatment, and 12 that's invaluable to me. 13 So if the internal auditors and finance staffs are 14 complaining that they can't get that kind of advice because 15 the outside auditors feel that that might jeopardize their 16 independence, then that is indeed a problem. We need to have 17 that kind of communication and open relationship and advice. 18 The other issue with regard to the way that outside 19 auditors, in many cases, are working with companies, is that 20 I think probably because one, you know, 404 and 21 Sarbanes-Oxley and 404 were done in a hurry, and because 22 companies got very little, if any, guidance as to how to 23 apply 404, how to assess their internal control processes. 24 The guidance that they were getting really was from 25 their outside auditors, and that has presented difficulties 1 for many companies. 2 If you take something like as simple as -- not 3 really simple, because it's a very important thing I think, 4 and that is the materiality of a control or a business 5 process. 6 That's something that I have traditionally looked 7 at quite a bit, you know, where the high risk areas in the 8 company. But for this process in this first year, it seems 9 that equal weighting has been given to all processes, whether 10 they are insignificant or whether they are highly significant 11 and highly risk. 12 So that is something that I really think needs to 13 be addressed as a joint effort by regulators and outside 14 auditors and internal audit. 15 How do we focus? I think that hopefully the 16 refocusing will come naturally, but I think that the 17 refocusing also is going to depend, to some extent, on how 18 the regulators intervene with some more comments about what 19 is important. 20 Because I believe AST suggests that each year must 21 end on its own. If each year, the outside auditors have to 22 audit every process without any rotation, without any 23 emphasis on risk, then we are back in the bind of having to 24 spend a lot of time on 404, possibly to the neglect of other 25 things. 1 MR. BELLER: Thank you very much. Ms. Cunningham, 2 you've got your card up. I also wanted to come back to the 3 cost question, and I think FEI, certainly if not the most 4 comprehensive and detailed work on costs, has certainly done 5 among the most detailed. It's the most detailed I've seen, 6 and would like you to, in addition to whatever else you 7 wanted to talk about, address the cost issue, I think with 8 particular reference. 9 The first year is what is was or is. What do you 10 see happening? The survey suggested, your survey suggested 11 that about 85 percent of companies think the costs will come 12 down. How do you see that? What do you see? What areas and 13 how much? But please, go ahead. 14 MS. CUNNINGHAM: Sure. First of all, I just want 15 to say one of the benefits, you know, were discussed already, 16 and we've learned sort of the notion that having an effective 17 internal control environment as a member of COSO, is vital to 18 the integrity of financial statements. But I won't go into 19 depth in what all those benefits are. You heard them all. 20 The costs. We've done several surveys. We've done 21 three or four over the last year and a half or so. Our most 22 survey we've done in March of 2005, which will hopefully 23 reflect more of the actual costs, particularly for the 24 accelerated implementation costs. 25 The average cost of implementing 404 is about 4.3 1 million. Companies that have over 25 billion in revenues 2 spent considerably more, about 15 million on average. 3 According to our survey, companies logged an average of over 4 26,000 hours to comply with the regulation, and one dramatic 5 thing more. 6 We've seen -- over the term that we've done the 7 surveys, we've seen the costs go from the first survey we did 8 in January of 2004, double by the time March 2005 hit. 9 The one thing that, you know, we also and I think 10 Mike alluded to it, but we also have to consider the cost 11 that isn't in there, is the opportunity cost. You know, the 12 audit companies are spending a considerable amount of time on 13 Section 404. It's diverted a lot of attention for senior 14 management and board time. 15 You know, we've taken time away from strategy, 16 dealing with competition in a global marketplace, innovation, 17 and moving the company forward. I think that opportunity 18 cost is another important aspect of the cost factor, if you 19 will, of 404. 20 MR. BELLER: How about looking forward? 21 MS. CUNNINGHAM: Looking forward, according to our 22 survey, we do expect to see a decrease in cost. A big piece 23 of that, the companies spent a lot of time hiring consultants 24 and staffing up to document initially a lot of the 25 transactions, if you will. So we'll see a lot of that cost 1 go down. 2 We're hopeful that the audit fees will also go down 3 in Year 2, as we see the training and the learning curve of 4 the auditors. Hopefully, they've learned some, you know, got 5 some efficiencies from the process. 6 So we are anticipating, and I believe our survey 7 said we are anticipating a decrease of about 40 percent of 8 total cost. 9 MR. BELLER: Thank you. 10 MR. NICOLAISEN: If I can follow up on that just 11 for a minute, I think the Big Four survey said something like 12 a 46 percent on the first year. 13 MS. CUNNINGHAM: Very consistent. 14 MR. NICOLAISEN: A lot of that, I think, is 15 understandable, and probably is best taken off the table for 16 consideration because it's history, and we need to move 17 forward. 18 But one of the conflicting things that we do here, 19 and maybe you can help us with that, is we do hear from a 20 number of different places that companies, while they have 21 closed the books on 404 for the first year, they don't 22 necessarily have in place the sustainable process that they 23 want to live with long-term. 24 They reacted. They did what they had to do, but 25 aren't necessarily yet in the position where this is routine 1 and baked into the process. Just curious as to what, you 2 know, is there an element of truth to that? 3 MS. CUNNINGHAM: I think, you know, we're moving 4 from a project orientation to a process orientation. I think 5 it will take time for companies to get to that sort of 6 sustainable ability to implement 404 and make it part of the 7 process. So that may take a little bit more time. But I 8 think it's a fair statement. 9 MR. BELLER: Mr. Miles, do you have a view on sort 10 of whether this is -- whether the sustainable processes are 11 now "baked in," or whether that's something you're going to 12 have to revisit over the coming years? 13 MR. MILES: We have already begun a process to 14 re-look at the way we implemented 404. We have made some 15 changes going into 2005. I don't think they're going to be 16 dramatic. One failed experiment was we tried to turn a lot 17 of people into auditors for a day. 18 MR. BELLER: Sounds like what Nicolaisen was doing 19 to me, and I too, have failed. 20 (Laughter.) 21 MR. MILES: I couldn't understand that. But there 22 were a lot of business people and operations people who were 23 not excited about that prospect. So we'll have teams that go 24 out and do the test work, is one of our major changes this 25 year. 1 MR. BELLER: Dr. Patzak? 2 DR. PATZAK: Well, first of all I would like to say 3 that I think that the present changes are necessary, and 4 these changes are a prerequisite that the costs come down. 5 But I had mentioned earlier, one example earlier, and that, 6 you know, that would lead me to the recommendation that it 7 should be possible to exclude a larger number of individual, 8 insignificant companies if there is a rigorous control and 9 risk management process in place. 10 Another example would be that we should have more 11 interpretive guidance on qualitative considerations when we 12 decide what's accounting significant. Allowing for a 13 risk-based approach. That, I think, a risk-based approach, 14 that would make it possible to get the costs down without 15 losing the benefits of 404. 16 I do feel that also in the implementation year, 17 that there's a downside out of this bureaucratic approach, 18 because we had to, for example within Siemens, we had to 19 focus a lot of our internal audit resources on checking the 20 progress on 404. 21 We have a specific financial audit group, you know, 22 comprising 70 auditors, which usually focus heavily on high 23 risk areas and huge projects and things like that. A lot of 24 their time was really now focused on checking specific 25 documentation needs and things like that. I do not think 1 that this really helps the confidence in financial reporting. 2 On the other hand, I think that a lot of companies 3 in that first year, because there was not enough guidance, 4 they come up with too many significant controls, which are 5 perhaps not really significant. 6 So for our company, we had more than 20,000 7 controls, nearly 30,000 controls. There will be, at least I 8 would see a need for a Phase 2 approach, one which basically 9 tries to get rid of controls which are not really necessary, 10 and more into the direction of preventing measures. 11 More use of IT controls, controls which are already 12 embedded in the ELP systems, in case manual controls and 13 things like that don't work. 14 So there is room also from the company side to 15 improve efficiency. There must be and that would be my 16 recommendation for some changes in the standard, and also see 17 that there is a clear, a logical consequence that the audit 18 fees should come down because there should be less need for 19 substantive audit procedures after so much time is spent on 20 assessing the internal controls structure. 21 MR. BELLER: Thank you very much. I see 22 Commissioner Glassman has her card up. Mr. Sylla, were you 23 going to address the same question before we -- 24 MR. SYLLA: I just wanted to make a quick comment 25 on the cost structure, but we can defer. 1 MR. BELLER: Okay. Commissioner Glassman? 2 COMMISSIONER GLASSMAN: Just following upon the 3 last point, is there -- since this is supposed to reflect 4 management's assessment of the effectiveness in their 5 internal controls, in being able to certify their financials, 6 that they're accurate and transparent, is there a difference 7 between what management sees as sufficient, necessary and 8 sufficient, in order to be able to make that certification, 9 and what the auditors have been required, been requiring 10 for -- to comfort themselves that management has the right 11 information? 12 MR. BELLER: Who would like to -- 13 (Laughter.) 14 MR. BELLER: A lot of people. Let me start with 15 Mr. Thain. 16 MR. THAIN: Yes. Commissioner, I think the 17 answer -- the simple answer to your question is actually yes, 18 because where companies, many, many companies have made 19 comments along the lines of there is not sufficient guidance 20 on what's material, that there needs to be more of a 21 risk-based approach, that in fact there's not enough reliance 22 on what management does. 23 Both management themselves and internal audit. 24 Even though the rule does in fact allow for reliance on 25 management and internal audit, that the response from 1 companies has been that the accounting firms have been 2 unwilling to do that. 3 So what has happened is that attestation has turned 4 into duplication. So companies have been, even companies who 5 do a lot of their own internal testing, have found their 6 accounting firms requiring them to test a much broader range 7 and a much greater sample size than what the companies think 8 is necessary. 9 MR. BELLER: Mr. Turner, you had your -- 10 MR. TURNER: Yes. When you go back in and start 11 digging through the companies that have actually filed with 12 material weaknesses, the 750 or so that we talked about, 87 13 percent of those had filed just previously with the 10-K or a 14 Q to that with a clean certification from the management 15 team, saying everything was fine. 16 Then all of the sudden when the auditors came in, 17 it became clear that the auditors saw it differently and saw 18 it as a material weakness. When we dig down into those, 19 where there is information, where there is disclosure about 20 the facts or you go pick up the teleconference call with the 21 executives, where they've described it on the teleconference 22 call, I must say that in most of those situations, as we 23 analyzed them, we thought that the auditors were absolutely 24 right-on and correct in their conclusions. 25 So the answer to your question, at least from the 1 public transparent disclosures is there's clearly a 2 difference. But as we see it, the auditors are calling it 3 right from an investors' perspective. 4 MR. BELLER: I see Commissioner Goldschmid has his 5 card up. Ms. Cunningham, did you want to address 6 Commissioner Glassman's question? 7 MS. CUNNINGHAM: Yes, just quickly. I want to 8 reiterate a lot of what John had said, but I think, you know, 9 the issue of the auditors spending a lot of time on the less 10 risky areas. I think particularly in the first year, they 11 spent a lot of time on areas that weren't, you know, didn't 12 hold out a lot of risk. 13 But I think the higher risk areas, the tone at the 14 top, etcetera, needs to be focused on a little bit more. 15 Taking a more risk-based approach would be appropriate. 16 I think, you know, the issue will be, you know, the 17 auditors are being regulated for the first time. I think the 18 issue will be how that inspection process comes out in the 19 first year, and what the inspectors' reactions are to the 20 process that the auditors took. 21 Because I did, were overly-cautious in the first 22 year because of the second-guessing, and because of the 23 plaintiffs' bar. 24 MR. BELLER: Mr. DiPiazza? 25 MR. DIPIAZZO: Let me begin by making it clear That 1 this was a very difficult year, and by anybody's description 2 you'd have to say that the process could be improved, that 3 the process had its inefficiencies, that judgments could be 4 second-guessed. 5 I think you have to put it in context. The focus 6 on controls, although companies have focused on controls for 7 years, they've never focused on them quite this way. They've 8 never focused on them with the level of ownership and 9 responsibility that you have today. 10 We refer to that as a level of deferred 11 maintenance. There was for years underinvestment in 12 documentation, underinvestment in truly understanding and 13 owning controls, deep into organizations. 14 Now I absolutely respect of my fellow colleagues or 15 panelists who say that maybe judgments were made that took 16 controls testing down levels that were too far. But I'll 17 give you an example. You want to test the human capital, a 18 human resource group. You want to test the controls they 19 have about new employees and employees leaving. 20 Most people would say "What does that have to do 21 with financial statements?" Until you find out what the 22 company real life was not taking people off of computer 23 access for two months after they left. These people had the 24 ability to transfer, wire cash, affect accounts after they 25 left the company. Is that an insignificant control? For 1 lots of people it might be. 2 I think you really have to say what did we find? 3 We found, and what are the differences between the way 4 management looked at this and the way the auditor looked at 5 this? Three-fourths, two-thirds to three-fourths of the 6 calls for the investment here was by the company, not by the 7 auditor. 8 We're in the process of going through this, 9 focusing on key controls. Maybe at times they went beyond 10 key controls, but I think that's the exception to the rule. 11 An average of 275 deficiencies per company had to be fixed 12 before the end of the year, from the best company down to the 13 smallest company or the weakest company in the group. 14 The ownership around that subject, the cost of that 15 remediation. Probably 10 to 15 percent of all the time that 16 was spent was just on the learning. What did all this mean? 17 That's not going to be duplicated. 18 Twenty percent was on documenting controls that 19 hadn't been documented clearly for a decade. That's not 20 going to be repeated, at least substantially not repeated. 21 And the remediation, which was again, 15 to 20 percent of 22 this process, which you would hope you would get it right. 23 There were some areas we could improve on. Costs 24 were spent because auditors were testing things that 25 companies just tested. The problem was this was all real 1 time. The standard was time; the companies were remediating, 2 defining, documenting and testing. If the auditors had 3 waited until the end and looked at that, you wouldn't have 4 had time. 5 I think in the future we clearly have to make that 6 much more efficient. But to be very fair, the standard 7 allows us that judgment. You don't have to change the 8 standard. What you have to do is impose that judgment and 9 inspect it in a way that's consistent. 10 MR. BELLER: Thank you. Commissioner Goldschmid? 11 COMMISSIONER GOLDSCHMID: Well, I was just reacting 12 to the tension, I think, that I've heard reflected around the 13 table. I think feel too, talking about risk-based 14 approaches, more use of internal staff, we're not counting 15 trivial subs and such, all make some sense. What I keep 16 suffering with is internal controls have been on the books in 17 the United States since 1977. We all know that was not taken 18 seriously year after year after year. The use of the outside 19 auditor clearly creates a discipline. 20 Now the trick is to make it as efficient and 21 sensible, and with as much judgment as possible. But the 22 natural tensions between management -- I mean, we left it to 23 management from 1977 on, and I take it no one here would 24 defend in general the quality of internal controls during 25 that period. 1 MR. DIPIAZZA: Just to be clear, and Commissioner, 2 I think it's fair to say that there were improvements to be 3 made. Ninety-plus percent of the companies had good control 4 structures. They needed to fix some things, but they got to 5 the end and they'd fix it, and financial statements were 6 fine. 7 So we shouldn't expand it and say management was 8 not doing good controls. But there was not the ownership. 9 There was not the focus at the board level or at the 10 management level that we have today. So we're better through 11 the process. 12 COMMISSIONER GOLDSCHMID: I think it's fair, but 13 when we first proposed the internal controls rules at the 14 SEC, the reports we got from business of how much change it 15 would take ran into the number of fingers and on the hours 16 per company, because everyone said we have internal controls. 17 Then they began to seriously look at them, and it was a 18 different kind of picture, you admit. 19 MR. BELLER: Chairman Donaldson. 20 COMMISSIONER DONALDSON: I want to take advantage 21 of this panel before it disappears. I want to ask the 22 question, which is how do we get out of the anecdotal phase, 23 and how do we get into the measurement phase? 24 What are the thoughts of all of you, anybody who 25 wants to comment on this, on methodology, if you will, 1 analytical methodology that can measure, truly measure the 2 effect of all of this? 3 MR. BELLER: Again, Mr. Kroszner? 4 MR. KROSZNER: Well, certainly this is something 5 that I think is extremely important. One way of doing it is 6 looking at the market reactions to whether something is 7 material or not material. 8 As Mr. DiPiazzo spoke about, an average of 275 9 deficiencies per company, but how many of those are material, 10 and what is the market judged as material or not material. I 11 think people are much more aware of these things, as Mr. 12 Turner spoke about before. The markets are much more aware, 13 much more sensitive and much more attuned to these. 14 But also, we can't look at just the -- a particular 15 type of deficiency in and of itself. It has to be put in 16 context, because its credibility in terms of the firm. Some 17 firms are more opaque and some firms are more transparent, 18 simply by the business that they're in. 19 Some businesses are much newer; some businesses are 20 much more volatile. That's always going to create a greater 21 information asymmetry, as economists talk about, between 22 what's known inside of the firm and what's known on the 23 outside. 24 So at a firm that is in a very steady business 25 where there's very little volatility, a deficiency there 1 might not be a problem. But that same "deficiency" could 2 raise more of an issue where there are potentially more 3 risks, because there's more volatility. 4 So I think the type of study that should be done 5 would look at not just the material violations or material 6 deficiencies themselves, but look at the characteristics of 7 individual firms. 8 Because exactly as Ms. Bush was mentioning and Mr. 9 Cook was mentioning, that there are -- there's an enormous 10 amount of heterogeneity. So not just say that one size 11 should fit all, but it should be the same. Look at the 12 details of the potential problems in the context of the firm. 13 There can be greater or less transparency in a 14 firm, depending on their characteristics, and really kind of 15 drill down into that. I think we're beginning to see that 16 and do that, and I think that would be an excellent thing for 17 the Commission to undertake, for the board to undertake and 18 certainly Mr. Turner has already started down that line. 19 MR. BELLER: Mr. Cook. 20 MR. COOK: Answering the chairman's question about 21 what do we do to take some of these things and turn them into 22 action and turn them into results. I think we've all 23 acknowledged we had to get through the first year, and there 24 was an awful lot of inefficiencies as there will also be in a 25 process that's this complicated the first time you take it 1 on. 2 I think everybody learned from that and has learned 3 some lessons that will be beneficial. I think maybe this 4 roundtable is the time to declare last year last year and get 5 conversations going that will help us do better going 6 forward. 7 I think we need to get the parties together to talk 8 about this, the different participants, because people are 9 not necessarily talking past each other but they're not 10 necessarily connecting either around what is it that the 11 standards require, what are the levels at which we should be 12 testing controls, what are the appropriate approaches. 13 I think we really ought to get onto that pretty 14 quickly. Sitting in an audit committee chairman's role, 15 we're waiting with eager anticipation for the plans for the 16 coming year, which usually are delivered some time around the 17 time of an annual meeting or shortly thereafter. 18 We've asked the auditing firms in all cases to give 19 us their estimates about what the costs of the 404 are going 20 to be in Year 2. I'm wildly encouraged by this 46 percent 21 figure, and I had been hearing much less than that. So that 22 at least is a sign. I'm only little bit concerned that 46 is 23 as high as it is, because the figures for last year ended up 24 being as high as they were. 25 There's certainly an element of possibility in 1 that. But the 46 percent is a pretty encouraging notion, and 2 we do have to get to this issue of cost and get it working. 3 I do really think the PCAOB people are very responsive and 4 interesting in doing what they can do to be helpful with 5 respect to implementation and guidance, that will lower the 6 expectations to an appropriate level. 7 A lot of this is not particularly new. The notion 8 that every year's audited internal control stands on its own 9 isn't substantially different in my thinking from the notion 10 that every year's audit of financial statements stands on its 11 own. 12 I don't think those are done in batches. I think 13 they're done in separate years, and so the notion of how you 14 go about auditing something each year is not completely new 15 and different. But I do think people need to get together 16 and start talking about the practicalities. 17 That's the leadership of the firms, the leadership 18 of the financial community, PCAOB, the SEC to the extent that 19 they have an interest and an opportunity to participate. I 20 think it's time to get this going, and try to do something 21 pretty quickly, because planning is underway for next year. 22 A lot of work is going to be done between now and 23 the summertime in getting ready for this. How much resources 24 we need to put behind it, how much we need to keep our 25 internal auditors deeply focused on 404 as opposed to other 1 activities, all of that has to get resolved in the next 2 couple of months, and I think we need to get the parties 3 going. 4 MR. BELLER: Right, and I think certainly speaking 5 for Don, we recognize the urgency of some of this. We only a 6 few minutes left. I do want to hit on a couple of things 7 that have been alluded to and maybe bring them out a little 8 bit more. 9 One, I want to ask Mr. Sylla, this issue of 10 opportunity cost. We had a meeting of our Small Business 11 Smaller Public Company Advisory Committee yesterday, and one 12 of the co-chairs, Tim Kim, the CEO of Kimball International, 13 who I think is in our audience, talks about the same thing, 14 which is the mind-share costs to senior management of some of 15 these requirements. 16 I guess the question I have for you is again, if 17 you put Year 1 sort of behind you, but with that as context, 18 is there an issue with mind-share and opportunity costs at 19 the senior management level? Certainly, the comments we've 20 received have suggested that there is, and if so, what should 21 be done to address it sort of by all the parties, auditors, 22 managers, regulators and so forth? 23 MR. SYLLA: You know, we would concur. With the 24 numbers that have been thrown out here, we probably for large 25 companies would on the high side of the numbers. Frankly, 1 you could characterize that as a class or you could 2 characterize it as an investment in the future. 3 Clearly, from our perspective, a significant amount 4 of time was spent in the first year, in things like 5 information-gathering, establishing processes and controls. 6 That we believe will not necessarily repeat itself. 7 As a result of having to do that, a good deal of 8 outside external resources were brought in to augment the 9 internal resources that we used. So we think that's a 10 one-time, and as long as we're throwing in numbers, I might 11 as well throw our number out. 12 We believe, based on what we know, and that's a 13 qualifier, that our costs would be down probably in the 14 vicinity of 50 to 60 percent moving forward. That's because 15 we've established, if you will, the internal infrastructure 16 and spent the money maybe up front in preparing, knowing that 17 this was not a one-shot deal. 18 Now I think from a senior management perspective, 19 as I indicated, the ownership in this thing clearly takes a 20 lot of time. There is no question, as you go through this, 21 we can't help but if you're putting your name on things, and 22 putting in your cost of risk, you take a lot of attention. I 23 don't think anyone would minimize that. 24 The challenge, of course, from an internal 25 perspective is the prioritization, not only with respect to 1 the work that had to be done on 404, but taking people from 2 the technology side of the business and various other pieces 3 of our business, and reallocating them to this process to get 4 it right. 5 As a result of that, it was very difficult to 6 quantify other aspects of the business that took a back seat 7 to this, because you could only put so much in the plate. So 8 other than wrestling with what we expect in the future, 9 clearly we see very little modest resources from the outside 10 required. 11 But the prioritization internally for both senior 12 management time and all the other people that make this thing 13 work is going to continue. I don't see that stopping in the 14 short run. 15 MR. BELLER: Mr. Miles, you have your card up, and 16 I'll recognize you. But I also want to ask you, do you think 17 that's a good thing or not? 18 MR. MILES: Good thing with regards to the 19 substantial amount of senior management focus on this 20 subject, as kind of a medium and long term issue. I think to 21 some degree it's probably going to be negative, in that it 22 will distract them from things that really are probably much 23 more significant, in terms of operating control strategy, 24 that they really should be focused on. 25 I do think they need to spend time on internal 1 controls, but that should not be their primary focus at the 2 top of the house. 3 The comment that I would like to make, and is 4 really to the Commission, was first of all, to say thank you 5 for delaying the acceleration of the filing deadlines. But I 6 would also ask that consideration be given to freezing that 7 at the point that it is. 8 That is, as the small filers come on line and the 9 foreign filers. I don't know within the accounting industry, 10 within our businesses, that there are the resources there to 11 staff up and get everything done by a March 1st deadline, and 12 a 35-day 10-Q deadline, without increasing the possible of 13 the occurrence of a reporting issue that could lead to a 14 material weakness, just because of the haste that would be 15 required by a business. So I would request that we keep that 16 there. 17 MR. BELLER: Following up on that a little bit, a 18 question for Mr. DiPiazza. A lot has been said, including in 19 the comments, about accounting firms being stretched for 20 resources, accounting firms bringing on large numbers of 21 people, accounting firms training on the fly, accounting 22 firms having people who aren't very experienced doing this 23 work. 24 Going, is Year 2 different? Is it more of the 25 same, and also I think a related question, all of the large 1 accounting firms have put comments in. Some of them suggest 2 that while other company costs may be going down in Year 2 3 and thereafter, people shouldn't expect the audit fee for 4 internal controls would go down, because we're in a brave new 5 world. What thoughts do you have on that? 6 A PARTICIPANT: What brave thought does he have? 7 (Laughter.) 8 MR. DIPIAZZA: There is no question that Year 1 9 resources were stretched both within companies and within the 10 audit firms. I mean, we bought 1,000 people from around the 11 world into the U.S., both to train them on how to apply this 12 to foreign and private issuers, and to get us through the 13 process. 14 We spent $50 million out of pocket training our 15 people. I hope I don't have to do that next year. If you 16 really look at what was accomplished in Year 1, with the 17 enormous documentation, the enormous remediation of controls 18 that had weaknesses. Whether they are material or 19 significant, these were all key controls. 20 A lot of that goes away, or at least it goes into a 21 continuance mode, as opposed to a first-year mode. So I 22 clearly see that the time and the energy and the effort and 23 the cost of the 404 audit will go down. 24 As we integrate the financial statement audit, and 25 remember this year we had a financial audit and we had a 404 1 audit, and they were running parallel. They were not 2 integrated. 3 All of the firms, not just the Big Four but all of 4 the firms dealing with public companies are looking at ways 5 now to make that a much more efficient process. So we also 6 believe these numbers are reasonable. 7 Just one other observation to the chairman. We 8 have an enormous level of transparency now, just a matter of 9 weeks after the filing, about what we've now learned. 10 Where are these weaknesses, and which people in the 11 organization spend hours and hours and hours assessing where 12 are the weaknesses? Where are the weaknesses in terms of big 13 companies and small companies? 14 I mean, it's clear. Companies under 200 million 15 have more material weakness issues than companies over five 16 billion. We have some issues around that. 17 Industry differences. There's a tremendous amount 18 of transparency, but I think both the analysts, the 19 regulator, the company and the auditors are now going to 20 begin to apply going forward that information, all of which 21 is going to make this system better. 22 I think a lot can be done within the current 23 standard, with good inspection and advice from the PCAOB, and 24 as Mike Cook says, good cooperation between the parties. 25 MR. BELLER: We are at that hour, the end of our 1 time. I'm going to give Chairman McDonough the last question 2 and maybe the last word. 3 MR. MCDONOUGH: It's actually a comment. I think 4 the secret of making sure that Year 2 is both more efficient 5 and better quality as it regards both the work of management 6 and the audit, is that the audit will in fact be integrated. 7 That's what it's supposed to be. 8 But in the first year, that was absolutely 9 impossible for the firms to do. By integrating the audit of 10 the financial statement and of the internal controls, there 11 will clearly be better efficiency, and we will have the 12 advantage that the firms had to jump through enormous hoops 13 in order to get enough bodies to do the internal control 14 work. 15 Those people are now much better trained in going 16 into Year 2, and they're going to do a better job. 17 MR. BELLER: Thank you very much Chairman 18 McDonough. I'm going to thank the panelists. We are going 19 to take a 15-minute break. Can we back here at 10:40 please? 20 Thank you. 21 (Break.) 22 PANEL TWO - REPORTING TO THE PUBLIC 23 MR. BELLER: I'd like to get started again. The 24 second panel this morning is going to address generally the 25 subject of disclosure and reporting to the public, around 1 Section 404. 2 As we have mentioned in the first panel, the 3 requirement to have effective internal control in fact dates 4 from 1977, and Section 404 does not change that requirement. 5 Section 404 is a disclosure and a reporting provision, which 6 requires managers to assess and disclose for the first time 7 whether their internal control is effective in their annual 8 reports, and for auditors to, in accordance with Auditing 9 Standard No. 2, audit management's assessment and the 10 effectiveness of internal control and deliver an audit report 11 on that subject. 12 Joining me on Panel 2 as the moderator is the chief 13 accountant of the Division of Corporation Finance, Carol 14 Stacey, who is an accountant, not just for a day. 15 (Laughter.) 16 MR. BELLER: Again, I'll introduce the panelists in 17 a moment. I don't know if all of the panelists were here for 18 the first, the introductory remarks for the first session. 19 I'll go over them very quickly. 20 One, if you want to be recognized, we want this to 21 be interactive. The moderators will reserve the right to 22 call on specific people. 23 But I would encourage you, as well as the members 24 of the Commission and the board, to seek recognition and the 25 way to do that is to turn your tent card on end, so we can 1 see it. 2 Second, we have asked you all to submit written 3 statements and all of your or most of you certainly have done 4 so. They are on the website, but for the sake of time, we're 5 asking that there not be opening statements and we will 6 enforce that. 7 Finally, if you are recognized and because we're 8 being webcast and not everyone who's listening can see us, if 9 you would identify yourselves. If one of the moderators has 10 not in recognizing you, that would be great. 11 I'm going to start again by introducing the panel 12 again for the folks that can't see. So I'm not going to go 13 back to the Commission and board again. 14 But the panelists, starting at my left, Mark Anson, 15 who's the chief investment officer at CALPERS. 16 To Mark's left, Jim Copeland, who's a member and 17 chair of a number of audit committees. 18 Nick Cyprus, who's the Senior Vice President, 19 Controller and Chief Accounting Officer of the Interpublic 20 Group of companies. 21 To Mr. Cyprus' left, the Honorable Barbara 22 Franklin, who is again a director and member of the boards of 23 directors of a number of public companies. 24 To Ms. Franklin's left, Curtis Hage, who's the 25 chairman and CEO of Home Federal Bank. 1 To Mr. Hage's left, John Huber, who's a partner at 2 the law firm of Latham and Watkins. 3 To Mr. Huber's left, Greg Jonas, who's the Managing 4 Director of Accounting Specialists Group at Moody's Investor 5 Services. 6 To Mr. Jonas' left, Bob Kueppers, who's the 7 Chairman of the Executive Committee of the AICPA's Center for 8 Public Company Audit Firms, and is also the Vice Chairman and 9 National Managing Partner for Professional Risk and 10 Regulatory Matters at Deloitte and Touche. 11 Finally, to Mr. Kueppers' left, Ed Nusbaum, who's 12 the CEO of Grant Thornton. 13 I guess I would begin with a question for Ms. 14 Franklin. As of the end of March, and I guess the numbers 15 are slightly changed, but certainly over 2,500 companies had 16 filed their 10-K's containing their initial assessments of 17 internal controls, and about eight percent had indicated that 18 their controls were not effective as a result of one or more 19 disclosed material weaknesses. 20 From your perspective, has that information and 21 disclosure and the disclosure around those assessments been 22 useful, and what suggestions would you make going forward for 23 improving that disclosure? 24 MS. FRANKLIN: Well, thank you and thanks to the 25 Commission for having this session. I think it's an 1 important subject. 2 I've got a couple of this with me, the kinds of 3 disclosures that are -- that you have just referred to. I 4 can look at this a couple of different ways. One as an audit 5 committee member and chairman, am I getting what I want from 6 management and the auditors. Look at it from just being a 7 director, or an investor. 8 There is something else that I would like assurance 9 of, with respect to how we get to reasonable assurance in 10 here. It's this, and I'll pick up a thread from your last 11 panel. 12 I would like assurance that the 404 internal 13 control compliance process was in fact focused on the areas 14 of greatest risk to financial statement misstatement. I am a 15 real advocate of risk assessment and enterprise risk 16 management, and prudent companies that are doing this, and I 17 think everybody ought to be doing it. 18 Out of that process, we do get a sense that what is 19 the magnitude of the impact of some risk; what is the 20 probability of it; and then who in management actually owns 21 that area to manage through. 22 You could just overlay that one thing right on 404, 23 and you could put your documentation, your testing, your 24 aggregation of significant deficiencies right into that kind 25 of a context. I know this was brought up the last session, 1 but I really think it's worth saying it again for each line 2 item in the financial statements. 3 I know we talked a little about key controls in the 4 last panel. It's not clear to me that key controls are the 5 same thing as -- if they're coming out of a risk assessment. 6 I think that's been true at the audit committee level. 7 We were so focused, particularly as the deadline 8 neared, on what was a significant deficiency and whether all 9 this stuff was going to get fixed, that we were not clear and 10 we were not really being told clearly what was really 11 important from a risk standpoint to a financial statement's 12 misstatements, and whether this may be operational or a 13 process or something else. 14 So I think this point is really important, and as 15 an investor, I would like some assurance, because I'm a 16 committee chairman too. 17 Related, each of the things had their own -- let me 18 back up here. The definitions of significant deficiency and 19 material weakness are wonderful. They're fascinating to read 20 that stuff. That's another conversation. 21 But beyond that, each of the firms have devised 22 their own quantitative guidelines as to what was a 23 significant deficiency and material weakness. The difficulty 24 that I saw through several different audit committees was 25 that the firms were not consistent among each other, in terms 1 of what those guidelines were, and I'm not sure they were 2 consistent among their clients either, each firm consistent 3 among its clients. 4 My concern was that again, looking at this from an 5 investment perspective, if we can have a lower threshold, 6 meaning a higher standard than what was a material weakness, 7 and that firm's clients had more material weaknesses than 8 some other firm's clients, how is the investment community, 9 how is an investor going to look at that, and what would be 10 the consequences? It could be unfairness across corporate 11 America. 12 The same thing with the consistency issue. How we 13 fix that, I'm not sure whether it's the PCAOB's ball to fix 14 it, whether the firm somehow has to get together and fix it, 15 whether the SEC has a role. But I see that as an issue, and 16 no matter which chair I'm sitting in, I would like some 17 assurance about both those things. 18 MR. BELLER: Okay. Thank you very much. Mr. 19 Jonas, what's your assessment of the utility of the reporting 20 and the disclosure that's been going on? 21 Let me throw one little supplemental question in 22 there as well, which is the companies are operating with -- 23 under a rule that's a Commission rule, that does not 24 prescribe a form of disclosure for management's assessment. 25 We've basically left it to management to describe 1 what they believe is material and important. The auditors 2 are operating under a board standard, which is quite 3 consistent with other audit standards, which does prescribe 4 pretty closely a form of report. 5 Do you think there should be more of a template for 6 management, or are there other ways to get management to 7 address what investors and users such as yourselves would 8 like to see? 9 MR. JONAS: Well, first on the broadest question, 10 you know, we perceive substantial benefits from these 404 11 reports, both in the reports that cite material weaknesses, 12 as well as reports that are clean. 13 (End Tape 1) 14 We think this is a central plank, 404 is, to 15 restoring investor confidence in the financial reporting 16 process, confidence that was badly damaged in the last few 17 years. 18 We perceive that companies are more focused on 19 accounting, auditing and quality financial reporting than 20 they have in the recent past. We perceive the companies are 21 investing, some for the first time in many years, their 22 infrastructure supporting quality reporting. 23 We also perceive that there's some better auditing 24 going on these days, under the notion that the more the 25 auditor knows about controls, the better the audit work. All 1 of which causes us, and we think other market participants, 2 to take comfort in the 404 process. 3 Where companies disclose material weaknesses, we 4 are getting benefits from that as well. We think that in 5 certain, but not all cases, and I'm sure in a later question 6 we'll be addressing does the market distinguish between some 7 material weaknesses than others. 8 But certainly in some cases, we believe that the 9 weaknesses cited are credit-relevant, and that it provides an 10 additional red flag that we would not have perceived absent 11 the 404 process. For that, we think it is credit-relevant. 12 Finally, and this is anecdotal as opposed to direct 13 evidence, but we have had a number of managements tell us 14 that they perceive benefits to them of having gone through 15 the 404 process, benefits not only in terms of approving 16 their accounting but just improving their control over the 17 business in general. 18 Now having said that, of course you'd be perhaps 19 disappointed if I didn't have a wish list of what might be 20 better in public disclosure, and I have five items on the 21 list. 22 First, while some companies do an excellent job of 23 describing exactly what is the material weakness, others do 24 not. We think that describing in detail what the problems 25 are is important, particularly if we're trying to distinguish 1 between certain material weaknesses that we think are 2 credit-relevant and those that are not. 3 Looking forward, we're particularly interested now 4 in what companies say about their plans to remediate their 5 control weaknesses. Again, we've some companies who are 6 quite explicit about what they plan to do and others that say 7 next to nothing about that. Looking forward, we're very 8 interested in the plan of remediation. 9 We would hope that the companies would update 10 investors quarterly about their remediation progress, and 11 that they would indicate when the remediation is complete 12 over the material weakness that was the subject of an earlier 13 report. 14 We would also like it if auditors were to be able 15 to report on the successful remediation of the control on an 16 interim basis, and not have to wait until the next audit 17 cycle. Thus, we're big fans of the PCAOB's proposal to at 18 least allow auditors to write those reports. Thank you very 19 much. 20 MR. BELLER: Mr. Anson, as another user of the 21 reports, including these disclosures, what is your reaction 22 to what we have seen so far and what we could or should be 23 doing going forward, "we" being everybody and not just the 24 Commission? 25 MR. ANSON: I always like to use the word "we." 1 First, I'd just like to add a comment. I know the first 2 panel talked a lot about costs, the cost of applying and 3 implementing Section 404. 4 You know, the people who ultimately bear the costs 5 are shareholders like CALPERS. We're willing to bear that 6 cost, because if those costs can prevent one more Enron or 7 one more WorldCom or one more Tyco-Adelphia, choose your 8 favorite corporate accounting scandal, that is money 9 well-spent in our opinion. 10 As an investor, if I can't trust the integrity of 11 the financial statements, they're worthless to me. Indeed, 12 we saw this in 2002, when saw that the risk premiums for 13 stocks in the U.S. stock market rose to its highest level in 14 25 years. The risk premium for stocks was higher than even 15 after 9/11, simply because people were so risk-averse because 16 they couldn't trust financial statements. 17 So I think it's a cost that shareholders are 18 willing to bear, and it helps trust the integrity of those 19 financial statements. 20 In terms of the benefits beyond that, they're less 21 tangible, but I think they're out there. There are one or 22 two things I'd like to point out. I think now, with the 23 advent of Section 404, you see the fiduciaries, the boards of 24 directors paying much keener attention to their fiduciary 25 duties. 1 If nothing else, they're much more inquisitive, 2 particularly those that sit on audit committees with regard 3 to the controls of the company. Now that doesn't mean that 4 Section 404 is a panacea, but my gosh, if you're getting 5 directors on audit committees to start asking questions with 6 their auditors and their management, that's a pretty good 7 start. 8 That's what it really, I think, is the best benefit 9 of Section 404. It forces people to think critically about 10 the integrity of the financial statements, the integrity of 11 the internal controls, and are we producing the right 12 information that all stakeholders need, using the word "we." 13 Not only shareholders but creditors, rating 14 agencies, directors forejudging the performance of management 15 when they grant their bonuses. So I think the bonuses are 16 hard to translate yet into dollars, but I think the benefits 17 will far outweigh the costs. Let me stop there with my 18 comments. 19 MR. BELLER: Thank you. Mr. Kueppers', you've left 20 your card up. 21 MR. KUEPPERS: I do. Thank you, Alan. I wanted to 22 comment on a couple of the previous points, including Barbara 23 Franklin's point about getting some assurance that the word 24 had a risk focus, a risk-based approach. 25 I do think there is room for improvement in that 1 area, and I think that many of us could observe, based on 2 experience now, some very minor areas that might have 3 received more focus than they otherwise might have. 4 I think that the key would be for the -- for our 5 regulators, the PCAOB, to provide some additional 6 interpretive guidance, because I think people would take that 7 very well as we get into Year 2 and begin to think about our 8 scope, which frankly is we're on the threshold of doing right 9 now. 10 The other element of this management reporting that 11 I want to point out is one of the things that makes it quite 12 useful is the requirement that in the event there is a 13 material weakness, there is a description or discussion. I 14 mean, this kind of transparent information to investors has 15 never existed before. 16 You know, Greg referred to the fact that maybe not 17 all material weaknesses are created equal when you hit that 18 threshold that requires public disclosure. It's helpful for 19 me to know that as an investor or as just a user of the 20 financials, that the company had an issue with the method by 21 which they reconciled their income tax accounts, and it rose 22 to the level that it created a judgment that material 23 weakness was present. 24 That's much different than having some pervasive 25 tone at the top issue, an ineffective audit committee or 1 something that would have a completely different flavor. 2 So I think the most useful thing is in the 225 3 reports that have already been filed, that have ineffective 4 controls and adverse reports, you get some sense of the 5 "what" that caused that trigger to be pulled. I think that's 6 tremendously helpful to investors. 7 MR. BELLER: Thank you. Turning to maybe the 8 preparer's side next, Mr. Cyprus, from an issuer's 9 perspective, what are your thoughts about the disclosure and 10 reporting requirements, and do you need more guidance from 11 us? Is it or do you feel comfortable knowing what it is that 12 investors and we want you to say, if there are material 13 weaknesses? 14 MR. CYPRUS: Well, I'd like to say one, I 15 appreciated actually, the flexibility that we got. So I 16 wouldn't say right off the batt that we would need more 17 guidance. At IPG, I want to say that the 404 process helped 18 us a lot. 19 In fact, I've been a controller at two Fortune 500 20 companies during this process, and I could tell you this. I 21 believe that 404 and Auditing Standard 2 as it was written, 22 has created significantly more focus by senior management on 23 control deficiencies. 24 They've been more active. They've been willing to 25 use budget dollars to solve control problems that might not 1 have been available in the past. I'm actually confident that 2 404 will result in the long run in better and more 3 transparent financial reporting. 4 I actually believe that due to the tenor of all the 5 controls that you've heard, that you'll probably have less 6 restatements in the long run too, because incidental 7 mistakes, because people have tightened and looked at the 8 control environment, I believe will be prevented. So I'm a 9 big advocate of 404. I would not make any changes at the 10 time. 11 As far as the flexibility of financial reporting, 12 IPG, because we noticed that we had material weaknesses and 13 we'd been disclosing those weaknesses in each quarter as soon 14 as we knew about them. In the second quarter, for instance, 15 of '04 we told the world that we didn't think our disclosure 16 controls were effective, because we had multiple material 17 weaknesses. 18 As we got into the third quarter, we gave you more 19 detail on those control activities that we felt had material 20 weaknesses. As we got to understand our material weaknesses, 21 we said "Geez, one of the reasons we delayed and one of the 22 companies that delayed 10-K filing," we had a map on where 23 our issues were. 24 We believed that more work needed to be done on the 25 numbers, and we basically delayed the K filing, putting 1 additional procedures in place, to make sure we as management 2 could get comfortable with the numbers. 3 The disclosure pattern we chose was actually to 4 follow almost literally the COSO framework itself. So if 5 you'll look at 12B25 filing that we filed under an 8-K, you'd 6 actually see that we talked about the control environment. 7 We talked specifically about control activities. We talked 8 about information and communication, and we talked about 9 monitoring controls. 10 We gave you our current assessment of where we 11 stand on that, so that analysts and investors could 12 understand better what the risk profile was of the company. 13 So I'm not sure if there wasn't a 404 whether you 14 would have seen this in the past. But there is, and I think 15 the benefits are significant in that one, management has a 16 map to what it needs to do to get its numbers better. 17 I believe what we also saw is that the auditors 18 have a map in what they need to do address these issues by 19 changing their audit scope, so that they could do substantive 20 testing more than they would have done in the past in those 21 areas that we've identified to be materially weak, so we 22 could get assurances and they could audit those numbers. 23 So I think 404 has done its job. 24 MR. BELLER: Thank you. Mr. Copeland, as somebody 25 who was in the auditor's chair for many years, and is now 1 sitting on audit committees, and particularly in the latter, 2 from the audit committee perspective, how did you see the 3 reporting and disclosure process and how do you think it 4 could be improved going forward? 5 MR. COPELAND: I'll repeat what everyone ha