[Federal Register: June 27, 2007 (Volume 72, Number 123)]
[Rules and Regulations]
[Page 35309-35322]
[DOCID:fr27jn07-26]

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Part II

Securities and Exchange Commission

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17 CFR Parts 210, 228, 229 and 240

 Amendments to Rules Regarding Management's Report on Internal Control
Over Financial Reporting; Final Rule

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 210, 228, 229 and 240

[Release Nos. 33-8809; 34-55928; FR-76; File No. S7-24-06]
RIN 3235-AJ58

Amendments to Rules Regarding Management's Report on Internal
Control Over Financial Reporting

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: We are adopting an amendment to our rules to clarify that an
evaluation which complies with the Commission's interpretive guidance
published in this issue of the Federal Register in Release No. 34-55929
is one way to satisfy the requirement for management to evaluate the
effectiveness of the issuer's internal control over financial
reporting. We are also amending our rules to define the term material
weakness and to revise the requirements regarding the auditor's
attestation report on the effectiveness of internal control over
financial reporting. The amendments are intended to facilitate more
effective and efficient evaluations of internal control over financial
reporting by management and auditors.

DATES: Effective Date: August 27, 2007, except the amendment to Sec.
210.2-02T is effective from August 27, 2007 until June 30, 2009.

FOR FURTHER INFORMATION CONTACT: N. Sean Harrison, Special Counsel,
Division of Corporation Finance, at<PHONE_NUMBER>, 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 20549-6628.

SUPPLEMENTARY INFORMATION: We are adopting amendments to Rules 13a-
15(c),\1\ 15d-15(c),\2\ and 12b-2\3\ under the Securities Exchange Act
of 1934 (the ``Exchange Act''),\4\ Rules 1-02,\5\ 2-02 \6\ and 2-02T
\7\ of Regulation S-X,\8\ and Item 308 of Regulations S-B and S-K.\9\
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    \1\ 17 CFR 240.13a-15(c).
    \2\ 17 CFR 240.15d-15(c).
    \3\ 17 CFR 240.12b-2.
    \4\ 15 U.S.C. 78a et seq.
    \5\ 17 CFR 210.1-02.
    \6\ 17 CFR 210.2-02.
    \7\ 17 CFR 210.2-02T.
    \8\ 17 CFR 210.1-01 et seq.
    \9\ 17 CFR 228.308 and 229.308.
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    In a companion release issued in today's Federal Register, we are
issuing interpretive guidance to assist companies of all sizes in
completing top-down, risk-based evaluations of internal control over
financial reporting.\10\ In addition, we are issuing a release to
request additional comment on the definition of the term ``significant
deficiency.'' \11\
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    \10\ Release No. 34-55929 (Jun. 20, 2007) (hereinafter
``Interpretive Guidance'').
    \11\ Release No. 34-55930 (Jun. 20, 2007).
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Table of Contents

I. Background
II. Discussion of Amendments
    A. Exchange Act Rules 13a-15(c) and 15d-15(c)
    1. Proposal
    2. Comments on the Proposal
    3. Final Rule
    B. Rules 1-02 and 2-02 of Regulation S-X and Item 308 of
Regulations S-B and S-K
    1. Proposal
    2. Comments on the Proposal
    3. Final Rule
    C. Definition of Material Weakness
    1. Proposal
    2. Comments on the Proposal
    3. Final Rule
III. Transition Issues
IV. Background to Regulatory Analyses
V. Paperwork Reduction Act
VI. Cost-Benefit Analysis
VII. Effect on Efficiency, Competition and Capital Formation
VIII. Final Regulatory Flexibility Analysis
IX. Statutory Authority and Text of Rule Amendments

I. Background

    In implementing Section 404(a) of the Sarbanes-Oxley Act of 2002
\12\ (``Sarbanes-Oxley''), the Commission adopted amendments to
Exchange Act Rules 13a-15 and 15d-15 to require companies, other than
registered investment companies, to include in their annual reports
filed pursuant to Section 13(a) or 15(d) \13\ of the Exchange Act a
report by management on the company's internal control over financial
reporting (``ICFR'') and a registered public accounting firm's
attestation report on ICFR. Rules 13a-15 and 15d-15 also require
management of each company to evaluate the effectiveness, as of the end
of each fiscal year, of the company's ICFR.\14\
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    \12\ 15 U.S.C. 7262.
    \13\ 15 U.S.C. 78m(a) or 78o(d).
    \14\ Release No. 33-8238 (June 5, 2003) [68 FR 36636]
(hereinafter ``Adopting Release''). See Release No. 33-8392 (Feb.
24, 2004) [69 FR 9722] for compliance dates applicable to
accelerated filers. See Release No. 33-8760 (Dec. 15, 2006) [71 FR
76580] for compliance dates applicable to non-accelerated filers.
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    On December 20, 2006, the Commission issued a proposing release
that contained interpretive guidance for management (``Proposed
Interpretive Guidance'') regarding its required evaluation of ICFR and
amendments to Exchange Act Rules 13a-15(c) and 15d-15(c) to make it
clear that an evaluation conducted in accordance with the Proposed
Interpretive Guidance was one way to satisfy the annual management
evaluation required by those rules. In addition, we proposed amendments
to Rule 2-02(f) of Regulation S-X to require that the registered public
accounting firm's attestation report on ICFR express a single opinion
directly on the effectiveness of ICFR, and to clarify the circumstances
in which we would expect that the accountant cannot express an opinion
on ICFR. We also proposed amendments to Rule 1-02(a)(2) of Regulation
S-X to revise the definition of attestation report to conform it to the
proposed changes to Rule 2-02(f).\15\
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    \15\ Release Nos. 33-8762; 34-54976 (Dec. 20, 2006) [71 FR
77635] (hereinafter ``Proposing Release'').
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    We received over 200 comment letters in response to our Proposing
Release.\16\ These letters came from corporations, professional
associations, large and small accounting firms, law firms, consultants,
academics, investors and other interested parties. Of these,
approximately 70 respondents commented on the proposed rule amendments.
We have reviewed and considered all of the comments that we received on
the proposed rule amendments. The adopted rules reflect changes made in
response to many of these comments. We discuss our conclusions with
respect to each proposed rule amendment and the related comments in
more detail throughout this release.
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    \16\ 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
.

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II. Discussion of Amendments

A. Exchange Act Rules 13a-15(c) and 15d-15(c)

1. Proposal
    Exchange Act Rules 13a-15(c) and 15d-15(c) require the management
of each issuer subject to the Exchange Act reporting requirements,
other than a registered investment company, to evaluate the
effectiveness of the issuer's ICFR as of the end of each fiscal year.
We proposed to amend these rules to state that, although there are many
different ways to conduct an evaluation of the effectiveness of ICFR,
an evaluation conducted in accordance with the Proposed Interpretive
Guidance would satisfy the evaluation requirement in those rules.

2. Comments on the Proposal
    While many commenters supported the proposed amendments to Rules
13a-15 and 15d-15,\17\ some expressed the view that although the
guidance is appropriately principles-based, the nature of the
requirements set forth in the Proposed Interpretive Guidance is not
well-suited to the type of safe-harbor protection intended by the
amendments.\18\ For instance, three commenters suggested that the
Proposed Interpretive Guidance does not contain specific, objective
criteria that a company's management could use to demonstrate that its
evaluation complies with the requirements of the Proposed Interpretive
Guidance.\19\ Consequently, two of these commenters went on to conclude
that the amendments may eventually lead to the Interpretive Guidance
being viewed as an exclusive evaluation approach. In light of these and
similar concerns, one commenter suggested broadening the amended rule
language to explicitly indicate that an evaluation provides a
reasonable basis for management's ICFR assessment if it includes: (1)
An identification of the risks that are reasonably likely to result in
a material misstatement of the company's financial statements; (2) an
evaluation of whether the company has placed controls in operation that
are designed to address those risks; and (3) a risk-based process for
gathering and evaluating evidence regarding the effective operation of
those controls.\20\
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    \17\ See, for example, letters from America's Community Bankers
(ACB), BP p.l.c. (BP), Business Roundtable, Enbridge Inc., European
Association of Listed Companies, Hudson Financial Solutions
(Hudson), ING Group N.V. (ING), PPL Corporation (PPL), Silicon
Valley Leadership Group (SVLG), The Hundred Group of Finance
Directors (100 Group), and UnumProvident Corporation
(UnumProvident).
    \18\ See, for example, letters from American Electronics
Association (AeA), James J. Angel, Cleary Gottlieb Steen & Hamilton
LLP (Cleary), Financial Reporting Committee of the Association of
the Bar of the City of New York (NYC Bar), and U.S. Chamber of
Commerce (Chamber).
    \19\ See, for example, letters from Cleary, NYC Bar, and Reznick
Group, P.C.
    \20\ See letter from Cleary.
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    One commenter opposed both the Proposed Interpretive Guidance and
the proposed rule amendments and expressed the view that management
will, as a result of the nature of the Proposed Interpretive Guidance,
claim the protection afforded by the amendments for deficient
evaluations.\21\ Another commenter expressed the view that the proposed
rule amendments could result in a ``minimalist'' attitude towards the
internal control evaluation on the part of management.\22\
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    \21\ See joint letter from Consumer Federation of America,
Consumer Action, and U.S. Public Interest Research Group.
    \22\ See letter from Tatum LLC.
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3. Final Rule
    After consideration of the comments that we received, we have
determined to adopt the amendments to Rules 13a-15(c) and 15d-15(c) as
proposed. The amended rules state that there are many different ways to
conduct an evaluation that will satisfy the evaluation requirement in
the rules, and the Interpretive Guidance clearly states that compliance
with the guidance is voluntary. Therefore, concerns that the amendments
may cause confusion as to whether compliance with the Interpretive
Guidance is mandatory or may result in an exclusive standard are
unfounded. We understand that many companies already complying with the
Section 404 requirements have established an ICFR evaluation process
that may differ from the approach described in the Interpretive
Guidance. There is no requirement for these companies to alter their
procedures to align them with the Interpretive Guidance.
    We have decided not to broaden the amended rule language to include
factors to consider in determining whether alternative methods satisfy
the standard primarily because we think this type of ``broadening'' may
actually limit the potential universe of acceptable evaluation methods.
For example, while we believe the Interpretive Guidance's top-down,
risk-based approach will result in both effective and efficient
evaluations of the effectiveness of ICFR, management may choose to
establish an alternative evaluation approach. An alternative approach
may be deemed preferable if it complements a company's existing quality
improvement processes or enterprise risk management methodologies and
still provides management with a reasonable basis for its assessment of
ICFR effectiveness. Therefore, we do not think it is appropriate or
necessary to mandate the approach set forth in the Interpretive
Guidance.
    Regarding the comments expressing concern that the principles-based
nature of the Proposed Interpretive Guidance may not easily lend itself
to the safe-harbor type provisions, we acknowledge that the amendments
to Rules 13a-15 and 15d-15 are of a somewhat different nature from
other safe-harbor provisions, which typically prescribe very specific
conditions that must be met before a company or person may claim
protection under the safe-harbor. Nonetheless, we believe establishing
the Interpretive Guidance as one way to satisfactorily evaluate ICFR
will serve the important purpose of communicating the objectives and
requirements of the ICFR evaluation. Moreover, most commenters
preferred that the guidance for conducting an evaluation of ICFR be
issued on an interpretive basis rather than codified as a rule.\23\
Accordingly, a direct reference in the rules to the Interpretive
Guidance will help ensure that companies are aware of the guidance.
    We are issuing the Interpretive Guidance, and taking a series of
other steps, to improve and strengthen implementation of the ICFR
requirements. Regardless of whether management uses the Interpretive
Guidance, we remain committed to a strong implementation of the ICFR
requirements and to ensuring that issuers perform a sufficient
evaluation. As is currently the case, the sufficiency of an evaluation
will be determined based on each issuer's particular facts and
circumstances.

B. Rules 1-02 and 2-02 of Regulation S-X and Item 308 of Regulations S-
B and S-K

1. Proposal
    Rule 2-02(f) of Regulation S-X requires the registered public
accounting firm's attestation report on management's assessment of ICFR
to clearly state the ``opinion of the accountant as to whether
management's assessment of the effectiveness of the registrant's ICFR
is fairly stated in all material respects.'' The term ``assessment'' as
used in Rule 2-02(f) refers to management's disclosure of its
conclusion about the effectiveness of the company's ICFR, not the
efficacy of the process followed by management to arrive at its
conclusion. To more effectively communicate the auditor's
responsibility in relation to management's assessment, we proposed to
revise Rule 2-02(f) to require the auditor to express an opinion
directly on the effectiveness of ICFR. We believe this opinion
necessarily conveys whether the disclosure of management's assessment
is fairly stated. In addition, we proposed revisions to Rule 2-02(f) to
clarify the rare circumstances in which the accountant would be unable
to express an opinion.
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    \23\ Approximately thirty-three commenters directly responded to
the question about whether the guidance should be issued as an
interpretation or codified as a Commission rule. Approximately 70%
of such respondents indicated that the guidance should be issued as
an interpretation.

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    We also proposed conforming revisions to the definition of
attestation report in Rule 1-02(a)(2) of Regulation S-X. The PCAOB
proposed a conforming revision to its auditing standard to reflect this
revision as well.\24\
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    \24\ PCAOB Release No. 2006-007: Proposed Auditing Standard--An
Audit of Internal Control Over Financial Reporting that is
Integrated with an Audit of Financial Statements. See http://www.pcaobus.org/Rules/Docket_021/index.aspx
 (hereinafter ``Proposed

Auditing Standard'').
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2. Comments on the Proposal
    We received comments on the proposed revisions to Rules 1-02(a)(2)
and 2-02(f) of Regulation S-X to require the expression of a single
opinion directly on the effectiveness of ICFR by the auditor in the
attestation report on ICFR. Those who commented on this proposed
amendment were equally divided, with approximately one-half supporting
the Commission's proposal to eliminate the auditor's opinion on
management's assessment of the effectiveness of ICFR,\25\ and the other
half expressing the view that, although the reduction to one opinion by
the auditor was preferable, the opinion retained would limit
improvements in the efficiency of the 404 process.\26\
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    \25\ See, for example, letters from Banco Ita[uacute] Holding
Financeira SA, BP, Cisco Systems, Inc. (Cisco), Computer Sciences
Corporation (CSC), Eli Lilly and Company (Eli Lilly), Frank
Consulting, PLLP, Grant Thornton LLP, Kimball International
(Kimball), Lubrizol Corporation (Lubrizol), MetLife, Inc. (MetLife),
NYC Bar, PPG Industries, Inc. (PPG), The Procter & Gamble Company
(P&G), and RAM Energy Resources, Inc.
    \26\ See, for example, letters from 100 Group, Alamo Group,
Association of Chartered Certified Accountants (ACCA), BHP Billiton
Limited (BHP), European Federation of Accountants (FEE), The
Financial Services Roundtable (FSR), Hess Corporation (Hess),
Hutchinson Technology Inc. (Hutchinson), Institute of Internal
Auditors (IIA), Institute of Management Accountants (IMA), Institut
Der Wirtschaftsprufer [Institute of Public Auditors in Germany]
(IDW), Ian D. Lamdin (I. Lamdin), Matthew Leitch, Nasdaq Stock
Market, Inc. (Nasdaq), National Venture Capital Association (NVCA),
Nike, Inc. (Nike), Robert F. Richter (R. Richter), Rod Scott,
Southern Company (Southern), and SVLG.
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    Commenters who supported the Commission's proposal believe that an
auditor's opinion directly on the effectiveness of a company's ICFR
provides investors with a higher level of assurance than the opinion
only on management's assessment. These commenters also suggested that
an audit opinion directly on the effectiveness of ICFR was a clearer
expression of the scope of the auditor's work. However, those who
opposed the Commission's proposal argued that an audit opinion directly
on the effectiveness of ICFR would require duplicative, unnecessary and
excessive testing by auditors and would therefore lead to higher audit
costs.\27\ These commenters suggested the auditor's work should be
limited to evaluating management's assessment process and the testing
performed by management and internal audit. They acknowledged that the
auditor would need to test at least some controls directly in addition
to evaluating and testing management's assessment process; however,
they expected that the auditor's own testing could be significantly
reduced from the scope required to render an opinion directly on the
effectiveness of ICFR.\28\ Additionally, commenters were concerned that
the proposed rule change was in direct conflict with Section 404(b) of
Sarbanes-Oxley, which explicitly calls for the auditor to issue an
attestation report on management's assessment of the effectiveness of
ICFR.\29\
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    \27\ See, for example, letters from 100 Group, ACCA, Hess,
Nasdaq, Nike, and Southern.
    \28\ See, for example, letters from BHP and NVCA.
    \29\ See, for example, letters from FEE, FSR, Hutchinson, IDW,
IIA, IMA, I. Lamdin, and R. Richter.
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    In view of the proposal to require only one opinion by the auditor
in its report on the effectiveness of a company's ICFR, commenters
thought that continued references in Rules 1-02(a)(2) and 2-02(f) of
Regulation S-X to an ``attestation report on management's assessment of
internal control over financial reporting'' would be confusing.\30\
These commenters suggested that we eliminate these references and refer
to the auditor's report only as an ``attestation report on internal
control over financial reporting.''
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    \30\ See, for example, letters from 100 Group, BDO Seidman LLP,
Cleary, Financial Executives International Committee on Corporate
Reporting (FEI CCR), Manulife Financial (Manulife), Microsoft
Corporation (MSFT), Neenah Paper, Inc (Neenah), and NYC Bar.
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3. Final Rule
    After consideration of the comments, we have decided to adopt the
proposed amendments to Rules 1-02(a)(2) and 2-02(f) of Regulation S-X
to require the expression of a single opinion directly on the
effectiveness of ICFR by the auditor in its attestation report on ICFR
because it more effectively communicates the auditor's responsibility
in relation to management's process and necessarily conveys whether
management's assessment is fairly stated. In view of this decision, we
agree with commenters that Rules 1-02(a)(2) and 2-02(f) of Regulation
S-X will be clearer if they refer to the auditor's report as an
``attestation report on internal control over financial reporting''
rather than an ``attestation report on management's assessment of
internal control over financial reporting.'' We, therefore, have made
this change. We also have made conforming changes to Rule 2-02T of
Regulation S-X and Item 308 of Regulations S-B and S-K.\31\
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    \31\ Item 308 sets forth the ICFR disclosure that must be
included in a company's annual and quarterly reports.
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    Despite the fact that the revised rules no longer require the
auditor to separately express an opinion concerning management's
assessment of the effectiveness of the company's ICFR, auditors
currently are required under Auditing Standard No. 2 (``AS No.
2''),\32\ and would continue to be required under the Proposed Auditing
Standard, to evaluate whether management has included in its annual
ICFR assessment report all of the disclosures required by Item 308 of
Regulations S-B and S-K. Both AS No. 2 and the Proposed Auditing
Standard would require the auditor to modify its audit report on the
effectiveness of ICFR if the auditor determines that management's
assessment of ICFR is not fairly stated. Consequently, the revisions
are fully consistent with, and will continue to achieve, the objectives
of Section 404(b) of Sarbanes-Oxley.
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    \32\ An Audit of Internal Control Over Financial Reporting
Performed in Conjunction With an Audit of Financial Statements.
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    In considering the concerns raised by commenters about the scope of
auditor testing that is required to render an opinion directly on the
effectiveness of ICFR, the Commission believes that an auditing process
that is restricted to evaluating what management has done would not
necessarily provide the auditor with a sufficient level of assurance to
render an independent opinion as to whether management's assessment
(that is, conclusion) about the effectiveness of ICFR is correct.
Moreover, the PCAOB's auditing standards with respect to a company's
ICFR derive from both Section 103(a)(2)(A)(iii) and Section 404(b) of
Sarbanes-Oxley. Section 404(b) of Sarbanes-Oxley requires the auditor
to ``attest to, and report on, the assessment made by the management of
the issuer.'' Section 103(a)(2)(A)(iii) of Sarbanes-Oxley requires that
each audit report describe the scope of the auditor's testing of the
internal control structure and procedures and present, among other
information: (1) The findings of the auditor from such testing; (2) an
evaluation of whether such internal control structure and procedures
provide reasonable assurance that transactions are recorded as
necessary to

permit preparation of financial statements in accordance with generally
accepted accounting principles; and (3) a description of material
weaknesses in such internal controls.\33\
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    \33\ Section 103(a)(2)(A)(iii) states that ``each registered
public accounting firm shall--describe in each audit report the
scope of the auditor's testing of the internal control structure and
procedures of the issuer, required by section 404(b), and present
(in such report or in a separate report)--
    (I.) The findings of the auditor from such testing;
    (II.) An evaluation of whether such internal control structure
and procedures--
    (aa) Include maintenance of records that in reasonable detail
accurately and fairly reflect the transactions and dispositions of
the assets of the issuer;
    (bb) Provide reasonable assurance that transactions are recorded
as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that
receipts and expenditures of the issuer are being made only in
accordance with authorizations of management and directors of the
issuer; and
    (III.) A description, at a minimum, of material weaknesses in
such internal controls, and of any material noncompliance found on
the basis of such testing.''
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    The Commission believes that an audit opinion directly on the
effectiveness of ICFR is consistent with both Section 404 and Section
103 of Sarbanes-Oxley. Further, the Commission believes that the
expression of a single opinion directly on the effectiveness of ICFR
clarifies that an auditor is not responsible for issuing an opinion on
management's process for evaluating ICFR.

C. Definition of Material Weakness

1. Proposal
    The Proposed Interpretive Guidance defined a material weakness as a
deficiency, or combination of deficiencies, in ICFR such that there is
a reasonable possibility that a material misstatement of the company's
annual or interim financial statements will not be prevented or
detected on a timely basis by the company's ICFR. Further, we indicated
that the definition formulated in the proposal was intended to be
consistent with its use in existing auditing literature and
practice.\34\
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    \34\ The PCAOB's Proposed Auditing Standard provided the
following definition of material weakness: ``a control deficiency,
or combination of control deficiencies, such that there is a
reasonable possibility that a material misstatement of the company's
annual or interim financial statements will not be prevented or
detected.''
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2. Comments on the Proposal
    Commenters expressed concern about differences between our proposed
definition of material weakness and that proposed by the PCAOB in its
Proposed Auditing Standard and requested that the two definitions be
aligned.\35\ Commenters also suggested that a single definition of
material weakness be established for use by both auditors and
management. They further thought that we should codify the definition
in our rules.\36\
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    \35\ See, for example, letters from Edison Electric Institute
(EEI), FEI CCR, Financial Executives International Small Public
Company Task Force (FEI SPCTF), The Institute of Chartered
Accountants in England and Wales (ICAEW), Nina Stofberg, and SVLG.
    \36\ See, for example, letters from FEE and ICAEW.
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    In addition, commenters pointed out that while the Proposed
Interpretive Guidance referred to significant deficiencies, the
Commission did not include a definition of significant deficiency
within the Proposed Interpretive Guidance.\37\ Despite the fact that
the Proposed Interpretive Guidance did not include a definition of
significant deficiency, commenters on this topic provided feedback
about both the Commission's proposed definition of material weakness
and the definition of significant deficiency as proposed by the
PCAOB.\38\ Certain commenters indicated that the Commission should
include a definition of significant deficiency in the Interpretive
Guidance.\39\
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    \37\ See, for example, letters from Cardinal Health, Inc.
(Cardinal), EEI, and Protiviti.
    \38\ The PCAOB's Proposed Auditing Standard provided the
following definition of significant deficiency: ``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.'' A significant misstatement was defined 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.''
    \39\ See, for example, letters from Cardinal and Protiviti.
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    Commenters also provided feedback on the probability language in
the definition of material weakness. Commenters expressing support for
the ``reasonable possibility'' standard in the proposed definition \40\
noted that this language improves the clarity of the existing
definition and will reduce time spent evaluating deficiencies.\41\ In
contrast, other commenters felt that the probability standard should be
changed.\42\ These commenters noted that the meaning of ``reasonably
possible'' was the same as ``more than remote'' and therefore would not
reduce the effort devoted to identifying and analyzing deficiencies.
Two of these commenters suggested the Commission use a ``reasonable
likelihood'' standard,\43\ and another suggested the Commission change
to a ``greater than fifty-percent'' standard.\44\ Commenters also
requested additional guidance about how the concept of ``materiality''
impacted the definition.\45\
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    \40\ See, for example, letters from Cisco, FEI CCR, Hudson,
MetLife, MSFT, and P&G.
    \41\ See, for example, letters from Cisco, Committee on Capital
Markets Regulation (CCMR), FEI SPCTF, Hudson, MetLife, MSFT, Nike,
P&G, and TechNet.
    \42\ See, for example, letters from the American Bar
Association's Committees on Federal Regulation of Securities and Law
and Accounting of the Section of Business Law (ABA), ACCA, Cardinal
Health, Inc., Chamber, CSC, IIA, Kimball, and NYC Bar.
    \43\ See letters from NYC Bar and Cleary.
    \44\ See letter from ABA.
    \45\ See, for example, letters from ABA, CCMR, CSC, Independent
Community Bankers of America, ISACA and IT Governance Institute,
P&G, and Rockwood Holdings, Inc.
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    Most of the commenters who addressed the reference to interim
financial statements in the definition of material weakness indicated
that the word ``interim'' should be removed from the definition,\46\
with only one commenter expressing the view that the reference to
interim financial statements should remain in the definition.\47\ Some
commenters who suggested removal of ``interim'' expressed the view that
because Section 404 of Sarbanes-Oxley mandates an annual assessment of
ICFR, the deficiency evaluation should also be based on the impact to
the annual financial statements. Others stated that the removal of
``interim'' would allow management and auditors to better focus on the
annual financial statements when evaluating the materiality of control
deficiencies.
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    \46\ See, for example, letters from ABA, Cisco, Deloitte &
Touche LLP, EEI, Eli Lilly, FEI CCR, FEI SPCTF, Ford Motor Company,
MSFT, P&G, and PPL.
    \47\ See letter from MetLife.
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3. Final Rule
    After consideration of the comments received, we have determined
that it is appropriate for the Commission's rules to include the
definition of material weakness since it is an integral term associated
with Sarbanes-Oxley and the Commission's implementing rules.
Management's disclosure requirements with respect to ICFR are
predicated upon the existence of a material weakness; therefore, we
agree with the commenters' suggestion that our rules should define this
term, rather than refer to auditing literature. As a result, we are
amending Exchange Act Rule 12b-2 and Rule 1-02 of Regulation S-X to
define the term material weakness.
    We have decided to adopt the material weakness definition
substantially as proposed. The Commission has determined that the
proposed material weakness definition appropriately describes those
conditions in ICFR that, if they exist, should be disclosed to
investors and should preclude a conclusion that ICFR is effective.
Therefore, our final rules define a material weakness as a

deficiency, or a combination of deficiencies, in ICFR 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.\48\ We anticipate that the
PCAOB's auditing standards will also include this definition of
material weakness.
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    \48\ Exchange Act Rule 12b-2 and Rule 1-02(p) of Regulation S-X.
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    After consideration of the proposed alternatives to the
``reasonable possibility'' standard in the proposed definition of
material weakness, we decided not to change the proposed standard.
Revisions that have the effect of increasing the likelihood (that is,
risk) of a material misstatement in a company's financial reports that
can exist before being disclosed could give rise to questions about the
meaning of a disclosure that ICFR is effective and whether the
threshold for ``reasonable assurance'' is being lowered. Moreover, we
do not believe improvements in efficiency arising from revisions to the
likelihood element would be significant to the overall ICFR evaluation
effort, due, in part, to our view that the effort evaluating
deficiencies would be similar under the alternative standards (for
example, ``reasonable possibility'' as compared to ``reasonable
likelihood''). Lastly, we do not believe the volume of material
weakness disclosures, which has declined each year since the initial
implementation of Section 404 of Sarbanes-Oxley, is too high such that
investors would benefit from a reduction in disclosures that would
result from a higher likelihood threshold.
    Regarding the reference to interim financial statements in the
definition of material weakness, while we believe annual materiality
considerations are appropriate when making judgments about the nature
and extent of evaluation procedures, we believe that the judgments
about whether a control is adequately designed or operating effectively
should consider the requirement to provide investors reliable annual
and quarterly financial reports. Moreover, if management's annual
evaluation identifies a deficiency that poses a reasonable possibility
of a material misstatement in the company's quarterly reports, we
believe management should disclose the deficiency to investors and not
assess ICFR as effective. As such, we have not removed the reference to
interim financial statements from the definition of material weakness.
    In response to the comments regarding the need for the Commission
to define the term ``significant deficiency,'' we are seeking
additional comment on a definition of that term as part of a separate
release issued in the Federal Register.

III. Transition Issues

    Although the amendments to Rules 1-02 and 2-02 of Regulation S-X
will no longer require the auditor to separately express an opinion
concerning management's assessment of the effectiveness of the
company's ICFR, audits conducted under AS No. 2 will continue to result
in a separate opinion on management's assessment until the PCAOB's
expected new auditing standard replacing AS No. 2 becomes effective and
is required for all audits. Until such time, companies may file
whichever report they receive from their independent auditor (that is,
either one that contains both opinions under AS No. 2 or the single
opinion under the expected new auditing standard).

IV. Background to Regulatory Analyses

    Congress enacted the Sarbanes-Oxley Act in July 2002. Section 404
of the Act directed the Commission to prescribe rules requiring each
issuer required to file an annual report under Section 13(a) or 15(d)
of the Exchange Act \49\ to prepare an internal control report. The
only Exchange Act reporting companies that Congress exempted from the
Section 404 requirements were investment companies registered under
Section 8 of the Investment Company Act.\50\
---------------------------------------------------------------------------

    \49\ 15 U.S.C. 78m or 78o(d).
    \50\ 15 U.S.C. 80a-8.
---------------------------------------------------------------------------

    To fulfill its statutory mandate, the Commission adopted rules in
June 2003 to require all Exchange Act reporting companies other than
registered investment companies, regardless of their size, to include
in their annual reports a report of management, and an accompanying
auditor's report, on the effectiveness of the company's internal
control over financial reporting (``ICFR'').\51\
---------------------------------------------------------------------------

    \51\ Release No. 33-8238 (June 5, 2003) (68 FR 36636).
---------------------------------------------------------------------------

    Although the Commission adopted rules in 2003 creating the
obligation for all reporting companies to include ICFR reports in their
annual reports, it provided a lengthy compliance period for non-
accelerated filers, which are smaller public companies with a public
float below $75 million.\52\ Under the compliance dates that the
Commission originally established, non-accelerated filers would not
have become subject to the ICFR requirements until they filed an annual
report for a fiscal year ending on or after April 15, 2005. In
contrast, accelerated filers and large accelerated filers--companies
with a public float of $75 million or more--became subject to the
Section 404 requirements with respect to annual reports that they filed
for fiscal years ending on or after November 15, 2004.
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    \52\ Although the term ``non-accelerated filer'' is not defined
in Commission rules, we use it to refer to an Exchange Act reporting
company that does not meet the Exchange Act Rule 12b-2 definition of
either an ``accelerated filer'' or a ``large accelerated filer.''
---------------------------------------------------------------------------

    The Commission provided this lengthy compliance period for non-
accelerated filers in light of both the substantial time and resources
needed by accelerated filers to properly implement the rules. In
addition, it believed that a corresponding benefit to investors would
result from an extended transition period that allowed companies to
carefully implement the new requirements. After each of the first two
years accelerated-filers implemented the Section 404 requirements, the
Commission held a roundtable discussion, and solicited comment on
issues that arose during implementation.\53\
---------------------------------------------------------------------------

    \53\ As a result of which, the Commission and its staff issued
guidance to assist companies in implementing these requirements.
---------------------------------------------------------------------------

    Since the initial extension period, the Commission has further
extended the compliance dates for non-accelerated filers. The
Commission adopted the most recent compliance date extension for non-
accelerated filers in December 2006.\54\ This extension was based, in
part, on a recommendation from the Commission's Advisory Committee on
Smaller Public Companies (``Advisory Committee''). In its Final Report,
issued on April 23, 2006, the Advisory Committee raised a number of
concerns regarding the ability of smaller companies to comply cost-
effectively with the requirements of Section 404. The Advisory
Committee identified as an overarching concern the difference in how
smaller and larger public companies operate.
---------------------------------------------------------------------------

    \54\ Release No. 33-8760 (Dec. 15, 2006) (71 FR 77635).
---------------------------------------------------------------------------

    It focused in particular on three characteristics: (1) The limited
number of personnel in smaller companies, which constrains the
companies' ability to segregate conflicting duties; (2) top
management's wider span of control and more direct channels of
communication, which increase the risk of management override; and (3)
the dynamic and evolving nature of smaller companies, which limits
their ability to have static processes that are well-documented.\55\
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    \55\ Final Report of the Advisory Committee on Smaller Public
Companies to the United States Securities and Exchange Commission
(Apr. 23, 2006) (``Advisory Committee Report'') available at http://www.sec.gov/info/smallbus/acspc/acspc-finalreport.pdf
.

---------------------------------------------------------------------------

    The Advisory Committee suggested that these characteristics create
unique differences in how smaller companies achieve effective ICFR that
may not be adequately accommodated in Auditing Standard No. 2 or other
implementation guidance as currently applied in practice. In addition,
the Advisory Committee noted serious ramifications for smaller public
companies stemming from the cost of frequent documentation changes and
sustained review and testing of controls perceived to be necessary to
comply with the Section 404 requirements.
    The Commission also granted the December 2006 extension in view of
a series of actions that the Commission and the PCAOB each announced on
May 17, 2006 that they intended to take to improve the implementation
of the Section 404 requirements. These actions included:
     Issuance of a Concept Release soliciting comment on a
variety of issues that might be included in future Commission guidance
for management to assist in its performance of a top-down, risk-based
assessment of ICFR;
     Consideration of additional guidance from COSO on
understanding and applying the COSO framework; \56\
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    \56\ On July 11, 2006, COSO issued guidance entitled ``Internal
Control Over Financial Reporting--Guidance for Smaller Public
Companies'' that was designed primarily to help management of
smaller public companies with establishing and maintaining effective
ICFR.
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     Revisions to Auditing Standard No. 2;
     Reinforcement of auditor efficiency through PCAOB
inspections and Commission oversight of the PCAOB's audit firm
inspection program;
     Development, or facilitation of development, of
implementation guidance for auditors of smaller public companies; and
     Continuation of PCAOB forums on auditing in the small
business environment.
    Pursuant to the most recent extension of the compliance dates, non-
accelerated filers are scheduled to begin including a management report
on ICFR in their annual reports filed for a fiscal year ending on or
after December 15, 2007, and an auditor's report on ICFR for a fiscal
year ending on or after December 15, 2008. It was our intention that
non-accelerated filers would be able to complete their assessment of
internal control without engaging an independent auditor during the
first year. In addition, to eliminate second-guessing of management
that might result from separating the management and auditor reports,
the rules provide that the management report included in a non-
accelerated filer's annual report during the first year of compliance
is deemed to be ``furnished'' rather than ``filed.'' \57\
    The December 2006 extension of the management report requirement
was intended to provide the non-accelerated filers with the benefit of
both the Commission's management guidance and the COSO guidance for
smaller companies before planning and conducting their initial ICFR
assessments. The extension of the auditor report requirement was
intended to:
     Afford non-accelerated filers and their auditors the
benefit of anticipated changes to the PCAOB's Auditing Standard No. 2,
and any implementation guidance issued by the PCAOB for auditors of
non-accelerated filers;
     Save non-accelerated filers the costs of the auditor
attestation to, and report on, management's initial assessment of ICFR;
     Enable management of non-accelerated filers to more
gradually prepare for full compliance with the Section 404 requirements
and to gain some efficiencies in the process of reviewing and
evaluating the effectiveness of ICFR before becoming subject to the
requirement that the auditor report on ICFR (and to permit investors to
see and evaluate the results of management's first compliance efforts);
and
     Provide the Commission with the flexibility to consider
any comments it received on the Concept Release and the proposed
guidance for management in response to questions related to the
appropriate role of the auditor in evaluating management's internal
control assessment process.
    On July 11, 2006, we issued a Concept Release to seek public
comment on the issues to be addressed in our guidance for management on
how to assess ICFR.\58\ The Commission received approximately 167
comment letters in response to the Concept Release, a majority of which
supported additional Commission guidance to management that is
applicable to companies of all sizes and complexities. The Commission
considered the feedback received in those comment letters in drafting
its Interpretive Guidance.
    In conjunction with issuance of the Interpretive Guidance, in this
release we are adopting amendments to the existing requirements of
Exchange Act Rules 13a-15(c) and 15d-15(c) that management of each
company subject to the Exchange Act periodic reporting requirements
evaluate, as of the end of each fiscal year, the effectiveness of the
company's ICFR. The amendments state that an evaluation that complies
with the Interpretive Guidance will satisfy the annual evaluation
requirement in Rules 13a-15(c) and 15d-15(c).
    We are also adopting amendments to Rules 1-02 and 2-02 of
Regulation S-X, and Item 308 of Regulations S-B and S-K, to state that
the company's auditor must express only one opinion on a company's
ICFR. This is a direct opinion by the auditor on the effectiveness of
the company's ICFR. Prior to the amendments, auditors expressed two
separate opinions: one on the effectiveness of a company's ICFR and
another on management's assessment of the effectiveness of the
company's ICFR. Finally, we are adopting an amendment to Exchange Act
Rule 12b-2, and a corresponding amendment to Rule 1-02 of Regulation S-
X, to define the term material weakness.

V. 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 rule amendments in this release will
impose any new recordkeeping or information collection requirements, or
other collections of information requiring OMB's approval.
---------------------------------------------------------------------------

    \57\ Management's report is not deemed to be filed for purposes
of Section 18 of the Exchange Act [15 U.S.C. 78r] or otherwise
subject to the liabilities of that section, unless the issuer
specifically states that the report is to be considered ``filed''
under the Exchange Act or incorporates it by reference into a filing
under the Securities Act or the Exchange Act.
    \58\ Release No. 34-54122 (July 11, 2006).
---------------------------------------------------------------------------

VI. Cost-Benefit Analysis

    The rule amendments and the Interpretive Guidance that we are
adopting are intended to facilitate more effective and efficient
evaluations of ICFR by management and auditors. Rules 13a-15 and 15d-
15, as initially adopted, and as amended, do not mandate any specific
method for management to follow in performing an evaluation of ICFR.
Instead, the rules recognize that the methods of conducting evaluations
of ICFR will, and should, vary from company to company. Commenters have
asserted that the lack of specific direction in

either Section 404 of the Sarbanes-Oxley Act or the implementing rules
on how management should conduct an evaluation of ICFR may have
resulted in the auditing standards becoming the de facto standard for
management's evaluation in many cases, which likely contributed to
excessive documentation and testing of internal controls by management
in initial compliance efforts.
    The benefits and costs to investors of the rule amendments and
Interpretive Guidance are directly related to the extent to which
issuers choose to rely on the Interpretive Guidance. In part, this is
because compliance is voluntary. In addition, companies already subject
to the reporting requirement have gained some efficiencies in the
evaluation process,\59\ and other sources have provided guidance on how
to conduct an ICFR evaluation.\60\ The very purpose of the rule
amendments and the Interpretive Guidance is to ease the compliance
burden created by Section 404 of the Sarbanes-Oxley Act. Because of
this, and because the use of Interpretive Guidance is voluntary, it is
unlikely that it could result in additional incremental cost to
issuers. Issuers that choose to use Interpretive Guidance will likely
do so because it reduces their overall compliance burden.

A. Benefits

    Our issuance of specific Interpretive Guidance for management on
how to conduct an ICFR evaluation should significantly lessen the
pressures on management to look to the auditing standards for guidance
as to how to conduct its evaluation.\61\ To the extent that these
pressures have led to excessive testing and documentation in the past,
the Interpretive Guidance and rule amendments should lead management to
avoid excessive costs and aid them in determining the level of effort
necessary to evaluate a company's ICFR.
    The extent of the benefits of the rule amendments depends on a
company's experience conducting an ICFR evaluation. As explained in the
release setting forth the Interpretive Guidance, the effort necessary
to conduct an initial evaluation of ICFR will vary depending on
management's existing financial reporting risk assessment and control
monitoring activities. After the first year of compliance, management's
effort to identify financial reporting risks and controls should
ordinarily be less because subsequent evaluations should be more
focused on changes in risks and controls rather than identification of
all financial reporting risks and the related controls. Further, in
each subsequent year, the documentation of risks and controls will only
need to be updated from the prior year or years, not recreated anew.
    Through the risk and control identification process, management
will have identified for testing only those controls that are needed to
meet the objective of ICFR (that is, to provide reasonable assurance
regarding the reliability of financial reporting) and for which
evidence about their operation can be obtained most efficiently. The
nature and extent of procedures implemented to evaluate whether those
controls continue to operate effectively can be tailored to the
company's unique circumstances, thereby avoiding unnecessary compliance
costs.
    In addressing a number of the commonly identified areas of
concerns, the Interpretive Guidance:
     Explains how to vary approaches for gathering evidence to
support the evaluation based on risk assessments;
     Explains the use of ``daily interaction,'' self-
assessment, and other on-going monitoring activities as evidence in the
evaluation;
     Explains the purpose of documentation and how management
has flexibility in approaches to documenting support for its
assessment;
     Provides management significant flexibility in making
judgments regarding what constitutes adequate evidence in low-risk
areas; and
     Allows for management and the auditor to have different
testing approaches.
    The Interpretive Guidance is organized around two broad principles.
The first principle is that management should evaluate whether it has
implemented controls that adequately address the risk that a material
misstatement of the financial statements would not be prevented or
detected in a timely manner. The guidance describes a top-down, risk-
based approach to this principle, including the role of entity-level
controls in assessing financial reporting risks and the adequacy of
controls. The guidance promotes efficiency by allowing management to
focus on those controls that are needed to adequately address the risk
of a material misstatement in its financial statements.
---------------------------------------------------------------------------

    \59\ Commenters on the Concept Release Concerning Management's
Reports on Internal Control Over Financial Reporting, Release No.
34-54122 (Jul. 11, 2006) [71 FR 40866], available at http://www.sec.gov/rules/concept/2006/34-54122.pdf
, expressed similar

views. See, for example, letters from the American Institute of
Certified Public Accountants, Crowe Chizek and Company LLC, and
Kreischer Miller, all available at http://www.sec.gov/comments/s7-11-06/s71106.shtml
.

    \60\ See, for example, The Institute of Internal Auditor's
Sarbanes-Oxley Section 404: A Guide for Management by Internal
Control Practitioners, May 2006.
    \61\ We are taking this action in conjunction with the PCAOB's
elimination of the auditor's requirement to evaluate the efficacy of
management's evaluation process.
---------------------------------------------------------------------------

    The second principle is that management's evaluation of evidence
about the operation of its controls should be based on its assessment
of risk. The guidance provides an approach for making risk-based
judgments about the evidence needed for the evaluation. This allows
management to align the nature and extent of its evaluation procedures
with those areas of financial reporting that pose the highest risks to
reliable financial reporting (that is, whether the financial statements
are materially accurate). As a result, management may be able to use
more efficient approaches to gathering evidence, such as self-
assessments in low-risk areas, and perform more extensive testing in
high-risk areas. By following these two principles, companies of all
sizes and complexities will be able to implement the rules effectively
and efficiently.
    The Interpretive Guidance reiterates the Commission's position that
management should bring its own experience and informed judgment to
bear in order to design an evaluation process that meets the needs of
its company and that provides a reasonable basis for its annual
assessment of whether ICFR is effective. This allows management
sufficient and appropriate flexibility to design such an evaluation
process. Smaller public companies, which generally have less complex
internal control systems than larger public companies, can scale and
tailor their evaluation methods and procedures to fit their own facts
and circumstances.\62\ Applying the Interpretive Guidance may thus
assist management of these companies in scaling and tailoring its
evaluation methods and procedures to fit their own unique facts and
circumstances in ways that may not be appropriate for larger companies
with more complex internal control systems. Through the rule
amendments, smaller companies can take advantage of the flexibility and
scalability in Interpretive Guidance to conduct an evaluation of ICFR
that is both efficient and effective at identifying material
weaknesses.
---------------------------------------------------------------------------

    \62\ Advisory Committee Report at pp. 39-40.
---------------------------------------------------------------------------

    By applying the principles set forth in the Interpretive Guidance,
companies of all sizes and complexities will be able to comply with the
rules more

effectively and efficiently. The total benefit to investors of the
Interpretive Guidance and rule amendments depends on the number of
companies that implement these principles and the extent to which their
practices under these principles depart from the principles and
practices that they would otherwise follow.
    Given that non-accelerated filers have not yet been required to
conduct an evaluation of ICFR, their use of Interpretive Guidance in
their first year of conducting an ICFR evaluation may enable them to
avoid some of the initial compliance costs and efforts that were
incurred by larger public companies during their early years of
compliance with Section 404's requirements. In this respect, investors
in non-accelerated filers may benefit more from the amended rules and
Interpretive Guidance than investors in larger public companies that
already have been required to conduct an evaluation.
    The amendments to Exchange Act Rules 13a-15(c) and 15d-15(c)
provide for a non-exclusive safe-harbor in that they do not require
management to follow the Interpretive Guidance, but still provide
assurance to management regarding its compliance obligations. Some of
the commenters on the Proposal questioned the benefits of these rule
amendments. As noted earlier in this release, three commenters
suggested that the Interpretive Guidance does not contain specific,
objective criteria that a company's management could use to demonstrate
that its evaluation complies with the requirements of the Interpretive
Guidance.\63\ The Office of Advocacy of the Small Business
Administration also stated in its comment letter that some of the
participants in a roundtable it hosted on the Section 404 requirements
asked for more details as to how the safe harbor protection could be
claimed and what type of liability protection it would afford.
---------------------------------------------------------------------------

    \63\ See, for example, letters from Cleary, NYC Bar, and Reznick
Group, P.C.
---------------------------------------------------------------------------

    The rule amendments are intended to provide those choosing to
follow the Interpretive Guidance with greater clarity and transparency
about their obligations relative to Section 404. For example, the
amendments to Exchange Act Rules 13a-15(c) and 15d-15(c) add a specific
reference to the Interpretive Guidance in the rules and thereby make
the guidance more visible and accessible to the managers of companies
subject to the ICFR evaluation requirement. When a company's management
relies on the Interpretive Guidance to conduct its evaluation, the
company does not have to take any special action to ``claim'' the
assurance provided by the rule amendments. In addition, the
transparency of the guidance may benefit investors by reducing costly
second-guessing about the sufficiency of management's evaluation raised
by any party, including the company's independent auditor. The
Interpretive Guidance is specific enough to enable a company to
demonstrate that its management followed the principles set forth in
the Interpretive Guidance in conducting its ICFR evaluation to gain the
assurance afforded by these rule amendments.
    The rule amendments encourage the use of the Interpretive Guidance
because it advises management to focus on the controls that address the
highest risk of material misstatement. This will benefit investors by
reducing the amount of testing and documentation conducted by
management and thus reducing the cost of compliance.\64\ The rule
amendments can remove obstacles by giving management clearer
information about its obligations and by reducing undue pressures from
auditors.
---------------------------------------------------------------------------

    \64\ Commenters expressed similar views. See, for example,
letters from BHP, Employees' Retirement System of Rhode Island,
Financial Services Forum, KPMG LLP, McGladrey & Pullen LLP, MSFT,
and State Street Corporation.
---------------------------------------------------------------------------

    The Commission did not receive any comments on the dollar magnitude
of the likely reduction in compliance costs from the rule amendments in
connection with the Proposal. However, the Commission did receive
historical estimates of total Section 404 compliance costs from the
early years of adoption. These estimates were obtained from surveys of
companies with a public float above $75 million in connection with our
May 2006 Roundtable on Internal Control Reporting and Auditing
Provisions. These historical estimates of the early compliance costs
incurred by the relatively larger companies ranged from $860,000 to
$5.4 million per company, depending on the survey.\65\ The management
cost that is the focus of the rule amendments appears to account for
the majority of this estimate. One commenter indicated in its comment
letter on the Proposal that it is especially important to reduce
management costs, as these costs are the most significant costs
associated with the Section 404 requirements, and can account for 70-
75% of the total compliance costs.\66\ Thus, even if the percentage
decline in compliance cost under the rule amendment is small, companies
and their investors could experience a substantial dollar benefit in
terms of lower costs of compliance.
---------------------------------------------------------------------------

    \65\ See, for example, Financial Executives International Survey
on Sarbanes-Oxley Section 404 Implementation (March, 2006) and CRA
International Sarbanes-Oxley Section 404 Costs and Implementation
Issues: Spring 2006 Survey Update.
    \66\ See letter from The Committee on Capital Markets
Regulation.
---------------------------------------------------------------------------

    Commenters expressed the view that the rule amendments and
Interpretive Guidance will result in more efficient and effective
evaluations of internal control relative to what would otherwise occur.
In commenting on the amendments, one commenter provided a quantitative
estimate of the expected reduction in compliance costs. This commenter
estimated that implementation of the Proposed Interpretive Guidance
could result in a reduction in company compliance costs of
approximately 10% in the first year of implementation (net of first
year costs of implementation of the Interpretive Guidance). The
commenter further estimated that implementation could result in an
additional 15-20% cost reduction over costs incurred in the initial
compliance year based on its own experience in conducting an evaluation
of internal control and its assessment of the potential efficiencies to
be gained from the Interpretive Guidance.\67\ The available qualitative
and quantitative evidence is consistent with our view that issuers will
implement the Interpretive Guidance to the benefit of investors.\68\
---------------------------------------------------------------------------

    \67\ See letter from CSC.
    \68\ Commenters, however, requested that we conduct an analysis
of the costs and benefits of the amendments after implementation and
assess whether the amendments and the Interpretive Guidance result
in cost reductions. See, for example, letters from Biotechnology
Industry Organization (BIO) and NVCA. We are sensitive to the costs
and benefits of our Section 404 rules, and we intend to monitor the
impact of the rule amendments and Interpretive Guidance.
---------------------------------------------------------------------------

    We anticipate that the amendments to Exchange Act Rule 12b-2 and
Rule 1-02 of Regulation S-X to define the term ``material weakness''
will benefit companies and investors. Companies will now be able to
refer to the definition in the Commission rules requiring management to
conduct an ICFR evaluation, rather than having to refer to the
definition in the audit standard. We believe that the definition
appropriately describes the ICFR conditions that, if they exist, should
be disclosed to investors and preclude a conclusion that ICFR is
effective.
    Commenters suggested that the rule amendments and Proposed
Interpretive Guidance will not significantly reduce costs as long as
there are significant differences between our management guidance and
the Proposed Auditing

Standard.\69\ To address these comments and enhance the benefit of the
rule amendments, we coordinated with the PCAOB to align our
Interpretive Guidance and the PCAOB's new auditing standard.
---------------------------------------------------------------------------

    \69\ See, for example, letters from Allstate Corporation,
Hudson, ICAEW, Minn-Dak Farmers Cooperative, Nasdaq, Supervalu Inc.,
and UnumProvident.
---------------------------------------------------------------------------

B. Costs

    As stated above, the obligation for all companies, regardless of
size, to comply with the ICFR requirements was established in 2002 when
Congress directed the Commission to adopt rules to implement Section
404. The rule amendments and Interpretive Guidance are designed to
reduce the burden of compliance with those requirements. The rule
amendments and Interpretive Guidance do not impose any new compliance
obligations on any reporting company. Because compliance with the
Interpretive Guidance is voluntary, it is likely that companies and
their management will choose to comply with the guidance only if they
determine that the benefits exceed the costs.
    Companies that have already completed one or more evaluations may
choose to continue to use their existing procedures if they are
satisfied with the effectiveness and efficiency of those procedures.
Alternatively, a company that already has been complying with the ICFR
requirements could choose to follow the Interpretive Guidance and to
make adjustments to conform its evaluation procedures to the guidance.
In that case, some commenters expressed the view that while changing
from the current evaluation approaches to the top-down, risk-based
approach laid out in the Interpretive Guidance could result in short-
term cost increases, it would promote a cost-effective approach in the
long-term.\70\ It is reasonable to conclude that companies will not
elect to follow the Interpretive Guidance if, from a cost standpoint,
they determine that is not in their long-term interest to do so.
---------------------------------------------------------------------------

    \70\ See, for example, letters from Ace Limited, Hutchinson, and
Neenah.
---------------------------------------------------------------------------

    For smaller public companies that have not been required to comply
with the ICFR requirements, the costs that they will incur are a direct
result of the imposition by the Congress of the statutory requirements
of Section 404 of the Sarbanes-Oxley Act on them. They may be able to
reduce their first-time evaluation costs by using the Interpretive
Guidance as compared to what those costs would have been.
    The Interpretive Guidance advises management on how to conduct an
efficient evaluation of ICFR, which could result in management doing
less work, and therefore produce cost savings for the company. Those
cost savings, however, could be offset if a company's auditor does not
choose to use management's work to the same extent it did before, due
to management choosing to follow the Interpretive Guidance and doing
less work as a result.\71\ Because use of the Interpretive Guidance is
voluntary, it is reasonable to conclude that management would choose to
reduce the extent and cost of its work only to the degree that it did
not result in an increase in the overall costs of complying with
Section 404, including auditor costs.\72\ On the other hand, the rule
amendments and Interpretive Guidance could increase the possibility
that the auditor will, during the Section 404 audit, perform additional
testing of internal controls beyond that which management performed in
reliance on the Interpretive Guidance.\73\
---------------------------------------------------------------------------

    \71\ See, for example, letters from Heritage Financial
Corporation, MSFT and Neenah.
    \72\ This cost-benefit analysis does not address the costs
associated with the ICFR audit standard itself because the rule
amendments do not affect the ICFR audit standard.
    \73\ See letter from UnumProvident.
---------------------------------------------------------------------------

VII. Effect on Efficiency, Competition and Capital Formation

    Section 3(f) of the Exchange Act \74\ 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 \75\ 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, 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.
---------------------------------------------------------------------------

    \74\ 15 U.S.C. 78c(f).
    \75\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    The rule amendments and Interpretive Guidance will promote
efficiency, and capital formation. The Interpretive Guidance and
related rule amendments promote efficiency by allowing management to
focus on those controls that are needed to adequately address the risk
of a material misstatement of the company's financial statements. The
guidance does not require management to identify every control in a
process or to document the business practices affecting ICFR. Rather,
management can focus its evaluation process and the documentation
supporting the assessment on those controls that it determines
adequately address the risk of a material misstatement of the financial
statements.
    One commenter expressed the view that the Section 404 requirements
have provided significant benefits to investors and business by
increasing the reliability of financial statements, strengthening
internal controls, improving the efficiency of business operations and
helping to reduce the risk of fraud.\76\ To the extent that the rule
amendments and Interpretive Guidance make the management evaluation
process more efficient, these benefits can all be retained at a lower
cost.
---------------------------------------------------------------------------

    \76\ See letter from The Committee on Capital Market Regulation.
---------------------------------------------------------------------------

    Under the Sarbanes-Oxley Act, all companies, except registered
investment companies, are subject to the requirement to conduct an
evaluation of their ICFR. Compliance with the amendments to Exchange
Act Rules 13a-15 and 15d-15 and Interpretive Guidance, however, will be
voluntary rather than mandatory and, as such, companies will be able to
choose whether or not to follow the Interpretive Guidance. The
amendments therefore will not impose any costs on companies that they
do not choose to incur. Presumably, companies will only choose to rely
on the Interpretive Guidance if they think that the benefits of using
the guidance outweigh the costs.
    The rule amendments will encourage use of the Interpretive Guidance
and thereby increase the efficiency with respect to the effort and
resources associated with an evaluation of internal control over
financial reporting and facilitate more efficient allocation of
resources within a company. The guidance is designed to be scalable
depending on the size of the company, which should reduce the potential
for internal control reporting requirements to impose a higher cost
burden on smaller companies relative to revenues.
    Capital formation may be promoted to the extent the cost of
compliance with the evaluation requirement is lowered. Smaller private
companies may be able to access public capital markets earlier in their
growth and at lower cost.
    We do not believe the rule amendments or the Interpretive Guidance
will impact competition. One commenter was concerned that the
Interpretive Guidance could become the

exclusive method by which companies would conduct an evaluation of ICFR
over time, and could discourage the development of future alternative
evaluation frameworks.\77\ However, the rules explicitly acknowledge
that there are many different ways to conduct an evaluation and the
Interpretive Guidance is not exclusive.
---------------------------------------------------------------------------

    \77\ See letter from NYC Bar.
---------------------------------------------------------------------------

VIII. Final Regulatory Flexibility Analysis

    This Final Regulatory Flexibility Analysis (``FRFA'') has been
prepared in accordance with the Regulatory Flexibility Act.\78\ This
FRFA relates to amendments to Exchange Act Rules 13a-15(c), 15d-15(c),
and 12b-2, Rules 1-02 and 2-02 of Regulation S-X, and Item 308 of
Regulations S-B and S-K. These rules require the management of an
Exchange Act reporting company, other than a registered investment
company, to evaluate, as of the company's fiscal year-end, the
effectiveness of the company's ICFR. Furthermore, these rules also
require the public accounting firm that issues an audit report on the
company's financial statements to attest to, and report on,
management's assessment of the company's ICFR. We are amending these
rules to: (1) Provide companies with the assurance that an evaluation
that complies with our Interpretive Guidance will satisfy the annual
management ICFR evaluation requirement; (2) require a company's auditor
to express only one opinion on the effectiveness of the company's ICFR;
and (3) define the term ``material weakness.'' An Initial Regulatory
Flexibility Analysis was prepared in accordance with the Regulatory
Flexibility Act and included in the release proposing these
amendments.\79\ The Proposing Release solicited comments on this
analysis.
---------------------------------------------------------------------------

    \78\ 5 U.S.C. 601.
    \79\ 5 U.S.C. 603.
---------------------------------------------------------------------------

A. Need for the Amendments

    The amendments are designed to facilitate more effective and
efficient evaluations of ICFR by sanctioning the Interpretive Guidance
as a method that can be used by management to conduct an ICFR
evaluation. Companies already have a legal obligation to establish and
maintain an adequate system of ICFR and to evaluate and report annually
on those financial reporting controls. Our current rules do not
prescribe a method or set of procedures for management to follow in
performing an evaluation of ICFR. Commenters have asserted that the
lack of direction in either Section 404 of the Sarbanes-Oxley Act or
implementing rules on conducting this type of evaluation has led many
companies to look to auditing standards as a guide to conducting the
evaluation. This has likely contributed to excessive documentation and
testing of ICFR.
    While the rule amendments and Interpretive Guidance are designed to
make ICFR evaluations by management more cost-effective for all
reporting companies subject to the Section 404 requirements, they will
be particularly useful to smaller public companies that have a public
float below $75 million. These companies have not yet been required to
comply with the Section 404 requirements. The rule amendments and
Interpretive Guidance will encourage managements of smaller companies
to scale and tailor their evaluation methods and procedures to fit
their companies' own particular facts and circumstances.

B. Significant Issues Raised by Public Comments

    In the Proposing Release, we requested comment on any aspect of the
IRFA, including the number of small entities that would be affected by
the proposed amendments, and the quantitative and qualitative nature of
the impact. Commenters addressed several aspects of the proposed rule
amendments and the Proposed Interpretive Guidance that could
potentially affect small entities. They expressed concern that the
proposed amendments would not provide certainty for management because
the Proposed Interpretive Guidance was too vague, did not provide
adequate guidance for small companies to scale their evaluation
procedures, and was inconsistent with several aspects of the PCAOB's
Proposed Auditing Standard.\80\
---------------------------------------------------------------------------

    \80\ See, for example, letters from AeA, BIO, IMA and U.S. Small
Business Administration's Office of Advocacy (SBA).
---------------------------------------------------------------------------

    In response to these comments, including comments submitted by the
Office of Advocacy of the Small Business Administration, we have
coordinated with the PCAOB to harmonize the Interpretive Guidance and
rule amendments with the proposed new auditing standard. We also have
made revisions to our Proposed Interpretive Guidance to add clarity
while still maintaining a principles-based approach. Other comments
that we received are discussed below.
    Smaller public companies and their investors could realize benefits
from the rule amendments that, measured in proportion to their
revenues, are greater than the benefits that would accrue to larger
companies and their investors. This is because, as commenters on the
Proposal and on previous Commission releases related to the Section 404
requirements pointed out, the burden of internal control reporting
compliance costs is ``disproportionately high'' for smaller public
companies compared to larger ones.\81\ To the extent that Interpretive
Guidance and the rule amendments reduce the cost of compliance with the
requirements of Section 404, these cost savings will be
disproportionately greater for smaller public companies and their
investors.\82\
---------------------------------------------------------------------------

    \81\ See, for example, the letter from the Office of Advocacy of
the Small Business Administration, citing the Advisory Committee
Report at p. 33.
    \82\ Nearly 5,000 companies already are subject to the Section
404 requirements. Larger companies may also be able to perform more
efficient ICFR evaluations based on the Interpretive Guidance, and
gain assurance that changes they make in their evaluation procedures
still comply with Commission rules.
---------------------------------------------------------------------------

C. Small Entities Subject to the Final Amendments

    The amendments will affect some issuers that are ``small
entities.'' Exchange Act Rule 0-10(a) \83\ defines an issuer, other
than an investment company, to be a ``small business'' or ``small
organization'' if it had total assets of $5 million or less on the last
day of its most recent fiscal year. We estimate that there are
approximately 1,110 issuers, other than investment companies, that may
be considered small entities. The amendments will apply to any small
entity, other than a registered investment company, that is subject to
Exchange Act reporting requirements.
---------------------------------------------------------------------------

    \83\ 17 CFR 240.0-10(a).
---------------------------------------------------------------------------

    Overall, approximately 6,000 smaller public companies that are
subject to the Exchange Act reporting requirements, but have a public
float below $75 million, will be required to comply with these
requirements for the first time in their annual reports for fiscal
years ending on or after December 15, 2007. The Interpretive Guidance
and rule amendments are intended to reduce the cost of compliance for
these companies. Overall, more than half of the reporting companies
subject to the Section 404 requirements are smaller public companies
that should benefit from the rule amendments and Interpretive Guidance.

D. Reporting, Recordkeeping, and Other Compliance Requirements

    The rule amendments and Interpretive Guidance are designed to
alleviate reporting and compliance burdens. They do not impose any new

reporting, recordkeeping or compliance requirements on small entities.
The amendments are designed to make compliance with existing
requirements more efficient. Many factors contribute to the cost of
compliance, including the size and complexity of the company and the
rigor of its controls. The degree to which the rule amendments will
reduce compliance costs will depend on these factors and on the
company's prior experience and access to information about alternative
methods of compliance with the Section 404 requirements. Therefore, it
is difficult to quantify the benefits of the amendments for small
entities.

E. Agency Action To Minimize Effect on Small Entities

    The Regulatory Flexibility Act directs us to consider alternatives
that would accomplish our stated objectives, while minimizing any
significant adverse impact on small entities. In connection with the
rule amendments and Interpretive Guidance, we considered alternatives,
including establishing different compliance or reporting requirements
that take into account the resources available to small entities,
clarifying or simplifying compliance and reporting requirements under
the rules for small entities, using design rather than performance
standards, and exempting small entities from all or part of the
Interpretive Guidance and rule amendments.
    Regarding the first alternative, the Commission has effectively
established different compliance requirements for smaller entities by
making the Interpretive Guidance scalable in order to take into account
the resources available to smaller public companies, including those
that are small entities. Regarding the second alternative, the
Interpretive Guidance and rule amendments clarify and simplify the
Section 404 reporting requirements for all reporting companies,
including small entities. The final rules create a principles-based set
of guidelines for management that will produce more effective and
efficient evaluations of ICFR for small entities, as well as other
reporting companies subject to the Section 404 requirements.
    The Interpretive Guidance describes a top-down, risk-based approach
to evaluating ICFR. It promotes efficiency for companies of all sizes
by allowing management to focus its efforts on those controls that are
needed to adequately address the risk of a material misstatement in a
company's financial statements.
    Regarding the third alternative, the rule amendments and
Interpretive Guidance set forth primarily performance rather than
design standards, in particular to aid the management of non-
accelerated filers (including small entities) in conducting an
evaluation of ICFR. The amendments provide assurance that compliance
with the Interpretive Guidance will satisfy the management evaluation
requirement in Exchange Act Rules 13a-15 and 15d-15. The rule
amendments and Interpretive Guidance afford companies choosing to
follow the Interpretive Guidance considerable flexibility to scale and
tailor their evaluation methods to fit the particular circumstances of
the company. This flexibility is especially beneficial to non-
accelerated filers (including small entities).
    For example, in many smaller companies senior management is more
involved in the day-to-day operations of the company. The Interpretive
Guidance describes how management's daily interaction, as well as other
forms of on-going monitoring activities, can provide evidence in the
evaluation process. This flexibility should enable smaller companies to
keep costs of compliance with the management evaluation requirement as
low as possible.
    The rule amendments explicitly state that a company's management
does not need to comply with the Interpretive Guidance. The amendments
provide assurance, however, to a company choosing to follow the
guidance that it has satisfied management's obligation to conduct an
evaluation of internal control in an appropriate manner. Small entities
should be able to reduce the amount of testing and documentation by
relying on the Interpretive Guidance rather than auditing standards to
plan and conduct their evaluations of ICFR.
    Regarding the final alternative, we believe that an exclusion of
small entities from the Interpretive Guidance and the rule amendments
would discourage small entities from using the principles-based
Interpretive Guidance and would be inconsistent with our goal of
developing a more effective and flexible ICFR evaluation process that
is scaled and tailored to meet the small entity's particular
circumstances.

IX. 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 Parts 228, 229 and 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. revising paragraph (a)(2);
0
b. redesignating paragraphs (p) through (bb) as paragraphs (q) through
(cc); and
0
c. adding new paragraph (p).
    The revision and additions read as follows:

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

* * * * *
    (a) * * *
    (2) Attestation report on internal control over financial
reporting. The term attestation report on internal control over
financial reporting means a report in which a registered public
accounting firm expresses an opinion, either unqualified or adverse, as
to whether the registrant maintained, in all material respects,
effective internal control over financial reporting (as defined in
Sec.  240.13a-15(f) or 240.15d-15(f) of this chapter), except in the
rare circumstance of a scope limitation that cannot be overcome by the
registrant or the registered public accounting firm which would result
in the accounting firm disclaiming an opinion.
* * * * *
    (p) Material weakness. The term material weakness is 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.
* * * * *

0
3. Amend Sec.  210.2-02 by revising paragraph (f) to read as follows:

Sec.  210.2-02  Accountants' reports and attestation reports.

* * * * *
    (f) Attestation report on internal control over financial
reporting. Every registered public accounting firm that issues or
prepares an accountant's report for a registrant, other than an
investment company registered under section 8 of the Investment Company
Act of 1940 (15 U.S.C. 80a-8), that is included in an annual report
required by section 13(a) or 15(d) of the Securities Exchange Act of
1934 (15 U.S.C. 78a et seq.) containing an assessment by management of
the effectiveness of the registrant's internal control over financial
reporting must clearly state the opinion of the accountant, either
unqualified or adverse, as to whether the registrant maintained, in all
material respects, effective internal control over financial reporting,
except in the rare circumstance of a scope limitation that cannot be
overcome by the registrant or the registered public accounting firm
which would result in the accounting firm disclaiming an opinion. The
attestation report on internal control over financial reporting shall
be dated, signed manually, identify the period covered by the report
and indicate that the accountant has audited the effectiveness of
internal control over financial reporting. The attestation report on
internal control over financial reporting may be separate from the
accountant's report.
* * * * *

0
4. Amend Sec.  210.2-02T by revising the section heading to read as
follows:

Sec.  210.2-02T  Accountants' reports and attestation reports on
internal control over financial reporting.

* * * * *

PART 228--INTEGRATED DISCLOSURE FOR SMALL BUSINESS ISSUERS

0
5. The authority citation for part 228 continues to read, in part, as
follows:

    Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 77k, 77s, 77z-2,
77z-3, 77aa(25), 77aa(26), 77ddd, 77eee, 77ggg, 77hhh, 77jjj, 77nnn,
77sss, 78l, 78m, 78n, 78o, 78u-5, 78w, 78ll, 78mm, 80a-8, 80a-29,
80a-30, 80a-37, 80b-11, and 7201 et seq.; and 18 U.S.C. 1350.
* * * * *

0
6. Amend Sec.  228.308 by revising paragraphs (a)(4) and (b) to read as
follows:

Sec.  228.308  (Item 308) Internal control over financial reporting.

    (a) * * *
    (4) A statement that the registered public accounting firm that
audited the financial statements included in the annual report
containing the disclosure required by this Item has issued an
attestation report on the small business issuer's internal control over
financial reporting.
    (b) Attestation report of the registered public accounting firm.
Provide the registered public accounting firm's attestation report on
the small business issuer's internal control over financial reporting
in the small business issuer's annual report containing the disclosure
required by this Item.
* * * * *

PART 229--STANDARD INSTRUCTIONS FOR FILING FORMS UNDER SECURITIES
ACT OF 1933, SECURITIES EXCHANGE ACT OF 1934 AND ENERGY POLICY AND
CONSERVATION ACT OF 1975--REGULATION S-K

0
7. The authority citation for part 229 continues to read, in part, as
follows:

    Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 77k, 77s, 77z-2,
77z-3, 77aa(25), 77aa(26), 77ddd, 77eee, 77ggg, 77hhh, 77iii, 77jjj,
77nnn, 77sss, 78c, 78i, 78j, 78l, 78m, 78n, 78o, 78u-5, 78w, 78ll,
78mm, 80a-8, 80a-9, 80a-20, 80a-29, 80a-30, 80a-31(c), 80a-37, 80a-
38(a), 80a-39, 80b-11, and 7201 et seq.; and 18 U.S.C. 1350, unless
otherwise noted.
* * * * *

0
8. Amend Sec.  229.308 by revising paragraphs (a)(4) and (b) to read as
follows:

Sec.  229.308  (Item 308) Internal control over financial reporting.

    (a) * * *
    (4) A statement that the registered public accounting firm that
audited the financial statements included in the annual report
containing the disclosure required by this Item has issued an
attestation report on the registrant's internal control over financial
reporting.
    (b) Attestation report of the registered public accounting firm.
Provide the registered public accounting firm's attestation report on
the registrant's internal control over financial reporting in the
registrant's annual report containing the disclosure required by this
Item.
* * * * *

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

0
9. 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
10. Amend Sec.  240.12b-2 by adding the definition of ``Material
weakness'' in alphabetical order to read as follows:

Sec.  240.12b-2  Definitions.

* * * * *
    Material weakness. The term material weakness is a deficiency, or a
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.
* * * * *

0
11. Amend Sec.  240.13a-15 by revising paragraph (c) to read as
follows:

Sec.  240.13a-15  Controls and procedures.

* * * * *
    (c) The management of each such issuer, that either had been
required to file an annual report pursuant to section 13(a) or 15(d) of
the Act (15 U.S.C. 78m(a) or 78o(d)) for the prior fiscal year or
previously had filed an annual report with the Commission for the prior
fiscal year, other than an investment company registered under section
8 of the Investment Company Act of 1940, must evaluate, with the
participation of the issuer's principal executive and principal
financial officers, or persons performing similar functions, the
effectiveness, as of the end of each fiscal year, of the issuer's
internal control over financial reporting. The framework on which
management's evaluation of the issuer's internal control over financial
reporting is based must be a suitable, recognized control framework
that is established by a body or group that has followed due-process
procedures, including the broad distribution of the framework for
public comment. Although there are many different ways to conduct an
evaluation of the effectiveness of internal control over financial
reporting to meet the

requirements of this paragraph, an evaluation that is conducted in
accordance with the interpretive guidance issued by the Commission in
Release No. 34-55929 will satisfy the evaluation required by this
paragraph.
* * * * *

0
12. Amend Sec.  240.15d-15 by revising paragraph (c) to read as
follows:

Sec.  240.15d-15  Controls and procedures.

* * * * *
    (c) The management of each such issuer, that either had been
required to file an annual report pursuant to section 13(a) or 15(d) of
the Act (15 U.S.C. 78m(a) or 78o(d)) for the prior fiscal year or
previously had filed an annual report with the Commission for the prior
fiscal year, other than an investment company registered under section
8 of the Investment Company Act of 1940, must evaluate, with the
participation of the issuer's principal executive and principal
financial officers, or persons performing similar functions, the
effectiveness, as of the end of each fiscal year, of the issuer's
internal control over financial reporting. The framework on which
management's evaluation of the issuer's internal control over financial
reporting is based must be a suitable, recognized control framework
that is established by a body or group that has followed due-process
procedures, including the broad distribution of the framework for
public comment. Although there are many different ways to conduct an
evaluation of the effectiveness of internal control over financial
reporting to meet the requirements of this paragraph, an evaluation
that is conducted in accordance with the interpretive guidance issued
by the Commission in Release No. 34-55929 will satisfy the evaluation
required by this paragraph.
* * * * *

    By the Commission.

    Dated: June 20, 2007.
 Nancy M. Morris,
Secretary.
 [FR Doc. E7-12298 Filed 6-26-07; 8:45 am]

BILLING CODE 8010-01-P