SEC adopts new audit requirements.

The Securities and Exchange Commission adopted revisions to its rules--imposed under the Private Securities Litigation Reform Act of 1995--that, as of April 17, require auditors to report a client's uncorrected illegal acts to the client's board of directors and to the SEC if the board does not do so.

The 1995 act imposed the audit requirements by adding section 10A to the 1934 Securities Exchange Act (for more information on the act, see "Tort Reform Revolution" and "The Reform Act: What CPAs Should Know," JofA, Sept. 96). One of the act's objectives was to detect and disclose fraudulent acts before they cause losses that give rise to lawsuits. To do this, the SEC adopted the section 10A rules, which require auditors--if they become aware that an illegal act has occurred--to determine its possible effect on the client's financial statements and to inform the company's management "as soon as practicable." The auditors also must ensure the client's board of directors has been informed of the illegal act.

Robert H. Herz, chairman of the American Institute of CPAs SEC regulations committee, said the revisions provide auditors with a whole sequence of events they are bound by law to observe. "The new SEC rules make it very clear at what point auditors have to inform the board and the SEC," said Herz. "CPA firms will have to implement their own procedures to ensure these rules are followed."

According to the revised rules, the board of directors has only one business day in which to notify the SEC if it receives notification from the auditors of a fraudulent act. If the auditors do not receive a copy of the board's notification to the SEC within one day, "by the end of the next business day" the auditors are required to furnish directly to the SEC a copy of the report given to the board of directors. The SEC warns that resignation from the audit does not negate the auditors' obligation to furnish the report to the SEC.

Redefining audit

The SEC also adopted an amendment to conform the definition of audit in regulation S-X with section 10A. According to the SEC, the amendment's purpose was to alert auditors and public companies that, in certain circumstances, the SEC could require audit procedures in addition to those required by generally accepted auditing standards.

The SEC received a number of comment letters, including one from the AICPA, objecting to the amendment on the grounds that the SEC's statutory authority to modify or supplement GAAS was limited to certain circumstances set forth in section 10A. Although the SEC rejected the objection, it included in its revisions notice that it would continue its practice of"looking to the private-sector standard-setting bodies designated by the accounting profession to provide leadership in establishing and improving GAAS."

For more information on the new audit requirements, contact Robert E. Burns or W. Scott Bayless, SEC Office of the Chief Accountant, at 202-942-4400 or Kathleen Clarke, SEC Division of Investment Management, at 202-942-0724.

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