Today, the United States Securities and Exchange Commission ("SEC" or "Commission") approved the adoption of several rules implementing Sections 208(a) (auditor independence), 401(a) (management discussion and analysis disclosure of off-balance sheet arrangements) and 802 (workpaper retention) of the Sarbanes-Oxley Act of 2002 (the "S-O Act"). The discussion below, which is followed by three SEC press releases summarizing the rules approved at today’s SEC meeting, highlights information provided at the meeting. It may not reflect nuances that appear in the official text of the final rules, which we expect the SEC to post on its website shortly.
Auditor Independence
The rules regarding the auditor independence were proposed on December 2, 2002. The Commission today approved final rules implementing the provisions of Sections 201-206 of the S-O Act, which prescribe independence standards for issuers’ outside auditors. The following points were discussed at today’s meeting:
- Partner Rotation . The proposed rules would have prohibited all partners on the audit engagement team from providing audit services to the issuer for more than five consecutive years and from providing audit services to the same issuer for the next five years (the "cooling off" period). The final rules have been revised. The five-year rotation and five-year cooling off period will still apply to the lead partner and the reviewing (or "concurring") partner on an audit team. There will be a seven-year rotation and two-year cooling off period for other audit partners who play a "key role" on a client’s audit team, and for audit partners who were lead auditors for a significant subsidiary of the issuer. The Commission staff at today’s meeting noted that a significant subsidiary would include any subsidiary whose assets or revenues constitute 20% or more of the consolidated assets or revenues of the issuer. The final rules will address the transition period for compliance with partner rotation requirements.
- Tax Services . The Commission said that under the final rules, auditors would be prohibited from representing an audit client in tax court or in other situations involving public advocacy. Other tax services will not be included in the category of prohibited non-audit services, however. Auditors will be permitted to provide other tax services that are pre-approved by the issuer’s audit committee. The Commission suggested that audit committees should take a close look at tax planning proposals made by auditors that do not serve any "business purpose," and ask whether the auditor’s involvement in implementing such proposals would impair their independence.
- Legal Services . The Commission stated that in general, legal services will be prohibited non-audit services. It recognized, however, that some services that are characterized as "legal" in foreign jurisdictions may not be prohibited non-audit services for purposes of the auditor independence rules. The audit committee should review the proposed service that is labeled a "legal service" in a foreign jurisdiction and determine whether it would be treated as a legal service if it were provided in the United States. If it would not be so treated, then the auditor may provide the service if the audit committee approves it.
- Pre-Approval Requirements . The Commission emphasized that although the S-O Act permits certain delegations of pre-approval duties, and permits the development of policies and procedures for preapproving non-audit services, such policies and procedures may not delegate pre-approval duties to management.
- Disclosure Categories . The final rules will not change the proxy statement disclosure categories for fees paid to an issuer’s auditor that were proposed by the Commission: audit fees, audit-related fees, tax fees, and all other fees.
Management Discussion and Analysis of Off-Balance Sheet Arrangements
The rules regarding the disclosure of off-balance sheet arrangements were proposed on November 4, 2002.. The Commission today approved final rules implementing the provisions of Section 401(a) of the S-O Act, which requires disclosure of off-balance sheet arrangements in issuers’ annual and quarterly reports. The following points were discussed at today’s meeting:
- The proposed rules would have required disclosure of an arrangement whenever the likelihood that the arrangement will have a material effect on the company is "higher than remote." Instead, the final rules incorporate a standard that requires disclosure only if the likelihood of a material effect is "reasonably likely," which is in keeping with current MD&A disclosure requirements.
- The definition of "off-balance sheet arrangement" set forth in the final rules is less expansive than the definition in the proposed rules. In addition, the final requirements regarding tabular disclosures of contractual obligations are more streamlined than those set forth in the proposed rules.
- Registrants will be required to comply with the disclosure requirements for off-balance sheet arrangements in Commission filings that are required to include financial statements for the fiscal years ending on or after June 15, 2003. Tabular disclosures of contractual obligations will be required for Commission filings that include financial statements for the fiscal years ending on or after December 15, 2003.
Workpaper Retention
The rules regarding the retention of audit-related workpapers were proposed on November 21, 2002.. The Commission today approved final rules implementing the provisions of Section 802 of the S-O Act, which requires retention of certain audit-related workpapers and other documents. The following point was discussed at today’s meeting:
- The retention period for audit-related documents has been increased from 5 years in the proposed rules, to 7 years in the final rules.
