(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.)

SEC and PCAOB Chairs Address Tax, Public Reporting

In remarks to the Tax Council Policy Institute, SEC Chairman Christopher Cox noted that approximately one-third of companies that have reported material weaknesses in their internal controls have reported that at least one of their weaknesses related to income taxes. Only revenue recognition accounted for more reports of material weakness, he said. Mr. Cox added that the income tax-related material weaknesses fell disproportionately on small and medium-sized companies, many of whom may have relied on their outside auditors for advice.

Mr. Cox said that a few common causes of the majority of material weaknesses include the inadequate application of generally accepted accounting principles for income taxes and inadequate documentation to support valuation allowances and foreign subsidiaries. Additional causes include inadequate controls on calculations and reconciliations and inadequate policies and procedures for reviewing complex or non-routine transactions. Mr. Cox said that the SEC and the Public Company Accounting Oversight Board are willing to improve their approaches to internal controls based on what has worked and what has not.

One of the ways in which the Enron officers were allegedly able to conceal their claimed misconduct was by taking advantage of the complexity of the accounting rules, according to Mr. Cox. He advised that the SEC and Financial Accounting Standards Board have joined together in a "war on complexity" which includes FASB's codification of the existing accounting literature in order to establish a single source for all GAAP materials, controlling the number of accounting pronouncements by different sources and FASB's project on uncertain tax positions. Mr. Cox said the SEC supports FASB's initiative to reduce the variations in accounting for uncertain tax positions.

One of the SEC's jobs is to ensure that the description of company tax treatment is in plain English. Mr. Cox advised that he is carrying forward former Chairman Arthur Levitt's initiative on plain English in accounting and other disclosure. Mr. Cox also promoted the use of interactive data which he said could be particularly useful in evaluating the tax treatment of complex transactions, and evaluating the consequences of alternative treatments.

PCAOB Remarks

The PCAOB's acting chairman, Bill Gradison, also spoke to the Tax Council Policy Institute. He believes that 2006 will be the most important year so far for the PCAOB. This year will mark the end of the first three-year inspection cycle for U.S. firms that audit fewer than 100 public companies, he explained. In addition, the board will be assessing the degree to which firms have addressed the quality control deficiencies that were identified during prior year inspections. If the deficiencies have not been addressed adequately, the Sarbanes-Oxley Act requires that the deficiencies be made public.

The board will soon publish its 2004 inspection findings which will provide a baseline for future inspections. Mr. Gradison said the reports should be useful to auditors, issuers, investors and tax specialists. Taxes have been an important part of the PCAOB's work, he explained, given that taxes are almost always material in auditing public companies' financial statements. The PCAOB has proposed ethics and independence rules that relate to tax services which are pending with the SEC.

Mr. Gradison noted that internal controls over the reporting of tax reserves require as much scrutiny by management as other internal controls. He cited a 2005 report which found evidence that controls within the tax area received less attention than they should. Mr. Gradison said that future inspection reports may help to inform the board of the impact of the board's rules on audit quality with respect to tax services and help determine whether additional steps should be taken.

Mr. Gradison reported that the board may consider standards on auditors' communications with their client companies' audit committee, on the elements of quality control at registered accounting firms and on engagement quality reviews. Mr. Gradison said that the board relies heavily on its standing advisory group which met last week to discuss the use of specialists in performing audits, risk assessment and litigation-related clauses in audit engagement letters. This spring, PCAOB inspectors will focus on whether auditors have implemented the guidance issued last May to improve the audits of internal control over financial reporting. These inspections are a big reason why Mr. Gradison expects 2006 to be such an important year for the PCAOB.