FINANCIAL EXECUTIVES INSTITUTE
September 30, 1999
Lynn Turner
Chief Accountant
U.S. Securities and Exchange Commission
Dear Lynn:
As a follow-up to our discussions with the SEC staff in the September 9
Liaison meeting, FEI’s SEC Subcommittee has examined past FEI
positions on management reports to shareholders and ascertained the
current views of the Committee on Corporate Reporting.
With respect to management including in the annual report a “Report of
Management’s Responsibilities” for internal controls and the financial
statements, we strongly support making such reports and have long
urged public companies to do so on a voluntary basis. Most large public
companies do in fact make such reports today.
We also support having a requirement for public companies to make such
reports, subject to considerations of how such reports might best be
made to provide important benefits at reasonable costs.
We think any requirement for such a report should outline the elements
which should be present in the report, but should not be prescriptive as to
exact language and format. It is important and useful that each company
be permitted to describe what it does in its own unique language, in much
the same way that the Management’s Discussion and Analysis is done
today.
We feel very strongly that there should not be a requirement to have such
reports audited and separately reported on by external auditors. There is
already a fully adequate general requirement for the auditor to read any
unaudited information that is supplied with the financial statements, but is
not a part of the financial statements, to ensure that such information is
not inconsistent with the audited financial statements.
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Here are the elements that we think are important to include in a “Report
of Management”
1.) Management should affirm its responsibility for the financial
statements and all data presented
2.) Management should affirm its responsibility for a system of internal
controls, provide a concise, general summary of how it addresses this
responsibility, and present its view as to whether the system in place
provides reasonable assurance that access to assets occurs in
accordance with management’s authorizations and that transactions
are appropriately recorded in the books and records.
3.) The report should be signed by the Chief Executive Officer and the
Chief Financial Officer and/or the Chief Accounting Officer.
Management should not be required to attest that “controls are effective
as of a certain point in time or during a certain period” or make any other
definitive statement that does not include the concept of reasonable
assurance.
We believe that a review of the annual reports of larger public companies
will show that there are many effective and informative approaches that
companies are using to make “Report of Management” communications to
shareholders and other users. A requirement to include a report of
management, coupled with the flexibility to portray each company’s
unique circumstances, can provide a significant benefit in the public
financial reporting process.
Attached for your information is a past position that FEI has expressed to
the SEC on the subject of management reports, along with voluntary
guidelines we first published for our FEI members many years before.
The CCR SEC Subcommittee of FEI appreciates this opportunity to
provide input on the subject of management reports, and will be pleased
to provide further information as may be needed.
Sincerely,
Susan Koski-Grafer
Susan Koski-Grafer
Vice President – Technical Activities
Financial Executives Institute
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PREVIOUS FEI POSITION
October 20, 1988
Mr. Jonathan G. Katz
Secretary
Securities and Exchange Commission
450 5th Street, N.W.
Washington, D.C. 20549
Re:
File No. S7-14-88: Release No. 33-6789, Report of Management’s
Responsibilities
Dear Sir:
The Committee on Corporate Reporting (CCR) of Financial Executives
Institute (FEI) appreciates the opportunity to comment on the subject
release. Since 1978, FEI has urged the voluntary inclusion in annual
reports of reports of management similar in many respects to the reports
which are now proposed to be required of SEC registrants. FEI also
supports the Treadway Commission recommendation in this respect. We
therefore support the SEC proposal to require reports of management’s
responsibilities, although with some important provisos and exceptions.
The most important proviso to our support of the proposed requirement is
our opposition to including management’s responses to auditors’ internal
control recommendations, because of the potential for significantly higher
audit costs if auditor review of internal controls is increased. We agree
that the management report will tend to further the Commission’s stated
objectives of improved public understanding of the respective roles of
management and the independent accountant, and perhaps heighten the
awareness of senior management of its responsibilities. However, we are
greatly concerned that the measurable costs of auditor involvement could
greatly exceed these unquantifiable benefits unless the final SEC release
clearly indicates that the SEC intends no auditor involvement beyond that
envisioned in SAS No. 8 – “Other Information in Documents Concerning
Audited Financial Statements”. Specifically, quoting from the SEC
release:
“SAS No. 8 requires the independent accountant to read other
information, such as the proposed management report, in a
document containing audited financial statements, and consider
whether such information, or the manner of its presentation, is
materially inconsistent with information appearing in the financial
statements. Further, this SAS requires that the independent
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accountant also consider whether such other information is a
material misstatement of fact (even though not inconsistent with the
financial statements). This responsibility extends to a material
misstatement that results from management’s failure to disclose a
fact necessary to make the statements made regarding internal
control not misleading. However, SAS No. 8 indicates that the
independent accountant has no obligation to perform any
procedures to corroborate such ‘other information’.”
The last sentence in the above quotation is inconsistent with the SEC’s
proposal to require reference in the report of management as to how
management has responded to any significant recommendations made by
its independent accountants. The user of financial statements containing
a management representation about auditors’ recommendations
concerning internal controls would be justified in concluding that the
auditor has performed much more extensive evaluations of internal
controls than is in fact the case in current practice.
For this reason, and because we find the usefulness of the information
highly questionable, CCR strongly opposes the requirement to include in
the management report responses to auditors’ control recommendations.
We would not object to a requirement that management express its
assessment of the effectiveness of the system of internal controls as they
affect financial reporting directly and provide reasonable assurance as to
the integrity of financial reporting, consistent with the recommendations
of the Treadway Commission. However, to require comment concerning
specific control suggestions of the internal and external auditors would
add little if any useful information concerning management’s assessment.
If there had been an inadequate response to such a suggestion, and it
were material, it would raise an SAS No. 8 issue with the auditor in
reviewing management’s statement concerning its assessment of
controls. To require further dissertation in the report of management
would be overkill.
CCR members’ views vary on the proposal to require that the
management report be signed by the principal executive officer, principal
financial officer and principal accounting officer. We therefore defer to
the individual companies’ responses to that issue and its possible liability
and other implications. Our members’ views are also divided on the
question whether the proposal may alter the allocation of liability among
auditors, board members, management, the registrant, and other.
Our comments with respect to the other issues raised in the release are
included in the attachment.
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In summary, we support the inclusion of reports of management in annual
reports but have major concerns as to cost effectiveness if the
Commission does not clearly state that auditor involvement beyond SAS
No. 8 procedures is not required.
We would be happy to discuss our views further.
Sincerely yours,
JAS/afc
Attachment
Joseph A. Sciarrino
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FEI-Committee on Corporation Reporting
Supplemental Comments on SEC Release No. 33-6789
Following are CCR Comments on the specific questions raised in the
subject release other than those addressed in our cover letter.
1.
Commentators are requested to address – whether alternative
disclosures should be required.
We do not believe any alternative disclosures should be
required. To do so could lead to meaningless boilerplate as
opposed to meaningful commentary.
2.
Comment is invited on the scope of internal controls encompassed
in the proposed rule.
We agree with the scope of internal controls encompassed
proposal.
3.
Comment is specifically invited on the proposed inclusion of a
materiality threshold.
We agree that any final requirement should include a
materiality threshold with respect to assessment of
effectiveness of system of internal controls. However, we
believe the materiality concept in the proposal is
inappropriate for assessment of an internal control system. A
more appropriate criterion would be the definition of a
“material weakness” in SAS No. 60 which is “—a reportable
condition in which the design or operation of the specific
internal controls structure elements do not reduce to a
relatively low level the risk that errors or irregularities in
amounts that would be material in relation to the irregularities
in amounts that would be material in relation to the financial
statements being audited may occur and not be detected
within a timely period by employees in the normal course of
performing their assigned functions.”
4.
Commentators are encouraged to address whether it would be
more appropriate to require management reporting for the period
rather than as of a point in time and whether it would be more
appropriate to permit reporting at other than fiscal year end as
recommended in the Treadway Commission report.
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We believe that point in time reporting is more appropriate in
connection with point in time financial statements. We also
believe the fiscal year end is generally the most appropriate
point, but would allow flexibility to use a point in time near
year end.
5.
Comment is requested as to whether the Commission should
specify any other items that should be addressed in a management
report.
We do not believe any other items should be specified.
6.
Comment is requested on whether the Commission should specify
responsibility of the auditor in the event of a noted misstatement in
a management report.
Such a specification is unnecessary because the auditor’s
responsibilities are already specified by Interpretation No. 1
to SAS No. 8.
7.
Comment solicited on whether the requirement should pertain only
to Form 10-K rather than the annual report to security holders.
We agree with the proposed scope in this respect. The
requirement should not be limited to the 10-K because, if
maximum benefit is to be derived from the management
report, it should be included in the document most read, the
annual report.
8.
Comment is requested on whether the requirement should extend to
registration statement for initial public offerings, whether SAS No. 8
procedures should apply thereto, whether any category of issuers
should be exempted, whether the proposed requirements should
apply to foreign private issuers and to registered investment
companies, and whether capital formation would be impacted.
We believe the requirements should extend to all registrations
and that none should be exempted. Acknowledgement of
management responsibilities and assessment of internal
controls may be of particular value in IPOs. SAS No. 8
procedures should apply.
We do not believe such a
requirement would impact the capital formation process.
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9.
Commentators are requested to indicate whether the Commission
should be more or less prescriptive regarding the specific items to
be addressed.
We do not believe the Commission should be more
prescriptive. Flexibility will permit management to prepare a
more meaningful report.
10.
Comment on whether independent accountants should be required
to report directly in the Form 10-K and annual report, either on
internal control structure of the registrants or the proposed
management report.
We believe strongly that such reporting should not be
required for the cost/benefit reasons discussed in our cover
letter.
11.
Comment on whether the proposed revisions, if adopted, would
have any adverse affect on competition.
We do not believe there would be an adverse effect on
competition if auditor involvement, and hence cost, is not
expanded beyond SAS No. 8 procedures.
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GUIDELINES FOR PREPARATION OF A
STATEMENT OF MANAGEMENT RESPONSIBILITY
FOR FINANCIAL STATEMENTS
Financial Executives Institute believes that a statement in the Annual
Report acknowledging management’s responsibility for the preparation of
the financial statements will help to improve the public’s understanding of
the respective roles of management and the auditor. This statement has
also been generally referred to as a "Management Report" or
"Management Certificate." We believe such a statement can provide a
convenient vehicle for management to describe the nature and manner of
preparation of the financial information and the adequacy of the internal
accounting controls. Logically, the statement should be presented in
close proximity to the formal financial statements. For example, it could
appear in conjunction with the auditor’s report, or in the financial review
or management analysis section.
Listed below are several subjects which should be considered when
preparing a management report. Obviously, not all of these subjects
would be appropriate in all cases. Also, while the statement should be
informative, care should be taken that any assurances given do not imply
a greater degree of accuracy or reliability than is possible within the
inherent limitations of the accounting system.
1.
2.
Management responsibility for:
a.
The preparation and presentation of the financial statements
in conformity with generally accepted accounting principles
appropriate in the circumstances.
b.
Other financial information in the Annual Report, consistent
with that in the financial statements.
c.
The quality of the data in the statements.
d.
The estimates and judgments required.
Management responsibility for maintaining a system of internal
accounting controls* designed to provide reasonable assurance as
to the integrity of the financial records and the protection of assets.
Comments on the control system could include, among other things:
a.
Communication of established written policies and
procedures.
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b.
Careful selection and training of qualified personnel.
c.
Organizational arrangements that provide an appropriate
division of responsibility.
d.
A program of internal audits and appropriate follow-up by
management.
3.
Management’s assessment of the effectiveness of the internal
accounting control system.*
4.
Independent public accountant responsibility for:
5.
6.
a.
An independent examination conducted in accordance with
generally accepted auditing standards.
b.
An expression of an opinion as to whether the financial
statements fairly present the financial position, operating
results, and changes in financial position.
The Board of Directors (and its independent Audit Committee)
responsibility for:
a.
Seeing that management fulfills its responsibilities in the
preparation of the financial statements, and for engaging the
independent public accountant.
b.
Composition of the Audit Committee and related
independence of its members.
c.
Periodic meetings with the representatives of the
independent public accountant and management to discuss
auditing and financial reporting matters.
d.
Assuring that independent auditors have full and free access
to meet with the Audit Committee, without management
present, to discuss the results of their examination, their
opinions on the internal accounting controls, and the quality
of financial reporting.
Other matters management may feel are appropriate to discuss,
such as:
a.
Reference to any change in independent auditors.
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7.
b.
Reference to ethical and legal policies for domestic and
international business activities.
c.
Reference to the corporation’s social responsibilities.
d.
The significance of uncertainties.
The signature of the Chief Financial and/or the Chief Executive
Officers may add stature to the statement.
*FEI members should consult legal counsel regarding the provisions of the
Foreign Corrupt Practices Act of 1977.
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