The primary mission of the SEC is to protect investors and maintain the integrity of the securities market. The Securities Act of 1933 requires that, prior to the offering or sale of securities, the issuer must register the securities offering with the SEC by filing a registration statement. The registration statement must contain financial and other material information concerning the securities and the issuer. Following the securities’ registration, the Securities Exchange Act of 1934 requires that the issuer make periodic filings disclosing its financial status and changes in condition. For example, issuers must file annual reports containing financial statements, which must be prepared in conformity with GAAP and audited by independent public accountants. During fiscal year 2000, the SEC received over 14,000 registrants’ filings. The SEC reviews selected issuers’ filings to ensure compliance with accounting and disclosure requirements. The SEC has enforcement authority under federal securities laws to take legal action against companies that do not comply with the securities laws. SEC’s critical role to protect investors’ interests has been made even more challenging with the significant changes in the global economy and capital markets over the past few years. The current business environment is characterized by a globalized, highly competitive economy; explosive growth in the development and use of technology; expansion in the number of public companies; and the unprecedented growth and in some cases subsequent decline in the market value of those securities. Furthermore, growth in equity values has placed tremendous pressure on public companies’ management to reach earnings or other performance targets and to meet or exceed the earnings expectations of the security analysts and investors. Missing these targets may cause a significant decline in a security’s market value and reduce management’s compensation in those cases when it is tied to achieving target earnings and/or stock market prices. Several major instances of misstated earnings have resulted in massive declines in the values of the affected companies. Recently, the SEC has become increasingly concerned with the inappropriate use of GAAP and the resulting effect on reported earnings and, in some cases, has required companies to restate their earnings. The SEC’s DCF oversees the disclosure of information, which is required by federal securities laws, to the investing public. DCF’s staff routinely reviews the disclosure documents filed by public companies with SEC and consults with OCA to resolve issues arising from the review of registrants’ filings. OCA is the SEC’s principal advisor on accounting and auditing matters. OCA also reviews registrants’ specific accounting treatment of complex issues as a result of prefiling inquiries from the registrants themselves. OCA encourages registrants to consult on those financial reporting and auditing issues that involve unusual, complex, or innovative transactions for which no clear authoritative guidance exists. As the SEC’s principal advisor on accounting and auditing matters, OCA provides rulemaking and interpretation initiatives that supplement private sector accounting standards and provide implementation guidance for financial disclosure requirements. OCA provides general interpretive and accounting advice through interpretive releases and letters, staff accounting bulletins, responses to telephone inquiries, speeches, and active participation with the standard-setting bodies. Under the Securities Exchange Act of 1934, the SEC has specific authority to establish accounting and reporting standards as part of its mandate to administer and enforce the provisions of the federal securities laws. Soon after its creation, the SEC decided to rely on accounting standards established in the private sector as long as such standards had substantial authoritative support. Since 1973, the Financial Accounting Standards Board (FASB) has been the designated organization in the private sector that establishes standards for financial accounting and reporting. The SEC officially recognizes GAAP standards established by FASB as authoritative. As such, the SEC requires compliance with GAAP in the presentation of financial statements. FASB’s deliberations are open to the public, and its standards are subject to public exposure and comment prior to issuance. The SEC is involved in establishing accounting standards through the oversight of, and close working relationship with FASB, and other professional standard-setting bodies. The SEC is also involved in establishing accounting standards through the adoption of rules and publication of interpretive guidance. Rules and interpretive releases, such as in the Codification of Financial Reporting Policies and Regulation S-X of the SEC, have an authority similar to pronouncements by FASB for SEC registrants. The SEC staff issues Staff Accounting Bulletins that represent interpretive guidance and practices followed by DCF and OCA in administering the disclosure requirements of the SEC. The SEC has relied on generally accepted auditing standards (GAAS) promulgated by the AICPA’s Auditing Standards Board (ASB) as the standard for independent audits. ASB’s deliberations are open to the public, and its standards are subject to public exposure and comment prior to issuance. The SEC monitors the structure, activity, and decisions of not only FASB, but also FASB’s Emerging Issues Task Force (EITF). EITF was formed in 1984 to provide timely financial reporting guidance on emerging issues before divergent practices became widespread and entrenched. Task force members are drawn primarily from public accounting firms but also include representatives of industry. The Chief Accountant of the SEC or his designee attends EITF meetings regularly as an observer and participates in the discussions, but does not have a vote. If the group reaches a consensus on an issue, generally FASB takes this as an indication that no further board action is needed. If no EITF consensus is possible, it may be an indication that action by FASB is necessary. EITF proceedings are documented in EITF Abstracts. The SEC staff and FASB and EITF members work together in an ongoing effort to improve the standard-setting process and to respond to various regulatory, legal, and business changes promptly and appropriately. In carrying out its responsibilities, OCA works with the private sector accounting profession, including the AICPA SEC Practice Section and the AICPA SEC Regulations Committee. The AICPA SEC Practice Section is part of the profession’s self-regulatory system, with a goal of protecting the public interest by improving the quality of CPA firms’ practice before the SEC. The AICPA SEC Practice Section establishes requirements for member firms and has a program to monitor those requirements. Member requirements include adhering to quality control standards and submitting to a peer review of each firm’s accounting and auditing practice every 3 years. The AICPA SEC Regulations Committee is part of the AICPA SEC Practice Section that acts as the primary liaison between the profession and the SEC on technical matters relating to SEC rules and regulations. The AICPA SEC Regulations Committee provides input to the SEC on accounting and auditing matters and communicates important SEC developments to its AICPA members. The AICPA SEC Regulations Committee includes accounting firms that belong to the AICPA SEC Practice Section as well as members from academia and industry. To fulfill our objectives, we interviewed officials and professional staff members from the SEC’s OCA. We reviewed relevant policies and procedures, including the Protocol for Registrant Submissions to OCA (effective December 1999) and OCA’s Policies for Handling Registrants Matters (dated August 2000). We focused on the procedures and controls employed by the SEC for resolving registrants’ prefiling accounting issues and issues on filings in which DCF consults with OCA. To gain an understanding of OCA’s procedures and the controls employed by the SEC throughout the process, we reviewed OCA’s case files of written submissions from registrants and their auditors. Although we reviewed cases to gain an understanding of the SEC’s process and the related issues, we did not perform testing to evaluate whether the SEC properly implemented its procedures throughout its caseload, nor did we evaluate the SEC’s final accounting positions on the cases that we reviewed. We interviewed representatives from the AICPA’s SEC Practice Section and SEC Regulations Committee, FASB’s EITF, and several CPA firms. We also interviewed representatives from Financial Executives International (FEI) and its Committee on Corporate Reporting. FEI is a professional association of senior financial executives, with many members from SEC registrant companies, which communicates its members’ views on emerging issues to standard-setting bodies and legislators. We also interviewed representatives from SEC registrant companies to obtain their views on the SEC’s process for handling accounting issues. We conducted our work from December 2000 through May 2001, in accordance with generally accepted government auditing standards. We requested comments from the SEC, the AICPA SEC Practice Section, the AICPA SEC Regulations Committee, and FEI. We received written comments and technical comments from the SEC and the AICPA. FEI advised us that they did not have official comments on this report. The SEC’s and the AICPA’s written comments are discussed in the “Agency Comments and Our Evaluation” section of this report and are reprinted in appendixes I and II. We incorporated the technical comments provided by the SEC and the AICPA throughout this report as appropriate. OCA receives both prefiling and active filing accounting issues for review through oral inquiries and written submissions from registrants and their auditors and from DCF. Oral inquiries received by OCA involve broad issues that are often not registrant specific. Registrants or their auditors can call OCA to ask prefiling accounting questions. Oral inquiries and OCA’s responses are considered informal and therefore not binding for a subsequent filing. Oral inquiries are sometimes done on a “no-name” basis, whereby the registrants or their auditors telephone OCA to ask questions without giving their names. However, OCA encourages registrants or their auditors to put accounting inquiries in writing to ensure a clear understanding of the facts, especially those involving complex, unusual, or innovative transactions for which no clear authoritative guidance exists.