Disclosure Required by Sections 404, 406 and 407 of the Sarbanes- Oxley Act of 2002

Federal RegisterOct 30, 2002

Ask Donna

What actually matters in this document.

Text

Part II

Securities and Exchange Commission

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17 CFR Parts 210, 228, et al.

Disclosure Required by Sections 404, 406 and 407 of the Sarbanes-Oxley

Act of 2002; Proposed Rule

Federal Register&thnsp;/&thnsp;Vol. 67, No. 210&thnsp;/

&thnsp;Wednesday, October 30, 2002&thnsp;/&thnsp;Proposed Rules

[[Page 66208]]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 210, 228, 229, 240, 249, 270 and 274

[Release Nos. 33–8138; 34–46701; IC–25775; File No.

S7–40–02]

RIN 3235–AI66

Disclosure Required by Sections 404, 406 and 407 of the Sarbanes-

Oxley Act of 2002

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: We propose to require companies to include a number of new

disclosures in their Exchange Act filings. First, companies would be

required to disclose the number and names of persons that the board of

directors has determined to be the “financial experts”

serving on the company's audit committee and whether they are

independent of management, and if not, an explanation of why they are

not. Second, companies would be required to include an annual internal

control report of management stating the following: management's

responsibilities for establishing and maintaining adequate internal

controls and procedures for financial reporting for the company;

management's conclusions about the effectiveness of the company's

internal controls and procedures for financial reporting as of the end

of the company's most recent fiscal year; and that the company's

registered public accounting firm has attested to, and reported on,

management's evaluation of the company's internal controls and

procedures for financial reporting. Third, companies would be required

to disclose whether they have adopted a code of ethics that covers

their principal executive officers and senior financial officers, or if

they have not, an explanation of why they have not, as well as

amendments to, and waivers from, the code of ethics relating to any of

those officers. These proposed rules would implement the requirements

in sections 404, 406 and 407 of the Sarbanes-Oxley Act of 2002. We also

propose to make revisions to our recently adopted rules requiring a

company's principal executive and financial officers to certify the

company's quarterly and annual reports and requiring the company to

conduct quarterly evaluations of its disclosure procedures and

controls. These rules would be amended to require quarterly and annual

certifications and quarterly evaluations of internal controls and

procedures for financial reporting. We also would amend the form of the

principal officers' certification contained in the quarterly and annual

report forms.

DATES: Comments should be received on or before November 29, 2002.

ADDRESSES: To help us process and review your comments more

efficiently, comments should be sent by hard copy or e-mail, but not by

both methods.

Comments sent by hard copy should be submitted in triplicate to

Jonathan G. Katz, Secretary, U.S. Securities and Exchange Commission,

450 Fifth Street, NW., Washington, DC 20549–0609. Comments also

may be submitted electronically at the following e-mail address: rule-

comments&commat;sec.gov. All comment letters should refer to File No.

S7–40–02; if e-mail is used, this file number should be

included in the subject line. Comment letters will be available for

inspection and copying in the Commission's Public Reference Room, 450

Fifth Street, NW., Washington, DC 20549–0102. Electronically

submitted comment letters will be posted on the Commission's Internet

Web site (http://www.sec.gov).\1\

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\1\&thnsp;We do not edit personal information, such as names or

electronic mail addresses, from electronic submissions. You should

submit only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: Ray Be, Special Counsel, or N. Sean

Harrison, Special Counsel, Division of Corporation Finance, at (202)

942–2910, with respect to registered investment companies, Katy

Mobedshahi, Senior Counsel, Division of Investment Management, at (202)

942–0721, or with respect to accounting issues, Michael Thompson,

Professional Accounting Fellow, Office of Chief Accountant, at (202)

942–4400, U.S. Securities and Exchange Commission, 450 Fifth

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Street, NW., Washington, DC 20549.

SUPPLEMENTARY INFORMATION: We are proposing amendments to Form

8–K,\2\ Form 10–K,\3\ Form 10–KSB,\4\ Form

10–Q,\5\ Form 10–QSB,\6\ Form 20–F,\7\ Form

40–F,\8\ Form 12b–25,\9\ Rule 12b–25,\10\ Rule

13a–14,\11\ Rule 13a–15,\12\ Rule 15d–14,\13\ and

Rule 15d–15\14\ under the Securities Exchange Act of 1934,\15\

Regulation S–B,\16\ Regulation S–K&thnsp;\17\ and

Regulation S–X.\18\ We are also proposing amendments to Form

N–SAR&thnsp;\19\ and proposed Form N–CSR&thnsp;\20\ under

the Securities Exchange Act of 1934 and the Investment Company Act of

1940,\21\ and Rule 30a–2&thnsp;\22\ and proposed Rule 30a–3

under the Investment Company Act of 1940.

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\2\&thnsp;17 CFR 249.308.

\3\&thnsp;17 CFR 249.310.

\4\&thnsp;17 CFR 249.310b.

\5\&thnsp;17 CFR 249.308a.

\6\&thnsp;17 CFR 249.308b.

\7\&thnsp;17 CFR 249.220f.

\8\&thnsp;17 CFR 249.240f.

\9\&thnsp;17 CFR 249.322.

\10\&thnsp;17 CFR 240.12b–25.

\11\&thnsp;17 CFR 240.13a–14.

\12\&thnsp;17 CFR 240.13a–15.

\13\&thnsp;17 CFR 140.15d–14.

\14\&thnsp;17 CFR 240.15d–15.

\15\&thnsp;15 U.S.C. 78a et seq.

\16\&thnsp;17 CFR 228.10 et seq.

\17\&thnsp;17 CFR 229.10 et seq.

\18\&thnsp;17 CFR 210.1–01 et seq.

\19\&thnsp;17 CFR 249.330; 17 CFR 274.101.

\20\&thnsp;17 CFR 249.331; 17 CFR 274.128.

\21\&thnsp;15 U.S.C. 80a–1 et seq.

\22\&thnsp;17 CFR 270.30a–2.

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I. Background

The strength of the U.S. financial markets depends on investor

confidence. Recent events involving allegations of misdeeds by

corporate executives, independent auditors and other market

participants have undermined that confidence.\23\ In response to this

threat to the U.S. financial markets, Congress passed, and the

President signed into law, the Sarbanes-Oxley Act of 2002 (the

“Sarbanes-Oxley Act”),\24\ which effects sweeping corporate

disclosure and financial reporting reform.

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\23\&thnsp;See, for example, John Waggoner and Thomas A.

Fogarty, “Scandals Shred Investors” Faith: Because of

Enron, Andersen and Rising Gas Prices, the Public Is More Wary Than

Ever of Corporate America,” USA Today, May 5, 2002, and Louis

Aguilar, “Scandals Jolting Faith of Investors,” Denver

Post, June 27, 2002.

\24\&thnsp;Pub. L. 107–204, 116 Stat. 745 (2002).

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This release is one of several that the Commission is required to

issue to implement provisions of the Sarbanes-Oxley Act. In this

release we propose rules to implement the following three provisions of

the Sarbanes-Oxley Act:

&sbull;&ensp;Section 407, requiring the Commission to adopt rules:

(1) requiring a company to disclose whether its audit committee

includes at least one member who is a financial expert; and (2)

defining the term “financial expert”;

&sbull;&ensp;Section 406, requiring the Commission to adopt rules

requiring a company to disclose whether it has adopted a code of ethics

for the company's senior financial officers, and if not, the reasons

therefor, as well as any changes to, or waiver of any provision of,

that code of ethics; and

&sbull;&ensp;Section 404, requiring the Commission to adopt rules

requiring a company's management to present an internal control report

in the company's annual report containing: (1) A

[[Page 66209]]

statement of the responsibility of management for establishing and

maintaining an adequate internal control structure and procedures for

financial reporting; and (2) an assessment, as of the end of the

company's most recent fiscal year, of the effectiveness of the

company's internal control structure and procedures for financial

reporting. Section 404 also requires the company's registered public

accounting firm&thnsp;\25\ to attest to, and report on, management's

assessment.

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\25\&thnsp;The term “registered public accounting

firm” is defined in section 2(a)(12) of the Sarbanes-Oxley Act

to mean a public accounting firm registered with the Public Company

Accounting Oversight Board (the “PCAOB”) in accordance

with the Sarbanes-Oxley Act.

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In connection with our proposed rules to implement the internal control

report requirements included in section 404 of the Sarbanes-Oxley Act,

we also propose several conforming revisions to our recently adopted

certification rules and related requirements.\26\

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\26\&thnsp;These include Exchange Act Rules 13a–14,

13a–15, 15d–14, 15d–15, Investment Company Act

Rules 30a–2 and 30a–3, Item 307 of Regulations S–B

and S–K and the forms of certification included in Forms

10–Q, 10–QSB, 10–K, 10–KSB, 20–F,

40–F, N–SAR and N–CSR.

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II. Discussion of Proposals

A. Proposed Disclosure About Financial Experts Serving on a Company's

Audit Committee

Many of the recent corporate scandals have centered on the quality

of a company's financial disclosure. These events have, among other

things, highlighted problems that can occur as a result of inadequate

oversight of a company's management and auditors by the company's board

of directors or audit committee. The Commission historically has

encouraged companies to establish independent audit committees to

oversee the work and independence of auditors. For example, in 1972 the

Commission recommended that companies establish audit committees

composed of outside directors.\27\ Others have expressed their support

for independent audit committees, including the National Commission on

Fraudulent Financial Reporting, also known as the Treadway

Commission,\28\ and the General Accounting Office.\29\ In 1999, we

adopted rules requiring companies to disclose whether their audit

committee members are independent, as defined by the relevant listing

standards.\30\

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\27\&thnsp;Accounting Series Release (ASR) 123 (March 23, 1972).

\28\&thnsp;See the Report of the National Commission on

Fraudulent Financial Reporting (1987). This commission, also known

as the Treadway Commission, was sponsored by the AICPA, the American

Accounting Association, the Financial Executives Institute (now

Financial Executives International), the Institute of Internal

Auditor and the National Association of Accountants. Collectively,

these groups were known as the Committee of Sponsoring

Organizations, or COSO.

\29\&thnsp;GAO, “CPA Audit Quality: Status of Actions

Taken to Improve Auditing and Financial Reporting of Public

Companies,” at 5 (GAO/AFMD–89–38, March 1989).

\30\&thnsp;Release No. 34–42266 (Dec. 22, 1999) [64 FR

73389]. This release addressed numerous issues related to auditor

independence.

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In 1998, the New York Stock Exchange, Inc. (the “NYSE”)

and the National Association of Securities Dealers, Inc. (the

“NASD”) sponsored a committee to study the effectiveness of

audit committees. This committee became known as the Blue Ribbon

Committee on Improving the Effectiveness of Corporate Audit Committees

(the “Blue Ribbon Committee”). In its 1999 report, the Blue

Ribbon Committee recognized the importance of the audit committee in

overseeing the corporate accounting and financial controls and

reporting of companies.\31\ The Blue Ribbon Committee noted that,

because of this important role, an audit committee has “a more

recognizable need for members with accounting and/or related financial

expertise.” Without some level of financial competence, members

of an audit committee may be unable to adequately perform their vital

corporate duties. In response to this report, the NYSE, the NASD,\32\

the American Stock Exchange, Inc. (the “AMEX”) and the

Pacific Exchange, Inc. (the “PCX”) adopted rules regarding

the composition of listed companies” audit committees.\33\

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\31\&thnsp;See Report and Recommendations of the Blue Ribbon

Committee on Improving the Effectiveness of Corporate Audit

Committees (1999).

\32\&thnsp;The NASD rules referred to herein apply to NASDAQ

listed companies.

\33\&thnsp;NYSE Rule 303.01, NASD Rule 4350(d)(2), AMEX Company

Guide §&thnsp;121 and PCX Equities Rule 5.3(b). See also

Release No. 34–42233 (December 14, 1999) [64 FR 71529],

Release No. 34–42231 (December 14, 1999) [64 FR 71523],

Release No. 34–42232 (December 14, 1999) [64 FR 71518], and

Release No. 34–43941 (February 7, 2001) [66 FR 10545]

respectively.

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The NYSE's and the PCX's rules require at least one member of a

listed company's audit committee to have “accounting or related

financial management expertise, as the Board of Directors interprets

such qualification in its business judgment.”&thnsp;\34\ The NASD

and the AMEX have similar rules that require each listed company to

certify that it has, and will continue to have, at least one member of

the audit committee that has past employment experience in finance or

accounting, a professional certification in accounting, or comparable

experience or background that demonstrates the individual's financial

sophistication.\35\ These rules provide, by way of example, that a

person who is or has been a chief executive officer, chief financial

officer or other senior corporate officer with financial oversight

responsibilities satisfies this criterion. In addition, all four self-

regulatory organizations require all members of the audit committee to

be independent and to be (or soon become) financially literate, subject

to limited exceptions.\36\ While the NYSE and PCX rules permit a

company's board of directors to interpret the financial literacy

requirements, the NASD and AMEX rules define financial literacy as

“the ability to read and understand fundamental financial

statements, including a company's balance sheet, income statement, and

cash flow statement.”&thnsp;\37\

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\34\&thnsp;NYSE Rule 303.01 and PCX Rule 5.3(b).

\35\&thnsp;NASD Rule 4350(d)(2) and AMEX Company Guide

§&thnsp;121.

\36\&thnsp;For example, the NASD Manual states that audit

committee members must become able to read and understand

fundamental financial statements within a reasonable time after

being appointed to the audit committee. Similarly, the NYSE listing

standard require such appointees to become financially literate, as

that term is interpreted by the board of directors, within a

reasonable period of time after appointment. Therefore, these rules

do not require that members be so qualified at the time of

appointment. Also, in general, with respect to foreign private

issuers, the self-regulatory organization rules accommodate

differences in home country practices regarding, among other things,

audit committee composition. The Sarbanes-Oxley Act does not exempt

foreign private issuers from the financial expert disclosure

requirements. Our proposed rules similarly do not include an

exemption for foreign private issuers.

\37\&thnsp;Id.

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Although the NYSE, NASD, AMEX and PCX already have rules regarding

the financial expertise of audit committee members, not all companies

that are required to file reports under Sections 13(a) and 15(d) of the

Exchange Act are subject to these requirements. Furthermore, the

Sarbanes-Oxley Act directs us to adopt rules defining the term

“financial expert” and specifies several attributes that we

must consider in crafting the definition. These attributes are more

detailed and rigorous than those reflected in the current self-

regulatory organization rules. Therefore, it is possible that a person

who previously qualified as a financial expert under the broader

guidelines included in the rules of the self-regulatory organizations

may not have sufficient expertise and experience to be considered a

financial expert under our proposed rules.\38\ In particular, our

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proposed rules would require a financial expert to have experience

preparing or auditing financial statements of a company that files

reports with us and experience with internal controls and procedures

for financial reporting (or similar expertise and experience in the

board of directors' judgment). The proposed disclosure requirements

regarding audit committee financial experts are described below.

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\38\&thnsp;The NYSE has indicated that it will await the

Commission's interpretation of the definition of the term

“financial expert” before proposing amendments to its

rules. See File No. SR–NYSE–2002–33 (pending

before the Commission). The NASD has indicated that it intends to

file rule proposals for the Nasdaq Stock Market with the Commission

addressing similar issues. Although we will continue to work with

the self-regulatory organizations to reconcile to the extent

possible the various definitions of expert.

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1. Proposed Disclosure Requirements

We propose to add new Item 309 to Regulations S–K and

S–B. In addition, we propose to add new Item 15(b) to Form

20–F and new Instruction B.(8) to Form 40–F. These proposed

items would be identical in substance and entitled, “Audit

Committee Financial Experts.” The proposed items would require

companies to disclose:

&sbull;&ensp;The number and names of persons that the board of

directors has determined to be the financial experts serving on the

company's audit committee; and

&sbull;&ensp;Whether the financial expert or experts are

“independent,” as that term is used in section 10A(m)(3) of

the Exchange Act, and if not, an explanation of why they are not.\39\

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\39\&thnsp;15 U.S.C. 78j–1(m)(3). The Sarbanes-Oxley Act

amended the Exchange Act to add this section.

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If the company does not have a financial expert serving on its audit

committee, the company must disclose that fact and explain why it has

no financial expert. For purposes of the proposed disclosure, the term

“audit committee” would be defined by section 3(a)(58) of

the Exchange Act.\40\

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\40\&thnsp;Section 3(a)(58) of the Exchange Act, as amended by

the Sarbanes-Oxley Act, defines the term “audit

committee” as “a committee (or equivalent body)

established by and amongst the board of directors of an issuer for

the purpose of overseeing the accounting and financial reporting

processes of the issuer and audits of the financial statements of

the issuer; and *&ensp;*&ensp;* if no such committee exists with

respect to an issuer, the entire board of directors of the

issuer.” 15 U.S.C. 78c(a)(58).

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Although the Sarbanes-Oxley Act does not specifically require

disclosure of the number or names of the financial experts,\41\ we

believe that it is appropriate to propose these requirements. Investors

likely would be interested in knowing how many financial experts a

company's board has determined are serving on its audit committee, or

whether it has determined that all of the audit committee members are

financial experts. Furthermore, disclosure of the names of the

company's financial expert or experts would assist investors in

evaluating the company's annual report and proxy or information

statement disclosure that describes the background and business

experience of the company's directors.\42\

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\41\&thnsp;The Sarbanes-Oxley Act only directs the Commission to

adopt rules requiring disclosure of whether or not the audit

committee has at least one member who is a financial expert and, if

not, why. See section 407 of the Sarbanes-Oxley Act.

\42\&thnsp;See Item 401(e) of Regulation S–K and Item

401(a)(4) of Regulation S–B [17 CFR 229.401(e) and

228.401(a)(4)].

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The primary benefit of having a financial expert serving on a

company's audit committee is that the person, with his or her enhanced

level of financial sophistication or expertise, can serve as a resource

for the audit committee as a whole in carrying out its functions.\43\

The mere designation of the financial expert should not impose a higher

degree of individual responsibility or obligation on a member of the

audit committee. Nor do we intend for the financial expert designation

to decrease the duties and obligations of other audit committee members

or the board of directors. Furthermore, in order to avoid any confusion

in the context of section 11 of the Securities Act,\44\ we do not

intend for such a person to be considered an expert for purposes of

section 11 solely as a result of his or her designation as a financial

expert on the audit committee. The role of the financial expert is to

assist the audit committee in overseeing the audit process, not to

audit the company. A conclusion that a financial expert is an

“expert” for purposes of section 11 might suggest a higher

level of due diligence than is consistent with the audit committee's

oversight responsibilities.

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\43\&thnsp;See Report and Recommendations of the Blue Ribbon

Committee on Improving the Effectiveness of Corporate Audit

Committees (1999).

\44\&thnsp;15 U.S.C. 77k.

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Section 407 of the Sarbanes-Oxley Act does not require disclosure

of whether the financial expert is independent. However, we believe

that such disclosure may be important to investors. Investors may be

interested to know, for example, if the only financial expert on the

audit committee is the company's chief financial officer or another

individual who is responsible for, or participates in, the preparation

of the company's financial statements. Therefore, we propose to require

disclosure of whether the identified financial expert or experts on the

audit committee are independent, as that term is used in section

10A(m)(3) of the Exchange Act, and if not, an explanation of why they

are not. In addition, we intend to propose rules directing the national

securities exchanges and national securities association to require a

company to have a completely independent audit committee as a condition

to listing.\45\

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\45\&thnsp;See section 301 of the Sarbanes-Oxley Act.

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Some companies do not have boards of directors and therefore do not

have board audit committees. For example, some limited liability

companies and limited partnerships that do not have a corporate general

partner may not have an oversight body that is the equivalent of an

audit committee. It may be important to investors to be aware that such

entities do not have such oversight bodies. Therefore, we do not

propose to exempt these entities from the proposed financial expert

disclosure requirements. If a limited liability company or limited

partnership does not have a similar oversight body, it must explain

that its organizational structure does not provide for such a body and

that it therefore does not have an audit committee. We do, however,

propose to exempt asset-backed issuers from this proposed disclosure

requirement. Because of the nature of these entities, such issuers are

subject to substantially different reporting requirements. Most

significantly, such issuers are not required to file financial

statements like other companies. Therefore, we do not believe

disclosure of whether such companies have a financial expert on its

audit committee would be of interest to investors.

Request for Comment

&sbull;&ensp;Would investors benefit from disclosure of the number

of the financial experts serving on the company's audit committee? Or

would it suffice to require disclosure only of whether at least one

financial expert serves on the audit committee?

&sbull;&ensp;Do investors need to know the names of the financial

experts on the audit committee? Would disclosure of the names

discourage people from serving as financial experts on an audit

committee?

&sbull;&ensp;Should the Commission specifically address the issue

of the degree of individual responsibility, obligation or liability

under state or federal law of a person designated as a financial expert

as a result of the designation? If the Commission should address this

issue, how should it do so?

&sbull;&ensp;Should we use a term other than “financial

expert”? For example, would

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the term “audit committee financial expert” be a more

appropriate title?

&sbull;&ensp;Is there other relevant information about the

financial expert or experts that a company should have to disclose? For

example, should we expand the disclosure required under Item 401(e) of

Regulations S–K and S–B, as it relates to directors that

the company has determined to be financial experts? If so, how?

&sbull;&ensp;Should we require disclosure of whether the financial

experts are independent, as proposed? If so, should we define

“independent” in the same manner as the term is used in

section 10A(m)(3) of the Exchange Act?

&sbull;&ensp;Should we incorporate an independence requirement into

the definition of “financial expert” so that any designated

financial expert must be independent to qualify under the definition?

2. Proposed Definition of “Financial Expert”

The Sarbanes-Oxley Act requires the Commission, in defining the

term “financial expert,” to consider whether a person has,

through education and experience as a public accountant or auditor or a

principal financial officer, controller,\46\ or principal accounting

officer of an issuer, or from a position involving the performance of

similar functions:

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\46\&thnsp;The Sarbanes-Oxley Act uses the term

“comptroller.” It is our understanding that a

comptroller position generally is the position in a government

agency or non-profit organization with oversight responsibilities

for the agency's or organization's primary accounting function. We

believe that for-profit organizations typically use the term

“controller” to describe this function. Therefore,

throughout this release, we have used the term

“controller” instead of the term

“comptroller.”

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(1) An understanding of generally accepted accounting principles

and financial statements;

(2) Experience in: (a) The preparation or auditing of financial

statements of generally comparable issuers; and (b) the application of

such principles in connection with the accounting for estimates,

accruals, and reserves;

(3) Experience with internal accounting controls; and

(4) An understanding of audit committee functions.

The “financial expert” definition included in the

proposed rules incorporates these four “attributes” with

several modifications.\47\ We also propose to require the financial

expert's experience to be related to companies that were, at the time

he or she held the position, publicly reporting companies. We believe

this requirement is appropriate because a person with experience as a

principal financial officer or principal accounting officer of a

private company may not have been exposed to the reporting requirements

of public companies.

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\47\&thnsp;See Instructions 1–4 to proposed Item 309 of

Regulations S–K and S–B. In particular, we propose to

break the four attributes into five attributes and several changes

to clarify that the required attributes include experience applying

generally accepted accounting principles in connection with the

accounting for estimates, accruals and reserves that are generally

comparable to those, if any, used in the company's financial

statements, and experience preparing or auditing financial

statements that present accounting issues that are generally

comparable to those raised by the company's financial statements.

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Moreover, the proposed definition states that the board of

directors can conclude that a person is a financial expert if, in lieu

of having experience as a public accountant, auditor, principal

financial officer, principal accounting officer, or controller, or

experience in a position involving the performance of similar

functions, the person has experience in a position that results, in the

judgment of the board of directors, in the person having similar

expertise and experience. If the board makes such a determination, it

would be required to disclose the basis for that determination. To

qualify as a financial expert, a person would, in all cases, have to

possess all of the attributes listed in the proposed definition.

The instructions to proposed Item 309 of Regulations S–K and

S–B would therefore define the term “financial

expert” to mean a person who has, through education and

experience as a public accountant or auditor or a principal financial

officer, controller, or principal accounting officer of a company that,

at the time the person held such position, was required to file reports

pursuant to section 13(a) or 15(d) of the Exchange Act, or experience

in one or more positions that involve the performance of similar

functions (or that results, in the judgment of the company's board of

directors, in the person's having similar expertise and experience),

the following attributes:

a. An understanding of generally accepted accounting principles and

financial statements;

b. Experience applying such generally accepted accounting

principles in connection with the accounting for estimates, accruals,

and reserves that are generally comparable to the estimates, accruals

and reserves, if any, used in the registrant's financial statements;

c. Experience preparing or auditing financial statements that

present accounting issues that are generally comparable to those raised

by the registrant's financial statements;

d. Experience with internal controls and procedures for financial

reporting;&thnsp;\48\ and

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\48\&thnsp;Section 407 of the Sarbanes-Oxley Act states that,

among other attributes, the SEC, in defining the term

“financial expert,” should consider whether a person has

experience with internal accounting controls. This release proposes

rules under section 404, which would require an annual report by

management evaluating the effectiveness of its internal controls and

procedures for financial accounting (a defined term). We believe

that this term has substantially the same meaning as “internal

accounting controls” in section 407. Therefore, we propose to

use the newly defined term for consistency.

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e. An understanding of audit committee functions.

In determining whether a potential financial expert has all of the

requisite attributes, the board of directors&thnsp;\49\ must evaluate

the totality of an individual's education and experience.\50\ The

company should consider a variety of factors in making that evaluation,

including:

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\49\&thnsp;See section II.A.3., Determination by the Board of

Directors of Who Is a Financial Expert, below.

\50\&thnsp;This approach is consistent with the approach taken

in NASD and NYSE rules. The NASD requires each issuer to have

“at least one member of the audit committee that has past

employment experience in finance and accounting, requisite

professional certification in accounting, or any other comparable

experience or background which results in the individual's financial

sophistication, including being or having been a chief executive

officer, chief financial officer or other senior officer with

financial oversight responsibilities.” NASD Rule

4350(d)(2)(A). Similarly, the NYSE requires at least one member who

has “accounting or related financial management

expertise.” NYSE Listed Company Manual 303.01. Both of these

provisions focus on the level of expertise without providing any

mechanical formula for determining whether an individual has the

requisite expertise.

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&sbull;&ensp;The level of the person's accounting or financial

education, including whether the person has earned an advanced degree

in finance or accounting;

&sbull;&ensp;Whether the person is a certified public accountant,

or the equivalent, in good standing, and the length of time that the

person actively has practiced as a certified public accountant, or the

equivalent;

&sbull;&ensp;Whether the person is certified or otherwise

identified as having accounting or financial experience by a recognized

private body that establishes and administers standards in respect of

such expertise, whether that person is in good standing with the

recognized private body, and the length of time that the person has

been actively certified or identified as having this expertise;

&sbull;&ensp;Whether the person has served as a principal financial

officer, controller or principal accounting officer of a company that,

at the time the person held such position, was required to file reports

pursuant to section 13(a) or 15(d) of the Exchange Act, and if so, for

how long;

[[Page 66212]]

&sbull;&ensp;The person's specific duties while serving as a public

accountant, auditor, principal financial officer, controller, principal

accounting officer or position involving the performance of similar

functions;

&sbull;&ensp;The person's level of familiarity and experience with

all applicable laws and regulations regarding the preparation of

financial statements that must be included in reports filed under

section 13(a) or 15(d) of the Exchange Act;

&sbull;&ensp;The level and amount of the person's direct experience

reviewing, preparing, auditing or analyzing financial statements that

must be included in reports filed under section 13(a) or 15(d) of the

Exchange Act;

&sbull;&ensp;The person's past or current membership on one or more

audit committees of companies that, at the time the person held such

membership, were required to file reports pursuant to section 13(a) or

15(d) of the Exchange Act;

&sbull;&ensp;The person's level of familiarity and experience with

the use and analysis of financial statements of public companies; and

&sbull;&ensp;Whether the person has any other relevant

qualifications or experience that would assist him or her in

understanding and evaluating the registrant's financial statements and

other financial information and to make knowledgeable and thorough

inquiries whether:

&sbull;&ensp;The financial statements fairly present the financial

condition, results of operations and cash flows of the company in

accordance with generally accepted accounting principles; and

&sbull;&ensp;The financial statements and other financial

information, taken together, fairly present the financial condition,

results of operations and cash flows of the company.

In the case of a foreign private issuer, the board of directors

also should consider the person's experience with public companies in

the foreign private issuer's home country, generally accepted

accounting principles used by the issuer, and the reconciliation of

financial statements with U.S. generally accepted accounting

principles.

This is not intended to be an exhaustive list of the factors that

the board of directors should consider in assessing whether a person

qualifies as a financial expert. Moreover, the proposed rules do not

specify the number of listed factors that a financial expert should

satisfy; satisfaction of any specific number of factors would be

neither necessary nor sufficient for a person to be considered a

financial expert. Most of these factors require a qualitative

assessment of a potential expert's level of knowledge or experience.

The fact that a person previously has served on an audit committee

would not, by itself, justify the board of directors in

“grandfathering” that person as a financial expert under

our proposed definition. Similarly, the fact that a person has

experience as a public accountant or auditor, or a principal financial

officer, controller or principal accounting officer or experience in a

similar position would not, by itself, justify the board of directors

in deeming the person to be a financial expert. The board of directors

would have to confirm that these persons have the requisite attributes

and the right mix of education and experience.

Some individuals who are particularly knowledgeable and experienced

in accounting and financial issues may have the requisite attributes

and mix of knowledge and experience to qualify as financial experts,

even though they may not have served in one of the specifically

identified positions. The board of directors would have to determine

whether an individual's qualifications, in the aggregate, satisfy the

financial expert definition.

Because of the significant role the audit committee plays in the

filing of a public company's financial statement, including the

preparation and filing of their own report, we would find it hard to

believe that an accountant serving as a financial expert on an audit

committee would not be practicing before the Commission.\51\ Therefore,

any accountant, while suspended or barred from practice under Rule

102(e)&thnsp;\52\ of the Commission's Rules of Practice, generally

would not be eligible to serve as a financial expert.

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\51\&thnsp;See 17 CFR 201.102(f).

\52\&thnsp;See 17 CFR 201.102(e).

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Request for Comment

&sbull;&ensp;Should we modify the proposed definition of

“financial expert” in any way? If so, how?

&sbull;&ensp;Should we require a financial expert to have direct

experience preparing or auditing financial statements of reporting

companies? Should experience reviewing or analyzing such financial

statements suffice? If so, why?

&sbull;&ensp;Should a financial expert have to possess all of the

“attributes” listed in the proposed definition? Should we

broaden the scope of individuals who may qualify as such an expert?

&sbull;&ensp;Do the five attributes adequately describe the

qualities that a financial expert should have? Should we add any

attributes?

&sbull;&ensp;Although we do not intend for the list of factors that

a company should consider in assessing a potential financial expert's

qualifications to be exhaustive, should we add any factors to the list?

If so, what other factors should we include? Conversely, should we

delete any proposed factors from the list? If so, which factors should

we delete?

&sbull;&ensp;Should the proposed rules provide for a different

standard or methodology for assessing a financial expert's

qualifications? If so, describe the preferred standard or methodology.

3. Determination by the Board of Directors of Who Is a Financial Expert

The Sarbanes-Oxley Act does not explicitly state who at the company

should determine whether any of the audit committee members is a

financial expert. Management is responsible for preparing the financial

statements. Therefore, it seems inappropriate for management to assess

the qualifications of audit committee members. Similarly, it does not

seem appropriate for the members of the audit committee, alone, to

assess their own qualifications. We believe that the board of directors

in its entirety, as the most broad-based body within the company, is

best-equipped to make the decision. Therefore, we propose to require

the company to disclose the number and names of the persons that the

board of directors has determined to be the financial expert or experts

serving on the company's audit committee.

Certain foreign private issuers have a two-tier board, with one

tier designated as the management board and the other tier designated

as the supervisory or non-management board. In this circumstance, we

believe that the supervisory or non-management board would be the body

within the company that is best-equipped to make the decision.

Request for Comment

&sbull;&ensp;Will investors find this information useful? Is there

more useful information on how financial experts are determined?

&sbull;&ensp;Should our rules require the company to disclose the

persons who are responsible for making the financial expert

determination on behalf of the company? Is the board of directors the

appropriate body to make such determination?

4. Impracticability of a “Bright-Line” Test

We considered, but do not propose, a “bright-line” test

for making the financial expert determination that

[[Page 66213]]

eliminates all elements of subjectivity. We do not believe that such a

test would best further the purposes of the statute. Our proposed

“financial expert” definition requires a qualifying

individual to possess all of the specified attributes, and in that

respect, does provide somewhat of a “bright-line” by

setting forth several fairly specific and objective standards to limit

the pool of potential financial expert candidates. The

“factors” also provide guidance to assist the board of

directors in making the financial expert determination. Clearly,

certain factors such as level of education and years spent in a

financial position are important indicia of whether an individual has

such knowledge and experience.

However, we are not convinced that any bright-line rule or fixed

formula that requires a financial expert to have specific academic

credentials or a specific number of years of service in a financial or

accounting position can ensure that an individual has the level of

understanding and experience required by the statute. As the Blue

Ribbon Committee stated regarding corporate governance and audit

committees, “one size doesn't fit all.”&thnsp;\53\ Indeed,

the more complicated the business, the greater the need for a higher

threshold of financial expertise. Therefore, we believe that a bright-

line test would be inappropriate for such determinations.

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\53\&thnsp;See Report and Recommendations of the Blue Ribbon

Committee on Improving the Effectiveness of Corporate Audit

Committees, at 7 (1999).

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Request for Comment

&sbull;&ensp;Should we create a bright-line test for the definition

of “financial expert'? If so, what should the test be?

5. Location of Disclosure

The Sarbanes-Oxley Act expressly states that companies must include

the financial expert disclosure in their periodic reports required

pursuant to section 13(a) or 15(d) of the Exchange Act. We propose to

require companies to include the new disclosure in their annual reports

on Forms 10–K&thnsp;\54\ and 10–KSB.\55\ We do not propose

to require companies to also include this disclosure in their quarterly

reports because we think that annual disclosure would adequately

fulfill investors' informational needs. In this regard, we note that

our pending Form 8–K proposals would require a company to

disclose the arrival or departure of a director.\56\ This information

would be included in part III of those forms. Consequently, the company

could incorporate this information by reference from its definitive

proxy or information statement that involves an election of directors,

if the company voluntarily chooses to include this information in its

proxy or information statement and then files such statement with the

Commission no later than 120 days after the end of the fiscal year

covered by the Form 10–K or 10–KSB.\57\ We also propose to

require this disclosure in annual reports filed by a foreign private

issuer on Form 20–F&thnsp;\58\ and by a Canadian issuer on Form

40–F.\59\

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\54\&thnsp;Referenced in 17 CFR 249.310.

\55\&thnsp;Referenced in 17 CFR 249.310b.

\56\&thnsp;Therefore if, for example, a director who is the

audit committee financial expert resigned or was removed from the

board one month after the company filed its annual report, the

company would have to disclose this event on a Form 8–K filed

within two business days after the director's departure. See Release

No. 33–8106 (June 17, 2002) [67 FR 42914]. The proposals in

that release have not yet been adopted. The proposals do not require

disclosure of whether the departing director is a financial expert.

We are seeking comment on whether we should require such disclosure.

\57\&thnsp;See General Instruction E(3) to Form 10–KSB [17

CFR 249.310b] and General Instruction G(3) to Form 10–K [17

CFR 249.310].

\58\&thnsp;Referenced in 17 CFR 249.220f.

\59\&thnsp;Referenced in 17 CFR 249.240f.

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Request for Comment

&sbull;&ensp;Should we also require the proposed financial expert

disclosure to appear in the company's proxy or information statement?

Is this information relevant to a security holder's decision to vote

for a particular director or to elect, approve or ratify the choice of

an independent public accountant?

&sbull;&ensp;Should we require the company to also disclose this

information in its quarterly reports?

&sbull;&ensp;Should we also require such disclosure in registration

statements filed under the Securities Act?

&sbull;&ensp;Should the company have to disclose specifically the

arrival or departure of a financial expert promptly after the

occurrence of the event? If so, should we modify our Form 8–K

proposed item regarding the arrival and departure of a director to also

require a company to disclose whether the departing director was, or

arriving director will be, a financial expert serving on the company's

audit committee? Should a company make appropriate disclosures if: a

financial expert leaves the audit committee, but remains on the board

of directors; or an existing director joins the audit committee as a

financial expert? Should a company only have to file a Form 8–K

if it previously disclosed in its annual report that it had a financial

expert and now has none?

&sbull;&ensp;A company currently may not have an audit committee

member who qualifies as a financial expert under the proposed

definition but may intend to seek one. In such a case, the proposed

rules would require a company to disclose that it does not have a

financial expert on its audit committee. However, the company could

explain that it is searching for a qualified individual to serve on its

audit committee. Should we provide companies with a transition period

to find such a person? If so, what would be an appropriate transition

period?

6. Registered Investment Companies

We are proposing to implement section 407 of the Sarbanes-Oxley Act

with respect to registered management investment companies by adding

disclosure requirements similar to those in proposed Item 309 of

Regulation S–K to proposed Form N–CSR.\60\ Proposed Item 4

of Form N–CSR would require a registered management investment

company to disclose annually: (i) The number and names of persons that

the board of directors has determined to be the financial experts

serving on the investment company's audit committee; (ii) whether the

financial expert or experts are independent, and if not, an explanation

of why they are not; and (iii) if the investment company does not have

a financial expert serving on its audit committee, the fact that there

is no financial expert and an explanation of why it has no financial

expert.\61\ In addition, the investment company would be required to

disclose the basis for a determination by its board of directors that a

person is a financial

[[Page 66214]]

expert if, in lieu of having experience as a public accountant,

auditor, principal financial officer, principal accounting officer, or

controller, or experience in a position involving the performance of

similar functions, the person has experience in a position that

results, in the judgment of the board, in the person having similar

experience and expertise.\62\ We are proposing the same definition of

“financial expert” for investment companies as for

operating companies, except that we are not including the factor

relevant to foreign private issuers.\63\

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\60\&thnsp;Referenced in 17 CFR 249.331 and 274.128. A

management investment company is an investment company other than a

unit investment trust or face-amount certificate company. See

section 4 of the Investment Company Act [15 U.S.C. 80a–4]. A

unit investment trust (“UIT”) is “an investment

company which (A) is organized under a trust indenture, contract of

custodianship or agency, or similar instrument, (B) does not have a

board of directors, and (C) issues only redeemable securities, each

of which represents an undivided interest in a unit of specified

securities; but does not include a voting trust.” Section 4(2)

of the Investment Company Act [15 U.S.C. 80a–4(2)]. A face-

amount certificate company is an investment company that engages or

proposes to engage in the business of issuing certain face-amount

certificates. Section 4(1) of the Investment Company Act [15 U.S.C.

80a–4(1)].

\61\&thnsp;The proposed amendments would add similar disclosure

requirements applicable to small business investment companies

(“SBICs”) to Item 102P3 of Form N–SAR. Proposed

Instruction (b) to Item 102P3 of Form N–SAR (referenced in 17

CFR 249.330 and 274.101). SBICs are investment companies that are

licensed as SBICs under the Small Business Investment Act of 1958.

We are proposing to add financial expert disclosure requirements for

SBICs to Form N–SAR because SBICs would not be required to

file reports on proposed Form N–CSR.

\62\&thnsp;Proposed Instruction 3 to Item 4 of proposed Form

N–CSR; proposed Instruction (b)(3) to Item 102P3 of Form

N–SAR.

\63\&thnsp;Proposed Instructions 2 and 4 to Item 4 of proposed

Form N–CSR.

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A financial expert would be considered to be

“independent” if he or she: (i) meets the criteria set

forth in section 10A(m)(3)(B)(i) of the Exchange Act; and (ii) is not

an “interested person” of the investment company as defined

in section 2(a)(19) of the Investment Company Act of 1940.\64\ We have

substituted the section 2(a)(19) test for the criteria set forth in

section 10A(m)(3)(B)(ii) of the Exchange Act, which would apply to

operating companies and require that the audit committee member not be

an affiliated person of the issuer or any subsidiary in order to be

considered “independent.” The section 2(a)(19) test is more

appropriate for registered investment companies because it is tailored

to capture the broad range of affiliations with investment advisers,

principal underwriters, and others that are relevant to

“independence” in the case of investment companies.

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\64\&thnsp;Proposed Item 4 of proposed Form N–CSR.

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The proposed disclosure requirements would apply to all registered

management investment companies, regardless of whether they are

required to file reports under section 13(a) or 15(d) of the Exchange

Act. They would not apply to unit investment trusts, which are

unmanaged investment companies that hold specified securities and,

unlike managed investment companies, are not required to provide

shareholder reports containing audited financial statements.

Request for Comment

&sbull;&ensp;Should the definition of “financial

expert” be modified for investment companies? Are the factors

that are relevant in determining whether someone is a “financial

expert” different for investment companies?

&sbull;&ensp;What definition of “independence” should

the disclosure requirements apply with respect to financial experts?

Should the definition incorporate the criteria set forth in section

10A(m)(3)(B)(i) of the Exchange Act and section 2(a)(19) of the

Investment Company Act, as proposed, or a different test, for example,

the test used for operating companies?

&sbull;&ensp;Should disclosure with respect to financial experts on

an investment company's audit committee be required annually, as

proposed? Should this disclosure be required on each report on Form

N–CSR or N–SAR, i.e., semi-annually?

&sbull;&ensp;For investment companies that would be required to

file reports on proposed Form N–CSR, should the financial experts

disclosure be required on Form N–CSR or Form N–SAR? Should

small business investment companies, which otherwise would not be

required to file proposed Form N–CSR, be required to use Form

N–CSR for this purpose?

B. Proposed Code of Ethics Disclosure

1. Proposed Rules Compared to Section 406 of the Sarbanes-Oxley Act

Section 406(a) of the Sarbanes-Oxley Act directs the Commission to

issue rules requiring a company that is subject to the reporting

requirements of section 13(a) or 15(d) of the Exchange Act to disclose

whether or not the company has adopted a code of ethics for its senior

financial officers that applies to the company's principal financial

officer and controller or principal accounting officer, or persons

performing similar functions. The Sarbanes-Oxley Act states that the

rules also must require companies that have not adopted such a code of

ethics to explain why they have not done so.

The Act defines the term “code of ethics,” as used in

section 406, to mean such standards as are reasonably necessary to

promote:

&sbull;&ensp;Honest and ethical conduct, including the ethical

handling of actual or apparent conflicts of interest between personal

and professional relationships;

&sbull;&ensp;Full, fair, accurate, timely and understandable

disclosure in the periodic reports required to be filed by the issuer;

and

&sbull;&ensp;Compliance with applicable governmental rules and

regulations.

Section 406(b) of the Sarbanes-Oxley Act further directs the

Commission to require a company subject to the Exchange Act reporting

requirements to immediately disclose on Form 8–K, or by Internet

or other electronic means of dissemination, any change in, or waiver

of, a provision of its code of ethics for its senior financial

officers.

Although section 406 of the Sarbanes-Oxley Act focuses on whether

or not a company has adopted a code of ethics applicable to its senior

financial officers, we believe that it is appropriate to propose rules

that also apply to a company's principal executive officer. Investors

not only have an interest in knowing whether a public company holds its

senior financial officers to certain ethical standards, but also

whether a public company holds its principal executive officer to

ethical standards as well. Therefore, we believe that it is consistent

with the purposes of the Sarbanes-Oxley Act to extend the scope of

section 406 to also include a company's principal executive officer.

Specifically, we propose to require a company to disclose whether it

has adopted a written code of ethics that applies to its principal

executive officer, principal financial officer, principal accounting

officer or controller, or persons performing similar functions. We also

propose to broaden the definition of the term “code of

ethics” used in section 406 of the Sarbanes-Oxley Act to include

three additional factors described in more detail below.

2. Description of the Proposed Code of Ethics Disclosure Requirements

We propose to add new Item 406 to Regulations S–B and

S–K, new Item 15(c) to Form 20–F and new Instruction B.(9)

to Form 40–F to require a company subject to the Exchange Act

reporting requirements to disclose:

&sbull;&ensp;Whether the company has adopted a written code of

ethics that applies to the company's principal executive officer,

principal financial officer, principal accounting officer or

controller, or persons performing similar functions;&thnsp;\65\ and

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\65\&thnsp;We expect that many companies already have a code of

ethics that applies to these officers, as well as additional

officers, directors and employees. We encourage companies to apply

the code of ethics to as broad a spectrum of personnel and

affiliates as practicable.

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&sbull;&ensp;If the company has not adopted such a code of ethics,

the reasons it has not done so.

For purposes of this new disclosure item, we would define the term

“code of ethics” to mean a codification of standards that

is reasonably designed to deter wrongdoing and to promote:&thnsp;\66\

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\66\&thnsp;The Sarbanes-Oxley Act section 406(c) definition of

the term “code of ethics” does not include the phrase

“to deter wrongdoing” that we have incorporated into

proposed Item 406 of Regulations S–K and S–B, but we

think that it is appropriate to expand the definition in this

manner. Although codes of ethics typically are designed to promote

high standards of ethical conduct, they also generally seek to

instruct those to whom they apply as to improper or illegal conduct

or activity and to prohibit such conduct or activity.

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(1) Honest and ethical conduct, including the ethical handling of

actual

[[Page 66215]]

or apparent conflicts of interest between personal and professional

relationships;

(2) Avoidance of conflicts of interest, including disclosure to an

appropriate person or persons identified in the code&thnsp;&thnsp;\67\

of any material transaction or relationship that reasonably could be

expected to give rise to such a conflict;

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\67\&thnsp;Under our proposal, although the company would retain

discretion to determine the identity of the appropriate person or

persons, such person should not be involved in the matter giving

rise to the conflict of interest. Furthermore, we believe the person

identified in the code should have sufficient status within the

company to engender respect for the code and the authority to

adequately deal with the persons subject to the code regardless of

their stature in the company.

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(3) Full, fair, accurate, timely, and understandable disclosure in

reports and documents that a company files with, or submits to, the

Commission and in other public communications made by the company;

(4) Compliance with applicable governmental laws, rules and

regulations;&thnsp;\68\

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\68\&thnsp;We propose to add “laws” to this prong of

the proposed definition. The Sarbanes-Oxley Act section 406(c)

definition refers only to compliance with applicable governmental

rules and regulations. This language also is intended to ensure

compliance with other provisions of the Sarbanes-Oxley Act,

including “up-the-ladder” reporting by lawyers,

“whistleblower” protection and the enhanced conflict of

interest provisions.

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(5) The prompt internal reporting to an appropriate person or

persons identified in the code of violations of the code;&thnsp;\69\

and

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\69\&thnsp;The concerns regarding the identification of

appropriate persons for the reporting of potential conflicts of

interest discussed above would similarly apply to the reporting of

violations of the code.

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(6) Accountability for adherence to the code.

The second, fifth and sixth prongs of this proposed definition

supplement the requirements specified by section 406 of the Sarbanes-

Oxley Act. We believe that these items are consistent with the

objectives of that section. A comprehensive code of ethics should set

forth guidelines requiring avoidance of conflicts of interests and

material transactions or relationships involving potential conflicts of

interests without proper approval. Moreover, an effective code of

ethics should describe the company's system for the internal reporting

of code violations.\70\ The code also should state clearly the

consequences for non-adherence to code provisions.

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\70\&thnsp;There are a number of provisions in the Sarbanes-

Oxley Act that require internal reporting of events. We believe that

it is incumbent upon public companies to coordinate these

requirements.

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In addition to providing the required disclosure, a company also

would have to file a copy of its ethics code as an exhibit to its

annual report.\71\ We believe investors would find such disclosure

useful.

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\71\&thnsp;See proposed Item 601(b)(14) of Regulations S–K

and S–B. Section 406 of the Sarbanes-Oxley Act does not state

that our rules must require a company to file a copy of the code of

ethics as an exhibit to its annual report, but we think investors

may be interested in examining the actual code itself, given that

codes are likely to vary significantly from one company to another.

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Request for Comment

&sbull;&ensp;Should the rules address whether a company has a code

of ethics that applies to its principal executive officer, as proposed,

or should the rules track the language of section 406 of the Sarbanes-

Oxley Act and require a company only to disclose whether it has a code

of ethics that applies to its senior financial officers?

&sbull;&ensp;Should we expand the definition of “code of

ethics,” as proposed, or should the definition adhere to the

language in section 406(c) of the Sarbanes-Oxley Act? Are there other

ethical principles that should be included in the definition?

&sbull;&ensp;Should the rules cover a broader group of officers? If

so, which group of officers should they cover? Should the general

counsel be covered? Should all executive officers be

covered?&thnsp;\72\

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\72\&thnsp;Exchange Act Rule 3b–7 [17 CFR 240.3b–7]

defines the term “executive officer” as a registrant's

president, any vice president of the registrant in charge of a

principal business unit, division or function (such as sales,

administration or finance), any other officer who performs a policy-

making function or any other person who performs similar policy-

making functions for the registrant. Executive officers of

subsidiaries may be deemed executive officers of the registrant if

they perform such policy-making functions for the registrant.

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&sbull;&ensp;Should the proposed rules require a company to

disclose whether it has a code of ethics that applies to its directors?

Do most companies have a code of ethics that applies to the board of

directors? Does the same code of ethics generally apply to the

company's executive officers and its directors?

&sbull;&ensp;Should we require the company to describe its

procedures to ensure compliance with the code of ethics?

&sbull;&ensp;Should we require the company to describe its

procedures for granting a waiver from a provision of its code of

ethics?

&sbull;&ensp;Should we require the company to disclose the date of

adoption of its code of ethics and the date of the most recent update

or the company's frequency of review of the code?

&sbull;&ensp;Should the company have to file the code of ethics as

an exhibit to its annual report as proposed? If not, should we also

require the company to describe the principal topics that the code

addresses?

&sbull;&ensp;Should we require disclosure regarding the existence

of a code of ethics in our other reports and registration statements,

including our Securities Act and Exchange Act registration statements?

3. Content of the Code of Ethics

The proposed rules do not specify every detail that the company

must address in its code of ethics, or prescribe any specific language

that the code of ethics must include. They further do not specify the

procedures that the company should develop, or the types of sanctions

that the company should impose, to ensure compliance with its code of

ethics. We believe that ethics codes do, and should, vary from company

to company and that decisions as to the specific provisions of the

code, compliance procedures and disciplinary measures for ethical

breaches are best left to the company. In addition, such an approach is

consistent with our disclosure-based regulatory scheme.

Many companies already maintain codes of ethics or conduct.\73\

These codes often contain specific policies and restrictions

addressing, among other things, such issues as insider trading and

conflicts of interest. The proposed rules would not require a company

to adopt a code of ethics if it has not already done so, or to amend

its existing code of ethics, but they would require a company that does

not have a code of ethics that meets the definition in the rule for the

specified officers to explain why it does not have such a code. A pre-

existing ethics code may satisfy the requirements of proposed Item 406,

but a company should review its code upon our adoption of final rules

to determine whether the code meets all of the standards included in

the rules' definition of a “code of ethics.” If a company

has a code, but it does not satisfy all parts of the definition, the

company would not be able to affirm that it has the type of code

contemplated by the rules.

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\73\&thnsp;On August 16, 2002, NYSE submitted proposed new

listing standards that would, among other things, require all NYSE

listed companies to adopt a code of business conduct and ethics

consistent with the principles enumerated in the listing standards.

See File No. SR–NYSE–2002–33. The NASD has

indicated that it intends to propose new listing standards that

would require a code of conduct for NASDAQ listed companies.

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4. Types of Companies That Would Be Subject to the Proposed Code of

Ethics Disclosure Requirements and Location of the Disclosure

All companies that file Form 10–K or 10–KSB reports

would be subject to the proposed disclosure requirement.\74\ We

[[Page 66216]]

also propose to require this disclosure in annual reports filed by a

foreign private issuer on Form 20–F and by a Canadian issuer on

Form 40–F.

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\74\&thnsp;This disclosure would be required by Item 10 of Form

10–K and Item 9 of Form 10–KSB.

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Request for Comment

&sbull;&ensp;Should we require a company to also provide the

proposed code of ethics disclosure in its quarterly reports? Should

such disclosure be made in a company's proxy and information

statements? Should it be disclosed in Securities Act registration

statements?

&sbull;&ensp;Should the requirement apply to foreign private

issuers, as proposed? If not, why?

5. Proposed Form 8–K or Internet Disclosure Regarding Changes to,

or Waivers From, the Code of Ethics

Section 406(b) of the Sarbanes-Oxley Act directs us to require

“immediate disclosure” by a company of any change to, or

waiver from, the company's code of ethics for its senior financial

officers.\75\ As discussed above, we propose to require the basic

ethics code disclosure with respect to a company's principal executive

officer as well as to its senior financial officers. We therefore also

propose to require current disclosure regarding changes to, or the

company's grant of a waiver from, a provision of the code of ethics

that applies to these same persons.

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\75\&thnsp;Under the proposed rules this would also include an

implicit waiver due to inaction on the part of the company with

respect to a reported or known violation of a code provision.

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On June 17, 2002, we proposed amendments to Form 8–K that

would expand significantly the number of disclosure items triggering a

Form 8–K filing requirement and accelerate the Form 8–K

filing deadline.\76\ In those proposals, we stated that we were

reviewing possible changes by self-regulatory organizations to their

corporate governance provisions, including changes that would require a

company to promptly disclose any revision that it makes to its code of

ethics, or ethics waiver that it grants.

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\76\&thnsp;See Release No. 33–8106 (June 17, 2002) [67 FR

42914].

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In light of the directive in section 406(b), we propose to add an

item to the list of Form 8–K triggering events to require

disclosure of the following:

&sbull;&ensp;A change to a company's code of ethics that applies to

the specified officers; or

&sbull;&ensp;A grant of a waiver of an ethics code provision to a

specified officer.\77\

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\77\&thnsp;See proposed Item 5.05 to Form 8–K. In Release

No. 33–8106, we proposed to reorganize and renumber the Form

8–K items as part of our Form 8–K proposals. The

proposed Item 5.05 designation is consistent with the renumbering

scheme proposed in that release.

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If choosing to provide the required disclosure on Form 8–K,

the company would have to file the report within two business days

after it made the change or granted the waiver.\78\ As an alternative

to reporting this information on Form 8–K, section 406(b) of the

Sarbanes-Oxley Act contemplates a company's use of the Internet as a

method of disseminating this disclosure.\79\ Many companies maintain

websites to provide information about themselves to the public. A

company's website is often an obvious place for investors to find

information about a company.\80\ We therefore propose to allow a

company to use its own Internet website, if it has a website, as an

alternative means of disseminating the proposed required disclosure

about changes in, or waivers from, its code of ethics.\81\ Under the

proposed rules, a company would be able to take advantage of the

Internet dissemination option only if it had disclosed in its most

recently filed annual report on Form 10–K or

10–KSB:&thnsp;\82\

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\78\&thnsp;A two business day filing period is consistent with

the accelerated filing deadline that we proposed in Release No.

33–8106.

\79\&thnsp;Section 406(b) of the Sarbanes-Oxley Act states that

our rules should require a company to report this disclosure on Form

8–K or by “dissemination by the Internet or by other

electronic means.” Our proposed rules would permit optional

dissemination of the required disclosure through the company's

website; it is not clear whether there are “other electronic

means” that would result in widespread dissemination of the

disclosure that would be accessible by a company's investors and

potential investors. This release seeks comment on that issue.

\80\&thnsp;We are allowing website disclosure in these limited

circumstances consistent with the terms of section 406 of the

Sarbanes-Oxley Act. The present proposal does not indicate that the

Commission deems website postings as sufficient to broadly and

simultaneously disseminate information to the public in other

contexts.

\81\&thnsp;A company choosing to post proposed disclosure about

a change to its code of ethics on its website also would have to

post a copy of the amended provision on its website.

\82\&thnsp;See proposed Item 406(b) of Regulations S–K and

S–B. Because investors may not expect these disclosures to be

made on the company's website in lieu of a Form 8–K filing, we

are proposing to require a company to provide investors with advance

notice that it may choose to use this option. Otherwise, investors

may be confused regarding the location of this disclosure.

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&sbull;&ensp;That it intends to disclose these events on its

Internet website, and

&sbull;&ensp;Its Internet website address.

If a company elects to disclose this information on its website, it

would have to do so within the same two-business day time period that

we propose to require for Form 8–K filings. In addition, we

propose that a company electing to provide disclosure in this manner

would have to make the disclosure available on its website for a period

of at least 12 months after it initially posts the disclosure. Although

the proposed rules would permit a company to remove information from

its website after the 12-month posting period, we propose to require

the company to retain this disclosure for a period of not less than

five years and to make it available to the Commission or its staff upon

request.\83\ We propose a 12-month period because we believe that it

would be inappropriate to allow a company to comply with this provision

by only briefly posting the disclosure on its website. Reports on Form

8–K are available to the public indefinitely after filing with

the Commission.

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\83\&thnsp;Proposed Item 406 of Regulations S–B and

S–K.

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Request for Comment

&sbull;&ensp;Are there any privacy concerns that we should consider

that would warrant narrowing the disclosure requirements regarding a

grant of a waiver from the code?

&sbull;&ensp;Is a “waiver” a sufficiently distinct and

formal event that the obligation to disclose will not present any

difficulties of interpretation? Should we modify the requirement to

ensure that “de facto, post hoc” waivers of codes'granted

or acceded to after the occurrence of the “violation” are

reported?

&sbull;&ensp;Should companies that use the Internet for these

disclosures also be required to have technology that allows investors

to be notified by e-mail when new information is posted to the website?

&sbull;&ensp;Should we require the filing of a Form 8–K

regardless of whether a company provides the proposed disclosure on its

website? Do investors need access to this information for longer than

12 months? How can we permit Internet disclosure and maintain a lasting

public record of the information?

&sbull;&ensp;Should we specify where and how this disclosure should

appear on a company's website if the company opts for the website

method of dissemination?

&sbull;&ensp;Are there other means of electronic dissemination that

our proposed rules should permit?

&sbull;&ensp;Should we require a company choosing to disclose

information about ethics code changes or waivers through its Internet

website to provide advance notice in the company's annual report of its

intent to satisfy the disclosure requirements in this manner, as

proposed?

&sbull;&ensp;Should we require all Exchange Act reporting companies

to disclose their website addresses? If so, should we

[[Page 66217]]

specify the location of this disclosure? For example, should it have to

appear on the front cover of all periodic and current reports, along

with the company's street address? Should a company have to disclose

its website address in, or on the front cover of, all of its Exchange

reports? Proxy and information statements? Exchange Act registration

statements? Securities Act registration statements?

Foreign Private Issuers

Foreign private issuers are not required to file current reports on

Form 8–K.\84\ Instead, they are required to file under the cover

of Form 6–K&thnsp;\85\ copies of all information that the foreign

private issuer: makes, or is required to make, public under the laws of

its jurisdiction of incorporation; files, or is required to file, under

the rules of any stock exchange; or otherwise distributes to its

security holders.\86\ We do not propose to change these reporting

requirements. We are proposing changes to Form 20–F and

40–F that would require a foreign private issuer to disclose any

change to its code of ethics made during the foreign private issuer's

past fiscal year that applies to the foreign private issuer's senior

officers. The foreign private issuer additionally would have to file

the change as an exhibit to Form 20–F or 40–F. Under the

proposals, a foreign private issuer also would have to disclose any

grant of a waiver from the code by the company to one of these

officers, that occurred during the foreign private issuer's last fiscal

year. A foreign private issuer could also make the disclosure under

cover of a Form 6–K or on its Internet website. We plan to

strongly encourage foreign private issuers to make these disclosures

promptly.

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\84\&thnsp;See Exchange Act Rules 13a–11 and 15d–11

[17 CFR 240.13a–11 and 15d–11].

\85\&thnsp;Referenced in 17 CFR 249.306.

\86\&thnsp;See Exchange Act Rule 13a–16 [17 CFR

240.13a–16].

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Request for Comment

&sbull;&ensp;Should we require foreign private issuers to file

disclosure about ethics code changes and waivers within two days under

cover of Form 6–K? Should we otherwise require a foreign private

issuer to promptly disclose ethics code changes and waivers?

6. Registered Investment Companies

We are proposing to amend Forms N–SAR and N–CSR to

require a registered investment company to:

&sbull;&ensp;Disclose annually whether each of the investment

company, its investment adviser, and its principal underwriter has

adopted a written code of ethics that applies to the principal

executive officer, principal financial officer, principal accounting

officer or controller, or persons performing similar functions of,

respectively, the investment company, its investment adviser, and its

principal underwriter;\87\

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\87\&thnsp;See proposed Instructions (a)(1) and (a)(7) to Item

102P3 of Form N–SAR; proposed Item 3(a) and proposed

instruction to Item 3(a) of proposed Form N–CSR. In the case

of a UIT, the code of ethics disclosure requirements would apply

with respect to the UIT's sponsor, depositor, trustee, and principal

underwriter. Proposed Item 133(a) of Form N–SAR.

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&sbull;&ensp;If the investment company, its investment adviser, or

its principal underwriter has not adopted a code of ethics, explain why

it has not done so;\88\

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\88\&thnsp;Proposed Item 133(a) and Instruction (a)(1) to Item

102P3 of Form N–SAR; proposed Item 3(a) of Form N–CSR.

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&sbull;&ensp;If the investment company, its investment adviser, or

its principal underwriter has, during the period covered by the report,

amended or granted a waiver from any code of ethics applicable to the

investment company's, investment adviser's, or principal underwriter's

principal executive officer, principal financial officer, principal

accounting officer or controller, or persons performing similar

functions, provide a brief description of the amendment or waiver in

the investment company's report on proposed Form N–CSR or Form

N–SAR, as applicable. In the alternative, the investment company

may disclose this information on its Internet website within two

business days after the occurrence of the amendment or waiver, if the

investment company has disclosed in its most recently filed report on

Form N–SAR or N–CSR its intention to provide disclosure in

this manner and its Internet address, it makes the information

available on its website for a 12-month period, and it retains the

information for a period of not less than six years following the end

of the fiscal year in which the amendment or waiver

occurred;&thnsp;\89\ and

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\89\&thnsp;Proposed Item 133(b) and (c), proposed Instructions

(a)(2) and (a)(3) to Item 102P3 and proposed Instruction (c) to Item

133 of Form N–SAR; proposed Item 3(b) and 3(c) and proposed

Instruction 3 to Item 3 of proposed Form N–CSR.

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&sbull;&ensp;Include any written code of ethics and amendment to

that code of ethics as an exhibit to the investment company's reports

on Form N–CSR or N–SAR.\90\

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\90\&thnsp;Item 134(b) and proposed Instruction (a)(4) to Item

102P3 of Form N–SAR; proposed Item 6(b) of proposed Form

N–CSR.

The proposed disclosure requirements would apply to all registered

investment companies, regardless of whether they are required to file

reports under section 13(a) or 15(d) of the Exchange Act. Management

investment companies generally would provide the required disclosure on

proposed Form N–CSR, and small business investment companies and

unit investment trusts would provide the required disclosure on Form

N–SAR.\91\ The proposed amendments would apply the same

definition of a code of ethics that we are proposing for operating

companies.\92\

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\91\&thnsp;See proposed Item 3 of proposed Form N–CSR

(management investment companies, other than SBICs); proposed

Instruction (a) to Item 102P3 of Form N–SAR (SBICs); proposed

Items 133 and 134(b) of Form N–SAR (UITs).

\92\&thnsp;Proposed Instruction (a)(6) to Item 102P3 and

proposed Instruction (b) to Item 133 of Form N–SAR; proposed

Instruction 2 to Item 3 of proposed Form N–CSR. See Section

II.B.2. above, “Description of the Proposed Code of Ethics

Disclosure Requirements.”

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We recognize that Investment Company Act Rule 17j–1 currently

requires investment companies, and their investment advisers and

principal underwriters, to adopt codes of ethics designed to prevent

fraud resulting from personal trading in securities by portfolio

managers and other employees.\93\ The amendments we are proposing today

would address a broader range of conduct, including disclosure provided

in filings with the Commission; compliance with governmental laws,

rules and regulations; and ethical conduct generally, including the

handling of actual or apparent conflicts of interest. As a result, we

believe that the proposals should apply with equal force to investment

companies and operating companies. However, to the extent that an

investment company, or its investment adviser or principal underwriter,

is considering implementing new or changed code of ethics provisions as

a result of today's proposals, it may wish to incorporate these

provisions, together with its existing code of ethics under Rule

17j–1, into a single comprehensive code of ethics.\94\

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\93\&thnsp;17 CFR 270.17j–1.

\94\&thnsp;Proposed General Instruction D to Form N–CSR

would permit a registered management investment company to

incorporate its code of ethics by reference from another document,

such as the fund's registration statement. See Item 23(p) of Form

N–1A; Item 24.2.r of Form N–2; Item 28(b)(17) of Form

N–3 (requiring codes of ethics required by Rule 17j–1 to

be filed as exhibits to registration statements).

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The proposed disclosure requirements would generally cover the same

entities covered by Rule 17j–1 (investment companies, investment

advisers, principal underwriters) because these are the entities with

respect to which conflicts of interest and other ethical issues are

most likely to arise. Like Rule 17j–1, the proposed amendments

would cover the code of ethics of an

[[Page 66218]]

investment company's principal underwriter only if: (i) The principal

underwriter is an affiliated person of the investment company or the

investment company's investment adviser; or (ii) an officer, director,

or general partner of the principal underwriter serves as an officer,

director, or general partner of the investment company or of its

investment adviser.\95\ Unit investment trusts do not have a corporate-

type management structure, but rather are created by a sponsor or

depositor that accumulates a portfolio of securities and deposits them

with a trustee under the terms of a trust indenture. Therefore, a unit

investment trust would not be required to disclose whether it has a

code of ethics because it has no officers. Rather, for unit investment

trusts, we are proposing to require disclosure with respect to codes of

ethics of the trust's sponsor, depositor, trustee or principal

underwriter.\96\ For unit investment trusts, the proposed amendments

would cover the code of ethics of a principal underwriter only if: (i)

The principal underwriter is an affiliated person of the trust or the

trust's sponsor, depositor, or trustee; or (ii) an officer, director,

or general partner of the principal underwriter serves as an officer,

director, or general partner of the trust's sponsor, depositor, or

trustee.\97\

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\95\&thnsp;Proposed Instruction 1 to Item 3 of proposed Form

N–CSR; proposed Instruction (a)(5) to Item 102P3 of Form

N–SAR. See also Investment Company Act Rule 17j–1(c)(3)

[17 CFR 270.17j-1(c)(3)].

\96\&thnsp;Proposed Items 133 and 134(b) of Form N–SAR.

\97\&thnsp;Proposed Instruction (a) to Item 133 of Form

N–SAR.

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Request for Comment

&sbull;&ensp;Is the proposed definition of a code of ethics

appropriate? Are there any modifications that should be made to this

definition in the case of investment companies?

&sbull;&ensp;Do the proposed code of ethics disclosure requirements

cover the appropriate entities, in addition to the registered

investment company itself? Should any entities be removed, or should

other entities (e.g., the administrator) be added?

&sbull;&ensp;Do the code of ethics disclosure requirements cover

the appropriate individuals at those entities? Should any of these

individuals be removed, or should other individuals be added?

&sbull;&ensp;Should we require registered investment companies,

like domestic operating companies, to use Form 8–K to disclose

amendments to, or waivers of, a code of ethics within two business

days? Or is our proposed approach of requiring periodic reporting of

this information on Form N–CSR or Form N–SAR appropriate?

Should we propose a separate form for prompt reporting of this

information? If we require periodic reporting of amendments and waivers

on Forms N–CSR and N–SAR, is the proposed alternative

option for disclosure of amendments and waivers on the investment

company's Internet website within two business days necessary or

appropriate?

&sbull;&ensp;For what period of time should we require an

investment company to retain information about amendments to, or

waivers from, codes of ethics, if it elects to post this information on

its website? Should the retention period be not less than six years

from the end of the fiscal year in which the amendment or waiver

occurred, which would be consistent with the standard retention period

for investment company records, or should it be some other period?\98\

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\98\&thnsp;See Investment Company Act Rule 31a–2 [17 CFR

270.31a–2] (requiring retention by registered investment

companies of various types of records for not less than six years).

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C. Management's Internal Controls and Procedures for Financial

Reporting

1. Management's Internal Control Report

Section 404 of the Sarbanes-Oxley Act directs the Commission to

prescribe rules that would require each annual report that a company,

other than a registered investment company,\99\ files pursuant to

Section 13(a) or 15(d) of the Exchange Act to contain an internal

control report: (1) Stating management's responsibilities for

establishing and maintaining adequate internal control structure and

procedures for financial reporting; and (2) containing an assessment,

as of the end of the company's most recent fiscal year, of the

effectiveness of the company's internal controls and procedures for

financial reporting.\100\

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\99\&thnsp;Section 404 of the Sarbanes-Oxley Act, and any rules

of the Commission under section 404, do not apply to any registered

investment company. Section 405 of the Sarbanes-Oxley Act. See

section II.C.4 below “Registered Investment Companies.”

\100\&thnsp;Section 404 also requires every registered public

accounting firm that prepares or issues an audit report for a

company to attest to, and report on, the assessment made by the

management of a company.

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Twice in the past, the Commission has proposed an internal control

report requirement. First, in 1979, following enactment of the Foreign

Corrupt Practices Act (“FCPA”),\101\ we proposed rules that

would have required a company to annually disclose certain information

about its internal accounting controls.\102\ The proposed rules would

have required a company's management to state its opinion as to whether

the company's systems of internal accounting control provided

reasonable assurance that:

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\101\&thnsp;Title I of Pub. L. 95–213 (1977). Partially

codified in 15 U.S.C. 78m(b)(2), these provisions require issuers,

with securities registered under section 12 of the Exchange Act, to

make and keep books, records, and accounts, which, in reasonable

detail, accurately and fairly reflect the transactions and

dispositions of the assets of the issuer; and to devise and maintain

a system of internal accounting control sufficient to provide

reasonable assurances that: (i) transactions are executed in

accordance with management's general or specific authorization; (ii)

transactions are recorded as necessary (a) to permit preparation of

financial statements in conformity with generally accepted

accounting principles or any other criteria applicable to such

statements, and (b) to maintain accountability for assets; (iii)

access to assets is permitted only in accordance with management's

general or specific authorization; and (iv) the recorded

accountability for assets is compared with the existing assets at

reasonable intervals and appropriate action is taken with respect to

any differences.

\102\&thnsp;Release No. 34–15772 (April 30, 1979) [44 FR

26702].

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&sbull;&ensp;Transactions were executed in accordance with

management's general and specific authorization;

&sbull;&ensp;Transactions were recorded as necessary: (a) To permit

preparation of financial statements in conformity with generally

accepted accounting principles (or other applicable criteria); and (b)

to maintain accountability for assets;

&sbull;&ensp;Access to assets was permitted in accordance with

management's general or specific authorization; and

&sbull;&ensp;The recorded accountability for assets was compared

with the existing assets at reasonable intervals and appropriate action

was taken with respect to any differences.

The proposed rules also would have required an independent public

accountant to examine and report on management's statement.

Commenters criticized the 1979 proposal for the scope and content

of the proposed management statement, and its close correlation to the

FCPA requirements. Many commenters viewed the proposal as requiring a

report on compliance with the law. Others pointed to the significant

voluntary and private-sector initiatives that had been undertaken in

this area and urged us not to preempt such efforts by promulgating

formal legal requirements. While we did not agree with all of the

commenters' concerns, the Commission at that time decided not to

proceed with the rulemaking to allow existing voluntary and private-

sector initiatives for public reporting on internal accounting control

to continue to develop. In 1980, the Commission formally withdrew the

proposal.\103\

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\103\&thnsp;Release No. 34–16877 (June 6, 1980) [45 FR

40134].

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[[Page 66219]]

Following the recommendations of the Treadway Commission, the

Commission again proposed rules in 1988 that would have required

companies to include in their annual reports a report of management's

responsibilities with respect to financial reporting, including its

responsibilities for the company's internal control system, and an

assessment of the effectiveness of that system.\104\ Our 1988 proposal

differed from the 1979 proposal in several respects. Under the 1988

proposal, management's report would have been signed on behalf of the

company's principal executive, financial, and accounting officers, and

would have contained:

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\104\&thnsp;Release No. 34–25925 (July 19, 1988) [53 FR

28009].

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&sbull;&ensp;A description of management's responsibilities for the

preparation of the company's financial statements and other financial

information included in a document containing the financial statements;

&sbull;&ensp;A description of management's responsibilities for

establishing and maintaining a system of internal control directly

related to, and designed to provide reasonable assurance as to the

integrity and reliability of, financial reporting;

&sbull;&ensp;An assessment of the effectiveness of the company's

system of internal control that encompassed material matters; and

&sbull;&ensp;A statement of how management responded to any

significant recommendations concerning its system of internal controls

made by its internal auditors and its independent accountants.

Our 1988 proposal attempted to avoid a direct correlation with the

FCPA by including a materiality threshold and focusing on the company's

entire system of internal controls, rather than just its internal

accounting controls. We received more than 180 comment letters in

response to the 1988 proposal, with a majority of commenters supporting

it. Many commenters, however, expressed concern over being required to

disclose management's response to significant auditor recommendations

on the management report. Furthermore, several commenters noted that

private sector organizations were working to develop standards for

reporting on the effectiveness of a company's internal controls.\105\

The Commission did not act on the proposals.

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\105\&thnsp;Committee of Sponsoring Organizations of the

Treadway Commission, Internal Control—Integrated Framework,

(August 1992) (the “COSO Report”).

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In light of the mandates of the Sarbanes-Oxley Act, we again are

proposing to require companies to include a report on their internal

controls and procedures for financial reporting in their annual

reports.

a. Proposed Disclosure

We propose to amend Item 307 of Regulations S–K and

S–B, as well as Forms 20–F and 40–F, to require a

company's annual report to include an internal control report of

management that includes:

&sbull;&ensp;A statement of management's responsibilities for

establishing and maintaining adequate internal controls and procedures

for financial reporting;

&sbull;&ensp;Conclusions about the effectiveness of the company's

internal controls and procedures for financial reporting based on

management's evaluation of those controls and procedures in accordance

with Exchange Act Rule 13a–15 or 15d–15, as of the end of

the company's most recent fiscal year;&thnsp;\106\ and

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\106\&thnsp;A proposed instruction to Item 307 of Regulations

S–K and S–B, Item 15(a) of Form 20–F and

Instruction B.(7) of Form 40–F states that if the conclusions

of the company's principal executive and financial officers are

reflected in management's conclusions disclosed in the internal

control report, the company does not have to include any separate

disclosure required by Item 307(a) (or relevant provision in the

foreign forms) regarding the conclusions of those officers about the

effectiveness of the company's internal controls and procedures for

financial reporting in its report for its fourth fiscal quarter.

Another proposed instruction to those provisions states that the

company is encouraged, but not required, to include the disclosure

required by Item 307(b) (or relevant provision in the foreign forms)

for the company's fourth fiscal quarter in the annual internal

control report, rather than disclose this information separately.

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&sbull;&ensp;A statement that the registered public accounting firm

that prepared or issued the company's audit report relating to the

financial statements included in the company's annual report has

attested to, and reported on, management's evaluation of the company's

internal controls and procedures for financial reporting.

The proposed amendments do not specify the exact content of the

proposed management report, as this likely would result in boilerplate

responses of little value. We believe that management should tailor the

report to the company's circumstances.

b. Internal Controls and Procedures for Financial Reporting

A key aspect of management's responsibility for the preparation of

financial information is its responsibility to establish and maintain

an internal control system.\107\ On August 29, 2002, we issued a

release adopting new Exchange Act Rules 13a–14 and 15d–14

to implement section 302 of the Sarbanes-Oxley Act. In that release we

stated that the term “internal controls”&thnsp;\108\ as

used in section 302 of the Sarbanes-Oxley Act is a pre-existing concept

that pertains to a company's financial reporting and control of its

assets.\109\ However, because there are a variety of different

definitions of the term “internal controls” and its meaning

has changed over time, there continues to be confusion regarding the

meaning and scope of the term.

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\107\&thnsp;See American Institute of Certified Public

Accountants (AICPA), Codification of Statements on Auditing

Standards (AU) 319.53, “Internal Control in a Financial

Statement Audit.”

\108\&thnsp;In this release we use the term “internal

controls” and “internal control structure”

synonymously.

\109\&thnsp;See Release No. 33–8124 (August 29, 2002) [67

FR 57276].

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One of the first attempts to define internal controls was reflected

in 1958 in the Statement on Auditing Procedure No. 29, in which the

Committee on Auditing Procedure of the AICPA subdivided the definition

of internal control into the following two components:

“administrative control” and “accounting

control.”&thnsp;\110\ This statement explained that the term

“accounting control” related directly to the safeguarding

of assets and the reliability of financial records. Examples included

systems of transaction authorization and approval, physical controls

over assets, and the plan of organization for separating duties

concerned with record-keeping from duties concerned with operations or

asset custody. “Administrative control” was defined as

mainly concerning operational efficiency or adherence to managerial

policies. Examples included statistical analyses, performance reports,

training programs, and quality-control procedures.

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\110\&thnsp;See Committee on Auditing Procedure, AICPA,

Statement on Auditing Procedure No. 29, “Scope of the

Independent Auditor's Review of Internal Control” (1958).

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In 1972, the Statement on Auditing Procedure No. 54 redefined the

administrative control and accounting control concepts.\111\ SAP No. 54

defined administrative control as the plan of organization, procedures,

and records concerned with the decision processes leading to

management's authorization of transactions. Accounting control was

defined as a plan of organization and the procedures and records that

are concerned with the safeguarding of assets and the reliability of

financial records and consequently are designed to provide reasonable

assurance that:

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\111\&thnsp;See Committee on Auditing Procedure, AICPA,

Statement on Auditing Procedure No. 54. The FCPA codified the

accounting control provisions of SAP No. 54, see note 58.

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[[Page 66220]]

&sbull;&ensp;Transactions are executed in accordance with

management's general or specific authorization;

&sbull;&ensp;Transactions are recorded as necessary (1) to permit

preparation of financial statements in conformity with generally

accepted accounting principles; and (2) to maintain accountability for

assets;

&sbull;&ensp;Access to assets is permitted only by management's

authorization; and

&sbull;&ensp;The recorded accountability for assets is compared

with the existing assets at reasonable intervals and appropriate action

is taken with respect to any differences.

In 1992, the Committee of Sponsoring Organizations of the Treadway

Commission (“COSO”) undertook an extensive study of

internal control. COSO defined internal control as “a process,

effected by an entity's board of directors, management and other

personnel, designed to provide reasonable assurance regarding the

achievement of objectives' in three categories—effectiveness and

efficiency of operations, reliability of financial reporting, and

compliance with applicable laws and regulations. COSO further stated

that internal control over each of these objectives consisted of the

control environment, risk assessment, control activities, information

and communication, and monitoring. In 1995, the AICPA's Auditing

Standards Board in Statement on Auditing Standards No. 78 codified this

definition of internal controls.\112\

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\112\&thnsp;Auditing Standards Board, AICPA, Statement on

Auditing Standards No. 78, “Consideration of Internal Control

in a Financial Statement Audit: An Amendment to SAS No. 55”

(1995).

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We believe that the purpose of internal controls and procedures for

financial reporting is to ensure that companies have processes designed

to provide reasonable assurance that:

&sbull;&ensp;The company's transactions are properly authorized;

&sbull;&ensp;The company's assets are safeguarded against

unauthorized or improper use; and

&sbull;&ensp;The company's transactions are properly recorded and

reported to permit the preparation of the registrant's financial

statements in conformity with generally accepted accounting principles.

We believe that these objectives are embodied in the definition of the

term “internal controls” as the term is defined in AICPA's

Codification of Statements on Auditing Standards (AU) section 319 and

is consistent with section 103 of the Sarbanes-Oxley Act.\113\

Accordingly, we propose to refer to AU section 319 to define currently

internal controls and procedures for financial reporting, pending

action by the Public Company Accounting Oversight Board.\114\ The

proposed definition would state that the term “internal controls

and procedures for financial reporting” means controls that

pertain to the preparation of financial statements for external

purposes that are fairly presented in conformity with generally

accepted accounting principles as addressed by the Codification of

Statements on Auditing Standards 319 or any superseding definition or

other literature that is issued or adopted by the Public Company

Accounting Oversight Board.

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\113\&thnsp;Among other things, section 103 of the Act [Pub. L.

107–204 103] directs the Public Company Accounting Oversight

Board to adopt auditing standards that would require all registered

public accounting firms to present in each audit report or in a

separate report: (1) The scope of the auditor's testing of the

internal control structure and procedures of the issuer; (2) the

findings of the auditor from such testing; (3) the auditor's

evaluation of whether such internal control structure and procedures

include maintenance of records that in reasonable detail accurately

and fairly reflect the transactions and dispositions of the assets

of the issuer, provide reasonable assurance that transactions are

recorded as necessary to permit preparation of financial statements

in accordance with generally accepted accounting principles, and

that receipts and expenditures of the issuer are being made only in

accordance with authorizations of management and directors of the

issuer; and (4) a description, at a minimum, of material weaknesses

in such internal controls, and of any material noncompliance found

on the basis of such testing.

\114\&thnsp;We believe that this definition integrates the

various concepts of internal control into a unified concept that is

widely understood by the accounting profession and issuers.

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Request for Comment

&sbull;&ensp;Should we propose a definition of internal controls

and procedures for financial reporting? If so, is the proposed

definition appropriate?

&sbull;&ensp;Should we define the term using AICPA's Codification

of Statements on Auditing Standards Section 319 definition? If not, are

there any other definitions we should use?

&sbull;&ensp;Should we propose specific disclosure criteria and

standards for the management report? If so, what disclosure criteria

and standards should we consider?

2. Attestation to, and Report on, Management's Internal Control Report

by the Company's Auditor

Section 404(b) of the Sarbanes-Oxley Act requires every registered

public accounting firm that prepares or issues an audit report for an

issuer other than a registered investment company&thnsp;\115\ to attest

to, and report on, management's assessment of the issuer's internal

controls and procedures for financial reporting. The attestation and

report required by section 404(b) must be made in accordance with

standards for attestation engagements “issued or adopted”

by the Public Company Accounting Oversight Board (the

“PCAOB”).

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\115\&thnsp;See section 405 of the Sarbanes-Oxley Act, which

states that rules under section 404 of the Act shall not apply to

registered investment companies.

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We are proposing amendments to Regulation S–X to reference

the attestation report that will be prepared by registered public

accounting firms and to require a company to file the attestation in

annual reports on Forms 10–K, 10–KSB, 20–F and

40–F.\116\ Section 404(b) of the Sarbanes-Oxley Act does not

require filing of the attestation report, but we believe that it is

essential in satisfying the purposes of this provision of the Sarbanes-

Oxley Act to require a company to file both the internal control report

and auditor's attestation report in its annual report.

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\116\&thnsp;See proposed Items 210.1–02(b) and

210.2–02(d) of Regulation S–X.

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Request for Comment

&sbull;&ensp;If we adopt the proposed amendments before the PCAOB

is operational, should we delay effectiveness of the rules until such

time as attestation engagements standards are issued or adopted by the

PCAOB?

&sbull;&ensp;Should the company have to file the attestation report

as part of the annual report? If so, should the report have to appear

in a particular part of the annual report? Where?

3. Quarterly Evaluation of Internal Controls and Procedures for

Financial Reporting

On August 29, 2002, we adopted new Exchange Act Rules 13a–14

and 15d–14 to implement section 302 of the Sarbanes-Oxley Act.

These rules require the principal executive and financial officers of

reporting companies to certify the information in their companies'

quarterly and annual reports. Specifically, new Rules 13a–14 and

15d–14 require each of these officers to disclose that:

&sbull;&ensp;He or she has reviewed the report;

&sbull;&ensp;Based on his or her knowledge, the report does not

contain any untrue statement of a material fact or omit to state a

material fact necessary in order to make the statements made, in light

of the circumstances under which such statements were made, not

misleading with respect to the period covered by the report;

&sbull;&ensp;Based on his or her knowledge, the financial

statements, and other financial information included in the report,

fairly present in all material respects the

[[Page 66221]]

financial condition, results of operations and cash flows of the issuer

as of, and for, the periods presented in the report;

&sbull;&ensp;He or she and the other certifying officers:

(1) Are responsible for establishing and maintaining

“disclosure controls and procedures” (a newly-defined term

reflecting the concept of controls and procedures related to disclosure

embodied in section 302(a)(4) of the Sarbanes-Oxley Act) for the

issuer;

(2) Have designed such disclosure controls and procedures to ensure

that material information is made known to them, particularly during

the period in which the periodic report is being prepared;

(3) Have evaluated the effectiveness of the issuer's disclosure

controls and procedures as of a date within 90 days prior to the filing

date of the report; and

(4) Have presented in the report their conclusions about the

effectiveness of the disclosure controls and procedures based on the

required evaluation as of that date;

&sbull;&ensp;He or she and the other certifying officers have

disclosed to the issuer's auditors and to the audit committee of the

board of directors (or persons fulfilling the equivalent function):

(1) All significant deficiencies and material weaknesses in the

design or operation of internal controls (a pre-existing term relating

to internal controls regarding financial reporting) which could

adversely affect the issuer's ability to record, process, summarize and

report financial data and have identified for the issuer's auditors any

material weaknesses in internal controls; and

(2) Any fraud, whether or not material, that involves management or

other employees who have a significant role in the issuer's internal

controls; and

&sbull;&ensp;He or she and the other certifying officers have

indicated in the report whether or not there were significant changes

in internal controls or in other factors that could significantly

affect internal controls subsequent to the date of their evaluation,

including any corrective actions with regard to significant

deficiencies and material weaknesses.

For purposes of the Exchange Act Rules 13a–14 and

15d–14, “disclosure controls and procedures” are

defined as controls and other procedures of an issuer that are designed

to ensure that information required to be disclosed by the issuer in

the reports filed or submitted by it under the Exchange Act&thnsp;\117\

is recorded, processed, summarized and reported, within the time

periods specified in the Commission's rules and forms.\118\

“Disclosure controls and procedures” include, without

limitation, controls and procedures designed to ensure that information

required to be disclosed by an issuer in its Exchange Act reports is

accumulated and communicated to the issuer's management, including its

principal executive and financial officers, as appropriate to allow

timely decisions regarding required disclosure.

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\117\&thnsp;These reports include quarterly reports on Form

10–Q or 10–QSB, annual reports on Form 10–K,

10–KSB, 20–F or 40–F, current reports, definitive

proxy materials filed under section 14(a) of the Exchange Act [15

U.S.C. 78n(a)], definitive information statements filed under

section 14(c) of the Exchange Act [15 U.S.C. 78n(c)] and amendments

to any of these reports or documents.

\118\&thnsp;See Exchange Act Rules 13a–14(c) and

15d–14(c).

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We also adopted new Item 307 of Regulations S–K and

S–B&thnsp;\119\ to require disclosure in the company's annual and

quarterly reports about the principal officers' evaluation of the

company's disclosure controls and procedures and whether or not there

have been significant changes to the company's internal

controls—disclosure that the principal officers must certify that

they have made.

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\119\&thnsp;In addition, we adopted corresponding amendments to

Forms 20–F and 40–F for private foreign issuers. See 17

CFR 249.220f and 17 CFR 249.240f.

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Regarding internal controls and procedures for financial reporting,

our recently adopted rules require the company's principal executive

and financial officers to disclose “any significant changes in

the company's internal controls or in other factors that could

significantly affect these controls subsequent to the date of their

evaluation, including any corrective actions with respect to

significant deficiencies and material weaknesses.” Despite the

reference to an evaluation in this disclosure requirement, our rules

currently do not require the company's principal executive and

financial officers, or the company itself, to conduct periodic

evaluations of the company's internal controls. New Exchange Act Rules

13a–15 and 15d–15 do, however, require a company to conduct

a quarterly evaluation of the company's disclosure controls and

procedures.

As explained above, section 404 of the Sarbanes-Oxley Act directs

us to propose and adopt rules that would require management to annually

assess the company's internal control structure and procedures for

financial reporting. Section 404 contemplates only an annual evaluation

of the company's internal controls. A company's officers already must

certify to significant changes to internal controls as required by

section 302 of the Sarbanes-Oxley Act.

To provide a basis for this quarterly disclosure about changes to

the company's internal controls and procedures for financial reporting,

and to create symmetry between our requirements for periodic

evaluations of both the company's disclosure controls and procedures

and its internal controls and procedures for financial reporting, we

propose to require the company's management to evaluate the

effectiveness of the design and operation of the company's internal

controls and procedures for financial reporting, as well as its

disclosure controls and procedures, with respect to each annual and

quarterly report that it is required to file under the Exchange

Act.\120\ In addition, we propose to modify the requirement in Exchange

Act Rules 13a–15 and 15d–15 that the evaluation be

conducted within the 90-day period prior to the filing date of the

quarterly or annual report, to require that the evaluation be made as

of the end of the period covered by the report.\121\ We are also

proposing conforming changes&thnsp;\122\ to Exchange Act Rules

13a–14, 13a–15, 15d–14 and 15d–15 and the form

of certification in Forms

[[Page 66222]]

10–Q, 10–QSB, 10–K, 10–KSB, 20–F and

40–F.

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\120\&thnsp;Rules 13a–15(b) and 15d–15(b). As

originally adopted, Rules 13a–15 and 15d–15 required the

company to carry out this evaluation under the supervision of, and

with the participation of the company's management, including the

company's principal executive and financial officers. To better

reconcile this requirement with the proposed rules under section 404

of the Sarbanes-Oxley Act, we propose to revise these rules to state

more directly that company's management, rather than the company

itself, must undertake the required evaluations with the

participation of the principal executive and financial officers.

\121\&thnsp;Rules 13a–15(b) and 15d–15(b).

\122\&thnsp;We have also made several clarifying amendments. In

particular, the current certification would require management to

disclose significant deficiencies to the auditors and audit

committee, and identify material weaknesses to the auditors. The

accounting literature states that a “reportable

condition” is one that represents significant deficiencies in

the design or operation of internal control. AICPA Codification of

Statements on Auditing Standards, section 325. A material weakness

is a reportable condition of a magnitude discussed in the

literature. Id. Therefore, material weaknesses are a subset of

significant deficiencies. To clarify, and amplify, that significant

weaknesses, including material weaknesses must be disclosed to the

auditor and audit committee, we have proposed clarifying language.

We have also added language to clarify that the certifying officers

need not personally design the company's controls and procedures,

and may have such controls and procedures designed under their

supervision. In so doing, we recognize that the certifying officers

may not have appropriate expertise to do so, and in such case should

obtain assistance from third parties. We have also clarified that

the reports conclusions must be based on the certifying officers'

evaluation as of the end of the period covered by the report.

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Request for Comment

&sbull;&ensp;Should we propose changes to Exchange Act Rules

13a–14, 13a–15, 15d–14 and 15d–15 to require

periodic evaluations of both the company's disclosure controls and

procedures and its internal controls and procedures for financial

reporting?

4. Federal Deposit Insurance Act Internal Control Reports

In 1993, the Federal Deposit Insurance Corporation (FDIC) adopted

rules implementing section 36 of the Federal Deposit Insurance

Act&thnsp;\123\ that requires, among other things, an insured

depository institution with total assets of $500 million or more to

prepare an annual management report that contains:

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\123\&thnsp;12 U.S.C. 1831m.

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&sbull;&ensp;A statement of management's responsibilities for

preparing the institution's annual financial statements, for

establishing and maintaining an adequate internal control structure and

procedures for financial reporting, and for complying with designated

laws and regulations relating to safety and soundness;\124\ and

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\124\&thnsp;The designated laws and regulations are federal laws

and regulations concerning loans to insiders and federal and state

laws and regulations concerning dividend restrictions. See 12 CFR

part 363, appendix A, guideline 12.

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&sbull;&ensp;Management's assessment of the effectiveness of the

institution's internal control structure and procedures for financial

reporting as of the end of the fiscal year and the institution's

compliance with the designated laws and regulations during the fiscal

year.\125\

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\125\&thnsp;See 12 CFR 363.2, adopted in 58 FR 31332.

The FDIC's rules additionally require the institution's independent

public accountant to examine, and attest to, management's assertions

concerning the effectiveness of the institution's internal controls

over financial reporting.\126\

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\126\&thnsp;12 CFR 363.3.

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Furthermore, the FDIC's rules permit an insured depository

institution that is the subsidiary of a holding company to satisfy its

internal control report requirement with an internal control report of

the consolidated holding company's management if:

&sbull;&ensp;Services and functions comparable to those required of

the subsidiary by section 36 of the Federal Deposit Insurance Act are

provided at the holding company level; and

&sbull;&ensp;The subsidiary has, as of the beginning of its fiscal

year, total assets of less than $5 billion, or total assets of $5

billion or more and a composite rating of 1 or 2 under the Uniform

Financial Institutions Rating System.\127\

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\127\&thnsp;This rating is more commonly known as the CAMELS

rating, which addresses Capital adequacy, Asset quality, Management,

Earnings, Liquidity, and Sensitivity to market risk. See 12 CFR

363.1(b)(2).

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Bank and thrift holding companies that are required to file reports

under section 13(a) or 15(d) of the Exchange Act would be subject to

the internal control reporting requirements that we are proposing

today. Although our proposed amendments are similar to the FDIC's

internal control report requirements, our proposed rules differ in a

few respects.\128\

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\128\&thnsp;Most notably, proposed Item 307(b) and (c) of

Regulations S–K and S–B would not require a statement of

compliance with laws and regulations as is required by FDIC Rule

363.2 [12 CFR 363.2].

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We are coordinating with the FDIC and other federal banking

regulators to eliminate, to the extent possible, any unnecessary

duplication between our proposed internal control report and the FDIC's

internal control report requirements. We expect to provide further

guidance on this subject in our release adopting final rules under

section 404 of the Sarbanes-Oxley Act.

5. Registered Investment Companies

Section 404 of the Sarbanes-Oxley Act does not apply to registered

investment companies, and we are not proposing to extend any of the

requirements that would implement section 404 to registered investment

companies.\129\ We are, however, proposing to make the following

technical changes to our rules and forms implementing section 302 of

the Sarbanes-Oxley Act for registered investment companies in order to

conform to the rule changes that we are proposing for operating

companies and for other reasons.

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\129\&thnsp;See section 405 of the Sarbanes-Oxley Act

(“Nothing in section 401, 402, or 404, the amendments made by

those sections, or the rules of the Commission under those sections

shall apply to any investment company registered under section 8 of

the Investment Company Act of 1940 (15 U.S.C. 80a–8).”).

The provisions that would not extend to registered investment

companies include proposed amendments to Item 307(a) of Regulation

S–K, Exchange Act rules 13a–14(b)(4)(iii) and (iv),

13a–15(b), 15a–14(b)(4)(iii) and (iv), and

15d–15(b) (disclosure of effectiveness of internal controls

and procedures for financial reporting); proposed Item 307(c) of

Regulation S–K (management report on internal controls); and

proposed Item 210.2–02(d) of Regulation S–X (attestation

to, and report on, management's internal control report).

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&sbull;&ensp;Exchange Act Rules 13a–15(c) and

15d–15(c), Paragraph (b)(4)(iii) of Investment Company Act Rule

30a–2, and proposed Investment Company Act Rule 30a–3(b).

The proposed amendments would specify that an investment company's

management must evaluate the effectiveness of its disclosure controls

and procedures, with the participation of the principal executive and

financial officers, as of the end of the period covered by each report

filed on Form N–SAR or Form N–CSR.

&sbull;&ensp;Paragraph (d) of Investment Company Act Rule

30a–2. The proposed amendments would include the same definition

of “internal controls and procedures for financial

reporting” that we are proposing in Exchange Act Rules

13a–14(d) and 15d–14(d).

&sbull;&ensp;Instruction (a)(i) to Item 77Q3 of Form N–SAR

and Item 5(a) of proposed Form N–CSR. The proposed amendments

would require the disclosure about the evaluation of the investment

company's disclosure controls and procedures by the investment

company's management to be as of the end of the period covered by the

report being filed.

&sbull;&ensp;Paragraph (b)(4)(vi) of Investment Company Act Rule

30a–2, Instruction (a)(ii) of Item 77Q3 of Form N–SAR, and

Item 5(b) of proposed Form N–CSR. The proposed amendments would

require disclosure of any significant changes to the registrant's

internal controls and procedures for financial reporting made during

the period covered by the report.

&sbull;&ensp;Item 6(a) of proposed Form N–CSR; paragraphs 1,

2, and 3 of the certification in instruction (a)(iii) to Item 77Q3 of

Form N–SAR; and paragraphs 1, 2, and 3 of the certification

section of proposed Form N–CSR. The proposed amendments would

expressly require the shareholder reports to be filed as an exhibit to

proposed Form N–CSR rather than as an Item response,\130\ and

would also revise the form of certification in Forms N–SAR and

N–CSR to make clear that the report being certified includes any

exhibits.

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\130\&thnsp;The proposed amendments would delete Item 1 of

proposed Form N–CSR.

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&sbull;&ensp;Paragraph (b)(4) of Investment Company Act Rule

30a–2, paragraph 4 of the certification in Instruction (a)(iii)

to item 77Q3 of Form N–SAR, and paragraph 4 of the certification

section of proposed Form N–CSR. The proposed amendments would

require the signing officers to state that they are responsible for

establishing and maintaining internal controls and procedures for

financial reporting, and that they have disclosed to the investment

company's auditors and audit committee all significant deficiencies in

the design and operation of internal controls and procedures for

financial reporting which could adversely affect the investment

company's ability to record, process, summarize and report financial

information required to be disclosed in the reports that it files or

submits under

[[Page 66223]]

both the Securities Exchange Act and the Investment Company Act.

&sbull;&ensp;Exchange Act Rule 12b–25(a) and (b)(2)(ii) and

Form 12b–25.\131\ The proposed amendments would require an

investment company to file a Form 12b–25 if it will not be able

to file a report on proposed Form N–CSR in a timely manner.

Filing of a Form 12b–25 would provide the investment company with

an automatic extension of time to file proposed Form N–CSR of up

to 15 calendar days following the prescribed due date.

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\131\&thnsp;Referenced in 17 CFR 249.322.

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&sbull;&ensp;General Instruction E of proposed Form N–CSR. A

proposed technical amendment would clarify that terms used in Form

N–CSR have meanings as defined in the Investment Company Act of

1940 and the rules and regulations thereunder.

Request for Comment

&sbull;&ensp;Should any rules regarding internal controls and

procedures for financial reporting be applied to registered investment

companies? If so, which specific rules and procedures should apply?

&sbull;&ensp;When we adopted the certification rules implementing

section 302 of the Sarbanes-Oxley Act, we stated that a single

evaluation of the effectiveness of the disclosure controls and

procedures for a series fund or family of investment companies could be

used in multiple certifications for the funds in the series or family,

as long as the evaluation had been performed within 90 days of the date

of the certified report.\132\ What is the effect of today's proposed

changes requiring that the evaluation be as of the end of the period

covered by the report on the ability to use a single evaluation for a

series fund or family of investment companies where the funds have

different fiscal years? Should we adopt the approach of today's

proposal, retain the approach that we previously adopted, or adopt a

different approach?

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\132\&thnsp;See Release No. 33–8124 (Aug. 28, 2002) [67 FR

57276, 57282 n. 86].

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6. Transition Period for Compliance With Rules Regarding Evaluations

of, and Reports and Attestations on, Internal Controls and Procedures

for Financial Reporting

The annual internal controls report by management, as well as the

related attestation and report on management's evaluation by auditors

are proposed new requirements. Although we believe that management and

auditors currently review such controls and procedures in conjunction

with a company's annual audit, we understand that in many cases such

reviews may not be as thorough or as detailed as the proposed rules

would require. We expect that companies and their auditors will require

substantial time to develop processes under relevant standards and to

train appropriate personnel to ensure compliance with these

requirements imposed by the Sarbanes-Oxley Act. Similarly, companies

and accounting firms likely will need additional time to actually

perform these activities.

The Sarbanes-Oxley Act does not impose a deadline for compliance

with section 404. Rather, the wording of this section contemplates

action by both the PCAOB as well as registered public accounting firms.

Specifically, the statute requires that auditor attestations conform

with standards for attestation engagements adopted by the PCAOB. We

therefore believe that Congress did not intend for the provisions of

this section to take effect until the PCAOB has established the

relevant attestation standards.\133\ Accordingly, we propose to delay

the effectiveness of our rules under section 404 to enable the PCAOB to

act and other relevant parties to prepare for compliance.

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\133\&thnsp;Such standards would be subject to approval by the

Commission.

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Specifically, we propose that the rules under section 404, if

adopted, would apply to companies whose fiscal years end on or after

September 15, 2003. This should provide the PCAOB sufficient time to

adopt standards for attestation engagements, as well as for companies

and auditors to prepare for the expected increase in workload.

We would not require companies to provide such reports or

attestations before the proposed date of effectiveness. However, to the

extent that a company desires to provide voluntarily an annual report

on the effectiveness of its internal controls and procedures for

financial reporting, we believe that existing accounting literature

should be followed. Similarly, although we do not require attestations

by auditors before the proposed rules become effective, we believe that

to the extent such attestations are made, accountants would perform

such attestations in conformity with existing accounting literature

regarding attestation engagements, including section 501 of the AICPA's

Statement on Standards for Attestation Engagements.

Similarly, we believe that the effectiveness of changes to

certifications by management in a company's annual and quarterly

reports also should be delayed until the company has had the

opportunity to perform the comprehensive evaluation of internal

controls and procedures for financial reporting contemplated by section

404. Therefore, we propose that management need not provide the

proposed amended certifications until the first annual report in which

the company includes the internal control report required under section

404. Accordingly, until a company is required to provide such report,

it need only provide certifications as adopted on August 29, 2002.\134\

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\134\&thnsp;See Release No. 33–8124 (August 29, 2002) [67

FR 57276].

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Request for Comment

&sbull;&ensp;What transition period do companies and registered

public accounting firms need to prepare to perform these undertakings?

Is the compliance date we propose adequate? If not, what date should we

adopt?

D. Asset-Backed Securities Issuers

In the release adopting the certification requirements,\135\ we

noted that issuers of asset-backed securities have a reporting

obligation under either sections 13(a) or 15(d) of the Exchange Act, at

least for a period of time. Because of the nature of asset-backed

issuers, the staff of the Division of Corporation Finance has granted

requests allowing asset-backed issuers to file modified reports under

the Exchange Act.\136\ The modified reporting structure for asset-

backed issuers allows issuers or depositors to file modified annual

reports on Form 10–K and to file reports on Form 8–K tied

to payments on the underlying assets in the trust. These reports

include a copy of the servicing or distribution report required by the

issuer's governing documents and information on the performance of the

assets, payments on the asset-backed securities and any other material

developments that affect the issuer. Because the information included

in these reports for asset-backed issuers differs significantly from

that provided by other issuers, as well as the structure of asset-

backed issuers we are proposing to exclude them from the disclosure

requirements under proposed Items 307, 309 and 406 of Regulation

S–K and S–B.

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\135\&thnsp;Id.

\136\&thnsp;See, for example, Release No. 34–16520

(January 23, 1980) (order granting application pursuant to section

12(h) of the Exchange Act [15 U.S.C. 78l(h)] of Home Savings and

Loan Association); Release No. 34–14446 (February 6, 1978)

(order granting application pursuant to section 12(h) of Bank of

America National Trust and Savings Association); Bay View

Securitization Corporation (January 15, 1998); and Key Bank USA,

National Association (May 9, 1997).

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[[Page 66224]]

E. General Request for Comment

We request and encourage any interested person to submit comments

regarding:

(1) The proposed changes that are the subject of this release,

(2) Additional or different changes, or

(3) Other matters that may have an effect on the proposals

contained in this release.

We request comment from the point of view of registrants, investors and

other users of information about the proposals. With regard to any

comments, we note that such comments are of greatest assistance to our

rulemaking initiative if accompanied by supporting data and analysis of

the issues addressed in those comments.

III. Paperwork Reduction Act

Form 10–K, Form 10–KSB, Form 20–F, Form

40–F, Form 10–Q, Form 10–QSB, Form 8–K, and

Form 12b–25 under the Exchange Act, Regulation S–K,

Regulation S–B, and Forms N–SAR and N–CSR under the

Exchange Act and the Investment Company Act contain “collection

of information” requirements within the meaning of the Paperwork

Reduction Act of 1995.\137\ We are submitting a request for approval of

the proposed revisions to these requirements to the Office of

Management and Budget (“OMB”) for review in accordance with

44 U.S.C. 3507(d) and 5 CFR 1320.11. An agency may not conduct or

sponsor, and a person is not required to respond to, a collection of

information unless it displays a currently valid control number.

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\137\&thnsp;44 U.S.C. 3501 et seq.

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Periodic Reporting Requirements

Form 10–K (OMB Control No. 3235–0063) prescribes

information that a registrant must disclose annually to the market

about its business. Form 10–KSB (OMB Control No. 3235–0420)

prescribes information that a registrant that is a “small

business issuer” as defined under our rules must disclose

annually to the market about its business. Form 20–F (OMB Control

No. 3235–0288) prescribes information that a registrant that is a

foreign private issuer must disclose annually to the market about its

business. Form 40–F (OMB Control No. 3235–0381) prescribes

information that a registrant that is eligible to use that form must

disclose annually to the market about its business.

Form 10–Q (OMB Control No. 3235–0070) prescribes

information that a registrant must disclose quarterly to the market

about its business. Form 10–QSB (OMB Control No. 3235–0416)

prescribes information that a registrant that is a “small

business issuer” as defined under our rules must disclose

quarterly to the market about its business.

We are proposing to add several disclosure requirements to these

forms relating to: (1) Whether a financial expert serves on a company's

audit committee; (2) the existence of a company code of ethics for

specified officers, and (3) management's assessment of the

effectiveness of a company's internal controls and procedures for

financial reporting. These proposals would increase the amount of

information that a registrant must compile and disclose in these forms.

With respect to the first two items, the information in these required

disclosures should be readily available to the management of a

registrant. Therefore, we expect the burden to compile and report this

information to be minimal. The third item requires management to

evaluate the effectiveness of the company's internal controls and

procedures for financial reporting. We expect that performing these

acts will impose a substantially greater burden than the other two

disclosure requirements.

Financial Expert. This proposed disclosure requirement would

increase the disclosure burden by requiring a registrant to report the

number and names of persons that the board of directors has determined

to be financial experts on its audit committee as well as whether the

expert is independent, and if not, an explanation of why they are not.

It would not require a registrant to have a financial expert on its

audit committee. Item 401 of Regulations S–K and S–B

already requires registrants to ascertain and disclose the business

experience of all of its directors. The inquiry that registrants should

make to satisfy this disclosure requirement should assist the

registrant in determining whether a particular director is a financial

expert under the rules. If the registrant does not have a financial

expert, the rule only requires that the registrant explain why it does

not have such a person on its audit committee. Therefore, we believe

the added burden of the proposed rule would be minimal. For purposes of

the PRA, we estimate that the proposed disclosure requirements

regarding financial experts will result in a minimal incremental

increase of 0.5 burden hours per issuer in connection with preparing

each annual report.

Code of Ethics. The proposed rule would require a registrant to

disclose whether it has adopted a written code of ethics for its

principal executive officer, principal financial officer, principal

accounting officer or controller, or persons serving similar functions.

If it has not, it must explain why. The proposed rule would not require

any company to adopt such a code of ethics. Management should be

readily able to determine whether or not its company has adopted a code

of ethics. In certain cases, the required disclosure would require

minimal analysis regarding why the company does not have a code. In

addition, in the first year, registrants must file a copy of the code

with the Commission. In the case of large manuals that must be filed,

we expect a small added cost to file such a document on EDGAR. In

addition, we estimate that the disclosure requirements regarding codes

of ethics will also cause a minimal increase of 0.5 burden hours per

issuer in connection with each annual report.

Management Assessment of Internal Controls and Procedures for

Financial Reporting. The proposed rules would require management to

assess its internal controls and procedures for financial reporting

every quarter. In addition, registrants must provide an internal

control report in its annual report as well as obtain an attestation on

that evaluation from the independent accountant that audited its

financial statements. The performance of, and report on, the assessment

will impose costs on registrants. This requirement would not apply to

registered investment companies.

Although we expect such evaluation to impose a burden on companies,

they are already required to evaluate on a quarterly basis the

company's disclosure controls and procedures. We believe that a

significant portion of internal controls and procedures for financial

reporting are included in disclosure controls and procedures. We

already received OMB approval for the added burden of evaluating

disclosure controls and procedures. Therefore, for purposes of this

release, we need only consider the added incremental burden imposed on

companies by the evaluation of that portion of internal controls and

procedures for financial reporting that is not subsumed by the

disclosure controls and procedures evaluation. In that submission, we

estimated that the evaluation of disclosure controls and procedures

would add a burden on each issuer of 5 hours per quarterly and annual

report. We estimate that the proposed rules would impose and additional

5 burden hours per issuer in connection with each quarterly and annual

report. We do not have any data to support this estimate. However,

[[Page 66225]]

because much of the burden is subsumed in the previous estimate, we

believe an estimate of 5 burden hours per quarter is conservative. In

addition, in conjunction with annual reports, a company must provide an

internal control report. Although the burden of the evaluation has

already been considered, the company must compile its conclusions into

a publicly disclosed report. We expect that preparation of this report

would add an additional 5 hours in conjunction with the annual report.

For PRA purposes, we do not need to consider the added burden to

the company of obtaining an attestation on that internal control report

by the company's auditor. The Sarbanes-Oxley Act currently requires

companies to obtain such an attestation. Our proposed rules do not

establish standards for the contents or format of such attestation. In

addition, the proposed rules requiring attestation would not be

effective until the PCAOB has had the opportunity to establish such

standards. The proposed rules would establish no requirements beyond

those required by the Sarbanes-Oxley Act except the requirement that

the attestation be filed. We do consider the incremental increase in

burden caused by this proposed requirement. We estimate that the costs

of filing such an attestation report would be minimal. Similar to our

estimates regarding disclosure of readily known information, such as

the existence of a code of ethics, we estimate that such filing would

create an added burden of 0.5 hours.

The burden hours for complying with these proposed requirements are

set forth below in the following table. Estimates regarding burden

within the company, for third party services, and for professional

costs were obtained by contacting a number of law firms and other

persons regularly involved in completing the forms.

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$300

&emsp; Annual Total hours/ Total 75% 25% professional

responses form burden&thnsp;\1\ company&thnsp;\2\ professional cost

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10–K........................................ 9,384 11.5 107,916 80,937 26,979 8,093,700

10–KSB...................................... 3,789 11.5 43,574 32,680.5 10,893.5 3,268,050

20–F........................................ 1,096 11.5 12,604 3,151 9,453 2,835,900

40–F........................................ 127 11.5 1,461 365.25 1,095.75 328,725

10–Q........................................ 26,746 5 133,730 100,297.5 33,432.5 10,029,750

10–QSB...................................... 11,608 5 58,040 43,530 14,510 4,353,000

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\1\&thnsp;Annual Responses × Total Hours per Form.

\2\&thnsp;The staff estimated the average number of hours each entity spends completing the form, and the average hourly rate for outside securities

counsel, by contacting a number of law firms and other persons regularly involved in completing the forms. For Forms 20–F and 40–F, we

estimate that 25% of the burden is imposed on the company and 75% of the burden is attributed to costs of third parties.

Our current OMB inventories and requested burden estimates are

presented in the following table.

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Current hour Expected hour Total expected Current cost Expected cost Total expected

&emsp; burden increase burden burden increase cost

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10–K.............................................. 12,337,614 80,937 12,418,551 1,233,761 8,093,700 1,241,854,700

10–KSB............................................ 3,435,676 32,680.5 3,468,356.5 343,568,000 3,268,050 346,836,050

20–F.............................................. 583,248 3,151 586,399 524,496,000 2,835,900 527,331,900

40–F.............................................. 175 365.25 440.25 440.5138,500 328,725 467,225

10–Q.............................................. 3,109,223 100,297.5 3,209,520.5 310,922,000 10,029,750 320,951,750

10–QSB............................................ 1,279,782 43,530 1,323.312 127,978,000 4,353,000 132,331,000

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Form 8–K

Form 8–K (OMB Control No. 3235–0060) prescribes

information about significant events that a registrant must disclose on

a current basis. Form 8–K also may be used, at a registrant's

option, to report any events that the registrant deems to be of

importance to shareholders. Companies also may use the form to disclose

the nonpublic information required to be disclosed by Regulation

FD.\138\ We are proposing to require disclosure in the Form 8–K

of any change in, or waiver of any provision of, a company code of

ethics for senior executive officers. Alternatively, companies may

disclose the required information on their websites.

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\138\&thnsp;17 CFR 243.100–103.

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We currently estimate that Form 8–K results in a total annual

compliance burden of 627,300 hours and an annual cost of $81,377,000.

We estimate the number of Form 8–K filers to be 13,200, based on

the actual number of Form 10–K and 10–KSB filers during the

2001 fiscal year. For purposes of this analysis, we estimate that the

number of reports on Form 8–K filed is 276,800.\139\ We estimate

that each entity spends, on average, approximately 5 hours completing

the form. We note that a company need not file a Form 8–K to

report these events if it discloses the information on its Internet

website. If a company elects to disclose such information only on its

website, the proposed rules would require the company to keep such

information on its website for 12 months and to keep such disclosure

for five years. We estimate that the cost of disclosing and maintaining

the information on a company's website would be no more than the cost

to file a Form 8–K. Therefore, for a particular reporting event,

whether disclosed on Form 8–K or through a company's website, we

estimate the burden would be 5 hours. We estimate that 75% of the

burden is prepared by the company and that 25% of the burden is

prepared by outside counsel retained by the company at an average cost

of $300 per hour. The staff estimated the average number of hours each

entity spends completing the form, and the average hourly rate for

outside securities counsel, by contacting a number of law firms and

other persons regularly involved in completing the forms.

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\139\&thnsp;This number assumes adoption of the proposals in

Release No. 33–8090 (April 12, 2002) [67 FR 19914] If adopted,

those proposals would cause companies to file estimated additional

215,500 Form 8–K reports each year.

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Under the proposals, we estimate that, on average, completing and

filing a Form 8–K if the proposed new disclosure items are

adopted would require the same amount of time currently spent by

entities completing the form—approximately 5 hours. We believe

that changes to a company's code of ethics and waivers from a code

[[Page 66226]]

will be relatively rare events. Therefore, we expect that on average, a

company will file a Form 8–K to report such an event once every

three years, resulting in a total increase of 4,400 filings on Form

8–K per year. The additional filings would result in an added

annual burden of 16,500 hours (4,400 × 5 × .75 = 16,500)

and a total annual burden of 643,800 (627,300 + 16,500). We estimate

that, if the proposals are adopted, the additional filings would result

in an added annual cost of $1,650,000 (4,400 × 5 × .25

× $300 = $1,650,000) and a total annual cost to issuers of

$83,027,000 ($81,377,000 + $1,650,000 = $83,027,000).

Regulation S–K and Regulation S–B

Regulation S–K (OMB Control No. 3235–0071) includes the

requirements that a registrant must provide in filings under both the

Securities Act and the Exchange Act. Regulation S–B (OMB Control

No. 3235–0417) includes the requirements that a small business

issuer must provide in filings under the Securities Act and the

Exchange Act.

The proposed changes to these items would create new items under

Regulation S–K and Regulation S–B. However, the filing

requirements themselves are included in Form 10–K, Form

10–KSB, Form 10–Q, Form 10–QSB, Form 20–F, Form

40–F, and Form 8–K. We have reflected the burden for these

new requirements in the burden estimate for those forms. These items in

Regulation S–K and Regulation S–B do not impose any

separate burden. We assign one burden hour each to Regulations

S–B and S–K for administrative convenience to reflect the

fact that these regulations do not impose any direct burden on

companies.

Investment Company Forms

Form N–SAR (OMB Control No. 3235–0330) under the

Exchange Act and the Investment Company Act is used by registered

investment companies to file periodic reports with the Commission. We

estimate that 4500 investment companies, including 798 unit investment

trusts and 2 small business investment companies, currently file

reports on Form N–SAR. The current estimated total compliance

burden of Form N–SAR is 154,450 hours. Unit investment trusts

would be required to make the proposed disclosure regarding codes of

ethics on Form N–SAR, and small business investment companies

would be required to make the proposed disclosure regarding codes of

ethics and financial experts on Form N–SAR. We estimate that the

proposed disclosure requirements will increase the annual burden of

filing Form N–SAR by 0.5 hours per unit investment trust, and by

1.0 hour per small business investment company. Therefore, the new

estimated total compliance burden of filing Form N–SAR would be

154,851 hours.

We issued a release proposing Form N–CSR on August 30, 2002,

pursuant to section 8(a) of the Investment Company Act [15 U.S.C.

80a–8] and section 13 of the Securities Exchange Act [15 U.S.C.

78m]. Proposed Form N–CSR would be used by registered management

investment companies to file certified shareholder reports with the

Commission. We estimate that 3700 registered management investment

companies would be required to file reports on Form N–CSR, and

the total compliance burden for Form N–CSR would be 111,000

hours, excluding the amendments proposed in this release. We estimate

that the proposed disclosure requirements would increase the annual

burden of filing Form N–CSR by

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