On January 22, 2003, the Securities and Exchange Commission ("SEC"), pursuant to Section 802 of the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley"), adopted Rule 2-06 under Regulation S-X ("Rule 2-06"), which will require accounting firms to retain for seven years certain records relevant to their audits and reviews of issuers' financial statements. [1] Rule 2-06 extends the five-year retention period proposed by the SEC in November 2002. [2] The longer retention period will be consistent with the forthcoming auditing standards from the Public Company Accounting Oversight Board (the "PCAOB").

Compliance with Rule 2-06 will be required for audits and reviews completed on or after October 31, 2003.

Documents Covered

Rule 2-06 will require an accountant to retain "records relevant to the audit or review," [3] including workpapers and other documents that form the basis of the audit or review of an issuer's financial statements, and memoranda, correspondence, communications, other documents, and records (including electronic records) that meet two criteria. The two criteria are that the materials:

• are created, sent or received in connection with the audit or review, and
• contain conclusions, opinions, analyses, or financial data related to the audit or review.

Non-substantive materials that are not part of the workpapers, such as administrative records, and other documents that do not contain relevant financial data or the accountant's conclusions, opinions or analyses will not meet the second criterion and will not have to be retained. In the Final Release, the SEC indicated that the following types of documents generally would not fall within the retention requirements of Rule 2-06, provided they do not contain information or data, relating to a significant matter, that is inconsistent with the accountant's final conclusions, opinions or analyses on that matter or the audit or review:

• Superseded drafts of memoranda, financial statements or regulatory filings;
• Notes on superseded drafts of memoranda, financial statements or regulatory filings that reflect incomplete or preliminary thinking;
• Previous copies of workpapers that have been corrected for typographical errors or errors due to training of new employees;
• Duplicates of documents; or
• Voice-mail messages

In addition, an issuer's financial information, records, databases, and reports that are examined on the issuer's premises, but are not made part of the accountant's workpapers or retained by the accountant, would not be deemed "received" by the accountant in connection with the audit or review, and need not be retained.

Workpapers Defined; Differences Of Opinion

Rule 2-06 will require an accountant to retain "workpapers and other documents." Both Section 802 and Rule 2-06 are intended to require the retention of more than what traditionally has been thought of as an accountant's "workpapers." Generally accepted auditing standards ("GAAS") do not use the specific term "workpapers." Rule 2-06 will define "workpapers" as "documentation of auditing or review procedures applied, evidence obtained, and conclusions reached by the accountant in the audit or review engagement, as required by standards established or adopted by the [SEC] or the [PCAOB]." The SEC based this definition on the following language from Statement on Auditing Standards ("SAS") No. 96, "Audit Documentation": "Audit documentation is the principal record of the auditing procedures applied, evidence obtained, and conclusions reached by the auditor." Rule 2-06 will not mandate the specific workpapers to be retained. The PCAOB, subject to SEC oversight, will have the ability to review and change the nature and scope of the required documentation of procedures, evidence, and conclusions related to audits and reviews of financial statements.

SAS No. 96 states that workpapers generally serve to provide the principal support for an auditor's report and to aid the auditor in the conduct and supervision of the audit. The SEC originally proposed that retained materials include not only those that support an accountant's conclusions about the financial statements but also those materials that may "cast doubt" on those conclusions. The SEC received several comments on this point, including that it was "unworkable" and would lead accountants to retain documents related to virtually every exchange of ideas on any topic. Commenters argued that it would also deter accountants from asking legitimate questions. Therefore, the "cast doubt" language has been replaced in Rule 2-06 with a requirement to keep records that either support the accountant's final conclusions or "contain information or data, relating to a significant matter, that is inconsistent with the auditor's final conclusions regarding that matter or the audit or review." Rule 2-06 will require that the accountant retain documents and records documenting a consultation on or resolution of differences in professional judgment.

The phrase "significant matter" is intended to refer to the documentation of substantive matters that are important to the audit or review process or to the financial statements of the issuer or registered investment company. While the SEC references SAS No. 96 for its discussion of the meaning of "significant," the SEC warns that the term is broader than the SAS No. 96 definition. The accountant's subjective determination of "significant" is not determinative. The more "objective test" of what may be significant to a reasonable investor should be applied in evaluating whether information is "significant."

Which Issuers?

As mandated by Sarbanes-Oxley, Rule 2-06 will require retention by accountants of the applicable documents of "issuers," as defined under Section 10A(f) of the Securities Exchange Act of 1934 (the "Exchange Act"), which was added by Sarbanes-Oxley. A Section 10A(f) issuer is a company with a class of securities registered under Section 12 of the Exchange Act, or that is required to file reports pursuant to Section 15(d) of the Exchange Act, or that files or has filed a registration statement that has not yet become effective under the Securities Act of 1933 and has not been withdrawn. In addition, Rule 2-06 will apply to audits and reviews of the financial statements of registered investment companies, which was not required by Sarbanes-Oxley. In the Final Release, the SEC states that it believed it to be important that the record retention requirements apply consistently to all registered investment companies, regardless of whether they fall within the periodic reporting requirements of the Exchange Act.

Neither Section 802 of Sarbanes-Oxley nor Rule 2-06 exempt accountants for foreign issuers. Therefore, the retention requirements will apply to domestic and foreign accounting firms conducting audits or reviews of foreign issuers' financial statements. The SEC noted in the Final Release that although foreign commenters had indicated that the requirement would impose more layers of retention requirements on these firms, none of the commenters had identified any direct conflict with foreign auditing requirements. The SEC and the PCAOB (when operational) will engage in further discussions to address the issues raised by certain foreign commenters regarding the PCAOB's oversight role and the access to records afforded to the SEC and PCAOB by Sarbanes-Oxley.

In the Proposing Release, the SEC had asked for comment on whether the application of Rule 2-06 should be extended to audits or reviews of the financial statements of registered investment advisers and broker-dealers that are not necessarily issuers or possibly to all issuers, whether or not they meet the requirements of Section 10A(f). The SEC had also asked whether similar document retention obligations should be extended to the issuers themselves and not just their accountants. Final Rule 2-06 will not apply to any of these entities. The SEC, however, cautioned that by not extending Rule 2-06 to such entities, it was not condoning more liberal document destruction policies for such entities, but expects them to retain relevant audit and review records in compliance with applicable laws and professional standards.

Retention Period

The retention period in Rule 2-06 will be seven years from the conclusion of the audit or review. It is not based on the fiscal period covered by the financial statements being audited or reviewed. The SEC increased the time period from five years as initially proposed to avoid inconsistency and confusion with the seven-year period prescribed for the PCAOB in Section 103 of Sarbanes-Oxley although the SEC recognized that there may be fewer documents required to be retained pursuant to Section 103.