November 29, 1999
Mr. Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
Mail Stop 6-9
450 Fifth Street, N.W.
Washington, DC 20549
File No. S7-22-99 SEC Release No. 34-41987
Audit Committee Disclosure
Dear Mr. Katz:
The American Institute of Certified Public Accountants (AICPA) is pleased to respond to the Commission's request for comments on its proposed new rules and amendments to improve disclosure related to the functioning of corporate audit committees and to enhance the reliability and credibility of financial statements of public companies, as presented in Release No. 34-41987, Audit Committee Disclosure (the Release). The AICPA is a national professional association of more than 330,000 certified public accountants in public practice, industry, government, and academia. Among other things, the AICPA establishes auditing and accounting standards, requires membership in its SEC Practice Section and compliance with the Section's membership requirements by firms that audit SEC clients, and mandates peer review of all firms with an accounting and auditing practice. These activities are undertaken to protect the public's interest in the quality of financial reporting.
The Release raises many important policy issues. Our letter provides a background of the AICPA's position on the importance of audit committees and specific comments on the following areas addressed in the Release:
Pre-Filing Reviews of Quarterly Financial Statements
The Audit Committee Report
Audit Committee Charters
Proposed Safe Harbors
Since as early as 1967, the AICPA has advocated the formation and effective use of audit committees comprising outside directors as part of the corporate governance process to protect the public interest and preserve the integrity of the nation's capital and financial markets. In 1977, the AICPA's Board of Directors reaffirmed this position, urging AICPA members to encourage corporate clients and employers to establish audit committees. In 1978, the AICPA's Special Committee on Audit Committees concluded that audit committees were necessary for both corporate directors and independent auditors to fulfill their respective responsibilities and endorsed the efforts of the stock exchanges, the NASD, and other bodies to require audit committees. The AICPA continues to believe in the importance of audit committees and urges an audit committee requirement on all stock exchanges.
Since 1977, many other studies have been performed on the benefits of the effectiveness of audit committees that resulted in substantive recommendations for improvement in the corporate governance process. The AICPA and the accounting profession have been avid supporters of these studies, as well as their conclusions and recommendations.
In 1987, the Committee of Sponsoring Organizations (COSO), sponsored in part by the AICPA, established a committee (the "Treadway Commission") to identify the conditions that may lead to fraudulent financial reporting and the necessary steps to reduce the frequency of occurrence. The Treadway Commission's conclusions highlight the need for independent audit committees and describe corporate governance "best practices" that could reduce the possibility of fraudulent financial reporting. Although most of the Treadway Commission's recommendations were directed to the SEC or public companies, the AICPA took a proactive approach in an attempt to ensure the effectiveness of the corporate governance process by meeting with the SEC to encourage the adoption of many of the recommendations. It should be noted that Statement on Auditing Standards No. 61 and AICPA SEC Practice Section membership requirements respond to several of the Treadway Commission's concerns.
In 1994, the POB Advisory Panel on Auditor Independence (the "Kirk Panel") issued its findings, Strengthening the Professionalism of the Independent Auditor, which identifies the need for a strengthened relationship between audit committees and the independent auditor in order to improve the overall financial reporting process. The AICPA embraced the Kirk Panel's recommendations as they related to the accounting profession and publicly responded in 1995 recognizing the importance of the relationship between the independent auditor and audit committees and endorsing the panel's recommendations for enhanced communications regarding the qualitative assessments and judgments necessary as part of the audit. The AICPA SEC Practice Section also developed "best practices" to assist CPA firms in evaluating and enhancing their policies and procedures for communicating certain qualitative assessments regarding the financial statements of their clients to the audit committees of those entities.
Throughout our history, the AICPA has consistently supported the formation and effective use of audit committees. These positions clearly protect the public's interest in maintaining and improving the quality of financial reporting.
Pre-Filing Reviews of Quarterly Financial Statements
The proposal would require that a company's interim financial statements be reviewed by an independent public accountant prior to the company filing its Form 10-Q or 10-QSB with the Commission. The Commission would still require that if a company discloses in its filings with the Commission that an independent auditor has performed a review of interim financial statements, it must file a copy of the auditor's report.
Requiring Interim Reviews. The AICPA strongly agrees with the Commission's objective of enhancing the reliability and credibility of interim financial statements of public companies. Reliable interim financial information is essential to the orderly functioning of today's capital markets in which investors rely heavily on and react quickly to current financial results. The involvement of independent accountants with interim financial information improves the reliability of such information. We therefore agree with the Commission's proposed requirement for reviews of interim financial statements.
We also note that in March 1999, COSO issued its report on fraudulent financial reporting which concluded, based on a sample of approximately 200 financial statement fraud cases, that most fraud in financial reporting among companies was committed by small corporations, with well below $100 million in assets. Accordingly, we believe this proposed requirement should apply to all public companies regardless of size.
Requiring Interim Reviews Prior to Earning Releases. Although we support requiring interim reviews, we believe that such reviews should not be required to be completed prior to "earnings releases." Both management and auditors need adequate time to prepare the financial statements and perform adequate review procedures. Requiring interim reviews prior to earning releases may cause delays in the earnings release process, thus hindering investors' ability to gain access to timely financial information. Conversely, accelerating the timetable for the review may lead to hasty decision-making, incorrect judgements and incomplete data and may thus jeopardize the quality of interim financial reporting. This proposed requirement seems to harm the marketplace and all parties involved. Further, we note that the release proposes a standard for quarterly reporting that is not required for annual financial reporting.
Filing of Review Reports. The Release also asks whether the Commission should require that a report on the independent auditors' review be filed. As stated above, we believe the involvement of independent accountants with interim financial information improves the reliability of such information. The benefits of interim involvement, however, are derived from the actual reviews performed, not the issuance and filing of a review report. We believe, therefore that the Commission should not require that a report resulting from the independent auditors' review be filed.
Modifications to SAS No. 71. In response to recommendations made earlier this year by the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees, the AICPA's Auditing Standards Board released an exposure draft of a proposed standard that would improve communication between independent auditors and corporate audit committees. The exposure draft, entitled, Amendments to Statement on Auditing Standards No. 61, "Communication With Audit Committees," and Statement on Auditing Standards No. 71, "Interim Financial Information," would require the auditors of public companies to discuss with management and the audit committee their judgments about the quality - and not just the acceptability - of the client's accounting principles as reflected in its financial reporting. The standard would be effective for fiscal years beginning in 2000. The proposal represents the Auditing Standards Board's role in a collaborative effort with the New York Stock Exchange, the National Association of Securities Dealers and the SEC. The Blue Ribbon Committee also recommended that the SEC require public companies to have the outside auditor review their quarterly financial information prior to the filing of the quarterly financial statements with the Commission. The Auditing Standards Board's proposal contains a provision under which the auditor would be obligated to discuss certain matters that arise from the review with the audit committee before the quarterly filing.
The Audit Committee Report
The Release would require audit committees to provide a report in the company's proxy statement (or information statement) disclosing whether the audit committee has reviewed and discussed the audited financial statements with management and discussed certain matters with the independent auditors. Audit committees would be required to state whether:
(1) the audit committee has reviewed and discussed the audited financial statements with management;
(2) the audit committee has discussed with the independent auditors the matters required to be discussed by SAS 61, as may be modified or supplemented;
(3) the audit committee has received the written disclosures and the letter from the independent auditors required by ISB Standard No. 1, as may be modified or supplemented, and has discussed with the auditors the auditors' independence; and
(4) based on the review and discussions described in paragraphs (a)(1) through (a)(3), anything came to the attention of the members of the audit committee that caused the audit committee to believe that the audited financial statements included in the company's Annual Report on Form 10-K or 10-KSB, as applicable, for the year then ended contain an untrue statement of material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which they were made, not misleading.
The ability to attract and retain high quality audit committee members is a critical element in a company's audit committee program. Adopting requirements for audit committees that would either 1) create burdensome reporting and performance measures or 2) increase the possibility future legal liability, may hinder this ability. We therefore recommend that the Commission reevaluate the reporting requirements of audit committees and limit reporting requirements to the process that the audit committee followed in performing its duties. Accordingly, we believe paragraph (4) above should be omitted from the final rule.
Audit Committee Charters
The proposal would require registrants to disclose whether they have an audit committee charter. Registrants would not be required to have a charter but if they do, they must include a copy of it as an appendix to the proxy or information statement at least once every three years. Registrants would not be required to include a statement about whether the audit committee has complied with the charter. If a charter is adopted, the Commission would not dictate the content of the charter.
It has been the AICPA's long-standing position that a well-designed audit committee charter is an effective tool for audit committees to use in determining its responsibilities, gaining access to appropriate resources, and discharging its authority to conduct any investigation it deems appropriate in fulfilling its responsibilities. Accordingly, the AICPA believes that in order for an audit committee to operate effectively, a comprehensive, unambiguous charter should be required that defines the audit committee's responsibilities throughout the year. The document should be monitored on an ongoing basis for relevancy and should be reviewed and approved by the board of directors at least once a year.
The AICPA believes that requiring registrants to include a copy of their audit committee charters as an appendix to the proxy or information statement would result in boilerplate disclosures and would thus dilute their effectiveness and usefulness. As an alternative, the AICPA recommends that the Commission consider requiring registrants to disclose a summary of their audit committee charters that provides users with an overview of the responsibilities of the audit committee as well as the practices and procedures followed to ensure compliance.
Proposed Safe Harbors
The proposal follows the Blue Ribbon Committee's recommendation to adopt liability "safe harbors" to cover the new disclosures. The "safe harbors" would track the treatment of compensation committee reports under Item 402 of Regulation S-K. Under the "safe harbors," the additional disclosure would not generally be considered "soliciting material," "filed" with the Commission.
As stated earlier, the ability to attract and retain high quality audit committee members is a critical element in a company's audit committee program. It is therefore essential that the final rule incorporate safe harbors that will allow audit committee members to serve without unreasonable exposure or liability under the Federal Securities Laws.
* * * * *
The AICPA appreciates the opportunity to comment on the Release. We would be pleased to discuss these comments with you at your convenience.
Robert K. Elliott