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

Federal Reserve, PCAOB Work to Assure Quality Audits

Using the experience gained from administering the internal control provisions of federal banking regulations, the Federal Reserve Board expects to work closely with the Public Company Accounting Oversight Board, to improve the quality assurance for audit services. This was the message delivered by Federal Reserve Board Governor Susan Schmidt Bies to the Oregon and Idaho Banking Associations.

Having seen weaknesses in the quality of external auditors' review of financial reporting and internal controls, bank regulators have issued an exposure draft to define a policy under which an auditor can be debarred from serving as an auditor of a bank. Bank regulators have had this authority since the early 1990s, Gov. Bies noted, but have not chosen to use it in the past. Regulators have relied on the quality assurance process of public accounting firms and the peer review process of the American Institute of Certified Public Accountants to monitor the quality of auditors.

Now, however, she noted that the Sarbanes-Oxley Act has charged the new oversight board with monitoring the quality of audit work. Since bank regulators rely heavily on the work of external auditors, the Federal Reserve is proposing that bank regulators also lay out the expectations for the quality of audit work and the conditions under which an individual or firm would be barred from audit work at a bank. Gov. Bies urged financial institutions to hire auditors who are concerned about emerging risks and best practice controls since they will provide resources to ensure that corporate governance and controls are appropriate for the organization and that internal controls evolve to keep pace with changing business practices.

Since 1991, the Federal Deposit Insurance Corporation Improvement Act has required that the chief executive officer and the chief financial officer of all SEC registrants report on the quality of internal controls. Regulators have noticed that at some banks that had breaks in internal controls the process of reporting on internal controls had become a "paper pushing " exercise rather than a robust part of the corporate governance process. The related lesson, according to Gov. Bies, is that compliance with a similar requirement in the Sarbanes-Oxley Act will require monitoring by bank regulators to reach the goal of strengthening accountability and governance.

On the application of the Sarbanes-Oxley Act to small, non-SEC registrant banks, Gov. Bies noted that the Federal Reserve is not requiring that they report on internal controls for either FDICIA or Sarbanes-Oxley purposes. But, in her view, recent losses at banks and notable corporate scandals demonstrate that sound governance and internal control practices are important for all financial institutions. Depending on the size, riskiness, and complexity of any bank's business mix, advised Gov. Bies, elements of the internal control framework developed by the Committee of Sponsoring Organizations of the Treadway Commission can provide a process to help identify and monitor areas in which controls should be strengthened.