On Dec. 13, 2004, the staff re-published previous FAQS covering the following topics:

• partner rotation -- transition questions
• audit partner and partner rotation
• prohibited and non- audit services
• audit committee pre-approval procedures
• audit committee communications
• fee disclosures
• "cooling off" period
• broker-dealer and investment advisers.

I would like to focus on the audit committee FAQs because they illustrate how helpful a review of these FAQs releases are to the financial professionals.

FAQ 1 takes the position that the audit committee of a parent company, whose subsidiaries do not have audit committees, can function as the audit committee of the wholly-owned subsidiaries for purposes of satisfying the pre-approval requirements. This position is not applicable to the mutual fund industry.

FAQ 2 discusses an issuer that is a listed company with foreign subsidiaries which are consolidated. In many instances the issuer's principal auditor is a member of a network of international accounting firms. In some instances the foreign subsidiaries have statutory audits performed by a firm outside of the member firm's network. Under the circumstances the audit committees must approve all of the audit services provided by both a principal auditor and the other accounting firm[s]. However, the failure of the audit committee to pre-approve audit services to be provided by another firm would not affect the independence of the principal auditor.

FAQ 3 deals with the issue of whether or not the audit committee can use monetary limits as the basis for establishing its pre-approval policies and procedures. The staff notes that there are three requirements that must be followed in the audit committee's use of pre-approval policies and procedures: (i) the policies and procedures must be detailed as to the particular services provided;(ii) the audit committee must be informed about each service and (iii) the policies and procedures cannot result in the delegation of this function or authority to the issuer's management. Accordingly, monetary limits cannot be the only basis for pre-approval policies and procedures as they do not contain the necessary details as to the particular services to be provided and may avoid whether or not the audit committee is properly informed about each service.

FAQ 4 emphasizes that the committee's pre-approval policies or procedures cannot use broad categorical approvals because the Commission's rules require that the pre-approval policies be detailed as to the particular service provided.
 
FAQ 5 under this heading discusses the level of detail needed for pre-approval policies. The appropriate level of detail for these policies will differ depending on the facts and circumstances of the issuer, but it cannot result in a delegation of the audit committee's responsibility to management. Management cannot make the decision as to whether or not a proposed service fits within the pre-approved services. In addition, pre-approval policies must be designed to ensure that the audit committee knows precisely what service it is being asked to pre-approve so it can make a well reasoned assessment of the impact of that service on the auditor's independence.
 
FAQ 1 under Audit Committee Communications notes that the underlying reasons or conclusion of an audit committee under Item 9(e) of Schedule 14A are not required to be disclosed, but can be disclosed on a voluntary basis. 
 
FAQ 2 notes that although the release implementing audit committee communications is silent on the effective date, the communications requirements under Rule 2-07 are effective for audit reports filed on or after May 6, 2003.
 
FAQ 3 notes that the audit committee communications rules apply to situations were the auditor is providing a consent. Since the communication should been made at the time of the audit, communication at the time of the consent may properly be restricted to updating the audit committee. However, if in the process of applying the audit procedures for updating disclose that the financial statements previously filed or audit report could have been affected then all relevant information should be communicated to the audit committee. 
 
FAQ 4 deals with a timing of audit committee communications when there are alternative applications of GAAP relating to material items that have been discussed with management subsequent to the balance sheet date that are not reflected in the financial statements. The staff notes that although the literal requirement is that these need not be discussed with the audit committee until the preparation of the financial statements for the period in which the transactions affect the financial statements occur, the better view is to communicate these concerns to the audit committee on a "real-time" basis.

FAQ 5 deals with a situation where there are reports by more than one accounting firm. Even if both firms are required to file consents, only the successor firm is required to communicate with the audit committee. However, the staff notes that prior to providing its consent the predecessor firm is required to perform all of the audit procedures specified in AU § 711. 
 
FAQ 6 deals with the situation where a significant portion of the audit is performed by an accounting firm other than the principal accountant, and the report of the principal firm refers to the other accountant. The audit opinions of both firms must be filed and both the predecessor and current accounting firm are required to provide the requisite communications to the audit committee.
 
There are similar FAQs for each of the other categories set forth in the beginning of this article. The staff regularly encourages financial professionals and their attorneys to contact them with respect to unusual issues, which are not covered by a FAQ. At the same time the staff discourages such inquiries when it is obvious to the staff that the issuer and/or the auditors are looking for ways to circumvent the rules.

The goal of the staff is to make the financial statements and related notes more transparent so that the investing public is in a better position to accurately assess the investment quality of an issuer. In fact, it has been my experience that the more transparent the financial statements and Management Discussion and Analysis, the higher the price-earnings multiple is for that particular company. Once investment analysts, brokers, financial writers and investors believe that in issuer is making full and understandable disclosures about its financial operations, they tend have more confidence and trust in the management of the issuer and its outside auditors.

See also: Read Between the Lines: The SEC on Accounting Issues

CHARLES HECHT has been a principal of his own law firm specializing in securities law since 1971. He was previously on the staff of the Division of Corporate Finance of the Securities and Exchange Commission at its headquarters in Washington, DC. Contact him at 212.490.3232 or visit www.securitiescounselors.com