Financial Reporting

FinancialReporting

January 2006

SEC Year in Review

Significant 2005 Developments

In 2005, the Securities and Exchange Commissionfocused much of its attention on evaluating the resultsof issuers’ and auditors’ efforts to implement the inter-nal control reporting requirements of Section 404 of theSarbanes-Oxley Act. For the first time, accelerated filersand their auditors were required to report on the effec-tiveness of internal controls in their 2004 annualreports. Everyone involved in the process – manage-ment, auditors, the SEC and the Public CompanyAccounting Oversight Board – agreed that the firstexperience was difficult and costly, requiring moreresources, people, and time than expected.

In April, the SEC held a public roundtable to obtain feedback on the first yearof Section 404 implementation from many interested parties, including direc-tors and officers of public companies as well as investors and auditors. Basedon this feedback, the Commission, the PCAOB, and their staffs issued state-ments and guidance that address commonly encountered issues. They encour-age a top-down, risk-based approach in planning, testing and evaluatingcontrols and highlight the need for professional judgment in determining thenature, timing, and extent of testing and in evaluating deficiencies. They alsoencourage open dialogue between companies and auditors concerning inter-nal control and accounting matters.

The Commission is particularly concerned about the costs and other diffi-culties that smaller companies and foreign companies face in preparing to imple-ment Section 404. As a result, in March the Commission deferred theimplementation date for non-accelerated filers and foreign private issuers for

Contents:New Commission Rules and Initiatives..........................................3

Deferral of Internal Control Reporting ...........................................3

Revisions to Accelerated Filer Definition and Accelerated FilingDeadlines ...........................................4

Securities Offering Reform .................5

Use of Form S-8 and Form 8-K by Shell Companies................................7

Public Release of Comment Letters...7

Delay of Statement 123(R) Implementation..................................7

First-Time Application of IFRS ...........8

XBRL Voluntary Reporting Program...8

Annual Report Disclosure of Certain Tax Penalties.......................................9

Proposed Rules..............................10

Deregistration by Foreign Private Issuers ...............................................10

Internet Availability of Proxy Materials ...........................................10

Commission and Staff Guidance...11

SAB 107 ................................................11

Use of Market Instruments in Valuing Employee Stock Options ..13

Statement on Internal Control Reporting ..........................................13

Recommendations of the Advisory Committee on Smaller Public Companies .....................................13

PCAOB Developments ..................14

Proposed COSO Guidance for Smaller Public Companies Reporting on Internal Control.......15

For Further Information ...............15

a year – to 2006. As the year pro-gressed, the SEC’s Advisory Com-mittee on Smaller Public Companiesbegan its work and focused on thisproblem. Based largely on theCommittee’s recommendations todate, the SEC has already providedrelief to smaller public companies intwo ways. First, in September theCommission delayed for an addi-tional year the requirement fordomestic and foreign non-acceler-ated filers to report on internal con-trol (to years ending on or after July15, 2007). Second, in December theSEC modified the accelerated filerdefinition and filing due dates. TheCommission created a new categoryof filers called “large accelerated fil-ers,” delayed or eliminated the finalphase-in of accelerated filingrequirements, and also made it eas-ier for companies to exit acceleratedfiler status when they have subse-quently decreased in size.

The Commission also completeda number of rulemaking initiativesin 2005. In June, it completed amulti-year effort to reform the secu-rities offering process under theSecurities Act. The new rules alsochange certain disclosure require-ments in periodic reports filed underthe Exchange Act. The Commission’sstaff has since issued two frequentlyasked questions documents thataddress a number of transition andinterpretation issues.

Beginning in 2005, companiesincorporated under the laws of aEuropean Union member country,and whose securities are publiclytraded within the EU, were gener-ally required for the first time toprepare their consolidated financialstatements under InternationalFinancial Reporting Standards. TheCommission adopted rules thatprovide relief to these issuers byallowing them to provide two years

of audited financial statements inthe year in which they implementIFRS instead of the generallyrequired three years.

During 2005 the Commission alsocompleted other rulemaking andinitiatives that had been proposedor started during 2004. It adoptedrules designed to strengthen theregistration and reporting require-ments for shell companies andrules to establish a voluntary pro-gram to furnish tagged data usingeXtensible Business ReportingLanguage in Commission filings.The Commission also followedthrough on its 2004 initiative tobegin making staff comment lettersand registrant responses publiclyavailable on its website.

The Commission and its staffdevoted significant attention to the implementation of FinancialAccounting Standards Board State-ment 123(R), Share Based Payment.Many companies faced the prospectof adopting Statement 123(R) duringthe third quarter of 2005. This raisedconcerns that implementing State-ment 123(R) in a period other thanthe first quarter of a fiscal year couldmake compliance more complicatedand comparisons of quarterly reportsmore difficult. In response to theseconcerns and to provide registrantswith more time to develop the nec-essary internal controls, the Com-mission adopted rules that for manycompanies delayed the implemen-tation date of Statement 123(R) tothe first quarter of 2006. The Com-mission’s staff also issued guidanceon implementing Statement 123(R)in the form of Staff AccountingBulletin 107.

In June, the Commission’s staffreported the results of a major studyof accounting for off-balance sheetarrangements, which was requiredby the Sarbanes-Oxley Act. The staff

studied issuers’ filings to determinethe extent of off-balance sheetarrangements and whether currentaccounting standards result infinancial statements that reflect theeconomics of such transactions in atransparent fashion. The staff took abroad view of the term “off-balancesheet” and addressed many topicsbesides special purpose entities,including investments in the equityof other entities, transfers of finan-cial assets (where there is continu-ing involvement), certain retirementarrangements, leases, contingentobligations and guarantees, deriv-atives, and other contractualobligations.

The staff concluded that trans-parency in reporting has improvedsince the Sarbanes-Oxley Act wasenacted, but there is still consider-able room for improvement. Thereport identified several key initia-tives to improve transparency inreporting, including: (1) discouragetransactions and transaction struc-tures primarily motivated byaccounting and reporting concerns,rather than economics, (2) expandthe use of objectives-orientedaccounting standards, (3) improvethe consistency and relevance ofdisclosures that supplement thebasic financial statements, and (4)communicate financial informationmore effectively to investors. Thestaff also recommended specificchanges to accounting and report-ing standards to improve trans-parency in financial statements,including: (1) reconsider accountingand reporting standards for leasesand defined benefit retirementplans, (2) continue work on consol-idation policy, (3) continue toexplore the feasibility of reportingall financial instruments at fairvalue, and (4) develop a disclosureframework that sets forth the objec-

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tives to be used in financial state-ment disclosures. The report isavailable on the SEC's website(http://www.sec.gov/news/studies/soxoffbalancerpt.pdf).

Of particular importance was thefact that the report identified reduc-ing the complexity of accountingstandards and financial reportingrequirements as a method ofincreasing the transparency andunderstandability of financial state-ments. This focused regulators andstandards setters on this issue, andas 2005 drew to a close, reducing thecomplexity of accounting standardsand financial reporting took aprominent place on the priority listof the Commission, its senior staff,and the FASB, with FASB ChairmanRobert Herz terming it no less thanan issue of “national importance.” Itseems clear that this issue will con-tinue to receive a great deal of atten-tion in the years to come.

Both the SEC and the PCAOBexperienced leadership changes. Atthe SEC, William Donaldsonstepped down as Chairman and wasreplaced by Christopher Cox inAugust. Donald Nicolaisen, ChiefAccountant, left the SEC in the fall,and Allan Beller, Director of theDivision of Corporation Finance, willleave in early 2006. Replacementshave not been named. At thePCAOB, Bill Gradison was namedacting Chairman in December. Hereplaces William McDonough, whoretired in November. The PCAOBalso named a new Chief Auditor,Thomas Ray. Mr. Ray replacesDouglas Carmichael, who resignedeffective in January 2006.

Looking forward to 2006, theCommission can be expected tocontinue to focus on the imple-mentation of internal control report-ing, particularly for smaller publiccompanies. The Committee of

Sponsoring Organizations of theTreadway Commission is scheduledto issue implementation guidancefor smaller companies. In addition,the Advisory Committee on SmallerPublic Companies is scheduled topresent its recommendations to theCommission in April. In December2005, the Committee preliminarilydecided to recommend eliminatingthe external audit requirementrelated to internal control overfinancial reporting for smaller pub-lic companies (management’sassessment would still be required)and exempting the smallest publiccompanies from internal controlreporting altogether.

Other areas of focus that are highon Chairman Cox’s agenda areimproving executive compensationdisclosure and using technology toimprove the usefulness of financialinformation to investors. In January2006, the Commission proposedrules to give shareholders moreinformation – in plain English – onexecutive compensation. The ruleswould require improved narrativesand more details about stockoptions, perquisites and severanceand retirement packages. If adopted,the changes would be the most sig-nificant in 14 years in the rules cov-ering what issuers must discloseabout how much top executives anddirectors are paid. The proposal isavailable on the SEC's website(http://www.sec.gov/rules/proposed/33-8655.pdf). The Commission hopes toexpand participation in the volun-tary program to provide tagged datareferred to above and in January2006 offered expedited filing reviewsto registrants that volunteer to par-ticipate.

The Commission and its staff willalso be reviewing the implementa-tion of IFRS. They will be evaluatingthe consistency in the manner in

which the standards are applied aswell as the transparency and overalleffectiveness of IFRS. This will be thebeginning of an effort to evaluatewhether the Commission might beable to eliminate the currentlyrequired reconciliation from IFRS toU.S. GAAP by the end of this decade.Former Chief Accountant DonaldNicolaisen provided his views onthe convergence of IFRS and U.S.GAAP and possibility of eliminatingthe reconciliation requirement in anarticle that is available on theCommission’s website (http://www.sec.gov/news/speech/spch040605dtn.htm).

The staff has been working forover a year on a project to developguidance on evaluating the materi-ality of errors in financial state-ments. The goal is to get allregistrants to do so in a consistentand appropriate manner. If the staffcompletes this project, it has thepotential to significantly affect manycompanies’ financial statements.

This letter summarizes many ofthe 2005 Commission and staffactivities described above. We dis-cuss rulemaking initiatives finalizedin 2005 first, followed by those stillin the proposal stage as ofDecember 31, 2005. Although notthe focus of this letter, we alsobriefly discuss certain 2005 activitiesof the Advisory Committee onSmaller Public Companies, COSO,and the PCAOB and its staff.

New Commission Rulesand Initiatives

Deferral of Internal ControlReporting (Releases 33-8545and 33-8618)At the beginning of 2005, non-accel-erated filers and foreign privateissuers were scheduled to beginreporting on the effectiveness of

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their internal controls in years end-ing on or after July 15, 2005. During2005, the SEC delayed the compli-ance date twice. In March, theCommission postponed the com-pliance date until the annual reportfor the first fiscal year ending on orafter July 15, 2006. In September, theCommission extended the compli-ance date for non-accelerated filersfor an additional year, until the firstfiscal year ending on or after July 15,2007. The September postponementdoes not extend to foreign privateissuers that meet the definition ofan accelerated filer (i.e. foreign pri-vate issuers that have been a report-ing company for at least 12 months,filed at least one annual report, andhave a world-wide public equityfloat of $75 million or more). A for-eign private issuer that meets thedefinition of an accelerated filermust adhere to the compliance dateadopted in March and begin to com-ply with the Section 404 require-ments in its first fiscal year endingon or after July 15, 2006.

The March Release is available on the SEC’s website at http://www.sec.gov/rules/final/33-8545.htm; theSeptember Release is available athttp://www.sec.gov/rules/final/33-8618.pdf.

Revisions to Accelerated FilerDefinition and AcceleratedFiling Deadlines (Release 33-8644)In December, the SEC adopted rulesto modify the accelerated filer defi-nition and filing deadlines. The rulesthe Commission adopted:• Created a new category of issuer

called a “large accelerated filer.” Acompany becomes a large accel-erated filer when it has a publicequity float of $700 million ormore as of the end of its secondquarter and meets the other testsincluded in the definition of an

accelerated filer. The existing def-inition of an “accelerated filer” waschanged to include companiesthat have at least $75 million butless than $700 million in publicequity float.

• Will accelerate the Form 10-Kreporting deadline (but not theForm 10-Q reporting deadline) forlarge accelerated filers. Largeaccelerated filers will becomesubject to a 60-day Form 10-K fil-ing deadline next year (i.e., in fis-cal years ending on or afterDecember 15, 2006). Until thattime, the Form 10-K filing dead-line will remain at 75 days afteryear-end. The current 40 days afterquarter-end deadline for quarterlyreports on Form 10-Q will remainin place permanently.

The Commission had proposedaccelerating the due date of largeaccelerated filers’ Form 10-Ks to60 days in years ending on or afterDecember 15, 2005, but decided togive these filers an additional yearof filing on the current scheduleprimarily to enable them to moreeffectively transition to internalcontrol reporting.

• Eliminate the final phase-in ofaccelerated filing dates for allother accelerated filers. The cur-rent 75-day Form 10-K deadlineand 40-day Form 10-Q deadlinewill remain in place for all otheraccelerated filers.

• Make it easier for an issuer tomove to a less accelerated filingcategory. Previously, an acceler-ated filer was required to meet thedefinition of a small businessissuer (i.e., public equity float andannual revenues of less than $25 million at the end of two con-secutive years) in order to exitaccelerated filing status in thesubsequent year. The new rulespermit an accelerated filer whose

public equity float has droppedbelow $50 million at the end of itssecond quarter to file an annualreport on a non-accelerated basisfor that same fiscal year. In addi-tion, a large accelerated filer ispermitted to exit large acceleratedfiler status in the same year as itspublic equity float has droppedbelow $500 million at the end ofits second quarter.

The tests to determine anissuer’s filing category are made atyear-end based in part on infor-mation as of the issuer’s mostrecent second fiscal quarter. Thus,the first report an issuer filesunder a new filing category isalways an annual report. Forexample, if in 2006 the publicequity float of an accelerated filerwith a December year-end dropsbelow $50 million on the last dayof its second fiscal quarter, theissuer is still required to file itsForm 10-Qs for the quarters end-ing June 30 and September 30,2006 on an accelerated basis(within 40 days of quarter-end) butmay file its Form 10-K for the yearending December 31, 2006 on anon-accelerated basis (within 90days of year-end).As discussed above, the determi-

nation of whether a registrant mustreport on internal control is cur-rently based on whether it is anaccelerated filer. Therefore, a regis-trant that is able to exit acceleratedfiler status under the amended def-inition will no longer be required toprovide management and auditorreports on internal control overfinancial reporting.

The due dates for Forms 10-K and10-Q under the previous rules andthe new rules are shown in Table 1on the next page. The new rules areeffective for fiscal years ending on orafter December 15, 2005.

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The Release is available on theSEC’s website (http://www.sec.gov/rules/final/33-8644.pdf).

Securities Offering Reform (Release 33-8591)In June, the SEC completed a multi-year effort to modernize the securi-ties offering process under theSecurities Act of 1933. The primaryfocus of the rules is on three aspectsof the offering process: (1) commu-nications about registered offerings,(2) the registration process, and (3)the delivery of information toinvestors. Certain additional disclo-sures in annual reports on Form 10-K and other Exchange Act reportswere adopted as well. The new rulestook effect on December 1, 2005.They do not apply to securities offer-ings involving business combina-tions. The major changes aresummarized below.

Categories of Issuers – The new rulescategorize issuers as follows:• Well-Known Seasoned Issuers (WKSIs),

a new category of issuers, receivethe most benefit from the rulechanges. WKSIs are the largestand most active issuers in the U.S.public capital markets. In 2004,

they represented approximately30% of listed issuers and accountedfor approximately 95% of U.S.equity market capitalization. AWKSI is an issuer that meets theregistrant requirements of Form S-3 or Form F-3 and has either (1) aworldwide market value of com-mon equity held by non-affiliatesof $700 million or more or (2) dur-ing the past three years issued atleast $1 billion aggregate principalamount of non-equity, non-con-vertible securities in registered pri-mary offerings for cash (i.e., notcounting securities issued in reg-istered exchange offers).

• Seasoned Issuers are eligible to useForm S-3 or Form F-3 to register aprimary offering of their securities.

• Unseasoned Issuers are required tofile Exchange Act reports but arenot eligible to use Form S-3 orForm F-3 to register a primaryoffering of their securities.

• Non-Reporting Issuers are notrequired to file Exchange Actreports. This category includesvoluntary filers.

• Ineligible Issuers do not qualify asWKSIs or for many other benefitsof the new rules. Several events or

characteristics can render anissuer ineligible. Examples includenot being current in filingExchange Act reports and violat-ing the anti-fraud provisions of thefederal securities laws. Communications about Registered

Securities Offerings – The new rulesrelax the “gun-jumping” and “quietperiod” provisions related to regis-tered offerings. These provisionshave inhibited communications bya company that is conducting asecurities offering because theymight be construed to be prohibitedoffers. The new rules allow issuersto make several types of communi-cations with certainty that they willnot constitute prohibited offers.• WKSIs are permitted to engage at

any time in oral and written com-munications, including the use atany time of a new type of writtencommunication called a “free writ-ing prospectus” (a written offermade outside the statutoryprospectus);

• All other issuers and offering par-ticipants are permitted to use afree writing prospectus after a reg-istration statement is filed.Unseasoned and non-reporting

Category Previous Rules Category New Rulesof Filer Deadlines for Reports Beginning of Filer Deadlines for Reports Beginning

with Annual Report for Fiscal Years with Annual Report for Fiscal YearsEnding on or after 12/15/05 Ending on or after 12/15/05

10-K Deadline 10-Q Deadline 10-K Deadline 10-Q Deadline

Accelerated Filer 60 days 35 days Large 75 days 40 days($75M or more) Accelerated Filer (Years ending on

($700M or more) or after 12/15/06– 60 days)

Accelerated Filer 75 days 40 days(between $75M

and $700M)

Non-Accelerated 90 days 45 days Non-Accelerated 90 days 45 daysFiler Filer

(Less than $75M) (Less than $75M)

Table 1 – Due Dates for Forms 10-K and 10-Q

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issuers must provide a statutoryprospectus to investors before orat the same time as they providea free writing prospectus;

• Reporting issuers may continue topublish regularly released factualbusiness information and for-ward-looking information at anytime;

• Non-reporting issuers may con-tinue to publish factual businessinformation that is regularlyreleased to persons other than intheir capacity as investors orpotential investors at any time;

• Communications by issuers morethan 30 days before the filing of aregistration statement will not beconsidered prohibited “gun-jump-ing” so long as they do not refer-ence the offering; and

• A broader category of routinecommunications regarding issuers,offers, and procedural matters isallowed.In many cases, free writing

prospectuses must be filed with theSEC. Companies are still liableunder the securities laws for mate-rial misstatements or omissions incommunications about an offering.

Registration Process – The new rulesstreamline the shelf registrationprocess. Shelf registration is aprocess by which an issuer can reg-ister an offering of securities thatwill be made on a delayed or con-tinuous basis (in contrast to anoffering that will commence imme-diately and be completed within ashort period of time). After the SECstaff declares a registration state-ment effective, the securities cangenerally be taken “off the shelf” andoffered without further clearance bythe SEC staff. The new rules stream-line the shelf registration process inthe following ways:• The information that can be

excluded from a base prospectus

(the prospectus included in theeffective registration statement)has been expanded and codifiedin a new rule (Rule 430B). Infor-mation omitted from a base pro-spectus pursuant to Rule 430Bmay subsequently be included by(1) filing a post-effective amend-ment, (2) filing a prospectus sup-plement or (3) including theinformation in a current or peri-odic Exchange Act report that isincorporated by reference to theprospectus.

• New Rule 430B also permits aseasoned issuer to omit from aprospectus covering a resale offer-ing the identity of the sellingsecurity holders and the amountof securities registered on theirbehalf, provided certain condi-tions are met.

• Immediate (rather than delayed)takedowns of securities coveredby shelf registration statementsare permitted once the registra-tion statement becomes effective.

• The requirement that an issuerregister only securities it intendsto sell within two years has beeneliminated.

• For WKSIs, a more flexible versionof shelf registration, referred to as“automatic shelf registration,” hasbeen established. Registrationstatements and post-effectiveamendments filed under the auto-matic shelf registration processare automatically effective uponfiling (i.e., without the possibilityof SEC staff review). The automaticshelf registration process also pro-vides more flexibility regarding theamounts and classes of securitiesthat can be included in a singleshelf registration.

• The new rules also streamline theregistration process for reportingissuers conducting offerings onForms S-1 and F-1. These formshave been amended to permit

issuers to incorporate previouslyfiled Exchange Act reports by ref-erence, so long as the reports areavailable on the issuers’ websitesand the prospectus identifies allreports and materials incorpo-rated by reference. Forms S-2 andF-2 have been eliminated, as theyare no longer necessary.Timing of Liability – The new rules

codify the SEC’s view that, for pur-poses of evaluating whether ade-quate information was delivered toan investor to avoid liability underSection 12(a)(2) of the Securities Act(i.e., whether the informationincludes a material misstatement oromission), the assessment of theinformation delivered is made at thetime an investment decision ismade – not later, when a revisedprospectus or prospectus supple-ment is filed. The new rules alsoextend the date to which issuers aresubject to Section 11 liability tomake it consistent with the date towhich underwriters are subject tosuch liability. A prospectus supple-ment now creates a new effectivedate and extends Section 11 liabil-ity for issuers (but not for officersand directors or experts, such asindependent auditors).

Final Prospectus Delivery – The newrules modernize the prospectusdelivery process by creating an“access equals delivery” model.Filing a final prospectus with theSEC and complying with other con-ditions satisfies the final prospectusdelivery requirements. Issuers nolonger have to print and deliver finalprospectuses.

Additional Disclosures in Exchange ActReports – The Exchange Act periodicreporting requirements were modi-fied to require the following:• Disclosure of risk factors in Form

10-K and Exchange Act registrationstatements on Form 10 (updatedinformation is required in Form

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10-Q when material changes haveoccurred);

• Disclosure in Forms 10-K, 10-KSBand 20-F of an issuer’s status as avoluntary filer of Exchange Actreports;

• For accelerated filers (includingforeign private issuers that meetthe definition of an acceleratedfiler), disclosure in Form 10-K orForm 20-F of unresolved com-ments from the SEC staff that theissuer believes are material andthat were more than 180 days oldas of year-end; and

• Disclosure in Forms 10-K and 20-F of whether or not an issuer is aWKSI.These disclosures are required

beginning with annual reports forfiscal years ending on or afterDecember 1, 2005. The disclosuresin Form 10-Q regarding materialchanges to risk factors must be pro-vided only after the issuer is firstrequired to include risk factor dis-closure in its Form 10-K.

The Release is available on theSEC’s website (http://www.sec.gov/rules/final/33-8591.pdf).

In September, the SEC staff issueda frequently asked questions docu-ment addressing questions relatedto transition to the new rules. TheFAQ document is available on theSEC’s website (http://www.sec.gov/divisions/corpfin/transitionfaq.htm).

In November, the staff issued asecond FAQ document addressinginterpretation questions of ongoingrelevance. That FAQ document isavailable on the SEC’s website athttp://www.sec.gov/divisions/corpfin/faqs/secu-rities_offering_reform_qa.pdf.

Use of Form S-8 and Form 8-K by Shell Companies(Release 33-8587)In June, the SEC adopted final rules

amending Forms S-8, 8-K, and 20-F,

as well as defining the term “shellcompany.” The rules (1) prohibit ashell company from using Form S-8and (2) require one to disclose addi-tional information when it ceases tobe a shell company. Domesticissuers must provide the disclosureson Form 8-K within 4 business daysof the event. The informationrequired is equivalent to that whichwould be required in a registrationstatement (i.e., Form 10). Foreignprivate issuers are required to pro-vide the same information, alsowithin 4 business days. Because for-eign private issuers are not subjectto Form 8-K reporting requirements,they must provide the informationon Form 20-F. A shell company maynot use Form S-8 until 60 days afterit has ceased being a shell companyand filed the required information.The rules are designed to assurethat investors in shell companiesthat acquire operations or assetshave timely access to the same kindof information as is available toinvestors in public companies withprior operations.

The Commission also amendedForms 10-Q, 10-QSB, 10-K, 10-KSB,and 20-F to require companies tocomplete a cover page checkbox toindicate whether they are a shellcompany.

The Release is available on theSEC’s website (http://www.sec.gov/rules/final/33-8587.pdf).

Public Release of CommentLettersIn May, the SEC began the processof publicly releasing staff commentletters and registrant responsesrelating to filings made after August1, 2004. It has taken longer to postthe correspondence than wasexpected because the staff needs tomake sure the correspondence to beposted does not contain information

covered by a confidential treatmentrequest. The staff began posting theletters to the Commission’s websitein batches and continues to do so.

Comment letters are accessibleon the SEC’s website at http://www.sec.gov/cgi-bin/srch-edgar. To search forcomment letters, enter the searchstring “upload”. To search for com-pany responses, enter the searchstring “corresp”.

See our January 2005 FinancialReporting letter for further detailsregarding this initiative (http://www.bdo.com/about/publications/assurance/FRL2004Review1-05-3.pdf).

Delay of Statement 123(R)Implementation (Release 33-8568)In April, the SEC delayed the effec-tive date of FASB Statement 123(R),Share-Based Payment, for public com-panies.

The effective dates of Statement123(R) were such that some compa-nies could have been required tofirst apply it in an interim periodother than the first fiscal quarter.(For registrants other than smallbusiness issuers, Statement 123(R)was effective as of the beginning ofthe first interim or annual periodbeginning after June 15, 2005. Forsmall business issuers, it was effec-tive as of the beginning of the firstinterim or annual period beginningafter December 15, 2005.) Inresponse to concerns that imple-menting Statement 123(R) in aperiod other than the first quarter ofa fiscal year could make compliancemore complicated and comparisonsof quarterly reports more difficult,the Commission changed the effec-tive date to allow adoption at thebeginning of a fiscal year. Regis-trants that are not small businessissuers may delay implementationof Statement 123(R) until the begin-

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ning of their first fiscal year thatbegins after June 15, 2005, and smallbusiness issuers may delay imple-mentation until the beginning oftheir first fiscal year that begins afterDecember 15, 2005.

The Release is available on theSEC’s website (http://www.sec.gov/rules/final/33-8568.pdf).

First-Time Application ofIFRS (Release 8567)Public companies in the EuropeanUnion were required to adoptInternational Financial ReportingStandards for their 2005 financialyears. Other countries, includingAustralia, have adopted similarrequirements calling for mandatoryuse of IFRS in periods beginningafter January 1, 2005. To facilitate theadoption of IFRS by foreign privateissuers, in April the SEC adoptedamendments to Form 20-F that pro-vide a one-time accommodationthat permits them, in the year theyadopt IFRS, to provide two years ofaudited financial statements insteadof the currently required three yearsin a registration statement or annualreport filed on Form 20-F. Theamendments do not eliminate therequirement that a foreign privateissuer reconcile its financial state-ments to U.S. GAAP. Eligible com-panies must reconcile their IFRSfinancial statements to U.S. GAAPfor each year presented.

To qualify for the accommodation,the issuer’s most recent auditedfinancial statements included in thefiling must be for the 2007 financialyear or earlier. In addition, the issuermust have adopted IFRS for the firsttime by an explicit and unreservedstatement of compliance with IFRSand its auditors’ report must beunqualified.

The accommodation also extendsto the financial statements of a

foreign business other than theissuer that must be included in theissuer’s filing pursuant to Rules 3-05(acquired businesses), 3-09 (equitymethod investees), 3-10 (guarantors)and 3-16 (collateral entities) ofRegulation S-X and to the financialstatements of a target company in abusiness combination transactionthat are included in a registration orproxy statement.

Previous GAAP Financial Statements –The rules allow, subject to certainadditional disclosure requirements,an issuer that switches to IFRS toinclude (or incorporate by reference)prior financial statements that wereprepared under the GAAP it previ-ously used. However, a side-by-sidepresentation of previous GAAP andIFRS basis financial statements isprohibited, and issuers that elect toinclude or incorporate previousGAAP financial statements mustprovide cautionary language withrespect to the data to avoid inap-propriate comparison with informa-tion prepared under IFRS.

Other Disclosures – In a registrationstatement that is dated more thannine months after the end of themost recent fiscal year, foreign pri-vate issuers must generally provideconsolidated interim financial state-ments that cover at least the first sixmonths of the current fiscal year andthe comparative period for the prioryear. In other situations, these unau-dited interim statements must beprepared on the same basis ofaccounting as the audited financialstatements that appear in the filing.However, the amendments providean initial adopter of IFRS with alter-natives for providing such interimstatements.

Compliance with EU GAAP – The newrules clarify that the accommoda-tion extends to issuers applying “EUGAAP” (i.e., IFRS as adopted by the

EU, which endorses IAS 39, FinancialInstruments: Recognition and Measure-ment, with the certain exceptions). Afirst-time adopter of EU GAAP mustprovide an audited reconciliationfrom EU GAAP to IFRS (whichincludes footnote disclosure equiv-alent to that required under IFRS)and an audited reconciliation fromEU GAAP to U.S. GAAP for the twoyears for which EU GAAP state-ments are provided.

Disclosures Regarding Exceptions toIFRS – IFRS 1, First Time Adoption ofInternational Financial Reporting Stand-ards, provides for various optionaland mandatory exceptions to retro-active application of some aspects ofother standards upon initial adop-tion of IFRS. The new rules requirecertain qualitative disclosures relat-ing to any of the mandatory or elec-tive exceptions under IFRS 1.

The Release is available on theSEC’s website (http://www.sec.gov/rules/final/33-8567.pdf).

XBRL Voluntary ReportingProgram (Release 33-8529)XBRL (eXtensible Business ReportingLanguage) is a standardized formatfor tagging financial information socomputers can extract, exchange,analyze, and display it. Using com-puters to perform these tasks allowsthem to be performed more quickly,cheaply, and accurately than if theyare performed manually.

In February, the SEC adoptednew rules to establish a voluntaryprogram to facilitate tagged datareporting using XBRL. The programallows registrants to voluntarily fur-nish certain financial data from arelated Exchange Act or InvestmentCompany Act filing as an exhibitin XBRL format. The SEC launchedthe program in March 2005 toreceive 2004 calendar year financialinformation.

COPYRIGHT 2006, BDO SEIDMAN, LLP 9

Financial Reporting

To participate in the program, reg-istrants must furnish the XBRL doc-ument as an exhibit, either with thefiling which reported the informa-tion or with a Form 8-K or 6-K. Reg-istrants are not permitted to submitan XBRL document before they filethe related official filing.

XBRL documents must containcertain mandatory content and maycontain additional optional content.Mandatory content consists of acomplete set of information for allperiods presented in the correspon-ding official EDGAR filing from oneor more of the following categories:• The complete set of financial

statements (not including foot-notes, schedules and auditors’reports);

• Earnings information set forth inItems 2.02 or 8.01 of Form 8-K orin Form 6-K; and

• For registered investment compa-nies only, financial highlights orcondensed financial information.Additional optional information

that may be included as part of anXBRL document includes auditopinions, certifications and man-agement’s discussion and analysisof financial condition.

XBRL data must reflect the sameinformation that is in the corre-sponding official filing (i.e., it maynot be changed, deleted, or sum-marized in any way). In addition, thedata in XBRL documents must betagged using the appropriate “stan-dard taxonomy.”

XBRL documents will not be con-sidered “filed” and therefore will notbe subject to certain liability provi-sions of the Exchange Act andInvestment Company Act.

The Release is available on theSEC’s website (http://www.sec.gov/rules/final/33-8529.htm).

In addition, the SEC staff hasissued frequently asked questions

and “spotlight” documents regard-ing the program (which are availableat http://www.sec.gov/info/edgar/xbrlfaq032105.htm and http://www.sec.gov/spot-light/xbrl.htm), and the PCAOB staffhas issued a frequently asked ques-tions document that provides guid-ance to auditors performing attestengagements related to the accu-racy of XBRL data. (Companies arenot required to obtain auditor attes-tations covering XBRL data.) Thisdocument is available on thePCAOB’s website at http://www.pcaobus.org/standards/staff_questions_and_answers/2005/05-25%20.pdf.

Thus far, participation in the pro-gram has been limited. In an effortto increase participation, in January2006 the SEC offered expedited fil-ing reviews to registrants that vol-unteer to participate. Furtherinformation about these incentivesis available at http://www.sec.gov/news/press/2006-7.htm.

Annual Report Disclosure ofCertain Tax Penalties (Rev. Proc. 2005-51)The American Jobs Creation Act of2004 added section 6707A to theInternal Revenue Code to (1) providea monetary penalty for the failure toinclude on any tax return any infor-mation required to be disclosed withrespect to certain “reportable” trans-actions, as described in Section1.6011-4(b) of the Income TaxRegulations, and (2) require SECregistrants to disclose any suchpenalties they are required to pay. InAugust, the Internal Revenue Serviceissued Revenue Procedure 2005-51to provide more detailed guidancewith respect to the required disclo-sures under section 6707A. (Therequirements are not reflected in anyof the SEC’s rules or forms.)

Companies must disclose thesetax penalties in Item 3 (Legal

Proceedings) of Form 10-K. While

Revenue procedure 2005-51 only

specifies a disclosure requirement

in Form 10-K, Section 6707A of the

Code specifies that the disclosure

requirement applies to all persons

required to file periodic reports

under section 13 or 15(d) of the

Exchange Act. This would also

include companies that are required

to file annual reports on Forms 10-

KSB, 20-F and 40-F. Companies that

incur these penalties and file annual

reports on forms other than Form

10-K should consult with their tax

advisors and legal counsel as to the

need for and appropriate way to

make the required disclosures.

The disclosure must include the

following:

• The amount of the penalty;

• Whether the penalty has been

paid in full;

• The Code section under which the

penalty was determined;

• A description of the penalty

imposed; and

• Under certain circumstances, the

requirement to pay the 40% accu-

racy-related penalty described in

Section 6663(h).

Companies must make the dis-

closures in the Form 10-K that

relates to the fiscal year in which the

IRS sends notice and demand for

payment of the penalty. If a com-

pany pays the penalty before the IRS

issues the notice, it must disclose

the penalty in the Form 10-K for the

fiscal year in which the payment is

made. Companies that do not dis-

close the penalties as required will

face additional penalties, which will

be imposed for each successive

Form 10-K that is filed without the

required disclosure. The additional

penalties must be disclosed as well.

The new disclosures are required

for penalties that relate to a tax

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return or statement due afterOctober 22, 2004.

Revenue Procedure 2005-51 maybe accessed via Internal RevenueBulletin 2005-33, which is accessibleat http://www.irs.gov/irb/.

Proposed Rules

Deregistration by ForeignPrivate Issuers (Release 34-53020)In December, the SEC proposed newrules that would relax the conditionsa foreign private issuer must meetto be permitted to exit the ExchangeAct reporting regime.

Under current rules, a foreign pri-vate issuer may suspend or, in somecases, terminate its Exchange Actreporting obligation if its registeredclasses of securities have fewer than300 record holders who are U.S. res-idents (or 500 holders who are U.S.residents, if the issuer’s total assetswere less than $10 million at the endof its last three fiscal years). Underthese rules, a foreign private issuermay find it difficult to stop filingExchange Act reports despite thefact that there is relatively littleinvestor interest in the U.S. The pro-posed rules would ease the condi-tions under which a foreign privateissuer could deregister a class ofsecurities and terminate (not justsuspend) its reporting obligationsunder the Exchange Act. For equitysecurities, the proposed conditionswould vary depending on whetherthe registrant is a well-known sea-soned issuer and include testsbased on the issuer’s Exchange Actreporting history, its offering andlisting history, its public float, andits trading volume.

The release is available on theSEC’s website (http://www.sec.gov/rules/proposed/34-53020.pdf).

Internet Availability of ProxyMaterials (Release 34-52926)In November, the SEC proposed for

public comment new rules that

would allow issuers and other per-

sons to use the internet to satisfy

proxy material delivery require-

ments. The SEC expects the pro-

posal to result in a substantial

decrease in printing and postage

costs incurred to comply with the

proxy rules.

Current rules require proxy mate-

rials (i.e., a proxy statement and, if

the shareholders meeting is one at

which directors are to be elected, an

annual report to shareholders) to be

delivered to shareholders with or

prior to a proxy solicitation. The

proxy materials must be in paper

form or, if the shareholder consents,

they may be delivered electronically.

The proposed rules would allow

issuers conducting proxy solicita-

tions to post their proxy materials on

a publicly available internet website

(other than the SEC’s website).

Issuers would be required to send a

paper notice to shareholders inform-

ing them of the availability of the

proxy materials. The notice would

have to be sent at least 30 days prior

to the shareholders meeting to

which the proxy materials relate, and

would have to contain a prominent

legend in bold-faced type that

includes the following information:

• The date, time and location of the

shareholders meeting;

• The address of the website where

shareholders can access the

related proxy materials;

• A toll-free number and e-mail

address that shareholders can use

to request paper copies of the

proxy materials free of charge; and

• A clear and impartial description

in plain English of the matters to

be considered at the meeting and

the company’s recommendationsregarding those matters.The proposed rules also contain

the following procedural require-ments:• The proxy voting card would have

to be accompanied by, and deliv-ered through the same medium(paper or electronic) as either thenotice or the proxy statement;

• Issuers would be required torespond to a shareholder’s requestfor paper copies of proxy materialwithin two days of the request;

• No information other than thatspecified in the rules would bepermitted to be included in thenotice, and no other shareholdercommunications could be sentwith the notice;

• Additional soliciting materialsthat are distributed after thenotice is sent would have to beposted on the website specified inthe notice; and

• Banks, brokers and other inter-mediaries that hold securities forbeneficial owners would berequired to forward the notice tothose beneficial owners.The proposed rules would have

no impact on any state law obliga-tion regarding proxy solicitations orannual meetings. Further, the pro-posed rules would not apply to busi-ness combination transactions.

The proposed notice and accessmodel would also be available topersons other than the issuer whoare soliciting proxies. Such personswould be required to deliver a noticesubstantially similar to that requiredby issuers by the later of 30 daysbefore the shareholders meeting or10 days after the issuer filed itsproxy materials.

The proposed rules are notexpected to be finalized until some-time after the 2006 proxy season.The Release is available on the

SEC’s website (http://www.sec.gov/rules/proposed/34-52926.pdf).

Commission and StaffGuidance

SAB 107In March, the Commission’s staffissued Staff Accounting Bulletin107. The SAB provides guidance forimplementing Statement 123(R).Subsequently, the Commissiondelayed the implementation datesfor Statement 123(R) as discussedabove. Following are highlights ofthe guidance in SAB 107:

Choice of Valuation Models – State-ment 123(R) expresses no prefer-ence for either of the two categoriesof option pricing models currentlyused in practice (i.e., closed formmodels, like Black-Sholes, or latticemodels, like binomial) and SAB 107confirms that either is acceptable forregistrants. SAB 107 also notes thatan issuer may switch from a closedform model to a lattice model andthis change would be a change inestimate, not a change in themethod of applying an accountingprinciple. Accordingly, a registrantwould not need a preferability letterfrom its independent accountants.

Assumptions About Expected Volatilityof Stock Price – One of the keyassumptions for option pricingmodels is an assumption about theexpected volatility of the stock priceover the expected term of theoption. SAB 107 notes that estimat-ing expected volatility is difficult. Itprovides guidance on measuringhistorical volatility, using impliedvolatility, and determining volatilityfor companies that recently becamepublic. In addition, the staff remindsregistrants that it is inappropriate touse the volatility of a stock marketindex in place of the volatility of

their own stock, because the aver-aging inherent in indexes causes thevolatility of an index to be lowerthan the volatility of the componentshares.

Assumptions About the Expected Termof Employee Options – SAB 107 dis-cusses the staff’s expectations abouthow companies should develop his-torical data about the average termsof past stock options. The staff notesacademic research indicating thatemployee exercise behavior is influ-enced by the rate of increase in theprice of the employer’s shares, andcautions that past behavior in dif-ferent stock price environmentsshould be used with caution in pro-jecting the future. If a registrantlacks sufficient experience, it mayuse information about similar com-panies’ employee exercise behavior.The staff notes that informationabout other companies may not bereadily available now, although thestaff expects compensation con-sultants to build databases over thenext couple of years. In the interim,if a registrant has neither relevantexperience of its own nor relevantexperience of similar companies,the staff will not object to use of anexpected term equal to the mid-point between the vesting date andthe expiration date of the option.

Analysis of Prior Credits to Capital fromExcess Tax Benefits – Under Statement123(R) an income tax benefit froman income tax deduction in excessthe tax benefit from compensationexpense for financial reporting pur-poses is credited to shareholders’equity. When the reverse happens,the shortfall is charged againstshareholders’ equity to the extent ofprior credits, and the remainder ofthe shortfall, if any, is charged to theprovision for income taxes. UnderStatement 123(R), the pool of priorcredits to shareholders’ equity for

this purpose is not the actualamount the employer credited toshareholders’ equity in prior years.Instead, it is the hypotheticalamount that the employer wouldhave credited to shareholders’equity since 1995 if it had followedthe fair value method of originalStatement 123.

SAB 107 allows for a practicalapproach that a registrant can useto develop the pool of credits toshareholders’ equity. Under thisapproach, a registrant only needs toknow about the pool of prior creditsto shareholders’ equity if and whenan employee award results in anincome tax deduction less thancompensation expense for financialreporting purposes. If and when thatoccurs, the employer needs to deter-mine whether it has enough priorcredits to absorb the shortfall in theincome tax deduction by workingbackwards from 2004 until it hasenough cumulative credits. If a reg-istrant’s stock price generally risesafter the adoption of Statement123(R), it may never need to go allthe way back to 1995. (Subse-quently, the FASB addressed thisissue in FSP FAS 123(R)-3, TransitionElection Related to Accounting for the TaxEffects of Share-Based Payment Awards,which provides a practical transitionelection related to accounting forthe tax effects of share-based pay-ment awards to employees.)

Interaction of Statement 123(R) with theSEC’s Redeemable Equity Rules – Agrant may qualify as an equity trans-action (rather than a liability) underStatement 123(R), because it is set-tled in shares, but the shares areredeemable upon the occurrence ofevents outside the control of theissuer. SAB 107 clarifies that theSEC’s rules requiring such securitiesto be reported outside of share-holders’ equity apply. If the grant

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vests over time, the amountreported outside of shareholders’equity would be the amount ordi-narily required by the SEC’s rulemultiplied by the portion ofemployee service that was renderedprior to the balance sheet date.

Capitalization of Compensation fromShare-Based Payment Transactions –Some registrants grant share-basedawards to employees whose cashcompensation is capitalized as partof the cost of inventory or self-con-structed plant. The share-basedcompensation for those employeesshould similarly be capitalized. SAB107 states that a registrant can esti-mate the amount of share-basedcompensation that would be capi-talized using inventory turnover orother measurements.

Applicability of Statement 123(R) toOptions Granted to Nonemployees – InSAB 107 the staff notes that share-based payment awards to nonem-ployees should be measured basedon the fair value of the servicesreceived or the fair value of theaward, whichever can be estimatedmore reliably. If the fair value of theaward can be estimated more reli-ably, which is ordinarily the case fora registrant, then EITF Issue No. 96-18 is the appropriate guidance touse in accounting for the award.That guidance would take prece-dence over Statement 123(R)’s guid-ance about when to measure fairvalue. However, EITF Issue No. 96-18 does not provide guidance onsome classification and measure-ment issues. SAB 107 suggests thatthe guidance in Statement 123(R)should be followed if there is noconflicting guidance in the EITF con-sensus. Most significantly, and in achange from prior staff guidance, fairvalue should be estimated based onthe expected term, rather than thecontractual term, for nonemployee

awards that have nontransferabilityand nonhedgeability characteristicslike employee awards. Awards toindividuals may have these charac-teristics, whereas awards to compa-nies typically do not.

Similarly, the staff indicates thatthe guidance in Statement 123(R)about whether an award is classifiedas a liability or as an equity instru-ment applies to nonemployeeawards.

Acceleration of Vesting before AdoptingStatement 123(R) – SAB 107 repeatsthe SEC staff’s views about the needfor robust disclosure in MD&A aboutthe impact of accelerating vestingand the business reasons why acompany accelerated vesting.

Transition Requirements for Companiesthat Become Public Companies afterAdopting Statement 123(R) – Generally,when a formerly nonpublic entitybecomes a public company, the staffbelieves that the fair value of equityawards should not be adjusted,because fair value is estimated atgrant date and is not adjusted forsubsequent developments. Thisguidance to not adjust the fair valueof equity awards would apply bothto (1) awards granted prior to adop-tion of Statement 123(R) and (2)awards granted after adoption ofStatement 123(R) but before becom-ing a public company. However, thevalue of liability awards is adjustedevery period until exercise, settle-ment, or expiration, so a newly pub-lic company should adjust the valueof liability awards to Statement123(R)’s public company fair valuemodel.

Classification of Compensation andNon-GAAP Financial Measures – SAB107 notes that it would be inappro-priate to classify the compensationexpense from share-based paymenttransactions in a caption differentfrom the other components of

employee compensation. If a regis-trant wants to highlight the amountof non-cash compensation expensearising from such awards, it can doso by parenthetic notation in thecaption on the income statement orby disclosure in the notes.

In addition, a measure of earningsthat excludes compensation expensefrom share-based payment transac-tions is a non-GAAP financial meas-ure which must adhere to therequirements of Regulation G and (ifincluded in an SEC filing) Regula-tion S-K Item 10(e).

Discussion in MD&A – The adoptionof Statement 123(R) will create non-comparability between pre- andpost-adoption financial statements.SAB 107 reminds registrants thatMD&A should discuss that non-comparability and help readersunderstand the effects of theaccounting change. SAB 107 specif-ically mentions the following itemsthat should be discussed:• The prior method used to record

compensation (APB 25 or originalStatement 123);

• The transition method used toadopt Statement 123(R) (modi-fied prospective or modified ret-rospective);

• One-time effects of adoption, ifany;

• Changes in option valuation mod-els or assumptions that wouldcause the fair-value-based com-pensation previously disclosed inthe notes to financial statementsto differ from the fair-value-basedcompensation recorded in earn-ings under Statement 123(R);

• Changes in the mix of employeecompensation, for example,decreased option grants andincreased cash salaries orincreased restricted stock awardsafter adoption of Statement123(R);

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• Changes in the terms of share-based payment awards, for exam-ple, shorter option lives, fastervesting, or the addition of per-formance conditions; and

• Total fair-value-based compensa-tion expense associated with priorawards that are not vested at theadoption of Statement 123(R) andthe weighted average period overwhich that compensation will berecorded in earnings.SAB 107 is available at http://www.

sec.gov/interps/account/sab107.pdf.

Use of Market Instruments inValuing Employee StockOptionsIn September, the SEC issued infor-mal staff progress reports from theSEC’s Chief Accountant and the staffof the SEC’s Office of EconomicAnalysis regarding using marketinstruments to value stock options.

In his report, the Chief Accountantencouraged continued research onmethods to obtain estimates of thefair value of employee stock options.However, he indicated that the SECis not currently aware of any instru-ments that have been sold in themarket to obtain an observable mar-ket price for valuing employee stockoptions. In addition, the ChiefAccountant cautioned that if aninstrument were designed for pur-poses of producing an appropriatevalue in a market-based transaction,but the actual market price variedsignificantly from the price obtainedthrough broadly-accepted optionmodeling techniques, questionswould arise about the use of theinstrument in determining fair valueof the option. The Chief Accountantadvised that early users of marketbased transactions will have toaddress and resolve these questionsto their satisfaction and to that oftheir auditor before the transaction

price for a market instrument couldbe used as the only basis to esti-mate the fair value of employeestock options.

The report from the staff of theOEA summarizes their evaluation ofpossible approaches to the designof a market instrument that could beused to value employee stockoptions. The approaches fall intotwo categories: (1) the “trackingapproach” and (2) the “terms andconditions approach.” The OEA con-cluded that of the two approaches,only the tracking approach may pro-duce a reasonable marketplace esti-mate of the fair value of employeestock options.

The reports are available at http://www.sec.gov/news/press/2005-129.htm

Statement on Internal Control ReportingIn May, the Commission and its staffreleased statements on the first yearof internal control reporting. Viewsexpressed at the April roundtablediscussed above were cited as animportant source of input. Thesestatements were intended to provideadditional guidance and clarifica-tion of certain issues and comple-ment the guidance the PCAOBreleased on the same date (which isdiscussed below). The guidancefocuses on the need for flexibilityand judgment in approaching inter-nal control reporting, stating, “Anoverarching principle of this guid-ance is the responsibility of man-agement to determine the form andlevel of controls appropriate foreach organization and to scope theirassessment and testing accordingly.One size does not fit all and controleffectiveness is affected by many fac-tors.” The staff guidance addressesthe following areas: the purpose ofinternal control, the concept ofreasonable assurance, the use of a

risk-based approach, the scope of

assessment and testing, evaluation

and disclosure of deficiencies and

weaknesses, information technology

issues, communications with audi-

tors, and issues related to small

businesses and foreign private

issuers.

With regard to communications

with auditors, the Commission and

staff encourage more open dialogue

between companies and auditors

concerning internal control matters

and accounting matters. In its State-

ment, the staff states that “as long

as management, and not the audi-

tor, makes the final determination

as to the accounting used, including

determination of estimates and

assumptions, and the auditor does

not design or implement account-

ing policies, such auditor involve-

ment is appropriate and is not of

itself indicative of a deficiency in the

registrant’s internal control over

financial reporting. Further, timely

dialogue between management and

the auditor may positively impact

audit quality and the quality of

financial reporting.”

The news release and additional

statement materials can be found

at: http://www.sec.gov/news/press/2005-74.htm.

Recommendations ofthe Advisory Committeeon Smaller PublicCompaniesIn December 2004, the SEC estab-

lished its Advisory Committee on

Smaller Public Companies to assess

the regulatory system for smaller

companies and recommend changes.

The Committee and its four sub-

committees (internal control, account-

ing standards, corporate governance

and disclosure, and capital forma-

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tion) met several times in 2005 andpreliminarily decided on its recom-mendations in December. The rec-ommendations are targeted atsmaller public companies, whichthe Committee defines as compa-nies whose aggregate market capi-talization comprises the bottom 6%of U.S. equity market capitalization(this equates to an equity marketcapitalization of below $700 – 750million). Some of the recommenda-tions apply only to microcap com-panies, a subset of “smaller publiccompanies” as defined above, whichthe Committee defines as compa-nies whose aggregate market capi-talization comprises the bottom 1%of U.S. equity market capitalization(this equates to an equity marketcapitalization of below $100 – 125million). The Committee is expectedto finalize its recommendations inMarch and is scheduled to submit areport of final recommendations tothe SEC in April. Highlights of theCommittee’s tentative recommen-dations are as follows:Internal Control Reporting• Exempt microcap companies

from all internal control reportingrequirements if they have rev-enues of less than $125 million.

• Exempt other smaller public com-panies from the outside auditrequirements of Section 404 ifthey have revenues of less than$250 million. (However smallerpublic companies would still berequired to perform a self assess-ment and issue a managementreport on the effectiveness ofinternal controls.)

• In the event that the recommen-dation to exempt smaller publiccompanies from the outside auditrequirements is not adopted, thenalternatively, develop a new audit-ing standard and approach basedon auditor testing of only the

design (not the effectiveness) of

internal controls.

Accounting Standards• Reduce the number of years of

financial statements smaller pub-

lic companies must provide in

SEC filings from three to two.

• Change the auditor independence

rules to permit de minimis viola-

tions.

• Permit microcap companies to

apply the same effective dates for

adopting new accounting stan-

dards as the FASB provides for

private companies.

• Consider additional guidance

regarding materiality that would

apply when correcting errors in

previously issued financial state-

ments.

• Develop a “safe harbor” protocol

for accounting for transactions

that would protect well-inten-

tioned preparers from regulatory

or legal action when the process

is appropriately followed.

Corporate Governance and Disclosure• As a condition to the relief from

internal control reporting, require

(1) additional disclosure regard-

ing internal controls and (2) addi-

tional audit committee corporate

governance standards.

• Increase the thresholds requiring

registration and permitting dereg-

istration under Sections 12(g) and

15(d) of the Exchange Act of 1934.

• Allow smaller public companies

to use Form S-3 and eliminate the

timely filing requirements of

Form S-3.

Capital Formation • Adopt a new private offering

exemption that does not prohibit

general solicitation and advertis-

ing for transactions with certain

persons.

• Make it easier for microcap com-

panies to go private.

Information about the Commit-tee’s activities is available on theSEC’s website at http://www.sec.gov/info/smallbus/acspc.shtml.

PCAOB Developments During 2005, the PCAOB and its staffalso continued to focus on theimplementation of Auditing Stand-ard No. 2, An Audit of Internal Controlover Financial Reporting in Conjunctionwith an Audit of Financial Statements.Following the April Roundtable dis-cussed above, the PCAOB issued apolicy statement regarding audits ofinternal controls, emphasizing thatauditors should:• Integrate their audits of internal

control with their financial state-ment audits;

• Exercise judgment and tailor theiraudit plans to the risks facingindividual clients;

• Use a top-down risk-basedapproach;

• Take advantage of the work of oth-ers; and

• Communicate with audit clientswho seek the auditors’ views onaccounting or internal controlissues.The policy statement can be

found at: http://www.pcaobus.org/Rules/Docket_008/2005-05-16_Release_2005-009.pdf.

Since the adoption of AS 2 in June2004, the PCAOB staff has releaseda series of questions and answersthat provide guidance on variousimplementation issues. In May thePCAOB staff released additionalQ&A guidance (questions 38through 55). The May Q&As respondto the issues raised by companiesand auditors, primarily related to thecosts of performing internal controlaudits. Topics addressed include:• Using a top-down risk-based

approach;

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• The extent of procedures required;• The impact of risk assessment on

the nature, timing, and extent ofprocedures;

• Varying the tests of controls fromyear to year;

• The auditor’s reliance on companyself-assessment;

• The roll-forward of interim controltests to year-end;

• The sufficiency of evidence thatthe control operated;

• Using the work of others; and• The auditor’s quarterly responsi-

bilities regarding management’scertifications.The PCAOB staff’s guidance can

be found on the PCAOB’s website(http://www.pcaobus.org/Standards/Staff_Questions_and_Answers/2005/05-16.pdf).

In November, the PCAOB releasedits report on the initial implemen-tation of AS 2. The report was basedlargely on the PCAOB’s summer2005 inspections of internal controlaudits of the larger accounting firms.The report focuses on the need forimproving the efficiency and effec-tiveness of internal control audits.The report is available on thePCAOB’s website (http://www.pcaobus.org/Rules/Docket_014/2005-11-30_Release_2005-023.pdf).

Additionally, in July the PCAOBadopted an auditing standard thatwould provide the foundation for anew voluntary engagement in whichauditors would report on the elimi-nation of a material weakness in acompany’s internal control overfinancial reporting. The standard isin response to management anduser concerns about the need for amechanism to provide assurance onmanagement’s assertion concerningthe elimination of a material weak-ness. Such engagements would not

be required by the Sarbanes-OxleyAct of 2002 or other securities lawsand would be purely voluntary. Thisstandard, which will not becomeeffective until approved by the SEC,is available on the PCAOB’s website(http://www.pcaobus.org/Rules/Docket_018/2005-07-26_Release_2005-015.pdf).

Also in July the PCAOB adoptednew rules relating to tax services,contingent fees, and certain generalethics independence standards.Under the new PCAOB rules, a reg-istered public accounting firm is notindependent of a publicly held auditclient if (1) the accounting firm pro-vides assistance in planning or pro-viding tax advice on certain types ofpotentially abusive tax transactionsto the client, (2) subject to certainexceptions, the accounting firm pro-vides a tax service to a member ofmanagement of the client whoserves in a financial reporting over-sight role, or (3) the accounting firmreceives directly or indirectly a con-tingent fee or commission from theclient for providing any service orproduct. In addition, the new rulesrequire registered public accountingfirms to provide certain informationto audit committees in connectionwith pre-approval to provide taxservices.

The PCAOB also adopted two newgeneral rules requiring registeredpublic accounting firms (1) to beindependent of their audit clientsthroughout the audit and profes-sional engagement period, and (2)to not violate the Sarbanes-OxleyAct of 2002, the PCAOB rules andstandards, the rules of the SEC, andall other professional standards.

The new rules will not take effectuntil approved by the SEC. They areavailable on the PCAOB’s website

(http://www.pcaobus.org/Rules/Docket_017/2005-07-26_Release_2004-014.pdf).

Proposed COSOGuidance for SmallerPublic CompaniesReporting on InternalControlIn October, the Committee ofSponsoring Organizations of theTreadway Commission released pro-posed guidance in the form of anExposure Draft entitled Guidance forSmaller Public Companies Reporting onInternal Control over Financial Reporting.The proposed guidance is meant toserve as a supplement to COSO'sInternal Control – Integrated Frameworkoriginally published in 1992, andwas developed to assist smallerpublic companies with regard tocompliance with the internal controlrequirements of Section 404 of theSarbanes-Oxley Act. The proposedguidance can be found athttp://www.ic.coso.org/.

For Further Information If you would like further informationor to discuss the implications ofthese matters, please contact theBDO Seidman, LLP engagementpartner serving you or one of the fol-lowing partners:

Lee Graul ([email protected])(312) 616-4667

Jeff Lenz ([email protected])(312) 616-3944

Wayne Kolins ([email protected])(212) 885-8595

COPYRIGHT 2006, BDO SEIDMAN, LLP 15

Financial Reporting

Material discussed in this Financial Reporting newsletter is meant to provide general information and should not be actedupon without first obtaining professional advice appropriately tailored to your individual facts and circumstances.