Highlights of the 2004 AICPA National Conference on Current SEC and PCAOB Developments

For a more complete discussion of Mr. Nicolaisen’s speech, please refer to the Heads Up newsletter referred to previously.

Mr. Nicolaisen’s complete speech can be obtained on the SEC’s web site via the following link:

1. Standards setting

2. Education

3. Application

4. Interpretation

5. Regulation

Each of these underpinnings, she said, is at a different stage of development. In moving toward the application of these underpinnings she suggested the following mantra: "quality in application yields confidence in capital markets." Ms. Erhardt stated that with the broad adoption of International Financial Reporting Standards (IFRS) in Europe in 2005, the SEC will have the opportunity to rigorously review how the U.S. GAAP reconciliation is prepared from an IFRS starting point. This picture, she said, will influence the SEC staff’s consideration of eliminating the reconciliation requirement and will give a more complete and accurate picture of the remaining differences between IFRS and U.S. GAAP.

Ms. Erhardt’s complete speech can be obtained on the SEC’s web site via the following link:

High-quality audited financial statements serve the public interest and help protect investors by providing them with relevant, reliable, and understandable financial information, broadly defined to cover the core financial statements and the related schedules and disclosures. High-quality audited financial statements require participation at all levels of the profession, including the following:

• The auditor has a significant role but is limited by the accounting standards and the preparers’ actions, and is only the last "gatekeeper."
• The FASB must provide objectives-based accounting standards that can be implemented and audited consistently.
• The PCAOB also must provide objectives-based auditing standards that are effective in reducing the incidence of materially misstated financial statements.
• Management and the audit committee must be committed to the intent, not merely the letter, of the accounting standards.
• Auditors must commit to the audit as their primary function

"The public’s trust costs nothing to lose," said Mr. Bailey, "but requires significant expenditures of time, talent and money to reclaim." Nevertheless, investor belief in the quality of auditors and audits will likely remain a matter of the public’s perception of auditors’ competence and independence.

A major focus of the SEC staff over the past year has been in the area of auditor independence. In an effort to meet both the letter and the spirit of the rules, audit committees and their auditors are engaging in substantive and detailed discussions about the types of services that the independent auditor should provide. According to Mr. Bailey, the SEC staff’s recent action to subpoena fee information for engagements with contingent fee arrangements is perhaps the single most visible and significant action in the area of auditor independence since the 2003 rules were finalized. Without independence in fact and appearance, auditors cannot satisfy their responsibility to the public.

The past year has been a time of significant change with regard to internal control over financial reporting, resulting in the following:

• Requirements of Section 404 of the Sarbanes Oxley Act of 2002 (Sarbanes-Oxley) became effective, requiring management to evaluate and report on its internal controls.
• The PCAOB completed its Section 404 companion audit standard (PCAOB Auditing Standard No. 2) on integrated audits, requiring auditors to attest to management’s evaluation of internal control.
• The SEC and the PCAOB provided frequently asked questions documents (FAQs) in response to a significant number of questions related to Section 404 (the SEC has issued 23 FAQs, available at www.sec.gov/info/accountants/controlfaq1004.htm, and the PCAOB has issued three sets of FAQs dated June 23, October 6 and November 22, 2004).

Mr. Bailey’s complete speech can be obtained on the SEC’s web site via the following link:

In a question-and-answer period following Mr. Baileys prepared remarks, Mr. Bailey answered several specific questions regarding auditor independence. Among his responses, Mr. Bailey noted:

• The SEC staff believes an independence violation exists if a member firm in a network is engaged to assist a Company in assessing its internal control and another member firm in the network is the Company’s independent auditor.
• The SEC staff believes there is no materiality threshold for determining auditor independence violations with respect to prohibited services.
• The SEC staff commented that an auditor would be independent in the following fact patterns:

  • An auditor assists a company in Section 404 documentation and assessment in Year 1 and the auditor is appointed the independent auditor for Year 2 so long as no services related to the Year 1 assessment are performed during Year 2
  • In Year 1, Auditor X is the company’s auditor and in Year 2 Auditor Y is appointed auditor. During Year 2, Auditor X performs what would be prohibited services if Auditor X were the auditor. (However, if a restatement is necessary for a year on which Auditor X reported, the SEC staff would like to see the specific facts and circumstances before making a determination.)

"A key to better reporting is to move away from the current compliance mindset in which financial reporting seems to be entrenched," said Mr. Taub. The focus on compliance has resulted in a setting in which the goal sometimes seems to be to do only what is necessary to comply with the rules, rather than to do what is necessary to communicate to investors. Disclosures in the areas of contingencies and off-balance-sheet arrangements are good examples of this shortcoming. Companies are encouraged to discuss the nature of contingencies and to disclose not only the low end of the range of possible loss, but the entire range. Likewise, companies should present a more complete picture of the off-balance-sheet risks and arrangements that affect the company and the way those risks and arrangements have affected the financial statements, even if this information is not specifically required by any rule or standard.

There are many ways to make financial statements more communicative, Mr. Taub said, and areas of improvement that should be on every issuer’s list include the following:

• The use of the direct method cash flows
• A move away from the smoothing mechanism allowed by FASB Statement No. 87, Employers' Accounting for Pensions
• Disclosure of expense information by the nature of the expenditure (e.g., salaries, material purchases, depreciation, rent) as a useful addition to the information by function (e.g., cost of sales, selling expenses)
• Meaningful disclosure of ranges of depreciable lives of fixed assets
• MD&A discussion with a focus on descriptive information that provides real insight as opposed to merely a collection of percentage increases or decreases, which could just as well be presented in a tabular format.

Mr. Taub cautioned companies against accounting-motivated transactions and underscored the problem faced by standards-setters when revising GAAP to respond to the structuring efforts of companies that are trying to avoid the intent of an accounting rule. The rules then become so detailed that they provide a roadmap for avoiding their intent. This problem was highlighted in the SEC staff report on principles-based accounting standards (Study Pursuant to Section 108(d) of the Sarbanes-Oxley Act of 2002 on the Adoption by the United States Financial Reporting System of a Principles-Based Accounting System). Mr. Taub pointed out that advisers and facilitators of these kinds of structured transactions have become the focus of recent enforcement efforts. He noted, however, that this is not to say that companies cannot structure transactions to meet accounting goals, but in doing so they should clearly disclose what they have done.

Mr. Taub’s complete speech can be obtained on the SEC’s web site via the following link

1. Well-Known Seasoned Issuer—an issuer that is required to file reports pursuant to Section 13(a) or Section 15(d) the Exchange Act and satisfies the following requirements:

a. The issuer must be current in its reporting obligations under the Exchange Act and timely in satisfying those obligations for the preceding 12 calendar months.

b. The issuer must be eligible to register a primary offering of its securities on Form S-3 or Form F-3.

c. The issuer either (1) must have outstanding a minimum $700 million of common equity market capitalization held by nonaffiliates or (2) must have issued $1 billion aggregate amount of debt securities in registered offerings during the past three years and register only debt securities.

2. Seasoned Issuer—an issuer that is S-3 eligible that is not a well-known seasoned issuer.

3. Unseasoned Issuer—an issuer that is required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act but does not satisfy the requirements of Form S-3 or Form F-3 for a primary offering of its securities.

4. Nonreporting Issuer—an issuer that is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act and does not file such reports voluntarily.

After the registration statement is declared effective, offering participants may still make written offers only through a statutory prospectus, except that they may use additional written offering materials if a final prospectus that meets the requirements of Securities Act Section 10(a) is sent or given prior to or with those materials.

Violations of these restrictions are often generally referred to as "gun-jumping," and we use the term "gun-jumping provisions" to describe the statutory provisions of the Securities Act that set forth these restrictions.

The proposed rules loosen many of the restrictions on communications during the offering process and attempt to modernize the securities law to account for technological developments and practices in the way information about companies is obtained. The general objectives are as follows:

• Eliminate concern over gun-jumping provisions for well-known seasoned issuers
• Provide exceptions for offers for all other reporting companies
• Permit more written communications during the offering process.

Two separate safe harbors from the gun-jumping provisions for ongoing business communications are being proposed:

• The first safe harbor would permit a reporting issuer’s continued publication or dissemination of regularly released factual business and forward-looking information at any time, including around the time of a registered offering.
• The second safe harbor would permit a nonreporting issuer’s publication or dissemination of factual business information that historically had been regularly released to persons other than in their capacity as investors or potential investors.

Finally, the proposed rule would provide all issuers a bright-line time period, ending 30 days prior to filing a registration statement, during which issuers may communicate without risk of violating the gun-jumping provisions.

As proposed, a free-writing prospectus that satisfies specified conditions could be used by a well-known seasoned issuer at any time. Further, a free-writing prospectus could be used by seasoned issuers after a registration statement has been filed and, in the case of unseasoned or nonreporting issuers, a free-writing prospectus could be used if a statutory prospectus has been filed with the Commission and has been delivered to the potential investor.

Information contained in a prospectus or prospectus supplement that is filed after the time of sale would be considered to be part of and included in a registration statement for purposes of liability under Section 11 of the Securities Act, which is assessed at the time the registration statement is declared effective. The proposal also addresses particular liability timing issues related to shelf registration statements.

· Issuers that file Exchange Act reports voluntarily would be required to check a box on the cover page of the annual report of Form 10-K to indicate that the filing is voluntary.

· The risk factor disclosure currently required in registration statements would be required in Annual Reports on Form 10-K. Updates to the risk factor disclosure would need to be included in quarterly reports on Form 10-Q.

· Accelerated filers would be required to disclose in their annual reports on Form 10-K any written SEC staff comments issued more than 180 days before the end of the fiscal year covered by the report that the issuer believes to be material and which remain unresolved as of the filing date of the report.

A few points about the Exemptive Order for the 45-day extension:

• The Form 10-K for calendar-year companies that are accelerated filers will still be due by March 16, 2005, and the Form 12b-25 extension can be utilized.
• The Form 10-K must include all required items other than the information called for under Section 404 and must (1) disclose any material internal control weaknesses that have been identified prior to the filing; (2) include the Section 302 and Section 906 certifications; and (3) include Regulation S-K Item 307, Disclosure Controls and Procedures, disclosures and Item 308(c) disclosures regarding changes in internal control over financial reporting.
• An amended Form 10-K must be filed within 45 days of the original due date of the Form 10-K
• The amended Form 10-K must include management’s annual report on internal control over financial reporting and the attestation report of the registered public accounting firm; new Section 302 certifications; and Regulation S-K, Item 307, and Item 308 disclosures, which would be revised as necessary for any material weaknesses or significant deficiencies that are noted during the 45-day extension period.
• An independent auditor’s consent related to the Section 404 attestation report would be required in the amended Form 10-K if the Form was being incorporated by reference into a Securities Act filing.
• The Exemptive Order created "temporary un-timeliness" (the company will not be considered a timely filer until they file an amended Form 10-K).
• The SEC staff does not plan any further exemptive orders to grant additional Section 404 reporting relief.

Carol Stacey, Chief Accountant of the Division of Corporation Finance, clarified several issues for companies taking advantage of the 45-day exemptive order. First, during the period prior to filing its amended 10-K with the Section 404 report, a registrant would not be considered a timely filer and would not be eligible to file a registration statement on Form S-3, nor would they be allowed to draw down on an effective Form S-3 until the amendment was filed. However the company would not lose its Form S-8 eligibility or its ability to raise capital under Rule 144.

Second, Ms. Stacey explained that under the 45-day exemptive order, Section 302 certifications in the Form 10-K before the report on internal control is filed may exclude the introductory language in paragraph 4 that refers to the responsibility of management for establishing and maintaining internal control over financial reporting, as well as the paragraph 4b language. When the company files its amended Form 10-K, it must include a Section 302 certification that would have the language that was previously omitted; however, paragraph 3 language would be omitted unless the financial statements were included in the amendment.

Nonetheless, the SEC staff expects that a company will be able to issue year-end financial statements even if a material weakness remains unremediated at year-end. Presumably, the auditor will design procedures necessary to assure that the financial statements do not include a material error that may have occurred as a result of that material weakness.

The SEC staff believes the principle executive and the principle financial officers need to re-evaluate their original conclusions surrounding the effectiveness of disclosure controls and procedures whenever the financial statements are required to be restated. The Staff believes these officers must also consider whether the disclosures previously made under Regulation S-K, Item 307 need to be modified, restated, or corrected. The disclosure should explain the relationship between failure of the company’s disclosure controls and procedures and the restated financial statements. In other circumstances the SEC staff would expect robust disclosure explaining why the officers continue to believe the disclosure controls and procedures continue to be effective after considering the fact that the financial statements were restated. Additionally, the company should disclose, pursuant to Item 308(c) of Regulation S-K and Exchange Act Rule 12b-20, what steps have been implemented to correct the internal control problems.

Officers may conclude that disclosure controls and procedures were not effective as of the end of the reporting period covered by the amended report, but effective by the time the Form 10-K amendment containing the Section 404 reports is filed However, in these circumstances, the SEC staff would expect the company to expand its disclosures to explain how management has determined that the disclosure controls and procedures are now effective given the material weakness or other matters that had been identified.

Regarding management’s assessment and reporting on internal control, Mr. Bailey, of the Office of the Chief Accountant, during a question and answer period, said the SEC staff believes that testing can be performed on controls after year-end but only if the tests are conducted using pre-year-end data. Additionally, remediation of control weaknesses that occurs after year-end should not favorably affect reports on internal control .

The rules do not specify where management’s report on internal control over financial reporting is required to be located in the filing, but it must appear close to the auditor’s attestation report. The SEC staff expects that many companies would choose to place their report and the related auditor attestation near MD&A or immediately preceding the audited financial statements. However, this would obviously not be the case for companies relying on the exemptive order and filing their report and the auditor’s attestation report on Form 10-K/A, because neither MD&A nor the audited financial statements would be required in that Form 10-K/A. Ms. Stacey, in response to a question, said the reports should be filed in Item 9A., "Controls and Procedures," of the Form 10-K/A

The SEC staff believes internal control over financial reporting is either effective or ineffective. Management is not permitted to conclude that internal control over financial reporting is effective if there are one or more material weaknesses. Additionally, management can not qualify its conclusion by stating that internal control over financial reporting is effective with certain qualifications or exceptions.

The SEC staff believes an auditor can disagree with a company as to the effectiveness of internal controls over financial reporting. This type of disagreement is not considered a disagreement under Regulation S-K, Item 304, "Changes in and Disagreements With Accountants on Accounting and Financial Disclosure." See SEC FAQ 6, for more explicit information.

After management’s first report on internal control over financial reporting, pursuant to Item 308(b) of Regulation S-K, the company is then required to disclose material changes in internal control over financial reporting in each quarter pursuant to Item 308(c).

As an example, the company (or parent) manufactures a product and sells it to a customer for $10. The customer pays no cash at the time of sale. Concurrent with the sale, the parent’s wholly owned subsidiary originates a long-term loan to the parent’s customer for $10 and remits the cash balance to the parent. The question is how the parent’s consolidated cash flows should reflect these transactions. The company asserted that at the consolidated level there is an investing cash outflow of $10 that is the result of the activity of finance subsidiary and an operating cash inflow of $10 that is the result from the cash collected by the parent. The SEC staff objected to this conclusion and believes that from the standpoint of the consolidated entity, there has been no cash inflow or outflow on the consolidated level. The company simply sold a product in return for a long-term loan. In evaluating this case the SEC staff considered Emerging Issues Task Force (EITF) Issue No. 85-12, Retention of Specialized Accounting for Investors in Consolidation, but concluded that it is not appropriate to extend this issue, by analogy, to the cash flow transaction of long-term customer receivables.

In addition to Mr. Hardiman’s comments as summarized above, Craig C. Olinger, Deputy Chief Accountant, stated during the conference that the SEC staff believes a company should treat cash flows generated from product-financing arrangements as well as asset-securitization transactions as operating activities.

Consistent with the practice recommended by the April 21, 2004, AICPA practice aid on this matter, the company has to apply a two-step methodology. First, the company needs to determine the entity value as a whole, referred to as the "enterprise value," and, second, to allocate the enterprise value to the outstanding equity securities in order to determine the fair value of a single share of stock.

The AICPA practice aid provides guidance on how to determine a best estimate of fair value when there is no market price for the securities and acknowledges the possibility of a discount for the lack of marketability. Discounts for marketability should not be ignored using a theory of conservatism. The goal is to try to get to the best estimate of fair value.

With respect to discounts for a "lack of control" to date the SEC staff has not heard an argument for such a discount that was persuasive , but acknowledges that a scenario could exist in which there is an actual change-of-control transaction and a company is able to demonstrate that an actual premium was paid.

The SEC staff noticed three recurring themes during its reviews of filings involving the cheap stock issue:

Enterprise valuation approaches generally fall into one of three broad categories:

a. Market approach

b. Income approach

c. Asset-based approach.

The SEC staff believes it is likely not appropriate to use the asset-based approach to determine the enterprise value on any measurement date during the reporting period included in a registration statement for the following reasons:

• The asset-based approach is generally only appropriate at the early stages of development (i.e., no financial history, no developed products, or small amount of invested cash). The SEC staff’s opinion is the company and its predecessor are beyond these early stages of development at the time they file the IPO.
• Applying the asset-based approach to later stages of development tends to understate the value of the enterprise because it fails to capture the value of internally generated goodwill.

In general there are three methods to allocate this value:

a. Probability-weighted expected return method

b. Option pricing method—using common stock as a call option on the company enterprise value

c. Current value method—determines the value of the stock considering dissolution and sale to be imminent

In evaluating the allocation method used in certain IPO registration statements the SEC staff noticed two trends that are inconsistent with theme 2: (1) companies are using the current value allocation method to determine compensation expense in one or more of the IPO reported periods and (2) companies are averaging the results of different allocation methods despite the fact that these methods yielded materially different results.

The SEC staff believes the use of the current value method is likely not appropriate within the IPO-reported periods, because it assumes dissolution or sale. This method should be limited to companies for which the assumption of going concern is irrelevant because a liquidity event is imminent. It would be highly unusual for these circumstances to exist in a pre-IPO period.

The SEC staff also questioned the appropriateness of averaging valuation methods yielding materially different results. In some cases the underlying conceptual differences between certain allocation methods would appear to render the results of averaging somewhat meaningless. If management chooses to average or otherwise weigh the different results, they must provide objective, verifiable evidence to support the weighting of those results. The SEC staff is skeptical that such evidence exists.

The issues recently raised by the SEC staff relate to situations in which the type of discount does not seem appropriate and the magnitude of the discount is not supported. The SEC staff believes that management should be aware that while qualitative factors may have entered into their determination, they ultimately have to quantify the discount and provide sufficient, objective support for the amount of any discount taken.

Item 10 of Regulation S-K defines non-GAAP measures, in part, as "numerical measures of the registrant’s historical or future performance." Because managed entity revenues are not revenues of the registrant, the SEC staff believes that the presentation of system-wide revenues is prohibited by Item 10 and may be misleading. However, the SEC staff has not objected to the inclusion of a footnote to the selected financial data that quantifies revenue managed for others and describes it in an appropriate context if it is important to an understanding of the company’s own revenues. As an example, consider a case in which a company’s management fee revenues are based on a percentage of revenues earned by the managed franchise. In this case, quantifying the managed franchise revenues might be useful to understand trends in the company’s own management fee revenues.

For financial institutions and retail companies, managed-basis disclosures that purport to present what the company’s performance would have been had a securitization not been accounted for as a sale are generally non-GAAP financial measures as long as those measures are not required otherwise by GAAP (i.e., FASB Statement No. 131, Disclosure About Segments of an Enterprise and Related Information, and certain disclosures required by FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.

Mr. Hardiman said there were two important things to note. First, the Staff has not asserted that all managed-basis measures are prohibited. Some managed-basis measures are required by FASB Statement 140. For example, when a company has a retained interest in securitized loans and continues to service the loans after the sale, FASB Statement 140 requires disclosure of total financial assets managed by entity, which includes both the sold loans and the loans on the balance sheet, as well as related credit quality and delinquency disclosures. Because these disclosures are required by FASB Statement 140, they are not considered non-GAAP measures.

Second, the SEC staff has not asserted that information about risks and benefits of retained interests are meaningless. On the contrary, if the company has a material exposure through its retained interests to assets and liabilities that are off-balance-sheet, the SEC staff would expect the company to include the disclosures required by Financial Reporting Release No. 67 Disclosure in Management's Discussion and Analysis about Off-Balance-Sheet Arrangements and Aggregate Contractual Obligations, for that retained interest as well as any additional information about these off-balance-sheet assets and liabilities, which might include quantified credit quality and interest rate spread statistics that are necessary for an understanding of the sources of risks and benefits inherent in the retained interest.

At the time of issuance of the non-GAAP rule, the SEC staff was cognizant that it would be impossible to contemplate all possible measures and all of the reasons for their use. Accordingly, the staff was very careful in writing the rules to avoid saying that certain adjustments and measures can never be presented. However, the SEC staff has made it very clear in FAQ 1 that a company should never use a non-GAAP measure in an attempt to smooth earnings.

The SEC staff has focused on the significance of the dividend to both the operations of the company and to the marketing of the offering. From an operations standpoint, paying all your bills and then taking the excess cash and giving it to your shareholders results in having no cash available for unforeseen needs and unexpected opportunities. From the marketing standpoint, the following three points are significant.

1. The return for the investors stems from the promise to pay a future dividend.

2. The discretionary nature of the dividend is a concern, because companies are not obligated to pay it and shareholders cannot make them pay it.

3. The lack of precedent is a concern when the company promising to pay dividends has little or no history of paying dividends that are comparable in terms of both amount and timing of the intended future dividends.

Within this context, the SEC staff evaluated the dividend policy disclosures and ultimately concluded that the following disclosures should be provided:

· The policy description—clear articulation of what the dividend policy will be, how the company arrived at it, and how they expect to be able to pay the dividend.

· The risk and limitations, which should include:

· Discretionary

· Intended policy can be modified/revoked at any time

· Dividends may not be paid in accordance with the policy

· Limitations imposed by covenants and state laws

· Consequences of no investment in future growth

· Assumes ability to refinance debt when due

· No provisions for unexpected cash needs

· Impact of adverse tax outcome, if any, and,

· Impact of subordination clauses, if any, when there are multiple classes of stock

· Inclusion of forward looking information that needs to include:

· The assertion of the company that it will have cash necessary to pay the intended dividends

· A balance of forward-looking "estimated cash available" with comparable historical amounts of "cash available"

· Identify differences from historical amounts such as:

· Increased costs due to being public

· Increased interest expense (for IDS)

· Changes in level of capital expenditures

· Explain why management believes they can pay intended dividend if historical amounts indicate otherwise

· Identify needs, if any, to borrow to pay dividend

· Include detailed assumptions used in forward—looking information

· Bullet point list of assumptions and any change from historical amounts is an acceptable presentation.

· Discussion of risks and possible outcomes if expected results are not achieved

· State whether management expects the company to be in compliance with debt covenants based on forward-looking operating results and expected cash flows

· Intended dividend policy should not be stated for periods in excess of periods supported by expected future cash flows

· MD&A analysis—liquidity and capital resources

· Intended dividend policy for the next year, and how they intend to fund (from operations, or borrowing)

· Assumption used for the cash available for dividends

· Effect of new securities and financing agreements, if any, such as the increase of interest expense.

It is important to note, however, that the above list is not all-inclusive. It is meant to give issuers a flavor for the things to consider in crafting disclosures and because the disclosures are based on management stated intent, this is an area where "one size does not fit all." Issuers will need to fit their disclosures to the specific facts and circumstances. These disclosures are not limited to IDS offerings. The Staff expects companies to provide the disclosures outlined above if they have plans to offer securities with the intention of paying significant dividends and have very little or no history of paying dividends of the magnitude of the intended future dividends.

· Auditor independence and tax services

· Financial fraud (including revenue recognition and significant unusual accruals)

· GAAS hierarchy/codification

· Communications with audit committees

· Engagement quality review

· Related parties

· Consistency of application of GAAP

· Confirmations

· Fair value

· Elements of quality control

· Risk assessment.

In connection with this order, the PCAOB adopted a temporary rule permitting auditors to date their reports on management’s assessment later than the date of their reports on the issuer’s financial statements. This temporary rule also waives the provision under AS 2 that the auditor’s report on the issuer’s financial statements include a paragraph that refers to the report on internal control over financial reporting. This temporary rule has been approved by the SEC.

If a company takes advantage of the exemptive order, the Chief Auditor’s recommendation to the Board is that the deferral should encompass the deferral of the completion of the working papers under AS 3 for the audit of the financial statements if the audit has been integrated with the audit of internal controls.

Auditor qualifications historically have been established in one of two ways: (1) affiliation with a U.S. firm that follows Appendix K to the AICPA SEC Practice Section Rules or (2) by directly demonstrating to the Office of the Chief Accountant knowledge and experience in applying U.S. GAAP, U.S. GAAS (now PCAOB standards), and SEC financial reporting and independence rules.

Appendix K has been adopted by the PCAOB and is now included in the PCAOB interim quality control standards (Rule 3400T).

The SEC staff will not object to audit reports that reference both the standards of the PCAOB and local auditing standards.

Article 2 of Regulation S-X does not specifically address how (i.e., in what name) the audit report must be signed. Historically, certain foreign affiliates of U.S. firms have signed the "international name" rather than the local (legal) name. In March 2004, the AICPA International Practices Task Force (IPTF) concluded that firms should sign audit reports using the PCAOB registered name. Additionally, affiliation with a U.S. firm should also be clear from the face of the audit report.

For a foreign issuer that has the following characteristics, the SEC staff would expect a U.S. licensed auditor:

· Incorporated in the United States but does business outside of the United States

· Incorporated abroad but does not meet the foreign private issuer definition.

However, the SEC staff also indicated that it will consider individual circumstances based on relevant factors, such as:

· Majority of assets, revenues, and operations are located outside of the United States, where the auditor resides

· Management and accounting records are located in the country where the auditor resides

· Majority of the audit work is conducted outside of the United States.

A U.S. or non-U.S. holding company with a substantial portion of its assets in a foreign country that restricts dividends or transfers outside that country is likely to have to file a parent-company-only schedule required by Item 17(a) of Form 20-F and Rule 5-04 of Regulation S-X when restricted net assets of subsidiaries exceed 25 percent of a registrant’s consolidated net assets. The schedule requires a condensed parent-only balance sheet, income statement, and cash flow statement.

"Restricted net assets" are amounts that may not be transferred to the parent company without the consent of a third party, such as a lender, regulatory agency or foreign government.

Even though the Form 20-F does not have any acceleration provisions, if a registrant loses its FPI status, it must also assess whether it is subject to accelerated filer deadlines.

If the registrant meets the accelerated filer definition, it also becomes subject to accelerated deadlines at the time it loses its FPI status, and if this happens during 2004, it is required to comply with Section 404 internal control reporting provisions in its 2004 annual report.