Robert N. Waxman
Certified Public Accountant
675 Third Avenue, Ste 2100
New York, NY 10017
November 25, 2002
Mr. Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 Fifth Street N.W.
Washington, D.C. 20549-0609
Re: File Number S7-39-02
Dear Mr. Katz:
I appreciate the opportunity to comment on the Commission's Proposed Rule: Improper Influence on Conduct of Audits (the "proposed rule"). Specific comments are setout below in bold.
A. Comments on the proposed rule:
1. Section 240.13b2-2(a)(2) states: "(2) Omit to state, or cause another person to omit to state, any material fact necessary in order to make statements made, in light of the circumstances under which such statements were made, not misleading to an accountant in connection with:"
This proposal uses "accountant," "independent public accountant," "certified public accountant," "registered public accountant," and "auditor." The Sarbanes-Oxley Act uses the terms "independent public accountant," "public accounting firm" and "registered public accounting firm." To avoid unnecessary confusion, fewer terms should be used, or if used, they should be used consistently. If for some reason this recommendation is not practicable, state in one rule the different meanings these terms have under the Acts.
2. Continuing, (a)(2)(i) says: "Any audit or examination of the financial statements of the issuer required to be made pursuant to this subpart;"
Under generally accepted auditing standards, it is clear that an audit is not an "examination," and further a review (in accordance with AU 722) is not an examination, so this language raises the question as to what is meant by an "examination"?
3. Further, (a)(2)(ii) requires "The preparation or filing of any document or report required to be filed with the Commission pursuant to this subpart or otherwise."
Many of the SEC's forms require the registrant to furnish financial statements, or file financial statements. For example Form 10-K states:
"Furnish financial statements meeting the requirements of Regulation S-X, except § 210.3-05 and Article 11 thereof, and the supplementary financial information required by Item 302 of Regulation S-K. Financial statements of the registrant and its subsidiaries consolidated (as required by Rule 14a-3(b)) shall be filed under this item. Other financial statements and schedules required under Regulation S-X may be filed as "Financial Statement Schedules" pursuant to Item 13, Exhibits, Financial Statement Schedules, and Reports on Form 8-K, of this form."
I note the recent confusion as to whether Form 6-K reports containing quarterly or interim financial information required Section 906 certification since Form 6-K reports are not "filed" under the 1934 Act, but are "furnished" to the SEC.
So, the question is what is the difference between "furnish" (as used in many of the periodic reporting forms) and "file" (if any)?
4. Subparagraph (b)(1). Footnote 16 says "We view `fraudulently' as modifying only `influence.'"
I recommend that this appear last in the phrase, thus "to take any action to coerce, manipulate, mislead or to fraudulently influence any independent public or certified accountant ..." to clarify what fraudulently modifies and avoid any incorrect interpretation of the rule.
5. The phrase "or was unreasonable in not knowing."
The phrase (unreasonable in not knowing) is neither clear nor understandable. Is it not sufficient to say "if that person knew"? If not, then "reasonable" should be inserted before "knew," and read-"if that person reasonably knew that such action...."
Further, whether the idea of "reasonable" (or "unreasonable") is the right standard for an officer, director or other persons conduct in view of the expectations of the investing public and markets should be re-examined and challenged in the final rule.
I suggest that "officer, director or" be inserted before "person," thus the rule would read "if that officer, director or person reasonably knew...."
6. Subparagraph (b)(1), the last phrase states, "that such action could, if successful, result in rendering such financial statements materially misleading."
As the commentary in the proposal points out "the auditor would not directly `render [the] financial statements materially misleading.'" Rather than this clarification appear in the commentary, it should be in the rule itself. Therefore, the rule would be better stated as "that such action could, if successful, result in the certified public accountant issuing an opinion or report that was not appropriate for the materially misleading financial statements of the issuer."
7. Subparagraph (b)(2).
Subparagraph (b)(2) should be moved and follow (c)(2), after redesignating paragraph (c) as (b). This shift will correct the logical flow of the rule.
Subparagraph (b)(2)(i). As additional examples consider adding "inconsistent use of generally accepted accounting principles, or using non-preferable GAAP." In place of the phrase "other standards," substitute "disclosure requirements of the Commission's rules and regulations."
Subparagraph (b)(2)(ii). It is not clear what is meant by "other professional standards." The final release should add (if appropriate)-
(a) the AICPA SEC Practice Section requirements (e.g., for concurring partner review, etc.),
(b) other generally accepted auditing standards adopted by the Public Company Accounting Oversight Board, or
(c) other international auditing standards.
After (b)(2)(iv), add "not to consult within the firm, or with other experts on technical accounting or audit matters, or with the Staff of the Commission."
B. Comments on Questions Raised in the Proposal:
1. Should we amend the definition of "officer" in rule 3b-2 to include specific references to additional individuals and entities who may perform "corresponding functions"?
Yes. This would reduce any future confusion as to exactly which employees are covered by the rule. This expansion would include those with similar authority at subsidiaries (both domestic and foreign), notwithstanding they do not have the title of "officer" or "director."
Further, the release cites 1934 Act Rule 3b-2 (which defines the term "officer"), 1934 Act section 3(a)(7) (which defines the term "director"), and 1934 Act Rule 3b-7 (which defines the term "executive officer"). It is recommended that these rules and section be combined and made part of the final rule.
2. Should we amend Regulation 13B-2 to craft a special definition of a public company officer for the purposes of that regulation?
3. If we amend rule 3b-2 or Regulation 13B-2, who should be included or excluded from the definition of "officer"?
I believe the proposed rule appropriately defines "officer," but see Item 1.
4. The proposal says that "We interpret Congress' use of the term "direction" to encompass a broader category of behavior than `supervision.'"
I agree with this interpretation, but it should be made clear in the rule itself that "someone may be "acting under the direction" of an officer or director might include not only the issuer's employees (including, for example, the internal law department and the internal auditors), but also include, customers, vendors or creditors who, under the direction of an officer or director,
(1) provide false or misleading confirmations or other false or misleading information to the auditors, or
(2) who enter into "oral agreements" or "other side agreements," or
(3) who withheld material relevant information.
5. The proposal states that "In appropriate circumstances, persons acting under the direction of officers and directors also may include other partners or employees of the accounting firm (such as consultants or forensic accounting specialists retained by counsel for the issuer) ...."
This language is not as precise as it should be and should be clarified. The rule should also include actions such as, "make a false statement or knowingly withhold any information."
6. Should we define by rule the scope of "any other person acting under the direction" of an officer or director?
This is absolutely essential. The final rule should distinguish between "direction," "guidance," "supervision," and " instruct(ion)."
7. The proposal says "Types of conduct that the Commission believes might constitute improper influence include, but are not limited to, directly or indirectly:
- Providing an auditor with inaccurate or misleading legal analysis,
Suggest adding "or not providing the underlying the legal rationale, tax purpose or consequences, or substance of a transaction or agreement."
- Seeking to have a partner removed from the audit engagement because the partner objects to the issuer's accounting,...."
8. The statement in Footnote 17 says that "There is no requirement in section 303(a) of the Act that the purpose be achieved."
This is vital in understanding the rule and should be carried forward as an integral part of the final rule, instead of being relegated to a footnote.
9. Should the types of conduct that might constitute actions to fraudulently influence an auditor be set forth in the rule? If so, which items listed in the preceding paragraph should be included or excluded? What additional types of conduct, if any, should be included?
Yes. All of them, plus those listed above.
10. Should we define by rule the phrase "independent public or certified public accountant"? The rules currently in Regulation 13B-2 refer to "accountant" as opposed to "independent public or certified public accountant." Should these rules, or the proposed rules, be changed to refer to the same term? Which term should be used?
I agree that fewer terms should be used, or (if this is not practicable) state in one rule that lists all terms used all have the same meaning under the Acts. See A1 above.
11. The release says "We believe Congress intended that the phrase encompass the professional engagement period and any other time the auditor is called upon to make decisions regarding the issuer's financial statements, including during negotiations for retention of the auditor and subsequent to the professional engagement period when the auditor is considering whether to issue a consent on the use of prior years' audit reports."
I am not certain this was the intention of Congress, and while I agree with the Commission's interpretation, the plain language in Section 303(a) "engaged in the performance of an audit" does not include these periods and the language in S-X Rule 2-01(f)(5)(ii) should be followed. This would then conform the rules to just one standard. Consequently, the professional engagement period should begin when the accountant either-
(a) signs an initial engagement letter (or other agreement to review or audit a client's financial statements), or
(b) begins audit, review, or attest procedures, whichever is earlier; and
(c) the professional engagement period ends when the audit client or the accountant notifies the SEC that the client is no longer that accountant's audit client.
It may be necessary to clarify whether or not S-X Rule 2-01(f)(5) needs to be modified to include or specifically exclude the "consent period" after the auditor has resigned, declined to stand for re-election, or was dismissed.
12. Should proposed rule 13b2-2(b)(2) provide a specific definition of "engaged in the performance of an audit"?
Yes, see the comments immediately above.
13. Is subparagraph (b)(2) of the proposed rule helpful or necessary? Should it be deleted? If subparagraph (b)(2) should be adopted, are the examples appropriately illustrative? Should more, or fewer, examples be included in the rule? If so, what examples should be added or removed?
14. The proposal asks whether to "replace the statement in subparagraphs (b)(1) and (c) that no person acting `under the direction' of an officer or director shall improperly influence the auditors of the issuer's financial statements, with a statement that no person acting "at the behest of" or "on behalf of" an officer, etc"
While the language used in the proposed rule tracks Section 303(a), the word "direction" needs no further clarification.
15. The proposal asks whether the word "fraudulently" in subparagraphs (b)(1) and (c)(2) be replaced with the word "improperly" or some other word to convey a mental state short of scienter.
Since Section 303(a) requires scienter and does not use "improperly," the final rule should not go beyond that which is required by the Act.
16. The proposal asks whether the language in (b)(1) and (c)(2) be replaced with "for the purpose of, or have the effect of, rendering the financial statements materially misleading" or some other phrase to convey that proving a particular purpose or intent is not required.
No, proving a particular purpose or intent is the correct standard and should be required.
17. We request comment on whether it is feasible to further clarify, consolidate, or simplify the proposed rules for small entities.
This rule should be equally applicable to all registrants and not be limited only to those meeting a revenue or public float cutoff.
It should clarify the responsibilities of officers, directors or other persons who are located at consolidated subsidiaries (both domestic and foreign), investees (carried on the equity method), and investments carried at either fair value or cost.
Lastly, the rule should clarify its applicability to foreign private issuers.
* * * * *
I will be pleased to discuss these comments or answer any questions that you may have. Please contact me at 212.468.7820.
Robert N. Waxman, CPA