Financial Executives InternationalMarch 12, 2003 Mr. Jonathan G. Katz
Re: File No. S7-40-02 Dear Mr. Katz: The Committee on Corporate Reporting ("CCR") of Financial Executives International ("FEI") wishes to take this opportunity to supplement its comments filed with the Securities and Exchange Commission (the "Commission") on Disclosure Required by Sections 404, 406 and 407 of the Sarbanes-Oxley Act of 2002 ("Proposed Rules"), Release Nos. 33-8138 and 34-46701. FEI is a leading international organization of 15,000 members including Chief Financial Officers, Controllers, Treasurers, Tax Executives, and other senior financial executives. CCR is a technical committee of FEI, which reviews and responds to research studies, statements, pronouncements, pending legislation, proposals, and other documents issued by domestic and international agencies and organizations. This document represents the views of the CCR and not necessarily the views of FEI. CCR congratulates the Commission on its expeditious and diligent implementation of the provisions of the Sarbanes-Oxley Act of 2002 ("the Act"). We recognize the historic importance of the creation of the Public Company Accounting Oversight Board ("PCAOB"), and we see it as a key element in the reform of our financial reporting process, which will play a significant role in restoring investor confidence. CCR is committed to actively participating with the Commission and the PCAOB in the process of developing rules that will implement not just the letter of the Act, but the spirit as well. Despite the Commission's substantial progress in implementing the Act and creating the PCAOB, CCR is increasingly concerned about a number of issues regarding Section 404 of the Act on "Management's Assessment of Internal Controls", specifically: (1) the lack of a final Commission rule specifying the scope of the Section 404 Attestation; (2) how auditing standards will be established under the PCAOB; and (3) the level of audit work that will be necessary for the independent auditor to attest to management's report on internal control in annual reports as outlined in Section 103 of the Act on "Auditing, Quality Control, and Independence Standards and Rules". In summary, we strongly urge the Commission and the PCAOB to:
Although guidance for compliance with Section 404 of the Act on "Management's Assessment of Internal Controls" is not yet available, CCR believes strongly that public companies should be required to include the report in Forms 10-K for years ending after December 15, 2003. Implementation of this requirement represents a substantial amount of work for many companies; however, CCR believes that the effort required to meet this deadline will result in important benefits because it will entail a rigorous documentation and review of internal controls by management. CCR is committed to working to establish guidance and best practices for management to meet its responsibilities on this tight timetable. Our major concerns, however, are focused on the scope, timing and development of standards for the auditor attestation on internal controls required in the Act. In drafting Section 404 of the Act, the Senate Committee on Banking, Housing and Urban Affairs made clear in its' related Senate Report No. 107-205 that its intention was to enhance the disclosure of information in public companies' annual reports for the benefit of shareholders, not to significantly increase audit work or augment related audit fees:
Congress also enacted Section 103 of the Act, which requires the PCAOB to establish the auditing and attestation standards for Section 404, in order to increase investor confidence by removing the inherent conflict of interest caused by the auditing profession creating these standards that auditors will follow. The members of CCR have an overriding concern with the current lack of a clearly defined scope framing the attest services to be provided by the independent auditor under Section 404 of the Act. This scope needs to be clearly set, stating whether the work of the independent auditor should result in 1) an audit opinion on the process followed by management in evaluating internal controls; 2) an audit opinion on the assertions made by management about those controls; or 3) a separate audit opinion on the quality of the company's internal controls. Each of these scope options would involve progressively more time, effort, and cost. Where Section 404 of the Act calls for each registered public accounting firm to "attest to, and report on, the assessment made by the management of the issuer", we believe it is calling for the first of the above three options. Certainly, by concluding with the statement "Any such attestation shall not be the subject of a separate engagement", the Act is clear that a separate audit opinion on the quality of internal controls is not appropriate. We believe it is extremely important for the Commission to clearly articulate the scope of these services and not leave this area open for a self-serving interpretation by the accounting profession. Due to recent developments, CCR is becoming progressively more concerned that the Commission and the PCAOB will be forced to hastily adopt auditing and attestation standards for Section 404, which have been created by a non-independent standard-setting body comprised solely of members from the auditing profession. Part of this problem would arise because the Commission has proposed a deadline for compliance with Section 404 even though it was not mandated by the Act to impose such a deadline. Moreover, the fact that the PCAOB is still functioning without a permanent Chairman and without critical staff inevitably creates uncertainty and impedes the development within the PCAOB of the full complement of independent capabilities and leadership intended by Congress. Under these unique and transitory circumstances, we believe that it is very important that the Commission not permit the accounting profession to rush to fill a perceived void in the area of standards to be used for purposes of Section 404(b) of the Act. We want to make it clear that CCR does not support the current efforts of the American Institute of Certified Public Accountants ("AICPA"), the ASB or its Internal Control Reporting Task Force to develop auditing standards for internal control attestation. The efforts of these bodies, acting outside the authority of the PCAOB, which, under the oversight of the Commission, has jurisdiction in this area, represents a continuation of the self-regulatory approach specifically rejected by the Act. Our concerns with the activities of this group are two fold. First, we do not believe that the ASB should be developing new auditing standards. Allowing the ASB to continue to act in the capacity of standard-setter through use of its designated task force would be inconsistent with the spirit of the Act. Furthermore, public accounting firms who make up the membership of the ASB are already actively marketing consulting services on compliance with the internal control attestation requirement. The public accounting industry seems poised to doubly benefit and profit from this auditing standard, which they seem to be hurriedly preparing. There is an inherent conflict of interest associated with the auditing profession setting their own standards and selling consulting services on those standards. We believe this approach must change if the investing public is to be given the assurance of objectivity in the setting of auditing standards that the Act intends to achieve. Therefore, we strongly believe that the PCAOB should take direct responsibility for establishing auditing standards and resist the temptation (in the face of proposed time restraints) of delegating the standard setting role to the auditing profession. Such a delegation would perpetuate the conflict of interests that existed in the old system, something that clearly needs to be avoided in order to assure investors of auditing standards that are necessary, properly focused and appropriately rigorous. We think the PCAOB should be directly responsible for developing the standards and guidelines that will be applicable to internal control attestation engagements. This new requirement of the Act is vitally important to enhancing the quality of financial statement audits, and how it gets implemented will largely set the tone for future audit standard setting. Our second concern with the activities of the ASB is that the proposed auditing standard on internal control will cause a significant unnecessary increase in audit time, effort and costs for all public companies. Although we are fully prepared to facilitate auditor attestation on internal controls and recognize that public companies will incur additional costs associated with Section 404(b) compliance, the earlier quoted excerpt from the Senate Committee Report accompanying the Act makes clear that Section 404 (b) was not intended to open the door to an entirely new and extensive testing regime with attendant exorbitant fee increases. The ASB proposal, in CCR's view, is headed precisely in that direction. If the proposal were to be adopted, it would cause a significant increase in audit firm work and related fees to be charged to all public companies. We believe that the development of the new standards by the PCAOB is essential to maintain the balanced approach to Section 404(b) implementation required by the Act. Further work on the ASB proposal should cease in order to permit the PCAOB to do its job in an orderly, reasoned and independent manner, as required by law. Given that the Commission is still in the process of fully staffing the PCAOB, we do not believe the implementation date for the auditor attestation report required by Section 404 as proposed by the Commission is feasible. In the Proposed Rules, the Commission has acknowledged that the Act "does not impose a deadline for compliance with Section 404" and "that Congress did not intend for the provisions of [Section 404] to take effect until the PCAOB has established the relevant attestation standards." In keeping with that view, we urge the Commission to reconsider its initially proposed effective date, and allow sufficient time for the PCAOB to establish appropriate auditing standards. As we believe this could take well into the third quarter of this year, we believe that the auditor attestation report should not be required until the 2004 reporting cycle. In addition, we urge the staff to request the ASB to stop the release of the exposure draft of their proposed new standard next week. We believe that the SEC and the PCAOB, rather than the ASB, should be responsible for establishing the scope, timing and development of this new standard. We believe it will be confusing to the public for a proposed standard to be released by the ASB and then potentially changed significantly by the PCAOB when it is established and has time to act. In conclusion, CCR believes that the management assertion on internal controls should be implemented as proposed by the Commission. We believe that, as permitted under the Act, the development of the new auditing and reporting standard for the auditor's attestation on internal controls be delayed until the PCAOB is established and has time to develop the standard. As such, we respectfully request that the Commission ask the ASB to stop the release of their exposure drafts in this area and delay the effective date of the auditor's reporting requirement until the 2004 reporting cycle. We appreciate this opportunity to express our views on these matters of vital importance to us all. We welcome the opportunity to discuss any and all issues with the SEC at its convenience. If you have any questions regarding this letter, please feel free to call Frank Brod at (989) 636-1541.
cc: The Honorable William H. Donaldson
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