(The news featured below is a selection from the news covered in SEC Today, which is distributed to subscribers of SEC Today.)

SEC To Seek Comment On Guidance For Management Under Section 404

The SEC took action on six initiatives at an all day open meeting yesterday, including a proposal for guidance to issuer's management in preparing its report on internal control over financial reporting, a reproposal of rules to permit foreign private issuers to terminate their registration and cease filing reports in the U.S., and a reproposal of terms and conditions relating to the broker exceptions for banks as contemplated by the 1999 Gramm-Leach-Bliley Act. The SEC also proposed a new antifraud rule under the Investment Advisers Act and a new definition for accredited investors relating to investments in certain private investment vehicles such as hedge funds. The SEC adopted a voluntary measure by which companies may notify shareholders of the posting of proxy materials on the Internet, along with a companion proposal to make the so-called "notice and access" model mandatory. The final action was approved by seriatim, in which the commissioners agreed to reissue for comment certain investment company governance provisions to include data collected by the Office of Economic Analysis.

The proposed guidance for management is a joint proposal of the Division of Corporation Finance and the Office of the Chief Accountant. Chairman Christopher Cox said it is an important part of the SEC's roadmap to improve the implementation of section 404. In addition to outlining a top-down, risk based evaluation process for internal control over financial reporting, the staff has proposed amendments to 1934 Act rules 13a-15 and 15d-15 to make clear that a company that evaluates its internal controls in accordance with the proposed guidance will satisfy the annual evaluation required by those rules. The staff has also proposed an amendment to Regulation S-X to eliminate the two auditors' opinions in the PCAOB's Auditing Standard No. 2, and require only one opinion on the effectiveness of internal control over financial reporting which includes the attestation on management's assessment. The PCAOB will propose a conforming change at its meeting next week.

Deputy Chief Accountant Zoe-Vonna Palmrose explained that management's evaluation is all about risk and materiality. The guidance does not provide details on how to approach the evaluation. It allows management to exercise significant and appropriate judgment tailored to the company's circumstances. The guidance provides management with significant flexibility on the level of documentation needed to support its evaluation, which recognizes the different circumstances of management and the auditors. The guidance represents a fundamental change to the way some companies are documenting their process, she said.

Palmrose said the guidance recognizes that accelerated filers have invested significant time and resources in developing their current evaluation process. That does not have to change. Management may follow the proposed guidance or may continue to use the processes they have already established.

Cox acknowledged the PCAOB for its exceptional collaboration in the steps for improving the implementation of section 404. The two main complaints have been the lack of scalability and excessive documentation, he said. Palmrose said the guidance does not create any artificial documentation requirements. It recognizes small companies' parameters. John White, the director of the Division of Corporation Finance, added that companies with effective procedures already in place may continue to follow them, but the guidance might help them become more efficient. The guidance is aimed more at the nonaccelerated filers that have not yet had to comply with section 404. 

Commissioner Paul Atkins asked why the staff chose to propose interpretive guidance rather than a rule. White said the guidance provides flexibility that can grow as the process evolves. He added that the concept release provided one set of comments that the staff was able to incorporate in the interpretive guidance. Atkins also asked why the guidance included so few examples. Palmrose replied that the staff was concerned that detailed examples would run the risk of being seen as de facto rules.

Commissioner Roel Campos said he believes the proposal will reduce, and in many cases eliminate, the problems that have plagued section 404. The expected changes to AS2 will be enormous, he said, and will strike the right balance. He predicted that the package of proposals will be seen as a framework that fixes section 404 and its implementation. The commissioners unanimously approved the issuance of the proposal for comment. The comment period will remain open for 60 days.

The remaining items upon which the SEC took action yesterday will be covered in upcoming issues of SEC Today.

Jacquelyn Lumb