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THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION 

UNOFFICIAL TRANSCRIPT 

OPEN MEETING 

MEETING THE COMPETITIVE CHALLENGES OF THE GLOBAL MARKETPLACE 

Wednesday, July 25, 2007 

(Amended 9/19/07) 

Diversified Reporting Services, Inc. 

(202) 467-9200 
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C O N T E N T S 

Item 1: Consideration of approval for PCAOB's 

Auditing Standard No. 5, Independence 

Rule 3525 and Conforming Amendments 4 

Item 2: Consideration of adoption of rule 

amendments to Exchange Act Rule 12b-2 

and Rule 1-02 of Regulation SX to 

define "significant deficiency" 80 

Item 3: Consideration whether to publish a 

Concept Release to solicit public 

comment on allowing U.S. issuers 

to prepare financial statements 

in accordance with ICFR 81 

Item 4: Consideration whether to propose 

amendments to the proxy rules under the 

Securities Exchange Act of 1934 121 
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P R O C E E D I N G S 

CHAIRMAN COX: Good morning. This is a meeting of 

the Securities & Exchange Commission under the Government in 

the Sunshine Act on July 25, 2007. 

We have a great deal of work today. Today's 

meeting is going to cover three vitally important topics for 

the future of our capital markets. 

We'll begin with rationalizing the implementation 

of Section 404 of the Sarbanes-Oxley Act. We'll move on to 

consideration of the role that International Financial 

Reporting Standards will play in America's future. 

And finally, we'll consider two proposals to 

address the question of how the federal proxy rules can be 

better aligned with the state law rights of shareholders. 

These topics are very much related to one another. 

As the world's capital markets converge and 

competition among both markets and financial products becomes 

broadly international, investors will demand more and more 

different things from securities regulation, that is, after 

all, intended to serve their interests. 

They'll want to know that the costs of regulation 

are aligned with the benefits it produces, which is why we're 

considering a completely rewritten audit standard to 

implement SOX 404. 

They'll demand better comparability among financial 
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statements from issuers in America and around the world, 

which is why we're considering a Concept Release on the 

relationship between International Financial Reporting 

Standards and U.S. Generally Accepted Accounting Principles. 

And shareholders of U.S. companies will insist that 

their property rights as owners and investors, which include 

above all else the right to choose the board of directors, be 

respected by the federal proxy rules. 

As was pointed out recently by the Committee on 

Capital Markets Regulation, shareholders of U.S. companies 

have fewer rights in a number of important areas than do 

their foreign competitors, giving foreign firms a competitive 

advantage. 

For that reason, the Committee on Capital Markets 

Regulation urged the SEC to address and resolve appropriate 

access by shareholders to the director nomination process. 

We'll consider two very different approaches to that issue 

today. 

So let's turn to the first item on the agenda, 

which is rationalizing the implementation of Section 404 of 

the Sarbanes-Oxley Act of 2002. 

The first item consists of two parts; first, 

approval of the PCAOB's Auditing Standard No. 5, "An Audit of 

Internal Control Over Financial Reporting that is Integrated 

with An Audit of Financial Statements," a related 
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independence rule and conforming amendments. And second, the 

adoption of a definition of the term "significant 

deficiency." 

Next Monday, July 30th, will mark the five-year 

anniversary of the Sarbanes-Oxley Act. Section 404 has posed 

the single biggest challenge to companies under the entire 

act, without question has imposed the greatest costs, but it 

has also contributed significantly to more reliable financial 

information and more reliable financial reporting as 

companies improve their internal controls to meet Section 

404's requirements. 

For the past two years, the Commission, the PCAOB 

and our respective staffs have been hard at work to improve 

the implementation of Section 404 while maintaining Section 

404's benefits and protections to investors. 

Over this two-year period we've held two 

roundtables in 2005 and 2006 to listen to issuers' first- and 

second-year experiences with the PCAOB Auditing Standard No. 

2. 

We also issued a Concept Release Concerning 

Management's Report on Internal Control Over Financial 

Reporting. We proposed and adopted additional extensions of 

time for non-accelerated filers, certain foreign private 

issuers and newly public companies. 

We provided the Staff Guidance. We convened the 
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Advisory Committee on Smaller Public Companies to study, 

among other things, the impact of Section 404 on smaller 

companies, and we proposed and adopted guidance for 

management to follow in conducting their evaluations of 

internal control over financial reporting. 

With respect to the PCAOB and the internal control 

auditing standard, last fall and winter we worked closely 

with the PCAOB and its staff as they developed their proposed 

new internal control auditing standard, and we convened an 

open meeting of the Commission on April 4th to discuss with 

our staff their approach to the PCAOB's proposed new standard 

and the alignment of that standard with our own management 

guidance. 

Along the way we carefully considered all of the 

public comments that we and the PCAOB received on Section 404 

implementation. Many companies and their auditors are now 

entering their fourth year of reporting on internal control 

over financial reporting. 

Throughout this period, management, auditors, 

investors and other interested parties have provided ongoing, 

extensive and enormously helpful feedback to both the 

Commission and the PCAOB about what has worked well and what 

could be improved. 

On May 24th, the PCAOB voted to replace the 

auditing standard under SOX 404 that had led to excessive 
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costs and serious implementation problems. They voted to 

replace it with a top-down, risk-based approach focused on 

internal controls that are material to a company's financial 

statements and scalable for companies of varying size and 

complexity. 

This new standard, Auditing Standard No. 5, can 

take effect only if it is approved as final by the SEC. On 

June 12th, the Commission published the new standard for 

public comment, and the comments have been overwhelmingly 

favorable. 

This morning, we consider whether to grant final 

approval to Auditing Standard No. 5. As we approach the 

five-year anniversary of Sarbanes-Oxley, we can be proud that 

confidence in our markets is restored, that compliance costs 

are coming down and that today the final approval of the 

PCAOB's Auditing Standard No. 5 will make a giant step 

forward in facilitating a more effective and efficient 

approach to the implementation of Section 404 by refocusing 

resources on what truly matters to the integrity of financial 

statements. 

This is an exceptionally positive step for investors and for 

America's capital markets. 

Although the new auditing standard and the 

Commission's guidance to management should enable 

cost-effective compliance with Section 404 for companies of 
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all sizes, smaller public companies -- as defined by the 

report of the Advisory Committee on Smaller Public Companies, 

which is specifically referred to in AS 5 -- should 

particularly benefit from the scalability built into the 

PCAOB's new auditing standard and the SEC's interpretive 

guidance. 

In addition, because we deferred Section 404's 

external audit requirement for the category of smaller 

companies that are non-accelerated filers until the filing of 

their 2008 annual reports, management of these smaller 

companies will have additional time to develop an evaluation 

approach specific to their facts and circumstances and to 

coordinate their approach with a cost-effective external 

audit. 

We're confident that Auditing Standard No. 5 will 

improve effectiveness and efficiency and will reduce 

inventory compliance costs, and we're committed to ensuring 

that its implementation is consistent with our expectations. 

To that end, we'll analyze real-world information 

to determine that the costs and benefits of implementing 

Section 404 are in line with our expectations. 

In addition, through our oversight of the PCAOB's 

inspection program we'll monitor whether audit firms are 

implementing Audit Standard No. 5 in a manner designed to 

achieve the intended results of audit efficiency and cost 
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reduction and whether the PCAOB is inspecting audit firms in 

a manner consistent with our expectations. 

With a significantly improved audit standard that 

enables auditors to deliver the most cost-effective audit 

services, the SEC and the PCAOB expect a change in the 

behavior of the individuals who are responsible for 

conducting internal control audits. 

I want to once again thank our staffs, in 

particular the Office of the Chief Accountant, the Division 

of Corporation Finance and the General Counsel's Office for 

all of their work. Your tireless efforts over the past year 

will benefit investors in our capital markets for many years 

to come. 

Specifically from the Office of the Chief 

Accountant, I'd like to recognize Zoe-Vonna Palmrose, Brian 

Croteau, Josh Jones, Amy Hargrett, Esmerelda Rodriguez, Jeff 

Ellis and Kevin Stout. 

From the Division of Corporation Finance I'd like 

to recognize Betsy Murphy and Sean Harrison. And, from the 

Office of General Counsel, David Frederickson. I'd also like 

to recognize the work of the PCAOB board and their staff for 

their efforts. 

Finally, I'd like to take this opportunity to 

express once again the Commission's appreciation to our own 

Advisory Committee on Smaller Public Companies and the 
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hundreds of investors, companies, auditors, professional 

organizations and others who responded to the Commission's 

and the PCAOB's various requests for comments regarding 

audits of internal control over financial reporting. 

The Commission's efforts in improving Section 404 

implementation were considerably aided by their helpful 

insights and suggestions. 

So I'll now recognize John White, Conrad Hewitt and 

Zoe-Vonna Palmrose for a presentation of the staff's 

recommendation. 

MR. WHITE: Thank you, and good morning. Chairman 

Cox and members of the Commission, as Chairman Cox has 

explained, we are here today to recommend that you approve 

the PCAOB's Auditing Standard No. 5, a related PCAOB 

independence rule, and conforming amendments to the PCAOB 

standards. Additionally, we're recommending that the 

Commission adopt a definition of the term "significant 

deficiency." 

The PCAOB's Auditing Standard No. 5, if approved by 

the Commission today, will replace the current Auditing 

Standard No. 2. The Independence Rule 3525 will require 

auditors to obtain audit committee pre-approval of non-audit 

services related to internal control over financial 

reporting. As you may recall, Auditing Standard No. 2 

contains a pre-approval requirement, but the PCAOB has 
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determined that it was more appropriate to include this 

requirement in its ethics and independence rules rather than 

to continue to include it within its internal control 

auditing standard. 

In addition, we are recommending that you approve 

for the first time a definition of the term "significant 

deficiency." We believe it is appropriate to include the 

definition of "significant deficiency" within the 

Commission's rules given the communications requirements in 

the rules implementing Section 404 of Sarbanes-Oxley as well 

as the certification requirements of Section 302 of 

Sarbanes-Oxley. 

Including a definition of "significant deficiency" 

in Commission rules in combination with the definition of 

"material weakness," which was adopted by the Commission this 

past May, will enable management, appropriately and 

conveniently, to refer to Commission rules and guidance for 

the meanings of these terms rather than referring to auditing 

standards, which it does today. 

Conrad and Zoe-Vonna will describe the proposed 

rule amendment to adopt the definition of "significant 

deficiency" and the comment letters received by the 

Commission on Auditing Standard No. 5 in more detail in a 

moment. 

Before we move to that, I wanted to take a moment 
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to reflect on the journey that we have taken to arrive at 

today's recommendations to the Commission, a journey that 

started soon after I arrived on the staff just a little over 

a year ago. 

Addressing the implementation of SOX 404 has been a 

significant priority of the Commission over past several 

years. As you know, the Commission and the PCAOB have been 

working closely together during this period to improve the 

implementation of Section 404. 

Going back to May 10, 2006, many of us were here in 

this very auditorium as the Commission and the PCAOB hosted a 

roundtable on second-year experiences with Section 404. 

The roundtable was followed one week later with 

press releases in which the Commission and the PCAOB each 

announced a series of steps they planned to take to improve 

the implementation of Section 404. 

In the Commission's press release, it outlined four 

actions that it was undertaking to improve the implementation 

of Section 404. 

These actions were: One, issuing for the first 

time guidance for management in performing its assessment. 

Two, working with the PCAOB in revising Audit Standard No. 2. 

Third, providing extensions of the compliance deadline for 

non-accelerated filers; and 4, providing SEC oversight of the 

PCAOB inspection process which was designed last year to 
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focus on the efficiency of Section 404 implementation. 

So I'm happy to say that with its actions today the 

Commission will have affirmatively acted on three of these 

four steps by providing extensions to non-accelerated filers 

at the end of last year, through its approval of interpretive 

guidance for management this past May, and now today with its 

consideration of Auditing Standard No. 5 to replace Auditing 

Standard No. 2. 

And that's not to say we haven't been working very 

diligently on the fourth item, our oversight of the PCAOB 

inspection process, but I'm going to leave that item to 

Conrad Hewitt to expand on in a moment. 

So since the May 2006 announcements, the PCAOB, in 

coordination with the SEC staff has been working to provide a 

new auditing standard, one that makes clear that the 

auditor's primary focus during an integrated audit is on 

areas that pose the highest risk of material misstatement to 

the financial statements and that does not require procedures 

unnecessary to an effective audit of internal controls. 

The PCAOB released its proposed new auditing 

standard in December of last year. Over 175 Comment Letters 

were received. In addition, as part of the Commission's 

process of issuing its interpretive guidance for management, 

we received over 200 Comment Letters many of which focused on 

the interplay between our interpretive guidance and the 
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PCAOB's auditing standard. 

As a result of the comments received on both 

proposals, the Commission held an open meeting on April 4, 

which you alluded to, to discuss its views on the comments 

received with respect to the auditing standard. 

The Commission directed the staff to focus on four 

areas when working with the PCAOB staff. The PCAOB and its 

staff considered the comments received and the Commission's 

guidance carefully and, as a result, made significant changes 

from its proposal in December. 

So the end result of their hard work is an auditing 

standard that is shorter, less prescriptive, focused on the 

areas of highest risk and clearly scalable to fit any 

company's size and complexity. 

Zoe-Vonna will speak in more detail about those 

changes, but I am very happy to report to you today that the 

staff of the Commission believes that you have a very much 

improved auditing standard for your consideration due to the 

PCAOB's and the Commission's coordinated efforts, and we in 

the staff are very pleased and very proud to make our 

recommendation to you here today. 

Before I turn it over to Conrad I'd like to 

acknowledge the cooperative efforts within the SEC staff as 

well as with the staff of the PCAOB. 

Investors in our capital markets deserve and they 
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are relying on our hard work and our teamwork to improve the 

implementation of Section 404, and I believe the public has 

been well served by an abundance of each. 

Chairman Cox, you've already thanked the many staff 

members who have worked on these releases as well as the 

PCAOB staff and the PCAOB who have worked with us. I just 

want to echo those thanks, and I say that with great 

sincerity. 

I'm very, very appreciative to everybody who has 

worked on this project, now for all the time that I've been 

on the Commission staff. With that I'll turn it over to you, 

Conrad. 

MR. HEWITT: Thank you, John, Chairman Cox and 

members of the Commission. The increased focus on companies' 

internal controls over financial reporting under Section 404 

of the Sarbanes-Oxley Act and the Commission rules has led to 

an improved investors' confidence in our financial markets. 

This improved confidence is a result of improved 

public disclosures related to ICFR. Also, the increased 

focus on internal controls has helped many companies to 

establish and maintain more effective internal controls. 

However, as you know, these benefits have come with 

costs that were significantly greater than expected. Of 

particular concern has been indications of audit and 

compliance costs for smaller companies. 
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Concerns for Section 404, of course, are not new. 

Efforts by the Commission and the PCAOB have been underway 

for some time to meet the challenge of providing new guidance 

and revising the prior requirements to better balance the 

implementation costs with the benefits. 

The proposed auditing standard that you are 

considering today to replace AS 2 is intended to address the 

specific concerns of smaller public companies by enabling and 

encouraging auditors to effectively tailor and scale their 

audits according to the relevant facts and circumstances of 

each company. 

If adopted, the new standard will become effective 

for audits fiscal years ended on or after November 15, 2007. 

That's this year. However, it is important to note that 

early adoption of the new standard would be permitted. 

In fact, the staff would encourage early adoption 

by auditors so that issuers and then investors can begin to 

benefit from the improvements that have been made relative to 

the effectiveness and efficiency in the conduct of internal 

control audits. 

Although Zoe-Vonna Palmrose will discuss the 

comment letters in more detail I want to highlight one 

additional matter. 

Some commenters expressed concern that there was 

not sufficient incentive for auditors to modify their methods 
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of performing the audit of internal controls. Therefore, 

they were concerned that the benefits afforded by AS 5 would 

not be fully implemented and realized. 

These commenters noted that it was important for 

the PCAOB to adjust its inspection program to align it with 

the many changes in the new audit standard and to respect the 

auditor's use of professional judgment in conducting the 

audit. Now, this has been an area that both the Commission 

and the PCAOB recognize and continue to focus on. 

For example, the inspection process was an area 

specifically identified in the Commission's and the PCAOB 

2006 Announcement of Actions following the Commission's 

second roundtable on Section 404 implementation. 

The PCAOB has incorporated procedures to evaluate 

the efficiency and effectiveness of ICFR audits in their 

inspection process. 

Further, as directed by the Commission, the staff 

is examining whether the PCAOB inspection program has been 

designed to be effective encouraging changes in the conduct 

of integrated audits to again to improve both efficiency and 

effectiveness of attestations on ICFR. 

The staff recognizes that even with the adoption of 

a new standard the hard work is not over. Appropriate 

implementation will be just as important as having an 

improved auditing standard in place. 
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If approved, we will work closely with the PCAOB, 

management, auditors and others to monitor the implementation 

of this new standard. I believe that it is also important 

for audit committees to be involved with the implementation 

to enable the success of Auditing Standard No. 5. 

The successful implementation of Auditing Standard 

No. 5 will depend on several participants in the financial 

reporting process. 

For example, the PCAOB has indicated that it will 

retrain its inspection team and adjust its inspection 

program. External auditing firms will need to retrain their 

staffs and change their audit programs for a more integrated 

audit. 

The management of each company can challenge its 

own evaluations of internal controls based upon our 

interpretive guidance. And just as important, audit 

committees should play a more active and direct role with 

particular attention to their Management Guidance 

implementation and the scope of the external auditor's 

year-end audits on an integrated basis in accordance with 

Auditing Standard No. 5. 

Now, if above are implemented properly, costs 

should become more in line with the benefits for investors 

and particularly for smaller, including micro cap, companies. 

Lastly, the staff believes it is appropriate for 
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the Commission to include a definition of a term "significant 

deficiency" in the Commission rules. 

The staff recommends that you adopt the definition 

which the Commission published for additional public comment 

in June. As you know, the definition of "significant 

deficiency" is used in the context of evaluating the minimum 

required communications under both Section 302 and 404 of 

SOX. 

That is, "A significant deficiency is a deficiency 

or a combination of deficiencies in internal control over 

financial reporting that is less severe than a material 

weakness, yet important enough to merit attention by those 

responsible for the oversight of a registrant's financial 

reporting." 

We received 22 comment letters on this proposed 

definition, and the majority of the commenters expressed 

their support for it. In addition, the commenters noted that 

a consistent definition of "significant deficiency" in our 

Commission rules and the PCAOB standards was important. 

The staff believes that the definition 

appropriately emphasizes the communication requirements 

between management, the audit committee and the independent 

auditors on those matters that are important enough to merit 

attention. 

And the definition will allow management to use its 
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judgment to determine deficiencies that should be reported to 

the audit committee and the independent auditor. 

At this point, I would like to reiterate the 

chairman's thanks to all the staff who worked tirelessly on 

our efforts to improve the implementation of Section 404. 

During this process, we worked closely with the PCAOB. 

And I would like to add my thanks to the board and 

staff of the PCAOB. We'd also like to thank the 

Commissioners and their staffs for all the hours they have 

worked together with us on this topic, a very important 

topic, over the past several months providing their input and 

guidance. 

At this time, I'd like to turn it over to my 

deputy, Zoe-Vonna Palmrose, who will discuss the Comment 

Letters of AS 5 in more detail. Zoe-Vonna. 

MS. PALMROSE: Thank you, Conrad. Let me begin by 

looking back a few months and reviewing. First, as John 

mentioned, the PCAOB received 175 letters when it exposed a 

draft of Auditing Standard No. 5 for public comment in 

December. 

Then, as has been noted, at this year's April 4th 

open Commission meeting, the Commission and staff discussed 

the comments received by the PCAOB along with those received 

by the Commission in connection with its proposed 

interpretive guidance for management. 
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At the 404 meeting, the Commission directed us to 

focus on four areas when working with the PCAOB staff. Those 

areas were, first, aligning the proposed auditing standard 

with the Commission's proposed interpretive guidance for 

management, particularly with regard to prescriptive 

requirements, definitions and terms. 

Two, scaling the audit to account for the 

particular facts and circumstances of companies, particularly 

in smaller companies. Three, encouraging auditors to use 

professional judgment, particularly in using risk assessment. 

And four, following a principles based approach to 

determining when and to what extent the auditor can use the 

work of others. 

We're very pleased to be able to report to you 

today that the PCAOB has addressed each of these areas in 

addition to the other matters raised by commenters in the 

version of AS 5 they adopted in May and that you're now 

considering. 

While I won't detail all of the improvements, 

suffice it to say this standard is much less prescriptive, 

appropriately allows for auditor judgment, eliminates 

unnecessary procedures from the audit and directs the auditor 

to focus on what matters most. 

These improvements are significant, and they are 

responsive to the comments received by the PCAOB, including 
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those discussed at our April 4th open meeting. 

Now let me turn to the comments in response to the 

Commission's June 7th request for comment on the standard you 

have before you. 

The Commission received 27 comment letters. These 

comment letters came from issuers, registered public 

accounting firms, professional associations, investors and 

others. Overall, many commenters expressed support for the 

proposed standard and recommended that the Commission approve 

the standard and the related conforming amendments. 

Some of these commenters requested that this 

approval be done on an expedited basis to enable auditors to 

implement the provisions of AS 5 prior to the required 

effective date. 

A number of commenters noted that AS 5 includes 

appropriate investor safeguards, that it will facilitate a 

more effective and efficient approach to the ICFR audit and 

that the PCAOB appropriately responded to concerns raised by 

issuers, auditors, investors and others. 

Specifically, some commenters noted that the 

standard's focus on principles rather than prescriptive 

requirements expands the opportunities for auditors to apply 

well-reasoned professional judgment. 

Still, a few commenters expressed their continuing 

concern that in reducing the number of ICFR related audit 
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opinions from two to one, the Commission and the PCAOB retain 

the wrong opinion. 

These few commenters indicated their belief that 

auditors should opine on the assessment made by management in 

order to comply with Section 404(b) of the Sarbanes-Oxley 

Act, which some go on to equate to opining on management's 

evaluation process. 

These commenters expressed their belief that 

auditors opining directly on ICFR, as opposed to management's 

assessment, entails unnecessary and duplicative work. The 

staff has carefully considered this comment and continues to 

believe that consistent with Sections 103 and 404 of the 

Sarbanes-Oxley Act and the Commission's recent rule 

amendments AS 5 requires the appropriate opinion to be 

expressed by the auditor. 

Further, the staff believes that an auditing 

process that's restricted to evaluating what management has 

done would not necessarily provide the auditor with a 

sufficient level of assurance to render an independent 

opinion as to whether management's assessment about the 

effectiveness of ICFR is correct. 

Finally, the staff believes that the expression of 

a single opinion directly on the effectiveness of ICFR is not 

only important from an investor protection standpoint but 

provides clear communication to investors that the auditor is 
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not responsible for issuing an opinion on management's 

process for evaluating ICFR. 

In the staff's view, an opinion on the latter may 

not only have the unintended consequence of hindering 

management's ability to apply appropriate judgment in 

designing their evaluation approach but also may have the 

effect of increasing audit costs without commensurative 

benefits to issuers and investors. 

As you know, the Commission sought comments on 

seven specific questions in a supplemental June release as 

part of its request for public comment. I'll touch on the 

responses we received to each of these seven questions, and 

then we'd be pleased to discuss in issues in greater detail 

and answer any questions that you might have. 

On the first question with respect to whether 

materiality is appropriately defined throughout AS 5 to 

provide sufficient guidance for auditors, the majority of 

commenters who expressed a view on this question said yes. 

Some commenters elaborated that while application 

of materiality concepts in the context of planning and 

performing an audit requires the use of judgment. AS 5 

appropriately specifies the basis on which those judgments 

should be made. 

The staff agrees that AS 5 adequately addresses 

materiality throughout the standard. Even so, a few 
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commenters expressed a view that some auditors may need 

further and clearer guidance than is provided about 

materiality generally for integrated audits of both ICFR and 

the financial statements. 

However, the staff does not believe that AS 5 is 

the appropriate forum to address broader questions about 

materiality as the concept of materiality is fundamental to 

the federal securities laws. Nonetheless, this is an area 

the staff continues to focus on in the broader context. 

With respect to the second question as to whether 

the communication requirement regarding significant 

deficiencies will divert auditors attention away from 

material weaknesses, commenters who expressed a view on this 

matter overwhelmingly said no. 

They said, for example, that AS 5 clearly directs 

the auditor to scope the audit to identify material 

weaknesses to be disclosed to investors, and the staff 

agrees. 

With respect to the third question whether AS 5 is 

sufficiently clear that multiple control deficiencies should 

only be looked at in combination if they are related to one 

another, most of those commenting on this question said yes, 

that AS 5 is sufficiently clear in this regard although a 

couple of commenters disagreed, stating that the auditor is 

expressing an opinion on the effectiveness of internal 
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control as a whole. 

Again here the staff agrees that AS 5 is 

sufficiently clear and notes that it's aligned with the 

Commission's interpretive guidance for management in this 

regard. 

With respect to the fourth question whether the 

definition of "material weakness" appropriately describes the 

deficiencies that should prevent the auditor from finding 

that ICFR is effective, the majority of those commenting on 

this topic responded affirmatively. And the staff agrees. 

On the fifth question related to the auditor's use 

of the work of others, the majority of those who commented 

expressed their view that AS 5 is clear about the extent to 

which auditors can use the work of others to gain 

efficiencies in the audit with some noting that AS 5 provides 

substantial flexibility in the application of auditor 

judgment when determining whether and to what extent to use 

the work of others. 

The staff agrees that AS 5 is sufficiently clear 

about the extent to which the auditor can use the work of 

others. However, two commenters recommended that if the work 

of others is found to be competent and reliable, then the 

standard should require the auditor to utilize it. 

But while we anticipate auditors would use the work 

of others under appropriate circumstances, including when the 
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approach results in greater efficiency, we do not believe 

that it's necessary or appropriate to preclude the auditor 

from utilizing his or her judgment in determining whether or 

not to use the work of others based on the particular facts 

and circumstances of the engagement. 

As to the sixth question on whether AS 5 will 

reduce costs and result in cost-effective integrated audits, 

a number of commenters stated their view that AS 5 as 

approved by the PCAOB together with the Commission's guidance 

for management will result in a reduction of the total 

Section 404 compliance effort. 

Some commenters agreed that a cost reduction would 

occur but also noted that the amount of reduced effort and 

cost associated with the ICFR audit will vary by company 

depending on factors such as the size, complexity, the degree 

of change from year to year, the quality of their internal 

control systems and documentation and the extent to which 

management appropriately applies the Commission's 

interpretive guidance for management. 

None of the commenters suggested that costs would 

increase. Even so, so commenters noted that while AS 5 my 

curtail excess of testing of controls and reduce some of the 

unnecessary documentation currently required for Section 404 

audits they still have concerns about the extent to which it 

will reduce costs for smaller companies. 
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A number of commenters urged the Commission and the 

PCAOB to closely monitor the extent to which the standard is 

implemented and achieves a reduction in costs and to take 

action if there's not an appropriate reduction. 

In a minute, I'll say more about this issue, but 

first and relatedly let me cover the seventh question as to 

whether AS 5 inappropriately discourages or restricts 

auditors from scaling audits, particularly for smaller 

companies. 

Most commenters who responded to this question said 

no. They noted that the standard appropriately discusses the 

concept of scalability based on size and complexity without 

including inappropriate restrictions on the auditor's ability 

to scale the audit. 

The staff agrees that AS 5 appropriately recognizes 

scaling and tailoring of all audits to fit the relevant facts 

and circumstances so that ICFR audits will fit the size and 

complexity of the company being audited rather than the 

company's control system being made to fit the auditing 

standard. 

The staff also agrees with the statement made by 

the board in its release to AS 5 that scaling will be most 

effective if it's a natural extension of the risk-based 

approach and applicable to all companies. 

Before leaving question seven I'd also like to 
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respond to the observation by some commenters that where 

feasible AS 5 should provide additional guidance on how to 

effectively plan an integrated audit for smaller companies 

along with some discussion of related best practices to 

enhance broader understanding of risk-based auditing. 

First, let me mention that the COSO guidance issued 

a year ago and directed to smaller companies should be 

helpful to both those companies whose COSO as their framework 

for evaluating their controls and their auditors in 

effectively and efficiently implementing 404. 

In addition, COSO currently is conducted a project 

to develop guidance intended to help organizations better 

understand the monitoring component of the framework and 

comply with Section 404 in a cost-effective manner. 

Further and importantly, for responding to the 

concerns of some commenters, the PCAOB has underway a 

separate project to develop guidance and education for 

auditors of smaller companies. 

We're monitoring this project. The staff 

recognizes its importance as part of getting a good 

implementation of AS 5 for non-accelerated filers on their 

first ICFR audits with their filings in 2009. 

Moreover, in addition to this project, the staff is 

working in a number of other ways as we go forward to monitor 

the implementation of the Commission's new guidance for 
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management and the PCAOB's new guidance for auditors. 

As selected examples, the staff will continue its 

ongoing participation in public forums and events to discuss 

the significant improvements made by the Commission and the 

PCAOB. 

As just one illustration, the staff participates in 

the PCAOB's forums on auditing in the small business 

environment. These forums are held throughout the country 

and designed to help share important information concerning 

the PCAOB with respect to registered public accounting firms 

and public companies operating in the small business 

community. 

Presentation materials from past events are 

available on the PCAOB's web site. These forums along with 

our speaking engagements provide for excellent two-way 

communication so that questions that arise can be dealt with 

on a real-time basis. 

Further, as Conrad noted, we expect a change in the 

behavior of the individuals who are responsible for following 

these new procedures. To that end, the PCAOB's inspection 

program will monitor whether audit firms are complementing 

the new auditing standard in a way that is designed to 

achieve the intended results. 

And it's noteworthy that the PCAOB's Office of the 

Chief Auditor, which drafted the standard, helps train PCAOB 
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inspectors on AS 5. Moreover, in our oversight capacity, the 

staff, at the Commission's direction, will monitor the 

effectiveness of the PCAOB's inspection process. 

So these are among the activities that illustrate 

going forward both the SEC and PCAOB will be focused on 

whether audit firms are achieving an effective and efficient 

implementation of the new 404 guidance. 

In closing, I'd like to reinforce the appreciation 

expressed by others to the Commission, including for your 

guidance to the staff throughout the year and especially at 

the April 4th open Commission meeting, to the PCAOB board and 

staff and to the Office and Division staff that have worked 

so hard on this project, including my staff, in particular, 

Brian Croteau, Josh Jones, Amy Hargrett, Esmerelda Rodriguez, 

Jeff Ellis and Kevin Stout. 

Brian Croteau and Josh Jones, who have played key 

roles in our efforts to rationalize the implementation of 404 

are at the table to help answer your questions. That 

concludes our opening remarks. 

Chairman Cox, staffs of the OCA and Division of 

Corp Fin would be happy to discuss any questions that you and 

the Commissioners might have. Thank you. 

CHAIRMAN COX: Thank you for that very complete 

presentation. This is a lot of work. We've covered a lot of 

ground, and I think everyone has a lot to be proud of. 
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At our April 4th open meeting, we discussed the 

need for AS 5 to make clear that the audit is scalable to 

account for the fact that companies come in different shapes 

and sizes and different complexities, and we were 

particularly focused on smaller companies. 

So I want to begin by asking how does AS 5 do this 

specifically? 

MS. PALMROSE: Well, let me start out by saying, 

first of all, its principles based. It offers the 

opportunity for the auditor to make judgments based on the 

facts and circumstances, and it's a risk-based approach, and 

so scaling is a natural extension of this approach. 

Second of all, AS 5 includes specific discussion on 

scaling the audit based on size and complexity of the 

company, and the staff agrees with this discussion and that 

scaling is the most effective way to get -- that reflects 

this natural, as I said, extension of the risk-based 

approach. 

Third, the Board made an important change from 

their December proposal. Not only did they have a special 

section that talked about scaling, but what they did is they 

imbedded scaling concepts that can apply in particular to 

small companies throughout the standard to help illustrate 

and provide a little bit more context and guidance in that 

setting. 
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And fourth, I should note that consistent with the 

discussion and plans there is the build-out of this guidance 

that is expected to come from the additional guidance that 

the board and staff are working on for smaller companies. 

And that project is progressing nicely, will be 

available for public comment in the not to distant future and 

will be able to be applied by auditors of small firms well 

before the implementation for the filings in 2009. 

CHAIRMAN COX: Thank you for that. We, of course, 

have published guidance for managements in meeting their 

obligations under Section 404(a). I seem to recall that the 

PCAOB is planning its own guidance for audits of smaller 

companies. How is that going? 

MS. PALMROSE: That's going well. Actually, that 

was part of just, sort of, what I briefly ended on. As you 

know, the staff is an observer on that project. We've been 

working with them. 

This project also has the advantage of having a 

task force that's made up of representatives from the public 

accounting firms, in particular the public accounting firms 

that are auditing smaller companies so not just the largest 

firms and their audits of smaller companies but the smaller 

firms, too. 

So that task force has been working with the PCAOB. 

We've been working as observers, and that guidance will, as I 
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said, be available for exposure in the not too distant 

future. But we are reviewing drafts of that as it goes along 

as are the task force. So it's going well. 

MR. WHITE: I might also mention that we're working 

on a brochure for smaller companies that will be, basically, 

a plain English explanation of how to use management guidance 

and to, kind of, lead companies through this that we think 

will be helpful to them. 

CHAIRMAN COX: And that's something, of course, 

that smaller companies have asked for, so that will be very 

responsive. 

MR. WHITE: Yes. It is something that they have 

asked for, and it was discussed in your congressional 

testimony a few weeks ago. 

CHAIRMAN COX: Excellent. John, you mentioned a 

number of ways in which the staff are going to monitor the 

implementation of AS 5 as well as Management Guidance. 

I note that we received a number of recommendations 

that we perform a cost study of AS 5. Could you describe 

what plans you have to study -- what plans the Agency has to 

study the costs of AS 5 and Management Guidance and when you 

might be in a position to report to us on these costs? 

MR. WHITE: We'd be glad to, but I think I'm going 

to let Zoe-Vonna do that because she has done most of the 

planning for this. 
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MS. PALMROSE: Well, I think that's overstated, but 

I certainly would be glad to provide some comments here. And 

the answer is yes, at the direction of the Commission. 

Actually, our Office of Economic Analysis will be 

conducting an analysis to address whether the costs and 

benefits of implementing Section 404 are in line with our 

expectations. 

The Office of Economic Analysis is working with the 

staffs of the other offices and divisions, and we have 

started the process of planning such a report. So we would 

be hopeful that those plans would be well in line within the 

not too distant future. 

As part of this, I should reaffirm that -- and in 

light of this direction, we're also revisiting the other 

research that has been done in what I call the growing 

literature and research related to the implementation of SOX. 

So it's not just our own efforts that we're 

considering, but we're considering the efforts of others, and 

that's informing not only how we think about the issues but 

also how we're developing our own study as we go forward. 

So the answer is yes. We're working in a number of 

ways to move this project along, and we recognize its 

importance. And it's really part of our over-arching 

activities in a number of ways to work on the implementation 

of 404. 
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MR. HEWITT: I might just add on that point, if I 

may, KPMG, there are other organizations also that do studies 

on these costs and benefits. And KPMG just came out with 

their third annual benchmark study of 404, and it will be 

interesting to see next year's. 

Because these costs won't be known until the end of 

this year or early next year as to what these actual costs 

are because of AS 5. There will be a lot of other 

information available that we'll be able to look at. 

CHAIRMAN COX: Thank you for that. One of the 

concerns that we've heard repeatedly over the past years 

relates to management feeling that it's constrained by the 

auditor in the development and execution of their own 

evaluation of internal control over financial reporting under 

404(a). 

What is different about AS 5, as it's finally 

before us, that provides us comfort that that problem has 

been fixed? 

MS. PALMROSE: Let me start off, and others can 

jump in here. First of all, there's a big change. AS 2 had 

what was known as the 40s paragraphs, which, essentially, 

required that the auditor evaluate management's process. 

Those are no longer in the standard. So there is no 

requirement in the standard for the auditor to explicitly 

evaluate management's process. 
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Second of all, there was no interpretive guidance 

for management. In other words, management actually looked 

to the auditing standard for guidance on doing their 

evaluation, and that's, of course, now changed with the 

guidance that we have provided for management. 

Again, it's important to recognize we've worked to 

align that so it will work together with the auditing 

standard. So management can look to our rules for guidance, 

and the auditors can look to the auditing standard. 

Management does not have to look to the auditing standard. 

Third of all, the auditor's report that I talked 

about briefly in my opening remarks we're down to one 

opinion, which makes sense, and that opinion is on the 

effectiveness of ICFR. 

So there's no notion because of the auditor's 

second opinion that that would equate to evaluating 

management's process. 

So all three of those are very helpful in 

responding in just big ways to this concern that management 

was constrained through their evaluation. 

MR. WHITE: I kind of like to say it the short way, 

that no longer does management have to follow the audit 

standard, but instead the auditors have to adjust their 

procedures to follow what management does. 

MS. PALMROSE: But let me just reinforce they are 
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aligned so that they can work effectively and efficiently 

together. 

CHAIRMAN COX: Well, that's good news. I just have 

one final question. I'm sorry. Do you have further comment, 

John, on that? 

MR. WHITE: No. 

CHAIRMAN COX: Okay. Just one final question about 

the range of comments that we received on AS 5. If you want 

to characterize the types of comments we received and in 

particular the comments that were received on significant 

deficiency and how we addressed those comments. 

MS. PALMROSE: I can start out, and others can 

chime in. I think it's important to recognize, first of all, 

we very much appreciate, we understand how time-consuming it 

is to write us, and we've asked for comment in a number of 

ways a number of times. 

But notice that the number of comments is much 

lower to AS 5 that was exposed for comment in June than it 

has been before. So it's less than a fourth of the people in 

terms of number. 

More importantly -- which provides some inferences 

that the larger marketplace is very happy with where it ended 

up, and also that's reinforced by the comment letters 

themselves. 

The comment letters are very supportive of this 
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standard and where it ended up, and that's also in terms of 

the "significant deficiency" definition, too. 

So there is contentment would maybe be the word I 

would choose with those standards and the proposed definition 

that will be in our rule as well as in AS 5. Overwhelming 

support I would characterize what we're hearing. 

MR. WHITE: The other thing, and I pointed it out 

earlier, we think it is a very good thing if nothing more 

than just good housekeeping that we now have the definition 

of "significant deficiency" and "material weakness" in our 

rules. 

We do, after all, ask CEOs and CFOs to certify with 

respect to those matters every quarter, and I think it's very 

nice to -- it's a good idea to have our own definitions there 

instead of having to look over at the auditing literature. 

CHAIRMAN COX: Well, thank you. I haven't any 

further questions. I just want to add since I thank the 

Office of the General Counsel, Office of the Chief Accountant 

and the Division of Corporation Finance but I didn't thank 

the people who run them, I want to thank particularly John 

White, Conrad Hewitt and Brian Cartwright for all of your 

work on this over a very long period of time. 

Since I haven't any further questions, it is up to 

Commissioner Atkins to carry the ball forward. 

COMMISSIONER ATKINS: Okay. Thank you very much, 
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Mr. Chairman. I, too, would like to commend the hard work of 

the Public Company Accounting Oversight Board and the staff 

here at the SEC and the Office of the Chief Accountant, 

Division of Corporation Finance and Office of Economic 

Analysis and the General Counsel's Office for all of your 

hard work. 

The audit standard that we're considering today is 

intended to enable auditors to conduct top-down audits that 

are focused on matters that they believe give rise to the 

greatest risk of material misstatements. 

Despite all of the public attention that's paid to 

other items on our agenda today, this matter is the most 

important that we consider today. I hope that today marks 

the start of a new phase of the life of Section 404 of the 

Sarbanes-Oxley Act. 

The infant years of Section 404 have been, to say 

the least, unpleasant. I had better caveat that. At least 

audit firms have been trumpeting record earnings. A couple 

months ago I ran across a full page advertisement by one of 

the Big 4 that boasted about, "five straight years of double 

digit growth." 

Now, this year, of course, just happens to be the 

fifth anniversary of the Sarbanes-Oxley Act. Implementation 

costs and efforts soared far above anyone's expectations. 

Accounting firms driven by pecuniary interest, a poorly 
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written rule and risk mitigation had every incentive to 

engage in make-work efforts. Managers and auditors engaged 

in check the box compliance exercises at direct cost to 

shareholders. 

Money and time spent on these exercises were 

diverted from other important areas. The magnitude of the 

troubles that arose under Audit Standard 2 made it clear to 

virtually everyone that mere modifications to the existing 

standard would not have been enough. A completely new 

approach was needed. 

As the old Chinese proverb says, rotten wood cannot 

be carved. I'm happy today to be able to vote for the 

replacement of Audit Standard 2 with Audit Standard 5. The 

old standard is not being laid to rest a day too soon. 

That said, we need to be cautious with respect to 

Audit Standard 5. Even under this less prescriptive leaner 

standard, success is not guaranteed. If this standard is 

implemented incorrectly, then we will not experience the 

clean break with the past that AS 5 is intended to bring to 

pass. 

Many commenters warned us that we and the PCAOB 

cannot simply sit back and relax now that AS 5 is in place. 

It's incumbent upon auditors to take the new guidance to 

heart. 

As part of this they will need to abandon the 
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notion that AS 5 governs management and instead allow 

management to follow the top-down risk-based approach that we 

set forth in the management guidance that we adopted last 

month. 

As the PCAOB itself has acknowledged, it must 

monitor the manner in which auditors implement the new 

standard. Likewise, the SEC, in fulfillment of its statutory 

responsibilities, must monitor how the PCAOB is overseeing 

the audit profession's implementation of AS 5. 

We need to be prepared to make changes if AS 5 

fails to deliver on its promises of reshaping internal 

control audits. 

Until we know whether AS 5 works, a further 

extension for non-accelerated filers I think is necessary. 

Let us give these small public companies an additional year 

to observe how their larger counterparts implement AS 5. 

I advocate not requiring them to file Section 404 

audit reports until they file financial statements for their 

fiscal year ending on or after December 15, 2009. Congress, 

of course, is considering delaying all internal control 

reviews. 

In the interim, I'm also looking forward to seeing 

the guidance that the PCAOB develops for audits of smaller 

companies, as we discussed earlier. I hope that this will go 

a long way towards addressing some of the concerns that small 
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companies raised about the standard. 

We're also considering, of course, the "significant 

deficiency" definition that's before us today, and I'm happy 

to support it as well. It's important both that we have a 

definition in our rules and that the definition matches the 

definition in Audit Standard 5. 

Significant deficiencies have been a continuing 

source of concern for me, but I hope that the new definition 

will help to alleviate those concerns. As the new definition 

appropriately acknowledges, a significant deficiency is less 

severe than a material weakness. 

Management and auditors are to concentrate their 

efforts on identifying material weaknesses. Accordingly, 

they should not scope or test for significant deficiencies. 

If attention is diverted to hunting for significant 

deficiencies, then internal control reviews will be derailed 

from their intended focus. 

It is in no one's interest, least of all the 

shareholders, who pay for internal control work, if 

management and auditors get tripped up in trying to identify 

issues that are not material. 

I approve also of the definition's pragmatic 

consideration of whether deficiencies are "important" enough 

to merit attention by those responsible for oversight of a 

registrant's financial reporting. 
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We should be clear this standard is consistent with 

the definition of "reportable condition," which is very well 

understood in the accounting literature. 

As I mentioned, in connection with Audit Standard 

5, implementation will be of the utmost importance. Even a 

well-constructed definition would be meaningless if the 

implementation is not carried out properly. 

I just have a few questions for you. I know the 

hour is getting later. Paragraph 30 of AS 5 directs an 

auditor to ask himself "what could go wrong" within a given 

significant account or disclosure. 

What boundaries are there to this question to 

ensure that an auditor does not invite mountains out of 

molehills through a series of extrapolations of what could go 

wrong? After all, it was just this type of thought process 

that led to so many problems under AS 2. 

MS. PALMROSE: Let me answer that question. First 

of all, it's important to note where paragraph 30 appears. 

It's in the context of identifying significant accounts and 

relevant assertions. 

In other words, what it is directing is for the 

auditor to think about the likely sources of potential 

misstatements that would cause the financial statement to be 

materially misstated. So materiality, what matters, what's 

important, bounds that discussion. 
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And it asks the auditor to think about what might 

be the likely sources of potential misstatement, and that's 

the "what could go wrong." It's not intended for them to 

consider every possible risk regardless of how insignificant. 

Instead, it's really intended to help focus on what 

matters most and the risks that could result in a material 

misstatement, and, under a risk-based approach, obviously, 

this is the important question, so it is the essential 

question. 

I also should add there's also a subtlety here that 

this question is actually one of alignment between management 

guidance and AS 5. 

Management guidance does not require that -- our 

guidance for management does not require management identify 

significant accounts and relevant assertions. It's actually 

imbedded in the COSO framework, but our guidance doesn't say 

you must walk through that gate per se. 

We say focus on the risk of material misstatement 

to the financial statements, and one of the subtle linkages 

here between what the auditor and management is doing is we 

included "what could go wrong" as the question that 

management would want to think about, too, in identifying 

those financial reporting risks, the risks of material 

misstatement. 

So both the auditor and management, even if they 
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don't use quite the same process or approach, are asking the 

same fundamental question, and both are taking a risk-based 

approach. And that's what is demonstrated by that question. 

COMMISSIONER ATKINS: Okay. As we're talking about 

materiality, then, if you look just up from paragraph 30 up 

to the earlier one, paragraph 29, there it refers to the 

evaluation of qualitative and quantitative risk factors in 

identifying significant accounts and disclosures in their 

relevant assertions. 

To get back to the point of materiality, then, what 

sort of qualitative factors are we talking about here? 

MS. PALMROSE: That paragraph does provide some 

enumeration of what would be qualitative risk considerations 

Let me ask Brian to, sort of, jump in here. 

MR. CROTEAU: As Zoe-Vonna said, actually, I think 

they're really listed there as examples of things you would 

want to think about. 

Some of those are quantitative, and others are 

qualitative but making the point that clearly it's not just a 

quantitative analysis when considering significant accounts 

and that the auditors qualitative assessments can impact and, 

in fact, remove a significant account, if you will, or add a 

significant account. 

So we think that's important so that it's not just 

a quantitative analysis that's done in considering scoping. 
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MR. HEWITT: A good example of that would where the 

estimates, the broad estimates in the accounting records and 

transactions and they end up in the financial statements 

whether it be warranty reserves, or those types of things. 

And those are all qualitative and not quantitative in nature, 

and that's where the risk is. 

COMMISSIONER ATKINS: Right. But this is still 

bounded ultimately by materiality at the consolidated level 

as we talked about at the proposing? 

MS. PALMROSE: Yes. 

COMMISSIONER ATKINS: Okay. So of course, this, 

basically, comes to the crucial problem of materiality and 

how one is supposed to divine what that might be especially 

in a prospective sense. 

And that has been particularly thorny, of course, 

in the internal control context and throughout financial 

reporting that we struggle with enforcement cases, and 

everything else. 

So what steps are we taking to try to provide more 

clarity with respect to materiality in general? 

MS. PALMROSE: Let me just start off by saying that 

you're absolutely right. The issues around materiality are 

really over-arching with respect to the financial statement 

audit that bleed into the ICFR audit. 

So they're much broader issues here. So the staff 
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is cognizant of that, and we do have in process work to 

examine the issues surrounding materiality both interim 

materiality and materiality in general. 

So the staff is working that issue and would hope 

to have some recommendations going forward at some point. 

COMMISSIONER ATKINS: Great. I would encourage 

that, because the last time the Commission -- actually, it 

was the staff, I guess, that addressed that was now eight 

years ago. I think it's high time that the Commission itself 

consider that. 

So I would encourage the chairman and the staff to 

push this forward as fast as possible, because that is the 

thing that's eating away at a lot of these things that people 

have to deal with. 

I guess sort of a related point is what material 

weaknesses are about and how they are defined. In paragraphs 

69 and 70 of AS 5, they set forth indicators of material 

weakness. 

Now, are these indicators which include, for 

example, restatements, are they definitive evidence of 

material weakness? 

MS. PALMROSE: No. Again, notice one change 

between AS 2 and AS 5 is the term "strong" has been deleted. 

So they are indicators. And, in fact, the discussion around 

those both in the standard itself and in guidance, the 
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released text as well as in management guidance are that 

these are judgmentally determined. 

So they're based on the facts and circumstances, 

and these are just considerations. They are not 

determinative of a material weakness. 

I might just add that the empirical evidence seems 

to support that. In other words, if we look at the material 

weaknesses, we find that the percentage of those that are 

reflected or are in conjunction with a restatement have 

dropped off significantly. 

So it does appear that auditors and management and 

audit committees, issuers are sorting through this and 

understand that it is based on the facts and circumstances 

and a judgment determination. 

MR. CROTEAU: And I might just add to Zoe-Vonna's 

comment to note that there's discussion of this in the 

PCAOB's release and our release that makes these points clear 

or at least interpretive guidance. 

COMMISSIONER ATKINS: Okay. Good. Now, the 

definition of "material weakness" refers to interim financial 

statements. So I was wondering how do we square that with 

our emphasis on consolidated annual type outlook. 

MS. PALMROSE: We actually did receive two 

comments. As you say, it does include in the definition of 

"material weakness" interim financials. We only had two 
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comments on this issue. 

So it doesn't appear that it's cause for much 

concern. Again, part of the angst around -- I should mention 

that one of commenters said, please, for heaven's sakes, 

don't hold anything up over this issue, too. 

But let me just retrace my steps and say that our 

discussion around the issues with respect to materiality also 

relate to interim materiality, too. And the staff, again, is 

cognizant of that in the context of the broader project. So 

we understand that. 

Anyway, from the standpoint of the ICFR audit, it's 

clear that scoping is based on annual materiality 

considerations. It's clear from the audit standard. It's 

clear from the release text. It's clear from our management 

guidance. There appears to be no confusion around that. 

Now, "interim" is still in the definition, because 

we think that interim financial reporting is important to 

investors. And even though you don't scope around interim 

materiality, controls over interim financial reporting are, 

essentially, one aspect that has to be considered. 

So those controls are something that needs to be 

considered. And also, and maybe most importantly, even 

though you don't scope to find, if you identify a material 

weakness, those -- excuse me. 

If you identify a control deficiency, those 
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controls deficiencies need to be evaluated as to whether 

they'll have a material impact on the interim financial 

statements, and that's all that this is asking to do here. 

The staff believes that investors have a right to 

know whether the control deficiencies identified would have 

an impact on the interim financials, and it's a disclosure of 

that that's being asked for here. 

COMMISSIONER ATKINS: I just wanted to bring that 

nuance out, because I think that's an important one from the 

scoping perspective. But of course, Qs are important also, 

as we know, for investors as far as the information that's 

disclosed. 

The Biotechnology Industry Association objected to 

the removal of the definition of "small company" from AS 5 in 

our management guidance. Why was no objective definition 

included? 

MS. PALMROSE: Well, actually, in both management 

guidance and in AS 5 there's still a footnote that recognizes 

the work of the Small Business Advisory Committee. That work 

is important. We very much appreciate it, informs the 

process, and there is that acknowledgment. 

There's not a quantitative bright line that's 

specified that if you're on one side of it you're large and 

the other side that you're small. 

That's actually an impediment to scaling. In other 
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words, it wouldn't make sense for a company that had two 

companies, one just slightly over a bright line and one 

slightly under a bright line, but something different would 

happen to them. 

That's not the way the standard is written. This 

is written so it's scaled based on facts and circumstances 

for companies based on their size and complexity, and those 

have to be determined within the context of each company. 

Also, it would make no sense to have companies on 

the lower end of a bright line that had very different facts 

and circumstances and expect the auditor to treat them the 

same. So, essentially, the scaling is important here, and 

bright lines would be an impediment to that. 

That's not to say that it isn't important to 

recognize that smaller -- the notion of a smaller company in 

conjunction with the complexity, and that's what is 

acknowledged with the footnote. 

COMMISSIONER ATKINS: I agree generally with that. 

I just worry that auditors who might be free to exercise 

their judgment about whether scaling is appropriate might 

simply hide behind complexity and then refuse to scale audits 

of small companies. 

MS. PALMROSE: I mean, it's unlikely that that 

would be the case, again, because that goes back to a 

risk-based approach. You'd have to identify what's higher 
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risk. 

So it's within that context. And again, that's 

what makes the scaling work for everyone. 

COMMISSIONER ATKINS: I think, in general, I'm 

happy to support the adoption of AS 5. We might not be 

completely happy with it. 

I'm at least happy to put AS 2 out of its misery 

or, more importantly, out of the shareholders' misery of 

paying for it. The secret will be in the implementation and 

how we monitor that. So thank you very much. 

CHAIRMAN COX: Thank you. Commissioner Campos 

COMMISSIONER CAMPOS: Thank you, Chairman Cox. 

Well, it has taken a long time to get here, but we've finally 

arrived. As promised, today marks the culmination of a 

tremendous amount of hard work and determination on the part 

of many people here at the SEC and at the PCAOB. 

I won't go again and list the names, but I think 

all of you know who you are, and the chairman and your 

division directors have mentioned all of you. 

Generally, first, I want to congratulate the PCAOB 

and their staff for responding to public comments and for 

crafting this excellent standard. 

Second, I also want to thank the staff of our 

Office of Chief Accountant for all the efforts in the 

process. I know that the General Counsel, the Office of 
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Economic Analysis and other offices also participated. 

I know that AS 5 is the product of intensive hard 

work and tremendous cooperation on the part of the staff of 

the SEC and the PCAOB. The adoption of AS 5 is evidence that 

we and the PCAOB have developed a framework to work on 

complex accounting issues and to resolve them in a 

professional manner. 

I think it is an important milestone, and I think 

that we have overcome certain growing pains and that we have, 

hopefully, established a framework to deal with tough issues, 

good faith differences of opinion and still come out with a 

joint position on guidance and rule-making. 

At this point, the SEC and the PCAOB, it seems to 

me, have done everything that we promised. After granting 

numerous extensions over the years to companies, particularly 

non-accelerated filers, we and the PCAOB have finally adopted 

standards and guidance for both auditors and management that 

should promote more effective and more efficient audits of 

internal control over financial reporting. 

I'm confident that AS 5 and the management guidance 

will greatly help companies of all sizes but particularly 

smaller companies comply with Section 404 in a cost-effective 

manner that seeks to minimize the possibility of a material 

misstatement in the financial statements. 

AS 5, as has been noted, is rational, right-sized 
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and principles based, an approach that should enable auditors 

to properly scale the audit for smaller or less complex 

companies. 

I'm confident that once auditors and companies 

begin to comply with and implement the new standard costs 

will be rational and appropriate for smaller public 

companies. From this point forward, issuers should have 

nothing to fear from Section 404 of the Sarbanes-Oxley Act. 

Certainly, investors both domestic and foreign have 

always appreciated the protections offered by SOX 404. Now 

they will still have the protections offered by SOX 404, but 

they will also benefit by getting these protections in a more 

efficient and cost-effective manner. 

As I repeatedly emphasized, the rigorous disclosure 

regime in the United States which protects the recent 

protections offered by Sarbanes-Oxley is a great protector of 

capital and, in my view, attracts capital from all over the 

globe. 

Let me focus on a few discreet aspects of AS 5 that 

I think deserve mentioning. First, much has been made by 

making the standard more principles based and top-down 

focused. 

This is entirely appropriate and necessary, but we 

can't lose sight of the fact that the passage of the 

Sarbanes-Oxley Act was due, in large part, to the massive 
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financial frauds of a few years ago; that is, intentional 

fraud by senior management who managed to override internal 

controls. 

In this respect, I think and hope that AS 5 has 

done an even better job of trying to focus auditors on the 

risk of fraud. Specifically, I know that addressing the risk 

of fraud has been moved into the "Planning the Audit" section 

of the standard. 

The focus on fraud risk during the planning stage 

of the audit should put fraud risk in the minds of auditors 

from the very beginning of the process. 

I also think it's appropriate that AS 5 provides 

examples of controls that might address fraud risks. This, 

too, should focus auditors on the biggest risk of a massive 

financial misstatement. 

I'm also pleased with respect to the definitions of 

"material weakness" and "significant deficiency." I know 

that we specifically asked the question about material 

weaknesses when we voted to put AS 5 out for public comment. 

I note that a majority of commenters believe that 

the definition appropriately describes the deficiencies that 

should prevent the auditor from concluding that internal 

controls over financial reporting are effective. 

Further, it is entirely appropriate for the 

definition to reference interim financial statements. It 
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makes perfect sense to me that if auditors uncover a 

deficiency that poses a reasonable possibility of a material 

misstatement in a company's Form 10-Q that deficiency should 

be disclosed to investors. 

I also think AS 5 has done a much better job with 

respect to scaling the audit. In particular, I appreciate 

the fact that the standard emphasizes that scaling should be 

based on both size and complexity of the company. 

As AS 5 notes, "Even a larger, less complex company 

might achieve its control objectives differently than a more 

complex company." Notably, however, the notion of scaling 

the audit should not result in a less rigorous audit, nor 

does it exempt smaller or less complex companies from any of 

the principles set forth in AS 5. 

In general, what makes AS 5 an appropriate and 

consistent standard is that all of the parts seem to fit 

together in a way that, hopefully, will produce a more 

effective yet more efficient audit. 

It allows companies to scale the audit to eliminate 

unnecessary procedures and to use more principles based 

approaches. In this way, auditors should focus on what 

matters most. Instead of checking the box auditors should 

focus on the big picture. 

With that said, let me just ask a few questions. 

I've focused on fraud controls and the fact that auditors 
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must consider the risk of fraud when planning the audit. 

Zoe-Vonna, do you think that AS 5 has done enough to focus on 

the risk of fraud? 

MS. PALMROSE: Yes. Actually, this is one of the 

areas that is a change between the exposure draft and the 

final standard, and the board and staff have taken it very 

seriously and, as you said, have moved up the fraud 

discussion to the Planning section. 

So the optics around it are important, too. That's 

part of emphasizing its importance. And as you said, there 

are now some examples of anti-fraud controls. And then the 

third thing is that the standard does discuss the expectation 

that fraud would be an area of high risk, and thus the 

auditor's efforts would respond to that higher risk. 

And so all of those are important elements in 

bringing this focus on fraud to the forefront, and we're very 

supportive of that, yes. 

COMMISSIONER CAMPOS: Given the significance of the 

improvements from AS 2, both auditors and management 

hopefully are very anxious for the new standard to be 

implemented. How soon can auditors begin using AS 5? 

MS. PALMROSE: Well, actually, AS 5 is effective 

for years ending on or after November 15, 2007, but it's 

important to note that early adoption is encouraged by the 

PCAOB, and we very much support that. 
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We really encourage auditors to take advantage of 

this ability, and we've heard that a number of audit firms 

have already started updating and integrating AS 5 into their 

audit programs, their materials and their training. So it 

looks like that is happening. 

Maybe I could use this as an opportunity to just 

cover something that's a little bit more technical here, too, 

and that's that the Commission's amendment to Regulation SX 

related to the required auditors attestation report -- that's 

the auditor's opinion on the effectiveness on internal 

control -- we adopted that in May. And it will become 

effective on August 27, 2007. 

So companies can begin filing the new single ICFR 

opinions proscribed in accordance with AS 5 in timely filings 

received starting on August 27th. So this means that 

auditors can begin using AS 5 today and can actually report 

on it as long as the reports will be filed by their client on 

or after August 27th. 

COMMISSIONER CAMPOS: Do you expect that to happen? 

MS. PALMROSE: Yes. 

COMMISSIONER CAMPOS: There has been much talk in 

various circles about the potential need of the small 

business community to get yet another extension. 

Now, we all know that we have a year for the 

management guidance and the management assessment to be done 
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before the second year and the second stage of full 

implementation for the smaller accelerated filers. 

In your technical view, is that enough time? 

MR. WHITE: Why don't I start on that. 

COMMISSIONER CAMPOS: Sure. 

MR. WHITE: I won't give the technical accounting 

view. I'm a lawyer, as you know. 

COMMISSIONER CAMPOS: I won't hold that against 

you. 

MR. WHITE: You probably should, actually, but 

never mind. Just to, kind of, break up the two pieces of it, 

the management assessment, of course, is due next spring, in 

March for the end of this year. 

I think that at least listening to the advice of 

the accountants around me we are pretty confident that 

companies will be able to follow the new management guidance 

and comply with the requirement in that time frame. 

Zoe-Vonna went through a fair amount of detail of 

how we had designed this and scaled it for smaller companies. 

We talked a lot about this back in May, actually. 

And we were, obviously, thinking about at the time 

that this was in time and would work for smaller companies in 

terms of the management assessment that's due next March, the 

reports that are due next March. 

In terms of the extension -- so the answer is we do 
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not believe there are any extensions needed with respect to 

404(a), because I think we were, basically, giving that 

advice back in May. 

With respect to 404(b), in effect, that's more than 

a year and a half from now before those reports are due. We 

are, obviously, going to be monitoring how things are going 

with AS 5. As Zoe-Vonna just described, we anticipate that 

companies that are already subject to AS 5 will be complying 

with it I will just say this season. 

So we will have kind of a season in which companies 

can -- we will see how it's working with larger companies. 

This is not something that you necessarily have to address at 

this stage. This can wait, basically. It is not a current 

topic, I would say. 

MR. HEWITT: I would like to add some information 

on this point, because we're talking about micro cap 

companies, those with a floating market cap of under 75 

million. 

These companies operate in a completely different 

environment. Their internal control system environment is 

completely different than anything else. The auditors have 

to approach the audit in a different approach because of the 

size and characteristics of these micro cap companies. 

So we believe hopefully that this year, when they 

address their management assessment of their internal control 
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system that it will be very important if they do that, and 

they should do that. 

They should also do it next year, because I think 

they'll gain some benefit by doing it, which they have never 

focused on before, especially as it pertains to any internal 

controls which they may have within these very micro cap 

companies. 

Now, as AS 5 replaces AS 2, AS 2 was never 

scalable. It was a large portion testing standard that 

auditors converted into a percentage of assets and revenues. 

A very high percentage, almost 80 percent, had to be covered. 

Micro cap companies could not afford that type of an audit, 

and neither could a lot of small companies towards that lower 

end of the scale. So I think we really need later this year 

to see those smaller companies, say around $100 million of 

micro cap, to see how they are implementing AS 5. 

PCAOB really has to pay attention to these micro 

cap auditors. These are not the Big 4 auditing firms. The 

Big 4 auditing firms do a very small percentage of these 

micro cap companies. 

So you have a small CPA firm that's going to be 

auditing internal control systems. They do not have the 

training or the resources to get their people up to speed. 

But hopefully, they will be able to do the that by the end of 

this year. 
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And I would think that the external auditing firms 

of these micro cap companies will work with the management 

and their accounting and financial people to help guide them 

and to prepare them for an audit of their internal control 

system. 

Personally, I want to wait and see to the end of 

this year to see how PCAOB does with the small CPA firms and 

how well they're trained, how well they understand AS 5 and 

scalability and then how well the small micro cap companies 

implement their management assessment of the internal control 

system. 

MS. PALMROSE: Maybe I can just provide a little 

bit of a elaboration, too, to build on what Conrad has said. 

We've talked a bit about the project that the PCAOB is 

working on, on guidance for auditors of smaller companies, 

and that guidance will actually address the concerns that 

Conrad has raised in terms of auditing in a small company 

context. 

That guidance will be in place in plenty of time to 

meet the audit requirements for the filings in 2009. The 

other point that we've talked about that's in place -- so all 

the components will be in place in order to do the audit in 

the small company context. 

But there's something that we also haven't talked 

about that is a change from AS 2 to AS 5, and that's that AS 
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5 also focuses on an integrated audit. And this will be 

something that will be important in this context. 

In other words, evidence from the financial 

statement audit informs the ICFR audit. Evidence from the 

ICFR audit informs the financial statement audit. And this 

is particularly important -- I mean, it's important in all 

companies, but it's also very important in this context in 

that these audits have tended to be substantive audits in the 

past. 

And so there is now this mechanism that's explicit 

that's it's an integrated audit, and evidence from each 

informs the other. And so that should help the 

implementation of ICFR audits in this context, too. 

COMMISSIONER CAMPOS: Well, in the smaller company 

context, can't we conclude that many of these companies have 

far fewer internal controls than what we ran into with the 

larger companies? 

And if you envision that you have small internal 

staffs, whether it's one or two or even three, there aren't 

that many moving parts in terms of internal controls. It 

puzzles me why it should be so difficult to do everything 

that we, essentially, designed together with the PCAOB, with 

AS 5 and management guidance. 

MS. PALMROSE: Yes. I think that's an important 

point. We talk about non-accelerated filers, but there's 
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really a distribution here. It should not -- with management 

guidance and the auditing standard, it should not be that 

difficult. 

COMMISSIONER CAMPOS: Okay. I'm going to stop it 

here. I'd like to thank everyone on our staffs, the PCAOB 

for all this time and all this effort and all this dedication 

to get AS 5 right and, of course, before then our management 

guidance. And I'm very, very pleased to support the 

finalization of AS 5. 

CHAIRMAN COX: Thank you. Commissioner Nazareth. 

COMMISSIONER NAZARETH: Thank you. As others have 

expressed, I would like to thank the PCAOB and their staff as 

well as our staff in the Office of the Chief Accountant for 

bringing this much improved auditing standard to us today. 

I'd also like to thank the Division of Corporation 

Finance for their work along with OCA in crafting the 

proposed definition of "significant deficiency." And I'm 

happy to support approving the PCAOB's proposed AS 5 as well 

as the proposed definition. 

With these actions today, we will address the most 

problematic implementation issues concerns the Sarbanes-Oxley 

Act. It is indeed a credit to the hard work of all concerned 

that the comment letters strongly support the new Auditing 

Standard No. 5. I believe that it is a tremendous 

improvement over AS 2, which is currently in place. 
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To the extent that the recent comment letters 

raised issues concerning the standard, most, if not all, such 

issues had already been raised and considered by the PCAOB in 

the course of its comment process. 

I'm pleased to vote to replace AS 2 with AS 5, and 

I think that this new standard has the potential to result in 

lower cost than AS 2 while remaining consistent with investor 

protection. 

I'm also very pleased that AS 5 is aligned with the 

interpretive guidance that the Commission issued recently for 

management. Through the revised standard and our guidance 

management and auditors will be directed to focus on areas 

that matter most, including those that pose a high risk of 

fraud. 

Our staff has worked very closely with the PCAOB in 

our oversight role, and I think that the outcome here has 

been very productive. 

At an open meeting on April 4, 2007, the Commission 

provided our staff with direction to work with the PCAOB in 

four particular areas -- alignment of AS 5 with the 

Commission's management guidance, improving the discussion of 

scalability within the standard, clarifying the auditor's 

ability to exercise judgment and following a principles based 

approach to determining when and to what extent auditors can 

use the work of others. 
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I'm pleased that AS 5 responds to these concerns 

that we raised at that meeting, and I'm optimistic that our 

interpretive guidance and the PCAOB's AS 5 will provide a 

useful coordinated framework for both management and 

auditors. 

Included in AS 5 is a definition of "significant 

deficiency" that matches the definition the Commission 

recently published for public comment. The comments received 

strongly support that definition, and I'm pleased to support 

adopting that definition as well. 

The definition focuses squarely on matters that are 

important enough to merit attention by those responsible for 

oversight of the company's financial reporting. An important 

benefit of the proposed definition is the flexibility that it 

will provide to management and auditors to use their 

judgment. 

While I certainly agree with the criticism that the 

costs and burdens of implementing Section 404 of 

Sarbanes-Oxley have been far too high it is important to 

remember that there are real benefits to both companies and 

shareholders when issuers comply with Section 404, including 

management's renewed sense of ownership over controls, 

innovative ways to make controls more efficient, better 

financial reporting and disclosure and the detection of 

problems before they become more serious. 
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All of these benefits improve investor confidence 

and the integrity of our markets. By focusing on the areas 

of highest risk, we can best achieve meaningful investor 

protection without excessive costs. 

The combination of the new AS 5 and the definition 

of "significant deficiency" that we are considering today and 

the guidance for management that we have already published 

will serve these important goals. 

You've answered an awful lot of questions. I just 

have one area that I'd like to focus on, and it's one that 

others have expressed concern about, which is, obviously, the 

importance of implementation in achieving the goals that were 

intended by these important changes in AS 5. 

Can you give us a little more specificity on how 

you intend to monitor implementation and whether there are 

any particular metrics that you're thinking of utilizing, 

either our staff or the PCAOB, to assess the goals have been 

achieved with AS 5? 

MS. PALMROSE: We can talk about that in several 

ways. In terms of the specifics on whether the auditing 

standard is working, the inspection process clearly provides 

a very useful context to do that. 

COMMISSIONER NAZARETH: But again, even as to the 

inspection process are there particular things that we intend 

to look at as we inspect the inspection process? 
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MS. PALMROSE: Yes. Let me just step back for a 

second here and say that our inspection of the inspection 

process is at, sort of, an odd place from the standpoint of 

AS 5 in that what is currently being done doesn't cover AS 5. 

And so part of what we're doing here is also 

dialoguing with the PCAOB in terms of how they are 

implementing AS 5 through their inspection process going 

forward. So we're actually working in terms of our oversight 

with them on that. 

There's multiple component to the inspection 

process. One is somewhat historical, but what we learn from 

that historical also informs how we think about the 

inspection for efficiency going forward. 

And then there's an explicit component in terms of 

what they're doing going forward with AS 5, which has 

included the training that the Office of Chief Accountant is 

giving their inspection teams in terms of the standard 

itself. So that's one component. 

The study that the Commission has directed under 

the leadership of the Office of Economic Analysis is another 

component of that, and here we're not only cognizant of what 

has been done -- we want to be cognizant of what has and is 

being done by others including, as Conrad said, surveys and 

evidence that's gathered by others. 

And that's informing our, sort of, design here and 
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methodology going forward. And again, that involves data 

that is both publicly available and there may be other 

components to that. 

So that's what we're working on now. So it's a 

little premature to give actually a methodology and 

milestones on that. Then, again, working in terms of public 

speaking and outreach with the -- we actually work with the 

PCAOB and present as part of their forum. So those are 

scheduled. 

And we have a number of speaking engagements and 

outreach activities scheduled to help educate as well as 

listen to the implementation of both management guidance and 

AS 5 and then working explicitly as an observer on auditing 

in a small business context project. 

So that has relatively -- it's very important, but 

it has a relatively more recent time schedule. And 

hopefully, that will be out for exposure in the near future. 

MR. HEWITT: I might just add to that point on how 

we can assure ourselves that the implementation will be 

completed as it should be when AS 2 was never completed. 

For example, we'll be looking at the PCAOB's 

training manual and looking at their training program of 

their inspection teams to ensure that they stick to the 

concept of AS 5 in terms of scalability, in terms of 

principles based and not have items in their training program 
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that may relate to, say, significant deficiencies, which do 

not belong in there. 

So that will be our starting point. And as they 

perform their inspection and write their reports, we'll be 

looking in their reports and their working papers to see if 

there's something that does not jive with the intent of AS 5 

in terms of implementing that standard. 

So there will be a lot of work for us at the end of 

this year and next year in that regard to make sure that AS 5 

is being implemented properly. 

COMMISSIONER NAZARETH: Thank you. I think that's 

a good plan. Obviously, you've done a lot of thinking about 

it. It is, obviously, a very important part of this whole 

process in order to achieve the goals that were intended. 

Thank you. 

CHAIRMAN COX: Thank you. Commissioner Casey. 

COMMISSIONER CASEY: Thank you, Mr. Chairman. I 

also want to commend the staff for their extensive work on 

the significant deficiency rule change release and the AS 5 

audit standard release. And I also want to extend my 

gratitude to the board and staff of the PCAOB for their work 

as well. 

I believe that the SEC and PCAOB have made great 

strides in retooling the audit standard and aligning it with 

Management Guidance. 
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The Commission's consideration and anticipated 

adoption of AS 5 today is an important milestone in our 

efforts to achieve greater efficiency and cost savings under 

404, but it is certainly not the final chapter, and we cannot 

simply close the book, claim success and move on. 

We have made necessary changes. It is now 

incumbent upon us to ensure they are sufficient. Indeed, as 

everyone has worked thus far to undue the unnecessarily 

burdensome management and audit practices that have developed 

from 404 I think there is also a strong recognition that much 

work lies ahead to ensure these changes are implemented 

effectively and achieve their purported benefits. 

Our recent release of management guidance and 

today's anticipated release of the new audit standard for 

internal controls are designed to help undo much of the 

burdensome consequences of 404 compliance; namely, they 

should drop costs down and are targeted to give the most 

relief to smaller issuers. 

With the new guidance and standard, managements and 

auditors are empowered and encouraged to approach internal 

controls assessments and audits in a principled risk-based 

manner. 

Our efforts have been focused on changing existing 

incentives and behavior so that mechanical and unnecessary 

box checking becomes a thing of the past and rational 
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analysis by professionals and fiduciaries becomes the norm. 

If this change happens, we should see the worst of 

SOX 404 disappear and the best of it -- investor confidence 

in financial statements -- apply to all companies. As we 

have no doubt learned from our work in this area over the 

last year among some of the key contributors to the 404 

problems were the definition of "material weakness" and 

"significant deficiencies." 

I am hopefully that our recent guidance, today's 

"significant deficiency" rule change and the new audit 

standard fix these problems by focusing the audit on 

identifying material weaknesses and ensuring that audits are 

not scoped to look for all deficiencies however insignificant 

or immaterial. 

I have carefully reviewed comments about these 

definitions, and while no one can be sure it appears that 

those who most closely work with assessing the strength of 

internal controls believe that cost savings can be achieved 

but that in no event should these changes result in increased 

cost. 

Another key problem was the undue cost burden 

expected to be borne by smaller companies when they are 

required to comply with 404. We have received many comments 

on AS 5, and while most are favorable in this regard 

believing that the new standard allows sufficient flexibility 
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and risk-based judgment to scale audits to smaller companies 

several commenters remain concerned that scalability remains 

an unproven concept in the absence of clear definitions and 

guidance. 

Indeed, this remains a central challenge that runs 

throughout our management guidance and is embraced in AS 5, 

attempting to infuse greater judgment and flexibility through 

a principles-based approach and avoiding detail checklists or 

rigid guidelines to become the de facto rule. 

I believe there is great value in a 

principles-based approach and that we should resist returning 

to the prescriptiveness of the AS 2 approach despite the 

greater clarity that some commenters legitimately seek. 

That being said we must gain confidence that 

scalability works before subjecting smaller companies to the 

costs of 404 and most particularly the audit requirement 

under 404B. 

In the course of considering our efforts and the 

comments we have received on management guidance and on AS 5, 

I have become convinced that further delaying implementation 

of the 404 audit requirement at least for smaller companies 

is necessary and appropriate. 

Delaying the audit requirement would be the most 

deliberate approach to ensuring that scalability and 

alignment are met for smaller companies before requiring them 
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to bear the cost burdens of compliance. 

Such a delay will ensure that the Commission and 

the PCAOB will be able to monitor how larger companies are 

faring under the new standard before subjecting smaller 

companies to the specter of 404 that may or may not work for 

them. 

Indeed, it may not be possible to have a firm grasp 

on how the changes of both the guidance and AS 5 at least for 

larger issuers are affecting 404 implementation until summer 

of next year at the earliest. 

Many of the comments we have received have called 

for "field testing," active monitoring and examination before 

proceeding with at least the audit requirement for smaller 

companies. 

I believe these comments are consistent with how 

the Commission has suggested we intend to monitor 

implementation. The only question is what is a realistic 

time frame to do so. 

Accordingly, the Commission and PCAOB need to 

remain engaged with this process to help users of this new 

standard and our management guidance achieve the benefits 

that we seek, and we must remain nimble and responsive so 

that if we find that costs are not coming down and that the 

unnecessary burdens of 404 are not lifting we can discover 

the causes and provide a remedy. 
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This means that we must also be willing to consider 

further revisions to this or related audit standards and 

further guidance for management. Along those same lines we 

must develop a plan for monitoring implementation of 

management guidance and AS 5 so that we know whether we are 

achieving our goals. We should consider how we will measure 

success, when and how we should take those measurements. 

Likewise, we should be mindful of how we influence 

implementation of 404 through our inspections of the PCAOB 

and through our Examination, Compliance and Enforcement 

programs. 

We do no greater harm than to ask the management 

and auditors to use greater professional judgment and then 

undermine that request by second-guessing that judgment if it 

is reasonable. So I look forward very much to monitoring our 

work in this area. 

I would also note -- and actually, I have a 

question on this point that I'll direct, but I think it is 

worth noting that some commenters continue to believe that we 

have eliminated the wrong opinion and that in order to fix 

404 we should require management to conduct an assessment of 

its internal controls and require the auditors to review that 

assessment rather than perform an audit of internal controls 

themselves. 

These commenters argue it is the audit requirement 
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itself that imposes undue cost not necessary to ensuring an 

adequate internal control regime. I believe that the 

Commission has sought to faithfully interpret and implement 

congressional intent on 404, and our approach reflects that. 

Ultimately, only time will tell whether that 

opinion that we have eliminated will assist in driving costs 

down. I am hopeful that it will and committed to taking 

necessary steps to do so. 

So with that I would like to ask the question on 

getting to some of the comments regarding eliminating the 

wrong opinion. Can the staff respond to the rationale behind 

it and why we're confident that the approach that we're 

taking is the right one? 

MS. PALMROSE: Yes. Let me review some of the 

points I was trying to make in my opening remarks. This has 

been an issue that we've closely considered, and the PCAOB 

has, too. So there have been long and deep deliberations 

over this issue, and we're quite confident that we have 

selected the right opinion. 

First of all, I think everybody agrees that it 

makes no sense to have two and that that was contributing to 

the problems and ambiguity. In fact, I will confess I taught 

it wrong. So I was part of the problem, and it's nice to be 

part of the solution. 

But having said that, in all seriousness, we 
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believe that the report on the effectiveness of ICFR 

satisfies the requirements of the Act, is what's necessary 

from an investor protection standpoint for the auditors to 

reach an opinion about the management's assessment and that 

this serves important investor protection and that it also 

has the side benefit of making very clear that the auditor is 

not opining on management's process. So the auditor is not 

driving management's evaluation process. 

So it's a win/win from the standpoint of costs. 

It's a win/win from efficiency. It's a win/win from the 

standpoint of investor protection. 

MR. HEWITT: I'd just like to add to that it's very 

difficult to audit management's process as such. Every 

company management will have a different process in terms of 

trying to establish their internal control system, and to 

audit that is not important. 

What is important in the audit of internal controls 

is for the auditor to look and find the high-risk key 

internal control points within the system and test those 

controls to see that they're functioning properly. 

It has nothing to do with the process or 

evaluation. So that's why the opinion is as we think it 

should be so the focus is where it's important and what is 

not important. 

COMMISSIONER CASEY: As we monitor the 
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implementation, if we were to find that the cost savings and 

the efficiencies that we were expecting were not being 

achieved, would the staff make recommendations to the 

Commission on any changes that need to be made? 

And have we had discussions or have we spoken to 

the PCAOB about having that kind of openness and ensuring 

that the standard and the management guidance are working 

effectively? 

MS. PALMROSE: Well, at this stage, we're committed 

to going forward with the implementation and acquiring the 

evidence. So I don't think there has been any conclusion or 

prejudgment about what that evidence would be or how one 

would react to it. 

I mean, one really has to see the evidence before 

one comes up with proposals to respond to it, but we're very 

optimistic, as I said, that with the guidance and with AS 5 

that all the pieces are in place and we've rationalized this 

process. 

COMMISSIONER CASEY: One further question. Some of 

the commenters raised concerns with management guidance or 

for smaller companies understanding what's required under 

management guidance. Clearly, it's voluntary, and we provide 

a safe harbor if they follow it. 

There has been some discussion here about their 

ability to get input on how they should apply management 
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guidance and COSO also providing a framework. 

There has also been the notion of providing greater 

direction from the Commission or being able to be more 

responsive in providing answers to questions that they might 

have. There was some discussion about an ombudsman. 

What challenges should we give consideration to in 

providing additional guidance? 

MS. PALMROSE: Well, first, as you did say, in 

terms of more specificity about what an evaluation could 

consist of, COSO has actually provided that in the guidance 

that is available for small companies that came out I think 

it was last June or July. And so that is available, and that 

can be applied. 

The staff does take calls in OCA, so we actually 

are responding to any requests for additional information and 

insights. So far the only request we've got is where is it, 

and we were able to respond to those. So far we haven't had 

questions develop, but we certainly are prepared to respond. 

COMMISSIONER CASEY: Thank you very much. 

MR. WHITE: As I mentioned, the Office of Small 

Business in Corp Fin is working on this brochure that will at 

least provide kind of a guide, I guess you would say. But of 

course the real place to look is in management guidance 

itself. I mean, it was written in a plain English workable 

way so that you can --
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COMMISSIONER CASEY: Can you speak a little bit 

more about the guide again, about how it's going to work for 

smaller companies that you're drafting? 

MR. WHITE: It is, we hope, a plain English 

user-friendly document that will help a smaller company when 

they are confronting, I guess you would say, starting down 

the road of management guidance of what's out there and the 

steps they need to go through. 

As I mentioned earlier, this was actually, I think, 

a request of the chairman when he was testifying a few weeks 

ago on the Hill. We thought it was a great idea, and we've 

gone to work on it. I think we're going to be actually done 

with it pretty soon. 

COMMISSIONER CASEY: Great. Thank you. I have no 

additional questions. 

CHAIRMAN COX: Is there any other question or 

discussion? If not, we'll move to a vote on the two 

proposals. 

First, does the Commission vote to approve the 

Public Company Accounting Oversight Board's Auditing Standard 

No. 5 and related Independence Rule 3525 and conforming 

amendments? 

COMMISSIONER ATKINS: Aye. 

COMMISSIONER CASEY: Yes. 

COMMISSIONER CAMPOS: Yes. 
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COMMISSIONER NAZARETH: Yes. 

CHAIRMAN COX: And the item is approved. Second, 

does the Commission vote to amend Exchange Act Rule 12b-2 and 

Rule 1-02 of Regulation SX to define the term "significant 

deficiency"? 

COMMISSIONER ATKINS: Yes. 

COMMISSIONER CAMPOS: Yes. 

COMMISSIONER CASEY: Yes. 

COMMISSIONER NAZARETH: Yes. 

CHAIRMAN COX: And that matter stands approved. 

Thank you all once again for outstanding work, and I want to 

take this opportunity also to thank the chairman of the 

PCAOB, Mark Olson, the entire Board and their staff once 

again. This was very much a collaborative work over a long 

period of time, and I think we all have a lot to be proud of. 

(A brief recess was taken.) 

CHAIRMAN COX: The next item on today's agenda is a 

recommendation from the Office of the Chief Accountant and 

the Division of Corporation Finance that the Commission issue 

a Concept Release. 

The purpose of the Concept Release would be to 

obtain information about the public's interest in allowing 

U.S. issuers, including investment companies, to prepare 

their financial statements in accordance with International 

Financial Reporting Standards as published in English by the 
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International Accounting Standards Board. 

U.S. issuers, of course, currently prepare their 

financial statements under U.S. Generally Accepted Accounting 

Principles. The Commission has long advocated for globally 

accepted accounting standards that are high quality, 

comprehensive and rigorously applied. 

As issuers and investors increasingly look beyond 

our borders for opportunities to invest and raise capital 

it's critical that the financial information they use to make 

their decisions be accurate and timely. 

Among the obstacles that must be overcome in making 

investment decisions are the different ways in which 

financial information can be reported. Often the differences 

are due simply to the fact that the issuers are located in 

different countries. 

That's why virtually everyone -- issuers, investors 

and stakeholders alike -- agrees that the world's capital 

markets would benefit from the widespread acceptance and use 

of high-quality global accounting standards. 

Global accounting standards benefit investors by 

allowing better comparisons among investment options and 

increased access to foreign investment opportunities. They 

reduce costs for issuers who no longer have to incur the 

expense of preparing financial statements using different 

sets of accounting standards. 
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And lower costs facilitate cross-border capital 

formation as well as benefit shareholders who ultimately bear 

the burden of the entire cost of the financial reporting 

system. 

Five years ago with the Commission's express 

support the Financial Accounting Standards Board and the 

International Accounting Standards Board formalized their 

commitment to the convergence of U.S. and international 

accounting standards. 

More than two years ago we endorsed a roadmap that 

will commit us to eliminating the U.S. GAAP reconciliation 

requirement for foreign private issuers with the result that 

eligible firms listing on U.S. exchanges could choose whether 

to report under IFRS or U.S. GAAP. 

Once the U.S. GAAP reconciliation requirement is 

eliminated, if an issuer chose IFRS, it wouldn't be required 

to reconcile the differences with U.S. GAAP just as today 

issuers reporting under U.S. GAAP are not required to 

reconcile the differences with IFRS. 

In supporting convergence between IFRS and U.S. 

GAAP, the Commission has recognized that progress could 

result in IFRS and U.S. GAAP co-existing and even freely 

competing in U.S. capital markets. 

This commitment to convergence has meant that 

issuers, markets and investors will some day have a choice, 
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because they, not the government, will decide between IFRS 

and U.S. GAAP. It has also meant that the SEC was seriously 

contemplating a system in which both foreign and domestic 

issuers would someday have that choice. 

In March, the Commission held a roundtable on IFRS 

to assess the impact of the co-existence of two sets of 

accounting standards on the U.S. markets, on the decisions 

that investors make and on the Commission's program of 

investor protection. 

We heard from key participants in the 

capital-raising process -- issuers, accountants, investors, 

credit rating agencies, investment bankers and, of course, 

lawyers -- on whether the benefits of eliminating the U.S. 

GAAP reconciliation requirement for foreign private issuers 

are, in fact, achievable in practice, and their responses 

were resoundingly positive. 

Today, nearly 100 countries require or allow the 

use of International Financial Reporting Standards. Since 

2005, when the European Union mandated the use of IFRS for 

public companies in all of its member states, the Commission 

has received a significant volume of financial statement 

filings using IFRS from foreign private issuers. 

Likewise, U.S. investors, analysts and others who 

rely on these issuers' financial statements are becoming 

increasingly familiar with IFRS. 
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In light of these developments and our roundtable, 

the Commission last month proposed to eliminate the 

requirement that foreign private issuers who submit financial 

statements prepared using IFRS also submit a reconciliation 

of those financial statements to U.S. GAAP. 

This proposal, if adopted, would result in the 

co-existence of two different sets of accounting standards in 

the U.S. capital markets. 

This morning we're considering publishing a staff 

Concept Release that solicits public comment on the future 

role of IFRS in U.S. markets and asks whether U.S. issuers 

should be permitted to use IFRS for purposes of complying 

with our rules and regulations. 

In some respects, this is a mirror image of 

allowing foreign private issuers to file IFRS financial 

statements without reconciling their financial statements to 

U.S. GAAP, because it would give U.S. issuers the same choice 

that foreign private issuers would have. 

This concept would also touch potentially every 

aspect of the U.S. capital markets from how U.S. accountants 

are educated and trained to how U.S. issuers prepare their 

financial statements, to how U.S. investors understand 

financial statements and to how accounting standards are 

developed and interpreted to apply to U.S. companies. 

The purpose, then, of this concept release is to 
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solicit views from a broad range of investors, issuers and 

other market participants on the benefits and the costs and 

the advantages and the disadvantages of allowing U.S. issuers 

to report using IFRS. 

This public feedback will be enormously valuable to 

the Commission. In addition, many countries have already 

made the change from their home country GAAP to IFRS, and we 

would be particularly interested in hearing from issuers and 

regulators and other affected parties in these jurisdictions 

to understand and learn from their experience. 

Before I recognize Conrad Hewitt and John White to 

lead the discussion of the staff's recommendation for 

soliciting that feedback through the proposed concept release 

I want to thank the staffs of the Office of the Chief 

Accountant and of the Division of Corporation Finance for 

your excellent work, in particular, Julie Erhardt, Jim 

Kroeker, Katrina Kimpel, Joe Ucuzoglu, Jeff Ellis, Stephen 

Brown, Mark Barton, Craig Olinger, Paul Dudek, Michael Coco 

and Sondra Stokes. 

I also want to thank Ethiopis Tafara and Sarah Otte 

from the Office of International Affairs, Richard Sennett 

from the Division of Investment Management and David 

Fredrickson and Zachary May from the Office of the General 

Counsel. 

So now I will turn it over to Conrad Hewitt and 
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John White. 

MR. HEWITT: Thank you, Chairman Cox and members of 

the Commission. It is truly amazing for an accountant that 

has been in the business for as long as I have to present to 

you today a proposed concept release to allow U.S. issuers to 

prepare their financial statements in accordance with IFRS 

instead of U.S. GAAP. 

When I began my career, it was a big deal during 

the course of any international work just to communicate with 

or visit others around the world. There was no thought of 

there being a practical way to work with the same set of 

accounting standards across borders. 

I am pleased that not only are we considering it, 

but many others are as well throughout the world. I realize 

this is the case only by virtue of the work you cited of both 

the Commission and many other parties over the years. 

All of these efforts have put me in a position 

where I, as Chief Accountant, think that it's appropriate at 

this time to recommend that the Commission ask investors, 

issuers, auditors and other market participants to help the 

Commission's exploration work by providing their views on the 

possibility of an IFRS option for use by U.S. issuers in 

preparing their financial statements for the purpose of 

complying with the rules and regulations of the Commission. 

The draft Concept Release that you have before you 
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is the document by which I recommend that the Commission seek 

this input over approximately the next 90 days. 

Please let me emphasize that I see this Concept 

Release as just that, an information-seeking document, and it 

does not conclude that U.S. issuers should be permitted to 

report under IFRS much less provide a timeline. 

Rather, among other things, the Concept Release 

describes and asks several questions about, A, the 

convergence work that has been underway for the past five 

years to align the content of IFRS and U.S. GAAP; 

B, the appropriateness of exploring the possibility 

for U.S. issuers to have that option to report under IFRS 

while the convergence work continues and; 

C, lastly, the effects on the obvious parties, 

investors and issuers, but also on other parties such as 

educators, auditors, specialists such as actuaries, 

regulators that are not security regulators and other market 

participants whose work would be impacted by implementing 

such an IFRS option. 

It does not take very long in thinking about each 

of these aspects of this policy matter for many questions to 

come to mind since the U.S. capital markets have not 

previously experienced the wide use of two different sets of 

accounting standards by issuers. 

The Concept Release would pose all those questions, 
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and I am sure commenters will let us know if we forgot one or 

two. 

Now, before I turn it over to John White, Director 

of the Division of Corporation Finance, I certainly want to 

express my thanks to all the members of our staff who have 

worked hard to think about these matters and prepare this 

Concept Release. 

And I would like to especially mention to my left 

here Rick Sennett, Chief Accountant for the Division of 

Investment Management who is here with me at the table, for 

the contributions of his group with respect to working to 

make this Concept Release inclusive of the interests of the 

possible use of IFRS by investment companies. 

I will now turn it over to John. 

MR. WHITE: Thank you, Conrad. Good afternoon, 

Chairman Cox, Commissioners. As Conrad discussed, the 

purpose of this Concept Release is to raise a series of 

questions to solicit public input on the possibility of 

allowing U.S. issuers to present their financial statements 

prepared in accordance with IFRS as published by the IASB 

instead of in U.S. GAAP in their filings with the Commission. 

Last month we were before you, and the Commission 

approved a proposal that we made for providing for specific 

rule changes which would allow foreign private issuers to 

present in their filings with the Commission financial 
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statements prepared in accordance with IFRS without 

reconciling those financial statements to U.S. GAAP. 

That proposal was a critical and dramatic step 

towards the regulatory framework that we're looking out 

towards of a single set of high-quality comprehensive global 

accounting standards. 

And as I guess I've said many times, consistent and 

faithfully applied comprehensive global accounting standards 

will provide investors with an enhanced ability to compare 

companies and will serve to improve confidence in our 

markets. 

So, all of this that I've described was the primary 

focus of a staff roundtable on IFRS that we held last March 

where I think most of us that are here today were at that 

roundtable. 

What we're presenting to you today in the form of a 

Concept Release is, I think it's really fair to say, is an 

even more dramatic step than what you did last month, because 

last month what you did related to certain foreign private 

issuers. 

Today we are talking about the possible choice to 

use IFRS by any U.S. issuer. We're talking about tenfold the 

number of companies that this would be available to. 

If the Commission were to provide U.S. issuers with 

a choice to include financial statements prepared in 
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accordance with either U.S. GAAP or IFRS, issuers would need 

to carefully consider that choice. 

We recognize that not all U.S. issuers would choose 

to use IFRS. Some, including those that do not have a 

significant customer base or operations outside the United 

States, would likely continue to present their financial 

statements prepared in accordance with U.S. GAAP in their 

filings with us. 

I think many of those companies are likely to be 

the smaller companies that would continue to stay with U.S. 

GAAP. 

We recognize that providing U.S. issuers with this 

choice would allow them to use one of two different sets of 

accounting standards, and while this is a necessary step 

along the road to global accounting standards, it does mean 

that we would have two sets of accounting standards out there 

that would have equal standing, that would be co-existing in 

our capital markets. 

Now, we recognize that this ability to use IFRS 

could benefit U.S. issuers in our ever increasing global 

capital marketplace, but we also recognize that investors and 

other market participants would need to understand and work 

with both IFRS and U.S. GAAP while comparing U.S. issuers, 

particularly since we expect many U.S. issuers would 

continue, as I said, to elect to stay with U.S. GAAP. 
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We need public input and believe this is the 

appropriate time to go out and seek that input, and that is 

why we're recommending this Concept Release to you. 

We're very interested in all of the views on the 

questions that we pose and, as Conrad alluded to, there are a 

lot of questions in this release, particularly, or including, 

I guess I would say, the questions related to when any 

potential change in reporting requirements might occur and 

how that should be implemented. So I think this is just a 

very exciting time to see this release and to get it out 

there to start the dialogue. 

Finally, in closing, I'd like to echo the 

Chairman's and Conrad's recognition of the staff's work in 

preparing the release. I guess I at this time need to go 

through the names myself, so I guess I will. 

I want to individually recognize again in the 

Office of Chief Accountant Julie Erhardt, Katrina Kimpel, 

Gina Evan, Jim Kroeker and now I have the benefit of calling 

him by how all of us refer to him, Joe U. I stumble less 

with Joe U. 

And in the Division of Corporation Finance, Craig 

Olinger, Sondra Stokes, Paul Dudek and Michael Coco and of 

course Rick Sennett in IM all for their invaluable 

contributions and I guess I would even say for their global 

vision in presenting this matter to you. 
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I guess I'd actually have to say that almost every 

one of the people that I've named has spent a lot of personal 

time with me teaching this topic to me and helping me 

understand it, and I really want to say thank you to everyone 

who has helped me with this process. 

With that I'll turn it over to Katrina. 

MS. KIMPEL: Thank you. The Office of the Chief 

Accountant and the Division of Corporation Finance recommend 

that you publish for public comment a Concept Release to 

elicit the public's interest in allowing U.S. issuers to 

prepare financial statements in accordance with International 

Financial Reporting Standards as published by the 

International Accounting Standards Board for purposes of 

complying with the rules and regulations of the Commission. 

The purpose of the Concept Release is to seek 

information about the potential effects that any such change 

may have on investors, issuers and market participants as 

well as the accounting profession generally. 

The Concept Release describes the Commission's past 

consideration with respect to reducing disparity between the 

accounting and disclosure practices of the United States and 

other countries as a means to facilitate cross-border capital 

formation while providing adequate disclosure for the 

protection of investors and the promotion of fair, orderly 

and efficient markets. 
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Accounting standard-setters have been encouraged to 

do the same as demonstrated by the Financial Accounting 

Standards Board and the IASB being committed for the last 

several years to the convergence of U.S. GAAP and IFRS. 

The Concept Release includes questions about 

whether the Commission should allow U.S. issuers, including 

investment companies, to prepare financial statements in 

accordance with IFRS as published by the IASB, including the 

anticipated effects on the U.S. public capital market of 

doing so and not doing so. 

If the Commission were to allow U.S. issuers to 

file financial statements prepared using either IFRS as 

published by the IASB or U.S. GAAP there would be 

implementation matters. For example, the Concept Release 

includes questions about the need for education in IFRS for 

financial statement users. 

We also are interested in the issues that would be 

encountered by U.S. issuers and their auditors in the 

application of IFRS in practice and existing Commission 

requirements. 

Additionally, we are interested in what issuers 

believe the cost of converting from U.S. GAAP to IFRS would 

be. We are recommending that this Concept Release be open to 

public comment for a period of 90 days after its publication 

in the Federal Register. 
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Thank you, and we are prepared to answer any 

questions that you may have. 

CHAIRMAN COX: Thank you very much. And thank you 

especially, Joe Ucuzoglu. I can say it often and proudly. 

MR. WHITE: I've never been able to say it. 

CHAIRMAN COX: Thank you, Katrina. Thanks to 

everyone who presented. Let me just start by jumping on a 

point that you began to discuss about who might be interested 

in a voluntary system in electing the use of IFRS. 

For most of America's public companies, 

particularly smaller public companies, almost any change in 

regulation is viewed as a cost. They're not leaping to move 

from Windows XP to Vista, and I don't imagine them all lining 

up to be early adopters to completely change over their 

entire accounting system. 

So why would any mid-cap or small cap company 

volunteer to use IFRS? And to put it the other way, will any 

U.S. issuers want to prepare their financial statements in 

accordance with IFRS, and why? 

MR. WHITE: Why don't I at least start with some of 

my experiences at least. And I guess I will have to say that 

companies that have talked to me have been largely the large 

multinational companies, and there seems to be a great deal 

of interest among them in this possibility. 

The two reasons that they cite are that they 
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believe it will be a lower cost and lower burden in preparing 

their financial statements because they're already following 

IFRS in their foreign operations, their foreign subsidiaries 

and that they think it will be much more efficient for them 

to be able to just prepare their financials in one standard. 

The other obvious benefit is in terms of access to 

capital. If other companies in their industry are also 

reporting in IFRS, then they may well want to be able to 

report in the same method, basically, as their competitors. 

And so particularly if they're competing internationally, at 

least listening to the larger companies they would like that 

benefit. 

I can't say I really heard it from the smaller 

companies. At least in my experience, they have not been at 

our door in the same way. Conrad, and Julie, you may have 

talked to smaller companies as well. 

MR. HEWITT: And I'll just add on to what John has 

said. We do know there is large multi-global U.S. companies 

that have adopted IFRS throughout the world because it's 

easier to consolidate their financial statements monthly and 

quarterly and annually. 

And it would make a lot of sense for those 

companies to certainly look at this option and adopt it if 

they're using it worldwide already and not in the U.S. In 

essence, they're maintaining two sets of very expensive 
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accounting records. 

Moving on down the chain to the mid-caps and small 

companies there's a large number of them that operate 

throughout the world and have operations and divisions and 

subsidiaries and plants, and so forth. 

These are not just sales offices, but these 

companies will have a more difficult time to move to this 

option, because you have to have a CFO, you need a 

controller, you need accounting staff in the U.S. that 

understands IFRS and how to apply them. And that does not 

exist today. 

So it will take a while for those companies, and 

these companies, by the way, are using U.S. GAAP throughout 

the world as much as they can get by with. They'll be 

required by statutory -- requirements of audit companies to 

provide statutory audits, but they're still using U.S. GAAP 

worldwide. 

CHAIRMAN COX: On the subject of two systems 

co-existing, which would be a prospect of a voluntary choice 

between one or the other systems, isn't it essentially the 

case we've already got that? 

Once we lift the reconciliation requirement you've 

got every foreign private issuer with the choice, and we can 

imagine what that choice will be for foreign issuers, to use 

either IFRS or U.S. GAAP. 
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They file with us their financial statements that 

investors get to consume are prepared using IFRS. So 

investors and analysts and we are already in the position of 

looking at both operating already in our markets; isn't that 

right? 

MR. HEWITT: That's very true. IFRS is becoming 

very popular throughout the world. Right now there is over 

100 countries that have adopted IASB standards, and there's 

more moving towards that direction. 

We know Canada is moving towards that direction. 

We met with them last month on this subject. Korea, which 

their GAAP is very similar to our U.S. GAAP, they have told 

us that they are moving to IFRS. 

So the analysts and investors here in the U.S. and 

throughout the world are becoming more and more accustomed 

and understand IFRS as being used in the financial statement 

reporting process. 

And that's important, because I think it will 

be -- it's already widely accepted, as you say, and I think 

it will be easy for the more sophisticated investors to 

accept IFRS financial statements. Maybe the retail 

investors, the small ones who never understand U.S. GAAP 

anyway because it's so complicated in certain areas, won't 

care. 

So I think it's here, and there will be some -- it 
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will take a while for everybody to get used to these types of 

standards in the U.S. 

MS. ERHARDT: I was just going to add I think the 

point of your question is, in essence, what brings us here 

today, which is if we, the staff, did nothing about U.S. 

issuers using IFRS, in substance, doing nothing is doing 

something, and it's precluding the use. 

And as a result, if the proposal goes forward for 

foreign issuers, we are indeed having a dividing line in our 

market where the two GAAPs co-exist based on country of 

incorporation outside the U.S., and they don't co-exist for 

U.S. issuers. 

So really, I think what's behind the staff's 

thinking is by doing nothing you're making that dividing 

line, and how do we know that dividing line is the right one? 

How do we know that the co-existence dividing line should be 

foreign choice, U.S. not? 

So we don't know, and so this Concept Release, in 

essence, elicits comment to say maybe that doesn't make 

sense. Maybe it does, but we'd like to know. As opposed to 

just continuing business as usual and by default having that 

dividing line. 

CHAIRMAN COX: If the dividing line is as you 

describe, a choice of accounting systems based on your 

jurisdiction of incorporation and that would be the regime 
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administered in the United States, might that, in fact, not 

be an incentive for people to pick up and reincorporate, 

leave America and come back as a foreign company? 

MS. ERHARDT: Yes, and hence we're here today to 

solicit input. 

CHAIRMAN COX: Just one last question. We recently 

announced the creation of a committee on improvements to 

financial reporting. Are they going to look at some of these 

questions, too? 

MR. HEWITT: Yes. There will be, basically, five 

segments that they'll be looking at, the five working groups. 

And one of them is on the international convergence, and is 

that model better than some of the the models that we're 

using in the U.S. 

They will have an observer present from IASB. 

They've already named that observer. We're hoping that what 

we do in this improvement to the financial reporting process 

that they'll take it back and also do the same thing over in 

Europe. 

CHAIRMAN COX: Thank you. I don't have any further 

questions. Commissioner Atkins. 

COMMISSIONER ATKINS: Thank you, Mr. Chairman. 

Just over a month ago we voted to propose that foreign 

private issuers be permitted to file their financial 

statements with us using IFRS without reconciling to U.S. 
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GAAP. 

At that meeting, I asked Julie Erhardt when we 

would see a Concept Release on whether U.S. issuers should be 

able to file their financial statements using IFRS. Julie 

promised to turn to that task as soon as possible, and so 

here we are. That's great. 

I congratulate you, Julie and Katrina Kimpel, Craig 

Olinger, Sondra Stokes and others who have worked so hard to 

make it possible for us to consider this release today. 

Once we start down the road of considering whether 

foreign private issuers can file in IFRS without 

reconciliation, the natural question, as you were just 

talking about, arises of whether U.S. issuers should be able 

to do the same. 

Some have even taken it one step further and 

suggested that we mandate the use of IFRS by U.S. issuers. 

Indeed, one of the panelists at our IFRS roundtable last 

March suggested just that, a former chief accountant. 

As more and more countries switch to IFRS the 

pressure is likely to build on the U.S. to do the same or, at 

a minimum, to permit it as an alternative. If IFRS becomes 

the dominant standard, it may not be in our best interests to 

try to swim against the tide. 

Of course, if IFRS is not applied consistently 

across the countries in which it's adopted, there will be 
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less of an appetite here for moving to such a standard. 

Before taking any definitive steps, however, I 

think it's important to look at all of the considerations 

that apply uniquely to U.S. companies. We also must 

thoroughly consider the direct and indirect costs of opening 

the door to the use of IFRS by U.S. issuers. 

The comments that we receive in response to our 

Concept Release will assist us in determining whether to go 

forward and, if so, how and when to do so. 

We also will gain useful information by observing 

how IFRS is used in practice and by participating in 

international efforts to achieve consistency. 

So I look forward to hearing from a wide range of 

commenters in response to the many questions in the Concept 

Release. One thing I should note is that input from the 

Office of Economic Analysis will be important as we decide 

how to proceed. 

We will not have the benefit, unfortunately, of 

Chester Spatt's insights. Today marks Chester's final open 

meeting. So thank you, Chester, for all of your 

contributions to the work of the SEC during your tenure here. 

I just have a few questions. One, are there 

certain types of U.S. companies for which you believe there 

to be particular pressure to shift to IFRS? 

MR. HEWITT: I'll go ahead. John mentioned a 
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couple items on that point. Yes. There are particular 

industries, such as the financial institution industry, where 

IFRS is very prevalent throughout the world. 

U.S. large banks like J.P. Morgan, investment 

companies will agree to have to look at it and say, you know, 

"The rest of our competitors are using it, and it's difficult 

not for us to use it and be competitive in the capital 

markets throughout the world." So those types of companies 

certainly. 

And then, as I said before, the large multi-global 

companies are using it now throughout the world and not in 

the U.S., but they definitely would want to consider it. 

COMMISSIONER ATKINS: Are there any industries or 

sub-industries where you think it's already a competitive 

issue for us, or is it too new? 

MR. WHITE: I thought it was mentioned at the 

roundtable that the airline industry was an industry that 

U.S. companies would be quite likely to migrate to IFRS. 

Were there other industries mentioned, Julie? That's the one 

I remember. 

MS. ERHARDT: No, not by name. But I think 

generically, think of any industries where maybe the larger 

players are domiciled outside the U.S. They would probably 

be the first to coalesce, if you will, because they're the 

furthest where the industry players would have moved along to 
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IFRS from other countries. 

Whereas, in industries where the larger players 

perhaps are more concentrated in the U.S., perhaps less of 

the industry has moved due to developments overseas, so maybe 

that would be a little slower to have an interest. 

MR. WHITE: One of the things that the securities 

analyst and the rating agency participant at the roundtable 

said was that in industries where they analyze in IFRS they 

take the U.S. GAAP numbers and, basically, convert them over 

to IFRS in their analysis, in any event, today or as best 

they can. Don't always have all the information you need. 

COMMISSIONER ATKINS: Right. One aspect of it, 

too, is to build competency here. So are U.S. universities 

starting to go down that line of teaching the differences 

between GAAP and IFRS? Obviously, discussions like this will 

help encourage that, I suppose. 

MR. HEWITT: No, they have not. I gave a speech at 

the University of Washington about two month ago, and I 

indicated that the international convergence, for example, is 

moving along, and it was going to be possible some day in the 

world there might be just one global standard-setter some day 

many years away. 

I urged them to start teaching IFRS in their 

classroom. One of the problems is there's not even a 

textbook as such yet. I'm sure they are being developed now, 
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but it takes a long time to get all this stuff moving. 

And then the final end of this whole process is in 

the U.S. here it has to be on our uniform CPA examination in 

the 50 states. There are no questions on the exam today 

concerning IFRS. 

COMMISSIONER ATKINS: Right. 

MR. HEWITT: There has to be in the future. 

MS. ERHARDT: I was just going to say on a 

practical level in two weeks Jim Kroeker and I are speaking 

before the annual meeting of all the accounting professors in 

the United States. So we will definitely cover this matter 

and encourage them. 

MR. WHITE: One group that I do think is moving 

forward are the large accounting firms. I mean, in 

discussions with them they are working quite hard on this. 

COMMISSIONER ATKINS: That's good. Okay. Thank 

you very much. 

CHAIRMAN COX: Thank you. Commissioner Campos. 

COMMISSIONER CAMPOS: Thank you. I'm also pleased 

to support the Concept Release. I'd like to thank the Office 

of Chief Accountant, the Division of Corporate Finance, the 

Office of International Affairs and all the individuals that 

are mentioned for all of their hard work. 

Obviously, this Concept Release follows on the 

heels of our release in which we propose to eliminate the 
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U.S. GAAP reconciliation requirement for foreign private 

issuers who file financial statements prepared in accordance 

with IFRS as published by the IASB. 

Given that we have proposed allowing foreign 

issuers to use IFRS without reconciliation this at least 

raises a question of whether we should also, to provide 

symmetry, allow U.S. issuers to also use IFRS. 

That said, I don't want to minimize the fact that 

allowing domestic U.S. issuers to use IFRS would be a very 

significant policy decision. There are many theoretical and 

practical issues that must be addressed before we actually 

take such a step. 

It does, however, seem appropriate to at least 

present the issue for public comment in such a Concept 

Release. 

Over the past few years there has been increased 

focus on the use of IFRS around the world and in particular 

in Europe. In just a few years, the Commission has seen a 

substantial increase in the number of filings containing 

financial statements prepared in accordance with IFRS from 

just a few in 2005 to over 100 in 2006. 

That said, it is not clear how much thought and 

attention issuers, investors and other interested parties in 

the United States have given IFRS. Indeed, even the 

Commission's recent proposal to allow foreign private issuers 
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to file financial statements prepared in accordance with IFRS 

without a reconciliation is tailored to the needs of foreign 

issuers. 

The importance of today's Concept Release, 

therefore, is that it seeks to highlight the use or the 

potential use of IFRS in the United States. As with the 

proposed release we issued last month, though, we need to 

make sure that there are no unintended consequences of our 

actions. 

For example, it is important that allowing U.S. 

issuers to use IFRS would not remove the incentive for 

convergence between IFRS and U.S. GAAP. As I stated 

previously, I hope that this would not occur because there 

are huge benefits for convergence. 

So it is imperative that we continue to be vigilant 

with respect to the ongoing IASB and FASB convergence project 

and ensure that it continues to move forward. 

Protection of U.S. investors is also paramount. We 

need to ensure that allowing U.S. issuers to prepare 

financial statements in accordance with IFRS serves this 

goal. There has been a great deal of talk about the fact 

that IFRS is more principles based as compared to U.S. GAAP, 

which is supposedly more rules based. 

While I think this is an over simplification, the 

critical issue is ensuring that accounting standards, be they 
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principle based or rule based, are specific enough to help 

guide conduct in a way that protects investors yet promotes 

and facilitates capital formation. 

In my opinion, at least some degree of specificity 

is required if one wants to hold people accountable for their 

actions. 

I have just a few questions. We've already 

proposed to eliminate the reconciliation requirement for 

foreign issuers, so presumably in one short year or so we 

will be tasked with evaluating the disclosures pursuant to 

IFRS by foreign issuers who are listed here in the U.S. and 

judge the reporting under IFRS. 

I take it that our agency is making arrangements to 

have expertise to do this and to understand whether 

enforcement -- hopefully, that's the very, very few 

situations -- is needed. Is that correct? 

MR. WHITE: Well, without speaking to the 

enforcement part, in terms of the internal efforts, I mean, 

we've already done that. 

We went through starting the summer of a year ago 

training, basically, I think everybody across OCA and across 

Corp Fin, I mean, all the accountants within the agency, 

because we started a really significant review process of all 

of the first-time IFRS filers where their 20-Fs came in a 

summer a year ago. 
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And that review project was, basically, completed 

in June, and there is actually posted on the web site -- I 

guess it came out after the meeting in June -- of a short, 

I'll call it a summary, report from OCA and Corp Fin laying 

out what we found in those reviews plus, by the way, links to 

all of the Comment Letter correspondence that has now been 

posted. 

We've had a lot of people working first trained and 

taught and spent a year on this project. We're, obviously, 

now, in some cases, looking at the second year of filings 

that have come in from these companies. 

We're probably well ahead of most everybody else. 

Is that fair to say, Julie, or not? 

MS. ERHARDT: Well, I'm not exactly sure who 

everybody else is. I can speak, perhaps, with respect to our 

interactions with securities regulators who have jobs like we 

have in other jurisdictions through IOSCO, the International 

Organization of Securities Commissions, which the Commission 

is a member. 

In particular, they have a subcommittee on 

Accounting and Auditing Disclosure which I happen to chair, 

and certainly through the meetings all over the world 

face-to-face, four-day meetings with our counterparts we 

certainly have a very good sense from those who are from 

jurisdictions that are further down the path in implementing 
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IFRS as to what they've been through, what issues they're 

facing, how they are handling them. 

So we sort of have an insider's view through our 

interaction with other regulators as to what's in store and 

where the rough spots might be. So that has certainly helped 

form the work that John described, and I envision those 

relationships and what we can take away and contribute to 

them will certainly guide our work going forward. 

MR. HEWITT: I just might add finally on that 

question that after the first round of filings that we've 

only had two real difficult issues of differences in 

understanding how they applied IFRS out of a couple 

hundred. 

And we have good experience in doing that, so I 

think we won't be doing anything differently when the U.S. 

firms and everybody else starts using IFRS. 

COMMISSIONER CAMPOS: Well, I'm sure investors will 

be very reassured that we are on top of our game and that we 

seem to have all of the experts in the U.S. on IFRS within 

the particular agency, seeing as no one else has really 

gotten to it. 

Let me ask another question, and that is that we've 

recently been asked or at least the question has been posed 

that the U.S. insisting, our agency insisting that IFRS in 

terms of foreign issuers be the IFRS that's issued or 
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promulgated by the IASB and not what may be adjusted by 

different jurisdictions such as the EU that by so requiring 

we are meddling in sovereign concerns. 

And I am wondering if that is an issue over time. 

What does it mean to domestic issuers in terms of what 

version of IFRS they will use? If they want to get the 

benefit of IFRS and they use the version that we find 

acceptable on our shores, which is what is being published by 

the IASB, but Europe has something different and has 

carve-outs and Australia has carve-outs and Asia has 

carve-outs, how are we going to reconcile that, and why is 

that an advantage? 

It seems like we will then have various versions of 

IFRS and possibly various versions of standards yet again. 

MR. WHITE: Well, we won't have various versions in 

the U.S. reporting, because foreign private issuers will be 

required to follow the IASB version, and U.S. issuers would 

be following the IASB version. So at least at that level you 

wouldn't have different standards. 

MS. ERHARDT: I think it's a little better than 

that in the sense that, to my knowledge, the countries that 

have moved to IFRS, while they may have carved out and 

created options locally, at the same time they have not 

precluded use of IFRS in the form issued by the IASB. 

So what we're proposing, which is to have issuers 
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prepare under IFRS as issued by the IASB, in essence, 

dovetails with the same type of approach other countries have 

gone, to allow it. 

The step that they've taken that you refer to is 

after some experience under their belt they've, for various 

reasons, found the need to make certain provisions optional 

but not preclude use of IFRS as published by the IASB. 

I have no way of knowing what those pressures are 

and if they have any analogy to what we experience in the 

U.S. and if we were to get to the point of accepting IFRS for 

U.S. issuers whether we might feel the same. That's a 

question I can't possibly predict. 

I think in pursuit of the idea that a company and 

their investors can work with one set of standards globally 

the same content, and, in essence, your financial statements 

can serve as a passport to various markets, and your 

investors will see the financial statements whether they buy 

your shares, you know, in London or in the U.S., that is 

coalescing, we think, around IFRS as published by the IASB. 

So the national versions, while they may serve 

national purposes, doesn't shut out the idea that the global 

passport would coalesce around the version that the IASB 

issues, and, in essence, that's the aspect of the policy 

matter that we're pursuing. 

COMMISSIONER CAMPOS: So we don't need to worry 
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about that? 

MS. ERHARDT: I'm not stressed. 

COMMISSIONER CAMPOS: Okay. I'm sleeping well at 

night, too. All right. These are interesting issues, and I 

guess, if there are concerns, we'll certainly hear from 

commenters on this. 

Again, I think it's a worthwhile release. It's 

timely. It's not often that we get a chance to think ahead 

and anticipate issues. Certainly, regulators are always 

accused of not anticipating. 

I think this is one case where we are, and we're 

actually asking, at least domestic players, to get involved 

and to give us their thoughts about this, which I think is a 

very, very good move. Thanks. 

CHAIRMAN COX: Thank you. Commissioner Nazareth. 

COMMISSIONER NAZARETH: Thank you. I'd like to 

thank the Office of Chief Accountant and the Division of 

Corporation Finance whose staffs have worked extremely hard 

in crafting this release. 

This topic was part of a discussion at our March 

2007 roundtable, and I'm interesting in hearing from a wider 

pool of commenters about the idea and especially about the 

timing of any possible proposal. 

While I think that the idea of allowing U.S. 

issuers to file using IFRS is appealing and may be 
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appropriate at some point in the future, we must carefully 

think through all of the implementation issues and all the 

implications before making a proposal in this area. 

In particular, we might want to wait until we have 

gained greater experience with foreign issuers using IFRS 

before proposing it as an option for U.S. issuers. 

As I said at our open meeting last month, investors 

need high-quality comparable financial information to make 

informed investment decisions. 

Allowing U.S. issuers to file using IFRS, as with 

last month's proposal to eliminate the U.S. GAAP 

reconciliation requirement for foreign private issuers filing 

using IFRS would mean that investors would need to be 

familiar with two sets of accounting standards, U.S. GAAP and 

IFRS as published by the IASB. 

I'm interested in hearing from commenters about 

whether this is a significant burden for investors or not. 

The IASB is a standard-setter that is outside of the 

Commission's regulatory jurisdiction. I'm interested in 

learning what impact commenters think this should have on 

whether the Commission should accept IFRS filings from U.S. 

issuers. 

I'm also very interested in what commenters expect 

the impact of such a proposal on the convergence process 

between U.S. GAAP and IFRS. Would there still be an 
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incentive to continue convergence if U.S. filers are allowed 

to file using IFRS? 

What would be the impact on U.S. GAAP? Is the 

convergence process far enough along to allow U.S. issuers to 

file using IFRS? 

I would hope that our actions would not slow or 

halt the convergence process, because I think that investors 

would greatly benefit if we can achieve a high-quality global 

set of standards used consistently throughout the world. 

So again, thank you for your continued hard work, 

and I look very forward to hearing from all parties about how 

they think that the Commission should proceed in this area 

and on what time frame. 

Again, I do think that it's a very fulsome release, 

a huge amount of questions, very, really, ideal way frame the 

dialogue so that we can get significant input. 

I just have one or two questions some of which 

relate to those that I've, hopefully, inspired some of the 

public to respond to. 

One is that the Commission's relationship with 

IASB, obviously, is quite different from our relationship 

with FASB. How do you think that should impact our 

consideration on whether U.S. filers should be able to file 

using IFRS? 

MS. ERHARDT: I think it's a relevant 
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consideration. In other words, in the end of the day, the 

Commission has responsibility for the accounting and 

disclosure practices that registrants use. 

Certainly, in carrying out that responsibility in 

the U.S. for many, many years, we have looked to the private 

sector to help us execute that. 

But helping us execute does not change the fact 

that ultimately we are responsible, and therefore we can't 

help but make very relevant to our considerations what our 

relationship is with the private sector body that's doing the 

work, whether it be the Financial Accounting Standards Board 

or, under this idea, the International Accounting Standards 

Board. 

So it certainly is a matter that we are 

considering. It's certainly a topic that we propose the 

Concept Release solicit some feedback on. 

But having said that, I'd also like to say that the 

International Accounting Standards Board is not an unknown 

commodity to us. 

Certainly, through the Commission's work for many 

years on promoting reducing disparity in accounting standards 

the staff have worked with the International Accounting 

Standards Board, its predecessor the committee to develop the 

standards. 

And the Concept Release describes the nature of our 
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interactions and our service on their advisory council, 

participation at their interpretation committee meetings, our 

monitoring their projects in the same manner that we do those 

of the Financial Accounting Standards Board, our work through 

IOSCO with whom they do consult in some of their selections 

of trustees, et cetera. 

So there is a large degree of interaction, but that 

does not change the fact that, as you acknowledge, it is 

different, and it's certainly something that we are 

considering. 

COMMISSIONER NAZARETH: And again, those 

differences go to also investors' ability to understand the 

financial statements since they have no experience with IFRS. 

Again that would, I assume, be another important 

consideration. 

MS. ERHARDT: Very much so. Education, when people 

say that, maybe immediately they tumble to thinking 

accounting classrooms and accounting professors and future 

accountants. 

The release tries to put first order of business 

investors understanding of IFRS, because if they have 

concerns about their level or their ability to understand, 

that's first and foremost what we want to know about. 

Then, certainly, it's not unimportant whether those 

accountants preparing the financial statements understand it 
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as well. If investors see rough spots in working with the 

product, that's first and foremost what we'd like to 

understand. 

COMMISSIONER NAZARETH: Okay. Thank you. 

CHAIRMAN COX: Thank you. Commissioner Casey. 

COMMISSIONER CASEY: I'm also very pleased to 

support the issuance of this Concept Release. Last month we 

published a proposal to eliminate the reconciliation 

requirement to U.S. GAAP for foreign private issuers that 

file financial statements in the U.S. prepared on the basis 

of the IASB version of IFRS. 

Given that proposal, issuing a Concept Release to 

solicit broad comment on whether U.S. issuers should be 

offered a similar choice is a logical and appropriate next 

step. 

The purpose of such a Concept Release would be to 

seek comment on whether U.S. issuers should be afforded the 

choice of preparing their financial statements under U.S. 

GAAP or IFRS, and, if so, what the implications would be for 

investors, issuers and our markets. 

Clearly, our consideration of whether to permit 

U.S. issuers to prepare financial statements using IFRS is 

taking place in the context of other important developments. 

The growing acceptance of IFRS in jurisdictions around the 

world, the progress of convergence efforts by the FASB and 
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the IASB, the increasingly international scope of many U.S. 

issuers' business operations and our own proposal to 

eliminate the reconciliation requirement are chief among the 

factors that compel the Commission to begin consideration of 

whether U.S. issuers should be permitted to use IFRS in 

preparing their financial statements. 

The Concept Release raises numerous questions about 

the use of IFRS by U.S. issuers, some theoretical, some more 

practical. 

For example, there are numerous questions designed 

to elicit information on the degree to which U.S. issuers 

would have an interest in filing in IFRS, how investors and 

market participants would react to a marketplace in which 

some companies would file in U.S. GAAP and others using IFRS 

and what the effect would be on the ongoing convergence 

process of permitting U.S. issuers to file in IFRS. 

On the more practical side, the Concept Release 

asks for input on the critical steps that would be needed in 

terms of investor education and auditor training to prepare 

for U.S. issuers' financial statements. 

I think no one underestimates the significance of 

such a move or the challenges that it might entail, but the 

more informed we are about the advantages, disadvantages and 

ramifications of such a change the better prepared we will be 

to respond appropriately given our statutory mandates of 
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investor protection, capital formation and fair and efficient 

markets. 

For this reason, I urge issuers, investors, market 

participants and other affected parties to assist the 

Commission in this important area by responding to the 

questions raised in the Concept Release. 

I am pleased to see that we have allowed for a 

90-day comment period to provide sufficient time for 

commenters to prepare their comments. I'd also like to thank 

the Office of the Chief Accountant and the Division of 

Corporate Finance for their excellent work, and I'm very 

pleased to support this Concept Release. I have no 

additional questions. 

CHAIRMAN COX: Thank you very much. Does any 

Commissioner have any additional questions? If not, we'll 

move to the vote. 

Does the Commission vote to publish a Concept 

Release to solicit public comment on allowing U.S. issuers, 

including investment companies, to prepare financial 

statements in accordance with International Financial 

Reporting Standards, as published in English by the 

International Accounting Standards Board for purposes of 

complying with the Commission's rules and regulations? 

COMMISSIONER ATKINS: Aye. 

COMMISSIONER CAMPOS: Yes. 
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COMMISSIONER CASEY: Yes. 

COMMISSIONER NAZARETH: Yes. 

CHAIRMAN COX: And the matter is approved. I want 

to thank everyone once again. And before you rise, because 

the Office of Economic Analysis was a significant contributor 

to this and because this is going to be Chester Spatt's last 

open meeting, I want to take this opportunity to thank on 

behalf of all of us our chief economist, Chester Spatt for 

your outstanding service. 

The SEC was very fortunate to attract you in the 

first place from Carnegie Mellon. We were doubly fortunate 

when you re-upped for a second tour of duty. 

You have distinguished this Agency with your own 

outstanding academic and professional reputation. You've 

added to the reputation of the SEC with your own luster. 

You've been an outstanding leader, a valued colleague and a 

giant in the ranks of investor protection. 

So on behalf of all of us on the Commission and on 

behalf of all the professional staff here in the home office 

and the thousands of us across the country not to mention 

America's investors and everyone who depends upon free and 

efficient capital markets, thank you very much for your 

outstanding service for a job well done. And we wish you God 

speed on your return to academia. 

MR. SPATT: It has been a privilege to serve at the 
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Agency. Thank you, Chairman Cox, for your very kind words. 

CHAIRMAN COX: Well, thank you very much. 

(Applause) 

CHAIRMAN COX: Thanks again. 

(A brief recess was taken.) 

CHAIRMAN COX: The final item is a recommendation 

from the Division of Corporation Finance concerning 

amendments to the federal proxy rules governing shareholder 

proposals and shareholder communications. 

The most significant of the proposed amendments 

concern the question of a shareholder's ability to propose 

procedures in a company's bylaws for the nomination of 

directors. 

Current Exchange Act Rule 14a-8(i)(8) provides that 

a company may exclude from its proxy materials a proposal 

that relates to an election for membership on the company's 

board of directors. 

The purpose of this provision is to prevent the 

circumvention of other proxy rules designed to ensure that 

shareholders receive adequate disclosure and that they have 

an opportunity to make informed voting decisions in election 

contests. 

In applying this provision, the Commission staff 

has determined that companies may exclude from their proxy 

statements proposals that would establish a process for 
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conducting contested elections outside of the Commission's 

detailed disclosure and regulatory regime governing contested 

elections. 

Last September, the U.S. Court of Appeals for the 

Second Circuit invalidated the SEC staff's long-standing 

interpretation of Rule 14a-8(i)(8). That interpretation had 

been applied since 1990, but the Court found it inconsistent 

with a prior interpretation. 

The Court said that it would, "take no side in the 

policy debate regarding shareholder access to the corporate 

ballot,” noting that "such issues are appropriately the 

province of the SEC." 

Since the effect of the decision is to create 

uncertainty about the application of Rule 14a-8 in the Second 

Circuit on the one hand and in the 11 other judicial circuits 

in America on the other hand, the Commission is required to 

act. 

Moreover, the effect of applying the Court's 

decision as a rule of general application would be to permit 

director election contests without the disclosures required 

by the election contest rules. 

In light of this opinion and the paramount 

importance of meaningful disclosure to investors in election 

contests, we've undertaken a careful and extensive review of 

the proxy process, including the provisions of Rule 14a-8. 
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This review included three roundtables this past 

May that focused on the relationship between the federal 

proxy rules and state corporation law, on proxy voting 

mechanics, and on shareholder proposals. 

Today we're formally considering two different 

proposed resolutions to this question so that as we continue 

to evaluate the legal, economic and policy aspects of all 

that's involved here we will continue to have choices. 

I've stated previously and will repeat again today 

that it's my intention as chairman to have a clear, 

unambiguous rule in place in time for the next proxy season. 

The Government in the Sunshine Act requires that 

whenever more than two commissioners are gathered to discuss 

policy-making on a matter such as this it must be at a public 

meeting. So unfortunately, the obvious way to work through 

tough technical and policy issues is off limits to us. 

That is, as commissioners, we can't get together, 

roll up our sleeves, sit around a table and brainstorm about 

potential ideas. Still, that's what this issue calls for, 

and so we'll be doing some of that work right here during 

this open meeting just as the Government in the Sunshine Act 

would have us do it. 

As you'll hear, we don't all agree. And when the 

dust settles today, we won't be finished. We won't be making 

any fateful decisions just yet, but instead we'll open up 
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these topics for formal comment from the entire country. 

By advancing two very different proposals, we'll 

have the benefit of the full breadth of commentary about 

different ways of attacking the issue. By considering 

serious alternatives, we'll have the benefit of a thorough 

analysis of a variety of ways to accomplish our intended 

objectives. 

This approach will also give us a richer context in 

which to evaluate public comment concerning the potential 

costs and benefits of any new rule, and exposing both of 

these proposals to public comment will enable us to better 

understand the impact that any new rule would have on 

competition, an analysis that we're required to undertake 

pursuant to Section 23(a)(2) of the Exchange Act. 

For all of these reasons, it's my intention to 

support both releases at the proposing stage. Having said 

that, the Commission's analysis of shareholder participation 

in the nomination and election of directors hardly begins 

with our proposals today. 

This issue and its several offshoots have a long 

and storied history, and many previous chairmen and 

commissioners have attempted to tackle them. As Chairman 

John Shad put it during the Reagan Administration, "The 

Commission has always encouraged shareholder participation in 

the corporate electoral process," and he added, "The SEC's 
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responsibilities for regulating proxy solicitation have been 

premised on a need to assure `fair corporate suffrage' for 

every security holder." 

He advanced an idea to use the Commission's 

jurisdiction over the Self-Regulatory Organizations to 

standardize listing standards regarding shareholder voting. 

We have a different approach before us today, but the 

objective remains the same. 

Fair corporate suffrage is just as important now as 

it was in the 1980s, and several commentators from all across 

the spectrum have recently been making the case. 

The distinguished group of securities experts, 

market professionals and academics that comprise the 

Committee on Capital Markets under the direction of Professor 

Hal Scott of Harvard Law School and the co-chairmanship of 

Glenn Hubbard, President Bush's former Chairman of the 

Council of Economic Advisors and John Thornton, the former 

president of Goldman Sachs, devoted an entire section of 

their recent report to shareholder rights. 

They did so because of the same reasons that the 

SEC today just approved our reforms of Sarbanes-Oxley and our 

Concept Release on IFRS, because in the committee's words, 

"the strength of shareholder rights in publicly-traded firms 

directly affects the health and efficient functioning of U.S. 

capital markets." 
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The Committee on Capital Markets observed that, 

"Overall, shareholders of U.S. companies have fewer rights in 

a number of important areas than do their foreign 

competitors." And they added that, "This difference creates an 

important potential competitive problem for U.S. companies." 

As one way of addressing that need, the committee 

recommended to the SEC that we take the opportunity of the 

Court's decision in the AIG case to ensure "appropriate 

access by shareholders to the director nomination process." 

But we enter upon this discussion today with the 

full benefit of recent experience that ended badly. Four 

years ago under Chairman Donaldson, the Commission proposed a 

rule that would have established a mandated procedure under 

which companies would be required to include shareholder 

nominees in their proxy materials. That rule generated 

enormous controversy and was ultimately unsuccessful. 

There are several lessons to infer from that 

experience. First, the federal proxy process must be 

respectful of the preeminent role of state law in determining 

shareholder rights. 

Second, as we heard repeatedly at our three May 

roundtables on the proxy process, changes to the existing 

system, even changes that everyone agrees are improvements, 

should be measured and incremental to ensure that, first, we 

do no harm. 
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Third, the federal proxy rules should not embellish 

shareholders' state law rights or create new ones but, 

rather, vindicate their existing rights under state law, the 

company's charter and its bylaws. 

And finally, the federal interest is preeminent 

when it comes to disclosure. Ensuring that shareholders get 

full and fair disclosure in connection with proxy contests is 

a fundamental concern of the Exchange Act and of this Agency. 

So neither of the proposals that we're considering 

today takes the approach of the aborted rule 14a-11, which 

for all intents and purposes would have imposed a national 

bylaw on every public corporation in America. 

Instead, today we're considering whether, if 

shareholders in companies wish to propose their own bylaws, 

should those proposals be allowed in the company's proxy 

materials and, if so, under what circumstances. 

And just as the many roundtable participants 

advised us to do, we will conduct this analysis on a 

foundation of respect for state law and for the fundamental 

principles of shareholder choice and private ordering that 

are the genius of our free enterprise system. 

At bottom, a share of stock is private property, 

and the law's enforcement of private property rights is what 

gives it its value. America's investors currently entrust 

over $20 trillion of their assets in exchange for these 
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property rights as holders of equity securities, and yet a 

common stockholder has precious few specific rights that 

under-gird this fantastic investment. 

And so it's of the utmost importance that what the 

stockholder does have is jealously guarded by our legal 

system. The stockholder is said to own the company, but he 

or she cannot direct management or the board to do anything. 

Indeed even 100 percent of the shareholders acting 

in concert couldn't do so. Instead, they must rely on the 

directors. Only after every unsecured creditor is taken care 

of does the common shareholder receive a penny in assets upon 

liquidation. 

A common stockholder can receive dividends, but 

only if the company decides to declare them. But the 

shareholders do have the ironclad legal right to do one thing 

for themselves, and that's to choose the company's directors. 

And yet some say the company's proxy materials, 

which are produced at the shareholders' expense, should under 

all circumstances be inaccessible to the shareholder when it 

comes to nominating directors. 

That would seem to stand the principle of fair 

corporate suffrage on its head, and that harsh conclusion 

would seem especially warranted if what's being considered is 

not the shareholder's opportunity to use the company's proxy 

to nominate a director but, rather, only to propose a bylaw 
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that would set up a procedure by which that could happen, but 

that would itself have to first be approved by a majority of 

the company's shareholders. 

Beyond all of this, as so many participants at our 

roundtable described, it's an irony that the federal proxy 

rules force many other things onto the corporate proxy that 

are at the periphery of the shareholder's rights, if they are 

within the scope of their state law rights at all. 

If a proposal has nothing to do with the ordinary 

business of the company, if it's nonbinding and even 

superfluous, then the proxy rules might well require its 

inclusion on the company's proxy. 

But if the proposal concerns the most fundamental 

of shareholder rights, the most unqualified, unbridled right 

that the shareholder has, then in the current system the 

answer is no and indeed no under all circumstances. 

As Chairman Shad observed in 1984, "under our 

corporate form of enterprise, more not less equity capital is 

essential to growth and development. The disenfranchisement 

of shareholders poses a present and real issue that must be 

debated and addressed." And I would add protecting the 

private property rights of America's shareholders is the only 

way to ensure that boards of directors remain accountable to 

the interests of investors. It's the check and balance on 

boards and management that's built into the corporate form 
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under state law, and its proper functioning is essential to 

our free enterprise system. 

Still some would say that any incremental 

improvement in the way the proxy system vindicates the 

shareholder's state law right to choose the directors will 

threaten capitalism. 

To that I would reply by all means we should be 

cautious and measured when we adjust the workings of our 

proxy system, and this process of soliciting public comment 

we're embarking upon today will ensure that. 

But we should also keep first principles firmly in 

mind. We cannot have capitalism without capital. There 

could be nothing more central to our mission of promoting 

healthy capital formation than defending the rights of 

capital and the property interests of shareholders. 

Ensuring that the proxy system respects the state 

law rights of shareholders is essential to maintaining the 

balance of federalism, and upholding the rights of ownership 

is fundamental to the maintenance of investor confidence and 

the workings of our entire free enterprise system. 

At this point, let me thank and congratulate my 

fellow commissioners for their diligent, professional and 

responsible investigation into these issues for the better 

part of a year. 

While the proposals we're considering today only 
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begin a process of public comment that will consume several 

more months they also mark the culmination of ten months of 

sustained work. 

Commissioners faithfully attended each of the 

roundtables on these subjects and devoted countless hours to 

study, to meetings, to research and to collaborative learning 

with our professional staff and many other participants in 

our capital markets. 

And during the last month since the Division's 

initial draft of its recommended release was circulated to 

all commissioners, they've contributed many useful comments 

and shepherded through many changes. I have no doubt that 

this process will continue during the weeks and months ahead. 

It’s been a hallmark of our work over the last 

two years on many, many difficult subjects that we've sought 

whenever possible to reach a unanimous result, because we 

knew that by first considering one another's viewpoints we 

would inevitably improve our own understanding and the final 

result even if in the end we didn't agree. 

Today, despite the difficulty that the Commission 

has had in wrestling with this issue over several decades all 

of us -- Commissioner Atkins, Commissioner Campos, 

Commissioner Nazareth, Commissioner Casey and I -- agree 

unanimously that the objective of this rule-making is to 

protect investors' interests and to promote capital formation 
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for the benefit of the entire nation. 

I hope and expect that all of us will continue to 

work to get it right. So before I turn it over to John White 

for a detailed explanation of the two alternatives, let me 

offer a very brief summary. 

The first proposal would amend Rule 14a-8(i)8) to 

codify the interpretation of the election exclusion since 

1990. That approach would ensure that in all proxy contests 

shareholders would receive the disclosures currently required 

under the other proxy rules, and it would permit the 

exclusion from the company's proxy materials of all 

shareholder-proposed bylaws concerning director nominations. 

The second approach would expressly permit the 

inclusion of such shareholder-proposed bylaws in the 

company's proxy materials. This approach would also ensure 

that shareholders received the disclosures currently required 

under the other proxy rules, and it would require important 

new disclosures about the shareholder or shareholders who are 

proposing the bylaw. 

The disclosures would be made under the schedule 

13D/G regime, which requires that shareholders who own more 

than 5 percent of the company's shares provide certain 

information about themselves. 

The shareholder proponent would have complete 

freedom to structure the bylaw so long as the procedure for 
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director nominations that it sets out complies with 

applicable state law and the company's charter and bylaws. 

This reflects the decision not to impose a federal 

one-size-fits-all approach, but rather to promote shareholder 

choice and private ordering. For this reason, the current 

proposal differs sharply from what the Commission proposed in 

2003. 

In addition, the second approach includes important 

new features to facilitate greater online interaction among 

shareholders and between shareholders and management. It 

would amend the proxy rules to remove obstacles to electronic 

shareholder communications. 

It would clarify that a company or shareholder who 

maintains an electronic shareholder forum is not liable for 

statements by any other participant in the forum, and it 

would also eliminate any ambiguity concerning whether 

participation in an electronic shareholder forum could 

constitute a proxy solicitation. 

I'd like now to thank the Division of Corporation 

Finance and the staff for your excellent work on these 

proposals. In particular, I want to thank John White, Marty 

Dunn, Lily Brown, Tamara Brightwell, Steve Hearne and Ted Yu. 

I also want to thank Brian Cartwright and the 

Office of General Counsel as well as Chester Spatt and the 

Office of Economic Analysis for your excellent work. 
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And now I'll turn it over to John White to explain 

the two proposals in more detail. 

MR. WHITE: Thank you again, Chairman Cox. As 

you've described, we are recommending this afternoon that the 

Commission publish two releases related to Rule 14a-8, the 

Shareholder Proposal Rule. 

In a moment, I'll turn this over to Lily Brown to 

describe the details of the two releases, but first just a 

comment. I'm going to be reiterating some of the things you 

just said in terms of the long process that we've gone 

through. 

The staff and the Commission has been studying and 

discussing this topic in a lot of detail since last 

September. We've looked at -- discussed many of the 

alternatives in a quite arduous process. 

And as you know, last May we had three roundtables 

that were attended by all of the Commissioners in which we 

heard a wide variety of views expressed by the participants. 

I should also mention that transcripts and video archives of 

those roundtables are available on the SEC web site for 

anyone who would like to see them. 

There has really just been a great deal of study, 

discussion and thought by everyone at this table and by the 

five of you. 

So after engaging in this process, as I say, 
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for almost a year now, we have decided to recommend that you 

publish for comment two releases which contain, as you 

describe, alternative and different approaches. 

This should allow a full range of public comment 

while still permitting the Commission to adopt a new final 

rule before the next proxy season, which you quite forcefully 

stated a few moments ago as your goal. 

So that's kind of where we're at in terms of what 

we've done here. Before I turn it over to Lily let me just 

thank the team, because it has really been an incredible 

effort by them during this long period not just getting these 

releases ready for you today but just the whole idea of 

putting on three roundtables in a single month. 

Some people don't realize what it is to put a 

roundtable on. I don't think anybody has ever put on three 

of them in one month on one topic. So it really is an 

incredible job the team has done here. 

Just to go through the key players, in Corporation 

Finance, Lily Brown, Tamara Brightwell, Ted Yu, Steve Hearne, 

and I left to last Marty Dunn, who I think has pretty much 

spent – he’s been involved with this topic all of his 

professional career or most of it. 

MR. DUNN: Five or six years flew by. 

MR. WHITE: A long part of his professional career. 

I mention that because you're going to hear from Marty as 
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we're answering the questions today. 

Others that are here at the table, in some cases 

behind us, in General Counsel's Office, David Fredrickson, 

Alex Cohen and Meredith Mitchell. In the Office of 

Investment Management, Susan Nash, Brent Fields, Tara 

Buckley. In the Office of Economic Analysis, Cindy 

Alexander. 

And I won't read through all the individual 

Commissioner's counsels, but there have been tremendous 

effort put in by the counsels of all five of you in inputting 

on this process. All of us in Corporation Finance and 

elsewhere on the staff are very appreciative of all their 

efforts. 

So with that I will turn it over to Lily to go 

through more details than I guess you did a moment ago. 

MS. BROWN: Thank you. Good afternoon. Today we 

are recommending that the Commission publish two releases 

related to Exchange Act Rule 14a-8, the shareholder proposal 

rule. 

The first release would propose amendments to Rule 

14a-8 that would enable shareholders to include shareholder 

nomination bylaw proposals in the company proxy materials 

where the proposal relates to a change in the company's 

bylaws that would be binding on the company if approved, the 

proposal is submitted by a shareholder or a group of 
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shareholders that has continuously held more than 5 percent 

of the company's securities for at least one year, and the 

shareholder or group of shareholders is eligible to and has 

filed a Schedule 13G that contains all required information. 

There would be no limitations in our rules as to 

the content of those proposals. They would need only to 

comply with applicable state law and governing corporate 

documents. 

However, critical to allowing this access to the 

company's proxy materials would be comprehensive disclosure 

regarding the shareholder proponent and the shareholder 

proponent's relationship and prior interactions with the 

company. 

As proposed, Regulation 14A and Schedule 13G would 

be amended to provide shareholders with additional 

information about the proponents of shareholder nomination 

bylaw proposals. These additional disclosures would be 

required by the shareholder proponents as well as by the 

company. 

The proposals also would assure that the existing 

disclosure requirements for solicitations in opposition would 

apply to nominating shareholders and their nominees under any 

such shareholder nomination procedure with the nominating 

shareholder being liable for any false or misleading 

statements in that disclosure. 
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Nominating shareholders and their nominees as well 

as the company would be subject to the additional Regulation 

14A and Schedule 13G disclosures as well. 

We also recommend that this release propose 

revisions to the proxy rules to promote greater online 

interaction among shareholders by removing obstacles in the 

current rules to the use of electronic shareholder forums and 

clarify the application of the liability provisions of the 

federal securities laws to statements or information on such 

a forum. 

The release also asks for public comment on a range 

of questions related to the shareholder proposals process 

under Rule 14a-8. 

Finally, we recommend that the Commission approve a 

second release in which it would propose amendments to the 

text of Rule 14a-8(i)(8) regarding proposals that relate to 

an election. These amendments are designed to clarify the 

operation of the exclusion in Rule 14a-8(i)(8) in a manner 

that is consistent with the Agency's prior interpretation of 

that exclusion. 

Under that interpretation, companies may permit the 

exclusion of proposals that would result in an immediate 

election contest or would set up a process for shareholders 

to conduct an election contest in the future by requiring the 

company to include shareholders' director nominees in the 
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company's proxy materials for subsequent meetings. 

Thank you. We would be happy to answer any 

questions you may have on the two releases. 

CHAIRMAN COX: Well, thank you. Because of, 

obviously, the way this works with respect to shareholder 

bylaws is the center of discussion, I want to ask about 

something that might otherwise not get quite as much 

attention. 

In one of the two alternatives there is the 

proposal that you just described to open up the space that 

we're roughly describing as electronic shareholder fora. I 

wonder if you could help describe what it is that we're doing 

and what we're not doing with this proposal. 

For example, would the federal proxy rules mandate 

a particular kind of online forum, or would this be, 

essentially, a free form opportunity for shareholders and 

companies to try out new ideas and be creative? 

MR. DUNN: Okay. I'll start with that. The key to 

it is that what we're making clear here is that folks can do 

it and that there's no particular way that we would say you 

can run a forum. 

The goal is to not inhibit how they develop. The 

purpose for this is to look through the proxy rules and try 

to think of things in there that careful people might look to 

to find ways not to that might inhibit them and to eliminate 
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those concerns; for example, the concern that there might be 

liability for one person for the statements of another on 

such a forum. And we provide clarity regarding liability is 

on the speaker. 

Questions about whether participation there might 

be deemed a solicitation under the proxy rules. In the 

proposals, very basically it would say that if it's 60 days 

before the meeting -- and there's a little bit if you 

announce later than that -- but, basically, 60 days before 

the meeting and you're not soliciting a proxy, then you'd be 

out of that definition. So folks don't have to worry about 

that part of it. 

Similarly, there would just be a statement in there 

saying that companies are allowed to do this. Shareholders 

are allowed to do this, which I think is very useful for 

folks to know. 

So the goal would be simply to get out of the way 

and let whatever technology, whatever ability folks have to 

come up with any way to interact, do petitions, look amongst 

each other, figure out ways to interact amongst each other 

and with the company. We'd let that flourish. 

CHAIRMAN COX: Existing federal law provides broad 

protections from liability for online access providers 

generally for statements of others on internet forums of 

various kinds. 
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So I take it what we're doing is we are adding to 

those liability protections specific coverage that in 

addition to not violating any other federal laws you're not 

violating the federal proxy rules. 

MS. DUNN: Yeah. I'm not sure who was in Congress 

at the time they got passed, so I don't know anybody who 

knows anything about that. But that is very clear with 

respect to other things, and because folks tend to be very 

cautious when the securities laws liability come around we're 

trying to take the same approach here. Exactly. 

CHAIRMAN COX: Just quickly, if you would -- we've 

discussed a lot at the three roundtables, which really were 

superb -- how do the Division’s recommendations reflect or 

respond to the participants' statements at those roundtables? 

MR. DUNN: The three main things that I took away 

from those discussions were the need to make sure that the 

federal securities laws and particularly the proxy rules are 

aligned with state law rights. The other was to make sure 

that no matter what you do disclosure has got to be 

paramount. And the third thing I saw was that, really, 

technology needs to be taken into account. 

So what we believe these do is do all three of 

those, actually. The proposals would definitely look more to 

the state law ability of folks to raise bylaw provisions. It 

would in conjunction with that recognize the overriding need 
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for disclosure, regardless. 

And the forum part definitely looks at technology, 

and the Commission has taken some other recent actions that 

go that direction as well, the e-proxy and the various things 

there. 

So to my mind, a lot of what we learned at the 

roundtables goes into this. I think we learned more at that 

than is done here, but what we do here I think fits within 

those areas. 

CHAIRMAN COX: All right. Thank you. I haven't 

any further questions, and so I'll recognize Commissioner 

Atkins. 

COMMISSIONER ATKINS: Ok. Thank you very much, 

Mr. Chairman. The topic before us today is one that’s long 

vexed many of our predecessors. It seems that at least once 

a decade we engage in a significant review of the proxy 

rules. 

Just look at what we did in 1976, 1982, 1992 and 

1998. I had a personal and intimate experience with the 1992 

changes, as did Marty Dunn, when I worked here with Marty. 

And now, during the first decade of the 21st Century this is 

already the second time that we've engaged in an extensive 

review and discussion of our proxy rules. 

The key question is how do we address the competing 

problems of collective action versus the tyranny of the 
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minority? How do we permit shareholders to effectively 

exercise their state corporate franchise rights without 

allowing a shareholder who may have only a nominal economic 

interest to highjack the agenda of all shareholders? 

We've tried to bridge this problem with Rule 14a-8, 

a rule that while far from being perfect has at least created 

a framework for dealing with this problem. 

Today we have proposed a couple of actions on this 

issue. The need to address this issue has been precipitated 

by the Second Circuit's decision last year in AFSCME v AIG. 

That decision has created an air of uncertainty as to what is 

the current state of our regulations with respect to the 

election exclusion of Rule 14a-8. 

This uncertainty must be cleared up. It is unfair 

to both companies and shareholders alike to keep the current 

murky situation in place. By doing nothing, we invite costly 

and fruitless litigation. 

It’s further unfair to create an environment where 

contested elections could occur for seats on the boards of 

directors outside of the disclosure regimen imposed by our 

own Rule 14a-12. Thus, the current situation is simply not 

acceptable. 

So as to the two proposals to be published for 

comment today, one I can support, and the other I cannot. 

There are aspects of the latter that I can support, but 
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overall I have significant questions regarding our authority 

to take some of the steps proposed to be taken. 

In particular, while I agree with the statements in 

the release emphasizing that it is substantive state law that 

governs shareholder rights I have concerns whether some of 

the proposals may conflict with that principle. 

I also worry about the slippery slope of some of 

the provisions in the proposal. Moreover, I do not believe 

that the second proposal takes into account all of the recent 

changes in corporate governance generally. 

It does not consider more measured steps that we 

can take to continue to drive down the costs and improve the 

efficiency of running a short slates of directors, even a short 

slate of one that may lead to the attaining of the goals of 

responsible long-term shareholders concerned with the 

financial performance of their companies. Nevertheless, I 

look forward to the debate that certainly lies ahead. 

As the Chairman said, a lot of discussion and 

thought has transpired among the Commissioners and the staff 

on this issue, especially during the past couple of weeks 

leading up to this meeting. 

I want to recognize especially the efforts of the 

staff who have literally sacrificed their weekends and their 

nights during this period in order to respond to the various 

ideas and suggestions being put forth by the Commissioners. 
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So your efforts are really tremendously appreciated by I'm sure 

all of us up here on the table. Thank you very much. 

I just have one question, and that's for our 

General Counsel. Just exactly what are we voting on now? I 

just want to make sure that it's a draft as to the 

interpretation and proposal with respect to 14a-8(i)(8) that I 

guess I received last night about 11 p.m. give or take a few 

minutes. 

And then as to the longer one, again it's a draft 

dated last night. I got it about midnight, and it's marked 

from changes from the 11th of July. 

MR. WHITE: I'll let Brian finish the answer, but 

you received an action memo, as you described, last night 

around 11:50 that had attached to it both of the releases. And 

those are the two releases you'd be voting on. 

MR. CARTWRIGHT: Just to complete the answer, I 

think, as in all matters that are brought before the 

Commission, the draft that is most recently before the 

Commission at the time of the vote is the draft on which the 

Commission is voting. 

And I believe, if I understand, and I think my 

colleagues in the Division agree the drafts that you refer to 

are the drafts before the Commission. 

COMMISSIONER ATKINS: Okay. I just wanted to make 

sure. Okay. With that, thanks. I look forward to hearing 
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the comments of my fellow Commissioners. 

CHAIRMAN COX: Thank you. Commissioner Campos. 

COMMISSIONER CAMPOS: Thank you very much. Let me 

also add my thanks to the staff and in particular Corp Fin 

and all the individuals who have participated and worked long 

hours on these two proposals. It’s been a mighty chore, 

and tremendous labor has been put into it. Let me echo my 

appreciation as well. 

These issues have been around since I joined the 

Commission five years ago, and it's incredible how, as time 

goes by, how we keep reflecting and dealing with the same 

issues in many respects. 

I do think the world has moved, and I do think the 

latest three roundtables have added to the record and the 

investigation that the Commission has done in this particular 

area. 

Essentially, it seems to me that all of this 

effort, essentially, boils down to a situation that exists in 

America that is very different than any other developed 

market in the world. That is, only in the United States - as 

compared to other developed markets - are shareholders who hold 

a voting class of shares, prevented from voting yes or no for 

directors. 

As we all know, shareholders can only vote yes or 

withhold their votes. Some have called this system -- we've 
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often heard this – “Soviet-style voting.” 

As the Chairman said, this system seems to fly in 

the face of basic ownership rights under our capitalist 

system for property. Do shareholders have a right to vote 

and influence the selection of directors, or is that simply 

an illusion? 

Under our laws, shareholders are not entitled to 

manage the day-to-day operations of a corporation. That is 

clear. Instead, however, they rely on management efforts of 

the board of directors who owe them fiduciary duties. 

So again it would seem logical and rational that 

shareholders who owned voting stock have the right to vote 

for directors or influence their selection in a meaningful 

way. 

It seems that there are greater issues and problems 

with the opponents who fear shareholder access. I think part 

of it is philosophical. Part of it is a view that 

shareholders are not really owners, which I think flies in 

the face of our corporate law. That view, sort of, maintains 

that shareholders are free riders who can, essentially, use 

the Wall Street rule and simply walk when they don't like 

what's going on. 

Of course, what this particular proposition ignores 

is that the time to walk is when the share price is at its 

lowest, and it seems hardly an option to sell your stock when 
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it's the lowest instead of trying to influence the company in 

a meaningful way to improve itself and have the share price 

go up. 

Further, large institutions today are heavily 

invested in indexes and cannot simply move large blocks of 

shares. If they do, that affects the price. So this is a 

serious issue, and that particular view I don't think deals 

with reality. 

Another reason that's often cited is that 

shareholder access will somehow disrupt the conduct of 

business at companies and boards. In my view, this 

particular argument doesn't hold water. 

Essentially, shareholders, in my evaluation and in 

my study, don't want to do the day-to-day business of boards. 

They intervene only when they have to and when there is 

repeated failure of performance and failure to take into 

account shareholder suggestions. 

So a company that is consistently underperforming I 

think quite naturally under a capitalist system should expect 

the attention of shareholders. 

So our proxy proposal or any proposal, frankly, in 

this particular area would not affect any company that is 

responsive to shareholders, I would submit. 

Finally, I hear the argument that: “There is so much 

to deal with with respect to SOX. Please don't add another 
 1 requirement.” Well, I think that the world today moves fast. 

2 The Commission didn't create the global economy. The 

3 Commission didn't create activist funds. 

4 The Commission didn't create all of the pressures 

5 and all of the financial competitive situations that exist. 

6 We didn't create the effort of private equity and hedge funds 

7 who are interested in this particular world. 

8 So I think it belies the issue. This is not 

9 something that a board can avoid by simply not having a rule 

10 that allows for shareholder proposals. Shareholder activism is 

11 something that occurs here today in spite of whatever the 

12 Commission may do. 

13 So, essentially, I think it comes down to is 

14 accountability, and I think under our capitalist system 

15 boards need to be accountable. That's the way they were 

16 designed under our basic laws from the premises and from the 

17 history of Anglo-Saxon law. 

18 There needs to be accountability to shareholders. 

19 Our particular proxy proposal today, and I'm talking about 

20 the first one that has to do with the 5 percent, would be a 

21 simple and elegant way of trying to accomplish under state 

22 law the means for a proposal to be made for a framework for 

23 shareholder access. 

24 Whatever that might be would be ultimately between 

25 the shareholders and the company and be governed by state 
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law. 

Having said that, I do support the -- let me be 

clear -- I support the proxy proposal today that involves the 

proposition to allow shareholder proposals to go forward, but 

I do have some deep reservations. 

I'm aware that many investors have said very 

publicly that a 5 percent ownership threshold is too high. 

This is especially the case, they argue, in large companies, 

in our large accelerated filer community, and the reason for 

that is very simple. 

If you put together the holdings of all of the 

major institutional investors that make up one of the large 

organizations, the Council of Institutional Investors, with 

respect to large companies, their combined holdings do not 

equal 1 percent. There may be some exceptions, but that's 

generally the rule. 

So investors have posed the question: is a rule 

in which a 5 percent threshold is proposed useful to 

investors? Is this threshold, essentially, too high so that 

the proposal is, essentially, useless and more optical and, 

in fact, an illusion? 

Several questions are asked in the release which I 

think promote or at least elicit responses from investors and 

commenters and academics about this particular question. 

In particular, one of the questions has to do with 
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whether the Commission should consider some sort of 

differentiated standard for large companies, which might mean 

that the percentage should be substantially lower than 5 

percent, maybe even 1 percent -- or lower, who knows -- or 

whether it should be higher. 

Also asked is whether a different set of standards 

should apply in terms of a threshold for smaller companies, 

mid-cap and small caps. 

So I today want to encourage investors and other 

commenters, academics, to make their views known and to give 

us their thoughts as to this particular proposal that has 

been offered. 

Separately, I also have great reservations about 

the question raised in this longer proposal that would allow 

the opting out, my terminology, of the SEC's 14a-8 procedures 

for non-binding or precatory proposals. 

The question poses a situation in which either 

shareholders or management through a bylaw proposal could 

eliminate the non-binding proposals being considered at all 

by a company. I mean, that could be the ultimate result of a 

proposal that is ultimately adopted by shareholders. 

I think the question is open as to whether such a 

proposal would require shareholder approval if the company or 

the board made it. 

I'm very concerned about whether it is good policy 
 1 to eliminate a particular opportunity that nuns, rabbis, 

2 Christian sects, environmentalists and others have used for 

3 placing non-binding proposals -- I'm sure I left someone 

4 out -- for consideration by management. 

5 As stated in the roundtables, this particular 

6 procedure under our oversight and under 14(a) often presents 

7 ideas that eventually get traction, get legs and turn into real 

8 proposals that are adopted by the company. 

9 So I'm interested in knowing what investors and 

10 commenters think about this particular question and the 

11 possible rule that may come out of this. 

12 Is it good policy to allow a system to take away 

13 this particular practice and force those types of activists 

14 to use other tactics? I look forward to those comments. 

15 As to the second release, I find myself in a 

16 position of not being able to support it. The second 

17 release, to my analysis, has many problems not the least of 

18 which is that it, essentially, puts investors in a position 

19 where they can no longer make any proposals if it were 

proposal. 

20 followed by the letter of the law, by the letter of this 

21 However, I find that it seems to me to be somewhat 

22 deficient in that it doesn't really answer many of the 

23 questions that the Second Circuit put. 

24 Without doing a legal analysis here, which I think 

25 others might be interested in doing, the Second Circuit did 
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state that: "The SEC fails to so much as acknowledge a 

changed position let alone offer a reasoned analysis of this 

change. The amicus brief," referring to our submission, "is 

curiously silent on any division action prior to 1990 and 

characterizes the intermittent post-1990 no-action letters 

which continue to apply the pre-1990 positions as mere 

mistakes." 

For that and for other reasons, I believe that this 

particular proposal will not change the status quo. As I 

read it, there's nothing in this release apart from the 

proposed rule that is really new. 

Thus, the interpretation of this release without 

more is, to quote the Second Circuit, "plainly at odds with 

the interpretation the SEC made in 1976." 

Given this, I hope and expect that the Agency will 

not be taking the position in the upcoming proxy season that 

this release without adopting a final release of some sort 

changes the current situation. 

But let me ask a couple of questions about that. 

Brian, perhaps you can help me. In your opinion, does this 

interpretive release have any current legal effect? 

Specifically, in your view, is it sufficient to effectively 

reverse the Second Circuit's decision and change our views as 

respect to what we do with no-action letters? 

MR. CARTWRIGHT: Well, the release, if adopted, 
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includes a provision that restates yet again the Agency's 

position under the existing 14a-8(i)(8). 

As was mentioned, 14a-8(i)(8) was adopted in 1976, 

and at that time the Commission said that Rule 14a-8 was not 

the proper means for effecting reforms in elections. And at 

least since 1990 the Agency through the Division of 

Corporation Finance in the no-action process that 14a-8 

itself sets forth has on countless occasions reiterated that 

position. 

Perhaps the most recent and full statement of that 

position was the statement the Commission made in the Second 

Circuit itself in which the Commission authorized -- it was 

actually under the signatures of John White and myself -- the 

submission after a request for an amicus brief from the 

Second Circuit of a very full explication of the 

Commission's, the Agency's long-standing position. 

What this proposed release would do would restate 

that conclusion. I thin I know that there are many who care 

very much about that restatement or not. 

Nonetheless, I think that the whole record of the 

Agency's position going back to 1976 would be before any 

court that would be considering this, or reconsidering it in 

the case of the Second Circuit, and saying it one more time. 

Well, one could ask the extent to which that would 

have a decisive effect on any judge or panel that might 
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consider it. So that's, I think, what it does. 

COMMISSIONER CAMPOS: So just to try to phrase it 

in a little bit my plainer version of English, you don't 

think this particular release, if adopted, the shorter 

release, would control any other court who is looking at this 

particular situation? 

MR. CARTWRIGHT: Well, it's a restatement of the 

Commission's existing position. So we might, assuming that 

it's adopted this afternoon, look at the state of affairs 

yesterday and the state of affairs tomorrow. 

What we would have tomorrow if it were adopted 

would be one more statement of the Agency's position, which 

it’s had for a very long time now. 

And as I say, I think can you ask how much effect 

that would have on a court in the Second Circuit or a court in 

any of the eleven other circuits. It's incremental. It's 

saying it again one more time, but that's all it is. 

COMMISSIONER CAMPOS: And this statement was, 

effectively, already before the Second Circuit the first 

time, wasn't it? 

MR. CARTWRIGHT: Yeah. The Second Circuit, of 

course, as everyone who has been following this is well 

aware, did not accept the Agency's long-standing 

interpretation. 

So the current state of the law in the Second 
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Circuit is contrary to the Agency's interpretation. One 

would assume that another court in the Second Circuit would 

feel bound by that precedent. It's always possible that 

there would be some way to argue that it shouldn't be bound, 

but, presumably, it would be. 

So I think saying the same thing again one more 

time without precluding any possibilities here is probably 

not highly likely to have an effect in the Second Circuit, 

and I think courts outside of the Second Circuit considering 

it have the whole record before them. 

This is one more occasion, if adopted, in which the 

Agency would have made that statement. Perhaps that would be 

persuasive to a judge, but you have to look at the whole 

package, and it's just one more iteration. 

COMMISSIONER CAMPOS: Thank you. Let me go to John 

or Marty, whoever wants to handle this one. So, what is, how 

is the Division of Corp Fin going to handle -- if we assume we 

adopt this second shorter release today, how is Corp Fin going 

to handle a request for a no-action position by the division 

with respect to excluding a bylaw proposal that would put a 

shareholder access process in place? 

MR. WHITE: Let me start by saying I think that's a 

very hypothetical question, because as Chairman Cox has 

described a few minutes ago we have every expectation that 

prior to the upcoming proxy season one of these proposals or 
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the other or some combination would be adopted so we will 

actually have a final rule in place. So we would not be in a 

situation to ever face a proposal --

COMMISSIONER CAMPOS: So the shorter proposal is 

not a final rule, in your view if adopted today? Is that 

what you're saying? 

MR. WHITE: It contains a rule proposal. A rule 

proposal is, obviously, not being adopted today. It's a rule 

proposal. 

COMMISSIONER CAMPOS: On the short interpretive 

release? 

MR. WHITE: Both releases are rule proposals or 

contain rule proposals. 

COMMISSIONER CAMPOS: Okay. All right. I just 

want to make clear that that was the case. So you're 

saying -- you're punting a little bit, because you're saying 

we'll have a final rule, and the division won't have to worry 

about that? 

MR. WHITE: Well, I started by saying it was 

a -- as you were posing it, it was a hypothetical question or 

quite likely to be hypothetical. 

If we were to have a no-action letter request prior 

to a final rule being adopted, based on our current thinking 

and the advice of the General Counsel's Office, which you 

just heard Brian's description, and remembering that any 
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shareholder proposal is very fact specific in terms of how 

you analyze it -- I mean, there are all kinds of different 

factors that may come into play with respect to a particular 

proposal -- we would be analyzing it and approaching it the 

same way as we did last season. 

COMMISSIONER CAMPOS: The same way as we did last 

season, which would be that we take no view, or words to that 

effect? You will not issue a no-action letter? 

MR. WHITE: We only put out a letter one time last 

season which we said we had no view. It was not a matter 

that was subject to the Second Circuit, or at least the 

company said it was not subject to the Second Circuit. 

COMMISSIONER CAMPOS: So you would expect to have 

the same view based on your current thinking as you did last 

season, correct? 

MR. WHITE: Based on our current thinking and based 

on our discussions with the General Counsel's Office, yes. 

COMMISSIONER CAMPOS: Okay. Now let me push you a 

little bit more. This is even more hypothetical. So assume 

we never go to a final rule. What would be the position of 

Corp Fin with respect to requests for no-action positions in 

a shareholder access bylaw proposal given today's adoption of 

the short release or putting it out? 

MR. DUNN: If we never adopt a rule, I'd be really 

disappointed in everybody. Where we are now what this says 
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is where we've thought -- and how is that for the dad in me 

coming out -- but it is where we've been all along --

COMMISSIONER CAMPOS: We'd all be disappointed. 

MR. DUNN: -- is what this says is this is the view 

of the Commission which the Commission has expressed before. 

That didn't hold sway in the Second Circuit in the recent 

decision. 

So where we are left with following this, following 

the discussion Brian just had as to how this plays, while it's 

an interpretation, it's a restatement of the interpretation. 

It's not a final rule, because it's a rule -- it's a current 

interpretation. It's not a final rule. It's a proposed 

rule. 

Based on what Brian just said I think we're in the 

same spot whether it's a week from now or six months from now 

is that we are still faced with this is the view of the 

Commission. There's an opposite view of the Second Circuit. 

There's not a final rule clarifying it or not 

another action clarifying it for us, and so that places us in 

the same spot we were last year regarding the level of 

certainty we can have. 

MR. CARTWRIGHT: I think that the division would be 

very much in the same position it was last time, and so it 

would be not inappropriate for it to take the same position. 

I think it would be very disappointing if the 
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Commission were unable to come to some resolution here, 

because I think what would happen is what started to happen 

but didn't quite happen in the last proxy season is that we 

would end up with litigation by private parties. 

This is litigation to which the Commission is 

typically a party, if at all, only as an amicus -- so not 

technically a party -- in other circuits. We would end up 

with a situation where there was great uncertainty around the 

nation, and that I think we all agree is not desirable. 

From our narrow view in OGC, it's not desirable. I 

think it's probably not desirable more generally. So I hope 

that, as Marty and John said, this turns out to be 

hypothetical only. 

COMMISSIONER CAMPOS: Well, I think we'll all be 

disappointed if we don't have a meaningful final rule. All 

right. I'm happy for those clarifications. I appreciate the 

thought that went into them. 

And again, I really am appreciative -- I know every 

other Commissioner and our staffs are -- of all the hard work 

that Corp Fin has done and all the other divisions that have 

weighed in as well. Thank you. 

CHAIRMAN COX: Thank you. Commissioner Nazareth. 

COMMISSIONER NAZARETH: Thank you. As it was 

originally contemplated, the proxy access proposal, which 

I'll call the first proposal, was intended to recognize the 
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legitimate interests of shareholders in the governance of the 

corporations they own. 

This proposal is designed to enable a meaningful 

percentage of shareholders to come together to propose a 

bylaw amendment regarding the procedures for nominating 

candidates to a company's board of directors. 

It would facilitate shareholders' exercise of their 

fundamental state law and company ownership rights to elect 

the board of directors. It would largely eliminate the 

artificial barriers that the federal proxy rules have erected 

to the exercise of these state law rights. 

The proposal would also mandate robust disclosure 

regarding the background and interaction of the proposing 

shareholders and the company, providing information necessary 

for shareholders to determine the extent to which the 

proposing shareholders may be acting in their own 

self-interests. 

The proposal was designed to balance the rights of 

shareholders with the legitimate goal of leaving the 

management of companies largely to the board and the 

managers, whose primary focus should be on profit generation. 

One key element of the proposal that was designed 

to achieve this goal were the thresholds that were set to 

trigger access; namely, that the proposing shareholder or 

group of shareholders have 5 percent or more of the stock and 
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that they have held the stock for at least one year. 

Whether these exact percentages and holding periods 

achieve the correct balance may well be an open question, and 

I would certainly encourage comment on this point, but the 

concept of requiring a meaningful percentage of ownership and 

a holding period to trigger the access to the proxy seemed 

very sensible to me. 

Today's proposal is based on another perfectly 

logical economic tenet. In a free market system, a majority 

of the shareholders will generally behave in their economic 

self-interest. 

When it comes to share ownership, their goals are 

profitability and integrity of the enterprise. In the vast 

majority of instances, these incentives will be consistent 

with those of a company's management. 

Unfortunately, there are notable instances, 

however, in which management acts in its own economic 

self-interest or chooses to ignore the express will of the 

shareholders and is unresponsive to them. 

In these instances, shareholders should have the 

ability to effect changes more effectively through the proxy 

process. 

Currently, shareholders have virtually no chance to 

do so through access to the company ballot. Our proxy rules 

do not facilitate it, and shareholders are forced to solicit 
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proxies on their own ballot, which is more costly and much 

less effective. 

This proposal appears to be responsive to many of 

the constructive comments we received at the roundtables on 

proxy access that were held over the past several months. We 

received very insightful input from a host of panelists many 

of whom focused on both the tension between federal proxy 

rules and the rights afforded shareholders under state law. 

Another area of focus at the roundtables and one on 

which we ask a variety of questions in this release relate to 

precatory proposals. 

In this release, we ask a number of 

thought-provoking questions on possible changes to Rule 14a-8 

rights concerning precatory proposals, including the 

possibility that shareholders could vote to establish access 

procedures concerning precatory proposals that differ from 

those in our rules. 

Now, unfortunately, after all this effort, I'm now 

concerned that all of this work towards greater shareholder 

democracy may not be realized and that the chances of 

effecting meaningful shareholder access may be minimal. 

Yesterday, I received for the first time an 

entirely different, indeed diametrically opposite 

alternative, to this shareholder access proposal. That is 

the second proposal that we are being asked to vote on today. 
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This one is probably best called the shareholder 

non-access proposal. I was previously told verbally that we 

should expect to be asked to vote on proposing a confirmation 

of the staff's pre-AFSCME position on proxy access. 

It was expressly understood that during the 

pendency of the comment process on these two proposals that 

we would maintain the status quo and not issue any 

interpretation that purported to move the starting line, so 

to speak, back to where we started, but that is exactly what 

was produced yesterday. 

Thus, we're being asked today to vote on two 

proposals, the second of which, at least on its face, 

purports to immediately return us back to our pre-AFSCME 

posture. 

What concerns me more, however, is that this 

shareholder access proposal could in fact -- although I don't 

think that it was the intention, it could, in fact, be turned 

on its head. 

There's at least a possibility given now that we 

have two proposals that the Commission could pick and choose 

from each of these diametrically opposed proposals and thus 

put shareholders in even a worse position than they are 

currently. 

And let me give you an example. Although I 

previously supported including the Discussion and Question 
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section on shareholder procedures for precatory proposals in 

this release partly because it is consistent intellectually 

with state law rights and the free market concepts in the 

access release, and it was coupled with increased access in the 

access release, it could now potentially be split from the 

shareholder nomination access proposal and coupled with the 

non-access proposal, at least potentially. 

So one can imagine a final rule-making in which we 

then are asked to consider both pre-AFSCME non-access and 

potentially more restrictive precatory proposal procedures. 

Indeed, one of the possible outcomes under this 

scenario could be the adoption by a board of directors 

without a shareholder vote at all of procedures concerning 

shareholder precatory proposals that are more restrictive 

than our current 14a-8 as long as this action was consistent 

with state law. 

Now again, I don't think that that was anybody's 

intention, but because we have these two proposals that is a 

possibility. And so it's for that reason that I'm extremely 

concerned about where we find ourselves having these two 

proposals today. 

A vote against the shareholder access proposal 

would make non-access a virtual certainty, but a vote for 

it does leave open this possibility of some problematic 

results. 
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So it's going to be very incumbent on all 

commenters to firmly establish what their positions are and 

how important these issues are to them as we deliberate on 

these incredibly important issues. 

So needless to say, this has been, I think, one of 

the more challenging issues that I've worked on since I've 

been here at the Commission, and I've worked on a few of them 

that were a little complicated. 

The challenges have undoubtedly also been extremely 

taxing and challenging for our staff as well, who throughout 

this process have acted with extraordinary energy and 

professionalism. 

And I really want to specifically recognize the 

staff for their countless hours that they've devoted to this 

exercise, particularly John White, Marty Dunn, Lillian Brown 

who I don't even want too think about how little sleep she’s 

gotten in the last week, Tamara Brightwell and Steven 

Hearne and obviously our friends as well in the Office of 

General Counsel. 

So with that I do just want to ask Brian to address 

a little bit because of my caution and concern about this 

precatory discussion. 

My reading of this is that the discussion was so 

fulsome and the questions in the release now are, in fact, so 

specific that at least as a technical matter we could move to 
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an adoption on the precatory section even though it's not 

drafted as a proposal but as questions. 

Could you comment on that, please? 

MR. CARTWRIGHT: Yeah. Let me sound like a lawyer, 

since I am, at the outset and say that it, obviously, would 

depend on the specifics of whatever was proposed to be 

adopted in the end, and careful analysis would have to be 

done there. 

The set of questions is, I think, dense. There are 

a lot of questions that are asked. I think the world is 

fairly on notice that the Commission could act in this area. 

So I think the Commission will have a great deal of 

flexibility when the time for adoption comes to take any one 

of a broad range of courses. When we get to the point where 

we're starting to crystallize down to one, then we'll have to 

take a close look and make sure that it fits with what has 

been proposed. 

COMMISSIONER NAZARETH: Thank you. 

CHAIRMAN COX: Thank you. Commissioner Casey. 

COMMISSIONER CASEY: I would also like to start by 

thanking the staff for all of your hard work. The process 

leading to today's votes on two proxy related releases has 

required quick work by the staff and has sought rapid 

response by the Commission. 

Today's larger proxy proposal that which would seek 
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to fundamentally change our proxy process presents a difficult 

challenging issue, and you have been able to work under 

extraordinary time pressure, often sacrificing much of your 

personal time and turning your attention away from other 

important work as you press forward with this work. 

Unfortunately, despite your hard work I find that I 

am only likely to be able to support one of the proposals 

before us today. I remain unable to support the broader 

proxy proposal offered today that would fundamentally change 

our proxy process. 

While I have supported the Commission's efforts to 

evaluate the operation and effectiveness of our proxy rules 

with an eye to considering whether changes to our rules are 

advisable or warranted, I have also firmly believed since the 

Second Circuit decision in the AFSCME v AIG case that the 

Commission must provide clarity and certainty by first 

reaffirming its long-standing interpretation that Rule 14a-8 

is not the proper means to wage a contested election and that 

bylaw proposals such as the AFSCME proposal are excludable 

under 14a-8(i)(8). 

I believe now, as I did in the months following 

that decision and leading up to this past proxy season, that 

that long-standing policy, a policy that we recently 

confirmed just last March in our submission to the Second 

Circuit, is sound and that it preserves a carefully crafted 
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disclosure regime for the protection of all shareholders. 

Further, recognizing the long history, sensitivity 

and significant import of these issues for shareholders and 

companies, I felt strongly that an open and deliberative 

process was necessary to inform the Commission's 

consideration and provide valuable input and context 

regarding the current state of the operation of our rules and 

whether they effectively serve the interests of all 

shareholders. 

The roundtables held two months ago were intended 

to bear these questions out and test assumptions about 

whether the appropriate balance in our rules continues to be 

struck appropriately. 

Unfortunately, I cannot support the broader proxy 

rule release before us today because I think it fails to 

adequately address both of these interests. 

I am, however, pleased -- and I want to discuss 

this a little bit more in some of my questions -- that the 

Commission is considering separately a release that reaffirms 

our long-standing position, clarifies our long-held view and 

proposes clarifying language should such language be 

necessary. 

Given the fundamental changes that would be 

proposed to our carefully crafted proxy regime, the 

challenges presented by any alterations to this regime and 
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the controversial nature of proposals in the proxy area 

generally, I do not think that the proposing release offering 

a new bylaw approach is appropriate at this time. 

The proposal suggests that the Commission believes 

that the option offered by the release is the best or 

preferred option, and I have no such confidence that this is 

so. 

Further, I do not believe that the single-option 

proposal makes a sufficient effort to rationalize the 

Commission's long-held positions on 14a-8 and instead offers 

an abrupt change of course with little explanation. 

In three weeks during May, the Commission hosted a 

series of roundtables to consider the role of our proxy rules 

and whether any changes to the rules should be considered. I 

viewed the roundtables and all of the work conducted before, 

during and after the roundtables as a fact-finding effort to 

inform the Commission on whether or not additional changes 

were necessary or desirable. 

The schedule included a roundtable considering the 

different federal and state rules in the proxy process, two 

weeks later a roundtable discussing the mechanics of the 

current process and the very next day a roundtable on 

shareholder proposals that could vindicate state law rights. 

Although this process was, in my mind, intended to 

inform our judgment the aggressive schedule suggested that it 
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was laying the foundation potentially for a predetermined 

proposal, and so I fear that much of what we learned during 

this process is not contained in the single-option bylaw 

proposal before us today. 

I understand that in the draft we received late 

last night there were additional questions added intended to 

elicit comments in an attempt to be responsive to these 

concerns, and I appreciate those changes very much, although 

I still believe they do not go far enough. 

Instead, today's bylaw proposal approach presents 

an abrupt change to our long-standing proxy process and fails 

to meaningfully discuss or offer alternatives that could 

potentially achieve the same or even better results. 

I have no confidence that this is the only 

direction that we can go, but I fear that the Commission's 

release of a single option proposal forces us in this one 

direction to the exclusion of other potentially viable 

alternatives. 

As I noted a moment ago, proxy access issues have 

historically been challenging to the Commission. We've 

considered similar proposals in the past as recently as in 

2003, as previously been noted, but the Commission has always 

stopped short of endorsing a fundamental change to the rules 

because such change alters the entire construct of our proxy 

rules, has the potential to skirt our careful disclosure 
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regime, touches fundamental notions of corporate governance 

and reaches the federal/state division of responsibility. 

This process has a 60-year history, and given the 

stakes, change has largely been measured and incremental. 

While the bylaw approach is at least theoretically 

intellectually appealing and compelling to me, the release's 

base assumption and practical implication continue to pose 

some real policy concerns. 

One of the key failures of previous proposals in 

this area is that the Commission sought to establish a 

federal access rule that pushed the envelope, in my view, of 

SEC authority into more substantive state law territory and 

also may have been inattentive to disclosure concerns. 

The bylaw proposal before us today attempts to 

address these concerns by hewing to state substantive law and 

by enhancing disclosure requirements for proponents, and 

while I find these considerations meritorious and necessary, 

the release before us still remains flawed. 

As I noted earlier, my view is shaped in part by 

the many views discussed at the roundtables. In these 

roundtables, participants discussed the role of the federal 

government in the proxy process and the important role of the 

states in defining shareholder rights and responsibilities. 

Many participants also described binding proposals 

as the most important shareholder rights, viewing precatory 
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proposals as less important. Still others asserted that 

precatory proposals, though largely a creature of federal not 

state law, constitute important shareholder rights. 

Participants discussed that the precatory process 

has evolved over the years into a process that certain 

shareholders view as important to exercising their voice to 

the company on a range of matters not all of which are 

related to the economic value of the company. 

According to many roundtable participants, it also 

has created a system in many cases whereby proponents use 

precatory proposals to engage management in discussions that 

result in real change. In some cases, these discussions and 

changes are hidden from the view of other shareholders. 

I question whether our proxy rules should be 

facilitating such conduct, and today's single-option proposal 

does not squarely address this condition. 

One over-arching theme I did take from the 

roundtables, however, was the need for caution and careful 

balance in considering any changes we might seek to make. 

And my view is that the bylaw change today is much more of a 

sea change. 

Other roundtable participants also addressed the 

absence of fiduciary responsibilities in non-management 

proponents and the effect this condition might have on other 

shareholders. 
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The single-option proposal, the bylaw proposal 

offered today, announced only today only briefly visits this 

question and only addresses it through disclosure. And 

again, there were many other topics that were discussed, 

including the role in the proxy process of advisory services, 

broker voting, majority voting, empty voting and over-voting. 

The release, in my view, does not seriously address 

many of these considerations, nor does it speak to or take 

stock in some other changes that have been going on in the 

market, including the rise of institutional investors and 

their ability to effect management and the new changes on 

e-proxy as far as bringing down costs for proxy solicitations. 

The natural next step we should be taking in light 

of all the considerations advanced in our fact-finding 

roundtable is, in my view, a release that posits several 

different approaches and seeks comment upon those approaches 

but that also invites different ideas. 

As I noted earlier, I understand that some effort 

was made in the last few hours to elicit such comments 

through questions, but the clear implication of today's 

single-option release is that the option is the preferred 

choice of the Commission. 

And without a more informed discussion it cannot be 

my preference, and I cannot support the narrow bylaw proposal 

in its current form. 
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With that said, I'd like to just further inquire 

from the general counsel regarding the Second Circuit's 

decision. Can you please articulate exactly what the Second 

Circuit found in terms of our need to further explain our 

position? 

MR. CARTWRIGHT: I don't think the Second Circuit 

found anything that was mandatory on the Commission. 

COMMISSIONER CASEY: Okay. 

MR. CARTWRIGHT: The Second Circuit did not accept 

the Commission's long-standing interpretation of existing 

14a-8(i)(8), and therefore at the present time in the Second 

Circuit the Commission's interpretation does not stand. That 

was the conclusion. 

COMMISSIONER CASEY: I'm sorry. Could you repeat 

that? I just couldn't hear you Brian. 

MR. CARTWRIGHT: I'm sorry. And that was the 

outcome of that case. We participated as, in the view of the 

Second Circuit, as an amicus. 

We're not a party, as we would not normally be in 

these circumstances, and they did not choose to adopt the 

view that the Agency propounded and which was consistent with 

the Agency's long-standing position. We lost. 

COMMISSIONER CASEY: I appreciate that. So in your 

view, it was incumbent upon the Commission to do what in 

order to clarify its approach? 
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MR. CARTWRIGHT: Well, that's not strictly a legal 

question, I guess. 

COMMISSIONER CASEY: Okay. 

MR. CARTWRIGHT: If you were asking me what would 

be needed to minimize legal uncertainty, I would say a clear 

Commission rule-making. There's two proposals before the 

Commission today. The outcome, if either of those are 

adopted, will be a much greater clarity than exists at the 

moment where we have a single circuit at variance with the 

position of the Agency. 

And as you know, within particularly what we've 

around here called the long release because it has more pages 

there's a fulsome set of questions. So there's lots of 

possibilities that remain open. 

I think my colleagues in the Division of 

Corporation Finance expressed the view that they would be 

disappointed if the Commission were unable to come to some 

conclusion. 

I think the Chairman has said very forcefully that 

he expects that the Commission will be able to reach a 

rule-making outcome. And if that happens, then we will have 

legal clarity, and the 2008 proxy season will be less 

potentially chaotic than it might otherwise be. 

COMMISSIONER CASEY: Thank you. 

CHAIRMAN COX: Commissioner Atkins. 
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COMMISSIONER ATKINS: I just wanted to follow up on 

that. With respect to the shorter release, I'll just read 

the one sentence of the summary up front. 

"The Commission is publishing its interpretation of 

and proposing amendments to Rule 14a-8(i)(8) to provide 

certainty regarding the meaning of exclusion in that rule." 

So I think there is a significant difference. The 

Second Circuit -- I guess I, sort of, disagree with the 

sweeping conclusion that you came to, Brian. 

But I think they ask for an explanation clearly. 

They parse carefully the deference to be given between an 

amicus and a rule-making. I think we're answering that 

question today in setting it out. 

And I guess my question to the Corporation Finance 

Division is in administering Commission rules do you believe 

that you should follow Commission rules and views, or do you 

think you should be free to disregard those? 

MR. CARTWRIGHT: Can I jump in just to respond for 

half a second before they answer? And that is the Second 

Circuit made it clear in its opinion that it considered the 

ultimate policy decisions in this arena to be the 

Commission's choice, not for the judiciary. 

So that's why the Commission can adopt a new 

revised 14a-8, the old 14a-8. The Commission has a great deal 

of freedom. I didn't mean to suggest anything to the 
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contrary. 

COMMISSIONER ATKINS: Okay. All right. And as to 

the explanation that they were looking for, I think that's 

being provided. 

But I guess my question is in view of the action 

that I guess we're going to take today, would you follow 

Commission interpretation in administering our rules? 

MR. WHITE: We would follow Commission 

interpretations. 

COMMISSIONER ATKINS: Okay. Thanks. 

CHAIRMAN COX: Is there any further question or 

discussion? If not, we'll move to the vote. 

Having designated these to everyone's satisfaction 

as the long release and the short release, the question will 

occur first on the long release. All those in 

favor? 

(Chairman Cox and Commissioners Campos and Nazareth 

voted in favor. Commissioners Atkins and Casey voted 

against.) 

And the recommendation is approved. 

The question next is on the short release. All 

those in favor? 

(Chairman Cox and Commissioners Atkins and Casey 

voted in favor. Commissioners Campos and Nazareth voted 

against.) 
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And the recommendation is approved. There being no 

further business to come before the meeting, the meeting is 

adjourned. Thank you all for a long day. 

(Whereupon, at 2:50 p.m., the meeting was 

concluded.) 

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