WEBMASTER NOTE: This is the unedited transcript of the Roundtable Discussion on
          Implementation of Internal Control Reporting Provisions held on April 13, 2005,
          which we received directly from the court reporter.  We are posting the
          transcript in this form to make it available as soon as possible.

          ================================================================================

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             6          UNITED STATES SECURITIES AND EXCHANGE COMMISSION

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            11                      ROUNDTABLE DISCUSSION ON

            12                 IMPLEMENTATION OF INTERNAL CONTROL

            13                        REPORTING PROVISIONS

            14

            15

            16

            17                     Wednesday, April 13, 2005

            18                             9:00 a.m.

            19

            20

            21                          SEC Headquarters

            22                       450 Fifth Street, N.W.

            23                          Washington, D.C.

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            25

             1                          C O N T E N T S

             2                                                            PAGE

             3

             4   Opening Remarks . . . . . . . . . . . . . . . . . . . . . . 4

             5        Chairman William H. Donaldson, U.S.

             6        Securities and Exchange Commission

             7

             8        Chairman William J. McDonough

             9        Public Company Accounting Oversight Board

            10

            11   Introduction and Panel One - The First Year . . . . . . .  15

            12        Moderators:

            13        Alan L. Beller, Division of Corporation Finance

            14        Donald T. Nicolaisen, Office of the Chief Accountant

            15

            16   Panel Two - Reporting to the Public . . . . . . . . . . .  59

            17        Moderators:

            18        Alan L. Beller, Division of Corporation Finance

            19        Carol A. Stacey, Division of Corporation Finance

            20

            21   Panel Three - Planning and Design . . . . . . . . . . . . 105

            22        Moderators:

            23        Andrew D. Bailey, Office of the Chief Accountant

            24        Donald T. Nicolaisen, Office of the Chief Accountant

            25

             1                          C O N T E N T S

             2                                                            PAGE

             3

             4   Lunch Break . . . . . . . . . . . . . . . . . . . . . . . 144

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             6   Panel Four - Documentation and Testing  . . . . . . . . . 144

             7        Moderators:

             8        Andrew D. Bailey, Office of the Chief Accountant

             9        Donald T. Nicolaisen, Office of the Chief Accountant

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            11   Panel Five - Using Judgment in  . . . . . . . . . . . . . 195

            12     Communication and Conclusions

            13        Moderators:

            14        Alan L. Beller, Division of Corporation Finance

            15        Carol A. Stacey, Division of Corporation Finance

            16

            17   Panel Six - Next Steps  . . . . . . . . . . . . . . . . . 238

            18        Moderators:

            19        Alan L. Beller, Division of Corporation Finance

            20        Donald T. Nicolaisen, Office of the Chief Accountant

            21

            22   Conclusion  . . . . . . . . . . . . . . . . . . . . . . . 281

            23

            24

            25

             1                       P R O C E E D I N G S

             2                            (9:00 a.m.)

             3             MR. BELLER:  Good morning.  Okay.  Thank you all

             4   for joining us, and I want to get started as close to on time

             5   as we can.  I'm Alan Beller, the director of the Division of

             6   Corporation Finance.  Don Nicolaisen, the Chief Accountant

             7   for the Commission, is sitting on my right.

             8             I'm going to ask the Commission chairman, William

             9   Donaldson, to open the proceedings.  Mr. Chairman.

            10                          OPENING REMARKS

            11             COMMISSIONER DONALDSON:  Thank you, Alan.  Good

            12   morning ladies and gentlemen.  Thank you all for coming

            13   today, and we welcome all of you on behalf of my fellow

            14   commissioners sitting here, and on behalf of the Commission

            15   itself.

            16             I want to thank the panelists in particular for

            17   their willingness to come to Washington, devote their energy

            18   and constructive thinking to a topic of great importance to

            19   the nation's public companies.

            20             I'd also like to extend a particular welcome to

            21   Chairman Will McDonough, sitting over there, and Directors

            22   Kayley Gillan, Dan Goelzer, Bill Gradison, Charlie Niemeier,

            23   all directors of the PCAOB, the Public Company Accounting

            24   Oversight Board.

            25             I think this is a great opportunity for all of us,

             1   and in particular our two organizations, to work and learn

             2   alongside each other.

             3             And so we thought was a necessary and

             4   understandable response to an unprecedented string of

             5   corporate scandals, which were rooted in intolerable

             6   governance, accounting and audit failures.

             7             Section 404 of the Act requires that management

             8   assess and report on the ineffectiveness of our internal

             9   controls over financial reporting, and that the company's

            10   external auditor report on both the internal controls and

            11   management's assessment of these controls.

            12             As I've said before, all of the provisions of the

            13   Sarbanes-Oxley Act, the internal control requirements of

            14   Section 404, may have the greatest potential to improve the

            15   accuracy and reliability of financial reporting.

            16             Strong controls are an important part of this goal,

            17   because our capital markets run on the basic premise that

            18   companies will present reliable and complete financial data

            19   for investment and policy decisionmaking.

            20             But we also understand that the process of

            21   implementing the requirements of Section 404, as well as the

            22   related SEC and PCAOB rules, has consumed considerable time,

            23   energy, resources and has generated intense debate.

            24             Our staff and the Commission and I have all heard

            25   stories, as I'm sure many of you have, of substantial and

             1   unanticipated expenses, including internal overhead, audit

             2   fees and software expenses, companies pulling staff from

             3   other strategic projects to help with internal control

             4   reporting, management and auditors talking past one another,

             5   and duplicative testing procedures with little or no reliance

             6   on prior work.

             7             With the distinguished and diverse group of

             8   panelists we've assembled, this is an opportunity for us to

             9   hear how the process really works for issuers in general. 

            10   Are these isolated instances or are they widespread?

            11             Which of the problems encountered this year were

            12   attributable to first-year growing pains, and which are

            13   likely to reoccur each year?  What are your suggestions for

            14   improvement, and how can we help further?

            15             We also want to know whether the steps we took to

            16   ease the process, such as issuing staff guidance and delaying

            17   compliance dates for some groups, were helpful.  We'd like to

            18   get an idea of how registrants and others feel they have

            19   benefitted from the internal control reporting process.

            20             We know that over 2,500 registrants have filed

            21   their internal control reports by March 31st, approximately

            22   eight percent reporting material weaknesses.  But we also

            23   heard from at least one accounting firm that within a group

            24   of 225 registrants the firm audits, approximately 63,000

            25   control deficiencies, that's an average of 275 per company,

             1   were identified and most importantly, remedied.  We look

             2   forward to hearing more about these.

             3             We also want to hear from investors.  Was the

             4   internal control information provided by companies helpful? 

             5   What was the investor community's reaction to reports of

             6   material weaknesses?

             7             This roundtable is an important vehicle for

             8   gathering feedback on all aspects of the reporting process,

             9   and as you can tell, I welcome the candid and constructive

            10   feedback from each of our panelists, as do our Commissioners.

            11             It's extremely important to me and our five

            12   Commissioners, as well as the PCAOB board members, that we

            13   hear the experiences and views of people who are familiar

            14   with implementing the internal control reporting provisions

            15   of Section 404.

            16             We also want to make sure we're helping companies

            17   and auditors accomplish the goals of Section 404 in the most

            18   effective and efficient way.  In addition to the information

            19   we learned from this roundtable, we also will be considering

            20   the written submissions we have received in response to our

            21   request for feedback.

            22             These submissions are available to the public on

            23   the SEC website.  The important work of the SEC Advisory

            24   Committee on Smaller Public Companies, which had their first

            25   meeting yesterday, also will inform our understanding of how

             1   Section 404 can be implemented in a most sensible way for

             2   smaller companies.

             3             I'm going to keep my remarks brief, because we have

             4   a lot to cover.  Again, let me express my thanks to all of

             5   the panels who agreed to be here today.  We appreciate the

             6   time that you're taking out of your very busy schedules, and

             7   willingness to share your views with us.

             8             We will be listening carefully, and I can assure

             9   you that we intend to consider all of the different views

            10   expressed today.  I will have further comments at the end of

            11   the roundtables regarding next steps.  For now, I'd like to

            12   give Bill McDonough, Chairman of the PCAOB, an opportunity to

            13   say a few words before we get started.  Bill?

            14             MR. MCDONOUGH:  Well, thank you, Bill.  On behalf

            15   of the Public Company Accounting Oversight Board, I would

            16   like to extend our appreciation to you, your fellow

            17   commissioners and the staff of the SEC for convening the

            18   roundtable discussion today.

            19             I know that we have all read many of the same

            20   surveys about the implementation of Section 404, and that we

            21   have all had occasion to meet and talk with issuers, with

            22   corporate directors, and with the auditors who are on the

            23   front lines of implementing the requirements of 404.

            24             But this roundtable gives us an important

            25   opportunity for public discussion of the specific issues that

             1   companies and their auditors have confronted, as they work to

             2   comply with the rigorous demands of this new law.

             3             I expect, based on my own conversations, that this

             4   will be a lively discussion.  I hope that it will also be

             5   constructive.

             6             Although companies have been required to have

             7   internal control over their accounting since the Congress

             8   enacted the Foreign Corrupt Practices Act in 1977, there is

             9   no doubt that the Sarbanes-Oxley Act's requirement for annual

            10   assessments and auditor attestations to those assessments,

            11   took corporate responsibilities to an entirely different

            12   level.

            13             At the same time that the board approved its

            14   standard for audits of internal control over financial

            15   reporting, my fellow board members and I acknowledged that

            16   the standard would entail extra work and cost for public

            17   companies.

            18             We also did our best at the time of our vote and at

            19   every opportunity in the year since the vote, to emphasize

            20   the flexibility and judgment that we built into Auditing

            21   Standard No. 2, including the provisions related to the

            22   auditors' use of the work of others.

            23             Unfortunately, we are hearing anecdotes that

            24   auditors are not always using the flexibility available in

            25   AS-2.  Instead of using judgment to tailor audit programs to

             1   the nature and size of an audit client, some auditors are

             2   applying a checklist approach to all audit clients,

             3   regardless of their complexity.

             4             I will say again what I have said many times, there

             5   is no one-size-fits-all approach to assessing company's

             6   internal controls.  Auditors should apply AS-2 in a manner

             7   that is proportional to the quality of management's

             8   monitoring of controls, as well as the complexity of the

             9   company.

            10             Untailored checklists to me are an early sign of

            11   poor quality judgments, which can lead to poor quality

            12   auditing.

            13             On the other hand, I have no doubt that some of the

            14   complaints being lodged about the assessment process being

            15   too rigorous and too extensive are being lodged in response

            16   to good auditors making hard decisions, auditors that are

            17   putting pressure on exactly the points of poor quality

            18   financial reporting that need to be squeezed.

            19             Whatever actions we take, we must not undermine the

            20   work of auditors who are using their best professional

            21   judgment to drive exactly the kind of improvements in quality

            22   financial reporting that the Act intended.

            23             I have said before, we will use our inspections,

            24   which begin this year in May, to assess the effectiveness of

            25   registered firms' implementation of AS-2, including the

             1   quality of the firm's judgments about planning audit programs

             2   appropriate to the nature of their clients.

             3             These inspections will provide the board with a

             4   powerful opportunity to learn the substance behind the

             5   anecdotes that we've been hearing.  Undoubtedly, there is

             6   more that we can do to encourage a smooth and reasonable

             7   implementation of 404, and that is what we are here to learn

             8   today.

             9             It may be that some confusion or hardships in the

            10   implementation of AS-2 can be addressed by additional

            11   guidance.  That would be the most rapid way to execute

            12   changes and the most timely for companies and their auditors.

            13             To the extent that what we hear today and read in

            14   the comment letters causes us to believe that any of the

            15   principles in AS-2 are fundamentally flawed, however, we

            16   would undertake rulemaking to improve the principals.

            17             In the end, no matter what action the board or the

            18   Commission may take as a result of the information we gather

            19   today, the ultimate responsibility for fulfilling the

            20   requirements of Section 404 remains with the men and women

            21   who lead and audit the companies that seek capital in our

            22   securities markets.

            23             The owners of those companies, investors, will

            24   ultimately determine whether the benefit that inspired

            25   Section 404, the increased reliability of company's financial

             1   statements, is overshadowed by labor and costs that bear no

             2   relationship to the goal of reassuring investors in our

             3   capital markets.

             4             Now with that in mind, I hope that we on the Board

             5   and Commission can come away from today's discussion with

             6   some very concrete ideas about specific actions that might

             7   address any unintentional burdens of Section 404.

             8             I also hope that participants in the roundtable

             9   will share specific examples of how the closer examination of

            10   internal controls has improved financial reporting, and

            11   provided the confidence and assurance we are all seeking on

            12   behalf of investors.  I look forward to the discussion.

            13             MR. BELLER:  Thank you, Chairman Donaldson and

            14   Chairman McDonough.  We're going to dive right in here.  Let

            15   me lay out a couple of ground rules.  I'm going to introduce

            16   the panelists in a moment.

            17             For the benefit of folks on the web who are

            18   observing this, or listening to this via webcast, I am going

            19   to tell you who's around the table and each of the other

            20   moderators will do that at the beginning of the panels.

            21             We have today the members of the Securities and

            22   Exchange Commission, starting -- we'll do this in order. 

            23   Rowell Campos, Harvey Goldschmid, William Donaldson, Cynthia

            24   Glassman and Paul Atkins.

            25             We also have the members of the Public Company

             1   Accounting Oversight Board.  We're pleased to have you with

             2   us this morning.  Kayley Gillan, Charles Niemeier, William

             3   McDonough, William Gradison and Dan Goelzer.  Thank you for

             4   joining us.

             5             The ground rules are I think fairly simple.  We

             6   have a lot of subjects to cover.  We have a large number of

             7   panelists, because we want to get a large number of views. 

             8   We need all panelists to submit written statements and the

             9   vast majority, if not all of them, where their organizations

            10   have.

            11             Those are on our public website in the file that

            12   we've opened for this event, and the audience is encouraged

            13   to, if they have not already, to look at them.  But we are

            14   going to ask panelists not to make opening statements as part

            15   of today's activities.

            16             There are too many of you, and we have too much

            17   ground to cover.  The moderators will take the liberty of

            18   directing certain questions at certain members of panels, and

            19   perhaps asking other members for specific follow-up.

            20             On the other hand, we want this to be interactive

            21   and we want this to be a discussion.  We encourage panelists

            22   who would like to add something with respect to any question,

            23   to let us know.

            24             We have over the years learned that we can learn a

            25   lot from our European brethren.  One of the things we've

             1   learned is that the best way to run one of these things and

             2   to seek to be recognized is to take your tent card and turn

             3   it up on end like that.  The moderators will see you.  It's

             4   much better than leaping out of your chair and raising your

             5   hand.

             6             We do want our panelists to not just echo other

             7   answers that have been given, again for the sake of time.  We

             8   will recognize as many panelists as we can in the course of

             9   the proceedings.

            10             As Chairman McDonough already indicated, it would

            11   be really helpful to the Commission and the board and their

            12   respective staffs to have answers that are as specific as

            13   possible.  Also, concise and to the point.  We are going to

            14   try to keep this moving.  We have a number of things we want

            15   to cover.

            16             We also very much encourage the members of the

            17   Commission and the members of the board.  You will have two

            18   moderators here for each of these panels.  Members of the

            19   Commission staff, Don Nicolaisen and I, will do the first

            20   panel.

            21             But if any Commissioner or board member has a

            22   subject that they think we're not getting to adequately or

            23   has a question they want to raise, please let us know in the

            24   same fashion and we will call on you and give you the floor.

            25             Finally, because we are being webcast, including

             1   audio, I think it's very helpful for our audience if people

             2   before they speak could just identify themselves, tell us who

             3   they are or tell the audience who they are.

             4             With that, I'm going to introduce the first panel

             5   and we're going to get started.

             6                     PANEL ONE - THE FIRST YEAR

             7             From my left, the panel's right, the Honorable Mary

             8   Bush, who's the president of Bush International and is also

             9   the member and chair of an audit committee or two and a

            10   director of a number of public companies.

            11             To Ms. Bush's left, Michael Cook, who is also the

            12   audit committee chair or a member of audit committees of a

            13   number of public companies.

            14             To Mr. Cook's left, Colleen Cunningham, who is the

            15   president and CEO of Financial Executives International.

            16             To Ms. Cunningham's left, Sam DiPiazza, who's the

            17   global CEO of PriceWaterhouseCoopers.

            18             Next in line, Randall Kroszner, who is a professor

            19   of Economics at the University of Chicago.

            20             Next to Mr. Kroszner, Bob Miles, who's the Senior

            21   Vice President and Controller of Washington Mutual.

            22             Next to Mr. Miles, Dr. Klaus Patzak, who is the

            23   Corporate Vice President for Financial Reporting and

            24   Controlling of Siemens, AG, and I want to thank Dr. Patzak

            25   for coming across the Atlantic for us this morning to

             1   participate.

             2             To Dr. Patzak's left, Casey Sylla, who is the

             3   chairman and president of Allstate Financial.

             4             To Mr. Sylla's left, John Thain, who's the CEO of

             5   the New York Stock Exchange.

             6             And finally, to Mr. Thain's left, Lynn Turner, who

             7   is with Glass, Lewis and Company, an advisory firm.

             8             Thank you all for joining us this morning.  I'd

             9   like to start off with a rather open-ended and general

            10   question.  I promise you other questions in the course of the

            11   day will be more pointed.  But let's start with a broad one.

            12             What in your view has been the most significant

            13   impact of the internal control reporting requirement of

            14   Section 404 in this, the first year of implementation?  I

            15   guess I'd like to ask Mr. Sylla to take the first crack at

            16   that question.

            17             MR. SYLLA:  Thank you.  As a sample of one fairly

            18   large company, the short answer is the impact has been

            19   positive.  With respect to more specificity, not to suggest

            20   that 2004 was the beginning of an internal control process

            21   with an organization of our size.

            22             But clearly, the impact of being able to increase

            23   the amount of oversight and governance has been positive,

            24   certainly looking at it in the long run.  In the short run,

            25   one could always conclude that there is a cost-benefit

             1   analysis which may or may not be deemed positive.

             2             However, the increased involvement -- I would list

             3   two or three items very quickly.  The increased involvement

             4   on the part of senior management with respect to the

             5   awareness of financial reporting has significantly increased. 

             6   There is no question about that.

             7             Secondly, with respect to the awareness of

             8   financial controls throughout the entire organization, on the

             9   part of line managers, that awareness has increased

            10   dramatically as well.

            11             I would suggest finally that certainly informal

            12   processes which in fact give you the ability to establish and

            13   update a maintenance program will serve us well in the

            14   future.

            15             All of this, of course, is intended to create a

            16   greater level of confidence, certainly by senior management. 

            17   It gives me a greater level of confidence, but more

            18   importantly, with respect to our board, audit committee and

            19   investors in general, we would put this very much on the

            20   positive side.

            21             MR. BELLER:  Thank you very much.  Mr. Miles,

            22   what's your reaction?

            23             MR. MILES:  The most significant impact for our

            24   organization was really the awareness that was created at the

            25   senior level, senior management level throughout the 

             1   organization and down through the business lines.

             2             Internal controls had always been a key part of our

             3   structure, and certainly with the FDIC Improvement Act, banks

             4   have been required to comply with an internal control

             5   reporting framework for many years.

             6             But I do think that this awareness was very

             7   significantly strengthened, and also for the senior officers

             8   that had to certify for Sections 906 and 302, this helped

             9   them to have the confidence to make those assertions.

            10             MR. BELLER:  From the auditors' side, Mr. DiPiazzo,

            11   what do you -- what would you underline as sort of the two or

            12   three headline points of the overall impact in the first

            13   year?

            14             MR. DIPIAZZO:  Mr. Chairman, I think you have to

            15   reflect on the overall change of the environment that we're

            16   facing today in the Sarbanes-Oxley.

            17             Maybe the most significant change in behavior

            18   within the capital markets, a dramatic shift of governance

            19   from the executive suite to the board room, ownership by the

            20   board around the issues of transparency and controls.

            21             The auditors changed focus of an audit process

            22   that's moving from analytics to a deeper sense of focus

            23   around controls.

            24             The auditor dealing with the fact that he's now

            25   subject to oversight, and frankly the whole process for how

             1   wide is the difficulty that our profession is having as it

             2   transitioned from a self-regulated to a regulated profession.

             3             Overall, I think the most significant impact coming

             4   out of 404 is the transparency.  Chairman Donaldson mentioned

             5   60,000 deficiencies in just 200 of our clients.  I think what

             6   it shows is that controls were underfocused-upon.  Now

             7   they're owned by management, by the leadership of companies,

             8   and I think significant progress is being made in remediating

             9   those problems.

            10             MR. BELLER:  Mr. DiPiazzo mentioned transparency. 

            11   Mr. Turner, what's your take on the advantage that 404 has

            12   brought to investors by virtue of increasing transparency

            13   around the control process?

            14             MR. TURNER:  There's no question that investors now

            15   have a better flavor for those companies who have high risk

            16   with their financing reporting because of a lack of controls. 

            17   We've seen through the end of last Friday about 750 companies

            18   actually report that they have problems.

            19             The good news is that not only were investors now

            20   able to determine whether those risks by NSS about what to do

            21   with that, but they were also then in a number of instances

            22   provided disclosures that indicated that the companies had

            23   adequately dealt with those in a number of cases, which is a 

            24   very positive thing as well.

            25             I think one of the things that's come out of this

             1   process is that at the beginning of it, while there was maybe

             2   a lack of awareness on the part of boards and corporate

             3   executives, I think equally there was a lack of awareness

             4   amongst investors, and investors really didn't know how to

             5   react to this.

             6             I think with the increased disclosures and

             7   increased information, which is much better than what it was

             8   before; we were never getting this type of disclosure about

             9   weaknesses but now are, they are now able to differentiate

            10   better between those companies where there's a problem that

            11   they should impact the stock price, and those that aren't.

            12             We are finding that the impact on the stock price

            13   is very much company by company.  There's no general trend.

            14             MR. BELLER:  Thank you.  Turning this, rotating

            15   this a little bit from the foreign private issuer, from the

            16   non-U.S. issuer perspective, Dr. Patzak.  I know your company

            17   has been working very hard at implementation, even though you

            18   have more time than some of the other companies represented

            19   around the table this morning.

            20             What would you say is different or special about

            21   the impact or the experience for a foreign private issuer?

            22             DR. PATZAK:  I would think that the difference,

            23   there is not a big difference between a foreign private

            24   issuer and the U.S. company.  It's more a difference between

            25   an international company, a decentralized company, a company

             1   doing business in a lot of industries, compared to a company

             2   which is perhaps not so diverse and international.

             3             For us being so diverse and fragmented was a huge

             4   implementation effort.  We started our 404 approach in late

             5   2002.  At that point of time we thought that we had to comply

             6   with it at the end of our fiscal year '03.

             7             Then we heard that there is a postponement, that we

             8   would not have to comply at that point of time.  So we

             9   requested a first progress report from our auditor.  Then we

            10   expected to have that implementation done at the end of our

            11   fiscal year '04.

            12             There was another postponement, which gave us more

            13   time.  We requested again from our auditor a progress report

            14   now based on Auditing Standard No. 2, and this standard

            15   significantly changed the way how we implemented 404.

            16             Now, as you know, we would even have one year more

            17   time, but we are now right in the middle of the

            18   implementation phase, and therefore we decided not to stop

            19   our progress, and we are finishing all the implementation

            20   work and testing work to be prepared for auditors to come in

            21   and make their analysis.

            22             As I mentioned earlier, the most significant

            23   problem that we have companies all over the world.  We

            24   operating in 190 countries, and only -- and most of our

            25   companies are insignificant by themselves, so we had to limit

             1   it to companies which have revenues of 0.1 percent of our

             2   consolidated revenues.

             3             These companies are located in -- all over the

             4   world.  They are in the United States and Europe, of course,

             5   and Germany.  But also in India and Singapore, and that makes

             6   it very costly and challenging for us to implement that.

             7             MR. BELLER:  I want to come back later, either to

             8   this panel or later panels, at the point that Dr. Patzak has

             9   identified, about both multiple locations and also the issue

            10   of hundreds or dozens of smaller operations which

            11   individually are not significant or material, and how they

            12   have been dealt with in this process.

            13             But having put that marker down, I guess Mr.

            14   Koszner, I'd like to ask you.  We've heard the problems of

            15   people who've been on the front lines, both at the companies

            16   and at the audit firms.

            17             Basically benefits, perhaps more costs than

            18   anticipated.  What's your take on sort of the overall impact

            19   and what we should be looking at in evaluating the first year

            20   on both sides of the ledger.

            21             MR. KROSZNER:  I'm very pleased that the focus has

            22   been on costs and benefits.  I know that's sort of an old

            23   song from economists, but it wasn't something that was always

            24   part of the regulatory framework, and I praise both Chairman

            25   McDonough and Chairman Donaldson and the members of the board

             1   and the Commission for focusing on that issue, because that's

             2   exactly how we have to think about these things, costs and

             3   benefits.

             4             In terms of the costs, certainly many of the

             5   members of the panel have done studies by their institutions

             6   to document the costs.  But we have to remember that the

             7   costs are not just simply based on business as usual in 2001

             8   and 2000.

             9             Things had to change, and the markets would have

            10   changed things anyway.  There would have been more emphasis

            11   on internal controls, more emphasis on transparency and

            12   conveying the stability and sturdiness of the internal work

            13   to the outside world.

            14             So we have to realize that costs would have gone up

            15   under any circumstance, just by market forces, completely

            16   independent of Section 404 or completely independent of

            17   Sarbanes-Oxley.  There have been a lot of private sector

            18   responses in addition to just the internal audit pieces.

            19             But the benefits are really where we have to focus

            20   on now, and we're still in the early part of trying to

            21   understand that.

            22             There's been a lot of concern, I think, about legal

            23   liability, which has gone to -- which has sometimes led to

            24   extreme moves to protect against potential liability, even

            25   though there may not be a great deal of substance that's

             1   associated with that.

             2             Mr. Turner mentioned something about market

             3   reactions, and I think that's where we need to go and

             4   continue to look at that much more carefully, because I think

             5   that could provide very good guidance to the Commission and

             6   to the board about where does the market thing that some sort

             7   of deficiency is material or not.

             8             Certainly there are thousands of potential

             9   mistakes, problems that can come up, but many of them aren't

            10   material.  We shouldn't be putting our ammunition there.  We

            11   shouldn't be putting our costs there.  We should be looking

            12   at what the markets really think are important.

            13             We're still in the very early stages of that. 

            14   We're just getting the revelations out, but I think that

            15   would be a very valuable study for the Commission and the

            16   board to do, for academics to continue to look at.

            17             Also, as Mr. Miles had mentioned, the banking and

            18   financial services industry has a good benchmark to look at

            19   also, because since the FDIC Improvement Act of '91, there's

            20   been an emphasis on internal controls, the so-called Basel II

            21   new capital standards are really emphasizing these things

            22   also.

            23             So there's been a lot of work that's been done in

            24   Basel on the bank regulators.  It might be useful to begin a

            25   discussion between the board, the Commission and the bank

             1   regulators, to see where they have gone.

             2             MR. BELLER:  Thank you very much.  Mr. Thain, you

             3   talk to a lot of issuers, and I guess I'm curious as to your

             4   perspective on the balance sheet at the end of the first

             5   year.

             6             MR. THAIN:  Yes, thank you Alan.  I do.  My

             7   perspectives here are different because I have input from

             8   many of our listed companies.  There are 2,760 companies

             9   listed on the New York Stock Exchange.  So I get input from

            10   them.

            11             So my comments are compilation of different views. 

            12   On the positive side of the ledger, and some of these

            13   reflecting comments you've already heard.  First, there's no

            14   question that Sarbanes, actually broadly speaking, was

            15   necessary and very crucial to restoring investor confidence

            16   broadly.  So I think that's a big plus.

            17             I mean there's no question that boards are now more

            18   independent of management.  I think audit firms are also

            19   taking a more independent posture with their clients.  I

            20   think there is definitely more of an awareness of internal

            21   controls throughout companies.

            22             I also think that both boards and senior management

            23   have formalized their risk management policies, which is

            24   good.  I think the internal audit function has been given

            25   greater importance in companies.

             1             There's no question that documentation of

             2   companies' policies and procedures has improved.  I think

             3   broadly speaking, the organizational tone at the top, the

             4   emphasis on this subject has also improved.  Again, all of

             5   that's good.

             6             Audit committees have been strengthened.  I think

             7   corporate behavior has in fact changed, and I broadly think

             8   that the financial markets, confidence in the financial

             9   markets, confidence in the integrity of financial statements

            10   have all been improved.  So that's on the plus side.

            11             On the negative side, and I hear this a lot, and

            12   this will be repetitive to what you've already said.  There's

            13   no question that the costs of 404 have been much higher than

            14   companies had expected or I think pretty much anyone had

            15   anticipated.

            16             There's a lot of discussion about the cost and

            17   benefits.  I think there are many companies who would say

            18   that they don't believe that the benefits achieved through

            19   404 have been worth the costs.

            20             I think a lot of what we should hope to get out of

            21   today, is how can we, going forward, what things can we do to

            22   keep all the benefits and all the positives, but try to

            23   reduce some of the costs, try to reduce some of the

            24   duplication of efforts, try to reduce some of the, what some

            25   companies would say is an overly degree of focus on what they

             1   would say are detailed transaction-level processes, rather

             2   than bigger picture firmwide risk management issues.

             3             MR. BELLER:  Mr. Thain, thank you very much.  I

             4   want to come back to costs and spend a fair amount of time on

             5   it.  Before I do that, I want to continue this general theme

             6   for just one more twist, and that is we have two members of

             7   this panel who spend a lot of time sharing and working on

             8   boards of directors and audit committees.

             9             I want to ask first Ms. Bush, from the perspective

            10   of an audit committee member, one of the things that

            11   Sarbanes-Oxley was intended to accomplish and I believe has

            12   accomplished is to increase the responsibility and importance

            13   of audit committees, and particularly their direct

            14   responsibility for what in plain English is sort of

            15   supervising, hiring and firing external accountants.

            16             From the perspective of an audit committee, and

            17   with the particular question of the internal control

            18   reporting requirement of 404 in mind, how do you see the

            19   overall impact in the first year, and how do you see the

            20   relationship between audit committee members and particularly

            21   external auditors?

            22             MS. BUSH:  I think that formalizing the reporting

            23   of external auditors to audit committees is probably a very

            24   good thing.

            25             I had the good fortune of having served on boards

             1   and on audit committees, where we as members of the audit

             2   committee always felt that we have very clear and open

             3   communication with the outside auditors, and that even though

             4   it's not a formal reporting relationship, that they indeed

             5   did report to the audit committee.  But as I say, the

             6   formalization is a good thing.

             7             What I find also has happened with regard to that

             8   is that there is a lot more communication off line by me as

             9   an audit committee chair, and by some of our other audit

            10   committee members, with the outside auditors.  That's also a

            11   good thing.

            12             That is not to say that we didn't have, as I said

            13   earlier, frank and open conversations with the external

            14   auditors earlier.  I am accustomed for a number of years now

            15   to always having the executive session with the outside

            16   auditors.

            17             Sometimes they are very short and sometimes they

            18   take a little more time, because I personally, and some of my

            19   colleagues on various audit committees, really take seriously

            20   getting the views of the outside auditors on what's happening

            21   internally, both with regard to the control process and the

            22   financial statements.

            23             Again, I think it's a good thing overall, and the

            24   other point that I want to make is that the benefit from what

            25   I have observed ranges the spectrum from company to company,

             1   and the benefits of 404 overall.

             2             I have seen some companies that -- where this was

             3   probably really needed, that even though there were no

             4   problems in the company, there were no problems with the

             5   financial statements, the controls and the documentation of

             6   the controls really were not up to par.

             7             There are other companies at the other end of the

             8   spectrum where the controls were in Triple A shape.  Making

             9   some tweaking in terms of documentation, but that was about

            10   all that was required.

            11             So I think that the benefits and therefore the

            12   costs that somebody earlier was raising, really vary widely

            13   over a wide spectrum.

            14             MR. BELLER:  Thank you very much.  Mr. Cook, I

            15   guess I'm curious as to your take on the same issues, but

            16   also would ask you to address the question of whether the

            17   internal control requirement has, in your view in any way

            18   interfered with communications between audit committees and

            19   their external auditors?

            20             MR. COOK:  Perhaps this is just the general view, I

            21   also see and I'll try not to repeat what others have said,

            22   see substantial benefits in 404.  I think it would be true in

            23   all companies, and the degree of benefit does vary.  I agree

            24   with Mary, considerably from company to company.

            25             But I think a lot of folks are sort of measuring

             1   the scorecard by how many people fail, as a measurement of

             2   benefit.  Perhaps that is at least one of the measures that's

             3   appropriate.  But there are a lot of excellent companies who

             4   have Double A if not Triple A controls, who have

             5   substantially improved their controls by the consequence of

             6   the focus that's been given to controls.

             7             I would suggest that the companies that I'm

             8   directly involved with are fine companies; they have

             9   excellent controls.  I think they would have passed the 404

            10   test the day Sarbanes-Oxley was passed.  I think they would

            11   have passed it a year ago, before the intense efforts of this

            12   past year were put in.

            13             But I would say each one of those companies

            14   benefits from the attention that was given deficiencies that

            15   were identified, improvements that were made, even though it

            16   would not show up in a report, and would not necessarily be

            17   evident and transparent to the investing community.

            18             So I think that's an important consideration, but I

            19   think -- and maybe we'll come back to this -- that may be a

            20   benefit which is much more in the first year and not a

            21   benefit that will be repeated as we go forward, which will

            22   bring us to a different part of the cost-benefit analysis.

            23             It has certainly changed what our committees do.  I

            24   think the audit committee agendas have been taken over.  I

            25   wouldn't say it's hostile, maybe not even unfriendly.  But

             1   there has been a takeover of our agenda during this past 12

             2   to 18 months, with the focus on 404.

             3             Unlike anything in my experience, all the way back

             4   to the Y2K, when we spent almost all of our time at audit

             5   committee meetings focused on Y2K for the best part of one to

             6   two years, depending on when you got started and how long it

             7   took you to finish.

             8             We have spent a great deal of time on this subject,

             9   and I think that's good.  I think it's been good for audit

            10   committee members.  They have become much more aware of

            11   controls.  They've been educated about the controls in a way

            12   that has been beneficial to them.

            13             But at the same time, it has taken time away from

            14   attention to other issues that are also very important, and I

            15   don't think that can be continued at that level.  I would say

            16   my experience would be all of our audit committees have spent

            17   the majority of their time during this past year -- whether

            18   it's 55 percent or 65 percent of 75 percent I don't know --

            19   but somewhere over 50 percent of our time on matters related

            20   to 404.

            21             That's fine, but that has to go back in a different

            22   direction going forward.  There are important accounting and

            23   financial reporting issues that need more time than they

            24   received during this past year, with the level of focus on

            25   404.

             1             The issue about relationships with the external

             2   auditing firms is interesting.  We have certainly refereed as

             3   many fee discussions -- I won't call them disputes -- heated

             4   and spirited discussions about fees during this past year,

             5   under the requirements of 404 and dealing with the costs of

             6   implementing it.

             7             As I have already experienced before, I don't think

             8   anybody is happy with the outcome.  I don't think the

             9   corporate community writing the checks is happy.  The

            10   external auditors, despite the views of some I don't think

            11   are particularly happy with the difficulties of dealing with

            12   the cost issues and the client relationship issues that have

            13   come from this.

            14             The audit committees kind of referee, and the best

            15   we can hope is that both parties will be equally unhappy at

            16   the end of the day, and that's kind of the standard that we

            17   aspire to.  But I do think there have been --

            18             MR. BELLER:  Sounds like shareholder proposal

            19   season in the Division of Corporation Finance.

            20             MR. COOK:  But there have been some tensions around

            21   this, to answer your question there.  There have been real

            22   tensions around this.  It's been a tough go, and there have

            23   been benefits achieved, but there have been a great deal of

            24   effort go into this and I think my own view of it is that

            25   there are lots of things that we can focus on in year one,

             1   but most of them are important only as they relate to what we

             2   do in the future and how we go forward from here.

             3             We can spend a lot of time debating cost-benefit

             4   without any clear answers, and my view is that if this has

             5   achieved one of the important objectives, which is restoring

             6   or enhancing investor confidence after some of the issues

             7   that caused this legislation to be enacted, as they say in

             8   the advertisement "that's priceless."

             9             So if they have achieved that, if they have

            10   achieved that, that certainly would justify a lot of the

            11   costs.

            12             MR. BELLER:  Ms. Bush, you have your card up.  I

            13   guess I'd ask you to address one thing that Mike has left

            14   with us, which is do you think and sort of how do you think a

            15   lot of committees can refocus their attention on things other

            16   than internal controls, to the extent that's a direction they

            17   should be moving in?  But also you sought the floor, so --

            18             MS. BUSH:  I sought the floor, because I thought

            19   there was one other point that I really should make, and this

            20   is not an issue that I have had as an audit committee member

            21   with the external auditors.

            22             But I've heard several companies, the internal

            23   audit staff and the finance staff, complain that the

            24   relationship with the external auditor has really changed,

            25   that they don't feel as free to consult with the external

             1   auditor about accounting treatments for various things.

             2             This, in my mind, is not good.  I think that

             3   managements of companies, finance staffs, have relied on that

             4   in the past.  Something needs to be done, so that those

             5   communications can be freed up again.

             6             I relate to that, because as an audit committee

             7   member, I have always found it invaluable to be able to sit

             8   there facing the outside auditors, and ask them very

             9   pointedly about accounting treatment for some issues that

            10   were questionable or that could have several different

            11   treatments.  What's the most conservative treatment, and

            12   that's invaluable to me.

            13             So if the internal auditors and finance staffs are

            14   complaining that they can't get that kind of advice because

            15   the outside auditors feel that that might jeopardize their

            16   independence, then that is indeed a problem.  We need to have

            17   that kind of communication and open relationship and advice.

            18             The other issue with regard to the way that outside

            19   auditors, in many cases, are working with companies, is that

            20   I think probably because one, you know, 404 and

            21   Sarbanes-Oxley and 404 were done in a hurry, and because

            22   companies got very little, if any, guidance as to how to

            23   apply 404, how to assess their internal control processes.

            24             The guidance that they were getting really was from

            25   their outside auditors, and that has presented difficulties

             1   for many companies.

             2             If you take something like as simple as -- not

             3   really simple, because it's a very important thing I think,

             4   and that is the materiality of a control or a business

             5   process.

             6             That's something that I have traditionally looked

             7   at quite a bit, you know, where the high risk areas in the

             8   company.  But for this process in this first year, it seems

             9   that equal weighting has been given to all processes, whether

            10   they are insignificant or whether they are highly significant

            11   and highly risk.

            12             So that is something that I really think needs to

            13   be addressed as a joint effort by regulators and outside

            14   auditors and internal audit.

            15             How do we focus?  I think that hopefully the

            16   refocusing will come naturally, but I think that the

            17   refocusing also is going to depend, to some extent, on how

            18   the regulators intervene with some more comments about what

            19   is important.

            20             Because I believe AST suggests that each year must

            21   end on its own.  If each year, the outside auditors have to

            22   audit every process without any rotation, without any

            23   emphasis on risk, then we are back in the bind of having to

            24   spend a lot of time on 404, possibly to the neglect of other

            25   things.

             1             MR. BELLER:  Thank you very much.  Ms. Cunningham,

             2   you've got your card up.  I also wanted to come back to the

             3   cost question, and I think FEI, certainly if not the most

             4   comprehensive and detailed work on costs, has certainly done

             5   among the most detailed.  It's the most detailed I've seen,

             6   and would like you to, in addition to whatever else you

             7   wanted to talk about, address the cost issue, I think with

             8   particular reference.

             9             The first year is what is was or is.  What do you

            10   see happening?  The survey suggested, your survey suggested

            11   that about 85 percent of companies think the costs will come

            12   down.  How do you see that?  What do you see?  What areas and

            13   how much?  But please, go ahead.

            14             MS. CUNNINGHAM:  Sure.  First of all, I just want

            15   to say one of the benefits, you know, were discussed already,

            16   and we've learned sort of the notion that having an effective

            17   internal control environment as a member of COSO, is vital to

            18   the integrity of financial statements.  But I won't go into

            19   depth in what all those benefits are.  You heard them all.

            20             The costs.  We've done several surveys.  We've done

            21   three or four over the last year and a half or so.  Our most

            22   survey we've done in March of 2005, which will hopefully

            23   reflect more of the actual costs, particularly for the

            24   accelerated implementation costs.

            25             The average cost of implementing 404 is about 4.3

             1   million.  Companies that have over 25 billion in revenues

             2   spent considerably more, about 15 million on average. 

             3   According to our survey, companies logged an average of over

             4   26,000 hours to comply with the regulation, and one dramatic

             5   thing more.

             6             We've seen -- over the term that we've done the

             7   surveys, we've seen the costs go from the first survey we did

             8   in January of 2004, double by the time March 2005 hit.

             9             The one thing that, you know, we also and I think

            10   Mike alluded to it, but we also have to consider the cost

            11   that isn't in there, is the opportunity cost.  You know, the

            12   audit companies are spending a considerable amount of time on

            13   Section 404.  It's diverted a lot of attention for senior

            14   management and board time.

            15             You know, we've taken time away from strategy,

            16   dealing with competition in a global marketplace, innovation,

            17   and moving the company forward.  I think that opportunity

            18   cost is another important aspect of the cost factor, if you

            19   will, of 404.

            20             MR. BELLER:  How about looking forward?

            21             MS. CUNNINGHAM:  Looking forward, according to our

            22   survey, we do expect to see a decrease in cost.  A big piece

            23   of that, the companies spent a lot of time hiring consultants

            24   and staffing up to document initially a lot of the

            25   transactions, if you will.  So we'll see a lot of that cost

             1   go down.

             2             We're hopeful that the audit fees will also go down

             3   in Year 2, as we see the training and the learning curve of

             4   the auditors.  Hopefully, they've learned some, you know, got

             5   some efficiencies from the process.

             6             So we are anticipating, and I believe our survey

             7   said we are anticipating a decrease of about 40 percent of

             8   total cost.

             9             MR. BELLER:  Thank you.

            10             MR. NICOLAISEN:  If I can follow up on that just

            11   for a minute, I think the Big Four survey said something like

            12   a 46 percent on the first year.

            13             MS. CUNNINGHAM:  Very consistent.

            14             MR. NICOLAISEN:  A lot of that, I think, is

            15   understandable, and probably is best taken off the table for

            16   consideration because it's history, and we need to move

            17   forward.

            18             But one of the conflicting things that we do here,

            19   and maybe you can help us with that, is we do hear from a

            20   number of different places that companies, while they have

            21   closed the books on 404 for the first year, they don't

            22   necessarily have in place the sustainable process that they

            23   want to live with long-term.

            24             They reacted.  They did what they had to do, but

            25   aren't necessarily yet in the position where this is routine

             1   and baked into the process.  Just curious as to what, you

             2   know, is there an element of truth to that?

             3             MS. CUNNINGHAM:  I think, you know, we're moving

             4   from a project orientation to a process orientation.  I think

             5   it will take time for companies to get to that sort of

             6   sustainable ability to implement 404 and make it part of the

             7   process.  So that may take a little bit more time.  But I

             8   think it's a fair statement.

             9             MR. BELLER:  Mr. Miles, do you have a view on sort

            10   of whether this is -- whether the sustainable processes are

            11   now "baked in," or whether that's something you're going to

            12   have to revisit over the coming years?

            13             MR. MILES:  We have already begun a process to

            14   re-look at the way we implemented 404.  We have made some

            15   changes going into 2005.  I don't think they're going to be

            16   dramatic.  One failed experiment was we tried to turn a lot

            17   of people into auditors for a day.

            18             MR. BELLER:  Sounds like what Nicolaisen was doing

            19   to me, and I too, have failed.

            20             (Laughter.)

            21             MR. MILES:  I couldn't understand that.  But there

            22   were a lot of business people and operations people who were

            23   not excited about that prospect.  So we'll have teams that go

            24   out and do the test work, is one of our major changes this

            25   year.

             1             MR. BELLER:  Dr. Patzak?

             2             DR. PATZAK:  Well, first of all I would like to say

             3   that I think that the present changes are necessary, and

             4   these changes are a prerequisite that the costs come down. 

             5   But I had mentioned earlier, one example earlier, and that,

             6   you know, that would lead me to the recommendation that it

             7   should be possible to exclude a larger number of individual,

             8   insignificant companies if there is a rigorous control and

             9   risk management process in place.

            10             Another example would be that we should have more

            11   interpretive guidance on qualitative considerations when we

            12   decide what's accounting significant.  Allowing for a

            13   risk-based approach.  That, I think, a risk-based approach,

            14   that would make it possible to get the costs down without

            15   losing the benefits of 404.

            16             I do feel that also in the implementation year,

            17   that there's a downside out of this bureaucratic approach,

            18   because we had to, for example within Siemens, we had to

            19   focus a lot of our internal audit resources on checking the

            20   progress on 404.

            21             We have a specific financial audit group, you know,

            22   comprising 70 auditors, which usually focus heavily on high

            23   risk areas and huge projects and things like that.  A lot of

            24   their time was really now focused on checking specific

            25   documentation needs and things like that.  I do not think

             1   that this really helps the confidence in financial reporting.

             2             On the other hand, I think that a lot of companies

             3   in that first year, because there was not enough guidance,

             4   they come up with too many significant controls, which are

             5   perhaps not really significant.

             6             So for our company, we had more than 20,000

             7   controls, nearly 30,000 controls.  There will be, at least I

             8   would see a need for a Phase 2 approach, one which basically

             9   tries to get rid of controls which are not really necessary,

            10   and more into the direction of preventing measures.

            11             More use of IT controls, controls which are already

            12   embedded in the ELP systems, in case manual controls and

            13   things like that don't work.

            14             So there is room also from the company side to

            15   improve efficiency.  There must be and that would be my

            16   recommendation for some changes in the standard, and also see

            17   that there is a clear, a logical consequence that the audit

            18   fees should come down because there should be less need for

            19   substantive audit procedures after so much time is spent on

            20   assessing the internal controls structure.

            21             MR. BELLER:  Thank you very much.  I see

            22   Commissioner Glassman has her card up.  Mr. Sylla, were you

            23   going to address the same question before we --

            24             MR. SYLLA:  I just wanted to make a quick comment

            25   on the cost structure, but we can defer.

             1             MR. BELLER:  Okay.  Commissioner Glassman?

             2             COMMISSIONER GLASSMAN:  Just following upon the

             3   last point, is there -- since this is supposed to reflect

             4   management's assessment of the effectiveness in their

             5   internal controls, in being able to certify their financials,

             6   that they're accurate and transparent, is there a difference

             7   between what management sees as sufficient, necessary and

             8   sufficient, in order to be able to make that certification,

             9   and what the auditors have been required, been requiring

            10   for -- to comfort themselves that management has the right

            11   information?

            12             MR. BELLER:  Who would like to --

            13             (Laughter.)

            14             MR. BELLER:  A lot of people.  Let me start with

            15   Mr. Thain.

            16             MR. THAIN:  Yes.  Commissioner, I think the

            17   answer -- the simple answer to your question is actually yes,

            18   because where companies, many, many companies have made

            19   comments along the lines of there is not sufficient guidance

            20   on what's material, that there needs to be more of a

            21   risk-based approach, that in fact there's not enough reliance

            22   on what management does.

            23             Both management themselves and internal audit. 

            24   Even though the rule does in fact allow for reliance on

            25   management and internal audit, that the response from

             1   companies has been that the accounting firms have been

             2   unwilling to do that.

             3             So what has happened is that attestation has turned

             4   into duplication.  So companies have been, even companies who

             5   do a lot of their own internal testing, have found their

             6   accounting firms requiring them to test a much broader range

             7   and a much greater sample size than what the companies think

             8   is necessary.

             9             MR. BELLER:  Mr. Turner, you had your --

            10             MR. TURNER:  Yes.  When you go back in and start

            11   digging through the companies that have actually filed with

            12   material weaknesses, the 750 or so that we talked about, 87

            13   percent of those had filed just previously with the 10-K or a

            14   Q to that with a clean certification from the management

            15   team, saying everything was fine.

            16             Then all of the sudden when the auditors came in,

            17   it became clear that the auditors saw it differently and saw

            18   it as a material weakness.  When we dig down into those,

            19   where there is information, where there is disclosure about

            20   the facts or you go pick up the teleconference call with the

            21   executives, where they've described it on the teleconference

            22   call, I must say that in most of those situations, as we

            23   analyzed them, we thought that the auditors were absolutely

            24   right-on and correct in their conclusions.

            25             So the answer to your question, at least from the

             1   public transparent disclosures is there's clearly a

             2   difference.  But as we see it, the auditors are calling it

             3   right from an investors' perspective.

             4             MR. BELLER:  I see Commissioner Goldschmid has his

             5   card up.  Ms. Cunningham, did you want to address

             6   Commissioner Glassman's question?

             7             MS. CUNNINGHAM:  Yes, just quickly.  I want to

             8   reiterate a lot of what John had said, but I think, you know,

             9   the issue of the auditors spending a lot of time on the less

            10   risky areas.  I think particularly in the first year, they

            11   spent a lot of time on areas that weren't, you know, didn't

            12   hold out a lot of risk.

            13             But I think the higher risk areas, the tone at the

            14   top, etcetera, needs to be focused on a little bit more. 

            15   Taking a more risk-based approach would be appropriate.

            16             I think, you know, the issue will be, you know, the

            17   auditors are being regulated for the first time.  I think the

            18   issue will be how that inspection process comes out in the

            19   first year, and what the inspectors' reactions are to the

            20   process that the auditors took.

            21             Because I did, were overly-cautious in the first

            22   year because of the second-guessing, and because of the

            23   plaintiffs' bar.

            24             MR. BELLER:  Mr. DiPiazza?

            25             MR. DIPIAZZO:  Let me begin by making it clear That

             1   this was a very difficult year, and by anybody's description

             2   you'd have to say that the process could be improved, that

             3   the process had its inefficiencies, that judgments could be

             4   second-guessed.

             5             I think you have to put it in context.  The focus

             6   on controls, although companies have focused on controls for

             7   years, they've never focused on them quite this way.  They've

             8   never focused on them with the level of ownership and

             9   responsibility that you have today.

            10             We refer to that as a level of deferred

            11   maintenance.  There was for years underinvestment in

            12   documentation, underinvestment in truly understanding and

            13   owning controls, deep into organizations.

            14             Now I absolutely respect of my fellow colleagues or

            15   panelists who say that maybe judgments were made that took

            16   controls testing down levels that were too far.  But I'll

            17   give you an example.  You want to test the human capital, a

            18   human resource group.  You want to test the controls they

            19   have about new employees and employees leaving.

            20             Most people would say "What does that have to do

            21   with financial statements?"  Until you find out what the

            22   company real life was not taking people off of computer

            23   access for two months after they left.  These people had the

            24   ability to transfer, wire cash, affect accounts after they

            25   left the company.  Is that an insignificant control?  For

             1   lots of people it might be.

             2             I think you really have to say what did we find? 

             3   We found, and what are the differences between the way

             4   management looked at this and the way the auditor looked at

             5   this?  Three-fourths, two-thirds to three-fourths of the

             6   calls for the investment here was by the company, not by the

             7   auditor.

             8             We're in the process of going through this,

             9   focusing on key controls.  Maybe at times they went beyond

            10   key controls, but I think that's the exception to the rule. 

            11   An average of 275 deficiencies per company had to be fixed

            12   before the end of the year, from the best company down to the

            13   smallest company or the weakest company in the group.

            14             The ownership around that subject, the cost of that

            15   remediation.  Probably 10 to 15 percent of all the time that

            16   was spent was just on the learning.  What did all this mean? 

            17   That's not going to be duplicated.

            18             Twenty percent was on documenting controls that

            19   hadn't been documented clearly for a decade.  That's not

            20   going to be repeated, at least substantially not repeated. 

            21   And the remediation, which was again, 15 to 20 percent of

            22   this process, which you would hope you would get it right.

            23             There were some areas we could improve on.  Costs

            24   were spent because auditors were testing things that

            25   companies just tested.  The problem was this was all real

             1   time.  The standard was time; the companies were remediating,

             2   defining, documenting and testing.  If the auditors had

             3   waited until the end and looked at that, you wouldn't have

             4   had time.

             5             I think in the future we clearly have to make that

             6   much more efficient.  But to be very fair, the standard

             7   allows us that judgment.  You don't have to change the

             8   standard.  What you have to do is impose that judgment and

             9   inspect it in a way that's consistent.

            10             MR. BELLER:  Thank you.  Commissioner Goldschmid?

            11             COMMISSIONER GOLDSCHMID:  Well, I was just reacting

            12   to the tension, I think, that I've heard reflected around the

            13   table.  I think feel too, talking about risk-based

            14   approaches, more use of internal staff, we're not counting

            15   trivial subs and such, all make some sense.  What I keep

            16   suffering with is internal controls have been on the books in

            17   the United States since 1977.  We all know that was not taken

            18   seriously year after year after year.  The use of the outside

            19   auditor clearly creates a discipline.

            20             Now the trick is to make it as efficient and

            21   sensible, and with as much judgment as possible.  But the

            22   natural tensions between management -- I mean, we left it to

            23   management from 1977 on, and I take it no one here would

            24   defend in general the quality of internal controls during

            25   that period.

             1             MR. DIPIAZZA:  Just to be clear, and Commissioner,

             2   I think it's fair to say that there were improvements to be

             3   made.  Ninety-plus percent of the companies had good control

             4   structures.  They needed to fix some things, but they got to

             5   the end and they'd fix it, and financial statements were

             6   fine.

             7             So we shouldn't expand it and say management was

             8   not doing good controls.  But there was not the ownership. 

             9   There was not the focus at the board level or at the

            10   management level that we have today.  So we're better through

            11   the process.

            12             COMMISSIONER GOLDSCHMID:  I think it's fair, but

            13   when we first proposed the internal controls rules at the

            14   SEC, the reports we got from business of how much change it

            15   would take ran into the number of fingers and on the hours

            16   per company, because everyone said we have internal controls. 

            17   Then they began to seriously look at them, and it was a

            18   different kind of picture, you admit.

            19             MR. BELLER:  Chairman Donaldson.

            20             COMMISSIONER DONALDSON:  I want to take advantage

            21   of this panel before it disappears.  I want to ask the

            22   question, which is how do we get out of the anecdotal phase,

            23   and how do we get into the measurement phase?

            24             What are the thoughts of all of you, anybody who

            25   wants to comment on this, on methodology, if you will,

             1   analytical methodology that can measure, truly measure the

             2   effect of all of this?

             3             MR. BELLER:  Again, Mr. Kroszner?

             4             MR. KROSZNER:  Well, certainly this is something

             5   that I think is extremely important.  One way of doing it is

             6   looking at the market reactions to whether something is

             7   material or not material.

             8             As Mr. DiPiazzo spoke about, an average of 275

             9   deficiencies per company, but how many of those are material,

            10   and what is the market judged as material or not material.  I

            11   think people are much more aware of these things, as Mr.

            12   Turner spoke about before.  The markets are much more aware,

            13   much more sensitive and much more attuned to these.

            14             But also, we can't look at just the -- a particular

            15   type of deficiency in and of itself.  It has to be put in

            16   context, because its credibility in terms of the firm.  Some

            17   firms are more opaque and some firms are more transparent,

            18   simply by the business that they're in.

            19             Some businesses are much newer; some businesses are

            20   much more volatile.  That's always going to create a greater

            21   information asymmetry, as economists talk about, between

            22   what's known inside of the firm and what's known on the

            23   outside.

            24             So at a firm that is in a very steady business

            25   where there's very little volatility, a deficiency there

             1   might not be a problem.  But that same "deficiency" could

             2   raise more of an issue where there are potentially more

             3   risks, because there's more volatility.

             4             So I think the type of study that should be done

             5   would look at not just the material violations or material

             6   deficiencies themselves, but look at the characteristics of

             7   individual firms.

             8             Because exactly as Ms. Bush was mentioning and Mr.

             9   Cook was mentioning, that there are -- there's an enormous

            10   amount of heterogeneity.  So not just say that one size

            11   should fit all, but it should be the same.  Look at the

            12   details of the potential problems in the context of the firm.

            13             There can be greater or less transparency in a

            14   firm, depending on their characteristics, and really kind of

            15   drill down into that.  I think we're beginning to see that

            16   and do that, and I think that would be an excellent thing for

            17   the Commission to undertake, for the board to undertake and

            18   certainly Mr. Turner has already started down that line.

            19             MR. BELLER:  Mr. Cook.

            20             MR. COOK:  Answering the chairman's question about

            21   what do we do to take some of these things and turn them into

            22   action and turn them into results.  I think we've all

            23   acknowledged we had to get through the first year, and there

            24   was an awful lot of inefficiencies as there will also be in a

            25   process that's this complicated the first time you take it

             1   on.

             2             I think everybody learned from that and has learned

             3   some lessons that will be beneficial.  I think maybe this

             4   roundtable is the time to declare last year last year and get

             5   conversations going that will help us do better going

             6   forward.

             7             I think we need to get the parties together to talk

             8   about this, the different participants, because people are

             9   not necessarily talking past each other but they're not

            10   necessarily connecting either around what is it that the

            11   standards require, what are the levels at which we should be

            12   testing controls, what are the appropriate approaches.

            13             I think we really ought to get onto that pretty

            14   quickly.  Sitting in an audit committee chairman's role,

            15   we're waiting with eager anticipation for the plans for the

            16   coming year, which usually are delivered some time around the

            17   time of an annual meeting or shortly thereafter.

            18             We've asked the auditing firms in all cases to give

            19   us their estimates about what the costs of the 404 are going

            20   to be in Year 2.  I'm wildly encouraged by this 46 percent

            21   figure, and I had been hearing much less than that.  So that

            22   at least is a sign.  I'm only little bit concerned that 46 is

            23   as high as it is, because the figures for last year ended up

            24   being as high as they were.

            25             There's certainly an element of possibility in

             1   that.  But the 46 percent is a pretty encouraging notion, and

             2   we do have to get to this issue of cost and get it working. 

             3   I do really think the PCAOB people are very responsive and

             4   interesting in doing what they can do to be helpful with

             5   respect to implementation and guidance, that will lower the

             6   expectations to an appropriate level.

             7             A lot of this is not particularly new.  The notion

             8   that every year's audited internal control stands on its own

             9   isn't substantially different in my thinking from the notion

            10   that every year's audit of financial statements stands on its

            11   own.

            12             I don't think those are done in batches.  I think

            13   they're done in separate years, and so the notion of how you

            14   go about auditing something each year is not completely new

            15   and different.  But I do think people need to get together

            16   and start talking about the practicalities.

            17             That's the leadership of the firms, the leadership

            18   of the financial community, PCAOB, the SEC to the extent that

            19   they have an interest and an opportunity to participate.  I

            20   think it's time to get this going, and try to do something

            21   pretty quickly, because planning is underway for next year.

            22             A lot of work is going to be done between now and

            23   the summertime in getting ready for this.  How much resources

            24   we need to put behind it, how much we need to keep our

            25   internal auditors deeply focused on 404 as opposed to other

             1   activities, all of that has to get resolved in the next

             2   couple of months, and I think we need to get the parties

             3   going.

             4             MR. BELLER:  Right, and I think certainly speaking

             5   for Don, we recognize the urgency of some of this.  We only a

             6   few minutes left.  I do want to hit on a couple of things

             7   that have been alluded to and maybe bring them out a little

             8   bit more.

             9             One, I want to ask Mr. Sylla, this issue of

            10   opportunity cost.  We had a meeting of our Small Business

            11   Smaller Public Company Advisory Committee yesterday, and one

            12   of the co-chairs, Tim Kim, the CEO of Kimball International,

            13   who I think is in our audience, talks about the same thing,

            14   which is the mind-share costs to senior management of some of

            15   these requirements.

            16             I guess the question I have for you is again, if

            17   you put Year 1 sort of behind you, but with that as context,

            18   is there an issue with mind-share and opportunity costs at

            19   the senior management level?  Certainly, the comments we've

            20   received have suggested that there is, and if so, what should

            21   be done to address it sort of by all the parties, auditors,

            22   managers, regulators and so forth?

            23             MR. SYLLA:  You know, we would concur.  With the

            24   numbers that have been thrown out here, we probably for large

            25   companies would on the high side of the numbers.  Frankly,

             1   you could characterize that as a class or you could

             2   characterize it as an investment in the future.

             3             Clearly, from our perspective, a significant amount

             4   of time was spent in the first year, in things like

             5   information-gathering, establishing processes and controls. 

             6   That we believe will not necessarily repeat itself.

             7             As a result of having to do that, a good deal of

             8   outside external resources were brought in to augment the

             9   internal resources that we used.  So we think that's a

            10   one-time, and as long as we're throwing in numbers, I might

            11   as well throw our number out.

            12             We believe, based on what we know, and that's a

            13   qualifier, that our costs would be down probably in the

            14   vicinity of 50 to 60 percent moving forward.  That's because

            15   we've established, if you will, the internal infrastructure

            16   and spent the money maybe up front in preparing, knowing that

            17   this was not a one-shot deal.

            18             Now I think from a senior management perspective,

            19   as I indicated, the ownership in this thing clearly takes a

            20   lot of time.  There is no question, as you go through this,

            21   we can't help but if you're putting your name on things, and

            22   putting in your cost of risk, you take a lot of attention.  I

            23   don't think anyone would minimize that.

            24             The challenge, of course, from an internal

            25   perspective is the prioritization, not only with respect to

             1   the work that had to be done on 404, but taking people from

             2   the technology side of the business and various other pieces

             3   of our business, and reallocating them to this process to get

             4   it right.

             5             As a result of that, it was very difficult to

             6   quantify other aspects of the business that took a back seat

             7   to this, because you could only put so much in the plate.  So

             8   other than wrestling with what we expect in the future,

             9   clearly we see very little modest resources from the outside

            10   required.

            11             But the prioritization internally for both senior

            12   management time and all the other people that make this thing

            13   work is going to continue.  I don't see that stopping in the

            14   short run.

            15             MR. BELLER:  Mr. Miles, you have your card up, and

            16   I'll recognize you.  But I also want to ask you, do you think

            17   that's a good thing or not?

            18             MR. MILES:  Good thing with regards to the

            19   substantial amount of senior management focus on this

            20   subject, as kind of a medium and long term issue.  I think to

            21   some degree it's probably going to be negative, in that it

            22   will distract them from things that really are probably much

            23   more significant, in terms of operating control strategy,

            24   that they really should be focused on.

            25             I do think they need to spend time on internal

             1   controls, but that should not be their primary focus at the

             2   top of the house.

             3             The comment that I would like to make, and is

             4   really to the Commission, was first of all, to say thank you

             5   for delaying the acceleration of the filing deadlines.  But I

             6   would also ask that consideration be given to freezing that

             7   at the point that it is.

             8             That is, as the small filers come on line and the

             9   foreign filers.  I don't know within the accounting industry,

            10   within our businesses, that there are the resources there to

            11   staff up and get everything done by a March 1st deadline, and

            12   a 35-day 10-Q deadline, without increasing the possible of

            13   the occurrence of a reporting issue that could lead to a

            14   material weakness, just because of the haste that would be

            15   required by a business.  So I would request that we keep that

            16   there.

            17             MR. BELLER:  Following up on that a little bit, a

            18   question for Mr. DiPiazza.  A lot has been said, including in

            19   the comments, about accounting firms being stretched for

            20   resources, accounting firms bringing on large numbers of

            21   people, accounting firms training on the fly, accounting

            22   firms having people who aren't very experienced doing this

            23   work.

            24             Going, is Year 2 different?  Is it more of the

            25   same, and also I think a related question, all of the large

             1   accounting firms have put comments in.  Some of them suggest

             2   that while other company costs may be going down in Year 2

             3   and thereafter, people shouldn't expect the audit fee for

             4   internal controls would go down, because we're in a brave new

             5   world.  What thoughts do you have on that?

             6             A PARTICIPANT:  What brave thought does he have?

             7             (Laughter.)

             8             MR. DIPIAZZA:  There is no question that Year 1

             9   resources were stretched both within companies and within the

            10   audit firms.  I mean, we bought 1,000 people from around the

            11   world into the U.S., both to train them on how to apply this

            12   to foreign and private issuers, and to get us through the

            13   process.

            14             We spent $50 million out of pocket training our

            15   people.  I hope I don't have to do that next year.  If you

            16   really look at what was accomplished in Year 1, with the

            17   enormous documentation, the enormous remediation of controls

            18   that had weaknesses.  Whether they are material or

            19   significant, these were all key controls.

            20             A lot of that goes away, or at least it goes into a

            21   continuance mode, as opposed to a first-year mode.  So I

            22   clearly see that the time and the energy and the effort and

            23   the cost of the 404 audit will go down.

            24             As we integrate the financial statement audit, and

            25   remember this year we had a financial audit and we had a 404

             1   audit, and they were running parallel.  They were not

             2   integrated.

             3             All of the firms, not just the Big Four but all of

             4   the firms dealing with public companies are looking at ways

             5   now to make that a much more efficient process.  So we also

             6   believe these numbers are reasonable.

             7             Just one other observation to the chairman.  We

             8   have an enormous level of transparency now, just a matter of

             9   weeks after the filing, about what we've now learned.

            10             Where are these weaknesses, and which people in the

            11   organization spend hours and hours and hours assessing where

            12   are the weaknesses?  Where are the weaknesses in terms of big

            13   companies and small companies?

            14             I mean, it's clear.  Companies under 200 million

            15   have more material weakness issues than companies over five

            16   billion.  We have some issues around that.

            17             Industry differences.  There's a tremendous amount

            18   of transparency, but I think both the analysts, the

            19   regulator, the company and the auditors are now going to

            20   begin to apply going forward that information, all of which

            21   is going to make this system better.

            22             I think a lot can be done within the current

            23   standard, with good inspection and advice from the PCAOB, and

            24   as Mike Cook says, good cooperation between the parties.

            25             MR. BELLER:  We are at that hour, the end of our

             1   time.  I'm going to give Chairman McDonough the last question

             2   and maybe the last word.

             3             MR. MCDONOUGH:  It's actually a comment.  I think

             4   the secret of making sure that Year 2 is both more efficient

             5   and better quality as it regards both the work of management

             6   and the audit, is that the audit will in fact be integrated. 

             7   That's what it's supposed to be.

             8             But in the first year, that was absolutely

             9   impossible for the firms to do.  By integrating the audit of

            10   the financial statement and of the internal controls, there

            11   will clearly be better efficiency, and we will have the

            12   advantage that the firms had to jump through enormous hoops

            13   in order to get enough bodies to do the internal control

            14   work.

            15             Those people are now much better trained in going

            16   into Year 2, and they're going to do a better job.

            17             MR. BELLER:  Thank you very much Chairman

            18   McDonough.  I'm going to thank the panelists.  We are going

            19   to take a 15-minute break.  Can we back here at 10:40 please? 

            20   Thank you.

            21             (Break.)

            22                PANEL TWO - REPORTING TO THE PUBLIC

            23             MR. BELLER:  I'd like to get started again.  The

            24   second panel this morning is going to address generally the

            25   subject of disclosure and reporting to the public, around

             1   Section 404.

             2             As we have mentioned in the first panel, the

             3   requirement to have effective internal control in fact dates

             4   from 1977, and Section 404 does not change that requirement. 

             5   Section 404 is a disclosure and a reporting provision, which

             6   requires managers to assess and disclose for the first time

             7   whether their internal control is effective in their annual

             8   reports, and for auditors to, in accordance with Auditing

             9   Standard No. 2, audit management's assessment and the

            10   effectiveness of internal control and deliver an audit report

            11   on that subject.

            12             Joining me on Panel 2 as the moderator is the chief

            13   accountant of the Division of Corporation Finance, Carol

            14   Stacey, who is an accountant, not just for a day.

            15             (Laughter.)

            16             MR. BELLER:  Again, I'll introduce the panelists in

            17   a moment.  I don't know if all of the panelists were here for

            18   the first, the introductory remarks for the first session. 

            19   I'll go over them very quickly.

            20             One, if you want to be recognized, we want this to

            21   be interactive.  The moderators will reserve the right to

            22   call on specific people.

            23             But I would encourage you, as well as the members

            24   of the Commission and the board, to seek recognition and the

            25   way to do that is to turn your tent card on end, so we can

             1   see it.

             2             Second, we have asked you all to submit written

             3   statements and all of your or most of you certainly have done

             4   so.  They are on the website, but for the sake of time, we're

             5   asking that there not be opening statements and we will

             6   enforce that.

             7             Finally, if you are recognized and because we're

             8   being webcast and not everyone who's listening can see us, if

             9   you would identify yourselves.  If one of the moderators has

            10   not in recognizing you, that would be great.

            11             I'm going to start again by introducing the panel

            12   again for the folks that can't see.  So I'm not going to go

            13   back to the Commission and board again.

            14             But the panelists, starting at my left, Mark Anson,

            15   who's the chief investment officer at CALPERS.

            16             To Mark's left, Jim Copeland, who's a member and

            17   chair of a number of audit committees.

            18             Nick Cyprus, who's the Senior Vice President,

            19   Controller and Chief Accounting Officer of the Interpublic

            20   Group of companies.

            21             To Mr. Cyprus' left, the Honorable Barbara

            22   Franklin, who is again a director and member of the boards of

            23   directors of a number of public companies.

            24             To Ms. Franklin's left, Curtis Hage, who's the

            25   chairman and CEO of Home Federal Bank.

             1             To Mr. Hage's left, John Huber, who's a partner at

             2   the law firm of Latham and Watkins.

             3             To Mr. Huber's left, Greg Jonas, who's the Managing

             4   Director of Accounting Specialists Group at Moody's Investor

             5   Services.

             6             To Mr. Jonas' left, Bob Kueppers, who's the

             7   Chairman of the Executive Committee of the AICPA's Center for

             8   Public Company Audit Firms, and is also the Vice Chairman and

             9   National Managing Partner for Professional Risk and

            10   Regulatory Matters at Deloitte and Touche.

            11             Finally, to Mr. Kueppers' left, Ed Nusbaum, who's

            12   the CEO of Grant Thornton.

            13             I guess I would begin with a question for Ms.

            14   Franklin.  As of the end of March, and I guess the numbers

            15   are slightly changed, but certainly over 2,500 companies had

            16   filed their 10-K's containing their initial assessments of

            17   internal controls, and about eight percent had indicated that

            18   their controls were not effective as a result of one or more

            19   disclosed material weaknesses.

            20             From your perspective, has that information and

            21   disclosure and the disclosure around those assessments been

            22   useful, and what suggestions would you make going forward for

            23   improving that disclosure?

            24             MS. FRANKLIN:  Well, thank you and thanks to the

            25   Commission for having this session.  I think it's an

             1   important subject.

             2             I've got a couple of this with me, the kinds of

             3   disclosures that are -- that you have just referred to.  I

             4   can look at this a couple of different ways.  One as an audit

             5   committee member and chairman, am I getting what I want from

             6   management and the auditors.  Look at it from just being a

             7   director, or an investor.

             8             There is something else that I would like assurance

             9   of, with respect to how we get to reasonable assurance in

            10   here.  It's this, and I'll pick up a thread from your last

            11   panel.

            12             I would like assurance that the 404 internal

            13   control compliance process was in fact focused on the areas

            14   of greatest risk to financial statement misstatement.  I am a

            15   real advocate of risk assessment and enterprise risk

            16   management, and prudent companies that are doing this, and I

            17   think everybody ought to be doing it.

            18             Out of that process, we do get a sense that what is

            19   the magnitude of the impact of some risk; what is the

            20   probability of it; and then who in management actually owns

            21   that area to manage through.

            22             You could just overlay that one thing right on 404,

            23   and you could put your documentation, your testing, your

            24   aggregation of significant deficiencies right into that kind

            25   of a context.  I know this was brought up the last session,

             1   but I really think it's worth saying it again for each line

             2   item in the financial statements.

             3             I know we talked a little about key controls in the

             4   last panel.  It's not clear to me that key controls are the

             5   same thing as -- if they're coming out of a risk assessment. 

             6   I think that's been true at the audit committee level.

             7             We were so focused, particularly as the deadline

             8   neared, on what was a significant deficiency and whether all

             9   this stuff was going to get fixed, that we were not clear and

            10   we were not really being told clearly what was really

            11   important from a risk standpoint to a financial statement's

            12   misstatements, and whether this may be operational or a

            13   process or something else.

            14             So I think this point is really important, and as

            15   an investor, I would like some assurance, because I'm a

            16   committee chairman too.

            17             Related, each of the things had their own -- let me

            18   back up here.  The definitions of significant deficiency and

            19   material weakness are wonderful.  They're fascinating to read

            20   that stuff.  That's another conversation.

            21             But beyond that, each of the firms have devised

            22   their own quantitative guidelines as to what was a

            23   significant deficiency and material weakness.  The difficulty

            24   that I saw through several different audit committees was

            25   that the firms were not consistent among each other, in terms

             1   of what those guidelines were, and I'm not sure they were

             2   consistent among their clients either, each firm consistent

             3   among its clients.

             4             My concern was that again, looking at this from an

             5   investment perspective, if we can have a lower threshold,

             6   meaning a higher standard than what was a material weakness,

             7   and that firm's clients had more material weaknesses than

             8   some other firm's clients, how is the investment community,

             9   how is an investor going to look at that, and what would be

            10   the consequences?  It could be unfairness across corporate

            11   America.

            12             The same thing with the consistency issue.  How we

            13   fix that, I'm not sure whether it's the PCAOB's ball to fix

            14   it, whether the firm somehow has to get together and fix it,

            15   whether the SEC has a role.  But I see that as an issue, and

            16   no matter which chair I'm sitting in, I would like some

            17   assurance about both those things.

            18             MR. BELLER:  Okay.  Thank you very much.  Mr.

            19   Jonas, what's your assessment of the utility of the reporting

            20   and the disclosure that's been going on?

            21             Let me throw one little supplemental question in

            22   there as well, which is the companies are operating with --

            23   under a rule that's a Commission rule, that does not

            24   prescribe a form of disclosure for management's assessment.

            25             We've basically left it to management to describe

             1   what they believe is material and important.  The auditors

             2   are operating under a board standard, which is quite

             3   consistent with other audit standards, which does prescribe

             4   pretty closely a form of report.

             5             Do you think there should be more of a template for

             6   management, or are there other ways to get management to

             7   address what investors and users such as yourselves would

             8   like to see?

             9             MR. JONAS:  Well, first on the broadest question,

            10   you know, we perceive substantial benefits from these 404

            11   reports, both in the reports that cite material weaknesses,

            12   as well as reports that are clean.

            13             (End Tape 1)

            14             We think this is a central plank, 404 is, to

            15   restoring investor confidence in the financial reporting

            16   process, confidence that was badly damaged in the last few

            17   years.

            18             We perceive that companies are more focused on

            19   accounting, auditing and quality financial reporting than

            20   they have in the recent past.  We perceive the companies are

            21   investing, some for the first time in many years, their

            22   infrastructure supporting quality reporting.

            23             We also perceive that there's some better auditing

            24   going on these days, under the notion that the more the

            25   auditor knows about controls, the better the audit work.  All

             1   of which causes us, and we think other market participants,

             2   to take comfort in the 404 process.

             3             Where companies disclose material weaknesses, we

             4   are getting benefits from that as well.  We think that in

             5   certain, but not all cases, and I'm sure in a later question

             6   we'll be addressing does the market distinguish between some

             7   material weaknesses than others.

             8             But certainly in some cases, we believe that the

             9   weaknesses cited are credit-relevant, and that it provides an

            10   additional red flag that we would not have perceived absent

            11   the 404 process.  For that, we think it is credit-relevant.

            12             Finally, and this is anecdotal as opposed to direct

            13   evidence, but we have had a number of managements tell us

            14   that they perceive benefits to them of having gone through

            15   the 404 process, benefits not only in terms of approving

            16   their accounting but just improving their control over the

            17   business in general.

            18             Now having said that, of course you'd be perhaps

            19   disappointed if I didn't have a wish list of what might be

            20   better in public disclosure, and I have five items on the

            21   list.

            22             First, while some companies do an excellent job of

            23   describing exactly what is the material weakness, others do

            24   not.  We think that describing in detail what the problems

            25   are is important, particularly if we're trying to distinguish

             1   between certain material weaknesses that we think are

             2   credit-relevant and those that are not.

             3             Looking forward, we're particularly interested now

             4   in what companies say about their plans to remediate their

             5   control weaknesses.  Again, we've some companies who are

             6   quite explicit about what they plan to do and others that say

             7   next to nothing about that.  Looking forward, we're very

             8   interested in the plan of remediation.

             9             We would hope that the companies would update

            10   investors quarterly about their remediation progress, and

            11   that they would indicate when the remediation is complete

            12   over the material weakness that was the subject of an earlier

            13   report.

            14             We would also like it if auditors were to be able

            15   to report on the successful remediation of the control on an

            16   interim basis, and not have to wait until the next audit

            17   cycle.  Thus, we're big fans of the PCAOB's proposal to at

            18   least allow auditors to write those reports.  Thank you very

            19   much.

            20             MR. BELLER:  Mr. Anson, as another user of the

            21   reports, including these disclosures, what is your reaction

            22   to what we have seen so far and what we could or should be

            23   doing going forward, "we" being everybody and not just the

            24   Commission?

            25             MR. ANSON:  I always like to use the word "we." 

             1   First, I'd just like to add a comment.  I know the first

             2   panel talked a lot about costs, the cost of applying and

             3   implementing Section 404.

             4             You know, the people who ultimately bear the costs

             5   are shareholders like CALPERS.  We're willing to bear that

             6   cost, because if  those costs can prevent one more Enron or

             7   one more WorldCom or one more Tyco-Adelphia, choose your

             8   favorite corporate accounting scandal, that is money

             9   well-spent in our opinion.

            10             As an investor, if I can't trust the integrity of

            11   the financial statements, they're worthless to me.  Indeed,

            12   we saw this in 2002, when saw that the risk premiums for

            13   stocks in the U.S. stock market rose to its highest level in

            14   25 years.  The risk premium for stocks was higher than even

            15   after 9/11, simply because people were so risk-averse because

            16   they couldn't trust financial statements.

            17             So I think it's a cost that shareholders are

            18   willing to bear, and it helps trust the integrity of those

            19   financial statements.

            20             In terms of the benefits beyond that, they're less

            21   tangible, but I think they're out there.  There are one or

            22   two things I'd like to point out.  I think now, with the

            23   advent of Section 404, you see the fiduciaries, the boards of

            24   directors paying much keener attention to their fiduciary

            25   duties.

             1             If nothing else, they're much more inquisitive,

             2   particularly those that sit on audit committees with regard

             3   to the controls of the company.  Now that doesn't mean that

             4   Section 404 is a panacea, but my gosh, if you're getting

             5   directors on audit committees to start asking questions with

             6   their auditors and their management, that's a pretty good

             7   start.

             8             That's what it really, I think, is the best benefit

             9   of Section 404.  It forces people to think critically about

            10   the integrity of the financial statements, the integrity of

            11   the internal controls, and are we producing the right

            12   information that all stakeholders need, using the word "we."

            13             Not only shareholders but creditors, rating

            14   agencies, directors forejudging the performance of management

            15   when they grant their bonuses.  So I think the bonuses are

            16   hard to translate yet into dollars, but I think the benefits

            17   will far outweigh the costs.  Let me stop there with my

            18   comments.

            19             MR. BELLER:  Thank you.  Mr. Kueppers', you've left

            20   your card up.

            21             MR. KUEPPERS:  I do. Thank you, Alan.  I wanted to

            22   comment on a couple of the previous points, including Barbara

            23   Franklin's point about getting some assurance that the word

            24   had a risk focus, a risk-based approach.

            25             I do think there is room for improvement in that

             1   area, and I think that many of us could observe, based on

             2   experience now, some very minor areas that might have

             3   received more focus than they otherwise might have.

             4             I think that the key would be for the -- for our

             5   regulators, the PCAOB, to provide some additional

             6   interpretive guidance, because I think people would take that

             7   very well as we get into Year 2 and begin to think about our

             8   scope, which frankly is we're on the threshold of doing right

             9   now.

            10             The other element of this management reporting that

            11   I want to point out is one of the things that makes it quite

            12   useful is the requirement that in the event there is a

            13   material weakness, there is a description or discussion.  I

            14   mean, this kind of transparent information to investors has

            15   never existed before.

            16             You know, Greg referred to the fact that maybe not

            17   all material weaknesses are created equal when you hit that

            18   threshold that requires public disclosure.  It's helpful for

            19   me to know that as an investor or as just a user of the

            20   financials, that the company had an issue with the method by

            21   which they reconciled their income tax accounts, and it rose

            22   to the level that it created a judgment that material

            23   weakness was present.

            24             That's much different than having some pervasive

            25   tone at the top issue, an ineffective audit committee or

             1   something that would have a completely different flavor.

             2             So I think the most useful thing is in the 225

             3   reports that have already been filed, that have ineffective

             4   controls and adverse reports, you get some sense of the

             5   "what" that caused that trigger to be pulled.  I think that's

             6   tremendously helpful to investors.

             7             MR. BELLER:  Thank you.  Turning to maybe the

             8   preparer's side next, Mr. Cyprus, from an issuer's

             9   perspective, what are your thoughts about the disclosure and

            10   reporting requirements, and do you need more guidance from

            11   us?  Is it or do you feel comfortable knowing what it is that

            12   investors and we want you to say, if there are material

            13   weaknesses?

            14             MR. CYPRUS:  Well, I'd like to say one, I

            15   appreciated actually, the flexibility that we got.  So I

            16   wouldn't say right off the batt that we would need more

            17   guidance.  At IPG, I want to say that the 404 process helped

            18   us a lot.

            19             In fact, I've been a controller at two Fortune 500

            20   companies during this process, and I could tell you this.  I

            21   believe that 404 and Auditing Standard 2 as it was written,

            22   has created significantly more focus by senior management on

            23   control deficiencies.

            24             They've been more active.  They've been willing to

            25   use budget dollars to solve control problems that might not

             1   have been available in the past.  I'm actually confident that

             2   404 will result in the long run in better and more

             3   transparent financial reporting.

             4             I actually believe that due to the tenor of all the

             5   controls that you've heard, that you'll probably have less

             6   restatements in the long run too, because incidental

             7   mistakes, because people have tightened and looked at the

             8   control environment, I believe will be prevented.  So I'm a

             9   big advocate of 404.  I would not make any changes at the

            10   time.

            11             As far as the flexibility of financial reporting,

            12   IPG, because we noticed that we had material weaknesses and

            13   we'd been disclosing those weaknesses in each quarter as soon

            14   as we knew about them.  In the second quarter, for instance,

            15   of '04 we told the world that we didn't think our disclosure

            16   controls were effective, because we had multiple material

            17   weaknesses.

            18             As we got into the third quarter, we gave you more

            19   detail on those control activities that we felt had material

            20   weaknesses.  As we got to understand our material weaknesses,

            21   we said "Geez, one of the reasons we delayed and one of the

            22   companies that delayed 10-K filing," we had a map on where

            23   our issues were.

            24             We believed that more work needed to be done on the

            25   numbers, and we basically delayed the K filing, putting

             1   additional procedures in place, to make sure we as management

             2   could get comfortable with the numbers.

             3             The disclosure pattern we chose was actually to

             4   follow almost literally the COSO framework itself.  So if

             5   you'll look at 12B25 filing that we filed under an 8-K, you'd

             6   actually see that we talked about the control environment. 

             7   We talked specifically about control activities.  We talked

             8   about information and communication, and we talked about

             9   monitoring controls.

            10             We gave you our current assessment of where we

            11   stand on that, so that analysts and investors could

            12   understand better what the risk profile was of the company.

            13             So I'm not sure if there wasn't a 404 whether you

            14   would have seen this in the past.  But there is, and I think

            15   the benefits are significant in that one, management has a

            16   map to what it needs to do to get its numbers better.

            17             I believe what we also saw is that the auditors

            18   have a map in what they need to do address these issues by

            19   changing their audit scope, so that they could do substantive

            20   testing more than they would have done in the past in those

            21   areas that we've identified to be materially weak, so we

            22   could get assurances and they could audit those numbers.

            23             So I think 404 has done its job.

            24             MR. BELLER:  Thank you.  Mr. Copeland, as somebody

            25   who was in the auditor's chair for many years, and is now

             1   sitting on audit committees, and particularly in the latter,

             2   from the audit committee perspective, how did you see the

             3   reporting and disclosure process and how do you think it

             4   could be improved going forward?

             5             MR. COPELAND:  I'll repeat what everyone has said. 

             6   I think, you know, 404 has been a positive thing for

             7   financial reporting in general, whether you're on the

             8   management side or on the governance side of things. 

             9   Certainly, if you're an auditor, I would suspect that that's

            10   viewed positively.

            11             I would say, however, that we have paid an

            12   unnecessary price for it.  I'm not complaining about paying

            13   the price for 404.  It's worth something.  But we have

            14   created, perhaps unavoidably, unnecessary costs associated

            15   with the benefits that we're receiving, and we have created a

            16   distraction and again perhaps an unavoidable distraction to

            17   both management and governance mechanisms in corporate

            18   America.

            19             On the positive side, weaknesses have been

            20   identified.  They've been remediated or plans have been

            21   developed for remediation, and as an audit committee chair, I

            22   can now insist that that remediation plan be completed.  It

            23   makes me sleep better at night.

            24             But I do believe that it's very important that we

            25   not oversell investors on what has occurred.  Operating

             1   controls were not covered by 404.  So it is entirely possible

             2   that we will very accurately report on an operational

             3   disaster.

             4             Even the best controls cannot necessarily preclude

             5   collusive fraud, and I worry that we are communicating that

             6   the investor does not have to worry about collusive fraud. 

             7   You can write this down.  We will see some collusive fraud in

             8   companies where there are no reported material weaknesses. 

             9   It will occur.

            10             Financial statements are inherently imprecise, and

            11   the various reports and attestations could reinforce an

            12   unreasonable expectation of investors about the precision of

            13   financial reporting, and particularly with the FASB's

            14   direction of toward fair value accounting, the imprecision in

            15   financial statements is perhaps likely to increase.

            16             As far as how the usefulness of the reporting could

            17   be improved, I would say that management and auditors need

            18   more guidance, and they need more specific guidance.  I would

            19   say they need a better process for offering that guidance

            20   before the fact, particularly with respect to the PCAOB.

            21             The PCAOB's primary role is the interface with the

            22   auditors.  But it has an incredible indirect impact on

            23   issuers.  I do believe there needs to be an official process

            24   or a formal process for allowing issuers to have access and

            25   input in the process and development of PCAOB standards.

             1             Allowing more flexibility in the timing of work and

             2   reporting could significantly reduce the cost, and also avoid

             3   some of the unintended consequences, which had been to delay

             4   reorganizations of corporations, delay the implementation of

             5   new IT systems, and also delaying acquisitions.

             6             I think it would be helpful if we'd modified the

             7   pass-fail system.  It would allow for more, dare I say the

             8   word "nuanced" reporting of internal control weaknesses.  The

             9   investment community is now trying to do that on their own. 

            10   They are trying to differentiate among the various

            11   weaknesses, on the theory that all material weaknesses are

            12   not created equal.

            13             I believe that it's not necessary to have to

            14   struggle with that.  We could do that through the reporting

            15   process.

            16             We need better definitions about materiality,

            17   particularly with respect to potential misstatements rather

            18   than actual misstatements, as they relate to quarters. 

            19   That's a technical problem in the way that we look at

            20   internal weaknesses from quarter -- internal control

            21   weaknesses from quarter to quarter, and how you determine

            22   whether or not they are material.

            23             Then finally, we need an effective system, again,

            24   for taking input around these issues before the fact.  Thank

            25   you.

             1             MR. BELLER:  Commissioner Glassman?

             2             COMMISSIONER GLASSMAN:  Thanks Alan.  To the extent

             3   that some of these infernal control weaknesses or

             4   deficiencies are really not that important to the ultimate

             5   financial reports, some are, some aren't, but all are being

             6   reported equally once they're identified, either to the audit

             7   committee and the board or to the public, are we diluting --

             8   is this diluting the meaningfulness of the ones that really

             9   are important?

            10             MR. BELLER:  Mr. Huber?

            11             MR. HUBER:  Yes.  My answer to your question,

            12   Commissioner, is yes, and my concern about the disclosure

            13   that is being done here is that rather than in essence

            14   promoting a disclosure policy of material weakness being a

            15   canary in the mine shaft for an investor, i.e., a warning to

            16   an investor that there is something there that the investor

            17   should look at, that he or she should pay attention, we as

            18   preparers of this disclosure have to treat all material

            19   weaknesses equally.

            20             You've heard that now from Deloitte; you've heard

            21   it from the preparers; you've heard it from everybody.  I

            22   think there is a fundamental difference between a one-time

            23   error in a complicated tax point, which is corrected before

            24   the 10-K is filed, and a pervasive revenue recognition

            25   problem in a multi-national company.

             1             It's just different, and the fact of the matter is

             2   right now the rules do not make a distinction between one and

             3   the other.  So therefore, from my side, in terms of preparing

             4   it, I endorse the flexibility.  I don't want to have precise

             5   checkpoint kinds of rules, because the multiplicity of these

             6   issues are such that you want management to tell their own

             7   story, just like you want management to tell its own story in

             8   MD&A.

             9             However, we need help with respect to the idea of

            10   what is a material weakness with respect to these issues,

            11   because companies can't differentiate right now.

            12             In terms of some of the points that Mr. Jonas was

            13   making, my answers to a number of his points are that the

            14   review staff in the Division of Corporation Finance is

            15   already implementing most of his points, and the PCAOB is

            16   implementing another one.

            17             But the fact of the matter is, this disclosure is

            18   brand new.  We've been here one year on this disclosure, and

            19   this disclosure has evolved from vague references to there is

            20   something wrong down in the engine room and we can't figure

            21   it out, to specific kinds of we have a hole in the boat, have

            22   you found it, and this is what we're doing about it with

            23   respect to the disclosure.

            24             The disclosure in the past year has gone from what

            25   I'd call one to an eight or a nine.  The difficulty is we

             1   can't differentiate between them.  My first point to the

             2   Commission if you have to decide what the purpose of this

             3   disclosure is.

             4             Is it the canary in the mine shaft, or do you just

             5   want to have disclosure for all of these things?  From my

             6   standpoint, it's the canary in the mine shaft, and from the

             7   investor's standpoint, I think the marketplace standpoint,

             8   they're going to make those distinctions whether you do it or

             9   not, and quite frankly, there go my people.  Must go and lead

            10   them is a standard that I would commend to your attention,

            11   because this is happening very quickly.

            12             MR. BELLER:  Mr. Nusbaum.

            13             MR. NUSBAUM:  Thank you.  What has been discussed

            14   is the fact that the disclosure of material weaknesses is

            15   significantly improved if everyone understands what the

            16   weaknesses are all about, and what the remedial actions are.

            17             So I would encourage, we would encourage the SEC to

            18   require plain English standards for the disclosure of

            19   material weaknesses, so that all the investors know what

            20   we're talking about, and also to provide greater flexibility

            21   on the disclosure of the remediation plans, including as I

            22   think was alluded to earlier, the proposal to allow the

            23   auditor or require the auditor to disclaim an opinion or add

            24   disclaiming language on those remediation plans.

            25             The disclosure of the material weaknesses, I think,

             1   are even more difficult on small and mid-cap public

             2   companies, because the COSO standards have been developed

             3   really for the largest of companies.

             4             Therefore, small and mid-cap public companies find

             5   that they have a higher incidence of reporting material

             6   weaknesses, simply because of these fixed standards.

             7             While we all try to avoid the one-size-fits-all

             8   requirement, because a standard does need to be improved for

             9   small businesses, as I know it's being worked on, but for

            10   many mid-cap public companies and small-cap public companies,

            11   they're already reporting material weaknesses that are a

            12   problem.

            13             If I can comment on one other thing, the discussion

            14   from an audit firm standpoint, the inconsistencies that are

            15   being applied, I think there really are some inconsistencies,

            16   unfortunately.  We do need to focus on best practices amongst

            17   the accounting firms in applying 404, the reporting on 404,

            18   and expanding the active and whole discussion of integrated

            19   auditing, where we combine the 404 test with the rest of the

            20   audit.

            21             That best practices really needs to be assisted by

            22   the PCAOB, by the SEC and by various professional

            23   organizations like the AICPA, to ensure that we really have

            24   consistency and improve efficiency.

            25             I think that the audit firms needs to share their

             1   methodology, share their software, share their policies in an

             2   organized manner, which will allow and foster the development

             3   of principle-based standards, and I think improve the use of

             4   judgment, as was discussed this morning.

             5             MR. BELLER:  Thank you.  There are a number of

             6   cards up, but I'm going to ask one follow-up first, because

             7   I'm confused.  What is it, and I'll let any of you answer,

             8   but poor old Mr. Huber may be the natural audience for this

             9   question.

            10             What is it about the SEC's rules that precludes

            11   companies and their advisors, their auditors and their

            12   lawyers from making sensible distinctions in their disclosure

            13   about material weakness A versus material weakness B.

            14             I will tell you, I'm not aware of anything.  So I

            15   guess I'd like to be enlightened.

            16             MR. HUBER:  Yes, it's always the warrior that comes

            17   up.  The answers, the rules do not differentiate.  Once you

            18   pass this threshold, once you go into material weakness, then

            19   the trigger mechanism for disclosure comes in.

            20             From my standpoint, the five W's, who found it,

            21   what is it, why did it happen, how does it affect your

            22   financial statements, what are you doing about it, who's

            23   doing it and when is it going to be fixed, comes in.

            24             The fact of the matter is by your description, you

            25   will in essence differentiate in embedded material weakness

             1   from a one-time kind of disclosure problem, either disclosure

             2   controls or procedures that are ineffective, tax or something

             3   like that.

             4             My point, though, is a different one.  My point is

             5   in terms of the disclosure policy that you're trying to come

             6   up with, the heart of this definition is SAB 99.  From my

             7   standpoint, SAB 99, which has a bridge to the financial

             8   statements, is an issue with respect to material weakness,

             9   because a lot of people, and this goes to the standard as

            10   well as how it's being applied, are applying it in a way that

            11   scoops up a lot more than what everybody on this panel and

            12   the prior panel was talking about investors really should

            13   know about, as opposed to it's nice to know about.

            14             So therefore my answer is the rules require you to

            15   go into material weakness.  They don't require you to go into

            16   significant deficiency.  I don't think this is an issue with

            17   respect to AS-2, as much as it an issue with respect to the

            18   concept of materiality and how it should be applied.

            19             For example, a material weakness that is pervasive

            20   and is going to take a long time to fix, is different than

            21   one that was identified before 12/31/04, was fixed before the

            22   10-K was filed, but the outside auditor on the measurement

            23   date is going to say you have a material weakness, and there

            24   is going to be an adverse opinion coming in with respect to

            25   404.

             1             Even though the management can say "We fixed it." 

             2   It's one of the most frustrating things, incidently, if you

             3   want to talk to management, is the CFO that looks at you and

             4   says "We fixed it.  Why do I have to carry this cross?"

             5             So the fact of the matter is, that's the way the

             6   disclosure system works, and I would respectfully submit that

             7   the tinkering necessary to fix that would go a long way

             8   toward making this disclosure much better, and implementing

             9   what I think is the purpose here, which is the canary in the

            10   mine shaft.

            11             MR. BELLER:  I see Chairman McDonough has his card

            12   up.  I'm going to pursue this one more round, if I could. 

            13   Ms. Franklin.

            14             MS. FRANKLIN:  I wanted to add an anecdote to this

            15   discussion about material weakness.  I want to say first yes,

            16   to Commissioner Glassman's question.

            17             The anecdote is this, and this happened in a board. 

            18   This is not a committee happily, an audit committee that I am

            19   chairing.  But it's a situation that I know a lot about.

            20             There was a material weakness determined toward the

            21   end of the process by the auditor, and the auditor and the

            22   CFO and actually the CEO, as I'm told the story, got into

            23   this, and they really had a terrible time of disagreement. 

            24   Such that the lead partner in this case is going to be

            25   removed.  Somebody else is going to be put in there.

             1             There are two things here.  Number one, this was a

             2   material weakness that probably wasn't a terribly important

             3   material weakness, as I got the story.  There are material

             4   weaknesses and material weaknesses.  So I'm agreeing with

             5   what's been said here about more clarity and what's important

             6   and what needs to be put before the public, etcetera.

             7             But the other point is the rupturing of

             8   relationships that I think has occurred in many cases,

             9   through this 404 process because of the stress of it, and a

            10   few other aspects, between management and the auditors.  I

            11   think there are a couple of things going on here.  Some of it

            12   had to do with what everybody thought was required, and I

            13   believe auditors are -- forgive me, those of you who are

            14   here, for saying this, but I think the firms are afraid.

            15             After you get to the situation of Andersen going

            16   down the drain, and then you have a new regulatory body, and

            17   not sure quite what that's going to be, not sure what the

            18   inspections of 404 are going to be.  I think auditors are

            19   afraid.

            20             In the case I'm talking about, when we partners

            21   said well, look right here.  It says this, and management you

            22   are being way too literal.  Well, I think the auditor can't

            23   help himself.  He has to be literal, because he's afraid of

            24   the situation he's in in this environment.

            25             So I think there's this kind of issue that we need

             1   to resolve.  How this gets resolved, I don't know.  How do we

             2   have auditors employing more judgment, a little more

             3   flexibility on all sides of the question.  But it really

             4   comes back to what is, in this case, what was the material

             5   weakness.  I'm worried about these relationships going

             6   forward.

             7             MR. BELLER:  Mr. Hage?

             8             MR. HAGE:  Just from the preparer and creator of

             9   the chaos out of this argument, I'd like to offer some

            10   observations.  I think that one of the problems is the notion

            11   of rule-based versus a principle-based concept here.

            12             In my experience, infernal controls in our company

            13   have been established as the culture of our company, and they

            14   were long-standing long before I came on the scene and were a

            15   part of my basic training.

            16             The observation is that they're continually

            17   evolving.  That isn't to say they're in a state of flux.  But

            18   they are always being reviewed, always in a state of being

            19   improved.

            20             For an audit examination to come in and at a point

            21   in time look at it and say "Okay, this is what I saw today,"

            22   may not clearly describe the environment of the company or

            23   the situation as a reality.  So to me, there has to be some

            24   balance of what's the underling culture and discipline here? 

            25   That has to balance off, you know, that on this day, this

             1   event wasn't properly in place.  But there was a process,

             2   there was a system to eventually get there.

             3             Risk-based is really important, I think.  To

             4   suggest that all failures of internal control are material is

             5   of the same magnitude as a gross overstatement and

             6   misrepresentation.

             7             I think, too, there has to be some redress to the

             8   qualifications of the person making the observation.  We're a

             9   smaller company and perhaps we don't get the highest, most

            10   experienced auditors on the audit team.  I think we've had

            11   good people, but every year we have at least a third of the

            12   team freshmen out of college, who are making their first

            13   experience on our premises.

            14             We teach them a lot, and at the end of the day, be

            15   subject to the student telling the teacher what's right and

            16   wrong about our process.  So most of that is not being

            17   brought out in the kinds of rules we're talking about here.

            18             So I would caution us to draw the conclusion that

            19   at the end of the day, only the auditor is absolutely

            20   correct, and no matter what management may have done, they're

            21   wrong.  I think there is room for the balance of experience

            22   and interpretation.

            23             So it's a multidimensional thing.  I'm not sure

            24   it's as simple as saying there can be one rule, one process

            25   that will solve the problem.

             1             MR. BELLER:  Okay, thank you.  Chairman McDonough?

             2             MR. MCDONOUGH:  I have three quick comments.  First

             3   of all, if there is a material weakness and the issuer says

             4   we have solved the material weakness after the date of the

             5   certification of the financial statement and of the internal

             6   control by the outside auditor, we have proposed a new

             7   standard which will allow that to be corrected in the course

             8   of the year, and that's one of the reasons we have it. 

             9   Common sense prevails.

            10             I'm really rather disturbed to hear about a lead

            11   partner being withdrawn because he or she didn't get along

            12   with the CEO and the CFO.  Rather to the contrary, I would

            13   think that if the top management of the audit firm felt that

            14   the partner was correct, they should resign.

            15             I don't think that we can have lead partners

            16   bullied into thinking that they've got to get along with the

            17   CEO or CFO or they're going to get canned.  I think that that

            18   is just very, very bad public policy.

            19             MS. GILLAN:  I would agree with that, Bill.

            20             MR. MCDONOUGH:  Jim Copeland mentioned that it

            21   would be good if the PCAOB had more investor input into our

            22   creation of standards.  Our standing advisory group on our

            23   standards has 30 people.  A distinct minority of those, like

            24   six or seven, are auditors.

            25             The rest are investors, issuers and even a few

             1   lawyers.  But for an example of the importance of investors,

             2   when we put out our proposed standard on the tax services

             3   that an audit firm could provide to an audit client, we were

             4   particularly interested in how investors felt about that.

             5             Through the work of the standing advisory group,

             6   through the very active contacts we have with investors, it

             7   turned out that some of the most congratulatory comments made

             8   on this proposal, which actually leaves the audit firms to do

             9   most of the old fashioned audit work.  We got them out of the

            10   knotty contingent stuff they should never have been in, for

            11   moral if not other reasons, and we say that they cannot do

            12   the personal tax returns of senior managers in line of

            13   financial reporting.  But essentially we leave the most other

            14   things.

            15             Well, needless to say the audit firms thought that

            16   was a pretty good idea.  What we were really interested in is

            17   how investors felt about it.  The reason that we felt that we

            18   could go forward and will continue to go forward is because

            19   of the strong positive investor reaction.

            20             MR. BELLER:  Thank you.  Ms. Gillan.

            21             MS. GILLAN:  Thank you.  I wanted to follow along

            22   that same line, and I've been intrigued with some of the

            23   comments both by this panel, as well as the first panel,

            24   about how investors have reacted to the reports that we have

            25   seen to date.

             1             I think Mr. Turner made the point that it has been

             2   on a case by case basis, which I applaud the investment

             3   community for not taking kind of a blanket or knee-jerk

             4   approach to these disclosures and looking at them.  I know

             5   the credit agencies have done this as well in determining

             6   what is really important to them going forward and what's

             7   not.

             8             This panel has suggested that perhaps that should

             9   guide a change, perhaps, in what is reported to investors and

            10   kind of learn how the investment community has reacted, what

            11   they consider to be more significant.  Rather than sort of

            12   speculate as to what investors want, should or need, I was

            13   jus hoping we can perhaps get some comments from the

            14   downstream users, Mr. Anson and Mr. Jonas, as to whether they

            15   would like fewer things reported to you.

            16             MR. ANSON:  Well, I guess I'll start and see what I

            17   can do to answer that.  First, before we had Section 404 of

            18   Sarbanes-Oxley, and we've heard my earlier comments, the

            19   whole stock market discounted financial statements in total. 

            20   That's why we had such a high equity risk premium in 2002

            21   across the whole stock market, because collectively we didn't

            22   trust the financial statements of all public companies.

            23             Now with the advent of Sarbanes-Oxley and Section

            24   404, we can now focus and localized our lack of trust on

            25   individual companies.  But this is a good thing, because we

             1   can focus in and drill down and find out what is wrong; is it

             2   a material weakness, and then we can use our judgment.

             3             Now there is the judgment of the auditor in

             4   reporting it to our management.  There is the judgment of

             5   management and how they disclose it in their financial

             6   statements.  Last, there is the judgment of investors.  How

             7   do we interpret it?  Do we think this is sufficiently

             8   red-flagged that we need to discount this company more

             9   heavily?

            10             We always like more information rather than less,

            11   and greater transparency than opaqueness.  But I think to the

            12   extent that affirmation comes out, we will look at companies

            13   on a one-by-one basis, and look for those where we think

            14   there truly are material weaknesses.

            15             You know, we're pretty smart people.  Just give us

            16   the information.  We'll know what to do with it.

            17             MR. BELLER:  Mr. Jonas.

            18             MR. JONAS:  Well, put us in the camp that not all

            19   weaknesses are created equal.  Last fall, we published a

            20   framework for thinking about which ones we were going to

            21   think was a big deal and which ones we weren't.

            22             I'm finding that after looking at all the companies

            23   that have reported material weaknesses, that it doesn't take

            24   us long, provided we have some details in the disclosure, it

            25   doesn't take us long to distinguish between those that we

             1   care about and those that we don't.

             2             Just a couple of brief statistics.  So far, 93

             3   companies that our rating agency rates have reported

             4   weaknesses, and of these we have considered 71 of the

             5   companies in detail with the rest yet to go, mostly because

             6   the data is still very fresh.

             7             We have -- of the 71 cases we've considered

             8   closely, we have had negative rating action in 12 of those

             9   cases, which is roughly 20 percent of the cases.  Which means

            10   in 80 percent of the cases, we're pretty relaxed about the

            11   nature of the control weaknesses that are reported.

            12             Now what I would observe, though, would you

            13   conclude from that that we ought to have a dramatic reduction

            14   in the number of weaknesses that companies talk about, and

            15   then, you know, maybe I would find that acceptable if you all

            16   were to adopt our particular framework for thinking about

            17   this.

            18             But I suspect that you're not, and I suspect that

            19   investors differ in their views about what's important and

            20   when, just as they differ on about every other issue.  That's

            21   what makes a market.

            22             So my vote would be the hold the course, report

            23   material weaknesses.  I don't think we have a robust amount

            24   as we do today.  Let the market figure out what's important

            25   and what's not.  I don't sense market overreaction today.  I

             1   do sense a balanced, measured approach on a case-by-case

             2   basis, and it seems to me that that's a reasonable way to

             3   proceed.

             4             MR. BELLER:  Mr. Kueppers, you have your card up?

             5             MR. KUEPPERS:  Yes, I remembered that.  Thank you. 

             6   Thank you, Alan.  I think one of the things we have to keep

             7   in perspective, and the eight percent number's been mentioned

             8   as sort of the scorecard so far.  In other words, eight

             9   percent of companies reported had material weaknesses.

            10             You know, John's point earlier.  Yes, they're

            11   different.  They may not all be the same, but you know, they

            12   all have met a threshold, sometimes using judgment, of a

            13   single common definition.

            14             The system we have has one class that is very

            15   public, one class significant deficiencies that's largely an

            16   internal reporting mechanism, and then another class that

            17   just doesn't, you know, just gets dealt with by the company.

            18             You know, several have mentioned a 270-some

            19   average, and that's exactly what your survey showed as well. 

            20   The truth is that many of the routine things are getting

            21   dealt with very routinely, and they don't deserve or require

            22   public disclosure.

            23             I think that's what you want.  You want constant

            24   repairs and maintenance on controls, as opposed to some of

            25   the catch-up we had to do this year, given the point made

             1   earlier about deferred maintenance.

             2             So I'm inclined to leave sort of this three-tiered

             3   system.  I mean, it is the design of the standard.  There are

             4   two issues with the definition that are sensitive; perhaps

             5   one is material, which John mentioned.  The other is interim

             6   has the same sort of status as annual, and that also creates

             7   a larger number of weaknesses and I'm not sure what to do

             8   with that.

             9             I will just point out that having interim in there

            10   does sort of change, you know, the calibration of the system.

            11             One more point, and this is very much off the point

            12   that I was just making, to Barbara's point about tension. 

            13   You know, I really do believe, and this is based, you know,

            14   this is maybe anecdotal but it's based on my experience in

            15   working with our clients and with my partners.

            16             There is much more tension today than would have

            17   been evident, you know, a couple of years.  I think a certain

            18   level of that is the result of 404 may be the topic de jure;

            19   it certainly is today while here.

            20             But I think it's also become sort of the repository

            21   for other changes and feelings about those other changes,

            22   whether it's frustration of getting, you know, good

            23   accounting advice from your auditor that used to be sort of

            24   just second nature and now seems to be a struggle.

            25             Some of the other changes about audit committee

             1   relations, rotation.  I mean, all the reforms that have come

             2   through in the last couple of years have aggregated into, in

             3   many ways, the focus on 404.

             4             I think that many people would expect there would

             5   be a healthy level of tension by the auditors, with

             6   management, in the audit committee room, in the board room

             7   when necessary, and it's very hard to measure when it's too

             8   much or when it's unhealthy.

             9             But I really believe a certain amount of that is

            10   the whole point.  I mean, auditors aren't the most positive

            11   people.  We tend to look for problems as opposed to anything

            12   else.  But you know, I sort of sense that that's what we're

            13   getting paid to do.

            14             I do believe the one area that could make a

            15   tremendous difference in the attitudes, and I think our

            16   colleagues at the SEC and the PCAOB can help us tremendously. 

            17   I think this notion of not giving accounting advice to audit

            18   clients on the fear either that it will breach independence 

            19   rules or that they aren't good enough so they have material

            20   weakness has just gotten completely off track.

            21             We have to be able to work with our clients on

            22   these complicated matters or nobody's going to get it right. 

            23   I think we have to get some sensibility back into that part

            24   of the equation.

            25             MR. BELLER:  I actually want to follow up on the

             1   tension point with Mr. Copeland, as an audit committee

             2   member.  Take not Ms. Franklin's scenario, and certainly not

             3   Ms. Franklin's outcome, which I think we probably all agree

             4   is the inappropriate one.

             5             How does an audit committee react when there is a

             6   completely honest, completely good faith, completely at

             7   loggerheads disagreement between management and the outside

             8   auditors with respect to whether there's a material weakness?

             9             MR. COPELAND:  Well, and I actually have not seen

            10   that event where it was not resolvable.  If I had been

            11   involved in that situation, I would have been Looking for an

            12   audit committee advisor to try and bring closure to that

            13   issue.

            14             Let me just say, though, that I'm aware of at least

            15   one other situation where, as in the issue that Barbara

            16   mentioned, there was a difference of agreement.  The

            17   auditors, the internal auditors and the CFO raised tone at

            18   the top issues.

            19             The CEO's solution to that was to fire those

            20   individuals.  The audit committee's approach to changing the

            21   tone at the top was somewhat different.  I think that

            22   Chairman McDonough would be happy with the resolution of that

            23   issue.

            24             PP  Me too.

            25             MR. COPELAND:  Now let me, if I can, with the

             1   privilege of the floor, just mention one other thing, and

             2   that is with response to Chairman McDonough's comment about

             3   the process.

             4             There is a process there and I have had access to

             5   it and I don't feel the least bit restricted in my ability to

             6   bend his ear on occasion.  But I've been told for years now

             7   when I was wearing my other hat as CEO of Deloitte that

             8   perception is really, really important.

             9             That is not the perception.  The perception out

            10   there is that the issuers do not have access to the SEC on

            11   issues of guidance about their extended scope and testing

            12   under 404, and they don't have access before the fact, to the

            13   PCAOB on issues that will profoundly affect them.

            14             So I will just say, as having been party to a

            15   profession that got beaten about the head and shoulders about

            16   perception, I would just encourage the participants in this

            17   process to accept the fact that the perception out there is

            18   that people don't have access and ability to influence things

            19   that are going to profoundly affect them, and long-term

            20   that's not good.

            21             MR. BELLER:  Thank you.  Mr. Nusbaum, you've had

            22   your card up for a while and have been very patient.  I want

            23   to respond to something Mr. Anson said, and our experience

            24   shows, and I think everyone would agree, that the reporting

            25   as well as the testing, but the reporting on internal

             1   controls and on the process has improved the quality of the

             2   financial statements and the reliability of the financial

             3   statements.

             4             While it may not eliminate all collusive fraud

             5   certainly, it certainly will reduce, I think, the likelihood

             6   of material financial statement fraud.  But internal controls

             7   are not just about the financial statements, and Mr. Anson

             8   referred to all of the other financial information that is

             9   used to make investor decisions.

            10             I think there is an area opportunity for us to look

            11   at internal controls on a broader level, and I'm not talking

            12   about operational controls.  But internal controls and the

            13   recording of financial information, other financial

            14   information.

            15             Our experience is by improving the controls on the

            16   financial statements, there has been maybe an unintended

            17   consequence that's a good one, to improve the controls over

            18   the reporting of other financial information.

            19             But there's an opportunity for us and I think a

            20   requirement for us to focus on how to improve the quality and

            21   reliability of the vast amount of other financial information

            22   that investors use to make decisions.

            23             MR. BELLER:  Mr. Huber, you've also been patient.

            24             MR. HUBER:  I want to go back to the comment about

            25   the marketplace and the need for information and disclosure. 

             1   My son is a buy-side analyst.  He's a charter financial

             2   analyst.  There's no amount of information you can give him

             3   that will satisfy him.

             4             He wants more all the time, just like in the movie

             5   with David Copperfield.  The fact of the matter is at a

             6   certain point the regulatory system has got to draw a line

             7   with respect to what the purpose of the regulation is, what

             8   the cost of the regulation is, and what disclosure is being

             9   put out there.  Otherwise, you will have regulatory

            10   dysfunctions.

            11             Moody's has already come up with a two bucket

            12   standard.  If you look at institutional shareholder services'

            13   Friday report from April 8th, they now have a eight-point

            14   grid.

            15             As a person who is supposed to link this with

            16   companies, I don't know whether I should follow the Moody's

            17   approach, the ISS approach, the SEC approach, which approach. 

            18   Because we're going to fracture this disclosure system soon,

            19   if some additional guidance isn't given with respect to what

            20   material weakness is and what it isn't.

            21             Because we're hearing sort of a uniform theme here

            22   that the analysts are going to discount the little stuff, but

            23   they still want it.  But I would respectfully submit the

            24   companies will not really tolerate the littler stuff when

            25   they see no need for it.

             1             It's the bridging of that gap, pardon my pun.  It's

             2   the bridging of that gap that I would respectfully submit is

             3   the job of the SEC and the PCAOB.

             4             MR. BELLER:  John, is the point -- maybe it's both

             5   points.  But is the point that the definition of material

             6   weakness sweeps in too many deficiencies, or is the point

             7   that once you've set that level, once you've set that

             8   materiality standard at an appropriate level, companies and

             9   their advisors are unable to make differentiations on their

            10   own between what's a material weakness that is a material

            11   weakness but shouldn't keep you up at night, and what's a

            12   material weakness that should keep you up at night?

            13             MR. HUBER:  It's the second, from my standpoint

            14   Alan.  I think what's really important is everybody is taking

            15   this area seriously.  Companies are taking it seriously. 

            16   Audit committees are taking it deadly seriously.  Auditors

            17   are.

            18             The fact of the matter is, in terms of 404, the

            19   threshold obtained is a material weakness.  It's not a, you

            20   know, little material weakness or a big material weakness. 

            21   It's a material weakness.  So therefore the system is

            22   predicated on that, and my suggestion from a disclosure

            23   policy standpoint is make changes to the materiality part of

            24   material weakness.

            25             That's something the SEC can do.  PCAOB doesn't

             1   have to do that, and the system will -- the other pieces of

             2   this system will work better.

             3             MR. BELLER:  Mr. Cyprus.

             4             MR. CYPRUS:  Just a couple of points.  One, you

             5   know, when we were talking about tension.  I actually think a

             6   little bit of tension is healthy.  I not only have a little

             7   tension in my auditors; sometimes I have tension with my own

             8   management team, you know, as we all talk about issues.  It's

             9   natural.  It's a good thing.

            10             Two, I believe that the issue of auditors being

            11   responsive to you when you deal in technical issues, I'm

            12   guessing that that might be more of an issue for companies

            13   that might not have technical staffs available to them.

            14             Because I have a pretty good technical staff, and I

            15   haven't really noticed that being an issue, because

            16   management usually makes the decisions.  Management usually

            17   analyzes the situation.  Management usually goes to the

            18   auditors and says "I think this is what we ought to do," and

            19   then it's appropriate for the auditor to comment, and that's

            20   what we've seen.

            21             So we haven't seen the auditor say "I'm sorry, we

            22   won't analyze."  What I have seen and what I have heard was

            23   when someone went to the auditor and says "Here's a

            24   transaction, what should I do?"  Well now you've got a

            25   different situation, and I think you've got to be specific

             1   between these nuances of what you're saying.

             2             Unless you're a company that doesn't have those

             3   capabilities, in which case what you'll need to do is figure

             4   out how to, in essence, get it.  You can buy it externally

             5   from -- there are other sources to get that help, all right. 

             6   So I think we have to be really careful.

             7             I also think that when you're dealing in those

             8   particular issues, I think it depends on who the staff is.  I

             9   just think different partners react differently, and you've

            10   got to sort of figure that piece out.  But I'm not seeing

            11   that as the overwhelming problem.  But I would see it as an

            12   issue for small businesses.

            13             What I was going to follow up is just that I have

            14   two more brief points as to the comments that were being

            15   made.  As far as disclosure of material weaknesses, you know,

            16   I think management has enough flexibility to disclose what it

            17   believes is a big weakness versus a little weakness.

            18             So I think the flexibility's there to get the

            19   points across.  On the other hand, if you think about it, I'm

            20   trying to figure out myself, if I think about the definition

            21   of a material weakness as more than a remote likelihood that

            22   something could go bump in the night.

            23             Well, if something could go bump in the night, in

            24   other words, you could have a material change to your

            25   financial statements, I find it hard to believe that that's

             1   not a material weakness that needs to be disclosed.

             2             So are we trying -- I'm a preparer too, and so to

             3   me, I think it's pretty clear if you read the types of

             4   material weaknesses, and I've disclosed probably nine control

             5   activities and other areas of material weakness.

             6             I think someone could go through mine and say

             7   "Revenue, that's a big one.  This one's a big one.  Now these

             8   aren't as big."  Any one of them, right, have a chance of

             9   more than a remote likelihood to have an impact on my

            10   financial statements.  So tell me which one I should decide

            11   not to disclose.

            12             So I might have a different point of view on that. 

            13   I think someone else can make the decision of what's more or

            14   less important to them.  I think we as preparers need to

            15   disclose it.

            16             The last issue, and I want to revert back to

            17   something that was done on Panel 1.  Robert Burroughs made a

            18   statement about financial reporting deadlines.  For those of

            19   us who do have control issues, and need to take time to make

            20   sure we address those issues in our financial statements, I'd

            21   like to encourage keeping the freeze on.

            22             If we move those deadlines forward, I could tell

            23   you that companies like mine and smaller businesses that need

            24   time to get good assurance around its results, will have a

            25   more difficult time that could either lead to more risk or,

             1   frankly, missing the deadline.

             2             So I would like to at least put that out there for

             3   you consideration.

             4             MR. BELLER:  Thank you.  I'm going to end this by

             5   Commissioner Goldschmid had his card up, and we'll --

             6             COMMISSIONER GOLDSCHMID:  Oh no.  I put it down, so

             7   we could hear from the others.  But, well two quick comments. 

             8   One is constructive tension is the language I like to use for

             9   our burden.  We don't want to go over that, I think.

            10             COMMISSIONER GLASSMAN:  It's my language as well,

            11   yes.

            12             COMMISSIONER GOLDSCHMID:  The other is that the

            13   disclosure system for material weakness is as principled as

            14   the United States will ever get.

            15             The idea was to give you lots of room to explain,

            16   and whether it's S&P or some other standard, you have room to

            17   write it in a way, take a look at what the market wants, and

            18   write it in a way that will explain "This one is a six-month

            19   problem; we'll get rid of it.  It's a one-shot affair and

            20   it's material but not all that big a deal.  This one is 12

            21   years and it's really deep."

            22             Write it.  Tell us, and then the market, the

            23   analysts and everyone else, including your son, John, will

            24   understand.

            25             MR. BELLER:  With that, I will close this panel. 

             1   Time is over.  I'm going to ask the audience, please, Panel

             2   No. 3 is going to start immediately.  We're just going to

             3   switch people and cards.

             4             So please, don't leave your seats.  This is not a

             5   break, and I'd like to thank the panelists, each and every

             6   one.  A very good discussion.  Thank you very much.

             7             (Break.)

             8                 PANEL THREE - PLANNING AND DESIGN

             9             MR. BELLER:  I think we're ready to get going with

            10   Panel No. 3 and we'll continue.  Thank you very much for

            11   sticking with us, and we thank you in particular for this

            12   very quick turnaround.

            13             Getting started here, I think we will just remind

            14   you, and I think most of the panelists have been here, so we

            15   don't need to get into too much detail.  If you want to

            16   speak, card goes up.  No opening comments.  No detailed,

            17   lengthy ten-minute dissertations, and we say that in the

            18   interest of respect to all the panelists.

            19             The Commissioners and the board members are of

            20   course encouraged to participate and ask questions, and they

            21   too will put their name tags up at the appropriate moment.

            22             Let me introduce Andy Bailey.  Andy is my deputy,

            23   and heads up the Professional Practice end of what we do in

            24   the Office of Chief Accountant.  That means he has an awful

            25   lot of contact with the PCAOB, and with the audit profession,

             1   and has oversight of most of the audit areas.  So with that,

             2   Andy, you want to get us started?

             3             MR. BAILEY:  I'll try to do that.  I think we're

             4   now moving into the sessions that get us down kind of on the

             5   ground, with respect to the actual documentation and testing

             6   that takes place.

             7             404 requires that management design and operate and

             8   test their own internal control systems, in order to make an

             9   independent assessment, while AS-2 requires auditors to test

            10   management's assertions and also test sufficiently to arrive

            11   at an independent assessment about performance of internal

            12   controls.

            13             Because the auditors all dependent so heavily on

            14   management traces, management and the auditor must ultimately

            15   agree on the scope and extent of testing necessary to

            16   accomplish both goals.

            17             I'm going to open with a fairly general question on

            18   this, and then we're going to proceed to a series of

            19   questions that have to do with issues that have been raised

            20   already, definitions of material weakness, what we mean by a

            21   risk on materiality issues, in terms of driving the extent of

            22   testing.

            23             Let me introduce the panelists.  From my left,

            24   working to the right, Chuck Bowsher, former Comptroller

            25   General of the United States or the Honorable Charles

             1   Bowsher.

             2             Frank Brod, VP and Controller of Dow Chemical and

             3   chair of the FEI Committee on Corporate Reporting.

             4             Alex Davern, Chief Financial Officer and Senior

             5   Vice President of Manufacturing and IT Operations of National

             6   Instruments, and chairman of the American Electronics

             7   Association Committee on the Reform of Sarbanes-Oxley 404.

             8             Lisa Flavin, Vice President, Audit, Emerson

             9   Electric.

            10             Jay Haberland, Vice President, Business Controls,

            11   United Technologies Corporation.

            12             Damon Silvers, Associate General Counsel of the

            13   AFL-CIO.

            14             Dr. Albert Teplin, Audit Committee Chair of Viad;

            15   Audit Committee member of Moneygram International.

            16             James Turley, Chairman and CEO of Ernst & Young,

            17   and Richard Ueltschy, Executive in Charge of Financial

            18   Institutions Audit Practice, Crowe Chizek.

            19             If I don't identify you or Don doesn't when we call

            20   on you, would you please identify yourself for the broadcast

            21   audience that does not have video.

            22             Turning first to Mr. Bowsher then, in your prepared

            23   statement, you indicated that the communications between

            24   management and the auditor need attention; that both

            25   management and the auditor may have made too little use of

             1   risk-based approaches to planning, design and testing; that

             2   auditors may have placed too much reliance on the work of

             3   others; and that the net result was an excessive duplication

             4   of work.  Quite a mouthful.

             5             If this is the case, what are the needs, the top

             6   priority needs for change, that have to be accomplished going

             7   forward.

             8             MR. BOWSHER:  Okay, Andy.  That's what I said in my

             9   prepared, and that's the way I do feel about it.  I do want

            10   to say though first, I also said in my prepared that I

            11   thought we made a lot of progress here in Year 1, and I think

            12   a lot of the people that worked very, very hard in the firms, 

            13   the auditing firms, have brought us a long way on 404.  I'm

            14   very pleased where we're at right now.

            15             I do believe, though, that we now have the

            16   documentation in front of the audit committees and in front

            17   of the managements that allow us to become much more

            18   efficient and effective in the second year and in the third

            19   year.  I hope that will also play into the way the assessment

            20   is done by the external audit firms.

            21             What we really have today for the first time is we

            22   have our accounting system documented by different processes. 

            23   We have it rated by risk.

            24             We have -- where we had some weaknesses going

            25   through this past year, where we got it remediated, and when

             1   we finally get our final report from the external audit firm

             2   and this company that I'm on the audit board, we had three

             3   material weaknesses -- three significant weaknesses and no

             4   material weaknesses.

             5             So we now literally have a report pride, and we

             6   know what we have to do here in the second year in that.

             7             Also, I think it is also incumbent upon the

             8   leadership of the companies and the audit committees to say

             9   how can we improve our financial management systems.  How can

            10   we modernize them so that they are not as costly to operate,

            11   and also not as costly to assess.

            12             In other words, we have to do management assessment

            13   every year.  We have to do an external audit assessment, and

            14   we really want to get either through centralization or

            15   computerization or outsourcing, whatever it takes to really

            16   get down to a financial management system that is very

            17   cost-effective.

            18             Then at that point, I hope we can get the

            19   assessment process down to a cost-effective.  I do believe

            20   that there was some miscommunication or misunderstanding

            21   between the PCAOB and the auditing firms this past year.

            22             But I think that can be corrected, and I know I've

            23   been talking.  I'm on an advisory committee to the PCAOB and

            24   I know they want to get it right, and I'm sure the accounting

            25   firms do too.

             1             So I think what we want to do is make sure when our

             2   engagement partner comes into our meetings, that he doesn't

             3   feel like he can't talk or discuss issues and things like

             4   that, which there was some of that this past year.  We want

             5   him to be or her to be a major partner, and how do we do this

             6   better the second and third year.

             7             One of the questions is how much work does the

             8   internal audit function do, and how much reliance does the

             9   external auditor place on that work.  I think that was not

            10   sorted out too well the first year, which you can expect.

            11             But I think we ought to get it sorted out very well

            12   in the second and third year here, so that we're not spending

            13   a lot of money for duplication, especially on the lower risk

            14   areas.  The higher risk areas, of course, you don't want to

            15   ignore them at all in the subsequent years.

            16             So I think you really needed some real good

            17   planning and meetings here, and I was a little disappointed

            18   at one of my audit committees, where I got next year's

            19   estimate, which was not much lower than this year's for the

            20   404 work by the external auditor, without ever suggesting we

            21   even have a meeting.

            22             In other words, I really think now in the next few

            23   weeks and months here, we ought to be getting together, the

            24   external auditor, the internal auditor, the CFO, all the key

            25   players, and especially even some of the people down the

             1   line, where they've had the delegation down there, that they

             2   own the process in the larger companies.

             3             So I think there's a lot of opportunity here to

             4   make cost savings, but also more effective assessments.  But

             5   it should also be based on trying to get a more effective and

             6   efficient accounting and financial reporting system at each

             7   company.

             8             MR. BAILEY:  Thank you.  We're going to try to

             9   delve into some of those detailed issues.  But before that,

            10   Dr. Teplin I know recently is an audit chair of an audit that

            11   was recently completed, and so had to go through that process

            12   this first year.  He was also a committee member on a firm, a

            13   company that is about to enter this process.

            14             I'm kind of wondering what your first experience

            15   was in getting the communications among the stakeholders, in

            16   order to get a reasonable plan, and what you think you're

            17   going to recommend as changes as you go forward with this

            18   second part?

            19             DR. TEPLIN:  Well, you're right, that we did -- at

            20   Viad, we did complete our audit at the end of this year or

            21   file early this year, and at Moneygram International we're in

            22   the process.  I wouldn't say that we're about to begin.  I

            23   would say that we're into the process.

            24             I think that first of all, the 404 clearly focused

            25   the attention of the audit committees that I'm on at least,

             1   and I'm sure all of them, on these internal controls.  We

             2   pushed and I'm sure that others pushed to make this, of

             3   course, a top priority work, using it as an opportunity to

             4   sharpen the controls that were in place.

             5             But we also, as we went through the process of

             6   scoping out the work and then carrying out the work, we found

             7   some surprises.  One, of course, was the cost.  Everybody

             8   underestimated these costs.  We underestimated our own

             9   internal costs.  The auditor underestimated their costs.

            10             I would not minimize the tension that was added to

            11   the system.  I agree.  Some of this tension probably was

            12   necessary.  However, at some point, and I think I'm beginning

            13   to believe we've reached that point, some of these tensions

            14   are non-productive.

            15             So far in 2005, we're looking for ways at Viad to

            16   refocus the process, to make it more cost-effective and so

            17   on, and looking for some fuller guidance and so on.  We were

            18   able to use, I think, our experience going forward into

            19   Moneygram, or at least I was.

            20             Of course, it was a spinoff.  So that the people

            21   that are on the Moneygram board were aware of what Viad was

            22   doing, and make the scoping process much more -- much

            23   sharper.  I think that one problem or one issue that we

            24   developed is where in the scoping process does the outside

            25   auditor come in.

             1             If they're not -- obviously you don't want your

             2   outside auditor, or they don't want to tell you they're going

             3   to audit this, this and this, all right.  So what happened I

             4   think in some companies, at least our experience was, that we

             5   thought the auditor was going to audit the middle of the

             6   onion.  We wanted to look at the whole thing around it, and

             7   make sure we captured everything.

             8             I think that some of that experience is being used

             9   now by Moneygram, and it's a much more focused process, and

            10   process that probably will be somewhat cleaner, although I

            11   don't think it's going to be less costly.

            12             MR. BAILEY:  To pursue a little bit further the

            13   tension issue and the potential imbalance we see in many of

            14   the letters coming through, that in this planning process,

            15   because the auditors and management have to come to an

            16   agreement, there are disagreements.  We're hearing that there

            17   may be an imbalance in the relationship.  Mr. Davern, would

            18   you like to comment on that?  Do you have any experience with

            19   that?

            20             MR. DAVERN:  Thank you, Andrew.  Well, in this

            21   whole area, I think that there certainly needs to be some

            22   consideration of the relationship and where the balance lies. 

            23   From our work at the AEA, we've seen a number of significant

            24   problems with the implementation all during 2004, especially

            25   for smaller companies.

             1             There's been a lot of discussion here today

             2   obviously with bigger companies.  I think it's interesting

             3   that the first panel really bore out, I think, the real issue

             4   that is faced by the majority of public companies.  That is

             5   that the framework being applied, the COSO framework being

             6   applied were designed for large companies with multibillions

             7   of dollars of revenue.

             8             Therefore, for them the implementation and their

             9   position as a valued client of a large auditor, is

            10   appropriate.  From our role, the average cost for large

            11   companies of more than $5 billion is about .05 percent of

            12   revenue.  However, the situation is dramatically different

            13   when you shift profile down to companies of less than $100

            14   million.

            15             Obviously significantly less valued as clients

            16   generally, because of their size and perceived risk, and from

            17   our estimates the average cost is about 2.5 percent of 

            18   revenue or about 50 times greater relatively for a smaller

            19   company than it is for a large company.

            20             It's also, I'm sure, well-appreciated by all the

            21   members of the Commission and the board that a large number

            22   of public companies are less than $100 million of revenue,

            23   although they make up a very small percentage of the market

            24   cap of public companies.  They make up less than ten percent

            25   of the market cap of public companies, and therefore of the

             1   risk to investors.

             2             In terms of the balance of relationship, when we

             3   looked at the issue from an AEA perspective, and the majority

             4   of our members are small companies, we see a number of issues

             5   that drive the costs disproportionately.  Those really rank

             6   in terms of number one, a lack of a small company framework

             7   which we talked about yesterday in the advisory committee

             8   meetings.

             9             Number two, is a checklist approach where most

            10   small company CFOs felt they had very little negotiating

            11   power in discussing with the external auditor how the

            12   approach would actually happen.

            13             I think if you talk to the majority of small

            14   company CFOs, and I think I've talked to well over 100 in my

            15   duties as the chairman of the AEA Committee, they received a

            16   checklist and had a very difficult time convincing the

            17   auditors to change that.

            18             Now I will say in the auditors' defense that a lot

            19   of this comes from the late standards that were issued, and a

            20   lot of confusion as to what the standard and metric will be

            21   applied by the PCAOB in the examination process.

            22             As several other panelists have said already, I

            23   think the examination process that goes on later this year is

            24   a really critical element in determining whether we're going

            25   to turn the corner on 404 in 2005, and bring the costs and

             1   benefits into balance.

             2             Another issue that came up clearly from our members

             3   is the lack of competition, or certainly very strongly

             4   perceived lack of competition in the audit market for public

             5   companies.  I think that's a public policy issue that

             6   deserves serous consideration.

             7             I think the area of most frustration in this whole

             8   area of balance in what should and should not be done really

             9   came around the area of IT controls.  IT controls became a

            10   major, major focus during the process of 404 in 2004.

            11             We dealt with a situation where most audit partners

            12   and a vast, vast majority of the audit staff really did not

            13   understand IT controls, I'll say very well.  But in many

            14   cases, very, very poorly.

            15             They underwent some quick training and then they

            16   were put in a position where they were trying to assess and

            17   dictate how very experience IT Department managers should run

            18   their IT operations.

            19             I think that that lack of balance in the

            20   relationship, and maybe it's also a lack of balance in the

            21   relationship between the PCAOB and the Big Four that led to

            22   this, resulted in a massive, I think, focus on largely

            23   irrelevant IT costs.

            24             I'll just close by saying from our estimates at the

            25   AEA, 45 percent of this total effort was spent around IT

             1   controls.  That's about $15 billion, based on our estimate. 

             2   We estimate the total effort cost of about $35 billion for

             3   all public companies in the aggregate.

             4             We have looked very hard and cannot find a single

             5   major investor loss that resulted from a materially

             6   inaccurate financial statement filed with the SEC, as a

             7   result of a failure of IT controls.  Now I'm sure there may

             8   be some out there, but I've looked hard.  I can't find them.

             9             So my conclusion is we spent $15 billion on this

            10   issue to solve a problem that does not exist, and I think

            11   putting more balance back into the relationship and I think

            12   giving more guidance and showing through the examination

            13   process that auditors will be allowed to use their

            14   professional guidance would be greatly beneficial in

            15   reassessing this going forward.

            16             MR. BAILEY:  Mr. Turley, would you like to wrap

            17   this up with public accountants' view of how that

            18   relationship has developed in this last year?

            19             MR. TURLEY:  Yes, and in fact while we probably

            20   have done things differently, for now I think we have common

            21   ground on many, many points.

            22             A couple of panels have consistently said there's

            23   great value that's been generated, and good things coming out

            24   of 404.  The first one, I think, one thing that has been

            25   undercommented is the impact it's had in conjunction with 302

             1   certifications and cascading out around organizations, and

             2   the combined impact on the culture of the people within the

             3   clients that we serve, and their commitment to controls,

             4   their commitment to getting it right.

             5             But I think that by anyone's estimation, there was

             6   an awful lot of rough start-up issues, and on that

             7   profession, we'd be the first to say, you know, we'd love to

             8   get more guidance and make sure we get it right.  I think

             9   someone on the first panel talked about, I think the words he

            10   said is, you know, "What is it the standards require?"  They

            11   were already said.

            12             And I think more guidance would be beneficial for

            13   the profession.  I think more guidance for issuers would be

            14   very beneficial.  I think the inspection process, as Alex

            15   said, would be very helpful in terms of shaping issues, both

            16   in areas where the profession spent too little focus and in

            17   areas where we spent too much focus.

            18             So I think that all of these issues are incredibly

            19   important as we move forward.  You know, our submission

            20   points out there are some other areas where I think we need

            21   to really put our heads together, to figure out the best way

            22   both to continue maximizing the great positives that come

            23   from 404, but to also make sure that the first year

            24   efficiencies or inefficiencies are eliminated.

            25             The learnings that have come from enormous effort

             1   by issuers, by regulators, by profession are then transmitted

             2   to all the second wave of auditors.  So I think today's the

             3   beginning of that process.

             4             MR. NICOLAISEN:  Jim, let me follow up, if I may,

             5   with just a quick question, and Richard, if you want to join

             6   in on this you certainly can.  But in the Big Four

             7   submission, you describe that there were an average, I think,

             8   of 348 deficiencies that were noted per company.  For the 90

             9   companies it's not a lot better, it's 30-some thousand

            10   deficiencies that were encountered.

            11             Different people could draw different inferences

            12   from that.  One group of people may look at that and say

            13   "Perhaps the level of detail that's being identified as a

            14   deficiency is too low, or the threshold is set too low." 

            15   Other may say "Is this indicative that we have more of a

            16   problem in the control world than we might think?"

            17             When you cut through it, you've described that 96

            18   percent of those deficiencies don't meet the threshold of

            19   being a significant deficiency.  They're reported to

            20   management, but they don't have to go to the audit committee. 

            21   Only, I think, five out of 30-some thousand ended up being

            22   material weaknesses.

            23             How could you put that into perspective?  I think

            24   this sort of plays, and this is a complicated question, but

            25   it sort of plays into this whole question of materiality,

             1   which from what I gather from much of the discussion earlier

             2   this morning, sets the threshold as to how much work both the

             3   company does in documenting controls, and how much work the

             4   auditor does.  Maybe you can give us a little more feel

             5   around that?

             6             MR. TURLEY:  Before you do that, because it really

             7   leads into the next question.  We may as well just keep the

             8   whole thing moving.

             9             Materiality judgments and risk judgments drive the

            10   extent of documentation and testing for both management and

            11   the auditor.  So rather than just address it in the narrow

            12   sense, you might pick it up and we'll just keep moving on

            13   that issue.

            14             But let me frame some of the material that the Big

            15   Four send to you collectively.  Each of the firms thought

            16   that getting it from, you know, real, live data on this would

            17   be beneficial for you.  So while we each submitted individual

            18   firm letters, collectively we accumulated some data for

            19   submission.

            20             The number of deficiencies you talked about,

            21   roughly 350 per big company, were deficiencies identified by

            22   the management processes, not by the firms.  So they were

            23   going through and so at one level, you know, the level of the

            24   filter was driven by management.  Now --

            25             MR. NICOLAISEN:  Let me just ask a question about

             1   that.  Now some people have said that that filter, while it

             2   may have been management's filter, was driven in large part

             3   by expectations set by the audit.

             4             MR. TURLEY:  Heavily driven by working together on

             5   that.  You're absolutely right, Don.  Of the 350, what the

             6   data showed is roughly 75, 77 I think was the actual number,

             7   at year-end had not been remediated.

             8             The 96 percent you talked about was the 96 percent

             9   of the unremediated weaknesses, or those that were then

            10   categorized, if you will, as control deficiencies,

            11   significant deficiencies or material weaknesses.

            12             You know, auditors and everyone did not go through

            13   and have to, if you will, categorize and make the decisions

            14   on those that were remediated.

            15             My own gut feel from talking with a lot of our

            16   clients, a lot of our teams, is in fact that it was very much

            17   in management's and in fact the profession's focus that as

            18   many of those that would have been material weaknesses or

            19   significant deficiencies were probably addressed first.

            20             I can't tell you whether, you know, it's more

            21   than -- and how much more than four percent.  My instincts

            22   are that a lot more of those that were remediated than four

            23   percent --

            24             MR. NICOLAISEN:  There could have been more.

            25             MR. TURLEY:  --would have been either significant

             1   deficiencies or material weaknesses, because it's in

             2   everyone's interest to get that fixed.

             3             Certainly the flip side is those regular control

             4   deficiencies that were easy, quick fixes were just fixed.  So

             5   I think that, you know, the issue is actually more of a

             6   positive statement on the strengthening of controls that has

             7   been a result of this process.

             8             Because when I look at the number of identified

             9   weaknesses, deficiencies, and how many of them have been

            10   remedied before year-end and absolutely every one that is

            11   identified and remains unremedied is going to be fixed, I see

            12   that as being a huge positive.

            13             MR. BAILEY:  Mr. Ueltschy.

            14             MR. UELTSCHY:  Yes, I would, and I think that Jim's

            15   interpretation of the data is pretty accurate.  I would also,

            16   though, like to compare his comments to Mr. Davern's, and

            17   point out that there are some significant differences between

            18   the data coming out of these larger companies, and the middle

            19   market companies that were largely represented based on the

            20   statistics that Mr. Davern described.

            21             The companies he's talking about are mostly the

            22   companies that could take advantage of the exemptive order

            23   that the Commission permitted.  It's important to note that

            24   we're having this conference before that deadline has passed.

            25             I think we will probably see some increases in the

             1   percentages of material weaknesses reported as a percentage

             2   of total filings when those companies hit.  Our firm largely

             3   deals with those middle market companies, and I think what we

             4   have seen from this whole question of scoping and materiality

             5   and duplication of effort, is that that's not the real

             6   question from a resource standpoint.

             7             But the real question for those companies from a

             8   resource standpoint is the issue raised in Panel 1 about mind

             9   share and opportunity costs and understanding.  Many of the

            10   companies that could take advantage of the exemptive order,

            11   with the market cap of under $700 million, simply only have a

            12   handful of people capable of understanding the concepts in

            13   AS-2, and in the COSO framework.

            14             Those people are under enormous time pressure,

            15   because of the tightness of deadlines, and they often do not

            16   fully understand the implications of the entire process until

            17   later in the year.  So the cost issues associated with many

            18   of the companies that would probably be in Mr. Davern's

            19   survey had to do with project management issues,

            20   understanding the framework issues.

            21             Many of them did not get their work completed

            22   until, you know, until near year-end.  Auditors certainly

            23   couldn't rely on their work, because their work wasn't

            24   completed timely.  Those are the many different challenges in

            25   that arena than with the large company arena.  The

             1   inefficiencies are orders of magnitude because of project

             2   planning issues.

             3             I think that's an important distinction, and while

             4   it doesn't represent the majority of market cap in the

             5   country, it's the vast majority of companies are going to be

             6   faced with those particular concerns.

             7             MR. NICOLAISEN:  And I think we're going to look

             8   for the Small Business Advisory Committee to help us out with

             9   some thoughts on that.

            10             MR. BAILEY:  I'll come back to the panelists. 

            11   Commissioner Glassman?

            12             COMMISSIONER GLASSMAN:  Thank you.  This is a

            13   variation of the question I asked the earlier panel.  Of

            14   the -- and this is really to Jim Turley and I guess any of

            15   the management types.

            16             How many, if any, of the 350 average deficiencies

            17   were ones that management really wouldn't have thought were

            18   important from the risk perspective, but were raised because

            19   of the auditor focus?

            20             MR. TURLEY:  Well, I think that without question

            21   the auditor focus and the management focus for many companies

            22   united reasonably earlier.  Not without great tension, as has

            23   been talked about before, but united early on sort of a

            24   framework view on how to look at things.

            25             Clearly, some of the matters that were, you know,

             1   common everyday control deficiencies, no one really got into

             2   a fight over, because they were nothing that would ever have

             3   been, you know, reported.  There are things that the company

             4   and the auditor felt ought to be strengthened.  So it didn't

             5   become a source of tension.

             6             Where the tension actually came at the back end,

             7   after tension at the front end, then the tension came at the

             8   back end on assessing whether or not for the remaining

             9   unremediated control deficiencies, they were significant

            10   deficiencies or material weaknesses.

            11             That's where we get into the great discussions.  As

            12   the last panel talked about, sometimes it got fairly heated. 

            13   So that's where it really came.

            14             MR. BAILEY:  I'm going to go to Mr. Silvers and

            15   then to board member McDonough or Chairman McDonough.

            16             MR. SILVERS:  I was hoping to respond from the

            17   investor perspective to the comments of the folks from the

            18   American Electronics Association, because I think it's

            19   important in this discussion that the common ground exists

            20   among the various parties at the table, that those pieces of

            21   common ground be identified.

            22             It's not, I don't believe, in the interest of

            23   investors to have a sort of one-size-fits-all or checklist

            24   approach to the structuring, the planning of 404's

            25   implementation or its execution.

             1             To the extent that smaller enterprises are

             2   identifying this as a fact of this first round, that's

             3   something that needs to be remediated.  I believe that just

             4   as the gentleman from the Electronics Association indicated,

             5   the appropriate way  for that to be remediated is through

             6   dialogue between the PCAOB and the audit firms.

             7             Investors, I believe, are very supportive of the

             8   general tone and direction that the PCAOB has indicated

             9   they're going to take in that regard.

            10             Secondly, there is, I believe, a significant

            11   investor concerns about the lack of competition in the audit

            12   market.  However, there's an ambiguity to this.  To the

            13   extent that that lack of competition essentially means that

            14   it's possible for auditors to extort high prices for their

            15   services from issuers, that's a problem for investors.

            16             On the other hand, if what the climate of real

            17   competition is really about is about the desire to be able to

            18   find a soft-hearted or soft-minded auditor.  That's -- we're

            19   not really interested in that.  It's a little hard to sort

            20   out which is which.

            21             Finally, with respect to IT controls, I believe

            22   it's correct that there has been perhaps some overemphasis in

            23   the area of IT controls.  However, I'm skeptical about the

            24   claim that IT controls are irrelevant to things that have

            25   gone wrong in corporate America in the last few years.

             1             Unless I'm mistaken, most of the ledgers that are

             2   kept in contemporary corporations are no longer kept in big

             3   binders.  They're kept on computers.

             4             I'm not an expert in IT controls, but it strikes me

             5   that the ability of somebody to alter an asset to a liability

             6   or the sort of thing that occurred at WorldCom, where large

             7   numbers moved from one column to the next did not occur with

             8   a pencil.  Thus, it seems to me that some expenditure on IT

             9   controls is probably a good thing.

            10             And finally, I believe that the general notion, and

            11   I think that Mr. Ueltschy -- I hope I've not mispronounced

            12   your name -- the general notion that there's a strain on

            13   smaller companies, smaller companies' staffing in relation to

            14   the initial round of compliance with 404 seems to me a

            15   plausible statement.

            16             The response by the Commission and the board in

            17   giving more time is the appropriate response.  What the

            18   investor community is very concerned about is the implication

            19   that anywhere at any point that ultimately somehow smaller

            20   companies do not have adequate controls.

            21             Our view is is that smaller companies need to have

            22   adequate, audited controls if they wish to access the public

            23   markets, and that no individual, certainly no union member

            24   should ever get -- should ever be asked to invest in a stock

            25   of a company which does not have audited and adequate

             1   internal controls.

             2             There's a part of the capital markets with highly

             3   expert people who are willing to take those risks, and that's

             4   where those companies should go.

             5             MR. BAILEY:  Chairman McDonough.

             6             MR. MCDONOUGH:  Thank you very much.  The people at

             7   the Public Company Accounting Oversight Board spent an

             8   immense amount of time reaching out around the country to

             9   find out what we think is really going on.

            10             We've had, for example, six meetings in various

            11   places around the country, where we spent a day with always

            12   two members of our five-person board present, talking with

            13   small and medium-sized audit firms, and then the next day we

            14   spend half a day with the -- typically the chairperson of the

            15   audit committee of small issuers.  This was an idea, by the

            16   way, inspired by my distinguished colleague, Kayley Gillan.

            17             One of the things that I think has become clear

            18   from those meetings, but especially dramatically from the

            19   pleasure I had in spending an hour with Alex Davern's AEA

            20   group, the fact that Alex has that wonderful soft language of

            21   County Tipperary in Ireland.  I should tell you he was

            22   playing nice guy today in his presentation, compared with the

            23   vitriol which he shared with me on that occasion.

            24             (Laughter.)

            25             MR. SILVERS:  I've developed a working hypothesis,

             1   which I think is going to be quite a challenge to the people

             2   from the accounting profession, and especially from the large

             3   firms, because some of these small companies use very large

             4   audit firms, very large accounting firms for their auditors,

             5   largely because their lenders and the rating agencies think

             6   that's a good idea.

             7             Now the opposite extreme is a company, which I

             8   won't identify, but a very large, very sophisticated company,

             9   that has Jim Turley's firm as its auditor.  They have a

            10   splendid dialogue between the audit company, the auditor and

            11   the firm, and at the end of the day, a very good result in

            12   the infernal control review attestation, and the increase

            13   from one year to the next in the audit fee was 28 percent. 

            14   You'll total for that in a minute, right Alex?

            15             I think what's happening is that for the small

            16   companies, especially in the technology area, where they're

            17   in a very sophisticated business, they may need a very

            18   sophisticated audit partner to be running the engagement.

            19             The nature of the big audit firms is it's very

            20   difficult for them to have a very sophisticated, highly

            21   experienced audit partner as the engagement partner.  Now

            22   either we're going to have to have some change over time, by

            23   which smaller firms have different auditors, or the -- which

            24   I think -- but I think a better solution would be.

            25             But however great a challenge it is, that the

             1   larger audit firm, certainly the top eight, figure out how do

             2   you get truly experienced people on these accounts where they

             3   are desperately needed.  Thank you.   

             4             I wanted to take the opportunity of Chairman

             5   McDonough's comments with respect to relying on others to

             6   kind of pose a question for Frank Brod, if you don't mind,

             7   and that is in all of this, we are dealing with planning,

             8   costs of documentation and testing.

             9             There has been a lot of discussion about relying on

            10   the work of others, relying on the internal auditor, relying

            11   on the auditor, the external auditor.

            12             I wonder if you could comment on that in terms of

            13   how this has played out at your firm?

            14             MR. BROD:  First of all, planning and design does

            15   drive costs.  There is no question about it, and the level of

            16   testing that goes on is really the biggest concern that we

            17   have.

            18             Just to correct a comment that my colleague from

            19   Ernst & Young said, because we proposed to our auditor an 80

            20   percent coverage ratio of all our assets, liabilities, income

            21   and expense accounts.  We wound up using 98 percent.  It was

            22   a full coverage of that.

            23             And Cynthia, to your question on deficiencies, our

            24   company had a comparable number to the averages.  I think

            25   they were a little over 300, but 290 of those were known

             1   before we ever started the evaluations, so there was very

             2   little new found.

             3             We had to evaluate that because of compensating

             4   controls and risks, but there was not a cost benefit to

             5   correcting those except in the Sarbanes-Oxley 404 requirement

             6   schemes.

             7             The extent of internal audit testing and all is a

             8   very interesting topic because we in our company have a very

             9   independent and competent internal audit function.  In fact,

            10   you heard from two of our audit committee members on the two

            11   previous panels.

            12             That group we use to do the predominant testing. 

            13   Our approach was to have control objectives set up, to set up

            14   a self assessment process, to have our internal audit group

            15   test those self assessments, and then have the external

            16   auditor go through and do the work they wanted.

            17             There was very little work that was relied upon by

            18   the auditor of the internal audit work or even management's

            19   work in that regard.

            20             It was a little bit disappointing.  In fact, we

            21   operate with four global service centers that handle all of

            22   our financial recordings and reporting.  The one in Singapore

            23   had 11 consecutive weeks of audit testing going on, all

            24   within one quarter.

            25             I did get a phone call from our service center

             1   leader who indicated he was a little concerned as to the

             2   accuracy of his quarterly results maybe because his folks did

             3   not have the attention on the work.

             4             I think it's a bit of a crime if the scope of the

             5   testing itself can create a potential deficiency.

             6             (Laughter.)

             7             MR. BROD:  We are very supportive at Dow and at FEI

             8   of the 404 standard.  We think it has benefits, but between

             9   the risk aversion added that the auditors have taken, whether

            10   it be from reading the words to mitigating their own

            11   litigation risks or perhaps in a revenue enhancing way of

            12   doing more testing.

            13             The other side is that there has to be a balance to

            14   the benefits that shareholders are going to gain from this. 

            15   We have raised confidence.  I'm not so sure that investors

            16   raising confidence is fully justified because there isn't a

            17   good view, I don't believe, that all this testing is going to

            18   eliminate fraud, where people act collusively in certain

            19   controls.  It still has the potential to exist.

            20             I think as we re-shape or re-look at how we can

            21   fine tune the standard going forward, we need to look at

            22   those areas, maybe not get the external auditor so involved

            23   in the very detailed testing of a mundane transaction.

            24             That is a very good area where the internal audit

            25   group could be relied upon, and let them put their attention

             1   where fraud actions start, which are in the minds of some

             2   executives even in structuring transactions or

             3   mischaracterizing transactions that are taking place.

             4             As you look at the types of things that have been

             5   uncovered, that seems to be more the area where it is.  I

             6   think there was only one instance where transactions were

             7   going through the system below the materiality screen.

             8             Materiality is the other point I think you need to

             9   look at and address as you go through these.  Those words in

            10   a standard about more than inconsequential.  In the words of

            11   our auditor, that is an extremely low standard.

            12             Is that really where we want to be for a

            13   significant deficiency, because it does drive a very deep

            14   level of testing.

            15             My audit committee, our management, would not

            16   accept anything but a clean opinion.  We will do whatever it

            17   takes in order to assure that.  We did as we went through

            18   that process.

            19             We do need to make sure, especially with the other

            20   words in AS-2 which says that each year must stand on its

            21   own, how that is interpreted, the fact that auditors cannot

            22   rely upon communicative knowledge of the fact that they would

            23   presumably have to re-test everything again, it is really an

            24   issue.

            25             The internal audits have tested IT controls very

             1   well in the past.  It's an area where they can be relied

             2   upon, as the way the standard is written today.

             3             If you have systems that haven't changed, if you

             4   have no change of processes around that, it's hard for me to

             5   believe the same level of testing is required in year two

             6   that would have been in year one.

             7             With each year having to stand on its own, the

             8   audit standard clearly says that the audit cannot reach back

             9   and use that judgment going forward.  That's an area that I

            10   think you will have to consider to modify.

            11             MR. BAILEY:  Frank, you commented on the more than

            12   inconsequential, but you did not comment on the more than

            13   remote, and both probability and materiality.

            14             Do you have any difficulty with the more than

            15   remote?

            16             MR. BROD:  That is risk based.  You have to look at

            17   what is the subsequent outcome of that, the auditor

            18   compensating controls and make it less risky or not.  You not

            19   only have to look at gross risk, but you have to look at net

            20   risk once all the other things that go on, the control

            21   things, are taken into consideration.

            22             Those standards are extremely low.  We have an

            23   entire project management system dealing with deficiencies. 

            24   In fact, it was so good in dealing with deficiencies, we

            25   added all our operational audit issues to it, too.  We are

             1   using it for tracking.

             2             Those levels are very, very small and we really

             3   need to concentrate the auditors' attention, even

             4   management's attention, on those things that will really make

             5   a difference.  I think the levels are way too low today.

             6             MR. BAILEY:  Ms. Flavin, thank you for patience.

             7             MS. FLAVIN:  I just wanted to make two comments, I

             8   guess. One deals with who is really driving management's

             9   assessment process, and the other one on duplication of

            10   effort.

            11             We have certainly seen benefits to 404.  They are

            12   real and they are present, but the cost and the

            13   implementation at a certain point did exceed the benefits,

            14   and not in terms of direct dollars, but for us in terms of

            15   duplication of testing in low risk areas, and the

            16   conservative interpretations of the standard that meant

            17   additional testing and scoping.

            18             A perfect example that I can give you in that

            19   regard for us was the fact that we as management really have

            20   virtually no professional judgment in this whole thing,

            21   because the firms are driving the interpretation, and they

            22   are the source that we look to.

            23             When we first identified a threshold for

            24   significant accounts, we used the threshold of five percent. 

            25   Our external auditor came in and said you know, no, we think

             1   it's 3.75 percent.  We, wanting to test as much if not more

             2   than them, dropped it to 3.5 percent.

             3             We picked up nine no risk accounts as being

             4   significant and added 15,000 hours of effort, all to raise

             5   our consolidated coverage of assets from 96.1 percent to 96.9

             6   percent, and raised our coverage of liabilities from 91

             7   percent to 94 percent.

             8             That additional effort and that conservative

             9   interpretation does very little to add to the assurance that

            10   we can provide to our stockholders.

            11             I think this is where we need to reign things in,

            12   when we look at these conservative interpretations.  Somebody

            13   needs to monitor the guidance, and we need additional

            14   guidance to make sure we are limiting this duplication of

            15   effort.

            16             I'll give you some examples of where we would like

            17   to see more guidance from the PCAOB.

            18             In terms of coverage, the concept of covering a

            19   large portion of the company, again, as management, we

            20   conducted a risk assessment to determine that.  We looked at

            21   factors such as size, results of last audit, complex

            22   accounting issues, management turnover, system changes, and

            23   we came up with a coverage level of 60 percent of the

            24   consolidated sales of the company.

            25             Our external auditor came in and said no, we think

             1   it needs to be 70 percent.  As a result, we went totally to

             2   the coverage based approach because we were a decentralized

             3   company with 620 operations around the world, the large

             4   majority of those of which are individually insignificant.

             5             That meant that we added 40 locations and another

             6   12,000 hours of additional time in documentation and testing.

             7             I think the PCAOB can be helpful if they can

             8   encourage a risk based approach to coverage.

             9             In addition, the concept of testing all relevant

            10   assertions over all significant accounts every year also

            11   needs to be looked at.  Again, I don't think we should ignore

            12   the knowledge that we have of our companies, the knowledge

            13   that we have of our control environment, and make sure we

            14   focus on the high risk areas, not just spending an inordinate

            15   amount of time on the low risk areas.

            16             I also think another way we can eliminate this

            17   duplication of effort is subtesting of internal audit work by

            18   the external auditor is allowed to constitute primary

            19   evidence, so we don't have this redundancy in the low risk

            20   areas.

            21             MR. BAILEY:  Lisa, what is clear to me is you have

            22   a lot of good points.

            23             MS. FLAVIN:  I have one more.  Can I make that?

            24             (Laughter.)

            25             MS. FLAVIN:  One more very important point is

             1   flexibility in the roll forward procedures.  Right now, the

             2   way the standard is written, if you are going to get any

             3   efficiencies, you need to do all your testing in the fourth

             4   quarter, which is really contrary to the concept that

             5   controls are a continuous process.

             6             We test at Emerson, right now we are doing the

             7   majority of our testing in the second quarter, and external

             8   auditors going back into the same locations testing the same

             9   controls in the third quarter, and we are both going back in

            10   the fourth quarter to roll forward all that testing.

            11             It's just very disruptive to our organization.  If

            12   we could use the risk based approach to determine those roll

            13   forward procedures, it would be much more effective.

            14             MR. BAILEY:  Jay Haberland, I appreciate your

            15   patience as well, and then we will go to Commissioner Atkins.

            16             MR. HABERLAND:  Just a couple of quick comments.  A

            17   lot of these sessions are going to be somewhat repetitive as

            18   themes become fairly common.

            19             Chairman McDonough has said a number of times and I

            20   agree with him 100 percent, that he endorses the use of

            21   judgment and believes the standard allows judgment.  I agree

            22   with him.

            23             However, the way it has been interpreted by the

            24   four firms, and I stress "interpreted," and I'm told by each

            25   of the firms interpreted in close concert with the PCAOB, it

             1   doesn't allow for the use of a lot of judgment.  It's very

             2   prescriptive.

             3             Benchmarking with colleagues across the country,

             4   the cover ratios are 60 to 70 percent of the balance sheet,

             5   50 percent of all major account line items and it is lock

             6   stepped across the businesses.

             7             Similar business to Lisa with similar operating

             8   entities, it forced us with numbers of cover well beyond what

             9   we had anticipated.  Similarly, we also scrapped for the

            10   first year our risk based model because it kind of looked

            11   silly in terms of the coverage we were getting.

            12             I guess what I would ask, it's very difficult to

            13   say to people we want you to use more judgment, we encourage

            14   that.  I think the proof is going to be in the inspection

            15   process, and I think as we look at the firms' workpapers, I

            16   would encourage them to look at that heavily in terms of how

            17   things are done.

            18             I think if that happens, I think we can drive down

            19   costs considerably on this.

            20             MR. BAILEY:  Commissioner Atkins?

            21             COMMISSIONER ATKINS:  I just want to be very quick

            22   and follow up on that, to maybe focus on what exactly is the

            23   question with Standard Two.  The heart and soul of the COSO

            24   framework is a risk based approach.

            25             What we have heard all morning actually has been

             1   shocking to me, that the accounting firms have been driving

             2   you towards more of a granular approach, and so I guess the

             3   problem is in looking at Standard Two again last night, all

             4   150 some pages of it, it is fairly granular already.

             5             They invite professional judgment, but I was just

             6   focusing on, for example, paragraph 16, which talks about

             7   inherent limitations in these internal control reports, and

             8   basically at the end invites, and I guess that is what you

             9   are focusing on when you are talking about what is going to

            10   happen in the examination process.

            11             If the examiners are going to go in and second

            12   guess the determinations that are made, it seems like that is

            13   driving what the auditors are doing.

            14             I was wondering if you all had anything to say

            15   about that.  I think that is probably the problem.

            16             MR. HABERLAND:  Internal control assumes the

            17   assumption of risk.  I think whenever you do that, whenever

            18   you exercise judgment, two people can have perfectly correct

            19   but very different perspectives on how you accomplish

            20   something.

            21             Again, I think the firms right now are reacting to

            22   the fact that they are going to be in effect audited for the

            23   first time.  If everybody gets together, if it is a very

            24   prescriptive approach, we did what we were supposed to do.

            25             Again, I don't know exactly how you say to people

             1   you use judgment, because it's just difficult.  Some people

             2   will.  Some people won't.

             3             I think it is also going to be an effort for the

             4   inspectors to exercise discretion and professional judgment

             5   as they review the work of the auditors.

             6             MR. NICOLAISEN:  I think we are going to have to

             7   close it out.  We are extremely appreciative of everybody's

             8   comments, and I really would like to say one more thing.

             9             My rule is whatever you say in one breath, when you

            10   have to take a breath, you're done.

            11             (Laughter.)

            12             MR. NICOLAISEN:  Anybody who would care to, you

            13   have an opportunity to do that right now.  Alex?

            14             MR. DAVERN:  I would just like to make one

            15   response, that decontrols related to the movement of

            16   accounts -- this is a big breath -- I think you should focus

            17   on a decision by someone to do something illegal, not IT

            18   control. I hope that people will really focus on the reality

            19   of the lack of benefit of a lot of this focus on IT controls. 

            20   Thank you.

            21             MR. BAILEY:  Albert?

            22             MR. TEPLIN:  I want to just return quickly for one

            23   breath to the $12 million, we don't find a lot of

            24   deficiencies, I would really wonder.  Internal controls were

            25   there before, we were finding deficiencies on inspections

             1   before 404.

             2             I don't think that those small deficiencies that

             3   were there or those deficiencies that were there should be

             4   used as a judgment that this is a good thing.  It's the

             5   material problems that matter.  Those are the ones you should

             6   focus on.

             7             MR. BAILEY:  Damon?

             8             MR. SILVERS:  It's been suggested that perhaps the

             9   concept of a genuinely independent audit and the concepts of

            10   timing with words like "annual" in the statute ought to be

            11   revisited.

            12             It has also been suggested perhaps that there is

            13   something wrong with the notion of the reviews of the firms,

            14   which I think are actually the solution to this problem

            15   rather than the cause.

            16             All three of those concepts are extremely dangerous

            17   to investors and to our economy.

            18             MR. BAILEY:  James, final word.

            19             MR. TURLEY:  I think it's clear from the comments

            20   up here that the term "soft hearted auditors" is an oxymoron.

            21             (Laughter.)

            22             MR. TURLEY:  At some level because the stories up

            23   here, they are not clients of ours, but we do take it

            24   personally.  This profession, the biggest eight firms, worked

            25   very closely together at the outset, trying to work with

             1   PCAOB to understand what was probably the biggest most

             2   fundamental change in many, many years, and we have tried our

             3   best to diligently implement the complex rule.

             4             We, like everyone here, look forward to the

             5   process, look forward to the inspections, and look forward to

             6   trying to get this in a way that is maximizing the benefits

             7   and minimizing the costs.

             8             MR. BAILEY:  Chairman McDonough, deep breath.

             9             (Laughter.)

            10             CHAIRMAN McDONOUGH:  Our inspection process is

            11   meant to be even handed.  We certainly have developed a great

            12   deal of excessive comments, from me especially, that it isn't

            13   one size fits all.

            14             When we do an inspection and look at the workpapers

            15   of individual audit engagements, it is at least as likely

            16   that we can come to the conclusion that the work done was

            17   excessive then it was inadequate.

            18             Is it likely that we will throw somebody in jail

            19   because we think they over did it?  Probably not.  Is it

            20   likely with our tough love approach to our responsibilities

            21   that we would have a very direct and perhaps severe

            22   discussion with the top management of the firm?  You bet.

            23             MR. BAILEY:  Thanks.  On that note, we will close

            24   and at 1:45, we will reconvene.

            25        (Whereupon, at 12:50 p.m., a luncheon recess was taken.)

             1                  A F T E R N O O N  S E S S I O N

             2               PANEL FOUR - DOCUMENTATION AND TESTING

             3             MR. NICOLAISEN:  This is panel number four of a six

             4   panel series.  We have passed the halfway mark, and we are in

             5   the home stretch.

             6             This afternoon, I think we are going to have an

             7   awful lot of interesting dialogue.  What we are looking for

             8   is increasing granularity to a point, and at the end of the

             9   day, we are going to try to summarize what we have actually

            10   heard.

            11             As we said earlier this morning, we are going to

            12   ask the panelists to reframe from reading any prepared

            13   speeches.  We have a limited amount of time and a maximum

            14   number of people.  It's just helpful if we would all do our

            15   best to make the point and then move on and let somebody else

            16   comment.

            17             It is appropriate to follow up with a response if

            18   you have a comment responding to what somebody else has said. 

            19   That's great.  I would not just repeat what somebody else has

            20   said, even if you agree with them.  You can kind of nod your

            21   head and we will get the message that you do agree with them.

            22             Let's keep our responses concise.  If you have a

            23   question, and this also applies to the Commissioners and

            24   Board members, if you have a question or you want to comment,

            25   please lift your little name tag up and turn it on its side,

             1   and we will as appropriately and as quickly as we can,

             2   recognize you.

             3             Let me introduce who we have here.  This is being

             4   Webcast.  I think in some places, it is sound only.  For the

             5   benefit particularly of those people, as you speak, if we

             6   don't do a good job of introducing you, it might be helpful

             7   just to identify who you are.

             8             To my left, we have the Board of the PCAOB, all of

             9   whom have been duly acknowledged earlier this morning.  On my

            10   right, the Commissioners of the SEC.

            11             Our panelists this afternoon include, and I'm going

            12   to read from left to right, Kimberly Parker Gavaletz.  She is

            13   vice president, head of Corporate Internal Audit, Lockheed

            14   Martin Corporation.

            15             Sitting next to her is Susan Gordon.  Susan is

            16   senior vice president and chief accounting officer at Viacom. 

            17   I know from past experience, one of the most enthusiastic

            18   people I've ever met about Section 404.

            19             (Laughter.)

            20             MR. NICOLAISEN:  Next to her is Keith Holmberg.  He

            21   is vice president of Financial Control Processes at British

            22   Petroleum.  He's probably responsible for the price of our

            23   gasoline.

            24             (Laughter.)

            25             MR. NICOLAISEN:  Jay Howell.  Welcome, Keith.  Jay

             1   Howell, who is associate director of assurance northwest

             2   region, BDO Seidman.

             3             Lee Level, corporate vice president and chief

             4   financial officer, Computer Sciences Corporation.  I think,

             5   Lee, you set the record in giving us three responses that we

             6   posted to our website, and we appreciate each and every one

             7   of those.

             8             Peter Minan, who is a partner with KPMG.  Chuck

             9   Noski, who is with Microsoft.  He chairs the audit committee. 

            10   Shelley Stein is chief operating officer of Grant Thornton.

            11             Welcome to all.  We look for a lively discussion. 

            12   Chuck, I am going to start with you.  I know Microsoft has

            13   not yet finished their process, if I'm correct.

            14             MR. NOSKI:  That's correct.  June 30th year end.

            15             MR. NICOLAISEN:  You are working hard towards that. 

            16   The way I would kind of like to start this session is to give

            17   you an opportunity to say what you think is working and what

            18   isn't.  Of course, you have to do that concisely.  All of

            19   these other people probably have some advice for you.  We

            20   would really welcome that advice from various perspectives.

            21             If you would care to get us started, Chuck.

            22             MR. NOSKI:  Sure.  Thank you, Don.

            23             I think probably the thing we want to focus on in

            24   this topic of documentation and testing, which is where an

            25   awful lot of the work has occurred and where much of the

             1   concern that was expressed this morning, really starts with

             2   the scoping, which was, as I recall, the topic of the last

             3   committee.  I'll try not to spend much time on that.

             4             I think scoping out what is in scope and what is

             5   not in scope in determining how you are going to document and

             6   test the internal control system for financial reporting is

             7   kind of key.

             8             Once you have done that, the experience so far that

             9   I have seen in the companies I'm associated with is about

            10   two-thirds in the implementation effort, the actual total

            11   effort, is associated with documentation and testing.  I

            12   think that is where you get a lot of the energy.

            13             For example, one Fortune 100 company that I'm

            14   familiar with is not Microsoft. They identified some 1,500

            15   processes and subprocesses, over 60 IT systems were

            16   identified and documented.  Within those 1,500 processes and

            17   subprocesses, they identified 9,000 key controls that were

            18   identified and tested, and about half of those were IT

            19   controls and half of those were financial and operationally

            20   oriented controls.

            21             MR. NICOLAISEN:  Does that strike you as an

            22   oxymoron, 9,000 key controls?

            23             MR. NOSKI:  Knowing the company, no, but 9,000 is a

            24   big number.  You start to imagine the amount of documentation

            25   and the amount of testing, and the number of people that got

             1   to test, as management and internal audit tested and then the

             2   outside auditors made selections from those 9,000 key

             3   controls.  A lot of work there.

             4             The work was probably impacted to a degree.  It was

             5   a 12/31 year end company, so it was impacted to a degree by

             6   the timing of the AS-2 issuance, so there was a bit of

             7   re-work there.

             8             I would also point out that in the testing phase,

             9   the company used their internal audit staff and devoted some

            10   90,000 hours to the testing element, as well as kind of

            11   remediating a bit of the documentation that they found was

            12   not completely effective.

            13             That's a pretty significant effort, and I would say

            14   largely in line with the statistics that were discussed this

            15   morning in terms of number of deficiencies found and the

            16   costs and the like that were determined.

            17             Maybe a couple of take aways, and then I'll turn it

            18   back to you.  I think from this year one experience, I think

            19   understanding whether we can move to more of a risk based

            20   approach, which was touched on this morning, for

            21   documentation and testing is really key.

            22             It's not clear to me we really need to test every

            23   key control every year for the full year, and how much

            24   testing do you need to be done by which constituencies,

            25   management, internal audit, external audit.

             1             More significantly, and maybe I can raise up the

             2   dialogue just a little bit, I think considering refocusing on

             3   the process, particularly in the testing area, with respect

             4   to key controls like management override of judgments,

             5   selection of alternative accounting principles, key estimates

             6   and judgments that management will make, non-routine

             7   transactions, we haven't talked about that much today, but as

             8   an audit committee member and as the chair of Microsoft's

             9   audit committee, I'm obviously very interested and concerned

            10   about controls.

            11             There is a lot of good reasons, good business

            12   reasons why companies want to have good internal controls,

            13   but from the perspective of the audit committee, I'm also

            14   interested in the quality of the financial information and

            15   disclosures that are presented to investors.

            16             That is one of the reasons why we are going through

            17   this gigantic exercise, to convince investors that they are

            18   getting a high quality of information, good judgments are

            19   being made, best estimates by management, transparency and

            20   the like.

            21             That would really suggest that we may want to spend

            22   more time in the testing and examination in the future on

            23   those kinds of controls which can really move the numbers

            24   probably more so than whether the payroll system is operating

            25   effectively in 70 different countries, whether the accounts

             1   payable systems are being done.

             2             In what I've seen to date, about two-thirds of the

             3   documentation and testing effort has been dedicated to

             4   transaction based activities, not to these key judgments of

             5   management tone at the top.

             6             Some of the things that we have seen, just by

             7   reading the newspaper, appear to be the areas that have

             8   really driven financial accounting and reporting fraud.

             9             MR. BAILEY:  Excellent.  Does anybody care to

            10   follow up on that?  Lee, you were shaking your head.

            11             MR. LEVEL:  I agree with most of what Chuck said.

            12             MR. BAILEY:  Don't say any more.  That's our rule.

            13             (Laughter.)

            14             MR. LEVEL:  I'll have my chance.

            15             MR. NICOLAISEN:  Let me ask you, in earlier panels,

            16   I also would have liked to have asked this and didn't get a

            17   chance, and it may not be fully appropriate here, but let me

            18   try any how.

            19             One of the things that we have heard is that the

            20   level of work that is being done by the external auditor is

            21   pretty well dictated by the external auditor, and is at a

            22   level of granularity that is pretty detailed.

            23             We have heard a lot about quality internal audit

            24   functions, what is the value that the internal audit function

            25   brings.

             1             If a company say the size of Microsoft had ten

             2   internal auditors or 500 internal auditors, would it make a

             3   difference in the work that is likely to be done by the

             4   external audit firm?

             5             Shelley, maybe you would want to take a crack at

             6   that.

             7             MS. STEIN:  What panel number are we on now?

             8             (Laughter.)

             9             MR. BAILEY:  Everything is fair game today.  It's

            10   in the documentation.

            11             MS. STEIN:  Absolutely.  I think one of the

            12   significant issues is the things that we have been talking

            13   about, AS-2, the guidance that is there, all relates to what

            14   the auditors need to go do.  If you go back to one of the

            15   panels this morning, specifically one of the participants

            16   said we went through and we did our risk based assessment in

            17   terms of what we needed to test and what our documentation

            18   needed to be, and then the auditors came in and applied AS-2,

            19   and we had to throw out what we were doing.

            20             I think it would be really helpful if the

            21   Commission could provide some guidance to the companies in

            22   terms of what their expectations were in that area, and I

            23   think it would make a huge difference.

            24             MR. NICOLAISEN:  One of the things -- I do hear

            25   that quite a bit.  I'm half serious and half joking here, but

             1   in part, what I hear is that the management side -- the

             2   auditors have AS-2, so they describe what they are doing and

             3   why they do it, and management says, well, do you really have

             4   to do that, and they hold up AS-2 and they say yes, we are

             5   required to do this.

             6             Whether that is totally true or not, I think is a

             7   subject of discussion.

             8             What I hear from management sometimes is a desire

             9   to have SEC guidance and hold it up against the auditors'

            10   guidance and say look, we don't have to do that.

            11             I have always suggested to people, to registrants

            12   in particular, be careful what you ask for because if you ask

            13   for guidance from us, it's not going to be targeted to a $100

            14   million market cap company.  It is going to be targeted to

            15   the Microsoft's of the world.

            16             Unfortunately, unless we have some real

            17   breakthroughs here with our small business advisory group,

            18   which we are hopeful of, it will likely be reasonably

            19   comprehensive guidance.

            20             Is that what you are talking about or is there some

            21   other level?  Is it a question of what is material or how do

            22   you define "materiality," just what is it you are really

            23   looking for when you talk about guidance that the Commission

            24   would provide?

            25             MS. STEIN:  May I follow on a little bit before you

             1   turn it over to the companies?

             2             MR. NICOLAISEN:  Yes.

             3             MS. STEIN:  I think part of it, too, is just the

             4   timing of when AS-2 came out, so therefore the companies were

             5   taking their best shot at what they thought they needed to

             6   do, and then they looked to AS-2 as a guide as well.

             7             I think part of it shakes out just from the fact

             8   that we are the first year going through.

             9             I also think it's important that we do be able to

            10   rely on the internal auditors.  I think we have to use some

            11   judgment and we need some guidance with respect to the

            12   principles, but common sense has to enter into it as well.  I

            13   think part of what the firms and the companies are waiting

            14   for is the PCAOB to go through and do their reviews so that

            15   we can get some best practices out of that and be able to

            16   apply it.

            17             Clearly, it would help the efficiency and the

            18   effectiveness of the audit, without a doubt, and it would

            19   make it easier on management as well as the auditors, and I

            20   think there is still a benefit to the stakeholders as well.

            21             MR. NICOLAISEN:  Kimberly?

            22             MS. GAVALETZ:  On your question about guidance, I

            23   really think there probably are three tiers of individuals

            24   involved here.  I think the intent of all of Sarbanes-Oxley

            25   and of the efforts there were to really make sure that the

             1   integrity of financials that everyone utilizes were really of

             2   the highest quality and you could count on those.

             3             I think the first fundamental component is the

             4   management ownership of everything.  That management team, in

             5   our group, they have done a control assessment across

             6   everything, and they actually do those almost quarterly, so

             7   they are on top of this throughout time, and they are not

             8   only documenting, but they are testing on an ongoing basis.

             9             It's not going to be just for last year.  It's

            10   ongoing and it was going on before that.

            11             Then on top of that, internal audit comes on and

            12   looks, how is that control assessment process really working. 

            13   Is it working, and doing some deeper dives in places, and

            14   they are also going across and looking, is this working, is

            15   it sufficient, is it covering the risk of the corporation not

            16   only in the financial but in other areas as well.

            17             Then you go up a tier to where the external

            18   auditors are really checking that whole umbrella.  They are

            19   seeing did management really do in their assessment what you

            20   expected them to do.

            21             This last year, we were doing everything so in

            22   parallel that I think it is remarkable what we have gotten

            23   through.  I think the state of internal controls across all

            24   the corporations is raised.  The awareness is hugely raised.

            25             I think the panel that was before this is in the

             1   key, the planning and the scoping.  I don't think we stepped

             2   back, and I think this is an excellent forum right here,

             3   where we are starting to step back and look at that, because

             4   the roles and the ownership of management keeping that

             5   ongoing monitoring and control function and having an

             6   internal audit shop that is able to look at that on an

             7   ongoing basis and be part of the culture is very healthy.

             8             I don't think we want to lose that.  I think the

             9   external auditors can actually get -- we have talked coverage

            10   versus risk -- both.  They can get both.  If they look at

            11   that whole landscape and what each group is doing and step

            12   back, they can figure out where the risks are, how are things

            13   being covered by the different contingents, and then going in

            14   and doing the level of re-testing they need to do in areas,

            15   or their own testing in other areas.

            16             I think there is a bigger picture here that in the

            17   planning side of this can actually even with less effort be

            18   able to do even more and sustain that.

            19             I'm afraid right now, unless we do something about

            20   looking at prior year's work or doing something relative to

            21   risk, we are still going to do a checklist sort of mentality

            22   and not really learn, and really move this state of internal

            23   controls, move the state of industry itself forward, unless

            24   we keep that ownership there, you can't audit it in.

            25             Being the head of audit, I know I can't audit it

             1   in.  When management owns it and takes it forward, that is

             2   the best thing that can happen with the company, and we need

             3   to be able to reinforce that.

             4             Some guidance along that way.  I don't know that it

             5   is rules.  I think examples, forums where management can talk

             6   among themselves, maybe with the external auditors there,

             7   maybe with some folks from the PCAOB that can help give their

             8   insights into some of these debates that are probably

             9   happening without the PCAOB in the room.  They are happening

            10   between the audit firms and their clients.

            11             I think that would be helpful and for people to

            12   view that.  That would help us go forward and again, keep the

            13   ownership where it belongs, keep the overall oversight and

            14   management of the companies moving forward, and really

            15   elevating and really making even stronger the role of the

            16   internal auditors.

            17             MR. NICOLAISEN:  Talk to me a little bit about

            18   documentation.  There probably are at least some people in

            19   this room who wouldn't be familiar with what you are actually

            20   talking about when we say "documentation."

            21             If I walked into the room of your documents, what

            22   would I see?

            23             MS. GAVALETZ:  For us, it is going to be on an IT

            24   system.  We actually did take that step.  Prior to

            25   Sarbanes-Oxley, we did have documentation, but it was all in

             1   people's files or on their shelves.

             2             It was a camp notebook.  Our accounting monitoring

             3   process that we had at that time, you would go get the camp

             4   notebook and you would see the processes, you would see the

             5   testing that management did behind that.  We as audit went

             6   and looked at that and then went and sampled different

             7   transactions and did some streams through there.

             8             Today, we have put it into kind of a data warehouse

             9   that has all of -- we are using Risk Navigator, and it has

            10   all our processes contained within it.  It has the process

            11   owners listed with it.  It also has the evidence of the

            12   testing.  You are able to go through that.

            13             We invested in that because going forward, we knew

            14   this wasn't an one time shot.  We wanted to keep going

            15   forward.

            16             As internal audit, it was great for us because just

            17   getting the matrix there together of knowing what were the

            18   controls you were going to test and what were we looking at

            19   was huge, because then we could at least test existence of

            20   the documentation.

            21             I think we went overboard, as someone said, is

            22   9,000 controls too many.  We have 6,000.  There are too many. 

            23   We are going to be doing this year a lot more of looking at

            24   those key controls, and not to ignore the others, but to

            25   determine how are they being monitored on their own, but they

             1   may not need the external auditors.  They may not even need

             2   internal audit.  It may be something within the business

             3   itself that looks at them, and then we will keep looking at

             4   that, is that universe correct, and going from there.

             5             MR. NICOLAISEN:  Susan?

             6             MS. GORDON:  Hi.  It's rare to address a crowd

             7   without a video, being in the entertainment business.

             8             (Laughter.)

             9             MS. GORDON:  Normally, I don't think Viacom people

            10   ever show up without a video, but we will pass on the video.

            11             Viacom was a very interesting adventure over the

            12   last two and a half years.  Being a media and entertainment

            13   company, you brought together cable networks, television,

            14   radio, outdoor entertainment, motion picture people to talk

            15   about 404.  Very interesting.

            16             (Laughter.)

            17             MS. GORDON:  What we took, and I think it was one

            18   of the wisest decisions we had from the beginning, was we

            19   standardized documentation requirements.  As many people are

            20   asking for the Commission and the PCAOB to standardize what

            21   you are looking for, we took the position at corporate that

            22   we were going to standardize what documentation we needed.

            23             We sent out to all, and there were 12 business

            24   units throughout the world that we have looked at, 111

            25   locations.  We had many, many different types of businesses,

             1   transaction cycles and everything that had to be addressed,

             2   but we said we were going to use a flow chart that was

             3   standard for everybody.

             4             We were going to have risk and control matrices

             5   similar to what you had, and we were going to house them in a

             6   repository.  We picked Open Pages.  Probably too late in the

             7   process, which was a big struggle kind of coming out at the

             8   end with getting the software up to date.

             9             Allowing us to have documentation housed in this

            10   repository gave us an opportunity to have all the results and

            11   be able to look at it without going out to each of the

            12   locations.

            13             The team at corporate was able to have access to

            14   what was happening with test results, what was happening with

            15   changes in key controls, if there were any.

            16             The important part about it is if you look at test

            17   results and having that housed in the system and documenting

            18   the test results for both the auditors, internal auditors,

            19   and management to look at, it gave us an opportunity in Open

            20   Pages to kind of grade, and have a competition, which I think

            21   helps with the media companies.  It helps in my case.

            22             You go to a sales department who never would have

            23   been concerned about controls, but if you identify you have

            24   an 86 percent pass rate on signing off on these sales orders,

            25   all of a sudden, they are as competitive as anybody else. 

             1   You have operations people to buy in on this and say I'm

             2   getting 100 percent next time.  Does that mean extra credit? 

             3   Do I get a day off?

             4             (Laughter.)

             5             MS. GORDON:  In many respects, it was key to kind

             6   of making 404 successful, that it wasn't accountants talking

             7   to accountants, but it was accountants talking to operations

             8   and business owners that took responsibility that they were

             9   going to be at the top of the class.

            10             MR. NICOLAISEN:  Really drove it into the business.

            11             MS. GORDON:  Drove it down to the lowest common

            12   factor for all of accounting and sales reps to general sales

            13   managers to television programmers.  It really took off.

            14             I think that was key to the success.  You still

            15   just ended up with a pass.  We were talking at lunch.  It

            16   wasn't like summa cum laude.

            17             (Laughter.)

            18             MS. GORDON:  It was well worth to have it and still

            19   be able to continue to have it and manage it and know what is

            20   going on.

            21             MR. BAILEY:  Absolutely.  Did you have any trouble

            22   getting a budget for this?

            23             MS. GORDON:  Yes.  Once again, entertainment.  I

            24   saw some fellow entertainer convincing entertainment people

            25   you are going to spend money.  We went in with a zero budget,

             1   maybe a couple of million here and there.  We spent three

             2   times more than we had anticipated, but well worth what we

             3   spent.

             4             I think we see some cut back in that going forward,

             5   as well as it took us three times as long to do it.  From

             6   that standpoint -- right now, we are working with project

             7   managers and internal audit.  All of our testers are

             8   internal.  We do not use internal audit.  We have identified

             9   key independent testers within each of the operations that

            10   goes in and looks at the tests.

            11             From that standpoint, those costs will continue,

            12   and it is just a drain on the time they have to spend on

            13   other areas.

            14             MR. BAILEY:  The auditors in this room are

            15   wondering what the controls were over the control process.  I

            16   think that is just inherent in the first time through in this

            17   exercise.  I would assume that tightens up.

            18             MS. GORDON:  I think as a company, we are better

            19   off for it.  There wasn't a time that we said we didn't come

            20   out ahead on this.

            21             MR. BAILEY:  Your documentation, you are feeling

            22   pretty good about?

            23             MS. GORDON:  Very good about the documentation.  I

            24   think we had the flow charts.  We had the key controls.  We

            25   had the matrices in there.  I'm able to look -- believe it or

             1   not, you don't think you have the time.  You are able to go

             2   into a system and drill down to test results at every one of

             3   the 111 locations and see if they actually passed themselves

             4   correctly or I would have had a different decision on it.

             5             MR. BAILEY:  That's great.  Peter Minan.

             6             MR. MINAN:  I wanted to respond to the question

             7   asked a while ago.  We are one of the audit firms that

             8   actually recommends there be some additional guidance for

             9   issuers.

            10             You had asked what kind of guidance we are looking

            11   for.  First, I want to try to put it into perspective.  From 

            12   my perspective as an external auditor, I believe AS-2 is

            13   fundamentally sound.  As an auditor, it provides the guidance

            14   and flexibility I need to do my job, including testing and

            15   documentation.

            16             MR. BAILEY:  You are not one of those guys that

            17   holds that up in front of you?

            18             MR. MINAN:  Pardon me?

            19             MR. BAILEY:  You don't hold it out and say this is

            20   what I have to do?

            21             MR. MINAN:  No, but as we all know --

            22             (Laughter.)

            23             MR. BAILEY:  Just checking.

            24             MR. MINAN:  The standard was new, the process was

            25   new.  It was evolving as we were going on.  It was evolving

             1   real time.

             2             Obviously, we didn't have a lot of precedent and

             3   historical experience by which we could make our judgments. 

             4   Frankly, that resulted in a steep learning curve, obviously,

             5   for us and for issuers, but also impacted our judgments.

             6             Frankly, going forward, I think there are some

             7   judgments that are going to be made that are different than

             8   were made in the past, particularly in an area such as the

             9   reliance by the outside auditor on the use of work of others.

            10             I think the guidance in AS-2 is adequate as it is

            11   now and provides all the flexibility we as auditors need to

            12   do that.

            13             I think there were some judgments made in the first

            14   year, a significant undertaking, that perhaps in some cases

            15   didn't make that as extensive a practice as it otherwise

            16   could be.

            17             For issuers on the other hand, I think --

            18             MR. NICOLAISEN:  Let me just follow up on that. 

            19   Does that expressly say the value of an internal audit

            20   function is worthwhile and it can impact on --

            21             MR. MINAN:  Absolutely.  Not only does the standard

            22   provide for that, but that's a well established practice

            23   among auditors for years and years.

            24             I think there are some practical applications that

            25   we dealt with in the first year of operations that may have

             1   led to some different courses, but that's a fundamental

             2   concept I believe strongly in.

             3             For issuers on the other hand, the process was just

             4   as new, just as evolving, just as everything else.  The

             5   guidance was considerably more limited.  COSO certainly

             6   provided a good framework for internal controls, but frankly

             7   didn't provide enough and wasn't intended to provide enough

             8   details to the nature and extent of testing that would be

             9   needed.

            10             As a result, I think with the concurrence of their

            11   auditors, maybe that is the right word, companies defaulted

            12   to an AS-2 standard by which they would evaluate their own

            13   assessment.

            14             What kind of guidance is needed?  I agreed with

            15   what was said earlier.  The guidance needs to be probably in

            16   the form of case studies or examples more than anything else,

            17   but it should cover a couple of key areas.

            18             First, it should cover specifically the nature,

            19   timing and extent of testing and documentation that is

            20   sufficient for management to reach its assessment, not for

            21   auditors, but for management.

            22             It also should address to what extent a company's

            23   ongoing control environment, risk assessment, monitoring

            24   processes should be considered and how that affects the

            25   testing.  Again, it's to kind of take some of the judgment

             1   out, but to allow maybe some case studies that would clarify

             2   what would be acceptable.

             3             Lastly, it should provide some guidance as to what

             4   extent management's activities that are performed on a day to

             5   day basis in the normal course of being management should be

             6   considered to be "management testing."  Even though that

             7   testing doesn't necessarily bear the characteristics of what

             8   I as an auditor would review as a traditional audit test.

             9             MR. BAILEY:  That is helpful.  Lee?

            10             MR. LEVEL:  As you know, I'm not in the

            11   entertainment business, but I am from Los Angeles.

            12             (Laughter.)

            13             MR. LEVEL:  To set the stage briefly on a couple of

            14   facts.  Our company is a March 31 year end.  We documented

            15   1,500 process controls and another 3,500 IT general controls. 

            16   Because of the type of company we are, we can give you an

            17   EAC, even though we are not quite done, we anticipate

            18   incurring some 125,000 hours in our effort.

            19             I want to flash back to a couple of points that

            20   were made earlier, which is why I asked for the mike.

            21             We really believe that additional guidance needs to

            22   be in the form of emphasizing the points that Chuck made up

            23   front around scoping.  We ended up with a percentage of

            24   coverage test, the risk assessment was removed from the

            25   process early on, and it had a material impact on our effort.

             1             We also find conservatism around documentation.  We

             2   find conservatism around the potential auditor workpaper

             3   documentation.

             4             To give you one small example, we reached an

             5   agreement with our auditors that we will literally remediate

             6   each and every deficiency, no matter what size, because we

             7   were told they have a firm policy that they need to dispense

             8   with in one form or another with every deficiency, no matter

             9   what the scale.

            10             As you indicated earlier, I guess before the mike

            11   was turned on, actually, after the mike was turned on, we

            12   have provided three letters.  I won't bore you with the ten

            13   suggestions we made.

            14             We think they would have an impact on all of these

            15   issues, and most importantly, they would allow us to achieve

            16   the ends that we all want at a lower cost.  Some of those,

            17   I'm sure, will come up later.

            18             MR. BAILEY:  I was listening to the documentation

            19   issue over here, and I like the use of the technology.  You

            20   said you benefitted.  Did you benefit in any way other than

            21   you understand your system better?  Were there payoff's for

            22   the company in terms of efficiencies, finding redundant

            23   activities that you were able to get rid of, things of that

            24   nature?

            25             MS. GAVALETZ:  Definitely, across all those areas. 

             1   For my company, we had been integrating companies for a long

             2   time.  This was a huge synergistic effort for us.  All

             3   companies have corporate, then there is the business areas

             4   and business units.  There is that nice healthy tension

             5   across all of that, and how much corporate guidance did you

             6   give.

             7             This was a huge draw to synergy crossing. 

             8   Businesses wanting to understand.  They wanted direction from

             9   corporate.  They wanted input from each other, and wanted to

            10   share best practices.  I think that just in culture alone and

            11   in getting a consistent view of internal controls across a

            12   corporation was enormous.

            13             I think going forward, it will give us the platform

            14   for more efficiencies going forward.  They will want to hear,

            15   okay, we have found a better way to do it across the whole

            16   corporation, and be quicker adopters.  It really has shown

            17   the value bringing things together.

            18             It has had many other tangential benefits for us.

            19             MS. GORDON:  I would agree with Kimberly.  We are a

            20   diverse company where we have had growth over the last few

            21   years.  We took this as an opportunity to kind of share what

            22   we thought key controls should be, so that we were able to go

            23   to perhaps maybe a smaller unit that didn't necessarily have

            24   those key controls built in from day one and say this is best

            25   practice here at this division, make sure we have it there.

             1             It wasn't necessarily just an ability for us to

             2   learn, but we really had some significant changes that we

             3   were able to put in.  Nothing to change anything from a

             4   material problem to an immaterial problem, but that we were

             5   able to say across the board this is how we think is best,

             6   that we want all account receivables write off's to be

             7   approved by the controller's office.  That was standardized.

             8             MR. NICOLAISEN:  You both said you were involved

             9   with large organizations that are emerging periodically.  Do

            10   any of you have active mergers going on at the moment?

            11             MS. GAVALETZ:  Active acquisitions.  Actually,

            12   that's very helpful.  Some of them are international

            13   acquisitions.  It is also setting a common framework in

            14   expectation, one, in the due diligence, really of the

            15   companies that want to be acquired.

            16             I was very thankful for the relaxation on the

            17   guidance around that because it really was affecting how

            18   companies did their business.  We can't buy this now because

            19   we can't integrate them in by the time we have to make our

            20   center.

            21             I think it is going to make more companies that are

            22   on the market to be bought get more ready ahead of time. 

            23   That will actually build industry over time into a healthier

            24   place, and it really is already happening.  It has definitely

            25   helped the due diligence process already, and it is going to

             1   help with the integration.

             2             I think the things we have already put in place,

             3   there is a template for them to use.  It is going to be

             4   easier to integrate them in.

             5             MR. NICOLAISEN:  Suppose the two of you merged.

             6             (Laughter.)

             7             MS. GORDON:  We're merging but we are also at the

             8   same time considering breaking up.

             9             MR. NICOLAISEN:  If you merged, would you be

            10   speaking a common language in your control processes and how

            11   you would document them, or would you assume each other's are

            12   acceptable?  Would you assume you would move to one platform?

            13             MS. GAVALETZ:  We would probably move to one

            14   platform before it's over.

            15             MS. GORDON:  We would move to one platform, I would

            16   think, and which had the best strength.

            17             MS. GAVALETZ:  We looked at every one of them. 

            18   That is what this helped us with a lot.  We already had a lot

            19   of different platforms, different things.  It really helps

            20   things come together.  We are not to be optimal yet, but we

            21   made more progress in one year than we did in the nine years

            22   before that.

            23             MS. GORDON:  Just to answer one further point on

            24   that.  On the documentation, what we have also benefitted

            25   from, when you look at your question back about the number of

             1   deficiencies, we are able to look at and drill down to those

             2   deficiencies, and where those deficiencies are coming from in

             3   the majority of cases, we were able to find out, it wasn't a

             4   problem as much as it was a test design problem, or it was a

             5   problem with there wasn't really a key control there that

             6   should be there, or we shouldn't have that as a key control.

             7             If you look at it, how many deficiencies, and we

             8   all have hundreds and hundreds of issues and deficiencies we

             9   have to look at, but if you have a personnel authorization

            10   form that's been signed by the receptionist on up to the

            11   senior vice president of human resources, but it was missing

            12   a clerk's signature, that's a failure.

            13             That's a deficiency that we go back and say let's

            14   redefine what is the actual key control there.  Is it

            15   sufficient that you have five senior vice presidents signing

            16   off on it.  That allowed us the documentation to kind of get

            17   that granular at times, which I think helped.

            18             MR. BAILEY:  Did you conclude in any of those --

            19             MS. GORDON:  The receptionist was the most

            20   important signature, no, in that particular case.  Only

            21   kidding.

            22             MR. BAILEY:  The more people that signed, the more

            23   the last signer depends on everybody else up to that point.

            24             MS. GORDON:  Yes, but there is only one key, and

            25   that is what we really had to hone in on, as opposed to

             1   defining and documenting and testing a process.  Everyone

             2   will say they do 100 percent of what they do correctly.

             3             MR. NICOLAISEN:  In that effort, was there any

             4   evidence that you were over controlled in some areas where

             5   you had actually cut back?

             6             MS. GORDON:  I know we were over controlled, our

             7   key control definition was way too many controls.  I think

             8   there were some inefficiencies that I think this year we are

             9   going to be spending more time on getting some of those out

            10   of the system.  It highlighted it because you had to

            11   understand the processes all across the company.

            12             MR. NICOLAISEN:  Jay?

            13             MR. HOWELL:  What I wanted to touch on, you picked

            14   up on the M&A access, and I wanted to develop that a little

            15   bit more.  One of the challenges that BDO has observed with

            16   our clients is clients that are going through rapid change

            17   process and the difficulty of implementing, documenting and

            18   testing controls where their business operations are changing

            19   underneath them very quickly.

            20             I know in the change process, there is often

            21   additional risk, and I'd like to emphasize that I think the

            22   404 process really does need to be risk based, and where

            23   there are changes, risk should be focused -- work should be

            24   focused on the risks resulting from those changes.

            25             However, where a company is a discontinuing

             1   operation or planning on discontinuing operations after year

             2   end, but spending a lot of time documenting controls that

             3   will exist at year end that are going away shortly, I don't

             4   know if that really lends itself from a risk standpoint to

             5   where work should be focused.

             6             A lot of the problems that we encountered were with

             7   regard to changes or events that were occurring from a

             8   corporate life cycle.

             9             One example is a company that in fourth quarter had

            10   a strike in a major operation, and as a result, was unable to

            11   test key controls in that operation.  There wasn't a lot they

            12   could do, management could do about that situation in the

            13   time they were permitted.

            14             MR. NICOLAISEN:  I'd like to follow up on that a

            15   little bit, not the strike, because that is an unique event.

            16             You described continuous change in the control

            17   systems as you go through.  Is there an implication then of

            18   some desire for continuous audit, something other than an one

            19   time activity at the end of a year?

            20             MR. HOWELL:  I think management needs to be

            21   continuously evaluating its controls.  If controls have

            22   changed materially quarter to quarter in its operations,

            23   there is a requirement for disclosure there.

            24             To continuously audit those changes, that is a good

            25   question.

             1             MR. NICOLAISEN:  I was using it a little more

             2   generically than continuous external audit.  I had more in

             3   mind a continuous activity within the organization that the

             4   external auditor might be able to rely on to a large extent

             5   if it was handled in the manner in which it was described

             6   over here.

             7             MR. HOWELL:  I definitely support that. As I

             8   indicated earlier, I think the change processes entities are

             9   going through often do result in increased risk.

            10             MR. NICOLAISEN:  Peter, let me ask you a question. 

            11   You have visited a number of companies and tone at the top is

            12   something that everyone has talked about so far this morning,

            13   how important that is.

            14             You walk into a company, can you get a sense of the

            15   place by walking in as to whether the tone at the top is

            16   right, or is there something you actually have to do?

            17             MR. MINAN:  It's probably more than just walking

            18   in.  You can often get a good feeling or bad feeling as the

            19   case may be based on a few interactive meetings, and not just

            20   meetings with the auditor and the client, but attending

            21   meetings with the CEO, CFO, and his or her staff.

            22             I think you can get a very good feel.  A lot of

            23   that doesn't lend itself necessarily to documentation and

            24   testing that we as auditors are used to seeing or in fact

            25   managements are used to doing in the context of reaching

             1   their assessment.

             2             I do think that there is some good feel or bad feel

             3   you can get by doing something other than verifying

             4   signatures occurring when you are talking about control

             5   environment and particularly tone at the top.

             6             I've seen that on clients.  We do it all the time

             7   when we go through the perspective client evaluation process. 

             8   We try to consider based on limited inquiries and limited

             9   attention we have in a particular circumstance whether we can

            10   kind of gauge that sense early on.

            11             I think you are absolutely right.

            12             MR. NICOLAISEN:  Chuck?

            13             MR. NOSKI:  Don, let me give you an anecdote from a

            14   board perspective on how you assess tone at the top.  About

            15   two years ago, I was invited to join the board of a Fortune

            16   500 company and went out and visited with the CEO and some of

            17   the senior management for the first time.  I didn't know

            18   these folks.

            19             I sat with the CEO for an extended period of time. 

            20   I asked him to tell me about his control attitude and his

            21   internal audit staff.  He explained to me that they didn't

            22   need an internal audit staff.  Imagine being an audit

            23   committee member of a company that doesn't have an internal

            24   audit staff.  You do your own risk assessment there.

            25             He said we look to our senior managers and their

             1   financial leaders to ensure we have good controls, and if

             2   something goes wrong, we fire them.  So, we don't need

             3   internal audit.

             4             I filed that away.  He then invited his chief

             5   financial officer in to visit with me.  The meeting went long

             6   enough and we drank enough coffee that the CEO had to finally

             7   leave the room.  I had the opportunity to visit with the CFO.

             8             I asked him how do the board meetings go, what kind

             9   of communication goes on there.  I said I assume you start

            10   out with a financial presentation.  He says, no, only the CEO

            11   makes presentations to the board.  I said even the

            12   presentation of monthly or quarterly operating results.  He

            13   said, yes, I've been here 17 years, I've never made a

            14   presentation to the board.

            15             I filed that away.  At the conclusion of that

            16   visit, I went back to the chairman of the nominating

            17   committee and declined to join that board, and that

            18   individual said gee, when I first joined the board, I had the

            19   same concerns you did, but after a while, I got used to it.

            20             (Laughter.)

            21             MR. NOSKI:  I thanked this individual for their

            22   time and attention and didn't join the board.  This is a well

            23   respected Fortune 500 company.

            24             MR. NICOLAISEN:  Peter has his head down and he is

            25   probably wondering is that his client.

             1             (Laughter.)

             2             MR. NOSKI:  Peter, we will talk.

             3             MR. MINAN:  None of those conversations sound

             4   familiar.

             5             (Laughter.)

             6             MR. LEVEL:  I've only been at CSC 15 years, and I

             7   do make financial presentations.

             8             (Laughter.)

             9             MR. LEVEL:  And our board hears from many others.

            10             This tone at the top thing is much broader than the

            11   CEO and what not.  It comes full circle back to the risk

            12   assessment issue, and it comes full circle back to how much

            13   documentation we need to do around 404.

            14             If we have any impressions from our first year, it

            15   is there has been too little effort committed to entity level

            16   controls, governance practices, risk assessment and the like,

            17   and much too much on process controls.

            18             I want to reiterate what one of the panelists in

            19   the last panel said.  Exceedingly too much around IT

            20   controls.  Part of that is due to the whole thing being new.

            21   Part of it is the fact that there are inadequate resources

            22   around the world that have the expertise to do reviews of IT.

            23             Our IT auditor gave me a fact last night, that

            24   worldwide, there are 36,000 CICI's, because of the escalation

            25   in wages, which I hope you will give us a chance to talk

             1   about, there are 14,000 applicants to be certified right now

             2   because of so much demand for those people.

             3             We commented in our letter, and I won't deal with

             4   it in detail, about the fact that the public accountants did

             5   not take, at least in our experience, did not take a holistic

             6   approach to the controls, IT controls.

             7             As you know, we manage IT infrastructure and secure

             8   networks around the world for large companies, large

             9   governments, including this one.  We think we have -- I

            10   don't -- I think we have expertise in our company around

            11   those issues.

            12             We had to work harder than we should have to have

            13   our auditors look around the network controls, which have

            14   eight or ten layers, rather than looking at the individual

            15   process controls underneath it.

            16             I think if you in one form or another, coming back

            17   to the risk thing, and the judgment issue that came up

            18   earlier, encourage the public accounting profession to move

            19   in that direction, management will equally be able to do so.

            20             MR. NICOLAISEN:  Keith?

            21             MR. HOLMBERG:  As a representative of a foreign

            22   filer, we are still not through this process completely

            23   ourselves, so I'm learning as much as I have to give.

            24             I think to your tone at the top question, to the

            25   extent that you think companies have been working under the

             1   Turnbull environment for a number of years, they have

             2   actually focused a lot of time on developing tone at the top

             3   in those activities.

             4             It would not behoove me as a representative of a

             5   European company to ask for more rules when we often talk

             6   about being principles' based.  Having worked as a VP now for

             7   about six companies, while you always hear that, it actually

             8   is very true.  For me to go to our chairman, our CFO, who are

             9   very supportive of this in principle, and if I can explain to

            10   them the principles of why we are doing this and they can

            11   understand that, getting resources, getting time, getting

            12   dollars is not an issue at all.

            13             If I go in and say I need resources and dollars for

            14   something that I can't explain from a principle based

            15   perspective, I have a very large struggle.

            16             Many of the people this morning have talked about

            17   duplicative testing and so forth.  I think that is an area

            18   where when I go in and talk to our senior executives about

            19   the need to have resources for testing at a process level and

            20   then independent internal testing and independent external

            21   testing, all for the same processes, that's when they start

            22   to vibrate and start asking why are we using resources for

            23   something that doesn't seem to be adding value.

            24             It's not only a dollar issue.  I think it is also

            25   we have a harder time keeping the hearts and minds of the

             1   organization when you begin to do that.  When you are asking

             2   them to document controls that they know they should have

             3   been keeping up for years and years, their heart is in it. 

             4   When you ask them to remediate deficiencies that are

             5   important to their business, their heart is in it.

             6             When you start asking them to support multiple

             7   testing environments with the same documentation, you kind of

             8   lose them.  You lose their hearts.

             9             I think that is where VPs, if we had something to

            10   say, that's where we would focus our attention, how do we

            11   make sure the time we are putting into it, which we don't

            12   mind if it is value added, how do we make sure we are

            13   focusing it in that area.

            14             MR. NICOLAISEN:  Is that attitude fairly typical in

            15   the U.K.?

            16             MR. HOLMBERG:  Yes.

            17             MR. NICOLAISEN:  When you think about us and what

            18   we are doing here?

            19             MR. HOLMBERG:  The times we get together with other

            20   U.K. based companies, by and large, again because of

            21   Turnbull, they spend a lot of time with tone at the top, and

            22   they don't mind conversations around documentation.  That is

            23   important.  They should have been doing it.  We all should

            24   have been doing it for a long time.

            25             They get very frustrated with asking questions as

             1   to why is the SEC or the PCAOB requiring things which don't

             2   seem to make sense from a business perspective.  They

             3   struggle with that.

             4             MR. BAILEY:  I would like to pursue a little

             5   further Lee Level's comment about technology.  Aside from the

             6   documentation issue generally, technology seems to be an area

             7   that has incurred a fairly high level of cost.

             8             I am wondering how many of you have experienced

             9   that in terms of looking to the application controls and

            10   testing application controls to the extent of not relying as

            11   heavily on the general controls in the IT systems.

            12             I think that is kind of what Lee was telling us,

            13   trying to get people to focus on those general controls.  I

            14   wonder if that is the experience across all the firms.

            15             MS. GAVALETZ:  I will just start.  From our area,

            16   it was kind of a mix.  I think it is because the guidance was

            17   kind of sketchy at the beginning.  It is kind of the last

            18   thing everybody got to, what do we really need to look at

            19   relative to IT.

            20             I think we successfully got through the general

            21   controls, and what we tried to do in the application controls

            22   area was understand there were processes controlling that. 

            23   If there were processes and they were being controlled and

            24   being utilized, we were able to rely on that more within my

            25   internal audit world, but also the external auditors.

             1             I do tend to agree that seems to still be the least

             2   focused area across all of the contingents.  I think this was

             3   a huge integrating function of the IT side with the financial

             4   controls themselves.

             5             We had people that were sitting two floors above

             6   the people they were supporting who had never met each other. 

             7   There were just such different communities, that this has

             8   already taken them to a whole new step and a new

             9   relationship, but I think going forward, the area that I

            10   would look to is the conflict is out there, for the folks

            11   that are IT, and that is what I spent most of my life doing,

            12   they know their IT stuff.  They will do it.  We would never

            13   finish anything because there is always something better you

            14   could do.

            15             That is in the mindset of a lot of the environment,

            16   and it does take the management and the assurance type folks

            17   to say we are really done.

            18             I would ask you to look at COSO and COBIT because I

            19   think that is part of where the underlying conflict is coming

            20   here.

            21             The real IT experts and folks that will tend to be

            22   the most zealous about this are very COBIT based.  They will,

            23   even argue it against COSO.  We heard it in one of the panels

            24   earlier today.  I think what happened, and I saw that was

            25   probably a little damaging at the beginning, was people just

             1   took the COBIT framework and started to use that as a

             2   checklist for every one of their audits.  That is very

             3   extensive.  It is a great framework, but I believe it is

             4   probably an overkill if you just sweep it across all of your

             5   financial applications.

             6             I think there is probably some research or some

             7   work across that, understanding what really needs to be done

             8   there, and again, giving some examples across it.  That

             9   conflict existed before Sarbanes-Oxley, and it will probably

            10   exist after, but I think it is at the heart when you really

            11   start to talk to the people auditing, that is where some of

            12   the conflict was.

            13             MR. BAILEY:  Jay, maybe before the original

            14   question, you could comment on that.

            15             MR. HOWELL:  Definitely.  I think IT controls

            16   continue to be an issue that should be focused on in the 404

            17   process.

            18             One of the things that I observed that was

            19   challenging and I think it has been challenging throughout

            20   time in the audit world is analyzing the IT controls and then

            21   looking at the deficiencies that result and the interplay of

            22   those deficiencies with other control deficiencies.

            23             Generally, you will have the IT people that come

            24   out and we think along with a number of the firms we are

            25   under resourced in that area.  It's an area where we do not

             1   have enough people and training, and it is something we will

             2   be focusing on to build our resources in that area.  I think

             3   it is a very important area.

             4             It is very important for those people to not just

             5   understand the IT aspect, but the interplay of the IT

             6   controls with the rest of the control environment, and to be

             7   able to analyze and assess that up to a final conclusion with

             8   respect to an area.

             9             That is a challenging aspect of the implementation

            10   of the standard.  I think it is something that we will all be

            11   learning, we are learning, how to do that better.

            12             My earlier comment was with regard to quality

            13   versus quantity.  I see again with the risk based emphasis

            14   that I'm advocating, an emphasis on quality.  A lot of the

            15   documentation is quantity oriented.  When you go look at the

            16   documentation, you actually look at what the teams and the

            17   companies have put together, it is in mind numbing detail.

            18             It is really hard to step back in the big picture

            19   and aggregate all of the various different findings up into

            20   final conclusions that are meaningful.  I think if the

            21   quantity wasn't there and the quality was focused on, it

            22   would be an easier and more meaningful process to go through

            23   and analyze from an aggregation standpoint.

            24             MR. NICOLAISEN:  This time through on the audit

            25   process will be an integrated audit, is what we have heard

             1   repeatedly.

             2             How different is that likely to be from what you

             3   have experienced this first year?

             4             MR. HOWELL:  From our standpoint, it's a challenge

             5   because in order to do the integrated audit, you have to have

             6   a certain base level of controls that you can then rely on. 

             7   If companies are operating in a changed environment and you

             8   are never really able to get that base level of controls, you

             9   are able to integrate to a certain point, but often the full

            10   benefits of that integration concept are hard to obtain, I

            11   think, in a lot of situations.

            12             MR. NICOLAISEN:  You may not be appreciably

            13   different.

            14             MR. HOWELL:  It remains to be seen.

            15             MR. NICOLAISEN:  Peter, would that be true of your

            16   firm, too?

            17             MR. MINAN:  As I said earlier today, we probably

            18   didn't get where we needed to get to this year for

            19   integrating our controls audit and our financial statement

            20   audits, and it is actually a number one priority for us going

            21   forward.

            22             I think that integrating the audit to the extent we

            23   can and recognizing there is some constraints that Jay

            24   mentioned, I think will result in efficiencies, and whether

            25   it is just the coordinating of the audit procedures with

             1   respect to the financial audit and the controls audit,

             2   whether it is developing the audit plan from the increased

             3   baseline of knowledge that we as auditors and management have

             4   of their internal control systems.

             5             I think it may be hard to crystallize that, but I

             6   think we should and do in fact expect there will be benefits

             7   in terms of efficiencies and effectiveness of going to our

             8   integrated approach.

             9             It was our desired goal this year.  We just didn't

            10   get there.

            11             MR. NICOLAISEN:  Shelley?

            12             MS. STEIN:  I just wanted to add that we probably

            13   have gone through some of the most sweeping changes that we

            14   have in our profession, at least in my career to date.

            15             The companies have gone through quite a lot in

            16   terms of trying to get this implemented, and certainly the

            17   firms have, and even the PCAOB has in terms of trying to get

            18   the guidance out there, as well as coming in to take a look

            19   at how we are doing it.

            20             We can't be sitting back and waiting to see how

            21   each firm is individually going to try and make it better.  I

            22   think one of the things that we can really take advantage of

            23   is if an implementation group was formed, probably similar to

            24   what FASB did with 133 on derivatives, if we can get together

            25   and talk about these things and come up with ideas on how we

             1   can do this better, I think it is going to have a huge, huge

             2   impact.

             3             Some of the things that we haven't touched on so

             4   much but I've heard bits and pieces of it, when you talk

             5   about continuous audit, I think these things are really

             6   important in terms of the ability to be able to get the work

             7   done.

             8             The amount of work that we have heard that is

             9   associated with this, both from the company standpoint, the

            10   firm standpoint, and the PCAOB standpoint, has been huge, and

            11   oh, by the way, we have only done the accelerated filers, we

            12   still have the non-accelerated filers to go.

            13             If you think about the time frame in terms of

            14   getting all this work done, being able to spread it out a bit

            15   and finding ways to do that that are acceptable to the

            16   companies and the firms and the regulators is huge.

            17             I think it has been great that you have relaxed

            18   some of the deadlines in this process, and you have taken a

            19   humanistic approach to it, but I would just encourage both

            20   the SEC and the PCAOB to reach out to the companies and to

            21   reach out to the firms in terms of when -- obviously we want

            22   the information better and faster.

            23             I am very concerned that the companies can't get

            24   enough people to do the work.  The firms can't get enough

            25   people to do the work.  The PCAOB can't get enough people to

             1   do the testing to come in to tell the firms, hey, this is

             2   right, here are some best practices.  I would hate to see us

             3   all losing people, leaving the profession, because we are

             4   trying so hard to get it done so fast.

             5             I think we even have to take a risk based approach

             6   to how we pursue this ourselves.

             7             MR. BAILEY:  There is an issue that actually might

             8   have been better for the second panel, but I think given the

             9   panel here, costs are driven by the nature of the auditors'

            10   requirement to do an audit of management's process and their

            11   test and the reasonableness of their opinion and a separate

            12   extension of that, if you would like, enough testing, in

            13   order to arrive at their own independent opinion.

            14             They rendered two opinions.  I wonder if you could

            15   reflect on what you think of that as a concept but also how

            16   you think the cost break might be breaking down between these

            17   two things.

            18             Do you really have to do a tremendous amount of

            19   more work in order to render that second opinion?

            20             Peter?

            21             MR. MINAN:  What was the question again?

            22             MR. BAILEY:  No. I managed to mess that up.  I

            23   think you got it.

            24             MR. MINAN:  I firmly believe in the fundamental

            25   concept that management should reach its assessment on its

             1   internal controls structure and should do sufficient testing

             2   and documentation of that testing to be able to do that.

             3             I also firmly believe we as auditors should attest

             4   both elements of that, both their successful assessment

             5   process as well as the effectiveness of the internal controls

             6   structure.  I'm behind this.

             7             What is the breakdown of costs?  I don't know. 

             8   There has been obviously some guidance through speech making

             9   and others that suggested whatever auditors do, management

            10   needs to do more of it.

            11             I think one of the things we talked about earlier,

            12   one of the things I talked about earlier, is to the extent we

            13   can get additional guidance out to the issuers, specifically

            14   directed to issuers, that can maybe take into consideration

            15   some of the things they do on a day to day basis that aren't

            16   "auditor type" tests, but can nonetheless serve as a basis

            17   for their assessment, I think you might see the costs

            18   improved, the costs reduced.

            19             MR. BAILEY:  The costs that the auditor incurs?

            20             MR. MINAN:  No, the costs -- when I use "costs,"

            21   generally the costs of the compliance with 404, which

            22   includes -- certainly an element of it is the external audit

            23   attestation, but a more significant element of it frankly is

            24   the costs in terms of their documentation, their monitoring

            25   and their ongoing testing.

             1             As I said earlier, because of a limited amount of

             2   guidance for issuers, I think we kind of maybe defaulted to

             3   an AS-2 standard for issuers, and perhaps that can be

             4   remedied or improved upon in future years if we are able to

             5   give some guidance examples where we as auditors can reach

             6   the conclusion that management's assessment is good and this

             7   process for doing it was also good based upon some guidance

             8   that they would be able to follow that is different than what

             9   we as auditors normally expect and what we are required to

            10   follow.

            11             MR. BAILEY:  Keith, do you have a comment on that?

            12             MR. HOLMBERG:  Yes, to some extent.  I think most

            13   companies would agree with his conclusion that we should be

            14   doing management assessment testing as well as external audit

            15   testing.

            16             I think it is the ratio and relationship between

            17   those two that needs to be adjusted, where we end up doing

            18   both too many times.

            19             Maybe by having a group of people representing all

            20   of the interested parties might get you there in terms of

            21   what different ideas might exist, but at the end of the day,

            22   I think it will rest with the Commission and PCAOB as to

            23   really dictating what the right incentives are for all the

            24   interested parties.

            25             Companies before 404 had the wrong incentives in

             1   terms of not doing internal controls, not following those

             2   because nobody cared and therefore, no costs or efforts were

             3   put into it.

             4             I think with 404 coming into play, that switched to

             5   where the audit firms have the wrong incentives to try and

             6   limit the amount of work they need to do.  Their incentives

             7   are driven, as many people have said today, by the avoidance

             8   of litigation, by protecting themselves, PCAOB reviews that

             9   will take place.

            10             They want to make sure everything is done.  They

            11   don't have an incentive to make those judgment calls.

            12             I think it is only yourselves that can actually say

            13   what are the right incentives that need to be in place so

            14   they get that balance right.

            15             Before lunch, Mr. McDonough said they would make

            16   that part of their review, not did you go far enough, but

            17   also did you go too far.  I think those are the kind, the

            18   tone from the top from the PCAOB that would actually help

            19   both companies and audit firms to recognize exactly what the

            20   expectations are from you all.

            21             MR. BAILEY:  I take away from these two answers,

            22   and I don't know what everybody else is going to say, but

            23   that we are not really having a discussion here about the

            24   basic principles behind the standard, the integrated audit,

            25   the various opinions.  It is strictly a matter of how can we

             1   bring the cost relationships more in line with what we

             2   perceive to be the benefits.  Is that correct?

             3             MS. GAVALETZ:  That's correct.

             4             MR. HOLMBERG:  That would be our conclusion.

             5             MR. HOWELL:  I would agree with that.  I would

             6   emphasize particularly for smaller companies, and I know the

             7   advisory committee that has been formed will be addressing

             8   that area, but a lot of these factors have a lot bigger

             9   impact on the smaller companies, and when they become due in

            10   2006, that is going to be a big hurdle to get over, to do

            11   these 404 audits for all of those enterprises, and for those

            12   enterprises to get maximum leverage from the things that we

            13   are uncovering today.

            14             MR. NICOLAISEN:  In closing, let's do left to

            15   right.  Kimberly, Susan and Lee.

            16             MS. GAVALETZ:  I would just like to comment on what

            17   Jay said there.  I think you had it perfectly, it is the cost

            18   relationship.  I don't think the principles, anybody is

            19   differing with here.

            20             I think on the cost side of it, there are a couple

            21   of things to look at.  We have all talked about the risk

            22   based approach.  That is clearly available in the standard. 

            23   I believe there is probably been a fear or a reluctance to do

            24   that in this first year, and also to see how the inspections

            25   come out.  Are they willing to make those risk judgments.

             1             I think relative to the use of other resources, the

             2   reliance on work of others, that is another part of that

             3   equation.  If you look at where all the work is being done

             4   and make some judgment calls about that being sufficient or

             5   needing to do a little bit on top of it, the use of internal

             6   audit.  It's just there for both management and for the

             7   external auditors to determine where is the best balance in

             8   all of that.

             9             I think there is a lot of opportunities as we go

            10   forward here to make this even better, and to make it more

            11   cost effective and to balance that cost benefit equation

            12   going forward.

            13             I think it has definitely been useful to this

            14   point.  I think getting this first round of documentation and

            15   testing together has been beneficial to firms.

            16             It was a road to hoe even for those of us who had a

            17   lot of it there.  It was a push to the finish line.  I think

            18   it gives us all a basis to take industry and our governance

            19   overall to another level.

            20             I loved the conversations on tone at the top.  You

            21   can walk in and have a few conversations and start to know

            22   that.  That is an auditable skill.  It's not the same way as

            23   checking numbers, but it's very auditable.

            24             Thank you again for having this forum and inviting

            25   me.

             1             MR. NICOLAISEN:  Thank you.  Susan?

             2             MS. GORDON:  I just wanted to say a few words. 

             3   Year two is going to be much better.

             4             MR. NICOLAISEN:  You promise?

             5             MS. GORDON:  I promise.  As the registrants out

             6   there know you got through it.  The fear factor of what was

             7   going on with what your auditors were going to be able to do.

             8             We talked at lunch about this earlier.  We have

             9   spent since March 16th, the day of the filing, we have spent

            10   that time to today going through and redefining our scope.

            11             As a company, we are going to go and I think

            12   present to the audit team and take like an aggressive

            13   position to say we are going to integrate this.  We are going

            14   to see where we can cut back and where we need to add.

            15             Some way, it is not going to be like it was like

            16   for year one and year two can only be better.

            17             MR. NICOLAISEN:  Lee?

            18             MR. LEVEL:  Very briefly.  We are on record of

            19   recommending the elimination of a separate management

            20   opinion.  I'd just like to state that orally as well.

            21             Further to the point about how the U.K. companies

            22   and others look at this, we found as one of the intangible

            23   costs, there are lots of dollar costs, but one of the

            24   intangible costs that we have faced is we have three regional

            25   offices outside the United States.

             1             We have lost internal auditors in each of those

             2   regions because the individuals involved don't want to do the

             3   more detailed type of work that we have talked about as the

             4   most significant to eliminate.

             5             In the U.S. in terms of costs, we have data. 

             6   Internal audit in the U.S., we have had twice as much

             7   turnover in the last year as we did historically.  We have

             8   had to raise pay levels in our internal audit staff three

             9   times our corporate merit level.

            10             The demand for these skills is just outrunning the

            11   supply.  I'm sure we are not the only company facing those

            12   issues.  Thank you.

            13             MR. NICOLAISEN:  Thank you.  Encourage your

            14   children to go into that business.

            15             (Laughter.)

            16             MR. NICOLAISEN:  To the audience, this session was

            17   an extremely important session.  It is also the toughest if

            18   you are not a technically minded person to participate in.

            19             The next two are now coming back up to the more

            20   generalized role.  The next panel deals with use of judgment,

            21   which I think everyone can equate to.  The last panel is an

            22   extremely important group, because that is where we talk

            23   about next steps and try to take inventory of what we have

            24   really learned here today.

            25             To this panel, I say thank you very much.  I

             1   sincerely appreciate your efforts, your participation.  Lee,

             2   if you want to send one more letter in, we would appreciate

             3   that, too.

             4             Thank you so much.  We will be back at 3:15.

             5             (A brief recess was taken.)

             6             MS. STACEY:  Good afternoon.  Thank you, everyone,

             7   for coming.  We are going to start panel five.

             8                   PANEL FIVE - USING JUDGMENT IN

             9                   COMMUNICATION AND CONCLUSIONS

            10             MS. STACEY:  Panel five is called using judgment in

            11   communication and conclusions.  Alan Beller and myself, Carol

            12   Stacey, will be leading this one.

            13             I wanted to mention again for those of you who may

            14   have just shown up, sort of the rules of order.  We won't

            15   have any opening remarks.  If someone has already said what

            16   you were dying to say, please keep it to yourself,

            17   recognizing that has already been said.

            18             If you would like to discuss a matter, please turn

            19   your tent cards on the end, and we will recognize you.

            20             We are joined once again by the Commissioners and

            21   by the members of the PCAOB.  We are going to dive right into

            22   it.  I am going to introduce who we have on panel five.

            23             From my left, we will start with Philip Ameen, vice

            24   president and comptroller of General Electric.  On his left,

            25   we have William Brunner, who is the chief financial officer

             1   and vice president and treasurer of First Indiana Corporation

             2   and is also a member of the American Bankers Association,

             3   actually the chairman of their accounting committee.

             4             To his left, we have Robert Hodgkinson, secretary

             5   of the Turnbull Review Group, and to his left, we have Larry

             6   Koch, a partner with Deloitte & Touche.  To Larry's left, we

             7   have Ron Lalonde, senior executive vice president and chief

             8   administrative officer of the Canadian Imperial Bank of

             9   Commerce.

            10             To Ron's left, we have Peter Lyons, a partner from

            11   Shearman & Sterling.  To Peter's left, we have David

            12   Shedlarz.  David is the chief financial officer of Pfizer. 

            13   To David's left, we have Teresa Sparks.  Teresa is the

            14   corporate controller of Symbion, and to  Teresa's left, we

            15   have Garrett Stauffer, a senior partner from the National

            16   Risk & Quality Practice of PricewaterhouseCoopers.

            17             Welcome, everyone.

            18             I'd like to start off this panel by throwing a

            19   question to Mr. Brunner.  Mr. Brunner, we have talked quite a

            20   bit about obviously the provisions of internal reporting, the

            21   American Bankers Association provided us with a number of

            22   suggestions in their comment letter to us.

            23             One of the specific areas that they discussed was

            24   the relationship between external audit and management, and

            25   basically suggested, as other panelists in earlier panels

             1   have, that there has been a decline in communications this

             2   past year, due to several areas.  The American Bankers

             3   Association attributed it to independence concerns, and there

             4   are other theories, too.

             5             What has been your experience with this issue or

             6   your association's experience?

             7             MR. BRUNNER:  As an association, we talk to all our

             8   members.  We may have the benefit of having an extremely

             9   broad range going anywhere from very small organizations to

            10   very large.

            11             We have found on a very consistent basis that

            12   across the board, organizations have found that their ability

            13   to use their auditors as sounding boards or as collaborators

            14   on issues has essentially gone down.

            15             I think it is a good bit more noticeable in smaller

            16   organizations than larger ones, which may have more core

            17   resources on their staffs.

            18             Yes, we have found that the environment is very

            19   much now where in our case banks, and quite a bit of

            20   isolation, to analyze situations as we always would, but

            21   before, completely before, you would take it to the auditor.

            22             Some of the consequences that we find that bring us

            23   concern is we think it can lead to quite often some

            24   suboptimal decisions.  You lose the benefits of some of the

            25   early synergistic thinking and talking between the parties.

             1             Some of these issues are extremely complicated.  We

             2   deal with a lot of financial assets which have a lot of

             3   changing and continuing review of the accounting treatment.

             4             There is a fear at times of companies being deemed

             5   significantly deficient or worse, if they have a fear of

             6   coming up with a different answer than their auditor might.

             7             Again, this situation we find particularly

             8   troublesome for smaller organizations who don't carry the

             9   breadth on staff of highly technical people to deal with all

            10   the changing issues that occur.

            11             One alternative we find is that companies are

            12   having to turn to yes, another outside advisor, again,

            13   layering on another level of costs.

            14             Because there is more layers, we are also finding

            15   and have evidence that timeliness of decisions sometimes are

            16   compromised.  It is just taking longer to work through the

            17   system and get them all worked out.

            18             In total, we believe this is quite an unfortunate

            19   consequence of the environment we are in, for whatever reason

            20   it is occurring.  We do believe that local informed and

            21   quality decisions are best made when the forces can get

            22   together and work on a transparent answer that truly reflects

            23   the financial economics of a given transaction.

            24             MS. STACEY:  Do you think it is more geared towards

            25   the smaller firms having difficulties rather than the larger?

             1             MR. BRUNNER:  I believe everyone is probably

             2   feeling a little bit more distant.  I think we hear more

             3   vocal the smaller you get, because quite honestly, that

             4   relationship of being able to have the other party to talk to

             5   is very, very important.

             6             In quite large organizations, my belief is if you

             7   want to talk to someone else professional in an given area,

             8   go next door.  There is probably another person on your

             9   staff.

            10             MS. STACEY:  I'd like to get probably the large

            11   company perspective and the small company perspective and the

            12   audit perspective.  Larry Koch, if you could weigh in.

            13             MR. KOCH:  First of all, Carol, I would agree with

            14   Mr. Brunner that there has been some confusion and

            15   uncertainty with respect to this matter I think throughout

            16   the public accounting community, the registrant community.

            17             I would say I do not believe the issue is limited

            18   to smaller companies.  GAAP these days is very, very complex.

            19   Transactions are very, very complex.  Large companies have a

            20   propensity to enter into very large, very complex

            21   transactions.

            22             I think the issue is germane really to the whole

            23   registrant community.

            24             Again, this is an area where judgment needs to be

            25   exercised as well.  I do believe it would be helpful to

             1   clarify and reaffirm the auditors' ability to work in a

             2   constructive manner with registrants early on with respect to

             3   the resolution of complex issues.

             4             I also would say I recognize that having the

             5   appropriate, if you will, technical resources for a

             6   registrant is an important element of internal control.  I

             7   personally believe that it is entirely feasible, in fact, I

             8   believe I do it in my working relationships with clients, it

             9   is feasible to be involved, be contributing, engage in

            10   dialogue constructively, yet not take the place of management

            11   in terms of being an element of the internal control, and

            12   still preserve the ability to step back and objectively

            13   assess whether the company, given its size and complexity,

            14   does indeed have the right level of expertise internally.

            15             MS. STACEY:  Basically what you are saying, the

            16   company needs to do a certain amount of their own homework,

            17   but then obviously the dialogue can be open between the

            18   auditor and the company.  It's not the company has to totally

            19   come up with a conclusion before they even start to talk to

            20   the auditor.

            21             MR. KOCH:  I would say it's not even clear to me

            22   that the company necessarily "has" to go first.  I think it

            23   can be an open dialogue from the very beginning.  There is no

            24   lock on good thinking, good ideas, and in depth

            25   understanding, particularly of the more complex standards as

             1   they apply in complex situations.

             2             MS. STACEY:  Mr. Ameen, maybe from a large company

             3   perspective?

             4             MR. AMEEN:  From a somewhat larger company

             5   perspective, I suppose, yes.

             6             It is clear to me that Sarbanes-Oxley has had a

             7   somewhat chilling effect on our communications with our

             8   auditors on accounting matters, which is unfortunate.  It was

             9   true before that we simply never ran into any sort of risk of

            10   having the auditors observe to our managers, to the audit

            11   committee, that we had a deficient depth or breadth of

            12   accounting expertise.

            13             I have something like 2,000 certified or chartered

            14   public accountants.  I have a technical staff reporting

            15   direct to me that I would compare with any in the world. 

            16   They are quite capable of what they are doing.

            17             Nonetheless, we now half a step before we take

            18   matters to our public accountants, which puts them at

            19   something of a disadvantage.

            20             The whole system, I think, the fear of reporting

            21   aspects is at a disadvantage.  I think there is long

            22   throughout history consultation on accounting matters before

            23   the deals are done and we are deciding where to make the

            24   debits and credits, going back to the old days of pooling of

            25   interest accounting in this very building of many a

             1   conversation, and one chief accountant said that about 50

             2   percent of his office time was spent consulting on poolings

             3   of interest.  I think that is not a bad precedent.

             4             There are also areas of expertise that regardless

             5   of how good my staff is, we are occasionally going to run

             6   into areas that we need supplemental information on.  My

             7   auditors have access to experience that I don't have.  They

             8   see other client situations.  They see other cases.  They in

             9   fact deal with conversations here in Washington that I'm not

            10   a party to, thankfully.

            11             (Laughter.)

            12             MR. AMEEN:  All of that information is relevant

            13   sometimes to the ways I structure, to the way I execute, and

            14   the way I account for transactions.

            15             I think it is unfortunate that we have lost that,

            16   but I do think under the current interpretations, it has been

            17   lost.

            18             MS. STACEY:  We have also heard just as a follow up

            19   to this conversation, not just communication issues between

            20   the auditor and the company, but also things like the

            21   financial reporting process has been slowed down because one

            22   party or another doesn't want to give or receive a draft of

            23   the financial statements until it is entirely final on

            24   management's point.

            25             I don't know if anyone here has experienced that,

             1   but I would be interested in that issue also.

             2             MR. AMEEN:  I will just respond to that one

             3   specifically, whereas each draft, and we go through probably

             4   a dozen drafts of the year end financial statements as an

             5   example, had previously been made available to KPMG

             6   immediately on preparation.  We don't do that now.  We wait

             7   for completion of a review cycle by my staff before we pass

             8   it onto KPMG.

             9             That is chilling in a process where the time cycle

            10   is getting shorter and shorter.

            11             MS. STACEY:  Can you give us some background as to

            12   why that is happening?

            13             MR. AMEEN:  These early drafts inevitably have

            14   errors in them, and I don't want a competition between the

            15   auditors saying that error is evidence of a weakness in

            16   internal control or we found it first.  It's a competition

            17   that you simply can't afford to have.

            18             MS. STACEY:  Maybe from a small company

            19   perspective, if Ms. Sparks could speak to the communication

            20   issue also.

            21             MS. SPARKS:  Sure.  Thank you.

            22             I think I bring two unique perspectives to the

            23   panel today.  One, I do represent a small to mid-sized

            24   company.  Our revenues are about $250 million, compared to my

            25   next door neighbor here, we are just a dot on the map, so to

             1   speak.

             2             Also, we were not classified as an accelerated

             3   filer.  We are currently in the midst of year one of 404.

             4             Those are my two unique perspectives.  As it

             5   relates to our communication with auditors -- I am also a

             6   representative of many health care companies that I have

             7   polled as I did my research in preparing to come here, just

             8   to get their feedback as well.

             9             We really reached a consensus that those

            10   relationships have been strained.  As a small company, we do

            11   operate as a health care company in a very highly regulated

            12   environment.  We are used to and accustomed to seeking expert

            13   advice as complex issues present themselves.

            14             The same holds true as we are preparing and

            15   determining today's complex accounting standards, and with

            16   having a limited staff, that has been something that has been

            17   an extremely valuable tool to our size company, of being able

            18   to seek our auditors' opinion and their guidance in those

            19   certain areas.

            20             Now, we always do our homework, but as I mentioned,

            21   we have a very limited staff.  We do see that as a very big

            22   issue for our company.

            23             MS. STACEY:  Mr. Lyons?

            24             MR. LYONS:  I just wanted to go back to the

            25   question of how often and when one sees drafts.  It is

             1   affecting transactions materially and slowing them down.

             2             If you are doing, for example, a carve out

             3   acquisition and the buyers are, for example, private equity

             4   firms, and there is going to be audited financials which will

             5   ultimately then probably be used in a 144(a) offering

             6   memorandum, you will thereafter be audited.

             7             The length of time it takes to get them out, and

             8   people are very reluctant because when you take the carve out

             9   and the accountants come in, it is going to take a long time

            10   because the nature and extent of the changes that we are

            11   seeing, these are financial statements that have been audited

            12   for years, but if it's a carve out, there is a different

            13   level of materiality, but there is also a different level of

            14   focus.

            15             It is slowing down transactions simply because

            16   people are very nervous to give them out until -- in the old

            17   days, you would say you know what, I can give them, they are

            18   management's financial statements, I can get an audit, it is

            19   not going to be a problem.

            20             People are very reluctant to take that position

            21   because they expect a lot of changes.  That is unfortunately

            22   what they are going in with the mindset.  There will be a lot

            23   of changes. That may not be well founded in all cases, but

            24   people have seen it often enough that they are very concerned

            25   about it.  It is affecting transactions in material ways.

             1             MS. STACEY:  Mr. Lalonde?

             2             MR. LALONDE:  I wanted to make two comments on

             3   this.  First of all, I'd say that I would certainly concur

             4   that the nature of the relationship between management and

             5   the auditors has changed.

             6             The first observation I was going to make is I

             7   think this predates Sarbanes-Oxley.  I think this really was

             8   driven in the first instance by independence issues, and I

             9   think independence like trust is as much a perception issue

            10   as it is a substantive issue.

            11             I think that is what drives the zero tolerance

            12   approach to independence and the rule structure, but also in

            13   the processes and procedures that are established by

            14   managements and audit committees.

            15             We actually had an unique circumstance in Canada on

            16   this point, as this change was taking place, I think.  The

            17   Canadian banks all had two auditors, and for historical

            18   reasons.  With the demise of Arthur Andersen, that left four

            19   major firms, and if you had two of them as your auditors, and

            20   as the tone of that conversation with management was

            21   changing, you were starting to find you had limited sources

            22   of advice for the kinds of complex issues that one would

            23   normally deal with accounting professionals on.

            24             That was one of the reasons frankly that we decided

            25   and the industry subsequently followed to move to a single

             1   auditor as opposed to employing two auditors.

             2             The second comment I was going to make is that I

             3   think I would also agree with the sentiment that has been

             4   expressed that this has had a bit of a chilling impact on the

             5   relationship between management and the auditors.

             6             I would say, however, I think there is an offset

             7   there, and the offset is I think it has had an enhancing

             8   impact on the relationship between the external auditors and

             9   the audit committee.

            10             My sense is that it was independence that drove

            11   this rather than evaluation of control issues, and I think

            12   that same thing that drove independence drove the

            13   relationship between the external auditors and the audit

            14   committee to become much more close.

            15             I would observe that I think audit committees, at

            16   least our audit committee, is using our external auditors

            17   much better as advisors and consultants, so management may be

            18   getting less value out of that relationship, but I think our

            19   audit committee is getting more value.

            20             MS. STACEY:  That is an interesting comment.  Thank

            21   you.  Mr. Hodgkinson, I hate to put you on the spot, but I am

            22   wondering across the pond if you are encountering the same

            23   issue in the U.K.?

            24             MR. HODGKINSON:  I think it would be fair to say

            25   no, but it is probably worth saying that the Turnbull

             1   guidance is not exclusively on financial reporting.

             2             I would also say that if we are thinking about the

             3   application of judgment, there is perhaps a linkage to this

             4   issue.  I think the application of judgment does require that

             5   you have a clear idea of what the objective is you are trying

             6   to achieve.  Something perhaps has gone a little wrong if

             7   provisions which are designed to improve the quality of

             8   financial reporting actually levitate against a process in

             9   which you improve the quality by consulting with those who

            10   can contribute to the decisions.

            11             At a basic level, we must have focused on some

            12   intermediate objectives which aren't appropriate.  The

            13   objective of this is to improve financial reporting.  That

            14   would seem in the common sense way that people have talked

            15   about to require that you have an informed debate because

            16   more informed people contribute to better decisions.

            17             I think that focus upon objectives is perhaps a

            18   theme that might be pursued here.

            19             MR. BELLER:  I guess I have a somewhat similar

            20   take.  I was going to describe it as what's wrong with this

            21   picture.  If the ultimate policy objective is to have the

            22   most accurate possible financial reporting in the most

            23   painful possible way, is what we are hearing good policy or

            24   not.

            25             I guess I would ask Mr. Stauffer, is what we are

             1   hearing good policy or not?  To the extent it's not, what do

             2   we need to get it back on the right track?

             3             MR. STAUFFER:  No, it's not good policy.  Clearly,

             4   in our mind, it's an unintended consequence.  It's driven bad

             5   behavior.  It's prevented good communications.  It has the

             6   impact of going backwards when you think about quality of

             7   financial reporting.

             8             I will say that early on, let's say right after the

             9   standard was issued last Summer, I believe there was a very,

            10   very stifling effect at that point in time.  It has gotten

            11   better, I believe, as we sit here today.  That's due to

            12   speeches made by both the SEC and the PCAOB, the PCAOB's FAQ

            13   on this topic.

            14             We, as I think industry, have made an effort to try

            15   to make sure we keep our partners and our staff informed of

            16   the issue and where the lines should be looked at.

            17             Management can advocate its responsibility for the

            18   selection of generally accepted accounting principles. 

            19   Management can have the auditor come in and record the

            20   journal entries and close the books and write the financial

            21   statements.  We all know that.

            22             That is a far cry from what I think we are talking

            23   about here, which is good communication that will improve the

            24   quality of financial reporting.

            25             MS. STACEY:  Mr. Shedlarz?

             1             MR. SHEDLARZ:  With your indulgence, I will address

             2   the issue but maybe take it down a slightly different path.

             3             I think what we are dealing with is human nature,

             4   one of the toughest things to arrest in this type of

             5   environment.  The utilization of professional judgment is

             6   critical to getting the balance right, even in terms of

             7   independence, but also in terms of the review and attesting

             8   to the internal controls.

             9             Both management and the outside accounting

            10   community are moving towards a mode of very conservative

            11   practices.  Until this is tested in the open environment,

            12   they are likely to stay there.

            13             This is a critical period in terms of getting the

            14   balance right.  I don't think the rules need a lot of

            15   modification.  I think the human activity needs a lot of

            16   addressing in terms of defining what is acceptable practice.

            17             I watch directly a lot of the constituencies

            18   reaching for absolute assurance in terms of independence,

            19   absolute assurance in terms of the internal control

            20   environment, when the best you can ever hope for is

            21   reasonable assurance.

            22             When you are trying to reach for the unobtainable

            23   goal, that is when you start to get practices that are going

            24   to start to weigh the balance risk of all this in terms of

            25   the benefit and the cost, probably in the wrong direction.

             1             You only have to take a look at the extent to which

             2   they are willing to rely on other activity, on behalf of the

             3   internal audit departments of various organizations, the

             4   extent to which they are defining at a certain level

             5   significant deficiencies.  You can go down through just about

             6   every major element and what you are finding is ultra

             7   conservatism.

             8             I look to the PCAOB in part in terms of listen,

             9   they allow for this flexibility, but maybe there is not a lot

            10   of belief in terms of the level of acceptance.  This critical

            11   stage now in terms of how you are going to exercise your

            12   authority which is so critically important and no one is

            13   begrudging is going to be defining in terms of whether or not

            14   we can strike this balance more correctly, whether it comes

            15   to engagements on the independence side, or it's the level of

            16   activity which is being carried out in a highly duplicative

            17   nature in terms of the internal control environment.

            18             It is a very important thing to get right in terms

            19   of human nature.

            20             MS. STACEY:  Let's go to Commissioner Goldschmid.

            21             COMMISSIONER GOLDSCHMID:  Picking up on David

            22   Shedlarz's comments, which I agree with, although

            23   conservatism isn't a bad word in this town right now.

            24             (Laughter.)

            25             COMMISSIONER GOLDSCHMID:  What we are really

             1   talking about is the chilling effect that seems to cut in

             2   lots of areas, certainly independence has been there, worry

             3   about scope, worry about reliance.  It is cutting across a

             4   bunch of areas and arguably creating a lot of -- I'm not sure

             5   any of this, by the way, comes out of Sarbanes-Oxley.  It may

             6   come out of other doctrines and other fears and the

             7   conservatism, using that word again, that may have developed.

             8             What can we do to bring it back into a more

             9   balanced cause, I guess is the question I would ask the

            10   panel.

            11             MS. STACEY:  Who would like to weigh in on that? 

            12   Mr. Lyons?

            13             MR. LYONS:  I'll give you a lawyer's response. 

            14   Really what I think, the accounting firms have been quite

            15   conservative.  I think they are responding appropriately.

            16             If I were the general counsel of an accounting

            17   firm, I would want them in facing the current environment

            18   with the liability they face, with a brave new world, where

            19   unfortunately they are out there doing something they have

            20   never done before, they have to conclude they face new and

            21   different risks.

            22             They have to be conservative about it.  I think the

            23   PCAOB has to give them comfort that when they make judgments,

            24   that is okay, that they make reasonable judgments, and they

            25   are going to have to communicate that those reasonable

             1   judgments are going to be consistent.  They will have to know

             2   that it's not going to increase the exposure to the four

             3   remaining big firms.

             4             I think the legal environment and the legal risks

             5   they face, and I think Commissioner Goldschmid's point, it is

             6   not just this, but it is part of it, that the whole

             7   environment that the accountants face is driving a lot of the

             8   conservatism we see.

             9             I don't think it is going to change unfortunately

            10   as much as we might like it to, unless and until the

            11   accountants can see a change in the regime they face that

            12   will allow them to exercise more judgment and allow their

            13   general counsel to be comfortable that they are not crazy

            14   doing it.

            15             MS. STACEY:  Before we move onto judgment related

            16   to material weaknesses and significant deficiencies, let's

            17   finish up this topic.

            18             Mr. Hodgkinson, did you have your tent up for this

            19   one or the last one?

            20             MR. HODGKINSON:  Yes, just to take up on the points

            21   about the preconditions of people exercising judgment.  I

            22   think you mentioned there has to be trust and others will

            23   accept that you have exercised judgments, and in fact, that

            24   others are prepared to exercise judgment.

            25             There are some deep things which need to be

             1   accepted as a consequence, and that is if you are going to

             2   have judgment, then you have to accept there will be some

             3   variability of outcome.  You can't have judgment which always

             4   leads to the same outcome in all circumstances.  That is

             5   quite difficult to accept, because a lot of people today have

             6   been asking for more and more guidance presumably to give

             7   them certainty that they are exercising judgment properly, in

             8   which case, they are not exercising judgment properly.

             9             (Laughter.)

            10             MR. HODGKINSON:  That is just a guy who has read

            11   all the detailed literature that tells him what the right

            12   answer is, whether it's right or wrong.  There has to be a

            13   broader atmosphere of trust.

            14             Actually, judgment isn't a little bit of seasoning

            15   that you sprinkle on some otherwise unpalatable meat.  It is

            16   actually the core of what you are after.  You want a system

            17   in which people exercise judgment, and the rigidity is

            18   something which you have to put up with, that goes with it,

            19   of certain pieces of guidance and rules, not the other way

            20   around.

            21             As soon as you are down the path of prescription,

            22   it is very hard to just sprinkle a little judgment around the

            23   edges.  It will look like a fairly illusory form of judgment.

            24             There are some big issues to accept, I think, and

            25   by all parties before judgment can simply be implemented.

             1             MS. STACEY:  Before we go to Mr. Koch, Commissioner

             2   Glassman wants to ask a question.

             3             COMMISSIONER GLASSMAN:  Thank you.  It's a

             4   follow-up on the judgment, although more specific, in this

             5   world of judgment, if management thinks something is not a

             6   material deficiency, a material weakness, and the auditors

             7   do, using their own judgments, how does that get resolved, if

             8   there are no specific guidelines?

             9             MS. STACEY:  I think that is one of the things we

            10   were going to go to next.  How do you determine that.  They

            11   are very good questions.  We were going to actually put Mr.

            12   Ameen on the spot.

            13             Let's hear Mr. Koch's answer first.

            14             MR. KOCH:  I would just say I believe in the near

            15   term, in terms of practical help in the exercise of judgment,

            16   perhaps in this area as well, I do think the upcoming PCAOB

            17   inspection season really does present quite an opportunity

            18   for the PCAOB to look at complicated real world examples,

            19   real world best practices and communicate that.  I think in

            20   near term, that is key.

            21             In terms of resolution of differences in judgment,

            22   I will confess I have not found that to actually be the case. 

            23   My sense is that reasoned people vetting through the specific

            24   facts and circumstances of the condition or sometimes

            25   combination of conditions at hand, will tend to arrive at a

             1   common judgment.

             2             Perhaps maybe even more important than that, in my

             3   experience, I have found that the issue so much doesn't turn

             4   on is this a material weakness or is it a significant

             5   deficiency.  It tends to turn on what is the issue, what is

             6   the best way to remediate it, let's get the remediation done

             7   and let's be in a position where at the "as of" date, at the

             8   end of the year, there is not even a question because it has

             9   been remediated.

            10             MS. STACEY:  You haven't experienced that many

            11   instances of disagreements over either what is a significant

            12   deficiency and what is a material weakness, how do you

            13   aggregate significant deficiencies?

            14             MR. KOCH:  Good healthy dialogue, yes.  Hard held

            15   differences of view at the end of the day, no.  We have been

            16   able to drive to commonality, again, in an environment where

            17   first and foremost, the issue is let's take care of the

            18   problem.

            19             MS. STACEY:  Mr. Ameen, can you comment on the

            20   judgments involved in identifying what is a deficiency?

            21             MR. AMEEN:  Just to give you a little scale, we

            22   identified a lot of controls, probably somewhere in excess of

            23   50,000, and tested many of those.  It's difficult in my

            24   environment to find one of those that would have been a

            25   material deficiency, because so many of them are distributed

             1   so broadly across so many organizations.

             2             However, the place you would start looking for such

             3   a deficiency would be at the very top level, where it all

             4   comes together, in corporate, and those systems sometimes are

             5   not the most robust, but have the largest numbers and

             6   therefore the greatest risks flowing through them.

             7             Fortunately, we did not run into deficiencies in

             8   those controls.  The numbers, once they are put together, are

             9   pretty well monitored and articulated pretty fluidly.

            10             It didn't turn out to be an issue, but I think the

            11   right answer is to err on the side of reporting in the

            12   interest of openness to the markets in all cases where there

            13   is any doubt.

            14             MR. BELLER:  Just to follow up, do you think you

            15   were able, both as a preparer, use your judgment, and were

            16   your auditors successful in using their judgment to focus

            17   their attention on that proportion of the 50,000 plus

            18   controls that were worth focusing on, or was it less

            19   rationally distributed than that from a risk assessment point

            20   of view?

            21             MR. AMEEN:  I have to say this was our second time

            22   through, 2004 was our second time through.  We had done what

            23   turned out to be a dry run for internal control reporting in

            24   2003.

            25             MR. BELLER:  For which we apologize.

             1             (Laughter.)

             2             MR. AMEEN:  Actually, it was a very significant

             3   learning process for us and for our auditors.  We were doing

             4   it without benefit of PCAOB rules, of course.  Having been

             5   through the exercise, having put the documentation together,

             6   we were miles ahead we thought of where we would have been

             7   otherwise.

             8             We had no push back at all that I'm aware of from

             9   KPMG on which controls we identified.  If anything, we would

            10   step a bit back from where we are, I think, on an internal

            11   evaluation basis.  In a distributor organization as

            12   diversified as we are, you really have to push down pretty

            13   deep.

            14             MS. STACEY:  Mr. Lalonde, I wanted to get to you

            15   because your company actually wasn't required to do it this

            16   year, and you actually went through the assessment process. 

            17   I wanted to get your thoughts.

            18             MR. LALONDE:  Yes, go figure.

            19             (Laughter.)

            20             MR. LALONDE: I was just going to reinforce a

            21   comment.  I don't think the issue here on judgment is around

            22   evaluating control deficiencies.  At least that certainly

            23   wasn't our experience.

            24             We evaluated and tested about 3,500 controls in

            25   this area, and because we thought that the gap between

             1   deficiency and significant deficiency was a little too big,

             2   we even invented an intermediate category between those two

             3   to get a little bit more granularity.

             4             Even looking across those four categories, I would

             5   say that the differences of opinion between management and

             6   the auditors were like a handful, and they were easily

             7   resolved.

             8             There is, however, I think a much bigger judgment

             9   issue that comes into play, and I think that comes back to

            10   something one of the previous panels was discussing, around

            11   scoping exercises and planning.

            12             My sense is that is where the big judgment factor

            13   comes in and where the big conservatism factor comes in, in

            14   figuring out what needs to be documented and tested.  My

            15   sense is that is where if there is dramatic overkill taking

            16   place because of the conservatism bias built into the whole

            17   process, and I'd say frankly not just auditors.  I think that

            18   bias exists amongst management as well to over club this in

            19   the current environment.

            20             I think that is where you have a problem with

            21   judgment being applied perhaps a little bit overly

            22   aggressively.

            23             MS. STACEY:  Mr. Shedlarz?

            24             MR. SHEDLARZ:  I would tend to agree with a lot of

            25   the former comments.  I would tell you interestingly enough,

             1   I think when you have a material weakness, everybody knows

             2   you have a material weakness.  You don't get a lot of debate.

             3             If you do, whether we like it or not, the auditor

             4   rules.  The debate tends to be around significant

             5   deficiencies.  That is important as well, because there you

             6   want to focus on things that are really important to the

             7   internal control environment and the integrity of the

             8   financial statements.

             9             My sense is again due to this conservative posture,

            10   a lot of things get thrown up on the table in that category

            11   that then get reviewed robustly and dealt with, which might

            12   not have a good payoff, and may in fact have a negative

            13   consequence in that you are not focusing on the things that

            14   really count in that category.

            15             Again, the extent to which we can help the

            16   community in understanding where the cut line is as not a

            17   material weakness, but more a significant deficiency, and

            18   where the focus needs to be in the system would probably be

            19   healthy.

            20             Some of that has to be worked out between the

            21   outside accounting firms and management and some of that can

            22   be assisted by the PCAOB as well.

            23             MS. STACEY:  I want to come back to the

            24   communication of significant deficiencies in a minute.

            25             Mr. Brunner, you had your tent up a little while

             1   ago and put it down and it is up again.  Go ahead.

             2             MR. BRUNNER:  To close up the item that I took it

             3   down for, my personal feeling is the desire and willingness

             4   -- I don't mean to speak for the auditors, but the ones I

             5   know -- and for management, they do prefer to have that open

             6   ongoing early dialogue.

             7             I don't think it is a fear or mistrust factor

             8   between the two individually.  I think it is fixable.  I

             9   think it is really a little bit of a given freedom of

            10   guidance of saying the judgment of determining when you have

            11   crossed that line of independence is one you have to make

            12   every day.  It can't be done by simply not talking.

            13             On the other, and this might be bleeding into the

            14   next topic, in judgment, the other areas, materiality, I find

            15   to be a very slippery slope.  We all talk about percentages

            16   and such.  The struggle with materiality is much from the

            17   concept of what could happen, and the judgment that goes into

            18   effect of saying what is the likelihood or what are the

            19   string of events that are going to have to make a "could."

            20             Taken to its extreme, the "could" could take you to

            21   a 100 percent assurance because well, some remote thing could

            22   happen.  I think there is some work that can be done on

            23   helping everyone get to the proper level of "could," and that

            24   would really substantially help in scoping.

            25             MR. BELLER:  This is more in terms of scope than in

             1   terms of what is a material weakness?

             2             MR. BRUNNER:  I think it can help in scoping

             3   because it will set the tone of what you work on in this

             4   period.  When an issue comes up, let's say you have scoped it

             5   and it comes in, then you get into the debate of significant

             6   deficiency or not.

             7             Then you are dealing with it came to the table

             8   possibly because it may or may not have been a material item,

             9   but once it is there, the "could" I find drives what the

            10   breaking point between not a significant deficiency, a

            11   significant deficiency, and a material weakness.

            12             I agree with an earlier comment.  Material

            13   weaknesses, they are pretty obvious.

            14             MS. STACEY:  Mr. Stauffer?

            15             MR. STAUFFER:  Just to go back on that one point I

            16   wanted to close out on relative to advice and the

            17   Commissioner's question as to what else can be looked at.

            18             The effect of not wanting to give your auditor

            19   information before it has been reviewed five times and

            20   causing delay, I think, is a very interesting topic.  It gets

            21   back to the issue that the standard talks about, who caught

            22   it first.

            23             I think more light around that issue on who caught

            24   it first and the debate on what that is really trying to

            25   drive at is very important because as mentioned here numerous

             1   times, it is stifling the process and creating timing

             2   problems as we move forward.

             3             Relative to deficiencies, it is clearly very, very

             4   judgmental.  There is no bright lines in this area, unless

             5   you have a slam dunk material weakness because the auditor

             6   found an error in financial statements that is 50 percent of

             7   net income, things start to become very difficult and

             8   judgmental.

             9             I would tell you that is a learning process also. 

            10   Most people, as most people didn't have to evaluate controls

            11   before and most people did not have to evaluate deficiencies

            12   before, so the newness of the process, the lack of guidance

            13   in the area, the implementation of the process, and I agree

            14   very much so with the "could" factor, has all driven this

            15   process to be highly judgmental, and help in the area of

            16   evaluating deficiencies and good practices, best practices,

            17   and guidance in that area is very important.

            18             MS. STACEY:  There was some suggestion in the

            19   comment letters that the engagement partners were in terms of

            20   determining what is a significant deficiency or material

            21   weakness consulting with their national risk partners and

            22   deferring to them on these types of issues.

            23             I wanted to see what the experience was with that,

            24   if those comments are in fact true.  It does beg the question

            25   are they being overly conservative if they are consulting

             1   with the risk partners whose main goal is probably to

             2   minimize risk.

             3             MR. STAUFFER:  I wouldn't call it consulting with a

             4   risk partner, but I would say we urge consultation in this

             5   first year to make sure number one, that we had a consistency

             6   in thought practice, and also to make sure that it was new,

             7   people weren't in a different area than we thought was

             8   appropriate, and it required a lot of judgment, so we thought

             9   it was important to bring enough resources to bear to draw

            10   the conclusion correctly.

            11             Yes, we did encourage consultation at the national

            12   level, but not necessarily from a risk perspective, but from

            13   a quality perspective and a consistency perspective.

            14             MS. STACEY:  Mr. Koch?

            15             MR. KOCH:  I would echo that.  We certainly

            16   encouraged and did consult quite a lot with our national

            17   office, but I would definitely say it did not become a matter

            18   of deferring to the national office for a conclusion.  That

            19   process always arrives at a commonality of judgment and a

            20   view of the firm.

            21             I wanted to touch also for a minute on the

            22   significant deficiency point, and a little bit of a different

            23   take on it.

            24             I think the level of communication interaction with

            25   audit committees has been extremely good throughout this

             1   process.  I think that in part has been driven by audit

             2   committees' expectations to be communicated with, and the

             3   higher level of interest that they obviously have had.

             4             I think if you will, the judgment, the capability

             5   to exercise judgment around significant deficiencies has been

             6   very helpful in, for example, situations where in the past,

             7   it may have been hard, if I can put it this way, to encourage

             8   management to get ahead of a fire, rather than fight it year

             9   in, year out from behind.

            10             I think the ability to aggregate situations --

            11   earlier there was discussion about information technology. 

            12   That would probably be the one area I would point to as an

            13   example of this.  To really have attention focused at the

            14   audit committee level driving to solutions that really I

            15   believe became more permanent solutions rather than, if you

            16   will, band-aids on individual items.

            17             Another point I would want to make about

            18   materiality as it plays into the judgments around significant

            19   deficiencies and material weaknesses, I do believe the

            20   question or the point of requiring deficiencies to be

            21   assessed as they may relate to quarters is something that

            22   should be given serious reconsideration.

            23             It can drive the materiality level to what I would

            24   argue at times is an inappropriately low level, and perhaps

            25   raise the risk of over reporting to the audit committee,

             1   maybe to an extent where the audit committee has difficulty

             2   separating the wheat from the chaff.

             3             MS. STACEY:  Before we go back to the panelists,

             4   Commissioner Atkins?

             5             COMMISSIONER ATKINS:  I just have a question

             6   regarding informal guidance.  When we are talking about as a

             7   policy maker here, when we set out our rules and what not,

             8   part of what happens is things get shaped by informal

             9   rulemaking from our staff and of course, staff at the PCAOB,

            10   through staff accounting bulletins and speeches, which were

            11   referred to before, which fall outside of any formal

            12   rulemaking process.

            13             I was wondering in this area in particular, when we

            14   are talking about what you all are struggling with, have you

            15   been getting any informal guidance?  Speeches have been

            16   referred to before.

            17             Has that been consistent with Commission rulemaking

            18   or has it tended to make the waters more murky, and then if

            19   we look down the road towards an inspection or examination

            20   program, which you all have suggested, how do we make that as

            21   transparent as possible?

            22             You are going to have a conflict between

            23   confidentiality concerns on the one hand and then guidance

            24   concerns on the other.

            25             I am worried about muddying the waters even more

             1   going ahead, and want to keep it as transparent as possible.

             2             MS. STACEY:  Anyone in particular?

             3             MR. BRUNNER:  I'll take a stab.  I'm not sure I can

             4   give you a fully quality answer.  Yes, I have seen where the

             5   water has been muddied through informal guidance coming out

             6   there.  I think it's a bit of a natural outcome of a very

             7   unsure environment.

             8             A lot of people working in an environment with

             9   regulators and so to speak bosses that are different, so they

            10   are grasping at pretty much anything that can be found to

            11   give guidance.

            12             I think yes, it is happening.  I think the more

            13   that can stabilize and the more we can give assurance that

            14   professional judgment still has a very strong place, your

            15   judgment can still have a strong place in this business, I

            16   think we will go a long way towards taking some of that

            17   grasping out of it.

            18             COMMISSIONER ATKINS:  Through a formal notice and

            19   comment process and maybe the FAQ process, that would

            20   probably be the most helpful in that area?

            21             MR. BRUNNER:  I think it would.

            22             MS. STACEY:  Mr. Lyons?

            23             MR. LYONS:  I want to come back to audit

            24   committees.  I would say as a general matter, our view is

            25   that in most of our clients, the audit committees are

             1   functioning far better than they did in the past.

             2             I don't think that is really a 404 result.  I think

             3   that is just the overall environment.  That has been a very

             4   good thing.

             5             I think we are seeing management -- far more often,

             6   you hear the CFO say well, you know, I'm just going to call

             7   the chairman of the audit committee to give him a heads up on

             8   this.  That is largely a good thing, although I think we do

             9   have to temper it.

            10             Some audit committee members would say I need

            11   better information, but I don't need the volume of

            12   information.  I think you need to recognize it.

            13             I would say, for example, to be on the audit

            14   committee of a General Electric, it has to be one of the most

            15   daunting tasks one can imagine, to actually spend the time

            16   and energy actually understanding an organization that large

            17   and complex.

            18             Sometimes audit committee members are saying we

            19   need more distillation.  It's not they don't want the raw

            20   data.  They can't do it.  They do urge sometimes a little bit

            21   of moderation.  I'm hopeful that will work itself out in a

            22   natural cycle, that perhaps now in some cases people are

            23   getting more -- there is maybe a little bit more

            24   communication than there might need be because you are

            25   imposing burdens that may be a little bit too much, but to me

             1   that is okay, if we can work out an equilibrium.

             2             I do think as a general matter, most audit

             3   committees are far better than they were.  The level of

             4   communication with audit committees between management is far

             5   better than it has been and with their auditors, as a general

             6   matter.  In that area, we have seen substantial improvements.

             7             MS. STACEY:  What do you think they are being

             8   provided that they don't necessarily need?  Is there anything

             9   as a result of our rules that they are being provided?

            10             MR. LYONS:  I don't know if it is a result of your

            11   rules, but what you need is something that distills it down,

            12   that tells them what are the issues.

            13             If I'm on an audit committee, I want something that

            14   says what are the ten issues or whatever the number is, that

            15   you guys wrestled with. Why don't we start with that.  Tell

            16   me what are the things you spent -- what did you spend your

            17   most time talking to your auditors about.  Let's start with

            18   that.  I need to know how the company is doing.  Let's start

            19   with the ten things or whatever the number is, and Larry, you

            20   might comment.  I want to start with that, tell me what you

            21   wrestled with, let's start there.

            22             MS. STACEY:  Let's give Mr. Stauffer a chance.  He

            23   has had his tent up for a while.

            24             MR. STAUFFER:  I'd like to just make sure you

            25   consider five areas in this evaluation of deficiencies that I

             1   think from my experience this past Winter have clearly made

             2   it a difficult area to deal with.

             3             The first area, and this is where I would agree

             4   with Larry, in the interim, the materiality issue. 

             5   Evaluating a potential deficiency, potential, not known

             6   deficiency at the interim level effectively reduces the

             7   materiality measures at quarterly levels.

             8             I think it makes it highly complex and probably not

             9   as appropriate as it should be.

            10             Second area is the aggregation or the combination

            11   of weaknesses, taking significant deficiencies in an area and

            12   aggregating to a material weakness.  That has proven to be

            13   highly complex.

            14             More best practices examples in that area, I think,

            15   would be very helpful, very judgmental to try to pull that

            16   together.

            17             The "could" factor is the other area that makes it

            18   very difficult. You are looking at a control deficiency that

            19   has not resulted in an error, and you are trying to determine

            20   what could happen here and develop some level of materiality

            21   criteria and magnitude and likelihood factors around

            22   something that never has maybe resulted in a significant

            23   adjustment to the financial statements.

            24             The other area which a lot of people had a problem

            25   with is what I would call the "well reasoned position." 

             1   Companies who have designed very good controls and processes

             2   around selection and application of GAAP find themselves

             3   having an incorrect decision being made, although very well

             4   reasoned.

             5             When you sit back and say should that -- that

             6   correction results in a misstatement to the financial

             7   statements that is material or maybe even a restatement, you

             8   sit back and say to yourself what would you have done

             9   differently there, and what control failed.  Very difficult

            10   area to deal with.

            11             Finally, I think some best practices and examples

            12   in the compensating control area.  It is an area that has

            13   prevented many significant deficiencies or deficiencies from

            14   becoming material weaknesses, but it is very difficult, not a

            15   lot of information and examples out there on how that should

            16   be applied.  I think there may be some inconsistency in that

            17   practice.  I think some help there would be very useful.

            18             MR. BELLER:  I want to make sure we get the two

            19   things in the few minutes we have left.  I know there are a

            20   lot of cards up.  I am hoping some of them address this, they

            21   both are follow ups to what we have been talking about.

            22             One is we have heard a lot today and there is a lot

            23   in the comments file about the need for additional guidance

            24   to issuers, so that they can -- it is guidance that goes

            25   beyond what is material, or at least it seems that it is

             1   guidance beyond what is material.

             2             It seems to be a suggestion that if the Commission

             3   either by rulemaking or by interpretation came up with

             4   something that looked like AS-2, then issuers would be better

             5   prepared to reach their own conclusions about scope and

             6   materiality, and they would have something to point at when

             7   the accountants pointed to AS-2 and said see.

             8             The 404 rules were consciously written to be very

             9   principles' based.  Reasonable assurance, reasonable levels

            10   of documentation, reasonable levels of scope.

            11             I guess if anyone on the panel could sort of help

            12   us out.  What would you want from the Commission that would

            13   make it easier to -- I guess the way I would describe it is

            14   allow issuers to be more comfortable and allow auditors to be

            15   more comfortable with issuers using their judgments.

            16             Another way I could phrase it would be that would

            17   make auditors more comfortable in deferring to issuers'

            18   judgments that conclusions are reasonable.

            19             Is there anything the panel can do to help us out

            20   on that one?  I think if you look at the file, a crucial

            21   piece of what we are hearing about, kind of the context in

            22   which it would be easier to exercise judgment.

            23             MS. STACEY:  Ms. Sparks, while you haven't adopted

            24   404 yet, perhaps you have a good perspective.

            25             MS. SPARKS:  That's currently where we are in the

             1   process.  I'm sure other members on the panel haven't

             2   forgotten that process.  It's not been that far removed.

             3             There is a lack of guidance for issuers.  If the

             4   issuer has the guidance they need to make the

             5   planning/documentation type decisions that fit their company,

             6   that makes sense for their company, and the auditors feel

             7   comfortable that they can rely on the judgment of management.

             8             I guess that goes back to the two things, one

             9   having some sort of guidance.  The last thing we want is to

            10   have more rules.  In the absence of rules, our judgment, our

            11   testing, our documentation is not allowed to be relied upon.

            12             Therefore, we are back to okay, we need more rules.

            13             The second thing is what are the repercussions to

            14   the auditors if they say well, we did rely, we did allow

            15   management's documentation, management's testing,

            16   management's conclusions to stand, what are the repercussions

            17   in that situation when they go through the inspection phase.

            18             MR. BELLER:  David?

            19             MR. SHEDLARZ:  I think this is where I started with

            20   all this.  Don't wish too much for what you want, you may get

            21   a lot of it.

            22             (Laughter.)

            23             MR. SHEDLARZ:  I don't want a lot of rules.  Let me

            24   say it right up front, I'm not looking forward to that.

            25             Again, for the outside accounting community, they

             1   are looking at the way this is going to be practiced.  They

             2   are playing into a dark hole.

             3             This season of reviews and investigations is going

             4   to be somewhat defining in terms of the extent to which we

             5   are going to encourage the utilization of their professional

             6   judgment, and also the extent to which they are going to show

             7   some flexibility.

             8             I just used as one example the principal evidence

             9   standard, which is basically we will rely on nothing the

            10   company has done.  I'm not sure, in fact, I'm pretty sure

            11   that is not what the PCAOB intended in terms of its guidance.

            12             Until they actually see the practice, until they

            13   actually see the evidence of the season, it is going to be

            14   very difficult to kind of change the behavior of the

            15   accounting community and in some respects management.

            16             I think some of the frequently asked questions and

            17   answers can help a little bit.  I think the proof is going to

            18   be how we are going to practice this in terms of the review

            19   of the PCAOB in this particular season.

            20             My sense is and I've heard Chairman McDonough talk

            21   about this on a number of occasions, they expect to be very

            22   balanced in their approach.  If that in fact occurs, I think

            23   some of this at least will show greater flexibility going

            24   forward, and maybe a greater balance in some organizations in

            25   terms of the cost and benefit.

             1             We did a survey of the business roundtable.  We had

             2   some numbers thrown on the table.  The upper end of the

             3   survey in terms of the number of internal controls that were

             4   reviewed is 80,000.  The upper end in terms of internal

             5   utilization of manpower in order to accommodate what is going

             6   on in terms of internal control testing and documentation is

             7   approaching a million hours by a firm.

             8             Again, I'm not pointing to any regulatory body here

             9   sitting at the table, but it does say some people are

            10   practicing this at the extreme in the interest of very

            11   conservative and a risk adverse approach to what is going on.

            12             MR. BELLER:  We are going to give Commissioner 

            13   Glassman the last word, but Robert Hodgkinson has been very

            14   patient with having his card up.  Go ahead, please.

            15             MR. HODGKINSON:  Thank you very much. I don't want

            16   to seem like I'm giving an advertisement for Turnbull,

            17   especially since we are in an open consultation phase and

            18   listening to people's experience.

            19             MR. BELLER:  For the audience who doesn't know what

            20   Turnbull is, it is the framework for internal control that

            21   has been adopted in the United Kingdom, and which is being

            22   examined.

            23             MR. HODGKINSON:  It was issued in 1999 and was one

            24   of the SEC approved frameworks.

            25             I think there are two points about the guidance for

             1   issuers coming first.  I think our experience was if it comes

             2   first, as it did in the case of Turnbull, it can be quite

             3   principles' based.  That is the guidance.  It is 15 pages,

             4   and in six years, there has been no supplements.

             5             It relates to the whole risk management and

             6   internal control spectrum, it doesn't just cover internal

             7   financial control.

             8             The guidance for auditors has followed, but it is

             9   for the review process, not an audit, and it is even slimmer,

            10   not even in its own book, at five pages.

            11             The lesson you might want to draw from this is

            12   perhaps there is an issue in kind of holding the nerve here,

            13   because in some of the feedback we have had on the

            14   consultation about whether we should revise this, people have

            15   said in the early years, they were compiling risk registers

            16   which were very voluminous and this is all controls.  This

            17   wasn't just financial reporting controls.

            18             Over the years, boards have wanted to kind of take

            19   control of the issue and get it away from the experts because

            20   they have to own it.  They have to sign up to this.  There is

            21   no excuse for not being able to read 15 pages.  There has

            22   been a transition towards boards taking ownership of it.

            23             There is an issue of kind of keeping the nerve and

            24   not issuing more and more guidance, which pushes it further

            25   away from boards to management because they are not paid to

             1   read 100 to 300 pages of guidance.

             2             This issue of holding the nerve there, and also one

             3   of the interesting issues is people have not been tempted to

             4   go into an endless kind of definitions here.  We have talked

             5   a lot today about definitions of significant deficiencies and

             6   control deficiencies and material weakness.

             7             Actually, what people have been asked to do is

             8   express an opinion on effectiveness.  In the guidance, we

             9   never went beyond the effectiveness. That is the word.  That

            10   is the word that management have to identify with.  As soon

            11   as we are off into the undergrowth of defining more and more

            12   terms, even the proposal, which seemed sensible at the time

            13   that we should define the word "could," we are never going to

            14   end.

            15             You can just say we are always going to have an

            16   undefined term, let's try to keep it as high level as

            17   possible, and get people to actually think what it means for

            18   them, and then when a PCAOB inspector comes along or an

            19   investor who wants to have a dialogue, you can talk about

            20   what it means to you, and then it might mean something

            21   different to them, but at least you are having a real

            22   conversation.  You are not having a theological debate about

            23   the word "could" or significant deficiency or whatever.

            24             MR. BELLER:  Commissioner Glassman?

            25             COMMISSIONER GLASSMAN:  I think my comment follows

             1   on that comment, which is perhaps we should think about

             2   rather than more guidance for issuers, pulling back on the

             3   specificity of the guidance for auditors. Maybe we can deal

             4   with that in the next panel.

             5             MR. BELLER:  Time is up.  For the audience, we are

             6   going to go right into the last panel.  Please don't take a

             7   break.

             8             I'd like to thank this panel, Carol and me, for a

             9   very constructive session.  Thank you very much.

            10                       PANEL SIX - NEXT STEPS

            11             MR. NICOLAISEN:  This is the panel I have been

            12   looking forward to, not because it is the last, but because

            13   this is the one where we actually get some direction as to

            14   where we might take this next.

            15             This is it, panel six.  We are going to be asking a

            16   few questions that I don't think have been asked yet.  We are

            17   also going to be looking for some guidance and advice and

            18   input from all of you.

            19             This is a session that I would really encourage

            20   both board members and commissioners to participate in, to

            21   the extent that you care to.

            22             Once again, if you put your tents up, that is the

            23   easy way for us, your name tags, that is the easy way for us

            24   to identify who is on the cue to speak next.  I'm not going

            25   to go through a whole lot of other rules because I think we

             1   have done that enough at this point in time.

             2             Let me get on with introduction of this panel. 

             3   Starting with Rodgin Cohen on my left, chairman of Sullivan & 

             4   Cromwell.  Tim Flynn, who is vice-chair of audit practice at

             5   KPMG.  Robert Greifeld, president and chief executive officer

             6   of Nasdaq.  Michele Hooper, president, Chicago Chapter,

             7   National Association of Corporate Directors and managing

             8   partner of The Directors' Council and audit committee chair

             9   and other things.

            10             Deborah Lambert.  Deborah is a founding partner of

            11   Johnson Lambert & Company.  She is also a member of COSO. She

            12   is on our small business advisory committee.

            13             Rebecca McEnally is a senior director of Capital

            14   Markets, CFA.  She is one of the analysts who keeps me honest

            15   and asks me a lot of questions, and for that, I am grateful.

            16             Tom Szlosek is vice president and controller for

            17   Honeywell International.  Of course, the Honorable David

            18   Walker, comptroller general of the United States.  Ann

            19   Yerger, who is executive director of the Council of

            20   Institutional Investors.

            21             Welcome to each of you.  Dave Walker, you haven't

            22   had an opportunity to give the voice of experience yet from

            23   the governmental perspective.  I know you wear a lot of hats

            24   or have worn a lot of hats that are much broader than that. 

            25   You have listened to some of this.  You have tremendous

             1   experience.

             2             Any suggestions for us as we go forward?

             3             MR. WALKER:  Well, Don, I think I and GAO may be

             4   somewhat uniquely positioned to be constructive here because

             5   in a former life, I was with Arthur Andersen when it was

             6   arguably the world's best firm, PricewaterHouse, Coopers &

             7   Lybrand, and now as comptroller general of the United States,

             8   we audit the U.S. Government, the I.R.S., the Bureau of

             9   Public Debt, the F.D.I.C., and yes, the SEC.

            10             (Laughter.)

            11             MR. WALKER:  I think it is important to understand

            12   that we, before 404 came around, and before Sarbanes-Oxley

            13   came around, GAO was voluntarily expressing opinions on

            14   systems of internal accounting controls ourselves in all of

            15   our audits, and we also had dealt with some of the

            16   independence issues and other issues.  We try to be ahead of

            17   the curve.

            18             Let me give you the bottom line, because we are in

            19   the business of speaking truth to power, and the SEC is

            20   power, and so is the PCAOB, I might add.

            21             I would respectfully suggest several things from

            22   all the evidence I have seen and that my very capable staff

            23   has seen.

            24             One, the concept behind Section 404 with regard to

            25   the additional emphasis on internal controls is valid, and

             1   that the law doesn't need to be changed.

             2             Secondly, the cost of implementation has been far

             3   in excess of what many anticipated, and I think there are

             4   several reasons for that.  In one case because I think people

             5   weren't doing nearly as much work on controls as some people

             6   thought they were or should have been doing, and in some

             7   cases because the reaction to the guidance under Standard 2

             8   has been such that people are now auditing every key control

             9   every year.  That is a huge swing in a pendulum in a very

            10   short period of time.

            11             Obviously, first year costs are a lot higher than

            12   recurring costs.  How much it will come down, reasonable

            13   people can differ.  I think the real question is where do you

            14   go from here, and not just with regard to the large public

            15   companies, but also those with a deferred implementation

            16   date, where do you go from here.

            17             I would respectfully suggest that our experience

            18   may be relevant for you to consider.  Under the financial

            19   audit manual that we use as a basis to express an opinion on

            20   internal controls, we use a risk based approach.  We do allow

            21   for a risk based approach where the auditor uses judgment to

            22   determine which key controls should be tested each year, and

            23   that determination is made each year with the idea that over

            24   a reasonable period of time, all key controls will be tested.

            25             I think what you get with that, with appropriate

             1   documentation, is you get a better balance from the

             2   standpoint of cost benefit, and I think it is something that

             3   could potentially be applied broadly going forward.

             4             I think the other thing that you have today that

             5   didn't exist in the past is you have the PCAOB's inspection

             6   program.  Therefore, the PCAOB's inspection program is such

             7   that it has the ability to look and to find out what the

             8   firms are doing in this regard, to try to help provide

             9   reasonable assurance that people aren't cutting back too far.

            10             I do think the answer is, and I would respectfully

            11   suggest, some type of a risk based approach similar to the

            12   financial audit manual that we use to do our audits.  We

            13   would be happy to share more details should the PCAOB and/or

            14   the SEC so desire.

            15             MR. NICOLAISEN:  Terrific.  Thank you very much.

            16             Let me just shift gears for a minute.  One of the

            17   things that we didn't talk a lot about is what doesn't the

            18   internal control work accomplish.

            19             I suppose some people might have been sitting here

            20   today and they listen to a company that has 50,000 or 60,000

            21   control processes in place that they view as key, which again

            22   sounds like an oxymoron to me, but I assume it is just

            23   important controls, and others that have looked at 9,000 or

            24   20,000 controls, and some people, I assume, could walk away

            25   from here assuming there will never be another fraud or there

             1   will never be another set of accounts that require

             2   restatement.

             3             Rebecca, you are raising your eyebrows.  Would you

             4   care to comment about that?

             5             MS. McENALLY:  Quite frankly, our view is Rule 404

             6   is the linchpin of Sarbanes-Oxley.  If we get this really

             7   right, just about everything else in all of Sarbanes-Oxley

             8   falls into place.  As we investors have had to re-learn very

             9   painfully in recent years, if we mess all of this up, it's

            10   going to be very bad indeed.

            11             The question for us is as it is for any kind of a

            12   system, what are the specific vulnerabilities of this system

            13   that we need to worry about most, not the 50,000 key

            14   controls, but what is the ultimate risk that we investors,

            15   the auditors, everyone else involved in this might face.

            16             The biggest wolf that we have to worry about eating

            17   us, we learn time and time again, as all of the painful

            18   collapses occurred, and that is the risk that a company's

            19   business model either is failing or has failed, and we don't

            20   know about it yet.  That's the biggest risk.

            21             In every one of them, from the tech bubble collapse

            22   all the way through the mega company collapses, that was the

            23   key element that somehow had escaped.

            24             What happened when that began happening was that

            25   first the accounting became increasingly exotic.  It is

             1   almost funny if it weren't so painful to read about it now. 

             2   Following that, in order to try to paper over the cracks as

             3   they were occurring increasingly in the public eye, was an

             4   override of the internal controls, circumvention of the

             5   internal controls, until our whole system finally crashed.

             6             What do we do about this?  That is the question. 

             7   It's not all that complicated, but it requires that we

             8   rededicate ourselves and shift some resources.

             9             Evaluating business risks, since I first studied

            10   auditing a very long time ago, has always been part of the

            11   objective of an audit.  However, it has usually gotten very

            12   short shrift.  I think most auditors, if you take them aside,

            13   would agree, well, we have lots of other things we have to

            14   do, yes, we pay attention, but that's not the biggest focus

            15   that we have right now.

            16             I would propose that we marry an evaluation of the

            17   ultimate business risks in the business model of a company to

            18   the broader audit plan.  It's not that big a deal to do it. 

            19   Auditors can do this if they are willing to do it and

            20   evaluate it.  Then target the controls from that perspective. 

            21   We will stop there.

            22             MR. NICOLAISEN:  Don't stop there. Give me a little

            23   more detail.  What would you envision that being, that the

            24   auditors would -- if I visit my friendly family doctor once a

            25   year, which my wife always tells me to do, and I get there

             1   and he usually says something like I want to take your blood,

             2   we are going to do this and that, test your blood pressure,

             3   basic things, can you still see across the room.

             4             Then he says some specific things.  Well, you are

             5   getting a little older.  I think this is a test that we ought

             6   to run now, but he doesn't do that every year.  He doesn't do

             7   the same test every year and the same thoroughness.

             8             Is that what you are talking about?  There would be

             9   some de-emphasis in certain areas from time to time, those

            10   things that are less risky?  Maybe you could just flush that

            11   out a little more for us.

            12             MS. McENALLY:  I think this helps focus the

            13   auditors' concern on the major problems that we are likely to

            14   face.  The big big overwhelming problems.  We are all talking

            15   about risk based audits, and that's fine.  I'm fine with

            16   that.  Internal control evaluations.

            17             Where are the big risks?  The biggest risks to

            18   investors are not that one tiny control down in the process

            19   will fail, but that the biggest part of the business, the

            20   business model itself is failing, and the potential for

            21   failure of all of the other systems cascading down is not

            22   caught early enough to bring that to light and to put the

            23   focus of the audit on that.

            24             It is patently obvious that is what occurred.  We

            25   could evaluate that in one way or another.  I think it is the

             1   evaluation of the model and the risks in the company's basic

             2   business model, where it stands in its business, is it

             3   profitable, is it failing, has the 20 percent compounded

             4   annual growth for 25 years started to cool.  That is a

             5   typical one.

             6             You start worrying after the tenth year of that,

             7   but they still continue on until they collapse.

             8             These are the kinds of things that we are concerned

             9   about. Let's focus on some of the biggest issues.

            10             MR. NICOLAISEN:  On the big issues.  Michele?

            11             MS. HOOPER:  I totally agree, but I would also

            12   encourage us to step back because the whole issue of risk

            13   based approach and enterprise risk management is not new with

            14   Section 404.

            15             When you look at what we have been doing on audits

            16   historically, we have been using risk based approaches to

            17   determine where the priority areas are.  We use cycling of

            18   those businesses. Even though it may be a smaller part of

            19   your business, it may be a less significant part of the

            20   overall revenues and profits to a firm, over a period of

            21   time, it does get reviewed and it does get looked at.

            22             New systems that come into an organization in terms

            23   of application process systems gets reviewed as those systems

            24   are implemented.

            25             In looking at 404 implementation, I would be saying

             1   and the NACD would be saying that those risk based approaches

             2   already have a model out there, and in integrating them, the

             3   process of internal controls, more with the financial audits,

             4   that we would be bringing those two closer together.  We

             5   would be using resources more efficiently.

             6             To use the term that was used in our last panel, I

             7   think improve the overall effectiveness of how we are using

             8   resources within our firms.

             9             MR. NICOLAISEN:  Rodg?

            10             MR. COHEN:  If I could comment quite briefly on

            11   what I thought were two critical points which the comptroller

            12   general made.

            13             One is benefit versus burden, and the other is risk

            14   based.  There is no question that there is substantial

            15   benefit from 404, and to me, the real issue is reducing the

            16   burden so it is more commensurate with the benefit.

            17             It is hard to imagine anything that could go

            18   further to doing that.  As Mr. Walker suggested, and I think

            19   the next two panelists suggested, to be more risk focused.

            20             Now let's go, if we may, to several other themes. 

            21   One is conservatism.  I think you have heard that universal,

            22   as an universal concern.  The danger here is that

            23   conservatism will say that everything is risky.  What good

            24   have we done.

            25             Then we have talked about rules, but there is a lot

             1   of skepticism about rules.  I'd like to come to a last theme

             2   which was struck, which I think does make very good sense in

             3   trying to deal with this risk based approach, and that is

             4   best practices.

             5             That is one where either elements of an industry

             6   can get together or you can go across industry lines.  It

             7   would be very important that this have the endorsement of the

             8   Commission and the PCAOB as a process so people can feel

             9   comfortable with it.

            10             Best practices has the opportunity to fill in a lot

            11   of gaps which there is an absolute reluctance to fill with

            12   rules.

            13             MR. NICOLAISEN:  Bob?

            14             MR. GREIFELD:  Two comments.  One, with respect to

            15   concentrating on the risk areas, I relate to the NASDAQ

            16   operation directly from a technology point of view, our core

            17   value added that we bring to the market is systems that stay

            18   up.  We have made what I think are wise decisions with

            19   respect to ascertaining the risk of various systems and how

            20   often they have to be tested.

            21             We have what we call a full and an incremental and

            22   a full cycle that we go through.  In a given year, certain

            23   systems have to be tested completely.  They have to be tested

            24   every year completely.  Other systems, you can bypass because

            25   they are just not as critical.

             1             Year one, we will test every system we have to make

             2   sure that in a disaster scenario, in a regular outage

             3   scenario, we can continue to serve the market.  Then we will

             4   have an incremental year where only the high value systems

             5   are tested.  Then we go back to a full year again.

             6             It is a risk based approach, and in our world, this

             7   operational risk is certainly more substantial than a

             8   financial risk.  People don't think of NASDAQ primarily on

             9   the financial side, but certainly on the operational side

            10   from operation of the market.

            11             We think that concept can be brought to bear in

            12   this arena.  We conducted a survey of our listed companies,

            13   and that was one of the top three responses.  Please let us

            14   have a risk based approach.

            15             The second comment I would make is with respect to

            16   having the business model tested as part of the audit

            17   process, with all due respect, I probably disagree with that

            18   point.  I believe if we have good numbers, then there is

            19   enough infrastructure in the industry through the analyst

            20   community that will opine upon whether the business model is

            21   going to work or not.

            22             I believe we got into trouble when the analyst

            23   community was opining upon numbers that were essentially not

            24   proven.

            25             If we do the Sarbanes-Oxley 404 correctly, then the

             1   business model testing or the business model testing that

             2   exists, there is the infrastructure that can make that

             3   determination.

             4             MR. NICOLAISEN:  Does that lead you to a conclusion

             5   that as long as the control processes are effective and

             6   working and people are doing what they say they are doing,

             7   that you would not end up with a potential restatement in a

             8   set of financial statements?

             9             MR. GREIFELD:  That sounds like a set up question

            10   to me.

            11             (Laughter.)

            12             MR. GREIFELD:  Any system you devise or any rules

            13   that you set up obviously are not going to be perfect and

            14   where there is a human will, there is a way to get around

            15   them.  I think we are just trying to increase the probability

            16   that it won't happen, and certainly I think that will be one

            17   of the net benefits.  There is no absolutes.

            18             MR. NICOLAISEN:  If you look at the banking

            19   industry, if they never had a bad loan, they would say they

            20   were too conservative in their lending practices and their

            21   various policies and procedures.

            22             Should we expect that we would not reach that level

            23   or we would have zero tolerance for a restatement or an error

            24   or a human mistake to occur?

            25             MR. GREIFELD:  Are you saying do we think we will

             1   get to that level?

             2             MR. NICOLAISEN:  I'm asking you if you think we

             3   should.  Do you think this process is intended to do that.

             4             MR. GREIFELD:  I don't believe the process is

             5   intended to get there, and I think it's an impossible goal to

             6   establish that as an outcome.  To the extent that you can't

             7   have one person do something improperly based upon 404

             8   controls, it doesn't mean you cannot have collusion between

             9   two or three.  That will happen.  The odds of them getting

            10   caught will increase dramatically, but it still will happen.

            11             MR. NICOLAISEN:  We just want to make sure there is

            12   some appropriate understanding.

            13             MS. YERGER:  Very quickly, and I am going to be

            14   unfortunately reiterating a few things.  I agree with Rebecca

            15   that the business risk is a key issue for all investors. 

            16   However, I also agree with what was just said, that what is

            17   most important is that investors have access to high quality

            18   financial statements to assess those risks.

            19             The problem we have had is we have not had those

            20   high quality financial statements, and in fact, we still are

            21   having problems, for anyone reading the paper these days.

            22             Clearly a few years ago, there was extreme distrust

            23   that internal and external auditors I think candidly were

            24   doing the jobs that investors were expecting of them, that

            25   they were looking at the internal controls, these were being

             1   evaluated, reviewed, updated and corrected when there were

             2   problems that hadn't been happening, and I think 404 is just

             3   vitally important in terms of getting the processes and

             4   requiring us to go through.

             5             I do not think 404 can stop fraud.  Unfortunately,

             6   bad people will do bad things.  The hope here obviously is

             7   that any kind of fraud hopefully will be uncovered before we

             8   are at a point where Worldcom is or some of these other

             9   companies.

            10             Regarding the risk based comments, which I think

            11   have been repeated themes throughout the morning and

            12   afternoon, my sense is that AS-2 does allow for that.

            13             I think the problem here is there may be an overly

            14   conservative construction and interpretation of AS-2 right

            15   now, and that's why I believe that what the PCAOB is going to

            16   be doing with its inspections and what is going to be coming

            17   out of the inspections is going to be vitally important in

            18   terms of signaling to the audit community what your

            19   expectations are of the audit process.

            20             MR. NICOLAISEN:  Tom Szlosek?

            21             MR. SZLOSEK:  Just listening to what Ann said, I

            22   totally agree.  We are probably in the sixth or seventh

            23   inning.  This probably might go to extra innings for all we

            24   know.

            25             The point is we have to let everybody get through

             1   the process, the inspectors, the non-accelerated filers, and

             2   then take a collective assessment of learning.

             3             Don, you asked about what doesn't this accomplish. 

             4   We heard a number of times today about eight percent of the

             5   companies have reported material weaknesses, but that means

             6   92 percent have not reported material weaknesses.

             7             Does that mean all 92 percent of us are good?  I

             8   would say no way.  There is a lot of opportunity.  There is

             9   probably a wide degree of excellence in financial reporting

            10   amongst those 92 percent.

            11             For me as a new controller to the company I'm in,

            12   and I'm surprised our audit committees aren't starting to ask

            13   for this, how good are you even though you passed relative to

            14   your peers and relative to the industry.

            15             Maybe that is something as we move on into the next

            16   cycle that we need to consider.  That is something probably

            17   for the regulators to decide.

            18             There are also things that the issuers can do as

            19   well.  We are not waiting for any magical solution to come

            20   along for us to reduce our costs by 46 percent.  We are not

            21   waiting for the auditors to come and give us a credit memo or

            22   anything like that.

            23             (Laughter.)

            24             MR. SZLOSEK:  You heard Susan talk about it earlier

            25   from Viacom.  We are sitting down and going through the

             1   process internally, and how can we be more efficient.  In a

             2   big multi-national company with lots of locations, one of our

             3   biggest challenges is standardization.  We have such a wide

             4   degree of standards in documentation and test scope.  There

             5   is a lot of homework that we can do, even in efficiency

             6   assessment internally, that can therefore make the auditors

             7   more efficient.

             8             We have a lot of homework to do.  I think the

             9   auditors also have a lot of homework to do.  The discussion

            10   on the risk based framework I think is very powerful.  I

            11   would encourage them to embrace that, and just to get away

            12   from the form driven aspects of this and really try and do

            13   what they do best, which is deploy their experience.

            14             I don't know how to encourage that.  It is

            15   certainly something that will address a lot of things we

            16   talked about earlier.

            17             MR. BELLER:  As specifically as you can, you have

            18   done some of it but I want to kind of ask you to go one step

            19   lower down, as specifically as you feel comfortable telling

            20   us, what are you planning to look at on your own in this

            21   first step, and is there anything that we can do that would

            22   encourage that in a constructive way?

            23             MR. SZLOSEK:  I talked about establishing

            24   standards.

            25             MR. BELLER:  Standardization.

             1             MR. SZLOSEK:  In everything from what is the form

             2   of your documentation.  We struggled and wrestled with that

             3   throughout the years.  We finally came to a standard, but

             4   it's not fully rolled out.

             5             Other examples in that area would be deficiency

             6   evaluation.  The second thing is striving for linearity. 

             7   This had a tendency to bunch up towards the end of the year. 

             8   We talked a lot about the tensions that existed between the

             9   auditors and the issuers.

            10             I think a lot of it had to do with the snow plow

            11   effect, suddenly it's November and December and you are still

            12   not there yet, and there is still guidance coming out. 

            13   Trying to pull that in is one thing we are really going for

            14   as well.

            15             A good tracking mechanism for deficiencies.  If you

            16   are a multi-national company like us with hundreds of

            17   locations, we learned a little bit too late that our tracking

            18   mechanisms were a deficiency in themselves.  We ended up

            19   getting it corrected.

            20             It is really important from an aggregation

            21   perspective to have something that you can use when you know

            22   you are going to be dealing with lots of deficiencies.  We

            23   are working on that.

            24             Company level controls.  One of the biggest

            25   deficiency areas for us, and we didn't have any material

             1   weaknesses, but one of the biggest deficiency areas for us

             2   was access to computer systems.  Honeywell has come together

             3   over the years through acquisition and acquisition, not a lot

             4   of integration systems.  You don't have centralized controls

             5   over access.

             6             You find yourself looking at each individual pocket

             7   and how you are controlling that.  What we ended up

             8   concluding -- what we did is we ran a number of different

             9   test scripts, like Oracle has its own test script, SAP has

            10   its own.  We had granted a lot of access that was not

            11   appropriate.  Theoretical in a lot of cases, very, very

            12   theoretical.  Nonetheless, things that were flagged.

            13             We had to sort through hundreds of those, literally

            14   hundreds of them to find the key few that we really needed to

            15   do something about, but the other 80 percent were mitigated

            16   by company level controls.

            17             We said, well, if that could happen, what would be

            18   the next step and what would be the next step.

            19             We came back and said during our planning for 2005,

            20   if the mitigating controls were the company level controls,

            21   the monitoring and so forth, why isn't that a major part of

            22   your up front emphasis to reduce the amount of the kind of

            23   testing I'm talking about.

            24             Those are kind of examples of the practical things

            25   we are trying to do.

             1             MR. NICOLAISEN:  That is very helpful. 

             2   Commissioner Atkins has his tent up.  I am going to ask David

             3   Walker first, because you have had yours up for a while as

             4   well.

             5             MR. WALKER:  First, I will quickly follow up on

             6   Rebecca's comment about business model risk.  I think that is

             7   a very, very important comment, and obviously that is

             8   something auditors ought to be taking into consideration with

             9   regard to the timing and scope of their control testing, if

            10   you will.

            11             I also think it has to do with the reporting

            12   element, because it is really above the traditional types of

            13   controls.  I would respectfully suggest that auditors need to

            14   think beyond going concern opinions.  Going concern is where

            15   you are within a year of tanking.  We need a little earlier

            16   warning system.

            17             Part of that has to do with the issue of is the

            18   business model broken.  I would respectfully suggest that if

            19   you read the GAO's audit opinion on the U.S. Government's

            20   financial statements for fiscal 2004, you will see an

            21   emphasis paragraph that says somebody's business model is

            22   broken.  While we are not issuing a going concern opinion,

            23   the business model is broken and needs to be fixed.

            24             (Laughter.)

            25             MR. NICOLAISEN:  Try following that.

             1             (Laughter.)

             2             COMMISSIONER ATKINS:  I just wanted to get back,

             3   because I agree with all the comments about risk based

             4   approach and what not, and to pick up Don's analogy of going

             5   to a doctor.  We all know doctors in a lot of ways are

             6   practicing defensive medicine.  That's what we have been

             7   hearing today, I think, about the accountants as well.

             8             We have all been hearing how one of the keys will

             9   be the exam process that the accounting board will be doing.

            10             My worry is, and I asked this of the last panel,

            11   that could yield a very ad hoc approach, and you all are

            12   expecting reasonable approaches to be coming out of this exam

            13   process.  It could go the other way as well, as we have seen

            14   on the banking side 15 years ago, and arguably in other

            15   places elsewhere.

            16             Rather than policy being set by examiners, I wanted

            17   to ask about what Rodg brought up about best practices, which

            18   I think is attractive, but that's exactly what COSO arguably

            19   was supposed to be.  I think some of us when we voted to

            20   approve AS-2, we felt that was also going to be best

            21   practices.

            22             Obviously, something has not clicked.  How do we

            23   effect this without having either an uncontrolled ad hoc

            24   approach, which will be not transparent, how do we approach

            25   this type of best practices thing to get to exactly what we

             1   are all trying to strive for?

             2             MS. McENALLY:  I'll take a shot at least at part of

             3   that.  I think a couple of things have to happen.  I think

             4   there is not just one mechanism to get feedback.  I think

             5   things like this are part of the feedback, where people start

             6   to at least develop a consensus as to what the problems and

             7   issues are.

             8             Clearly sitting here today, there are themes that

             9   recurred in every single panel we heard.

            10             There are lots of forums and opportunities as we

            11   move into the accounting world, where people get the

            12   opportunity to share ideas in different kinds of forums.  I

            13   think there will be consensus through articles, through

            14   forums, through that kind of thing.

            15             I think also the different bodies will have

            16   opportunities.  I am involved with the COSO project that is

            17   looking at this from the small business, and if we think the

            18   large companies have had trouble implementing this, we have a

            19   potential real big issue with the smaller companies.

            20             I think we have a real advantage right now, that we

            21   have a little bit of time on our hands, that we have a

            22   delayed implementation for the smaller companies, and we have

            23   the lessons we are hearing and learning from the larger

            24   company implementation, and we have to make sure that we take

            25   advantage of that.

             1             The COSO group has set up a project, a task force

             2   now, that is trying to develop implementation guidance for

             3   COSO, for the smaller public companies specifically.  Very

             4   narrowly focused on smaller public companies.  It is guidance

             5   that is intended to be published this Summer.  It will be an

             6   exposure draft this Summer, that will at least get the

             7   thinking in people's hands at that point in time, and then at

             8   a later point in time with the smaller companies, it would

             9   then be published in a final form in September.

            10             This is not intended to be prescriptive.  It tends

            11   to be very risk based.  This whole idea of the risk

            12   assessment and business risk and feeding that into the

            13   assessment of internal controls in these smaller companies is

            14   clearly the driver.

            15             It is intended to focus on some of the unique

            16   issues that impact the smaller companies, just for example,

            17   the management override issue in a smaller company can be

            18   very different and very uniquely addressed in the internal

            19   control system in a smaller company, and what compensating

            20   controls or monitoring might be in effect, whether it is

            21   through board and audit committee monitoring or some other

            22   type of monitoring to help mitigate that management override.

            23             You have similarly control activities, where you

            24   typically might not have segregation of duties.  How might

            25   that be addressed in the smaller entity.

             1             The idea that perhaps because management provides

             2   more oversight, maybe there will be some examples there.

             3             I think as we move forward, that is one whole

             4   sector in terms of maybe it is not a large market cap, but it

             5   is a lot of companies where we have opportunities to in

             6   various forums to present and help people deal with

             7   implementation and deal with future tweaking of what is being

             8   done.

             9             I think in that case, this guidance is intended to

            10   be used both by the companies and by the auditors working

            11   with those smaller companies.

            12             That is one example of the kind of things I think

            13   you will see evolving now.

            14             MR. NICOLAISEN:  Ms. Hooper, was your tent card up,

            15   too?

            16             MS. HOOPER:  Yes.  I agree with that, but I would

            17   also say that part of the issues that I've seen and others

            18   have talked to me about and on the audit committees that I

            19   participate in and chair, part of a real issue we had last

            20   year was timeliness of information and guidance getting out

            21   to us.

            22             We already are in year two.  We are already

            23   beginning to scope out, we are already beginning to talk

            24   about what went well, what we need to do differently as we go

            25   into year two.  We are in year two.

             1             I would respectfully encourage us to move with some

             2   deliberate speed.  We can't take months and months to begin

             3   to dialogue and bring out additional information on how both

             4   we as corporations and the external audit firms approach the

             5   second year.

             6             I do agree with the comment that was made earlier

             7   about being able to look at best practices.  Best practices

             8   work.  It is something that allows you to begin to get a

             9   level of consistency about how people see things.  It allows

            10   you to see case studies, if you will, so that you can then

            11   bring that knowledge in house.

            12             We can't take forever to begin to do that.  I agree

            13   with what I am hearing, but would encourage speed.

            14             MR. NICOLAISEN:  There is some urgency to the task.

            15             MS. HOOPER:  Absolutely.

            16             MR. NICOLAISEN:  Mr. Greifeld, were you responding

            17   to the Commissioner?

            18             MR. GREIFELD:  Yes.  The way we see the world is

            19   the audit firms are in a very difficult position in that the

            20   threat of lawsuits is very real, and there hasn't been very

            21   clear guidance or very clear direction to refer to this

            22   guidance as the standard to move along.

            23             If I'm in charge of an audit firm, I know I want to

            24   protect against lawsuits, I also know I would probably like

            25   to increase revenue.  To the extent I take a conservative

             1   view on what the requirements are, then I accomplish both

             2   goals.

             3             When we talked to our listed companies, 76 percent

             4   of them actually said Sarbanes-Oxley was a good thing and

             5   they were in support of it.  The support is there, but where

             6   it falls down is in terms of the cost of implementing this. 

             7   This is the last panel.  You obviously have heard this

             8   before.

             9             The solution has to be where the audit firm has

            10   clear direction with respect to what the standards are, and I

            11   posed this to certain CEOs.  I said what you are asking for

            12   basically is for more rules, if you follow this to the

            13   logical end.  Their answer, surprisingly enough, was I would

            14   prefer at this point to have more clear set rules if you can

            15   relief some of the costs and the uncertainty of the

            16   implementation.

            17             I think those are fairly dramatic comments.

            18             MR. NICOLAISEN:  Conditional rules.  Rules if we

            19   like them.

            20             MR. GREIFELD:  Rules that they know their audit fee

            21   will be reduced or the cost of just the total implementation

            22   and the continued implementation of 404 would be reduced.  I

            23   think they are dramatic comments.

            24             MR. BELLER:  I actually want to ask Mr. Flynn of

            25   KPMG kind of a variant of the question that Tom Szlosek posed

             1   and answered, which is sort of what are you doing in the next

             2   two to three months without regard to what we are doing as an

             3   urgent matter to make your two different from your one?

             4             MR. FLYNN:  Let me comment.  Number one, in regard

             5   to fraud and your question regarding fraud, clearly

             6   Sarbanes-Oxley and 404 have gone a long way to deter fraud,

             7   to limit fraud, but they are not going to prevent fraud.  We

             8   talked about collusion, human nature, certain things.

             9             In terms of what we are trying to accomplish, our

            10   number one goal is audit quality, for the benefit of the

            11   capital markets, transparency in the investors.  That is what

            12   we are focused on within our profession today.  I think we

            13   have made a lot of strives.

            14             We have talked about some of the tensions today and

            15   the costs associated with different things.  Part of that is

            16   we are doing more robust audits.  We are trying to balance

            17   all things.

            18             Is the business model and the business risk

            19   assessment a process of the audit?  Is the internal control

            20   risk assessment process part of the audit as it relates to

            21   the financial statement risk and assertions?  The control

            22   environment and how that relates to our substantive audit

            23   procedures, and then reporting and disclosures and

            24   transparency.

            25             We are simply doing more audit work, more testing

             1   of controls and transactions than we did two or three years

             2   ago.  That is to improve audit quality across the profession

             3   as well as improve transparency in financial reporting.

             4             I think we have made great strives working with the

             5   regulators and working in the profession and with our clients

             6   to make that happen.

             7             If you look at 404, 404 was not intended to be a

             8   mild exercise.  It was intended to be a robust exercise to

             9   bring great benefit to the financial reporting and

            10   transparency.

            11             There is no question that in year one, we didn't

            12   all get things right, and there is great room for

            13   improvement, both at the auditors' perspective as well at the

            14   issuers' perspective.

            15             What we are doing, what we believe the auditors can

            16   do, are the following three things.  Number one, truly

            17   integrate the audit process this year.  It was a goal in year

            18   one.  It didn't get accomplished.  We can give you all the

            19   reasons why and we all know the deadline slipped, the timing

            20   of guidance, the timing of the pronouncement, but the reality

            21   is it was a first time through the process.

            22             To make judgments of what we could rely on and what

            23   the outcomes might be ahead of time to adjust the audit

            24   process, we simply didn't have the ability to do that in the

            25   first year.

             1             We are focused as a firm in its profession to make

             2   that happen in year two.  We have the time to work with our

             3   clients.

             4             We brought together 50 partners on April 7th to be

             5   briefed in our firm on 404. What went well, what didn't go

             6   well, what can we improve, how can we help our clients

             7   improve their process.

             8             We have the time to plan the audit as an integrated

             9   audit and with our clients to make that happen in year two,

            10   and we are confident that will happen.

            11             Number two, better use of other's work.  Statement

            12   number two has the flexibility to allow that to happen.  It

            13   did not happen in year one to the degree we would have liked

            14   it to happen.  Again, there are reasons why that was the

            15   case.

            16             It was the first time through.  Our clients'

            17   resources were dedicated on their responsibilities, executing

            18   their management assessment process.  Again, having applied

            19   the time to execute with the deadlines we all faced and not

            20   knowing the outcomes, it didn't allow that to happen.

            21             We are focused on making that happen in year two.

            22             The third point is being more consultive with our

            23   clients.  We talked about that in the last panel.  How can we

            24   work with our clients more, scoping and designing and more of

            25   a cooperative process.  Working together in an appropriate

             1   way to bring independence and transparency to the process.

             2             That is what we are doing over the next number of

             3   months to improve the process.  We think there are things the

             4   issuers can do as well.  Embed the 404 process in the fabric

             5   of your organization.  Make the operating people responsible

             6   for the control environment.  Then use internal audit to go

             7   check and do compliance work on top of that, additional

             8   assurance.

             9             In addition, companies have a vast knowledge of

            10   their control portfolio today.  They didn't have it two or

            11   three years ago.  Look at that control environment, how can

            12   you improve it.  Go from manual controls to automated

            13   controls.  Go from detective controls to preventive controls. 

            14   Look at the business processes those controls impact and use

            15   it to improve the business processes, reduce the number of

            16   controls but make them stronger by automated and preventive

            17   controls.

            18             That is a key opportunity to recover the investment

            19   on 404 beyond compliance.  Let's do it not as a compliance

            20   exercise, but a business improvement opportunity.

            21             The regulator, a lot of our guidance, there are

            22   areas we can all use guidance on.  We heard all about it

            23   today.  Statement number two can work.  It is not about

            24   re-doing statement number two.  It's about getting practical

            25   examples.

             1             As the PCAOB does inspections this year, we would

             2   encourage you early on in the process to have another forum

             3   like this where you talk about what were your early findings,

             4   so we can embed those findings in this year's audit cycle to

             5   help us integrate 404, and make sure you are making the

             6   proper judgments that are based upon facts and based upon

             7   experiences.

             8             We can use that now to make better judgments in

             9   year two with the help of all parties in the process.

            10             MR. NICOLAISEN:  Rodg and then Commissioner

            11   Goldschmid.

            12             MR. COHEN:  There are, I think, two very key

            13   questions which have been asked, Commissioner Atkins' and

            14   then Don, yours.  Actually, I think they are related.

            15             Let me start with Commissioner Atkins' question,

            16   which I think is quite important.  This may be unnecessary

            17   because the chair of the PCAOB, I think, knows better than

            18   anybody in the United States what I am going to say, but

            19   there is an issue of tone from the top, not merely at

            20   registrants, but also at agencies, and particularly that is

            21   critical when the agency has an examination function.

            22             If the tone is you better not make a mistake in

            23   your examination, that is going to lead to one result.  If

            24   the tone is to err is human, to forgive is divine, that is a

            25   very different way the examinations are conducted.

             1             How that relates, I think, Don, to your question,

             2   is what can you expect out of 404.  I would suggest that in

             3   this area, perhaps the greatest enemy of the good isn't the

             4   bad but striving for perfection.  It is not going to be

             5   perfect.  There will still be fraud.

             6             I do believe that even robust internal controls and

             7   excellent accounting oversight is not going to prevent in all

             8   cases loss of value or even insolvency due to flawed business

             9   models.  The most that you can hope for is that the flaws

            10   will be disclosed as early as practical.

            11             MR. NICOLAISEN:  Commissioner Goldschmid?

            12             COMMISSIONER GOLDSCHMID:  I wanted to test what I

            13   think I have been hearing in this panel and all day, in fact. 

            14   If I understand it correctly, there has been relatively

            15   little criticism of Section 404 itself in Sarbanes-Oxley, and

            16   relatively little, and Alan Beller is biased, but I am, too,

            17   about the SEC's drafting in the area.

            18             (Laughter.)

            19             COMMISSIONER GOLDSCHMID:  Relatively little, I

            20   would say, about audit standard two in the PCAOB's drafting,

            21   most of the focus all day, and it's been true in this panel,

            22   has been on implementation, and on the conservative

            23   atmosphere, and that drives excess costs.  It drives the lack

            24   of communication.  It drives most of the problems that have

            25   been raised all day.

             1             If I understand where you are telling us it ought

             2   to be driven now, it would be towards more guidance, good

             3   practice, some combination of that type, to a sensitive

             4   PCAOB/SEC review of this first year, where we know there have

             5   been bumps and we know the second year would be better, and

             6   then to look at the judgmental areas, reliance, risk based

             7   assessments, integrated audit, as a way of moving -- these

             8   are all contemplated, if I read our documents correctly, in

             9   what has already been done in terms of framework.

            10             And then there is a special area that was

            11   mentioned, which is the small public company area, and I am

            12   hoping COSO and the new committee that is meeting is going to

            13   bring us fruit to bear.

            14             That, at least if I'm hearing it correctly, is what

            15   I think I am hearing.  Does anyone want to correct me?

            16             MR. WALKER:  It wouldn't be a correction.  It would

            17   be a clarification.  I think some of the language that I have

            18   seen at least in the preamble of standard two is such that in

            19   implementing standard two, some have taken a very

            20   conservative approach.

            21             Reasonable people can differ on what language is

            22   intended to mean, but the bottom line is guidance now needs

            23   to be provided as to what the intent was, and that can get

            24   the job done without necessarily changing the standard.

            25             COMMISSIONER GOLDSCHMID:  I accept the amendment,

             1   David.

             2             (Laughter.)

             3             MR. NICOLAISEN:  Deborah Lambert?

             4             MS. LAMBERT:  I agree with everything you said, but

             5   would take it one step further regarding COSO, and one

             6   additional thought there.

             7             There is a limit to where COSO stops, particularly

             8   when it gets to the CPA firms and the implementation of

             9   auditing standard number two, particularly as we start to

            10   deal with these many smaller companies coming up, many of

            11   which were not audited by the big four or big eight firms.

            12             We need to pay careful attention to make sure we

            13   are getting best practice type guidance and best thinking to

            14   those firms.  They are harder to reach.  There has already

            15   been some outreach efforts.  Those can't stop.  Those need to

            16   continue because this is a whole other cycle of thoughts and

            17   issues.  That is a really important factor if we are going to

            18   be successful in the next wave of implementation.

            19             MR. NICOLAISEN:  Robert Greifeld?

            20             MR. GREIFELD:  I completely agree with the

            21   Commissioner.  He is my commissioner.  He regulates my

            22   markets.

            23             (Laughter.)

            24             COMMISSIONER GOLDSCHMID:  You didn't need that

            25   clarification.

             1             MR. GREIFELD:  I do actually completely agree and

             2   it was incredibly well said.

             3             (Laughter.)

             4             MR. GREIFELD:  I would just add a point with

             5   respect to the small companies.  Again, with the survey that

             6   we did, it was more dramatic than I thought, the differential

             7   on the impact.  It really was ten times the cost as a percent

             8   of revenue for a small company versus a large company.  To

             9   me, that is a crisis point that we have to respond to.

            10             Another issue you have with small companies, with

            11   the crunch for 404, there are a decent percentage of them

            12   that were essentially fired by their auditing firms.  There

            13   has to be something in the regulation that says if you get

            14   dumped by your audit firm, that you have some type of leeway

            15   or some type of consideration with respect to testing for

            16   these controls.

            17             MR. BELLER:  Just as a data point, when you say

            18   "small firm?"

            19             MR. GREIFELD:  The smallest category we had was

            20   $100 million market capital or less.

            21             MR. NICOLAISEN:  Michele?

            22             MS. HOOPER:  I also agree with what you said. I

            23   believe that there is a "but" to the end of what you said in

            24   my opinion, which is I think I've heard full support, but

            25   only if it can be a reasonable situation for firms to

             1   undertake.

             2             Right now, as it is currently being implemented, as

             3   we have currently gone through it, the costs far outweigh the

             4   benefits when you look at the inability and the way in which

             5   the accounting firms are indeed executing and implementing.

             6             If indeed we are able to implement some of the

             7   things that Mr. Flynn said, which I was quite frankly

             8   delighted to hear, and I'm sitting here thinking, good grief,

             9   we can go home now.

            10             (Laughter.)

            11             MS. HOOPER:  If they are indeed going to implement

            12   it as the spirit from what you all say was intended, then I

            13   think that will greatly go forward to easing the burden on

            14   companies.

            15             The way it is structured now, and the way we are

            16   seeing -- quite frankly, in some discussions that I've

            17   already had relating to the execution of year two, that

            18   flexibility is not getting down to the bottom line troops.

            19             Part of the challenge for us is to bring the spirit

            20   of what the SEC and PCAOB is trying to garner into the

            21   reality of what we are facing on a day to day basis.  There

            22   is still a very large gap there.

            23             MR. NICOLAISEN:  Commissioner Atkins?

            24             COMMISSIONER ATKINS:  Actually, I just wanted to

            25   take a moment and maybe somebody on the panel can address

             1   this, maybe Bob or somebody, but here we obviously have in

             2   this coming year the rest of non-accelerated filers who are

             3   coming on board, and literally thousands of companies.

             4             The question is do we need more of a phase in? 

             5   Right now, we have heard them, but there still is a date

             6   certain by which they need to comply.

             7             Is there a capacity to deal with that, do we need

             8   to have like a staggered implementation?

             9             MR. NICOLAISEN:  Let me do sort of a follow up to

            10   that same theme.  One of the things we heard from a number of

            11   preparers and auditors today was an appeal to say the

            12   accelerated filing that is now in effect will be in effect

            13   for everyone, could we re-visit that and go back to an extra

            14   two weeks in the closing process.

            15             Anyone who knows me knows I always feel information

            16   delayed is information lost.  I'm not a firm advocate of

            17   that, but I would certainly be willing to listen to those who

            18   have strong views.

            19             Certainly, we heard those today from the preparers

            20   and auditors.  From the investor perspective, I would be

            21   particularly interested in your thinking on that.

            22             MS. YERGER:  I think I would agree.  Clearly, we

            23   want the financials out as quickly as possible, but if they

            24   are not ready or they are not going to be high quality, then

            25   I think a delay is perfectly reasonable.

             1             I don't think there is any problem with the small

             2   companies.  We all want to be reasonable and give them time

             3   to implement.  I just don't think this needs to be sort of an

             4   ongoing promise they are going to have this additional time. 

             5   I think we need -- frankly, it just seems to me it is too

             6   early to tell what is going to happen with the small

             7   companies, and I'm sure in a few months, we will all have a

             8   much better sense.

             9             MR. NICOLAISEN:  It wasn't just the small

            10   companies, it was everyone that was asking for it.

            11             MS. YERGER:  We would strongly disagree with that.

            12             MR. NICOLAISEN:  Rebecca?

            13             MS. McENALLY:  I agree with Ann on this,

            14   straightforwardly.

            15             MR. NICOLAISEN:  I think we are very close to the

            16   end.  What I like to do is to give everyone a chance to

            17   express one last thought.  We can go right down the table, if

            18   that works, starting with you, Rodg.  If you don't care to

            19   say anything, that is certainly fine, too.

            20             MR. COHEN:  Let me just say my thanks to the

            21   Commission and PCAOB for doing this.  I think this is a very

            22   critical start.  There is not as much substance today, lots

            23   of ideas, nothing directly coming out, but the tone is very

            24   important.  It is equally important that the music be carried

            25   through with some action coming out of today's meeting.

             1             MR. FLYNN:  I just would leave the thought that it

             2   has been a very painful process for many people involved with

             3   it this year.  I think a lot has been learned in year one.  I

             4   think a lot has been accomplished to strengthen the financial

             5   markets and transparency and quality, and I'm confident that

             6   year two will be a much different experience, if we balance

             7   the appropriate implementation and changes.

             8             We talked about guidance.  At the same time, keep

             9   the same rigor in terms of what we are trying to accomplish

            10   here to 404.

            11             MR. NICOLAISEN:  One of the things that I think

            12   would be helpful, and we have talked about this, the best

            13   practice examples, and also the databases that the firms have

            14   accumulated of a whole lot of information, and I'm not sure

            15   all of that is suitable for public dissemination, but perhaps

            16   it is.

            17             I think the academic community and economists would

            18   be particularly interested in having the ability to study

            19   that data.  I would encourage particularly those of you who

            20   have done a lot of research and have accumulated significant

            21   information to think about making that available.

            22             MR. GREIFELD:  Certainly, I appreciate the

            23   opportunity to be here today.  One thought I'll express which

            24   I haven't heard so far is there is a true up side to

            25   Sarbanes-Oxley 404.  We have documented a number of different

             1   processes, certainly nowhere near 80,000, but in reviewing

             2   some of these processes that are now documented, we realize

             3   they don't make a lot of sense.

             4             We have the opportunity now to go back and

             5   re-engineer it, and based upon the time constraints, we said

             6   just document.  We will certainly look to do that in 2005.

             7             Just a final thought with respect to small

             8   companies, again, to try to really make the point real.  When

             9   you are asking a small company to segregate duties where you

            10   have one person doing three jobs, it just comes across as

            11   obviously an expense and counter-intuitive, and trying to

            12   introduce formality in a small company where their reason for

            13   being is their informality and their ability to adjust very

            14   quickly to market opportunities and respond quicker than

            15   larger better capitalized firms, you can realize how big of a

            16   set of damages you can create for these small firms.

            17             MR. NICOLAISEN:  Michele?

            18             MS. HOOPER:  At the NACD, we are very pleased to be

            19   a part of this discussion and I applaud the taking of time to

            20   spend in listening to the dialogue for a whole day.  That

            21   sends a very strong signal to the constituents of the

            22   organization.

            23             The opportunity to bring more judgment and more of

            24   a focus on best practice and enterprise risk management, I

            25   think, benefits not only the large firms but also the small

             1   firms.

             2             Within the NACD, we have a number of members and a

             3   great constituent in the small and mid-sized mid-cap

             4   companies. They are crying out for a process that is more

             5   efficient for them than what they have seen, people that have

             6   filed as of March 31 going through.

             7             Part of the opportunity I believe is learning from

             8   each other and learning from what we have done and getting

             9   information out on a more timely basis.

            10             MS. LAMBERT:  This day has been very valuable, and

            11   I thank you very much for all the effort you have put into

            12   it.

            13             My plea really runs to everybody's Summer vacation

            14   and the COSO exposure draft should be available this Summer,

            15   just in time for beach reading.

            16             (Laughter.)

            17             MS. LAMBERT:  We truly want as much input as

            18   possible into the guidance that will be in this COSO

            19   implementation guide for the smaller public companies.  I

            20   really encourage everybody to please provide feedback to that

            21   from the beach.

            22             MR. NICOLAISEN:  Do you have a www.com for that?

            23             MS. LAMBERT:  We will have one.

            24             MS. McENALLY:  I don't know, Deborah, I will do my

            25   best.

             1             (Laughter.)

             2             MS. McENALLY:  About the cost benefit issue, just

             3   one small observation.  I kept hearing that companies are

             4   paying the costs.  No, companies don't pay the costs.  The

             5   costs are borne by the share owners ultimately, and the

             6   question is what costs will the share owners pay.

             7             Mark Anson remarked this morning he's happy to pay

             8   the costs.  This is worth it.  The alternatives are higher

             9   costs of capital, which is what we share owners do when we

            10   start getting really edgy, or in the worse possible case,

            11   where the business model has collapsed, and everything is

            12   gone, the entire investment, which amounted to hundreds of

            13   billions of dollars in all of the cascading costs.

            14             I think yes, the costs are large, they are falling

            15   disproportionately on small companies, and I hope we can make

            16   some adjustments that ease that a bit, but that is very

            17   important.

            18             At the end of the day, let me return to what I

            19   first said.  I think Sarbanes-Oxley is by far the most

            20   important thing we investors have received in years and

            21   years.  I think it is has worked extremely well.  It is

            22   reflected in the votes we investors are making, but above

            23   all, 404 is the most important part, and we have been

            24   particularly happy with the way that has played out.

            25             MR. SZLOSEK:  Just quickly, as a controller of a

             1   Fortune 100 company, all kidding aside or all complaining

             2   aside about 404 and Sarbanes-Oxley in general, the provisions

             3   have gotten a lot more people into the tent with me, in terms

             4   of the management team, the operations team and so forth.

             5             I am not in there alone any more.  That if nothing

             6   else is a huge benefit for somebody in a position like mine

             7   and a lot of similar positions.

             8             I truly embrace the provisions.  I don't think 404

             9   is the best part of Sarbanes-Oxley yet.  I think we have

            10   talked a lot about the wrinkles that need to be worked out. 

            11   I don't think anything needs to change from a legislative or

            12   guidance perspective until we get through the second year.

            13             I think we need to be cognizant of all we have

            14   heard about, see how each of the constituents react, the

            15   auditors, the preparers, the inspectors, and come back in a

            16   year and say did it really make a difference, did we get 46

            17   percent of the costs out.  Did we see less material

            18   weaknesses and so forth.

            19             That will be the proof.  We can't force that.  We

            20   can't accelerate that until we get a chance to learn from our

            21   experiences from the first year.

            22             MR. WALKER:  I want to very quickly compliment you

            23   on holding the roundtable. Thanks for the invitation.  I

            24   would encourage you to take a look at the financial audit

            25   manual because I think it has a lot of relevant information

             1   that could be useful to your discussions and deliberations.

             2             MR. NICOLAISEN:  Will do.

             3             MS. YERGER:  Final comment on cost benefit. Costs

             4   are obviously making all the headlines.  We have heard today

             5   they should be going down.  We expect they will continue to

             6   go down.  We think the benefits are much longer term in

             7   nature.  They are very difficult to quantify.  In the long

             8   run, improved financial statements, higher quality audits,

             9   more engaged audit committees and improved tone at the top

            10   will benefit everybody in the markets.

            11             MR. NICOLAISEN:  Terrific.  Thank you all very

            12   much, thank you to all the panelists.

            13             MR. BELLER:  Thank you.

            14             Chairman Donaldson, would you like to say a few

            15   words in conclusion?

            16                             CONCLUSION

            17             CHAIRMAN DONALDSON:  Definitely.  Let me begin on

            18   behalf of my colleagues on the Commission to thank a lot of

            19   people.  First and foremost, I'd like to thank these two

            20   gentlemen and their staff, who have really put in a lot of

            21   work in terms of preparing this meeting.  I would say it

            22   evidences a great deal of judgment in the selection of the

            23   panels we have had.

            24             I want to thank the panel and the rest of the

            25   panels for being here and spending your time as you have.

             1             I would like to thank the people in the audience. 

             2   This has been an amazing attendance.  I hope that the press

             3   is still here.

             4             (Laughter.)

             5             CHAIRMAN DONALDSON:  I hope everybody in this

             6   audience is here because they have an interest in this

             7   subject and today's proceedings are adding to.  I know they

             8   have added for me a dimension of thought that you only get by

             9   listening to people talk.

            10             I think we are going to fill up on the Internet on

            11   our website with lots of recordings on what has been said

            12   here.  I hope all of us will do a little bedtime reading as

            13   we reflect not only on what we have heard, but what we read.

            14             Of course, I want to thank Bill McDonough and the

            15   PCAOB Board, your colleagues, for your participation as

            16   partners in this with us.

            17             Today, I think we have had a very open and

            18   insightful dialogue about the implementation of the internal

            19   control reporting provisions. Several themes have been

            20   identified.  For example, the discussants revealed that many

            21   companies have experienced benefits and improvements to their

            22   internal controls as a result of the implementing of these

            23   requirements.

            24             Internal control requirements also have led to an

            25   improved focus on internal controls by all stakeholders

             1   involved, improved focus on controls has a potential to pay

             2   dividends for sure in the future in terms of investor

             3   confidence, transparency, the quality of financial

             4   statements, as you say so correctly, cost of capital

             5   ultimately and shareholder returns.

             6             However, we also have heard there are some areas

             7   related to implementation of the new requirements that may

             8   need further attention or clarification, implementing this

             9   major new requirement has not been without costs and not

            10   without a learning curve.

            11             Therefore, I am instructing the staff to evaluate

            12   the feedback we have received on these topics and consider

            13   whether and how we can improve the guidance available to

            14   management and auditors in order to improve the effectiveness

            15   of the process.

            16             Given the importance of the issue and the

            17   preparatory work that is already underway for assessments of

            18   internal controls for 2005, I have asked the staff to

            19   complete their evaluation as quickly as possible.  We are

            20   well aware of what is coming down the pike.

            21             Finally, we have heard some of the very special

            22   challenges that smaller companies may face.  With our small

            23   company advisory board and their ongoing work and very

            24   valuable input here, well organized and well underway, we are

            25   very sensitive to the concerns of Section 404.  We know it is

             1   a priority issue for our advisory committees.

             2             I look forward to their work and the potential

             3   recommendations.

             4             Again, I want to thank everybody.  I think this has

             5   been a great meeting, and I think it has been not only

             6   informative, but as they say, really fun to get at the

             7   issues.

             8             Thanks a lot.

             9             MR. NICOLAISEN:  Bill?

            10             CHAIRMAN McDONOUGH:  I think we have all agreed

            11   that 404 has many positive results and yet the cost benefit

            12   has to be improved, especially for small and medium sized

            13   companies.

            14             As a former central banker, I am convinced that

            15   small and medium sized companies create all the economic

            16   growth in our country, and certainly create ultimately new

            17   jobs.  We have to do something for them.

            18             Our responsibility at the PCAOB has to do with the

            19   accounting firms which audit public companies.  I don't think

            20   there are people on this planet more convinced than those of

            21   us at the PCAOB that auditors must show judgment which also

            22   means they must have a risk based approach to their work.

            23             It is also clear from what we have heard today that

            24   we and they have not been completely successful in the first

            25   year in bringing full judgment to bear.

             1             We have been listening very carefully, not only

             2   today, right after we put out our auditing standard two a

             3   year ago, we created two internal control implementation task

             4   force working groups, one for auditors, the big eight plus,

             5   one for issuers, mostly large and a few small companies.

             6             They met most recently with the issuers on Friday

             7   and with the auditors on this Monday.  We are putting

             8   together a small firm implementation working group.

             9             You may have noticed during the breaks that our

            10   five board members got together, and then I had a little

            11   staff meeting with our three distinguished senior staff

            12   people in the standards area, Doug Carmichael, Tom Ray and

            13   Laura Phillips, sometimes known as Miss 404.

            14             Here is what we have decided to do.  We will put

            15   out the first staff guidance 30 days from today.  Actually,

            16   that is a Friday, and people don't pay attention to things

            17   put out on Friday's, so we will in fact put out the guidance

            18   on the following Monday, which will be the 16th of May.

            19             Our standing advisory group for our standards area,

            20   which as I mentioned this morning, is made up of a relatively

            21   small number of accountants, issuers, and especially

            22   investors, and they meet next on June 8th and 9th.

            23             We will dedicate the entire agenda of that meeting

            24   to what is it that we need in additional staff guidance

            25   coming from all the input that we get, and we will also

             1   decide about that time whether we have to re-open auditing

             2   standard two in order to clarify some basic principles

             3   through rulemaking.

             4             The reason we want to do it through staff guidance

             5   as much as possible is because we can do it quickly.  The

             6   rulemaking would take about another four or five months, and

             7   that puts us much too late into the next cycle.

             8             On our inspection process, I should remind you of

             9   the view of the relationship of the PCAOB towards the

            10   accounting profession that is shared by all the board

            11   members, but especially was brought by me from being a

            12   banking supervisor.

            13             I had the hottest seat in banking supervision in

            14   the United States for ten years, and chaired the Bazelle

            15   Committee on Banking Supervision.

            16             What we do is we relate to the accounting firms in

            17   the following way.  As long as you are trying to improve the

            18   quality of your service to the American people in the way

            19   that the representatives of all the audit firms who were here

            20   today spoke, but especially very eloquently just recently by

            21   Tim Flynn, we will work with you, the profession, in order

            22   that you can do your job better to help the American people.

            23             They know fully well that if they do something

            24   wrong, especially if it involves moral turpitude, we will

            25   beat the hell out of them.

             1             What will we learn from our inspections?  The

             2   inspections aren't meant to go and say you did a great job,

             3   you did a lousy job.  It is did a given firm in some areas do

             4   quite well, but in other areas, what I suspect and spoke

             5   about earlier this morning, in dealing with the smaller

             6   clients, where their staff is not as experienced, it's pretty

             7   clear they didn't in fact do as good a job as they did with

             8   their big clients, what are they going to do about that?

             9             You heard something from Tim on what his firm is

            10   planning to do about it.

            11             From this will come the best practices approach. 

            12   Here is the best practice for an audit firm to use in dealing

            13   with its clients and in dealing with internal controls.  That

            14   way, without punishing anybody or hanging people on lamp

            15   posts, we can get the best practices out to the audit firms,

            16   and in that way, through the most possible, to improve the

            17   credibility of financial statements and the internal controls

            18   related thereto, so that we can have greater economic growth

            19   for the people of our country and the world.

            20             That is what we plan to do.

            21             MR. BELLER:  Thank you, Chairman McDonough.  I am

            22   going to hold you all for 30 more seconds while I thank the

            23   people who are really responsible for this being a successful

            24   day, and that is Don Nicolaisen's and my staff.

            25             I know Chairman Donaldson mentioned them, but I

             1   want to do it as well.  Don Nicolaisen's and my staff are in

             2   the Office of Chief Accountant and the Division of

             3   Corporation Finance.  People are going to say we did a great

             4   job, but  Don and I know they did a great job.  We are just

             5   up here doing what they told us to do.

             6             Thank you very much, and thank you all.  Thank you

             7   to the panels.  Thank you to the board members, the

             8   Commission, those in the audience, and those unseen people on

             9   the web who have listened to us today.

            10             Thank you.

            11             (Applause.)

            12             (Whereupon, at 5:39 p.m., the roundtable was

            13   concluded.)

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