Definition of the Term Significant Deficiency, 44924-44927 [E7-15556]

Download as PDF 44924 Federal Register / Vol. 72, No. 153 / Thursday, August 9, 2007 / Rules and Regulations SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 210 and 240 [Release Nos. 33–8829; 34–56203; File No. S7–24–06] RIN 3235–AJ58 Definition of the Term Significant Deficiency Securities and Exchange Commission. ACTION: Final rule. AGENCY: We are defining the term ‘‘significant deficiency’’ for purposes of the Commission’s rules implementing Section 302 and Section 404 of the Sarbanes-Oxley Act of 2002. DATES: Effective Date: September 10, 2007. SUMMARY: N. Sean Harrison, Special Counsel, Division of Corporation Finance, at (202) 551–3430, or Josh K. Jones, Professional Accounting Fellow, Office of the Chief Accountant, at (202) 551– 5300, U.S. Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549. SUPPLEMENTARY INFORMATION: We are adopting amendments to Rule 12b–2 1 under the Securities Exchange Act of 1934 (the ‘‘Exchange Act’’) 2 and Rule 1– 02 3 of Regulation S–X.4 FOR FURTHER INFORMATION CONTACT: I. Background On June 27, 2007, the Commission issued interpretive guidance and rule amendments to help public companies strengthen their evaluations and assessments of internal control over financial reporting (‘‘ICFR’’) while reducing unnecessary costs.5 The Interpretive Release provides guidance for management on how to conduct an evaluation of the effectiveness of a company’s ICFR under the Commission’s rules implementing Section 404 of the Sarbanes-Oxley Act of 2002.6 The guidance sets forth an approach by which management can conduct a top-down, risk-based evaluation of ICFR. The rule amendments, among other things, provide that an evaluation that complies with the interpretive guidance is one way to satisfy the annual evaluation 1 17 CFR 240.12b–2. U.S.C. 78a et seq. 3 17 CFR 210.1–02. 4 17 CFR 210.1–01 et seq. 5 See Release No. 33–8809 (Jun. 20, 2007) [72 FR 35310, Jun. 27, 2007] and Release No. 33–8810 (Jun. 20, 2007) [72 FR 35324, Jun. 27, 2007] (hereinafter ‘‘Interpretive Release’’). 6 15 U.S.C. 7262. rwilkins on PROD1PC63 with RULES_2 2 15 VerDate Aug<31>2005 18:34 Aug 08, 2007 Jkt 211001 requirement in Exchange Act Rules 13a– 15(c) and 15d–15(c).7 The Interpretive Release also added a definition of the term ‘‘material weakness’’ to the Commission’s rules. The term is defined as ‘‘a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the registrant’s annual or interim financial statements will not be prevented or detected on a timely basis.’’ 8 As part of the Commission’s efforts to provide more guidance to management on ICFR, the Commission initially sought comment on both the terms ‘‘significant deficiency’’ and ‘‘material weakness’’ in a concept release on ICFR requirements,9 and then proposed and adopted a definition of the term ‘‘material weakness.’’ 10 Several commenters pointed out that while the proposing release for the interpretive guidance 11 referenced the term ‘‘significant deficiency,’’ the Commission did not include a definition of the term in the proposal.12 Certain commenters indicated that the Commission should include a definition of significant deficiency in the Interpretive Release.13 In light of the comments received in response to the proposed interpretive guidance, and because Commission rules implementing Section 302(a) of the Sarbanes-Oxley Act require senior management to certify they have communicated significant deficiencies to the audit committee and the external auditors, the Commission solicited additional comment on a definition for ‘‘significant deficiency.’’ In a release issued on June 27, 2007, the Commission requested additional comment on the following definition of the term ‘‘significant deficiency:’’ 14 A deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a 7 17 CFR 240.13a–15(c) and 15d–15(c). Rule 1–02(p) of Regulation S–X [17 CFR 210.1–02(p)] and Exchange Act Rule 12b–2 [17 CFR 240.12b–2]. In this release, we are moving the definitions to new paragraph (a)(4) of Rule 1–02. 9 Release No. 34–54122 (Jul. 11, 2006) [71 FR 40866, Jul. 18, 2006] available at http:// www.sec.gov/rules/concept/2006/34–54122.pdf. 10 See Release No. 33–8809 (Jun. 20, 2007) [72 FR 35310, Jun. 27, 2007]. 11 Release No. 33–8762 (Dec. 20, 2006) [71 FR 77635, Dec. 27, 2006]. 12 See, for example, letters from Cardinal Health, Inc. (‘‘Cardinal’’), Edison Electric Institute, and Protiviti to Release No. 33–8762, File No. S7–24– 06. 13 See, for example, letters from Cardinal and Protiviti to Release No. 33–8762, File No. S7–24– 06. 14 Release No. 33–8811 (Jun. 20, 2007) [72 FR 35346, Jun. 27, 2007]. material weakness, yet important enough to merit attention by those responsible for oversight of a registrant’s financial reporting. We received 22 comment letters in response to the request for additional comment.15 These letters came from accounting firms, professional associations, corporations and other interested parties. We have reviewed and considered all of the comments that we received on the proposed definition. We discuss our conclusions with respect to the comments in more detail in this release. II. Discussion A company’s principal executive officer and principal financial officer must certify that they have disclosed significant deficiencies in the design or operation of ICFR that are reasonably likely to adversely affect the company’s ability to record, process, summarize and report financial information, to the external auditor and the audit committee, with the intended result that these parties can more effectively carry out their respective responsibilities with regard to the company’s financial reporting.16 Including a definition of ‘‘significant deficiency’’ in Commission rules, in addition to the definition of ‘‘material weakness,’’ will enable management to refer to Commission rules and guidance for information on the meaning of these terms rather than referring to the auditing standards. In developing the definition of ‘‘significant deficiency,’’ we considered comments received in response to the Public Company Accounting Oversight Board’s proposed auditing standard for audits of internal control over financial reporting. In its proposed auditing standard, the PCAOB proposed to define significant deficiency as ‘‘a control deficiency, or combination of control deficiencies such that there is a reasonable possibility that a significant misstatement of the company’s annual or interim financial statements will not be prevented or detected.’’ 17 Further, 8 See PO 00000 Frm 00002 Fmt 4701 Sfmt 4700 15 The comment letters are available for inspection in the Commission’s Public Reference Room at 100 F Street, NE., Washington, DC 20549 in File No. S7–24–06, or may be viewed at http://www.sec.gov/comments/s7-24-06/ s72406.shtml. 16 See Section 302(a)(4) of the Sarbanes-Oxley Act (requiring signing officers to certify that they are responsible for establishing and maintaining internal controls and have designed the internal controls to ensure that material information relating to the issuer is made known to the signing officers, and have disclosed any significant deficiencies in internal control to the independent auditors and audit committee) [15 U.S.C 7241]. 17 See PCAOB Proposed Auditing Standard, An Audit of Internal Control Over Financial Reporting that is Integrated with an Audit of Financial Statements and Related Other Proposals (PCAOB Release No. 2006–007, Dec. 19, 2006). E:\FR\FM\09AUR2.SGM 09AUR2 Federal Register / Vol. 72, No. 153 / Thursday, August 9, 2007 / Rules and Regulations the PCAOB proposed to define a significant misstatement as ‘‘a misstatement that is less than material yet important enough to merit attention by those responsible for oversight of the company’s financial reporting.’’ In response to the comments received on its proposal, the PCAOB, working with the Commission staff, decided to modify its proposed definition to focus the auditor on the communication requirement surrounding the term ‘‘significant deficiency’’ and to clarify that auditors should not scope their audit procedures to search for deficiencies that are less severe than a material weakness. In proposing the definition, we believed that the focus of the term ‘‘significant deficiency’’ should be on the communications required to take place among management, audit committees and independent auditors. Therefore, we believed that the framework for the definition of ‘‘significant deficiency’’ should vary from that recently adopted for ‘‘material weakness.’’ Unlike the definition of the term ‘‘material weakness,’’ we did not believe it was necessary for the proposed definition of ‘‘significant deficiency’’ to include a likelihood component (that is, reasonable possibility). Rather, we believed that a definition focused on matters that are important enough to merit attention would allow for, and indeed encourage, sufficient and appropriate judgment by management to determine the deficiencies that need to be reported to the independent auditor and the audit committee. rwilkins on PROD1PC63 with RULES_2 Comments on the Proposal A majority of commenters expressed their support for the proposed definition,18 noting that it would further the Commission’s objective of improving implementation of the provisions of the Sarbanes-Oxley Act of 2002. These commenters also noted that the definition would permit the exercise of appropriate judgment by management and independent auditors to determine those deficiencies in ICFR that are important enough to merit attention by those responsible for oversight of financial reporting. In addition, they 18 See, for example, letters from BDO Seidman, LLP; Center for Audit Quality; Committees on Federal Regulation of Securities and Law and Accounting of the Section of Business Law of the American Bar Association; Deloitte & Touche LLP; Ernst & Young LLP; Financial Executives International—Small Public Company Task Force; Grant Thornton LLP; KPMG LLP; PepsiCo; PricewaterhouseCoopers LLP; The Internal Auditors Division of the Securities Industry and Financial Markets Association; Sprint Nextel Corporation; and The Institute of Internal Auditors. VerDate Aug<31>2005 18:34 Aug 08, 2007 Jkt 211001 noted that a consistent definition of significant deficiency in the Commission’s rules and in the PCAOB’s standards was imperative to promoting effective and efficient compliance by management and auditors with respect to their responsibilities to communicate and respond to significant deficiencies in internal control. Some of these commenters also supported the Commission’s inclusion of the term within its rules so that management could look to the Commission’s rules for the definition.19 A number of commenters agreed that the proposed definition of ‘‘significant deficiency’’ should not include a likelihood component.20 However, a few commenters stated the definition should include a likelihood component because they believed that the addition of such a component would enhance management’s ability to evaluate deficiencies that need to be communicated to the audit committee.21 We agree with the commenters who stated that it was not necessary for the definition to include a likelihood component, as it could have the unintended effect of diminishing the use of appropriate judgment by management and independent auditors in performing the evaluation. We believe that excluding a likelihood component from the definition reduces the chance that management or independent auditors will design and implement evaluations or audits for the purpose of identifying deficiencies that are less severe than material weaknesses. Further, we believe the guidance provided in our Interpretive Release and in the PCAOB’s Auditing Standard No. 5, An Audit of Internal Control Over Financial Reporting that is Integrated with an Audit of the Financial Statements (‘‘Auditing Standard No. 5’’), appropriately outlines that the scope of each evaluation is to detect material weaknesses, which is also consistent with comments the 19 See, for example, letters from BDO Seidman LLP; Center for Audit Quality; Committees on Federal Regulation of Securities and Law and Accounting of the Section of Business Law of the American Bar Association; Deloitte & Touche LLP; Ernst & Young LLP; Grant Thornton LLP; KPMG LLP; and PricewaterhouseCoopers LLP. 20 See, for example, letters from BDO Seidman, LLP; Committees on Federal Regulation of Securities and Law and Accounting of the Section of Business Law of the American Bar Association; Deloitte & Touche LLP; Ernst & Young LLP; Grant Thornton LLP; PepsiCo; Society of Corporate Secretaries and Governance Professionals; U.S Chamber Center for Capital Market Competitiveness; and The Institute of Internal Auditors. 21 See, for example, letters from Financial Executives International—Small Public Company Task Force; PricewaterhouseCoopers LLP; and Simone Heidema and Erick Noorloos. PO 00000 Frm 00003 Fmt 4701 Sfmt 4700 44925 Commission received related to Auditing Standard No. 5.22 Therefore, we decided not to add a likelihood component to the definition as adopted. Many commenters believed the definition allowed for the appropriate exercise of management and auditor judgment regarding what is important enough to merit attention based on each company’s particular facts and circumstances, and that some variability in the nature of items reported to the audit committee and auditors may result.23 However, these commenters believed that this would be acceptable based on the specific facts and circumstances of the individual registrants, and the fact that significant deficiencies are not required to be disclosed publicly. Some commenters also requested that further clarification be provided by the Commission related to the proposed definition. One commenter suggested that it should be clarified to allow for management, at its discretion, to communicate deficiencies to the audit committee and the auditor that it does not believe are significant deficiencies in order to provide management with the appropriate flexibility to communicate other matters as it deems appropriate.24 Other commenters requested additional guidance on determining whether a deficiency is a significant deficiency.25 Some of these commenters suggested that additional guidance such as providing qualitative and quantitative thresholds to consider in the evaluation, would provide management and auditors a basis to agree on whether a deficiency is a significant deficiency and would minimize unnecessary costs.26 One of these commenters noted that further guidance with regards to materiality generally was important to provide management and auditors with more clarity when evaluating deficiencies, which would enable a more effective and efficient process. With respect to the communication requirements associated with significant 22 See comments received for Releases 34–55912 and 34–55876. 23 See, for example, letters from BDO Seidman, LLP; Deloitte & Touche LLP; Ernst & Young LLP; Financial Executives International—Small Public Company Task Force; Grant Thornton LLP; PepsiCo; and PricewaterhouseCoopers LLP. 24 See letter from The Society of Corporate Secretaries and Governance Professionals. 25 See, for example, letters from Keith Bishop; New York State Society of Certified Public Accountants; Sprint Nextel Corporation; and U.S. Chamber Center for Capital Market Competitiveness. 26 See, for example, letters from New York State Society of Certified Public Accountants; U.S. Chamber Center for Capital Market Competitiveness. E:\FR\FM\09AUR2.SGM 09AUR2 44926 Federal Register / Vol. 72, No. 153 / Thursday, August 9, 2007 / Rules and Regulations deficiencies, we note that the definition of significant deficiency is used in the context of evaluating the minimum required communications under Sections 302 and 404 of the SarbanesOxley Act of 2002. Neither this definition nor the Commission’s rules preclude management from communicating additional deficiencies to the audit committee or the independent auditor. Finally, with regards to requests for additional guidance noted above, including on materiality when evaluating the significance of deficiencies and quantitative and qualitative guidance, we believe that the definition allows management and auditors to appropriately utilize their judgment in determining those deficiencies that are important enough to merit the attention of those responsible for oversight based on their individual facts and circumstances. Further, we do not believe that the definition of significant deficiency is the appropriate forum to address broader questions about materiality, which are fundamental to the federal securities laws. Final Rule We are adopting the definition of ‘‘significant deficiency’’ substantially as proposed. We believe the definition appropriately emphasizes the communication requirements between management, the audit committee and independent auditors on those matters that are important enough to merit attention and will allow management to use its judgment to determine the deficiencies that need to be reported to the audit committee and the independent auditor. In addition, we believe that it is important that management and auditors use the same definition of ‘‘significant deficiency.’’ Therefore, our final rules define a significant deficiency as: A deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the registrant’s financial reporting.27 rwilkins on PROD1PC63 with RULES_2 III. Paperwork Reduction Act Certain provisions of our ICFR requirements contain ‘‘collection of information’’ requirements within the meaning of the Paperwork Reduction Act of 1995 (‘‘PRA’’). We submitted 27 Rule 1–02(a)(4) of Regulation S–X [17 CFR 210.1–02(a)(4)]. We are adding a new paragraph (a)(4) to the rule to define both the terms ‘‘material weakness’’ and ‘‘significant deficiency.’’ ‘‘Material weakness’’ was previously added to paragraph (p) of Rule 1–02. VerDate Aug<31>2005 18:34 Aug 08, 2007 Jkt 211001 these collections of information to the Office of Management and Budget (‘‘OMB’’) for review in accordance with the PRA and received approval for the collections of information. We do not believe the adoption of the definition of ‘‘significant deficiency’’ will impose any new recordkeeping or information collection requirements, or other collections of information requiring OMB’s approval. IV. Cost-Benefit Analysis A detailed analysis of the benefits and costs was included in our releases proposing and adopting amendments to rules regarding management’s reports on ICFR.28 The amendments that we are adopting in this release define the term ‘‘significant deficiency.’’ We requested comment on whether the amendments would impose any additional benefits or costs on public companies or small entities. No commenter identified any additional costs or burdens that would result from the proposed definition. Three commenters suggested that the definition would not result in any additional costs,29 while a number of commenters suggested that the definition may reduce the amount of time needed by management and auditors to evaluate whether or not deficiencies are significant.30 Several commenters also noted that one of the significant benefits of the proposed definition was the flexibility provided, which allows management and auditors to utilize their judgment to focus on those matters that are important enough to merit attention by those responsible for oversight of financial reporting.31 Two commenters expressed concern that companies would have difficulty in applying the definition because they believed more guidance was necessary to allow management and independent auditors to define and calibrate their procedures in order to minimize any unnecessary costs.32 Most commenters, however, noted that the definition would permit the exercise of appropriate judgment by management 28 See Release No. 33–8762 (December 20, 2006) [71 FR 77635, Dec. 27, 2006] and Release No. 33– 8809 (Jun. 20, 2007) [72 FR 35310, Jun. 27, 2007]. 29 See, for example, letters from BDO Seidman, LLP; Committees on Federal Regulation of Securities and Law and Accounting of the Section of Business Law of the American Bar Association; and Deloitte & Touche LLP. 30 See, for example, letters from BDO Seidman, LLP; PepsiCo; Society of Corporate Secretaries and Governance Professionals; and The Institute of Internal Auditors. 31 See, for example, letters from BDO Seidman, LLP; Grant Thornton LLP; PricewaterhouseCoopers LLP; and The Institute of Internal Auditors. 32 See letter from U.S. Chamber Center for Capital Market Competitiveness and New York State Society of Certified Public Accountants. PO 00000 Frm 00004 Fmt 4701 Sfmt 4700 and independent auditors to determine those deficiencies in ICFR that are important enough to merit attention by those responsible for oversight of financial reporting. We believe that, on balance, the amendments will allow management to use sufficient and appropriate judgment to determine whether any identified deficiencies need to be reported to the auditor and the audit committee. The flexibility allowed by the definition will enable management and auditors to more efficiently and effectively perform their evaluations based on a company’s individual facts and circumstances. In addition, many commenters noted that a consistent definition between the Commission’s rules and the PCAOB’s standards was imperative to promote effective and efficient compliance by management and auditors with respect to their responsibility to communicate and respond to significant deficiencies in internal control over financial reporting.33 A consistent definition between the Commission’s rules and the PCAOB’s audit standards will enable management and independent auditors to more efficiently and effectively perform their responsibilities to communicate significant deficiencies in internal control over financial reporting. Finally, eight commenters expressed their view that the definition would not have any special impact on smaller public companies.34 We do not believe that these amendments will have much, if any, added impact on the costs to public companies or small entities. V. Effect on Efficiency, Competition and Capital Formation Section 3(f) of the Exchange Act 35 requires the Commission, whenever it engages in rulemaking and is required to consider or determine if an action is necessary or appropriate in the public interest, also to consider whether the action will promote efficiency, competition and capital formation. Section 23(a)(2) of the Exchange Act 36 also requires the Commission, when adopting rules under the Exchange Act, to consider the impact that any new rule would have on competition. In addition, 33 See, for example, letters from BDO Seidman, LLP; Center for Audit Quality; Deloitte & Touche LLP; Ernst & Young LLP; Grant Thornton LLP; PepsiCo; PricewaterhouseCoopers LLP; and Sprint Nextel Corporation. 34 See, for example, letters from BDO Seidman, LLP; Committees on Federal Regulation of Securities and Law and Accounting of the Section of Business Law of the American Bar Association; Deloitte & Touche LLP; Ernst & Young LLP; Grant Thornton LLP; PepsiCo; PricewaterhouseCoopers LLP; and The Institute of Internal Auditors. 35 15 U.S.C. 78c(f). 36 15 U.S.C. 78w(a)(2). E:\FR\FM\09AUR2.SGM 09AUR2 Federal Register / Vol. 72, No. 153 / Thursday, August 9, 2007 / Rules and Regulations Section 23(a)(2) prohibits the Commission from adopting any rule that would impose a burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act. The Commission’s releases proposing and adopting amendments to rules regarding management’s reports on ICFR contained a detailed discussion of the effects of the rule amendments on efficiency, competition and capital formation.37 We received some comments on the effects of the rule on efficiency. Four commenters on the proposal believed the proposed definition of ‘‘significant deficiency’’ would facilitate more efficient certifications of quarterly and annual reports by allowing management to use its judgment in evaluating the severity of an identified deficiency.38 The flexibility allowed by the definition will enable management and auditors to more efficiently and effectively perform their evaluations based on a company’s individual facts and circumstances, which will promote efficiency. In addition, a consistent definition between the Commission’s rules and the PCAOB’s audit standards will enable management and independent auditors to more efficiently perform their responsibilities to communicate significant deficiencies in internal control over financial reporting. We did not receive any comments on capital formation or competition. We do not believe that the rule amendment will impact capital formation or competition. commenter suggested that there would be a significant impact on any small entities. VII. Statutory Authority and Text of Rule Amendments The amendments described in this release are being adopted under the authority set forth in Sections 12, 13, 15, 23 of the Exchange Act, and Sections 3(a) and 404 of the Sarbanes-Oxley Act. List of Subjects 17 CFR Part 210 Accountants, Accounting, Reporting and recordkeeping requirements, Securities. 17 CFR Part 240 Reporting and recordkeeping requirements, Securities. Text of Amendments For the reasons set out in the preamble, the Commission amends title 17, chapter II, of the Code of Federal Regulations as follows: I PART 210—FORM AND CONTENT OF AND REQUIREMENTS FOR FINANCIAL STATEMENTS, SECURITIES ACT OF 1933, SECURITIES EXCHANGE ACT OF 1934, PUBLIC UTILITY HOLDING COMPANY ACT OF 1935, INVESTMENT COMPANY ACT OF 1940, INVESTMENT ADVISERS ACT OF 1940, AND ENERGY POLICY AND CONSERVATION ACT OF 1975 1. The authority citation for Part 210 continues to read as follows: I Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z–2, 77z–3, 77aa(25), 77aa(26), 78c, 78j–1, 78l, 78m, 78n, 78o(d), 78q, 78u–5, 78w(a), 78ll, 78mm, 80a–8, 80a–20, 80a–29, 80a–30, 80a–31, 80a–37(a), 80b–3, 80b–11, 7202 and 7262, unless otherwise noted. 37 See Release No. 33–8762 (December 20, 2006) [71 FR 77635, Dec. 27, 2006] and Release No. 33– 8809 (Jun. 20, 2007) [72 FR 35310, Jun. 27, 2007]. 38 See, for example, letters from BDO Seidman, LLP; Grant Thornton LLP; PepsiCo; and PricewaterhouseCoopers LLP. 39 See for example, letters from BDO Seidman, LLP; Deloitte & Touche LLP; Ernst & Young LLP; rwilkins on PROD1PC63 with RULES_2 VI. Regulatory Flexibility Act Certification The Commission hereby certifies pursuant to 5 U.S.C. 605(b) that the definition of ‘‘significant deficiency’’ will not have a significant economic impact on a substantial number of small entities. We requested comments on the anticipated impact and seven commenters stated that the definition would not have any special impact on smaller public companies.39 No § 210.1–02 Definitions of terms used in Regulation S–X (17 CFR part 210). VerDate Aug<31>2005 18:34 Aug 08, 2007 Jkt 211001 2. Amend § 210.1–02 by: a. Adding paragraph (a)(4); b. Removing paragraph (p); and c. Redesignating paragraphs (q) through (cc) as paragraphs (p) through (bb). The addition reads as follows: I I I I * * * * * Grant Thornton LLP; PepsiCo; PricewaterhouseCoopers LLP; and The Institute of Internal Auditors. PO 00000 Frm 00005 Fmt 4701 Sfmt 4700 44927 (a) * * * (4) Definitions of terms related to internal control over financial reporting. Material weakness means a deficiency, or a combination of deficiencies, in internal control over financial reporting (as defined in § 240.13a–15(f) or 240.15d–15(f) of this chapter) such that there is a reasonable possibility that a material misstatement of the registrant’s annual or interim financial statements will not be prevented or detected on a timely basis. Significant deficiency means a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the registrant’s financial reporting. * * * * * PART 240—GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934 3. The authority citation for Part 240 continues to read, in part, as follows: I Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 78j, 78j–1, 78k, 78k–1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u–5, 78w, 78x, 78ll, 78mm, 80a– 20, 80a–23, 80a–29, 80a–37, 80b–3, 80b–4, 80b–11, and 7201 et seq., and 18 U.S.C. 1350, unless otherwise noted. * * * * * 4. Amend § 240.12b–2 by adding the definition of ‘‘Significant deficiency’’ in alphabetical order to read as follows: I § 240.12b–2 Definitions. * * * * * Significant deficiency. The term significant deficiency is a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the registrant’s financial reporting. * * * * * By the Commission. Dated: August 3, 2007. Nancy M. Morris, Secretary. [FR Doc. E7–15556 Filed 8–8–07; 8:45 am] BILLING CODE 8010–01–P E:\FR\FM\09AUR2.SGM 09AUR2

Agencies

[Federal Register Volume 72, Number 153 (Thursday, August 9, 2007)]
[Rules and Regulations]
[Pages 44924-44927]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E7-15556]



[[Page 44923]]

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Part II





Securities and Exchange Commission





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17 CFR Parts 210 and 240



Definition of the Term Significant Deficiency; Final Rule

Federal Register / Vol. 72, No. 153 / Thursday, August 9, 2007 / 
Rules and Regulations

[[Page 44924]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 210 and 240

[Release Nos. 33-8829; 34-56203; File No. S7-24-06]
RIN 3235-AJ58


Definition of the Term Significant Deficiency

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: We are defining the term ``significant deficiency'' for 
purposes of the Commission's rules implementing Section 302 and Section 
404 of the Sarbanes-Oxley Act of 2002.

DATES: Effective Date: September 10, 2007.

FOR FURTHER INFORMATION CONTACT: N. Sean Harrison, Special Counsel, 
Division of Corporation Finance, at (202) 551-3430, or Josh K. Jones, 
Professional Accounting Fellow, Office of the Chief Accountant, at 
(202) 551-5300, U.S. Securities and Exchange Commission, 100 F Street, 
NE., Washington, DC 20549.

SUPPLEMENTARY INFORMATION: We are adopting amendments to Rule 12b-2 \1\ 
under the Securities Exchange Act of 1934 (the ``Exchange Act'') \2\ 
and Rule 1-02 \3\ of Regulation S-X.\4\
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    \1\ 17 CFR 240.12b-2.
    \2\ 15 U.S.C. 78a et seq.
    \3\ 17 CFR 210.1-02.
    \4\ 17 CFR 210.1-01 et seq.
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I. Background

    On June 27, 2007, the Commission issued interpretive guidance and 
rule amendments to help public companies strengthen their evaluations 
and assessments of internal control over financial reporting (``ICFR'') 
while reducing unnecessary costs.\5\ The Interpretive Release provides 
guidance for management on how to conduct an evaluation of the 
effectiveness of a company's ICFR under the Commission's rules 
implementing Section 404 of the Sarbanes-Oxley Act of 2002.\6\ The 
guidance sets forth an approach by which management can conduct a top-
down, risk-based evaluation of ICFR. The rule amendments, among other 
things, provide that an evaluation that complies with the interpretive 
guidance is one way to satisfy the annual evaluation requirement in 
Exchange Act Rules 13a-15(c) and 15d-15(c).\7\ The Interpretive Release 
also added a definition of the term ``material weakness'' to the 
Commission's rules. The term is defined as ``a deficiency, or 
combination of deficiencies, in internal control over financial 
reporting, such that there is a reasonable possibility that a material 
misstatement of the registrant's annual or interim financial statements 
will not be prevented or detected on a timely basis.'' \8\
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    \5\ See Release No. 33-8809 (Jun. 20, 2007) [72 FR 35310, Jun. 
27, 2007] and Release No. 33-8810 (Jun. 20, 2007) [72 FR 35324, Jun. 
27, 2007] (hereinafter ``Interpretive Release'').
    \6\ 15 U.S.C. 7262.
    \7\ 17 CFR 240.13a-15(c) and 15d-15(c).
    \8\ See Rule 1-02(p) of Regulation S-X [17 CFR 210.1-02(p)] and 
Exchange Act Rule 12b-2 [17 CFR 240.12b-2]. In this release, we are 
moving the definitions to new paragraph (a)(4) of Rule 1-02.
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    As part of the Commission's efforts to provide more guidance to 
management on ICFR, the Commission initially sought comment on both the 
terms ``significant deficiency'' and ``material weakness'' in a concept 
release on ICFR requirements,\9\ and then proposed and adopted a 
definition of the term ``material weakness.'' \10\ Several commenters 
pointed out that while the proposing release for the interpretive 
guidance \11\ referenced the term ``significant deficiency,'' the 
Commission did not include a definition of the term in the 
proposal.\12\ Certain commenters indicated that the Commission should 
include a definition of significant deficiency in the Interpretive 
Release.\13\
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    \9\ Release No. 34-54122 (Jul. 11, 2006) [71 FR 40866, Jul. 18, 
2006] available at http://www.sec.gov/rules/concept/2006/34-
54122.pdf.
    \10\ See Release No. 33-8809 (Jun. 20, 2007) [72 FR 35310, Jun. 
27, 2007].
    \11\ Release No. 33-8762 (Dec. 20, 2006) [71 FR 77635, Dec. 27, 
2006].
    \12\ See, for example, letters from Cardinal Health, Inc. 
(``Cardinal''), Edison Electric Institute, and Protiviti to Release 
No. 33-8762, File No. S7-24-06.
    \13\ See, for example, letters from Cardinal and Protiviti to 
Release No. 33-8762, File No. S7-24-06.
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    In light of the comments received in response to the proposed 
interpretive guidance, and because Commission rules implementing 
Section 302(a) of the Sarbanes-Oxley Act require senior management to 
certify they have communicated significant deficiencies to the audit 
committee and the external auditors, the Commission solicited 
additional comment on a definition for ``significant deficiency.'' In a 
release issued on June 27, 2007, the Commission requested additional 
comment on the following definition of the term ``significant 
deficiency:'' \14\
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    \14\ Release No. 33-8811 (Jun. 20, 2007) [72 FR 35346, Jun. 27, 
2007].

    A deficiency, or a combination of deficiencies, in internal 
control over financial reporting that is less severe than a material 
weakness, yet important enough to merit attention by those 
---------------------------------------------------------------------------
responsible for oversight of a registrant's financial reporting.

    We received 22 comment letters in response to the request for 
additional comment.\15\ These letters came from accounting firms, 
professional associations, corporations and other interested parties. 
We have reviewed and considered all of the comments that we received on 
the proposed definition. We discuss our conclusions with respect to the 
comments in more detail in this release.
---------------------------------------------------------------------------

    \15\ The comment letters are available for inspection in the 
Commission's Public Reference Room at 100 F Street, NE., Washington, 
DC 20549 in File No. S7-24-06, or may be viewed at http://
www.sec.gov/comments/s7-24-06/s72406.shtml.
---------------------------------------------------------------------------

II. Discussion

    A company's principal executive officer and principal financial 
officer must certify that they have disclosed significant deficiencies 
in the design or operation of ICFR that are reasonably likely to 
adversely affect the company's ability to record, process, summarize 
and report financial information, to the external auditor and the audit 
committee, with the intended result that these parties can more 
effectively carry out their respective responsibilities with regard to 
the company's financial reporting.\16\ Including a definition of 
``significant deficiency'' in Commission rules, in addition to the 
definition of ``material weakness,'' will enable management to refer to 
Commission rules and guidance for information on the meaning of these 
terms rather than referring to the auditing standards.
---------------------------------------------------------------------------

    \16\ See Section 302(a)(4) of the Sarbanes-Oxley Act (requiring 
signing officers to certify that they are responsible for 
establishing and maintaining internal controls and have designed the 
internal controls to ensure that material information relating to 
the issuer is made known to the signing officers, and have disclosed 
any significant deficiencies in internal control to the independent 
auditors and audit committee) [15 U.S.C 7241].
---------------------------------------------------------------------------

    In developing the definition of ``significant deficiency,'' we 
considered comments received in response to the Public Company 
Accounting Oversight Board's proposed auditing standard for audits of 
internal control over financial reporting. In its proposed auditing 
standard, the PCAOB proposed to define significant deficiency as ``a 
control deficiency, or combination of control deficiencies such that 
there is a reasonable possibility that a significant misstatement of 
the company's annual or interim financial statements will not be 
prevented or detected.'' \17\ Further,

[[Page 44925]]

the PCAOB proposed to define a significant misstatement as ``a 
misstatement that is less than material yet important enough to merit 
attention by those responsible for oversight of the company's financial 
reporting.'' In response to the comments received on its proposal, the 
PCAOB, working with the Commission staff, decided to modify its 
proposed definition to focus the auditor on the communication 
requirement surrounding the term ``significant deficiency'' and to 
clarify that auditors should not scope their audit procedures to search 
for deficiencies that are less severe than a material weakness.
---------------------------------------------------------------------------

    \17\ See PCAOB Proposed Auditing Standard, An Audit of Internal 
Control Over Financial Reporting that is Integrated with an Audit of 
Financial Statements and Related Other Proposals (PCAOB Release No. 
2006-007, Dec. 19, 2006).
---------------------------------------------------------------------------

    In proposing the definition, we believed that the focus of the term 
``significant deficiency'' should be on the communications required to 
take place among management, audit committees and independent auditors. 
Therefore, we believed that the framework for the definition of 
``significant deficiency'' should vary from that recently adopted for 
``material weakness.'' Unlike the definition of the term ``material 
weakness,'' we did not believe it was necessary for the proposed 
definition of ``significant deficiency'' to include a likelihood 
component (that is, reasonable possibility). Rather, we believed that a 
definition focused on matters that are important enough to merit 
attention would allow for, and indeed encourage, sufficient and 
appropriate judgment by management to determine the deficiencies that 
need to be reported to the independent auditor and the audit committee.

Comments on the Proposal

    A majority of commenters expressed their support for the proposed 
definition,\18\ noting that it would further the Commission's objective 
of improving implementation of the provisions of the Sarbanes-Oxley Act 
of 2002. These commenters also noted that the definition would permit 
the exercise of appropriate judgment by management and independent 
auditors to determine those deficiencies in ICFR that are important 
enough to merit attention by those responsible for oversight of 
financial reporting. In addition, they noted that a consistent 
definition of significant deficiency in the Commission's rules and in 
the PCAOB's standards was imperative to promoting effective and 
efficient compliance by management and auditors with respect to their 
responsibilities to communicate and respond to significant deficiencies 
in internal control. Some of these commenters also supported the 
Commission's inclusion of the term within its rules so that management 
could look to the Commission's rules for the definition.\19\
---------------------------------------------------------------------------

    \18\ See, for example, letters from BDO Seidman, LLP; Center for 
Audit Quality; Committees on Federal Regulation of Securities and 
Law and Accounting of the Section of Business Law of the American 
Bar Association; Deloitte & Touche LLP; Ernst & Young LLP; Financial 
Executives International--Small Public Company Task Force; Grant 
Thornton LLP; KPMG LLP; PepsiCo; PricewaterhouseCoopers LLP; The 
Internal Auditors Division of the Securities Industry and Financial 
Markets Association; Sprint Nextel Corporation; and The Institute of 
Internal Auditors.
    \19\ See, for example, letters from BDO Seidman LLP; Center for 
Audit Quality; Committees on Federal Regulation of Securities and 
Law and Accounting of the Section of Business Law of the American 
Bar Association; Deloitte & Touche LLP; Ernst & Young LLP; Grant 
Thornton LLP; KPMG LLP; and PricewaterhouseCoopers LLP.
---------------------------------------------------------------------------

    A number of commenters agreed that the proposed definition of 
``significant deficiency'' should not include a likelihood 
component.\20\ However, a few commenters stated the definition should 
include a likelihood component because they believed that the addition 
of such a component would enhance management's ability to evaluate 
deficiencies that need to be communicated to the audit committee.\21\ 
We agree with the commenters who stated that it was not necessary for 
the definition to include a likelihood component, as it could have the 
unintended effect of diminishing the use of appropriate judgment by 
management and independent auditors in performing the evaluation. We 
believe that excluding a likelihood component from the definition 
reduces the chance that management or independent auditors will design 
and implement evaluations or audits for the purpose of identifying 
deficiencies that are less severe than material weaknesses. Further, we 
believe the guidance provided in our Interpretive Release and in the 
PCAOB's Auditing Standard No. 5, An Audit of Internal Control Over 
Financial Reporting that is Integrated with an Audit of the Financial 
Statements (``Auditing Standard No. 5''), appropriately outlines that 
the scope of each evaluation is to detect material weaknesses, which is 
also consistent with comments the Commission received related to 
Auditing Standard No. 5.\22\ Therefore, we decided not to add a 
likelihood component to the definition as adopted.
---------------------------------------------------------------------------

    \20\ See, for example, letters from BDO Seidman, LLP; Committees 
on Federal Regulation of Securities and Law and Accounting of the 
Section of Business Law of the American Bar Association; Deloitte & 
Touche LLP; Ernst & Young LLP; Grant Thornton LLP; PepsiCo; Society 
of Corporate Secretaries and Governance Professionals; U.S Chamber 
Center for Capital Market Competitiveness; and The Institute of 
Internal Auditors.
    \21\ See, for example, letters from Financial Executives 
International--Small Public Company Task Force; 
PricewaterhouseCoopers LLP; and Simone Heidema and Erick Noorloos.
    \22\ See comments received for Releases 34-55912 and 34-55876.
---------------------------------------------------------------------------

    Many commenters believed the definition allowed for the appropriate 
exercise of management and auditor judgment regarding what is important 
enough to merit attention based on each company's particular facts and 
circumstances, and that some variability in the nature of items 
reported to the audit committee and auditors may result.\23\ However, 
these commenters believed that this would be acceptable based on the 
specific facts and circumstances of the individual registrants, and the 
fact that significant deficiencies are not required to be disclosed 
publicly.
---------------------------------------------------------------------------

    \23\ See, for example, letters from BDO Seidman, LLP; Deloitte & 
Touche LLP; Ernst & Young LLP; Financial Executives International--
Small Public Company Task Force; Grant Thornton LLP; PepsiCo; and 
PricewaterhouseCoopers LLP.
---------------------------------------------------------------------------

    Some commenters also requested that further clarification be 
provided by the Commission related to the proposed definition. One 
commenter suggested that it should be clarified to allow for 
management, at its discretion, to communicate deficiencies to the audit 
committee and the auditor that it does not believe are significant 
deficiencies in order to provide management with the appropriate 
flexibility to communicate other matters as it deems appropriate.\24\ 
Other commenters requested additional guidance on determining whether a 
deficiency is a significant deficiency.\25\ Some of these commenters 
suggested that additional guidance such as providing qualitative and 
quantitative thresholds to consider in the evaluation, would provide 
management and auditors a basis to agree on whether a deficiency is a 
significant deficiency and would minimize unnecessary costs.\26\ One of 
these commenters noted that further guidance with regards to 
materiality generally was important to provide management and auditors 
with more clarity when evaluating deficiencies, which would enable a 
more effective and efficient process.
---------------------------------------------------------------------------

    \24\ See letter from The Society of Corporate Secretaries and 
Governance Professionals.
    \25\ See, for example, letters from Keith Bishop; New York State 
Society of Certified Public Accountants; Sprint Nextel Corporation; 
and U.S. Chamber Center for Capital Market Competitiveness.
    \26\ See, for example, letters from New York State Society of 
Certified Public Accountants; U.S. Chamber Center for Capital Market 
Competitiveness.
---------------------------------------------------------------------------

    With respect to the communication requirements associated with 
significant

[[Page 44926]]

deficiencies, we note that the definition of significant deficiency is 
used in the context of evaluating the minimum required communications 
under Sections 302 and 404 of the Sarbanes-Oxley Act of 2002. Neither 
this definition nor the Commission's rules preclude management from 
communicating additional deficiencies to the audit committee or the 
independent auditor. Finally, with regards to requests for additional 
guidance noted above, including on materiality when evaluating the 
significance of deficiencies and quantitative and qualitative guidance, 
we believe that the definition allows management and auditors to 
appropriately utilize their judgment in determining those deficiencies 
that are important enough to merit the attention of those responsible 
for oversight based on their individual facts and circumstances. 
Further, we do not believe that the definition of significant 
deficiency is the appropriate forum to address broader questions about 
materiality, which are fundamental to the federal securities laws.

Final Rule

    We are adopting the definition of ``significant deficiency'' 
substantially as proposed. We believe the definition appropriately 
emphasizes the communication requirements between management, the audit 
committee and independent auditors on those matters that are important 
enough to merit attention and will allow management to use its judgment 
to determine the deficiencies that need to be reported to the audit 
committee and the independent auditor. In addition, we believe that it 
is important that management and auditors use the same definition of 
``significant deficiency.'' Therefore, our final rules define a 
significant deficiency as:
    A deficiency, or a combination of deficiencies, in internal control 
over financial reporting that is less severe than a material weakness, 
yet important enough to merit attention by those responsible for 
oversight of the registrant's financial reporting.\27\
---------------------------------------------------------------------------

    \27\ Rule 1-02(a)(4) of Regulation S-X [17 CFR 210.1-02(a)(4)]. 
We are adding a new paragraph (a)(4) to the rule to define both the 
terms ``material weakness'' and ``significant deficiency.'' 
``Material weakness'' was previously added to paragraph (p) of Rule 
1-02.
---------------------------------------------------------------------------

III. Paperwork Reduction Act

    Certain provisions of our ICFR requirements contain ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995 (``PRA''). We submitted these collections of 
information to the Office of Management and Budget (``OMB'') for review 
in accordance with the PRA and received approval for the collections of 
information. We do not believe the adoption of the definition of 
``significant deficiency'' will impose any new recordkeeping or 
information collection requirements, or other collections of 
information requiring OMB's approval.

IV. Cost-Benefit Analysis

    A detailed analysis of the benefits and costs was included in our 
releases proposing and adopting amendments to rules regarding 
management's reports on ICFR.\28\ The amendments that we are adopting 
in this release define the term ``significant deficiency.'' We 
requested comment on whether the amendments would impose any additional 
benefits or costs on public companies or small entities. No commenter 
identified any additional costs or burdens that would result from the 
proposed definition.
---------------------------------------------------------------------------

    \28\ See Release No. 33-8762 (December 20, 2006) [71 FR 77635, 
Dec. 27, 2006] and Release No. 33-8809 (Jun. 20, 2007) [72 FR 35310, 
Jun. 27, 2007].
---------------------------------------------------------------------------

    Three commenters suggested that the definition would not result in 
any additional costs,\29\ while a number of commenters suggested that 
the definition may reduce the amount of time needed by management and 
auditors to evaluate whether or not deficiencies are significant.\30\ 
Several commenters also noted that one of the significant benefits of 
the proposed definition was the flexibility provided, which allows 
management and auditors to utilize their judgment to focus on those 
matters that are important enough to merit attention by those 
responsible for oversight of financial reporting.\31\
---------------------------------------------------------------------------

    \29\ See, for example, letters from BDO Seidman, LLP; Committees 
on Federal Regulation of Securities and Law and Accounting of the 
Section of Business Law of the American Bar Association; and 
Deloitte & Touche LLP.
    \30\ See, for example, letters from BDO Seidman, LLP; PepsiCo; 
Society of Corporate Secretaries and Governance Professionals; and 
The Institute of Internal Auditors.
    \31\ See, for example, letters from BDO Seidman, LLP; Grant 
Thornton LLP; PricewaterhouseCoopers LLP; and The Institute of 
Internal Auditors.
---------------------------------------------------------------------------

    Two commenters expressed concern that companies would have 
difficulty in applying the definition because they believed more 
guidance was necessary to allow management and independent auditors to 
define and calibrate their procedures in order to minimize any 
unnecessary costs.\32\ Most commenters, however, noted that the 
definition would permit the exercise of appropriate judgment by 
management and independent auditors to determine those deficiencies in 
ICFR that are important enough to merit attention by those responsible 
for oversight of financial reporting. We believe that, on balance, the 
amendments will allow management to use sufficient and appropriate 
judgment to determine whether any identified deficiencies need to be 
reported to the auditor and the audit committee. The flexibility 
allowed by the definition will enable management and auditors to more 
efficiently and effectively perform their evaluations based on a 
company's individual facts and circumstances. In addition, many 
commenters noted that a consistent definition between the Commission's 
rules and the PCAOB's standards was imperative to promote effective and 
efficient compliance by management and auditors with respect to their 
responsibility to communicate and respond to significant deficiencies 
in internal control over financial reporting.\33\ A consistent 
definition between the Commission's rules and the PCAOB's audit 
standards will enable management and independent auditors to more 
efficiently and effectively perform their responsibilities to 
communicate significant deficiencies in internal control over financial 
reporting. Finally, eight commenters expressed their view that the 
definition would not have any special impact on smaller public 
companies.\34\ We do not believe that these amendments will have much, 
if any, added impact on the costs to public companies or small 
entities.
---------------------------------------------------------------------------

    \32\ See letter from U.S. Chamber Center for Capital Market 
Competitiveness and New York State Society of Certified Public 
Accountants.
    \33\ See, for example, letters from BDO Seidman, LLP; Center for 
Audit Quality; Deloitte & Touche LLP; Ernst & Young LLP; Grant 
Thornton LLP; PepsiCo; PricewaterhouseCoopers LLP; and Sprint Nextel 
Corporation.
    \34\ See, for example, letters from BDO Seidman, LLP; Committees 
on Federal Regulation of Securities and Law and Accounting of the 
Section of Business Law of the American Bar Association; Deloitte & 
Touche LLP; Ernst & Young LLP; Grant Thornton LLP; PepsiCo; 
PricewaterhouseCoopers LLP; and The Institute of Internal Auditors.
---------------------------------------------------------------------------

V. Effect on Efficiency, Competition and Capital Formation

    Section 3(f) of the Exchange Act \35\ requires the Commission, 
whenever it engages in rulemaking and is required to consider or 
determine if an action is necessary or appropriate in the public 
interest, also to consider whether the action will promote efficiency, 
competition and capital formation. Section 23(a)(2) of the Exchange Act 
\36\ also requires the Commission, when adopting rules under the 
Exchange Act, to consider the impact that any new rule would have on 
competition. In addition,

[[Page 44927]]

Section 23(a)(2) prohibits the Commission from adopting any rule that 
would impose a burden on competition not necessary or appropriate in 
furtherance of the purposes of the Exchange Act.
---------------------------------------------------------------------------

    \35\ 15 U.S.C. 78c(f).
    \36\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    The Commission's releases proposing and adopting amendments to 
rules regarding management's reports on ICFR contained a detailed 
discussion of the effects of the rule amendments on efficiency, 
competition and capital formation.\37\ We received some comments on the 
effects of the rule on efficiency. Four commenters on the proposal 
believed the proposed definition of ``significant deficiency'' would 
facilitate more efficient certifications of quarterly and annual 
reports by allowing management to use its judgment in evaluating the 
severity of an identified deficiency.\38\ The flexibility allowed by 
the definition will enable management and auditors to more efficiently 
and effectively perform their evaluations based on a company's 
individual facts and circumstances, which will promote efficiency. In 
addition, a consistent definition between the Commission's rules and 
the PCAOB's audit standards will enable management and independent 
auditors to more efficiently perform their responsibilities to 
communicate significant deficiencies in internal control over financial 
reporting. We did not receive any comments on capital formation or 
competition. We do not believe that the rule amendment will impact 
capital formation or competition.
---------------------------------------------------------------------------

    \37\ See Release No. 33-8762 (December 20, 2006) [71 FR 77635, 
Dec. 27, 2006] and Release No. 33-8809 (Jun. 20, 2007) [72 FR 35310, 
Jun. 27, 2007].
    \38\ See, for example, letters from BDO Seidman, LLP; Grant 
Thornton LLP; PepsiCo; and PricewaterhouseCoopers LLP.
---------------------------------------------------------------------------

VI. Regulatory Flexibility Act Certification

    The Commission hereby certifies pursuant to 5 U.S.C. 605(b) that 
the definition of ``significant deficiency'' will not have a 
significant economic impact on a substantial number of small entities. 
We requested comments on the anticipated impact and seven commenters 
stated that the definition would not have any special impact on smaller 
public companies.\39\ No commenter suggested that there would be a 
significant impact on any small entities.
---------------------------------------------------------------------------

    \39\ See for example, letters from BDO Seidman, LLP; Deloitte & 
Touche LLP; Ernst & Young LLP; Grant Thornton LLP; PepsiCo; 
PricewaterhouseCoopers LLP; and The Institute of Internal Auditors.
---------------------------------------------------------------------------

VII. Statutory Authority and Text of Rule Amendments

    The amendments described in this release are being adopted under 
the authority set forth in Sections 12, 13, 15, 23 of the Exchange Act, 
and Sections 3(a) and 404 of the Sarbanes-Oxley Act.

List of Subjects

17 CFR Part 210

    Accountants, Accounting, Reporting and recordkeeping requirements, 
Securities.

17 CFR Part 240

    Reporting and recordkeeping requirements, Securities.

Text of Amendments

0
For the reasons set out in the preamble, the Commission amends title 
17, chapter II, of the Code of Federal Regulations as follows:

PART 210--FORM AND CONTENT OF AND REQUIREMENTS FOR FINANCIAL 
STATEMENTS, SECURITIES ACT OF 1933, SECURITIES EXCHANGE ACT OF 
1934, PUBLIC UTILITY HOLDING COMPANY ACT OF 1935, INVESTMENT 
COMPANY ACT OF 1940, INVESTMENT ADVISERS ACT OF 1940, AND ENERGY 
POLICY AND CONSERVATION ACT OF 1975

0
1. The authority citation for Part 210 continues to read as follows:

    Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-3, 
77aa(25), 77aa(26), 78c, 78j-1, 78l, 78m, 78n, 78o(d), 78q, 78u-5, 
78w(a), 78ll, 78mm, 80a-8, 80a-20, 80a-29, 80a-30, 80a-31, 80a-
37(a), 80b-3, 80b-11, 7202 and 7262, unless otherwise noted.


0
2. Amend Sec.  210.1-02 by:
0
a. Adding paragraph (a)(4);
0
b. Removing paragraph (p); and
0
c. Redesignating paragraphs (q) through (cc) as paragraphs (p) through 
(bb).
    The addition reads as follows:


Sec.  210.1-02  Definitions of terms used in Regulation S-X (17 CFR 
part 210).

* * * * *
    (a) * * *
    (4) Definitions of terms related to internal control over financial 
reporting. Material weakness means a deficiency, or a combination of 
deficiencies, in internal control over financial reporting (as defined 
in Sec.  240.13a-15(f) or 240.15d-15(f) of this chapter) such that 
there is a reasonable possibility that a material misstatement of the 
registrant's annual or interim financial statements will not be 
prevented or detected on a timely basis. Significant deficiency means a 
deficiency, or a combination of deficiencies, in internal control over 
financial reporting that is less severe than a material weakness, yet 
important enough to merit attention by those responsible for oversight 
of the registrant's financial reporting.
* * * * *

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

0
3. The authority citation for Part 240 continues to read, in part, as 
follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 
78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 
80b-11, and 7201 et seq., and 18 U.S.C. 1350, unless otherwise 
noted.
* * * * *

0
4. Amend Sec.  240.12b-2 by adding the definition of ``Significant 
deficiency'' in alphabetical order to read as follows:


Sec.  240.12b-2  Definitions.

* * * * *
    Significant deficiency. The term significant deficiency is a 
deficiency, or a combination of deficiencies, in internal control over 
financial reporting that is less severe than a material weakness, yet 
important enough to merit attention by those responsible for oversight 
of the registrant's financial reporting.
* * * * *

    By the Commission.

    Dated: August 3, 2007.
Nancy M. Morris,
Secretary.
[FR Doc. E7-15556 Filed 8-8-07; 8:45 am]
BILLING CODE 8010-01-P