Implementation of Section 10A of the Securities Exchange Act of 1934

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 210 and 240

[Release No. 34-37594; IC-22162; File No. S7-20-96].

RIN 3235-AG70

Implementation of Section 10A of the Securities Exchange Act of

1934

AGENCY: Securities and Exchange Commission.

ACTION: Proposed Rule.

-----------------------------------------------------------------------

SUMMARY: The Securities and Exchange Commission (``Commission'' or

``SEC'') today is soliciting comments on proposed rule amendments to

implement the reporting requirements in section 10A of the Securities

Exchange Act of 1934 (the ``Exchange Act''). Section 10A requires,

among other things, that the auditor of a registrant's financial

statements report to the registrant's board of directors certain

uncorrected illegal acts of the registrant, and that the registrant

notify the Commission that it has received such a report. If the

registrant fails to provide that notice, the auditor is required by

section 10A to furnish directly to the Commission the report given to

the Board. The proposed amendments to the Commission's Exchange Act

Rules are intended to implement those reporting requirements. The

proposed amendment to Regulation S-X would conform the definition of

``audit'' in that regulation with the wording in section 10A.

DATES: Comments on the proposed amendments should be received on or

before October 28, 1996.

ADDRESSES: Comments should be submitted in triplicate to Jonathan G.

Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street,

N.W., Washington, D.C. 20549. Comments also may be submitted

electronically at the following E-mail address: [email protected].

Comment letters should refer to File No. S7-20-96; this file number

should be included on the subject line if E-mail is used. All comments

will be available for public inspection and copying in the Commission's

Public Reference Room, 450 Fifth Street, N.W., Washington, D.C. 20549.

Electronically submitted comments may be posted on the Commission's

internet web site (http://www.sec.gov).

FOR FURTHER INFORMATION CONTACT: Robert E. Burns or W. Scott Bayless,

at (202) 942-4400, Office of the Chief Accountant, Mail Stop 11-3, and

for investment company issues, Kathleen Clarke, at (202) 942-0724,

Division of Investment Management, Mail Stop 10-6, Securities and

Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.

SUPPLEMENTARY INFORMATION: The Commission is proposing to amend its

Exchange Act Rules, 17 CFR 240, by adding Rule 10A-1, and Regulation S-

X, 17 CFR 210, by revising Rule 1-02.

I. Background

Title III to the Private Securities Litigation Reform Act of 1995,

Public Law 104-67, enacted on December 22, 1995, added section 10A to

the Exchange Act. This section codifies certain professional auditing

standards and imposes expanded obligations on auditors 1 to report

in a timely manner certain uncorrected illegal acts 2 to a

registrant's board of directors. It further requires the registrant, or

if the registrant fails to do so then the auditor, to provide

information regarding the illegal act to the Commission.

---------------------------------------------------------------------------

\1\ For the purpose of this release, the term ``auditor'' refers

to any independent public or certified public accountant who is

performing or has performed an audit of a registrant's financial

statements and whose audit report has or will be filed with the

Commission in accordance with the federal securities laws or the

Commission's regulations. See, e.g., sections 12(b)(1) (J) and (K),

13(a)(2), and 17(e) of the Exchange Act, 15 U.S.C. 78l(b)(1) (J) and

(K), 78m(a)(2), and 78q(e), and the Commission's Regulation S-X, 17

CFR Sec. 210. The term ``independent accountant'' is used in the

regulatory text in order to be consistent with existing provisions

in Regulation S-X.

\2\ Section 10A(f) defines the term ``illegal act'' broadly to

mean ``an act or omission that violates any law, or any rule or

regulation having the force of law.'' This definition is consistent

generally with Statement on Auditing Standards No. 54, ``Illegal

Acts by Clients,'' para.2 (January 1, 1989), AU Sec. 317.02, which

states, ``the term illegal acts . . . refers to violations of laws

or governmental regulations.''

---------------------------------------------------------------------------

Section 10A(a) requires that audits of registrants' financial

statements include, ``in accordance with generally accepted auditing

standards, as may be modified or supplemented from time to time by the

Commission--''

1. Procedures designed to provide reasonable assurance of detecting

illegal acts that would have a direct and material effect on the

determination of financial statement amounts;

2. Procedures designed to identify related party transactions that

are material to the financial statements or otherwise require

disclosure therein; and

3. An evaluation of whether there is substantial doubt about the

registrant's ability to continue as a going concern during the ensuing

fiscal year.3

---------------------------------------------------------------------------

\3\ Section 10A(a) (1), (2), and (3).

---------------------------------------------------------------------------

Certain procedures in each of these three areas already are

required by generally accepted auditing standards (``GAAS'') 4 in

the United States and are further codified in the Statements on

Auditing Standards (``SAS'') 5 adopted by the Auditing Standards

Board (``ASB''), the senior technical body for auditing matters of the

American Institute of Certified Public Accountants (``AICPA'').6

The Commission staff historically has worked closely with the ASB. The

staff, among other things, attends ASB meetings, reviews and provides

the ASB with comments on draft Statements on Auditing Standards, and

has periodic meetings with ASB representatives to discuss items on the

ASB agenda and other matters of mutual concern. The Commission staff

plans to continue these practices.

---------------------------------------------------------------------------

\4\ In February 1941, the Commission amended Rule 2-02 of

Regulation S-X, 17 CFR Sec. 210.2-02, to require that the

independent accountant state in his or her report ``whether the

audit was made in accordance with generally accepted auditing

standards. . . .'' Accounting Series Release No. 21 (February 5,

1941). In this release, the Commission defined ``generally accepted

auditing standards'' to mean the application of ``generally

recognized normal auditing procedures'' with professional competence

by properly trained persons. The Commission defined ``generally

recognized normal auditing procedures'' to be those normally

employed by skilled accountants and those prescribed by

authoritative bodies dealing with the subject of auditing, such as

accounting societies and governmental bodies having jurisdiction in

the area. Id. Following this addition to the Commission's rules, the

relevant professional committee at the time, the Committee on

Auditing Procedure, began a study to determine which auditing

standards should be included within ``GAAS.'' In 1948, the

membership of the predecessor organization to the American Institute

of Certified Public Accountants (``AICPA'') approved ten standards

as constituting GAAS. See, AICPA, Codification of Statements on

Auditing Standards, AU Sec. 150.02. These ten standards are

supplemented by Statements on Auditing Standards, which currently

are issued by the Auditing Standards Board of the AICPA.

\5\ Currently effective Statements on Auditing Standards are

published by the American Institute of Certified Public Accountants

in the Codification of Statements on Auditing Standards. Provisions

in the Codification are designated as ``AU Sec. .'' For standards

addressing those procedures mandated by section 10A, see SAS 54,

``Illegal Acts by Clients'' (January 1, 1989), AU Sec. 317; SAS 45,

``Related Parties'' (September 30, 1983), AU Sec. 334; and SAS 59,

64, and 77 reprinted in ``The Auditor's Consideration of an Entity's

Ability to Continue as a Going Concern'' (January 1, 1989), AU

Sec. 341. See also SAS 53, ``The Auditor's Responsibility to Detect

and Report Errors and Irregularities'' (January 1, 1989), AU

Sec. 316. The ASB is in the process of re-examining SAS 53, SAS 54,

and other auditing standards related to the detection and reporting

of financial fraud. References in this release are to auditing

standards in effect at the date of this release.

\6\ The ASB's 15 members serve on a part-time basis and are

appointed for one year terms that may be extended for up to three

years.

---------------------------------------------------------------------------

In addition to the requirement in section 10A(a) that auditors

perform procedures designed to enhance the detection of fraudulent

financial reporting, section 10A(b) contains provisions that would

require an auditor to report directly to the Commission

[[Page 45731]]

certain detected illegal acts if the registrant fails to do so.

Under section 10A(b), if, while conducting the audit of the

registrant's financial statements, the auditor becomes aware of

information indicating that an illegal act (whether or not material to

the financial statements) has occurred or may have occurred, then the

auditor would be required, in accordance with GAAS, ``as may be

modified or supplemented from time to time by the Commission,'' to

determine whether it is ``likely'' that an illegal act has occurred

and, if so, its possible effect on the financial statements (including

any contingent monetary effects, such as fines, penalties, and

damages).7 The auditor would be required to inform the

registrant's management of the illegal act ``as soon as practicable.''

In addition, the auditor must assure him/herself that the registrant's

board of directors is adequately informed, by management or otherwise,

of any detected illegal act.8

---------------------------------------------------------------------------

\7\ Section 10A(b)(1)(A). See, SAS 54, Paras. 10-15. AU

Sec. 317.10-.15. Paragraph 11 of SAS 54 sets forth additional audit

procedures that might be necessary once the auditor becomes aware of

a possible illegal act.

\8\ Section 10A(b)(1)(B). See, SAS 54, para. 17, AU Sec. 317.17.

---------------------------------------------------------------------------

Although GAAS contains procedures for similar notification of

illegal acts to managements and boards of directors,9 section

10A(b) contains the additional requirement that these notifications

occur ``as soon as practicable.'' 10

---------------------------------------------------------------------------

\9\ See, SAS 54, Paras. 10 and 17, AU Sec. 317.10 and .17.

\10\ The addition of this time period reflects the original

legislative efforts in this area to provide an earlier warning to

the SEC of registrants' potential illegal acts than may occur under

the current Form 8-K procedures, see note 20 infra, and in audit

reports. See H.R. Rep. No. 102-890, 102d Cong., 2d Sess. 3 (1992),

which contained the predecessor legislation to Section 10A and

stated:

This legislation amends the Securities Exchange Act of 1934

(Exchange Act) to improve fraud detection and disclosure with

respect to public companies by codifying auditing standards in

certain specified areas and by providing a mechanism for earlier

warning to the Securities and Exchange Commission of certain illegal

acts by registrants.

---------------------------------------------------------------------------

After the auditor determines that the audit committee or the board

of directors has been adequately informed of an illegal act and the

auditor reaches three specified conclusions, the auditor is required by

section 10A(b)(2) to report those conclusions directly to the board of

directors ``as soon as practicable.'' The three conclusions set forth

in section 10A(b)(2) that trigger the auditor's obligation to report to

the board are that:

1. The illegal act has a material effect 11 on the

registrant's financial statements,

---------------------------------------------------------------------------

\11\ The auditor should consider both the quantitative and

qualitative materiality of the act, including contingent liabilities

that might be created by the illegal act. See, e.g., SAS 54, para.

13, AU Sec. 317.13.

---------------------------------------------------------------------------

2. Senior management has not taken, and the board of directors has

not caused senior management to take, timely and appropriate remedial

actions with respect to the illegal act, and

3. The failure to take remedial action is reasonably expected to

warrant either a departure from the auditor's standard audit

report,12 when made, or the auditor's resignation from the audit

engagement.13

---------------------------------------------------------------------------

\12\ See, SAS 58, ``Reports on Audited Financial Statements,''

para. 10, AU Sec. 508.10, for a general discussion of the

circumstances that may require the auditor to depart from the

standard report and the types of opinions, other than the standard

report, that may be expressed by the auditor in various

circumstances.

\13\ Section 10A(b)(2)(A), (B), and (C). See generally, SAS 54,

Paras. 18-22, AU Sec. 317.18-.22.

---------------------------------------------------------------------------

If the board of directors receives a report that the auditor has

reached these conclusions, then the board has one business day to

notify the Commission that it received such a report. If the auditor

does not receive a copy of the board's notice to the Commission within

that one business day period, then by the end of the next business day

the auditor is required to furnish directly to the Commission a copy of

the report given to the board (or the documentation of any oral report

14).15 The auditor's resignation from the audit engagement

does not negate the auditor's obligation to furnish his or her report

to the Commission in these circumstances.16

---------------------------------------------------------------------------

\14\ For documentation requirements under GAAS, see, e.g., SAS

54, para. 17, AU Sec. 317.17, and SAS 61, ``Communication with Audit

Committees,'' para. 3 (January 1, 1989), AU Sec. 380.03.

\15\ Section 10A(b)(3).

\16\ Section 10A(b)(4).

---------------------------------------------------------------------------

Section 10A(c) states that there is no private right of action

against auditors based on any findings, conclusions, or statements

expressed in their reports to the Commission. It should be noted,

however, that this section does not address private rights of action

based on, among other things, the auditor's failure to make the

required report, the auditor's failure to comply with GAAS or

Commission requirements during the conduct of its audit or other work,

or for the preparation of any other reports or statements filed with

the Commission.

Section 10A(d) subjects auditors to civil money penalties if the

Commission finds in a cease and desist proceeding 17 that the

auditor willfully failed to comply with the direct reporting provisions

in section 10A. Similar penalties may be imposed on any person who was

a cause of such a violation.18

---------------------------------------------------------------------------

\17\ Under the Securities Enforcement Remedies and Penny Stock

Reform Act of 1990, Pub. L. 101-429, (the ``Remedies Act'') auditors

are subject to the Commission's cease and desist proceedings under

section 21C of the Exchange Act but not to civil money penalties

under section 21B. Under the Remedies Act, auditors are not subject

to temporary cease and desist orders as set forth in section 21C(c)

of the Exchange Act. Although failure to file a required report may

justify disciplinary proceedings under Rule 102(e) of the

Commission's Rules of Practice, 17 CFR Sec. 201.102(e), auditors are

not subject to civil money penalties in such proceedings.

\18\ Under section 10A(d), the determination to impose a civil

money penalty on auditors and those causing a violation of the

auditor's reporting requirements and the amount of such a penalty

are governed by section 21B of the Exchange Act.

---------------------------------------------------------------------------

Section 10A(e) states that, except for the civil money provisions

in section 10A(d), nothing in section 10A shall be held to limit or

otherwise affect the authority of the Commission under the Exchange

Act.

II. Discussion of Proposed Rules

A. Proposed Rule 10A-1.

Proposed Rule 10A-1 is based on the premise that the notice and

reports under section 10A are to assist the Commission in performing

its enforcement responsibilities and, therefore, will be non-public.

Disclosure to the public of registrants' illegal acts will continue to

be made in modified audit reports 19 or, when the auditor has

resigned, been dismissed, or elected not to stand for re-election, on

Form 8-K 20

[[Page 45732]]

under the Exchange Act and on N-SAR 21 under the Investment

Company Act of 1940 (the ``Investment Company Act''), among others.

---------------------------------------------------------------------------

\19\ For the effect of illegal acts on the audit report, see,

SAS 53, Paras. 26 and 27, AU Sec. 316.26 and .27, and SAS 54,

Paras. 18-21, AU Sec. 317.18-.21. See generally, SAS 58, 64, and 79

reprinted in Reports on Audited Financial Statements (January 1,

1989), which describes the standard report and the various opinions

that may be reflected in the auditor's report. SAS 58, Paras. 7-10,

AU Sec. 508.07-.10.

\20\ Item 4 of Form 8-K, 17 CFR Sec. 249.308, Item 304 of

Regulation S-K, 17 CFR Sec. 229.304, and Item 304 of Regulation S-B,

17 CFR Sec. 228.304. In summary, these provisions state that a

registrant must file a Form 8-K, providing the information required

by item 4 of that form, within five business days of the date that

the registrant's auditor (or an independent accountant upon whom the

auditor expressed reliance in its audit report regarding a

significant subsidiary) resigns, declines to stand for re-election,

or is dismissed, and within five business days of the date a new

auditor is engaged. The registrant is to ask the former auditor to

provide the registrant with a letter indicating whether the former

auditor agrees with the disclosures in the Form 8-K that reports the

termination of the audit engagement and, if not, the respects in

which the auditor disagrees. This letter is to be filed with the

Commission as an exhibit by amendment to the registrant's Form 8-K

within 10 business days of the date that the Form 8-K was filed.

The registrant's Form 8-K must state, among other things:

whether the former auditor resigned, was dismissed, or declined to

stand for re-election and the date thereof; whether the auditor

modified his or her report on the registrant's financial statements

for either of the last two fiscal years and, if so, the nature of

the modification; whether the decision to change auditors was

recommended or approved by the audit committee or board of

directors; whether, in connection with the audits of the financial

statements for the two most recent fiscal years, and any subsequent

interim period, there were any disagreements between the auditor and

the registrant on any matter of accounting principles or practices,

auditing scope or procedure, or financial statement disclosure. The

Form 8-K also must provide disclosure of any instance within the

applicable time period where the former auditor advised the

registrant that (1) the internal controls necessary for the

registrant to develop reliable financial statements did not exist,

(2) information had come to the auditor's attention that led him or

her no longer to be able to rely on management's representations, or

that made the auditor unwilling to be associated with the

registrant's financial statements, (3) there was a need to expand

significantly the scope of the audit and, due to the auditor's

resignation or for any other reason, the scope was not expanded, or

(4) information had come to the auditor's attention affecting the

reliability of past audit reports or financial statements and the

issue had not been resolved to the auditor's satisfaction prior to

the auditor's resignation, dismissal, or declination to stand for

re-election.

\21\ Sub-item 77K of Form N-SAR, 17 CFR Sec. 274.101, requires

investment companies filing Form N-SAR to provide the information

required by item 4 of Form 8-K. Sub-item 77K of Form N-SAR notes

that notwithstanding the requirements in Form 8-K to file more

frequently, registrants need only file such information semi-

annually in accordance with the requirements of Form N-SAR.

---------------------------------------------------------------------------

In testifying on prior bills that contained the same reporting

requirements, the Commission stated, ``[W]e anticipate that reports

filed under section 10A would be confidential and exempt from

disclosure under the Freedom of Information Act.'' 22 The

Commission further noted,

\22\ Testimony of Richard C. Breeden, Chairman, U.S. Securities

and Exchange Commission, Concerning H.R. 574, The Financial Fraud

Detection and Disclosure Act, Before the Subcommittee on

Telecommunications and Finance of the House Committee on Energy and

Commerce, 103d Cong., 1st Sess., 32 (February 18, 1993).

---------------------------------------------------------------------------

Premature disclosure of the issuer and auditor reports could,

among other things, interfere with the Commission's investigation,

deprive the issuer or other persons of the right to a fair trial or

impartial adjudication, constitute an unwarranted invasion of

privacy, or disclose a confidential source. In addition, issuer and

auditor reports under Section 10A might contain confidential

commercial or financial information exempt from disclosure under

FOIA Exemption 4, 5 U.S.C. 552(b)(4).23

\23\ Id.,, at 32 n. 36.

---------------------------------------------------------------------------

The Commission's testimony further states that the direct reporting

provisions in the bill might provide an earlier warning of certain

illegal acts that could allow the Commission to begin enforcement

investigations at an earlier date.24

---------------------------------------------------------------------------

\24\ Id.,T1 at 31.

---------------------------------------------------------------------------

Accordingly, the proposed rule provides that the reports of both

the board and the auditor would be non-public and exempt from

disclosure under the Freedom of Information Act to the same extent as

the Commission's investigative records.\25\

---------------------------------------------------------------------------

\25\ See 5 U.S.C. 552(b)(7), which exempts from disclosure

certain ``records or information compiled for law enforcement

purposes.''

---------------------------------------------------------------------------

Despite the confidential nature of the reports under section 10A,

these reporting requirements should improve the quality of public

disclosures in Forms 8-K and N-SAR and in audit reports on registrants'

financial statements, because it is unlikely that registrants and

auditors will make public disclosures that are incompatible with the

confidential reports made to the Commission. Also, the direct reporting

requirements in section 10A should give auditors additional leverage to

prompt management to correct illegal acts and to make appropriate

adjustments in their financial statements.

Proposed Rule 10A-1 designates the Commission's Office of the Chief

Accountant (``OCA'') as the appropriate office to receive the notice

provided by any registrant under section 10A(b)(3) and any reports

provided by auditors under section 10A(b)(3) or 10A(b)(4). OCA

expeditiously will forward copies of the notice or report to all

appropriate offices and divisions within the Commission. The notice or

report may be provided to other agencies, as appropriate.

Delivery of the notice or report to OCA may occur under proposed

Rule 10A-1 in any manner, provided the notice or report is received by

OCA within the statutory time period. Currently, the most timely manner

of delivery may be through submission of a facsimile,\26\ telegraph, or

personal delivery. In the future, procedures may be developed for

registrants and auditors to deliver confidential information directly

to OCA via electronic mail. Proposed Rule 10A-1 would permit use of

such means of delivery.\27\

---------------------------------------------------------------------------

\26\ The phone number for OCA's facsimile machine currently is

(202) 942-9656. Such phone numbers, however, are subject to change

without notice and registrants and auditors should verify the

accuracy of the number before use.

\27\ A similar provision applies to auditors of broker-dealers.

See Rule 17a-5(h)(2) under the Exchange Act, 17 CFR Sec. 240.17a-

5(h)(2), which states that if, during the course of audit or interim

work, the auditor determines that any material inadequacies exist in

the accounting system, internal accounting control, procedures for

safeguarding securities, or certain other practices and procedures,

then the auditor shall call those inadequacies to the attention of

the chief financial officer of the broker-dealer, who has the

obligation to notify the Commission and the designated examining

authority within 24 hours thereafter. If the auditor does not

receive a copy of that notice within that 24 hour period, or if the

auditor disagrees with the statements in the notice, then the

auditor must inform the Commission and the designated examining

authority of the material inadequacy within the next 24 hours.

---------------------------------------------------------------------------

Proposed Rule 10A-1 sets forth the required contents for a

registrant's notice to the Commission. This notice would be in writing

and identify the registrant and the auditor, state the date the auditor

made its report to the board, and provide a summary of the report. The

required summary would describe the act and the potential impact of

that act on the registrant's financial statements. This information is

consistent with the requirement under GAAS that the auditor's

communication with the registrant's audit committee ``should describe

the act, the circumstances of its occurrence, and the effect on the

financial statements.'' \28\ The proposed rule specifically would

permit a registrant to provide additional information regarding its

view of, and response to, the section 10A report it has received from

the auditor.

---------------------------------------------------------------------------

\28\ SAS 54, para. 17, AU Sec. 317.17.

---------------------------------------------------------------------------

Regarding reports filed by auditors, proposed Rule 10A-1 would

specify that if the report does not identify clearly both the

registrant and the auditor, then the auditor must attach that

information to the report submitted to OCA.

Proposed Rule 10A-1 makes it clear that providing the notice or

report in accordance with section 10A and the proposed rule does not,

in any way, affect the obligations of the registrant and the auditor to

file and make all applicable disclosures required by the Commission's

rules, including, without limitation, Forms 8-K and N-SAR, and of the

auditor to comply with GAAS reporting requirements.\29\ Similarly, the

proposed rule states that the confidential nature of the notice and the

report to the Commission does not diminish a registrant's or auditor's

obligations to make full disclosures required by the Commission's

rules, forms, reports, or disclosure items, or by applicable

professional standards.

---------------------------------------------------------------------------

\29\ In addition, one of the membership requirements of the SEC

Practice Section of the AICPA is that members notify registrants in

writing of the cessation of an auditor-client relationship. The

member also is required to send a copy of that notification to the

Commission's Office of the Chief Accountant.

---------------------------------------------------------------------------

B. Proposed Rule 1-02(d).

The proposed amendment would conform the definition of ``Audit (or

examination)'' in Rule 1-02(d) of Regulation S-X with section 10A, by

noting that audits of the financial statements of Commission

registrants should be performed in accordance with generally accepted

auditing standards as

[[Page 45733]]

may be modified or supplemented by the Commission.

III. Investment Companies

Section 10A and proposed Rule 10A-1 apply to all audits required

pursuant to the Exchange Act, including those prepared on behalf of

investment companies that have reporting obligations under the Exchange

Act.30 The Commission requests comment whether the proposed

reporting requirements under Rule 10A-1 need to be modified to reflect

the operations of investment companies.

---------------------------------------------------------------------------

\30\ See sections 13(a) and 15(d) of the Exchange Act, 15 U.S.C.

78m(a) and 78o(d), and section 30(a) of the Investment Company Act,

15 U.S.C. 80a-29(a). Form N-SAR requires investment companies to

file information with the Commission about their operations,

including audited financial information. Rule 30a-1 under the

Investment Company Act, 17 CFR Sec. 270.30a-1, provides that

investment companies filing annual reports on Form N-SAR are deemed

to have satisfied the reporting requirements of sections 13(a) and

15(d) under the Exchange Act and section 30(a) under the Investment

Company Act.

---------------------------------------------------------------------------

IV. General Request for Comments

The Commission seeks comments from all interested persons wishing

to address any aspect of the proposed rules.

The Commission also is requesting comments on whether the proposed

amendments, if adopted, would have an adverse impact on competition or

would impose a burden on competition that is neither necessary nor

appropriate in furthering the purposes of the Securities Act of 1933

and the Exchange Act. Comments in this regard will be considered by the

Commission in complying with its responsibilities under section 23(a)

of the Exchange Act.31

---------------------------------------------------------------------------

\31\ 15 U.S.C. 78w(a).

---------------------------------------------------------------------------

V. Cost/Benefit Analysis

Comments are requested related to any costs or benefits associated

with the proposed rules. The costs of complying with proposed Rule 10A-

1, which is intended to carry out the purposes of new section 10A the

Exchange Act, are expected to be de minimis. Such costs for a

registrant may include converting the information in the auditor's

report to the board into a notice that conforms to the rule and

delivering that notice, via facsimile or otherwise, to the Commission's

Office of the Chief Accountant. Costs for the auditor may include

assuring that the report to the board identifies the registrant, as

required by the proposed rule, and the cost of delivering that report,

via facsimile or otherwise, to the Commission's Office of the Chief

Accountant.

Benefits would include an earlier warning to the Commission of

possible illegal acts by registrants and potential improvements in

public disclosures in Forms 8-K and N-SAR regarding changes in

registrants' auditors and in audit reports that are modified due to

registrants' illegal acts.

VI. Summary of Regulatory Flexibility Analysis

An Initial Regulatory Flexibility Analysis has been prepared in

accordance with 5 U.S.C. 603 concerning proposed Rule 10A-1. The

analysis notes that the proposed rule is intended to implement the

reporting requirements of section 10A of the Exchange Act.

As discussed more fully in the analysis, the proposed rule would

affect small entities, as defined by the Commission's rules, but would

affect small entities in the same manner as other registrants. The

analysis notes that alternatives that provide for different means of

compliance for small entities or which exempt small entities from the

proposed rules would not be consistent with the statutory requirements.

Moreover, the cost of complying with the proposed rule should be de

minimis, even for small registrants.

Written comments are encouraged with respect to any aspect of the

analysis. Such comments will be considered in the preparation of the

Final Regulatory Flexibility Analysis if the proposed rules are

adopted. A copy of the analysis may be obtained by contacting Robert E.

Burns, Chief Counsel, Office of the Chief Accountant, U.S. Securities

and Exchange Commission, Mail Stop 11-3, 450 Fifth Street, N.W.,

Washington, D.C. 20549.

VII. Paperwork Reduction Act

Proposed Rule 10A-1 contains ``collection of information''

requirements within the meaning of the Paperwork Reduction Act of 1995

[44 U.S.C. 3501 et seq.] and the Commission has submitted the proposed

rules to the Office of Management and Budget for review in accordance

with 44 U.S.C. 3507(d). The title for the collection of information is

``Amendments to Implement Exchange Act Section 10A.''

The Supporting Statement to the Paperwork Reduction Act submission

notes that the proposed rule is intended to implement the reporting

requirements found in recently enacted section 10A of the Exchange Act,

and that the proposed rule would have a negligible effect on the annual

reporting and cost burden of Commission registrants. As discussed

above, the notice provided by the registrant would contain the minimum

amount of information necessary to identify the registrant and the

auditor, indicate the date the auditor provided the report to the board

of directors as specified in section 10A, and summarize the report

given to the board. The summary would be based on information required

to be given to the board of directors under GAAS. The auditor's report,

furnished only in the event that the registrant does not fulfill its

reporting responsibilities, would consist only of the report given to

the board of directors and, if necessary, additional information to

identify clearly the registrant and the auditor.

Potential respondents are entities with reporting obligations under

the Exchange Act and their auditors, although it is anticipated that

the reporting requirements under section 10A rarely will be triggered.

On those rare occasions when the reporting requirement is triggered, it

is estimated that the total recordkeeping and reporting burden, beyond

that directly required by the statute, would not exceed one hour per

respondent.

As notices must be filed by a registrant within one day of

receiving a report from its auditor, and the auditor must file its

report (if necessary) the next day, there are essentially no

recordkeeping or retention requirements.

Filing the notices and reports, when necessary, is required by

section 10A of the Exchange Act and therefore is mandatory. As

explained above, however, the notices and reports will be kept

confidential while the Commission has an enforcement interest in the

information contained in those notices and reports.

Pursuant to 44 U.S.C. Sec. 3506(c)(2)(B), the Commission requests

comments concerning: whether the proposed collection of information is

necessary for the proper performance of the function of the Commission,

including whether the information shall have practical utility; on the

accuracy of the Commission's estimate of the burden of the proposed

collection of information; on the quality, utility, and clarity of the

information to be collected; and whether the burden of collection of

information on those who are to respond, including through the use of

automated collection techniques or other forms of information

technology, may be minimized.

Persons desiring to submit comments on the collection of

information requirements should direct them to the Office of Management

and Budget, Attention: Desk Officer for the Securities and Exchange

Commission,

[[Page 45734]]

Office of Information and Regulatory Affairs, Washington, D.C. 20503,

and also should send a copy of their comments to Jonathan G. Katz,

Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W.,

Washington, D.C. 20549 with reference to File No. S7-20-96. The Office

of Management and Budget is required to make a decision concerning the

collection of information between 30 and 60 days after publication, so

a comment to the Office of Management and Budget is best assured of

having its full effect if the Office of Management and Budget receives

it within 30 days of publication.

List of Subjects

17 CFR Part 210

Accounting, Reporting and recordkeeping requirements, Securities.

17 CFR Part 240

Reporting and recordkeeping requirements, Securities.

Text of Proposed Rulemaking Amendments

In accordance with the foregoing, Title 17, Chapter II of the Code

of Federal Regulations is proposed to be amended as follows:

PART 210--FORM AND CONTENT OF AND REQUIREMENTS FOR FINANCIAL

STATEMENTS, SECURITIES ACT OF 1933, SECURITIES EXCHANGE ACT OF

1934, PUBLIC UTILITY HOLDING COMPANY ACT OF 1935, INVESTMENT

COMPANY ACT OF 1940, AND ENERGY POLICY AND CONSERVATION ACT OF 1975

1. The authority citation for Part 210 is revised to read as

follows:

Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77aa(25),

77aa(26), 78j-1, 78l, 78m, 78n, 78o(d), 78w(a), 78ll(d), 79e(b),

79j(a), 79n, 79t(a), 80a-8, 80a-20, 80a-29, 80a-30, 80a-37(a),

unless otherwise noted.

2. By revising Sec. 210.1-02(d) to read as follows:

Sec. 210.1-02 Definitions of terms used in Regulation S-X (17 CFR part

210).

* * * * *

(d) Audit (or examination). The term audit (or examination), when

used in regard to financial statements, means an examination of the

financial statements by an independent accountant in accordance with

generally accepted auditing standards, as may be modified or

supplemented by the Commission, for the purpose of expressing an

opinion thereon.

* * * * *

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF

1934

3. The authority citation for Part 240 is revised to read as

follows:

Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77eee, 77ggg,

77nnn, 77sss, 77ttt, 78c, 78d, 78i, 78j, 78j-1, 78l, 78m, 78n, 78o,

78p, 78q, 78s, 78w, 78x, 78ll(d), 79q, 79t, 80a-20, 80a-23, 80a-29,

80a-37, 80b-3, 80b-4, and 80b-11, unless otherwise noted.

4. By adding Sec. 240.10A-1 to read as follows:

Sec. 240.10A-1 Notice to Commission of issuers' illegal acts.

(a)(1) If any issuer with a reporting obligation under the Act

receives a report requiring a notice to the Commission in accordance

with section 10A(b)(3) of the Act, 15 U.S.C. 78j-1(b)(3), the issuer

shall provide such notice to the Commission's Office of the Chief

Accountant within the time period prescribed in that section. The

notice may be provided by facsimile, telegraph, personal delivery, or

any other means, provided it is received by the Office of the Chief

Accountant within the required time period.

(2) The notice specified in paragraph (a)(1) of this section shall

be in writing and:

(i) Shall identify the issuer (including the issuer's name,

address, phone number, and file number assigned to the issuer's filings

by the Commission) and the independent accountant (including the

independent accountant's name and phone number, and the address of the

independent accountant's residence or principal office);

(ii) Shall state the date that the issuer received from the

independent accountant the report specified in section 10A(b)(2) of the

Act, 15 U.S.C. 78j-1(b)(2);

(iii) Shall provide a summary of the independent accountant's

report, including a description of the act that the independent

accountant has identified as a likely illegal act and the potential

impact of that act on all affected financial statements of the issuer

or those related to the most current three year period, whichever is

shorter; and

(iv) May provide additional information regarding the issuer's

views of and response to the independent accountant's report.

(3) Provision of the notice in paragraphs (a)(1) and (a)(2) of this

section does not relieve the issuer from its obligations to comply

fully with any other reporting requirements, including, without

limitation:

(i) The filing requirements of Form 8-K, Sec. 249.308 of this

chapter, and Form N-SAR, Sec. 274.101 of this chapter, regarding a

change in the issuer's certifying accountant and

(ii) The disclosure requirements of item 304 of Regulation S-B or

item 304 of Regulation S-K, Secs. 228.304 and 229.304 of this chapter.

(b)(1) Any independent accountant furnishing to the Commission a

copy of a report (or the documentation of any oral report) in

accordance with section 10A(b)(3) or section 10A(b)(4) of the Act, 15

U.S.C. 78j-1(b)(3) or 78j-1(b)(4), shall provide that report (or

documentation) to the Commission's Office of the Chief Accountant

within the time period prescribed by the appropriate section of the

Act. The report (or documentation) may be provided to the Commission's

Office of the Chief Accountant by facsimile, telegraph, personal

delivery, or any other means, provided it is received by the Office of

the Chief Accountant within the time period set forth in section

10A(b)(3) or 10A(b)(4) of the Act, 15 U.S.C. 78j-1(b)(3) or 78j-

1(b)(4), whichever is applicable in the circumstances.

(2) If the report (or documentation) provided to the Office of the

Chief Accountant in accordance with paragraph (b)(1) of this section

does not clearly identify both the issuer (including the issuer's name,

address, phone number, and file number assigned to the issuer's filings

with the Commission) and the independent accountant (including the

independent accountant's name and phone number, and the address of the

independent accountant's residence or principal office), then the

independent accountant shall place that information in a prominent

attachment to the report (or documentation) and shall provide that

attachment to the Office of the Chief Accountant at the same time and

in the same manner as the report (or documentation) is provided to that

Office.

(3) Provision of the report (or documentation) by the independent

accountant as described in paragraphs (b)(1) and (b)(2) of this section

does not replace, or otherwise satisfy the need for, the newly engaged

and former accountants' letters under items 304(a)(2)(D) and 304(a)(3)

of Regulation S-K, Secs. 229.304(a)(2)(D) and 229.304(a)(3) of this

chapter, respectively, and under items 304(a)(2)(D) and 304(a)(3) of

Regulation S-B, Secs. 228.304(a)(2)(D) and 228.304(a)(3) of this

chapter, respectively, and does not limit, reduce, or affect in any way

the independent accountant's obligations to comply fully with all other

legal or professional

[[Page 45735]]

responsibilities, including, without limitation, those under generally

accepted auditing standards and the rules or interpretations of the

Commission that modify or supplement those auditing standards.

(c) Notices and reports furnished to the Office of the Chief

Accountant in accordance with paragraphs (a) and (b) of this section

shall be non-public and exempt from disclosure pursuant to the Freedom

of Information Act to the same extent and for the same periods of time

that the Commission's investigative records are non-public and exempt

from disclosure under, among other applicable provisions, 5 U.S.C.

552(b)(7) and Sec. 200.80(b)(7) of this chapter. The preceding sentence

shall not relieve, limit, delay, or affect in any way, any issuer's or

independent accountant's obligations to provide all public disclosures

required by law, by any Commission disclosure item, rule, report, or

form, or by any applicable accounting, auditing, or professional

standard.

By the Commission.

Dated: August 22, 1996.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 96-21889 Filed 8-28-96; 8:45 am]

BILLING CODE 8010-01-P