In our audit of the fiscal year 2004 financial statements for SEC, we found the financial statements as of and for the fiscal year ended September 30, 2004, including the accompanying notes, are presented fairly, in all material respects, in conformity with U.S. generally accepted accounting principles; SEC did not have effective internal control over financial reporting (including safeguarding of assets), but had effective control over compliance with laws and regulations that could have a material effect on the financial statements as of September 30, 2004; and no reportable noncompliance with laws and regulations we tested. We issued an unqualified, or clean, opinion on the SEC’s financial statements. This means that the financial statements and accompanying notes present fairly, in all material respects, SEC’s financial position as of September 30, 2004, and, as well, certain other financial information that the statements must provide: net cost, changes in net position, budgetary resources, financing, and custodial activities for the year then ended. We also found that the statements conform to U.S. generally accepted accounting principles. In order to reach our conclusions about the financial statements, we (1) tested evidence supporting the amounts and disclosures in the financial statements, (2) assessed the accounting principles used and significant estimates made by management, and (3) evaluated the presentation of the financial statements. We found three material weaknesses in internal control and thus issued an adverse opinion on internal control—stating that SEC management did not maintain effective internal control over financial reporting and the safeguarding of assets as of September 30, 2004. Internal control over financial reporting consists of an entity’s policies and procedures that are designed and operated to provide reasonable assurance about the reliability of that entity’s financial reporting and its process for preparing and fairly presenting financial statements in accordance with generally accepted accounting principles. It includes policies and procedures for maintaining accounting records, authorizing receipts and disbursements, and the safeguarding of assets. Because SEC makes extensive use of computer systems for recording and processing transactions, SEC’s financial reporting controls also include controls over computer operations and access to data and computing resources. Our opinion on SEC’s internal control means that SEC’s internal control did not reduce to a relatively low level the risk that misstatements material to the financial statements may occur and go undetected by employees in the normal course of their work. This conclusion on SEC’s internal controls did not affect our opinion on SEC’s financial statements. This is because during the audit process SEC made the adjustments identified during the audit as necessary for the fair presentation of its financial statements. However, the weaknesses we found could affect other, unaudited information used by SEC for decision making. Our evaluation of internal control covered SEC’s financial reporting controls which also cover certain operational activities that result in SEC’s financial transactions, such as activities pertaining to stock exchange transaction fees, public-filing fees, maintaining disgorgements and penalties receivable, payroll-related transactions, and others. We also tested SEC’s compliance with selected provisions of laws and regulations that have a direct and material impact on the financial statements. For example, we tested for compliance with sections of the Securities Exchange Act of 1934, as amended, that requires SEC to collect fees from the national securities exchanges and the National Association of Securities Dealers based on volume of stock transactions, and sections of the Securities Act of 1933, as amended, that requires SEC to collect fees from registrants for public filings. Our tests found no instances of noncompliance that are reportable. We also found that SEC maintained, in all material respects, effective internal control over compliance. I would now like to discuss in detail the three material internal control weaknesses we found during our audit. We found that SEC did not have formalized processes or documentation for the procedures, systems, analysis of accounts, and personnel involved in developing key balances and preparing the financial statements and related disclosures. As I will discuss later, this issue is compounded by SEC’s limitations with its financial management system. Also, SEC did not have formalized quality control or review procedures. As a result, we identified errors in the beginning asset and liability balances and in the September 30, 2004, draft financial statements prepared by SEC management, that if had not been corrected, would have resulted in materially misleading operating results for fiscal year 2004. SEC’s lack of formalized processes, documented procedures, and quality assurance checks, significantly delayed the reporting of fiscal year 2004 financial results, consumed significant staff resources, caused audit inefficiencies, and resulted in higher financial statement preparation and audit costs. I would like to highlight the following items we found: SEC did not have documentation providing an explanation or a crosswalk between the financial statements and the source systems, general ledger accounts, account queries, and account analyses. SEC did not maintain a subsidiary ledger for certain activities, such as customer deposit amounts pertaining to filing fees. Accounting staff had difficulty in retrieving support for certain account balances, such as undelivered-order amounts, and for certain property and equipment leases. Reconciliations of detail and summary account balances were not prepared for certain financial statement line items, such as for the customer deposit liability relating to filing fees and the associated earned filing fee revenue; the accounts receivable related to exchange fees and the related amount of earned exchange fee revenue; and the budgetary accounts related to undelivered and delivered orders, thus requiring SEC staff to create an audit trail after the fact. There also was no consistent evidence of supervisory review of journal entries, including closing and adjusting journal entries made in connection with preparing quarterly and year-end financial statements. Comprehensive accounting policies and procedures were still in draft or had not yet been developed for several major areas related to financial statements, including disgorgements and penalties, filing fees, exchange fees, and fixed asset capitalization. GAO’s Standards for Internal Control in the Federal Government requires that controls over the financial statement preparation process be designed to provide reasonable assurance regarding the reliability of the balances and disclosures reported in the financial statements and related notes in conformity with generally accepted accounting principles, including the maintenance of detailed support that accurately and fairly reflect the transactions making up the balances in the financial statements and disclosures. In addition, an effective financial management system includes policies and procedures related to the processing of accounting entries. SEC’s difficulties in the area of financial statement preparation are exacerbated because SEC’s financial management system is not set up to generate the user reports needed to perform analyses of accounts and activity on a real-time basis leading to SEC’s staff-intensive and time- consuming efforts to prepare financial statements. Because SEC does not maintain standard schedules for producing certain basic reports of account detail for analysis, users have to request reports generated on an ad hoc basis by a software application whose operations are known only to some SEC staff. Also, as I will discuss in more detail later, not all of SEC’s systems used for tracking and recording financial data are integrated with the accounting system. Federal agencies preparing financial statements are required to develop a financial management system to prepare a complete set of statements on a timely basis in accordance with generally accepted accounting principles. The financial statements should be the product of an accounting system that is an integral part of an overall financial management system with structure, internal control, and reliable data. Office of Management and Budget Circular No. A-127, Financial Management Systems, requires that each agency establish and maintain a single integrated financial management system—basically a unified set of financial systems electronically linked for agencywide support. Integration means that the user is able to obtain needed information efficiently and effectively from any level of use or access point. (This does not necessarily mean having only one software application covering all financial management system needs or storing all information in the same database.) Interfaces between systems are acceptable as long as the information needed to enable reconciliation between the systems is accessible to managers. Interface linkages should be electronic unless the number of transactions is so small that it is not cost beneficial to automate the interface. Reconciliations between systems, where interface linkages are appropriate, should be maintained to ensure data accuracy. To support its financial management functions, SEC relies on several different systems to process and track financial transactions that include filing and exchange fees, disgorgements and penalties, property and equipment, administrative items pertaining to payroll and travel, and others. Not all of these systems are integrated with the accounting system. For example, the case-tracking system and the spreadsheet application used to account for significant disgorgement and penalty transactions and the system used to account for property and equipment are not integrated with the accounting system. Without a fully integrated financial management system, SEC decision makers run the risk of delays in attaining relevant data or using inaccurate information inadvertently while at the same time dedicating scarce resources toward the basic collection of information. A properly designed and implemented financial statement preparation and reporting process (which encompasses the financial management system) should provide SEC management with reasonable assurance that the balances presented in the financial statements and related disclosures are materially correct and supported by the underlying accounting records. To address the issues related to SEC’s financial statement preparation and reporting processes, we recommended that SEC take the following 13 actions to improve controls over the process. 1. Develop written policies and procedures that provide sufficient guidance for the year-end closing of the general ledger as well as the preparation and analysis of quarterly and annual financial statements. 2. Establish clearly defined roles and responsibilities for the staff involved in financial reporting and the preparation of interim and year-end financial statements. 3. Prepare a crosswalk between the financial statements and the source systems, general ledger accounts, and the various account queries and analyses that make up key balances in the financial statements. 4. Maintain subsidiary records or ledgers for all significant accounts and disclosures so that the amounts presented in the financial statements and footnotes can be supported by the collective transactions making up the balances. 5. Perform monthly or periodic reconciliations of subsidiary records and summary account balances. 6.