Thank you. Chairman Cox and members of the Commission:
As Chairman Cox has explained, we are here today to recommend that you approve the PCAOB's Auditing Standard No. 5, a related PCAOB independence rule, and conforming amendments to PCAOB standards. Additionally, we are recommending that the Commission adopt a definition of the term "significant deficiency."
The PCAOB's Auditing Standard No. 5, if approved by the Commission today, will replace the current Auditing Standard No. 2. The independence rule, Rule 3525, will require auditors to obtain audit committee pre-approval of non-audit services related to internal control over financial reporting. Auditing Standard No. 2 contains a pre-approval requirement, but the PCAOB has determined it was more appropriate to include this requirement in its ethics and independence rules, rather than continue to include it within the internal control auditing standard.
In addition, we are recommending that you approve for the first time a definition of the term "significant deficiency." We believe that it is appropriate to include the definition of "significant deficiency" within the Commission's rules given the communication requirements in the rules implementing Section 404 of Sarbanes-Oxley, as well as the certification requirements of Section of 302 of Sarbanes-Oxley. Including a definition of "significant deficiency" in Commission rules, in combination with the definition of "material weakness," which was adopted by the Commission this past May, will enable management, appropriately and conveniently, to refer to Commission rules and guidance for the meaning of these terms, rather than referring to the auditing standards.
Conrad and Zoe-Vonna will describe the proposed rule amendment to adopt the definition of significant deficiency and the comment letters received by the Commission on AS No. 5 in more detail, but before we move on to that, I wanted to take a moment to reflect on the journey we have taken to arrive at today's recommendations to the Commission — a journey that started soon after I arrived on the staff just over a year ago. Addressing the implementation of Section 404 has been a significant priority for the Commission over the past several years. As you know, the Commission and the PCAOB have been working closely together during this time to improve the implementation of Section 404. On May 10, 2006, many of us were here in this very auditorium as the Commission and the PCAOB hosted a roundtable on second year experiences with Section 404. The roundtable was followed a week later with press releases in which the Commission and the PCAOB each announced a series of steps they planned to take to improve the implementation of Section 404. In its press release, the Commission outlined four actions it was undertaking to improve the implementation of Section 404. Those actions were:
Well, I am happy to say that with its actions today, the Commission will have affirmatively acted on three of these four steps by providing extensions to non-accelerated filers at the end of last year, through its approval of the Interpretive Guidance for management this past May, and now with its consideration of Auditing Standard No. 5 to replace Auditing Standard No. 2. And, that's not to say we haven't been working very diligently on the fourth item — our oversight of the PCAOB inspections programs — but I'll let Conrad speak to that in a moment.
Since the May 2006 announcements, the PCAOB, in coordination with the SEC staff, has been working to provide a new auditing standard — one that makes clear that the auditor's primary focus during an integrated audit is on areas that pose the highest risk of material misstatement to the financial statements and that does not require procedures unnecessary to an effective audit of internal control. The PCAOB released its proposed new auditing standard in December of last year. Over 175 comments letters were received. In addition, as part of the Commission's process of issuing its Interpretive Guidance for management, we received over 200 comment letters, many of which focused on the interplay between our new Interpretive Guidance and the PCAOB's auditing standard. As a result of the comments received on both proposals, the Commission held an open meeting on April 4 of this year to discuss its views on the comments received with respect to the auditing standard. The Commission directed the staff to focus on four areas when working with the PCAOB staff. The PCAOB and its staff considered the comments received and the Commission's guidance carefully and, as a result, made significant changes to its December proposal. The end-result of their hard work is an auditing standard that is shorter, less-prescriptive, focused on the areas of highest risk and clearly scalable to fit any company's size and complexity. Zoe-Vonna will speak in more detail about those changes, but I am happy to report to you today that the staff of the Commission believes that you have a very much improved auditing standard for your consideration due to the PCAOB's and the Commission's coordinated efforts, and we on the staff are very pleased and very proud to make our recommendation to you today.
Before I turn it over to Conrad, I would like to further acknowledge the cooperative efforts within the SEC's staff as well as with the staff of the PCAOB. Investors and our capital markets deserve and are relying on our hard work and our teamwork to improve the implementation of Section 404, and I believe the public has been well-served by an abundance of each.
Chairman Cox, you have already thanked the many staff members who have worked on these releases, as well as the PCAOB and its staff, who have worked with us — and I echo those thanks.
Now I'd like to turn it over to Conrad and Zoe-Vonna.