(The news featured below is a selection from the news covered in Federal Securities Law Reporter, which is distributed to subscribers of Federal Securities Law Reporter.)

ABA Meeting Panelists Discuss Accounting, Internal Controls

Carol Stacey, the chief accountant in the SEC's Division of Corporation Finance, was among the speakers at a recent ABA meeting. Ms. Stacey spoke to the law and accounting committee on current issues at the division, including annual report reviews. The staff continues to try to get better disclosure in the management's discussion and analysis section of the financial statements through the comment letter process, she said. Revenue recognition continues to be the number one issue on which the staff comments and the number one issue in enforcement, although this year she noted that option backdating is also a high ranking issue in enforcement.

Ms. Stacey acknowledged that part of the problem stems from the volume of the related literature, which numbers up to 200 pieces. The Financial Accounting Standards Board's codification project should help, she said, but she was unsure of the timeframe for its completion. Ms. Stacey plans to update the staff accounting and disclosure outline in the coming weeks. She said the update will include a section on the disclosure of unpaid claims and other liabilities related to insurance.

Ms. Stacey was asked whether the staff looks at analysts' reports to see what investors think is important. The staff sometimes looks at analysts' reports, she said, especially if the same question is being asked and a company is not answering it. However, the staff pursues most issues because it believes they are important for investors of a given company. The staff does not start with the analysts' reports. It starts by asking the questions it believes should be asked, she said. 

Ms. Stacey also responded to an inquiry about whether the staff is open to any guidance from what people outside the SEC think is important. She said she hopes that it is evident from the comment process that the staff concentrates on the most important areas.

Ms. Stacey also discussed when a company must file a Form 8-K for Item 4.02 reflecting the nonreliance on previously issued financial statements or a related audit report. The item was built upon the notion of nonreliance, not restatements, she said. When you know there is a problem you must inform the market. She acknowledged that some companies have filed the information in a Form 10-K or 10-Q if the timing corresponds to the discovery of nonreliance and she agreed with the GAO that the SEC should conform the instructions to Form 8-K with staff guidance issued in November 2004.

However, when asked whether the staff is working on an amendment to ensure the information is filed on Form 8-K, she said the staff would look at the issue. Nonreliance on the financial statements is an alert to the market, she emphasized, so do not wait for the next Form 10-Q or 10-K to report it.

Internal Controls

John Huber, a partner with Latham & Watkins LLP, presented a list of top challenges for in-house and outside counsel with respect to internal control over financial reporting, the first of which is being brought into the room and being given a seat at the table. Internal controls should not be within the sole purview of the accountants, he said. At the same time, it is important that lawyers know the accounting standards. They should be well-grounded in accounting, he said. Mr. Huber cited the nine accounting firm framework for evaluating process and transaction level exceptions and deficiencies, which he said should not be foreign to securities lawyers.

Lawyers should know where internal controls over financial reporting end and disclosure controls and procedures continue, he said. There is substantial overlap. Mr. Huber noted that the SEC is importing more and more accounting principles into its disclosure requirements. One has to know the accounting principles to do the disclosure controls and procedures, he said.

A well-functioning system of internal controls can detect weaknesses before they become problems, according to Mr. Huber. A material weakness should be viewed as the canary in the mine shaft. Lawyers can help in that area by working with the disclosure committee. Early detection is worth its weight in gold, he added.

Another challenge is having access to adequate and reliable information. Lawyers also must convince everyone that Item 4 of Form 10-Q and Item 9A of Form 10-K on controls and procedures are disclosure documents and should be drafted with the lawyers' guidance, in his view. The lawyers in the Division of Corporation Finance are the ones who comment, he explained, not the accountants.

Thomas Ray, the chief auditor for the Public Company Accounting Oversight Board, acknowledged that the first year of applying Auditing Standard No. 2 was very challenging, but maintained that auditors were not taking advantage of the flexibility the standard provides. The PCAOB is determined to amend the standard, however, and recently announced the meeting date of December 19, 2006, to consider the revisions.

Mr. Ray said that auditors read and understood the previous guidance the PCAOB issued with respect to the standard, but some thought it conflicted with Auditing Standard No. 2 and would not apply it. The PCAOB plans to include the guidance in the revised standard. In response to a question about the two-part opinion the auditor must render in connection with internal controls, Mr. Ray noted that it reflects the way the Sarbanes-Oxley Act was written. However, the board is reconsidering its definitions of significant deficiency and material weakness, he said.

An ABA member questioned why the PCAOB would be involved in defining material weakness, given that it should be the SEC's responsibility. He said the PCAOB's job is to oversee auditing. Mr. Ray responded that the definition of materiality is within the purview of the SEC but the PCAOB can give the auditors guidance.

Mr. Ray repeated that Auditing Standard No. 2 is a principles-based standard with respect to professional judgment and scalability. The revised standard will be scalable to companies of all sizes. There will always be a tremendous need for sound judgment, he said, since the internal controls of a very large company will look very different from those of a small company.

Mr. Ray responded to accusations that the PCAOB "second-guesses" auditor judgments. The board does not "second-guess," he said. Rather, the board evaluates the accounting. 

An ABA member stated that the entire panel discussion reflects what has led his clients to remain private. Mr. Huber said he believes that Section 404 is necessary and that Auditing Standard No. 2 has merit, but that the requirements have also caused a lot of companies to conduct their initial public offerings overseas or to go private. The SEC did not ask for Section 404, he added, and when it was mandated by Congress, it was an "empty box."