Association for Investment Management and Research
12 December 2002
Jonathan G. Katz
Re: Improper Influence on Conduct of Audits--File No. S7-39-02
Dear Mr. Katz:
The U.S. Advocacy Committee (USAC) of the Association for Investment Management and Research (AIMR)1 appreciates the opportunity to comment on the SEC's proposed rule that prohibits company management from engaging in any action that is designed to render the company's financial statements materially misleading. The USAC is a standing committee of AIMR charged with responding to new regulatory, legislative, and other developments in the United States affecting the investment profession, the practice of investment analysis and management, and the efficiency of financial markets.
The USAC strongly supports efforts by the SEC to address all areas of abuse by company management that affect the integrity of the company's financial reporting. A company's annual report is an important source of information relied upon by investors as a valuable indicator of the company's health. Manipulation of the auditing process thus runs counter to the spirit and purpose of having an independent third party conduct the audit, and ultimately deprives the investor of reliable financial information.
Clearly, for financial reports to be useful to investors and the marketplace in general, they must be accurate and free from manipulation. Any actions that purposefully skew the disclosures in an annual report not only fly in the face of corporate ethics, but undermine the integrity of the financial reporting system. The objective of this proposal is thus without challenge.
We support the proposal's focus on the process of conducting an audit insofar as the auditors rely on others for valid information, and on the requirement that management not circumvent that process, either directly or indirectly. Part of the audit process relies on certain representations and confirmations by management in a variety of areas, including the status of accounts receivable and other revenue recognition. Similarly, auditors seek corroborative information from an issuer's customers and vendors in attesting to the fairness and quality of an issuer's financial statement for the period in question. Manipulation of this information by customers and vendors (e.g., behind the scenes discounts, "round-tripping" revenue recognition) distorts the conclusions drawn by the auditors and thus undermines the accuracy of information presented in an issuer's financial reports.
We agree that "acting under the direction of" an issuer's directors and officers is preferable to an "under the supervision" standard. As drafted, the arm of culpability extends to a range of people whose actions are deemed to have played a role in making an issuer's financial statements materially misleading. While management may not be able to control the actions of parties who are not employees, we do believe that management must be held responsible when it directs outside parties to manipulate their inventory, alter records of revenue transactions (including customer orders, contracts, shipping documents, sales orders) or expenses (including confirmations of purchases), or to take other actions designed to sidestep auditors' inquiries. The conveyance or withholding of information that intentionally skews the mix of information provided the auditors subverts the audit process and ultimately results in misleading financial statements.
We appreciate and support the underlying objective of this proposed rule. We are keenly aware of the need to restore investor confidence in the markets, in light of the accounting problems and corporate governance issues that have surfaced during the last months. Investors must be able to rely upon the information contained in a company's annual report, without questioning the accuracy of particular pieces of information or the integrity of the reporting process.
If we can provide additional information, please do not hesitate to contact Deborah Lamb at 770.971.7010, firstname.lastname@example.org or Linda Rittenhouse at 434.951.5333, email@example.com.
Cc: Members of the U.S. Advocacy Committee