-
Report of the Financial
Stability Board to G20 Finance Ministers and Central Bank
Governors
-
Managed Funds Association
Comments on Section 929X of the Dodd-Frank
from the
Managed Funds Association
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SEC has approved the new 8
Auditing Standards of the PCAOB
Dear Member,
We have some interesting developments.
First, the
Report of the Financial Stability Board
to G20 Finance Ministers and Central Bank Governors,
covering the
progress in the Implementation of the G20
Recommendations for Strengthening Financial Stability.
It provides an overview of work
underway to implement the G20 recommendations for
strengthening financial stability.
It focuses on international policy development and
implementation that has taken place since the G20 Seoul Summit
in November 2010.
Second,
we have interesting comments from the
Managed Funds Association,
on
Section 929X of the Dodd-Frank.
Third,
the
proposed PCAOB Rules on Auditing Standards Related
to the Auditor’s Assessment of and Response to Risk and Related
Amendments to PCAOB Standards have been
approved by the SEC, and one more time,
Sarbanes Oxley professionals have new
exciting business opportunities.
The Sarbanes Oxley amendment in the Dodd Frank Act,
and the new 8 Auditing Standards that improve the risk management
framework and ask more from auditors and risk managers, make
Sarbanes Oxley knowledge and experience even more valuable.
Become a Member and Receive the New Member Orientation
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Progress
in the Implementation of the G20 Recommendations for
Strengthening Financial Stability
Report of the Financial Stability Board
to G20 Finance Ministers and Central Bank Governors
Implementation of reforms to bank capital
and liquidity standards
Following the endorsement by the
G20 Leaders of the Basel III package
of capital and liquidity reforms at the November Seoul summit,
the Basel Committee issued the Basel III rules text on 16
December 2010.
All members will now put in
place the necessary regulations and/or legislation to
implement the Basel III framework on 1 January 2013, such that
it can be fully phased in by 1 January 2019.
The Committee will closely observe the impact and
behaviour of the liquidity ratios, the rules for which include a
review clause to address any unintended consequences.
The observation period
will be used to monitor the impact of the standards on smaller
institutions versus larger ones, and on different business
lines, especially focusing on the impact on retail versus
wholesale business activities; the
observation period for the Liquidity Coverage ratio began on 1
January 2011.
Final changes to the Liquidity Coverage Ratio (LCR)
would be made by mid-2013 and to
the Net Stable Funding Ratio (NSFR) by
mid-2016.
The LCR, including any revisions, will be introduced
on 1 January 2015. The NSFR, including any revisions, will move
to a minimum standard by 1 January 2018.
Basel III also includes a simple leverage ratio,
the transition period for which began on 1 January 2011 and
includes a supervisory monitoring period and a parallel run
period.
The supervisory monitoring period will focus on
developing templates to track in a consistent manner the
underlying components of the agreed definition and resulting
ratio.
The parallel run period
commences on 1 January 2013 and runs until 1 January 2017.
During this parallel run period, the Committee will
assess whether the proposed design and calibration of the
minimum Tier 1 leverage ratio of 3% is appropriate over a full
credit cycle and for different types of business models. Bank
level disclosures of the leverage ratio and its components will
start on 1 January 2015.
Based on the results of the parallel run period, any
final adjustments to the definition and calibration of the
leverage ratio will be carried out in the first half of 2017,
with a view to migrating to a Pillar 1 treatment on 1 January
2018 based on appropriate review and calibration.
In November 2010, the G20
recommended that the Basel Committee evaluate the impact of
regulatory regimes on trade finance, with an emphasis on low
income countries.
The BCBS asked its Policy Development Group to carry
this work forward, in close cooperation with the BIS.
At its February meeting, the PDG invited a number of
interested constituents to give a presentation on the trade
finance topic.
The BCBS will finalise its recommendations in this
area in time for the November 2011 G20 Leaders Summit.
Addressing
systemically important financial institutions (SIFIs)
At the November 2010 Summit, the G20 Leaders
endorsed the policy framework, work processes and timelines set
out in the FSB report “Reducing the moral
hazard posed by systemically important financial institutions”
and encouraged the FSB and standard setting bodies to complete
their remaining work in accordance with the endorsed work
processes and timelines in 2011 and 2012.
The report set out a policy framework for addressing
the moral hazard risks associated with SIFIs whose disorderly
failure, because of their size, complexity and systemic
interconnectedness, would cause significant disruption to the
wider financial system and economic activity.
The framework combines:
- a resolution framework and other measures to
ensure that all financial institutions can be resolved safely,
quickly and without destabilising the financial system and
exposing the taxpayer to the risk of loss;
- a requirement that SIFIs and initially in
particular global SIFIs (G-SIFIs) have higher loss absorbency
capacity to reflect the greater risks that these institutions
pose to the global financial system;
- more intensive supervisory oversight for
financial institutions which may pose systemic risk;
- robust core financial market infrastructures to
reduce contagion risk from the failure of individual
institutions and
- other supplementary prudential and other
requirements as determined by the national authorities.
The FSB will establish a Peer Review Council
within the FSB to assess national G-SIFI policy implementation.
This will be based on an evaluation framework for the
application and review of G-SIFI policies to be set out by the
FSB, in consultation with the standard-setters, by end-2011.
The initial reviews will take place at end-2012.
G-SIFI determination and
loss absorbency
The BCBS is finalising its
methodology to assist in determining the globally
systemically important banks.
The BCBS presented a provisional methodology to the
FSB in December.
Based on feedback from the Group of Governors and
Heads of Supervision, the Committee’s oversight body, and from
the FSB, the Committee is amending this methodology to better
capture global activities, and to strengthen the measurement of
interconnectedness, substitutability and complexity.
Following a data collection exercise conducted in
January 2011, the methodology is currently being revised and
will be reviewed by the Committee at its meeting on
8-9 March.
The IAIS also provided to the FSB in January 2011 a
status report on a preliminary methodology to assess systemic
importance of insurers and expects to provide details of the
preliminary methodology to the FSB in March.
The finalised methodologies will be sent to the FSB as
input to the determination by the FSB and national authorities
by mid-2011 of those institutions to which the FSB G-SIFI
recommendations will initially apply.
In Seoul, the G20 Leaders endorsed
“a requirement that SIFIs and initially
in particular financial institutions that are globally systemic
(G-SIFIs) should have higher loss absorbency capacity to reflect
the greater risk that the failure of these firms poses to the
global financial system.”
The FSB, in consultation with the standard setters,
will recommend the additional degree of loss absorbency and the
instruments by which these can be met by end-2011.
The BCBS is developing a framework to assess the
magnitude of additional loss absorbency that G-SIFIs should
maintain.
The Committee will review this methodology at its
March meeting and expects to complete its study of the magnitude
of additional loss absorbency by mid-2011.
The IAIS will provide input to the FSB on what
measures could be applied to insurers identified as G-SIFIs,
taking into account the differences in characteristics of
business models between insurers and banks.
Proposals for G-SIFIs’
additional loss absorbency will be sent for public
consultation during the second half of 2011, before the end-2011
recommendations are made.
Resolution tools and
regimes
The FSB SIFI report endorsed at Seoul recommended
that “All jurisdictions should undertake
the necessary legal reforms to ensure that they have in place a
resolution regime which would make feasible the resolution of
any financial institution without taxpayer exposure to loss from
solvency support while protecting vital economic functions
through mechanisms which make it possible for shareholders and
unsecured and uninsured creditors to absorb losses in their
order of seniority.”
A comprehensive work programme is underway to set out the essential
features and tools that national resolution regimes for
financial institutions, including non-bank financial
institutions, should have to meet these objectives (Key
Attributes of Effective Resolution Regimes).
These will identify the essential resolution tools and
powers, including: sector-specific attributes of resolution
regimes that are necessary to protect depositors, policy holders
and investors, as well as restructuring mechanisms, which may
include contractual and/or statutory debt-equity conversion and
write-down tools; critical framework conditions for effective
cross-border cooperation and information sharing in managing and
resolving a distressed financial institution; essential elements
of institution-specific cross-border cooperation agreements;
essential elements of recovery and resolution plans (RRPs); and
criteria for authorities to assess the resolvability of
individual institutions.
In developing these Key
Attributes the FSB is drawing on sector-specific work of
the BCBS, IAIS, IOSCO, IADI and further technical work that is
underway, as well as the changes that are currently underway or
have recently been implemented at national and regional levels.
A FSB Steering Group on Resolution is coordinating this work and
will prepare a draft of the Key Attributes by mid-2011 which
should be finalised by the end of the year.
The
BCBS Cross-Border Bank
Resolution Group is conducting a
survey on national resolution regimes and tools and will
report the preliminary results of this stock-take in mid-2011.
The objective is to assess progress against the March
2010 Recommendations on Cross-border Bank Resolution and to
assess the legislative and other changes to national resolution
regimes and policies needed to accomplish effective resolution
of SIFIs.
The IAIS adopted the Standard on Cross-border
Cooperation on Crisis Management in October 2010 and is
currently developing an issues paper on resolution of
cross-border insurance legal entities and groups, which it aims
to complete by April 2011.
The FSB Cross-border Crisis Management Group (CBCM)
is assessing progress in the work of the institution-specific
Crisis Management Groups, and will formulate criteria for
authorities to assess the resolvability of SIFIs and identify
the essential elements for RRPs. It will present a
report on its work to the FSB Plenary by mid-2011 and report on
progress in the development of RRPs for G-SIFIs in
Q4 2011.
An FSB Working Group on Bail-in is examining the
legal and operational aspects of contractual and statutory
bail-ins, as well as the marketability and other issues bearing
on the viability of these instruments.
Its objective is to identify the statutory framework
conditions and legal procedures that would be needed for an
effective implementation of statutory and contractual bail-in in
the national context and in the context of cross-border group
structures of SIFIs and for bail-in to serve as a
loss-absorption instrument and resolution tool. The Group will
present a report on its work to the FSB in Q2 2011.
As the work on resolution progresses, the FSB will in
the course of 2011 undertake consultations with market
participants and private sector experts.
Supervisory intensity and
effectiveness
Standard setters and national supervisors are
addressing the recommendations of the FSB’s November 2010 report
on “Intensity and Effectiveness of SIFI Supervision”.
National banking supervisors
are self-assessing their compliance with the BCBS core
principles covering mandates, powers, resources and independence
which create the foundation for effective supervision. The
self-assessments will be sent to the FSB by June 2011.
Supervisory agencies in many countries are
addressing shortcomings in their supervisory frameworks. This
will be enhanced by work which is underway co-operatively
between the BCBS and FSB to assess changes supervisors are
making to their supervisory tools and methods.
BCBS, IAIS and IOSCO are tightening their core
principles, implementation standards and assessment
methodologies and criteria to provide enhanced guidance to
supervisors and more support to assessors including IMF/World
Bank FSAP assessments. BCBS will report on its work in this area
to the FSB by end-2011.
Shadow Banking
At the November 2010 Seoul Summit, in view of the
completion of the new capital standards for banks (Basel III),
the G20 Leaders recognised the potential for regulatory
tightening to increase the incentives for business to migrate to
the shadow banking system and for the need to close regulatory
gaps.
They requested that the FSB, in collaboration with
other international standard setting bodies, develop
recommendations to strengthen the regulation and oversight of
‘the shadow banking system’ by mid-2011.
In response to this request the FSB organised a
workshop of experts hosted by the UK FSA on 6 December 2010 to
exchange views on the shadow banking systems.
The FSB has since formed a task force to draft a
scoping paper that will
(i) clarify what is meant by “the shadow banking
system (SBS)”,
(ii) set out potential approaches for a monitoring
framework around shadow banking and
(iii) develop a range of options for discussion
setting out possible regulatory measures to address the issues
posed by shadow banking, including the possibility for both
regulation of shadow banking directly and regulation of banks’
interactions with the shadow banking system.
Based on the work of the task force, the FSB will
develop initial recommendations by
mid-2011 and submit recommendations to the G20 in autumn.
Shadow banking is inherently complex as it mutates over time and
varies across jurisdiction. The FSB will continue its work on
this complex issue in the second half of 2011.
Improving the OTC and
commodity derivatives markets
The G20 Leaders’ Declarations from the Seoul,
Toronto and Pittsburgh summits, and
the FSB’s recommendations,
made in its October 2010 report on Implementing OTC Derivatives
Market Reforms, set out actions and
timelines for achieving reforms in the OTC derivatives markets.
Work is now underway nationally
and regionally to implement these reforms.
At the Seoul Summit, the G20 also asked the FSB to
consider what future work may be needed on commodities
derivatives.
The FSB is monitoring the progress being made in
international fora and jurisdictional implementation of reforms
in the OTC derivatives market.
The bodies responsible for carrying out the actions
recommended by the FSB to implement reforms - CPSS and IOSCO, as
well as the OTC Derivatives Supervisors Group and OTC
Derivatives Regulators Forum - are providing an assessment of
progress to the FSB.
IOSCO recently published its analysis of exchanges and
electronic platforms for derivatives trading. IOSCO and CPSS are
currently drafting a report which will set out:
(1) minimum data reporting requirements and
standardised formats for derivatives contracts; and
(2) the methodology and mechanism for the aggregation
of derivatives data on a global basis.
The report will cover reporting requirements for both
for market participants reporting to trade repositories and for
trade repositories reporting to the public and to regulators for
the purpose of macro- and micro-surveillance. In addition,the
CPSS and IOSCO will publish by April 2011 a consultative report
on standards for financial market infrastructures, both as this
relates to payment and securities settlement and to central
counterparties in the OTC derivatives markets.
The FSB will consider these inputs and also analyse
FSB member questionnaire responses and report on international
and jurisdictional implementation progress to the G20 Finance
Ministers and Central Bank Governors in April.
The FSB is also
considering
whether further recommendations may be needed to carry out the
G-20 commitments to exchange or electronic platform trading,
central clearing and reporting of OTC derivatives transactions
to trade repositories.
One issue to be addressed is ensuring fair and open
access, both direct and indirect, to OTC derivatives CCPs.
As implementation progresses, inconsistencies may give
rise to opportunities for regulatory arbitrage.
The FSB will be vigilant in monitoring emerging risks
and reporting to the G20 any areas where action needs to be
taken.
Active analysis of transparency and oversight of
the commodity derivatives market is also underway.
A joint report of the IEA, IEF, IOSCO and OPEC on the
assessment of oil spot market prices by oil price reporting
agencies, and how this affects the
transparency and functioning of oil markets, will be considered
by the FSB and reported to G20 Finance Ministers and Central
Bank Governors in April.
In a separate workstream, IOSCO will develop standards
of best practice for the regulation and supervision of commodity
derivatives markets, taking into account recent regulatory
experience in the areas of contract design and market
surveillance.
While this report will put particular emphasis on oil
commodity markets in light of the G20’s interest in this area,
recommendations are expected to be of broad application to
financial commodity markets, including agricultural-based
contracts.
The FSB will consider recommendations regarding
commodity derivatives market regulation and supervision in the
context of the agreed reforms to OTC derivatives markets more
generally, and IOSCO will deliver a final report on supervision
and regulation of commodity derivatives markets by the fall.
Developing macroprudential
frameworks and tools
At their meeting in Seoul in November 2010, G20
Leaders concluded that further work on macroprudential
frameworks was a priority and asked the FSB, jointly with the
IMF and BIS, to provide an update to the Ministers and Governors
in February on progress in the development of macroprudential
policy frameworks.
The update that is being sent to the Ministers and
Governors summarises the work underway internationally and
nationally to develop effective
macroprudential policies and frameworks, by drawing also on
surveys conducted by the BIS and IMF.
The three organisations are currently discussing the
workplan for the remainder of 2011, to focus primarily on
analytical challenges, on the possibility to distil from
stocktaking exercises lessons for the development of policies
and frameworks, on providing forums for international
information sharing and cooperation.
A joint FSB/IMF/BIS conference
on macroprudential policy frameworks will be held in the spring.
The three organizations will submit a joint progress
report, outlining advances in the state of knowledge and
covering both international and national developments,
to G20 leaders at their November 2011
Summit.
Progress towards
convergence on strengthened accounting standards
At the Seoul Summit, the G20 Leaders re-emphasised
the importance of achieving a single set
of improved high quality global accounting standards and
called on the
International Accounting
Standards Board (IASB) and the Financial Accounting Standards
Board (FASB) to complete their convergence project by the end of
2011.
The IASB and FASB have made substantial progress
toward their June 2011 target date for convergence of their key
financial instruments standards while retaining target
completion dates for other projects in the second half of 2011.
The US SEC continues to work
toward making a determination by end-2011 whether to incorporate
IFRS into the financial reporting system for US issuers.
Progress toward FSB recommendations for improved,
converged accounting standards is being made in
four main areas.
• Lending activities:
The FSB is particularly supportive of the development
of converged standards that would not expand the use of fair
value in relation to the lending activities of financial
intermediaries.
The IASB issued IFRS 9 in November 2009 which includes
an amortised cost category for financial assets such as loans
and certain investments in debt securities. While the FASB had
previously proposed in May 2010 to use fair value measurement
for lending activities, in January 2011 the FASB decided to
develop an amortised cost category for inclusion in the final
standard on financial instruments.
This decision was informed by views expressed in
comment letters received and during an extensive programme of
investor outreach.
•
Impairment of financial
assets:
The FSB recommended that the IASB and FASB incorporate
a broader range of available credit information than in existing
provisioning requirements, so as to improve the recognition of
credit impairment and transparency to investors while also
potentially helping lessen procyclicality.
In January 2011, the IASB and FASB jointly
issued an exposure draft proposing a converged expected loss
approach for open portfolios that seeks to improve upon
their earlier separate proposals by building on comments
received, including from an Expert Advisory Panel.
•
Addressing valuation
uncertainty in fair value measurement guidance:
Further enhancements to IASB and FASB fair value
measurement standards during the first half of 2011 will align
requirements about how to measure fair value, including when
markets become less active, and will address adjustments and
enhanced disclosures for valuation uncertainty.
•
Offsetting/netting of
financial instruments:
Differences between the current IASB and FASB
approaches to the offsetting/netting of financial assets and
liabilities can result in significant differences in the total
assets of large financial institutions, according to the
approach used.
In response to stakeholders’ concerns, including those
of the FSB and BCBS, in January 2011 the Boards issued an
exposure draft proposing changes to converge their standards on
offsetting/netting of derivative contracts and other financial
instruments.
Strengthening adherence to
international supervisory and regulatory standards
The FSB in February 2011 published
two country peer reviews, on Italy
and Spain, and expects to publish two thematic peer reviews in
March, on risk disclosures by market participants and mortgage
underwriting and origination practices. Three new country peer
reviews are scheduled for 2011, on Australia, Canada and
Switzerland.
Three thematic peer reviews will also be undertaken in
2011, on compensation practices (see below), deposit insurance
systems and a topic still to be determined.
Reforming compensation
practices to support financial stability
The G20 Leaders, at the Toronto Summit,
encouraged all countries and financial
institutions to fully implement the FSB Principles for
Sound Compensation Practices and their Implementation Standards
by end-2010 and
called on the FSB to undertake ongoing
monitoring in this area and to carry out another peer review
assessment in 2011.
As steps towards meeting this call, in
September 2010,
the FSB Secretariat requested that member national authorities
share the results of any stocktaking exercises undertaken to
gauge the progress of industry compliance with the Principles
and Standards, along with information on the national regulatory
framework in place concerning compensation structures and detail
on the role of supervisors in examining compensation practices
at financial institutions.
To support the 2011 peer
review assessment, the FSB also established last year a
working group to develop more detailed criteria to assess
progress towards the implementation of the Principles and
Standards. The criteria group is now concluding its work.
The follow-up review will examine the implementation
of the FSB Principles and Standards by significant financial
institutions, focussing on the nature and extent of any
weaknesses in the implementation, as well as on policy measures
and actions taken by national authorities.
The Peer Review Team will be formed and begin its
work in March in order to capture in this second thematic review
the Spring 2011 bonus round. The thematic review report will be
discussed by FSB Plenary in July and be published well ahead of
the Cannes Summit.
Co-operation and
information exchange initiative
The FSB in March 2010 launched an initiative to
promote global adherence to cooperation and information exchange
standards on financial regulation and supervision.
The initiative has met with considerable success so
far; all but a few of the jurisdictions contacted by the FSB
either already demonstrate sufficiently strong adherence to the
relevant standards or are implementing reforms to strengthen
their adherence.
At the November 2010 Seoul Summit the G20 Leaders
called on the FSB “to determine by spring 2011 those
jurisdictions that are not cooperating fully with the evaluation
process or that show insufficient progress to address weak
compliance with internationally agreed information exchange and
cooperation standards, based on the recommended actions by the
agreed timetable.” The FSB will determine by April 2011 into
which of several categories to place each jurisdiction under
evaluation, including the identification of non-cooperative
jurisdictions.
The FSB
will publish in
April 2011 a progress report, without the names of any
jurisdictions, that summarises the status of the initiative and
the next steps.
The FSB will also consider the publication in late
2011, ahead of the November G20 Summit, of the names of all
jurisdictions in the initial pool for further evaluation,
including a list of non-cooperative jurisdictions.
Other issues
Financial stability and
regulatory issues in emerging and developing economies
A proposal has been prepared and discussed at the
FSB Plenary for taking forward the work on identifying and
examining financial stability issues that are of particular
relevance for emerging market and developing economies.
The end product will be a joint report by theFSB, IMF
and World Bank (WB) that will be sent to G20 Finance Ministers
and Central Bank Governors in October.
While the issues to be covered in the report will be
identified jointly, the FSB, IMF and WB will divide amongst
themselves primary responsibility in addressing individual
issues according to their respective expertise and mandates, and
will work together on cross-cutting issues.
In order to avoid overlaps and the duplication of
efforts, the report will focus on financial stability issues
that are not being addressed adequately by existing
international initiatives, while the recommendations will
identify policy options to address those issues in a consistent
manner across countries.
The FSB’s part of this work will involve a small
working group that includes both FSB members and financial
authorities that are not FSB members. A joint interim report
will be discussed by the FSB Plenary in July, and it will then
be presented for feedback to FSB regional consultative groups
and other international fora before it is finalised.
Consumer Finance Protection
At the G20 Seoul Summit in November 2010, the
Leaders asked the FSB “to work in collaboration with the OECD
and other international organizations to explore, and report
back by the next summit, on options to advance consumer finance
protection through informed choice that includes disclosure,
transparency and education; protection from fraud, abuse and
errors; and recourse and advocacy.”
The FSB is establishing a consultative process to take
forward this work, and a work plan will be finalised in late
February 2011.
Reducing reliance on CRAs
The FSB’s high-level principles to reduce reliance
on CRA ratings, published in October 2010, aim to trigger a
significant change in existing practices, setting out in broad
terms the direction of change needed and asking standard-setters
and regulators to follow up by defining the more specific
actions that will be needed to implement the changes.
The FSB will report to G20 Finance Ministers and
Governors in April and October 2011
on progress in translating the principles into more specific
policy actions and of the planned medium-term timetable and
milestones, based on information collected from standard-setting
bodies and national and regional regulators.
Addressing data gaps
revealed by the financial crisis
In November 2009, the G20
Finance Ministers and Central Bank Governors endorsed 20
recommendations to address information gaps set out in the
report “The Financial Crisis and Information Gaps” prepared by
the FSB Secretariat and IMF staff.
A follow-up report was prepared for the June 2010
meeting of Ministers and Governors in Busan.
An updated progress report will be submitted to G20
Ministers and Governors in June 2011.
The FSB is leading work on recommendations 8 and 9
of the above report, aiming at improving collection and sharing
of data on interlinkages between systemically important
financial institutions and their exposures to countries, sectors
and markets, through the development of a common draft data
template.
Work on those issues has been underway since March
2010 in a working group composed of national authorities and
relevant international institutions, including the IMF, and the
proposals for the draft template will be submitted to the FSB
shortly.
The work has also addressed
data gaps in banks’ funding structure and dependencies
and has developed a draft set of recommendations on data sharing
between authorities.
Implementation of the new template will enable more
informed microprudential and macroprudential assessments,
support crisis management, and contribute to the data framework
necessary for identifying and monitoring systemically important
financial institutions.
Market integrity issues
At the Seoul Summit, IOSCO was asked to develop by
June 2011 and report to the FSB recommendations to promote
markets’ integrity and efficiency to
mitigate the risks posed to the financial system by the latest
technological developments.
IOSCO is working to report to
the FSB on “dark pools” by June 2011, and to issue a
consultation report on high-frequency and algorithmic trading by
mid-2011, with a view to finalising policy recommendations in
that area by October 2011.
In addition, the FSB is
monitoring key financial innovations, including in
high-frequency trading and exchange traded funds, in order to
identify potential emerging vulnerabilities at an early stage,
with input from its members including the BIS Markets Committee
and OECD.
Managed Funds Association Comments on Section 929X of
the Dodd-Frank Act
Statutory Language
The starting point for implementing statutory
requirements is, of course, the statutory language itself.
The relevant language in
Section 929X provides:
The Commission shall prescribe
rules providing for the public disclosure
of the name of the issuer and the title, class, CUSIP number,
aggregate amount of the number of short sales of each security,
and any failures to deliver the security following the end of
the reporting period.
At a minimum, such public disclosure shall occur
every month.
A plain reading of the language in Section 929X(a)
requires the SEC to issue rules providing for aggregate public
disclosure of short sales, not disclosure of individual market
participants’ short sales.
The legislative history with respect to this
provision, as discussed in detail below, further evidences a
clear Congressional intention to move away from a requirement to
publicly disclose information about individual short sales and
instead to require public disclosure of aggregate (i.e., not
individualized) disclosure of short sales.
Legislative History
The language that eventually became codified as
Section 929X of the Dodd-Frank Bill originated in a bill
proposed in October of 2009 by Majority Leader Steny Hoyer.
That proposed bill contained the following provision:
The Securities and Exchange
Commission shall require brokers to publish daily information
regarding the identity of short sellers, the companies whose
shares are being sold short, the number of shares that are sold
short, and new fails to deliver.
Brokers must disclose in
customer account agreements that lending shares for short
selling may result in the loss of voting rights if the shares
are on loan on the record date for a corporate election and the
substitute dividend payments might be taxed at higher rates than
normal dividends.
Majority Leader Hoyer subsequently amended his
proposed legislation to require large money managers to report
their individual short sales to the SEC, though such reports
were exempted from Freedom of Information Act (“FOIA”) requests.
The amended legislation also required the SEC to publish
aggregate short sale information publicly.
The relevant portion of Majority Leader Hoyer’s
revised legislation provided:
Section 13(f) of the Securities Exchange Act of
1934 (15 U.S.C. 78m(f)) is amended by redesignating paragraphs
(2), (3), (4) and (5) as (3), (4), (5) and (6) respectively and
inserting after paragraph (1) the following:
"(2) A. Every institutional investment manager
that effects a short sale of an equity security shall also file
a report on a daily basis with the Commission in such form as
the Commission, by rule, may prescribe.
Such report shall include, as applicable, the name of
the institutional investment manager, the name of the issuer and
the title, class, CUSIP number, number of shares or principal
amount, aggregate fair market value of each security, and any
failures to deliver the security. For purposes of section 552 of
title 5, United States Code, this subparagraph shall be
considered a statute described in subsection (b)(3)(B) of such
section.
B. The Commission shall prescribe rules providing
for the public disclosure of the name of the issuer and the
title, class, CUSIP number, aggregate amount of the number of
short sales of each security, and any failures to deliver the
security following the end of the reporting period.
At a minimum, such public disclosure shall occur
every
three months."
This proposed language set out a clear framework
for short sale reporting.
It required private, individualized reporting by
institutional money managers with that information being
protected from FOIA requests.
We believe that the revised
language modified Section 13(f) of the Securities Exchange Act
of 1934 (the “Exchange Act”) for two primary reasons.
First, because Section 13(f) applies to all
institutional money managers, amending that section of the
Exchange Act would ensure that the SEC received information from
a wide variety of market participants without imposing a
reporting burden on individual investors.
In addition, we believe the bill amended Section 13(f)
of the Exchange Act to include short sale reporting by
institutional money managers, on a private basis, because 13(f)
already requires money managers to report their long positions.
The revised short sale disclosure bill also
required the SEC publicly to report aggregate short sale
information.
Reading these two provisions together, the intent of
the legislation was clear; the SEC would privately collect
individual short sale positions and then aggregate short sale
information and publish it publicly.
Reading the second paragraph to require public
reporting of individual short positions would render meaningless
the FOIA exemption in the first paragraph, as there would be no
reason to provide a FOIA exemption for publicly available
information.
House Financial Services Committee Chairman Barney
Frank included a modified version of Majority Leader Hoyer’s
language in his manager’s amendment to H.R. 4173.2 The following
language was added to the end of new paragraph (2)(A) to provide
even stronger confidentiality protections regarding the
individualized reporting to the SEC:
The information contained in reports of an
institutional investment manager filed with the Commission
pursuant to this section, shall be subject to the same
non-disclosure and confidentiality protection provided under
section 204(b)(8) of the Investment Advisers Act of 1940.
Section 7422 of H.R. 4173, as passed by the House,
included this revised version of the provision, which
clearly provided for two different
reporting regimes. Paragraph (2)(A) of Section 7422 required
private, individualized reporting to the SEC on a confidential
basis and paragraph (2)(B) required public, aggregate and
anonymous reporting by the SEC.
The version of the bill passed by the Senate prior
to the House-Senate conference did not contain an analogous
provision to Section 7422.
The only provision in the Senate bill relevant to
short selling was Section 415, which called for an SEC study and
a report to Congress with any recommendations for market
improvements.
During the House-Senate conference,
House leaders proposed amending the
Senate bill by including the text in Section 7422 in the final
conference report.
The Senate accepted the House amendment, with one
change, which deleted paragraph (2)A. from the text.
As a result of the agreement in conference, the
paragraph requiring private, daily reporting on a confidential
basis was deleted from Section 929X, but the paragraph on
public, aggregate reporting by the SEC was retained.
There is no indication that the
Senate proposal to delete the paragraph requiring daily, private
reporting to the SEC was intended to affect the clear meaning of
the paragraph requiring public, aggregate reporting by the SEC.
Some may suggest that because Section 929X amends
Section 13(f) of the Exchange Act this somehow indicates a
Congressional intent to require individualized disclosure of
short sales.
As noted, we appreciate that Section 13(f) of the
Exchange Act generally requires institutional investment
managers to make public disclosure of long positions of certain
equities. We also understand that the exchanges and the
Financial Industry Regulatory Authority ("FINRA”) currently
report aggregate short positions, leading some to question why
Congress would enact a provision that reflected current
practice.
We do not think it is unusual
for Congress to codify an existing practice, to ensure
that it continues.
Moreover, while FINRA and the exchanges currently make
public certain reports with aggregate short positions, we are
unaware of any publicly available report that contains
comprehensive, market-wide, aggregate short sale information
(i.e., a report that aggregates short sale information by
security across all exchanges, over-the-counter transactions,
and so-called “arranged” stock lending).
As such, Section 929X could be
interpreted to require a new, market-wide public report on the
aggregate number of short sales of a security.
As outlined above,
our
review of the sequence of events leaves little doubt that
Congress was well aware of the changes to the scope of this
provision and that it sought to require aggregate reporting and
not individualized reporting.
In our view, trying to
interpret Section 929X as an extension of the existing
individualized reporting provision for long positions ignores
both the specific statutory language and the evolution of the
provision.
Finally, we believe that it was clear intention of
Congress to require aggregate reporting and not individualized
reporting of short positions.
8 New
Auditing Standards (referred to as “Risk Assessment Standards”)
On September 15, 2010,
the Public Company Accounting Oversight Board (the “Board” or the
“PCAOB”) filed with the Securities and Exchange Commission (the
“Commission”) a notice (the “Notice”) of proposed rules (File No.
PCAOB 2010-01) on Auditing Standards Related to the Auditor’s
Assessment of and Response to Risk and Related Amendments to PCAOB
Standards.
Those eight
auditing standards (hereinafter referred to as
“Risk Assessment Standards”), which
will supersede six of the Board’s interim auditing standards, are:
• Auditing Standard (“AS”) No. 8, Audit Risk;
• AS No.
9, Audit Planning;
• AS No. 10, Supervision of the Audit
Engagement;
• AS No. 11, Consideration of Materiality in
Planning and Performing an Audit;
• AS No. 12, Identifying
and Assessing Risks of Material Misstatement;
• AS No. 13,
The Auditor’s Responses to the Risks of Material Misstatement;
• AS No. 14, Evaluating Audit Results;
• AS No. 15,
Audit Evidence.
December 23, 2010 - The
Commission is granting approval of
the proposed rules. The rules are effective
for audits of fiscal years beginning on or after December 15,
2010.
We are well into
the transition from the Basel II to Basel III in many banks and
financial groups.
Description
The Board adopted eight auditing standards and related
amendments that are designed to benefit investors by
establishing requirements that enhance the
effectiveness of the auditor’s assessment of and response to the
risks of material misstatement in an audit.
Assessing and responding to risks underlies the entire audit
process.
The risk assessment standards that the PCAOB is
replacing were part of the Board’s interim standards and were in
large part written twenty to thirty years ago.
In adopting
the new Risk Assessment Standards, the Board intended to
build upon and improve the risk framework
that was already established by the interim standards,
rather than replacing that framework altogether.
Key
changes made to the standards include an
increased emphasis on fraud risks, an increased emphasis on
disclosures, inclusion of multi-location audit requirements, an
alignment of the standards with AS No. 5, and inclusion of a
concept of materiality more specifically grounded to that
used in the federal securities laws.
The Commission finds
that the proposed PCAOB Rules on Auditing Standards Related to the
Auditor’s Assessment of and Response to Risk and Related
Amendments to PCAOB Standards (File No. PCAOB-2010-01)
are consistent with the requirements of the
Sarbanes-Oxley Act of 2002, as amended (the “Act”) and the
securities laws and are necessary or appropriate in the public
interest or for the protection of investors.
Today we will discuss 3 of these standards (8, 9 and 15)
Some interesting parts:
Auditing Standard No. 8 - Audit
Risk
Audit risk is a
function of the risk of material misstatement and detection
risk.
Risk of material misstatement at the assertion level
consists of the following components:
a. Inherent risk, which
refers to the susceptibility of an assertion to a misstatement,
due to error or fraud, that could be material, individually or
in combination with other misstatements, before consideration of
any related controls.
b. Control
risk, which is the risk that a misstatement due to error
or fraud that could occur in an assertion and that could be
material, individually or in combination with other
misstatements, will not be prevented or detected on a timely
basis by the company's internal control. Control risk is a
function of the effectiveness of the design and operation of
internal control.
In an audit of financial statements,
detection risk is the risk that
the procedures performed by the auditor will not detect a
misstatement that exists and that could be material,
individually or in combination with other misstatements.
Auditing Standard No. 9 - Audit
Planning
Persons with Specialized Skill
or Knowledge
The auditor should
determine whether specialized skill or knowledge is needed
to perform appropriate risk assessments, plan or perform audit
procedures, or evaluate audit results.
Auditing Standard No. 15 -
Audit Evidence
This standard explains what
constitutes audit evidence and establishes requirements
regarding designing and performing audit procedures to obtain
sufficient appropriate audit evidence.
Audit evidence is all the
information, whether obtained from audit procedures or
other sources, that is used by the auditor in arriving at the
conclusions on which the auditor's opinion is based.
Audit evidence consists of both
information that supports and corroborates management's
assertions regarding the financial statements or internal
control over financial reporting and information that
contradicts such assertions
Appropriateness is the
measure of the quality of audit evidence, i.e., its
relevance and reliability.
To be appropriate, audit evidence must be both
relevant and reliable in providing
support for the conclusions on which the auditor's opinion is
based.
Relevance and Reliability
Relevance. The relevance of
audit evidence refers to its relationship to the the objective
of the control being tested.
The relevance of audit evidence depends on:
a. The design of the audit procedure used
b. The timing of the audit
Inquiry
Inquiry consists of seeking
information from knowledgeable persons in financial or
nonfinancial roles within the company or outside the company.
Inquiry may be performed throughout the audit in
addition to other audit procedures. Inquiries may range from
formal written inquiries to informal oral inquiries. Evaluating
responses to inquiries is an integral part of the inquiry
process.
Auditing Standard No. 8
Audit Risk
Introduction
1. This standard discusses the auditor's consideration
of audit risk in an audit of financial statements as part of an
integrated audit or an audit of financial statements only.
Objective
2. The
objective of the auditor is to conduct the audit of financial
statements in a manner that reduces audit risk to an
appropriately low level.
Audit Risk
3. To form
an appropriate basis for expressing an
opinion on the financial statements, the auditor must
plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material
misstatement due to error or fraud.
Reasonable assurance is obtained by reducing audit
risk to an appropriately low level through applying due
professional care, including obtaining sufficient appropriate
audit evidence.
4. In an audit of financial statements, audit risk is
the risk that the auditor expresses an inappropriate audit
opinion when the financial statements are materially misstated,
i.e., the financial statements are not presented fairly in
conformity with the applicable financial reporting framework.
Audit risk is a function of the
risk of material misstatement and detection risk.
Note: The auditor should look to the requirements of
the Securities and Exchange Commission for the company under
audit with respect to the accounting principles applicable to
that company.
Risk of Material Misstatement
5. The risk of material misstatement refers to the
risk that the financial statements are materially misstated.
Auditing Standard No. 12, Identifying and Assessing
Risks of Material Misstatement, indicates that the auditor
should assess the risks of material misstatement at
two levels:
(1) at the financial statement level and
(2) at the assertion level
6. Risks of material misstatement at the financial
statement level relate pervasively to the financial statements
as a whole and potentially affect many assertions.
Risks of material misstatement at the financial
statement level may be especially relevant to the auditor's
consideration of the risk of material misstatement due to fraud.
For example, an ineffective control environment, a
lack of sufficient capital to continue operations, and declining
conditions affecting the company's industry might create
pressures or opportunities for management to manipulate the
financial statements, leading to higher risk of material
misstatement.
7. Risk of material
misstatement at the assertion level consists of the following
components:
a. Inherent risk, which refers
to the susceptibility of an assertion to a misstatement, due to
error or fraud, that could be material, individually or in
combination with other misstatements, before consideration of
any related controls.
b. Control risk, which is the risk
that a misstatement due to error or fraud that could occur in an
assertion and that could be material, individually or in
combination with other misstatements, will not be prevented or
detected on a timely basis by the company's internal control.
Control risk is a function of the effectiveness of the design
and operation of internal control.
8. Inherent
risk and control risk are related to the company, its
environment, and its internal control, and the auditor assesses
those risks based on evidence he or she obtains.
The
auditor assesses inherent risk using information obtained from
performing risk assessment procedures and considering the
characteristics of the accounts and disclosures in the financial
statements.
The auditor assesses control risk using
evidence obtained from tests of controls (if the auditor plans
to rely on those controls to assess control risk at less than
maximum) and from other sources.
Detection Risk
9. In an audit
of financial statements, detection risk is the risk that the
procedures performed by the auditor will not detect a
misstatement that exists and that could be material,
individually or in combination with other misstatements.
Detection risk is affected by
(1) the effectiveness of the substantive procedures
and
(2) their application by the auditor, i.e., whether
the procedures were performed with due professional care.
10. The auditor uses the assessed risk of material
misstatement to determine the appropriate level of detection
risk for a financial statement assertion.
The higher the risk of material
misstatement, the lower the level of detection risk needs to be
in order to reduce audit risk to an appropriately low level.
11. The auditor reduces the level of detection risk through
the nature, timing, and extent of the substantive procedures
performed. As the appropriate level of detection risk decreases,
the evidence from substantive procedures that the auditor should
obtain increases.
Auditing Standard No. 9
Audit Planning
Introduction
1. This standard establishes requirements regarding
planning an audit.
Objective
2. The
objective of the auditor is to plan the audit so that the audit
is conducted effectively.
Responsibility of the
Engagement Partner for Planning
3. The engagement
partner is responsible for the engagement and its performance.
Accordingly, the engagement partner is responsible for
planning the audit and may seek assistance from appropriate
engagement team members in fulfilling this responsibility.
Engagement team members who assist the engagement
partner with audit planning also should comply with the relevant
requirements in this standard.
Planning an Audit
4.
The auditor should properly plan the audit.
This standard describes the auditor's responsibilities
for properly planning the audit.
The term, "auditor," as
used in this standard, encompasses both the engagement partner
and the engagement team members who assist the engagement
partner in planning the audit.
5. Planning the audit includes establishing the
overall audit strategy for the engagement and developing an
audit plan, which includes, in particular, planned risk
assessment procedures and planned responses to the risks of
material misstatement.
Planning is not a discrete phase of an audit but,
rather, a continual and iterative process that might begin
shortly after (or in connection with) the completion of the
previous audit and continues until the completion of the current
audit.
Preliminary Engagement
Activities
6. The auditor should perform the following activities
at the beginning of the audit:
a. Perform procedures regarding the continuance of the
client relationship and the specific audit engagement
b. Determine compliance with independence and ethics
requirements
Note: The determination of compliance with
independence and ethics requirements is not limited to
preliminary engagement activities and should be reevaluated with
changes in circumstances.
c. Establish an understanding with the client
regarding the services to be performed on the engagement.
Planning Activities
7. The nature and extent of planning activities that
are necessary depend on the size and complexity of the company,
the auditor's previous experience with the company, and changes
in circumstances that occur during the audit.
When developing the audit strategy and audit plan, as
discussed in paragraphs 8-10, the auditor should evaluate
whether the following matters are important to the company's
financial statements and internal control over financial
reporting and, if so, how they will affect the auditor's
procedures:
• Knowledge of the company's
internal control over financial reporting obtained during
other engagements performed by the auditor;
• Matters affecting the industry in which the company
operates, such as financial reporting practices, economic
conditions, laws and regulations, and technological changes;
• Matters relating to the
company's business, including its organization, operating
characteristics, and capital structure;
• The extent of recent changes,
if any, in the company, its operations, or its internal
control over financial reporting;
• The auditor's preliminary judgments about
materiality, risk, and, in integrated audits, other factors
relating to the determination of material weaknesses;
• Control deficiencies previously communicated to the
audit committee or management;
• Legal or regulatory matters
of which the company is aware;
• The type and extent of available evidence related to
the effectiveness of the company's internal control over
financial reporting;
• Preliminary judgments about the effectiveness of
internal control over financial reporting;
• Public information about the company relevant to the
evaluation of the likelihood of material financial statement
misstatements and the effectiveness of the company's internal
control over financial reporting;
• Knowledge about risks related to the company
evaluated as part of the auditor's client acceptance and
retention evaluation; and
• The relative complexity
of the company's operations.
Note: Many smaller companies have less complex
operations.
Additionally, some larger, complex companies may have
less complex units or processes.
Factors that might indicate
less complex operations include:
fewer business lines;
less complex business processes and financial reporting systems;
more centralized accounting functions; extensive involvement by
senior management in the day-to-day activities of the business;
and fewer levels of management, each with a wide span of
control.
Audit Strategy
8. The
auditor should establish an overall audit strategy that sets the
scope, timing, and direction of the audit and guides the
development of the audit plan.
9. In establishing the overall audit strategy, the
auditor should take into account:
a. The reporting objectives of the engagement and the
nature of the communications required by PCAOB standards
b. The factors that are significant in directing the
activities of the engagement team
c. The results of preliminary engagement activities17/
and the auditor's evaluation of the important matters in
accordance with paragraph 7 of this standard,
d. The nature, timing, and extent of resources
necessary to perform the engagement.
Audit Plan
10. The
auditor should develop and document an audit plan that includes
a description of:
a. The planned nature, timing, and extent of the risk
assessment procedures;
b. The planned nature, timing, and extent of tests of
controls and substantive procedures;
c. Other planned audit procedures required to be
performed so that the engagement complies with PCAOB standards.
Multi-location Engagements
11. In an audit of the financial statements of a company with
operations in multiple locations or
business units, the auditor should determine the extent
to which audit procedures should be performed at selected
locations or business units to obtain sufficient appropriate
evidence to obtain reasonable assurance about whether the
consolidated financial statements are free of material
misstatement.
This includes determining the
locations or business units at which to perform audit
procedures, as well as the nature, timing, and extent of the
procedures to be performed at those individual locations or
business units.
The auditor should assess the risks of material
misstatement to the consolidated financial statements associated
with the location or business unit and correlate the amount of
audit attention devoted to the location or business unit with
the degree of risk of material misstatement associated with that
location or business unit.
12. Factors that are relevant to the assessment of the
risks of material misstatement associated with a particular
location or business unit and the determination of the necessary
audit procedures include:
a. The nature and amount of
assets, liabilities, and transactions executed at the
location or business unit, including, e.g., significant
transactions executed at the location or business unit that are
outside the normal course of business for the company, or that
otherwise appear to be unusual given the auditor's understanding
of the company and its environment;
b. The materiality of
the location or business unit
c. The specific risks
associated with the location or business unit that present a
reasonable possibility24/ of material misstatement to the
company's consolidated financial statements;
d. Whether the risks of material misstatement
associated with the location or business unit apply to other
locations or business units such that, in
combination, they present a reasonable possibility of
material misstatement to the company's consolidated financial
statements;
e. The degree of centralization
of records or information processing;
f. The effectiveness of the
control environment, particularly with respect to
management's control over the exercise of authority delegated to
others and its ability to effectively supervise activities at
the location or business unit; and
g. The frequency, timing, and
scope of monitoring activities by the company or others
at the location or business unit.
13. In determining the locations or business units at
which to perform audit procedures, the auditor may take into
account relevant activities performed by internal audit, as
described in AU sec. 322, The Auditor's Consideration of the
Internal Audit Function in an Audit of Financial Statements, or
others, as described in Auditing Standard No. 5. AU sec. 322 and
Auditing Standard No. 5 establish requirements regarding using
the work of internal audit and others, respectively.
14. AU sec. 543, Part of Audit Performed by Other
Independent Auditors, describes the auditor's responsibilities
regarding using the work and reports of other independent
auditors who audit the financial statements of one or more of
the locations or business units that are included in the
consolidated financial statements
In those situations, the auditor should perform the
procedures in paragraphs 11-13 of this standard to determine the
locations or business units at which audit procedures should be
performed.
Changes During the Course of
the Audit
15. The auditor should modify the overall
audit strategy and the audit plan as necessary if circumstances
change significantly during the course of the audit, including
changes due to a revised assessment of the risks of material
misstatement or the discovery of a previously unidentified risk
of material misstatement.
Persons with Specialized Skill
or Knowledge
16. The auditor
should determine whether specialized skill or knowledge
is needed to perform appropriate risk assessments, plan or
perform audit procedures, or evaluate audit results.
17. If a person with
specialized skill or knowledge employed or engaged by the
auditor participates in the audit, the auditor should have
sufficient knowledge of the subject matter to be addressed by
such a person to enable the auditor to:
a. Communicate the objectives of that person's work;
b. Determine whether that person's procedures meet the
auditor's objectives; and
c. Evaluate the results of that person's procedures as
they relate to the nature, timing, and extent of other planned
audit procedures and the effects on the auditor's report.
Additional Considerations in Initial Audits
18. The auditor should undertake the following
activities before starting an initial audit:
a. Perform procedures regarding the acceptance of the
client relationship and the specific audit engagement; and
b. Communicate with the predecessor auditor in
situations in which there has been a change of auditors in
accordance with AU sec. 315, Communications Between Predecessor
and Successor Auditors.
19. The purpose and objective of planning the audit
are the same for an initial audit or a recurring audit
engagement.
However, for an initial audit, the auditor should
determine the additional planning activities necessary to
establish an appropriate audit strategy and audit plan,
including determining the audit procedures necessary to obtain
sufficient appropriate audit evidence regarding the opening
balances.
Auditing Standard No. 15
Audit Evidence
Introduction
1. This standard explains what
constitutes audit evidence and establishes requirements
regarding designing and performing audit procedures to obtain
sufficient appropriate audit evidence.
2. Audit evidence is all the
information, whether obtained from audit procedures or
other sources, that is used by the auditor in arriving at the
conclusions on which the auditor's opinion is based.
Audit evidence consists of both
information that supports and corroborates management's
assertions regarding the financial statements or internal
control over financial reporting and information that
contradicts such assertions.
Objective
3. The
objective of the auditor is to plan and perform the audit to
obtain appropriate audit evidence that is sufficient to support
the opinion expressed in the auditor's report
Sufficient Appropriate Audit
Evidence
4. The auditor must plan and perform audit procedures
to obtain sufficient appropriate audit evidence to provide a
reasonable basis for his or her opinion.
5. Sufficiency is the measure of the quantity of audit
evidence.
The quantity of audit
evidence needed is affected by the following:
• Risk of material misstatement
(in the audit of financial statements) or the risk associated
with the control (in the audit of internal control over
financial reporting). As the risk increases, the amount of
evidence that the auditor should obtain also increases.
For example, ordinarily more evidence is needed to
respond to significant risks.
• Quality of the audit evidence
obtained. As the quality of the evidence increases, the
need for additional corroborating evidence decreases.
Obtaining more of the same type of audit evidence,
however, cannot compensate for the poor quality of that
evidence.
6. Appropriateness is the measure of the quality of
audit evidence, i.e., its relevance and reliability.
To be appropriate, audit evidence must be both
relevant and reliable in providing support for the conclusions
on which the auditor's opinion is based.
Relevance and Reliability
Relevance. The relevance of audit evidence refers to
its relationship to the the objective of the control being
tested.
The relevance of audit evidence depends on:
a. The design of the audit procedure used
b. The timing of the audit
Using Information Produced by
the Company
10. When using information produced by the company as
audit evidence, the auditor should evaluate whether the
information is sufficient and appropriate for purposes of the
audit by performing procedures to:
• Test the accuracy and completeness of the
information, or test the controls over the accuracy and
completeness of that information; and
• Evaluate whether the information is sufficiently
precise and detailed for purposes of the audit.
Financial Statement
Assertions
11. In representing that the financial
statements are presented fairly in conformity with the
applicable financial reporting framework, management implicitly
or explicitly makes assertions regarding the recognition,
measurement, presentation, and disclosure of the various
elements of financial statements and related disclosures.
Those assertions can be
classified into the following categories:
• Existence or occurrence
– Assets or liabilities of the company exist at a given date,
and recorded transactions have occurred during a given period.
• Completeness – All
transactions and accounts that should be presented in the
financial statements are so included.
Observation
16. Observation consists of looking at a process or
procedure being performed by others, e.g., the auditor's
observation of inventory counting by the company's personnel or
the performance of control activities.
Observation can provide audit
evidence about the performance of a process or procedure,
but the evidence is limited to the point in time at which the
observation takes place and also is limited by the fact that the
act of being observed may affect how the process or procedure is
performed.
Inquiry
17. Inquiry consists of seeking
information from knowledgeable persons in financial or
nonfinancial roles within the company or outside the company.
Inquiry may be performed throughout the audit in
addition to other audit procedures. Inquiries may range from
formal written inquiries to informal oral inquiries. Evaluating
responses to inquiries is an integral part of the inquiry
process.
Note: Inquiry of company personnel, by itself, does
not provide sufficient audit evidence to reduce audit risk to an
appropriately low level for a relevant assertion or to support a
conclusion about the effectiveness of a control.
Confirmation
18. A confirmation response represents a particular
form of audit evidence obtained by the auditor from a third
party in accordance with PCAOB standards.
Recalculation
19. Recalculation consists of checking the
mathematical accuracy of documents or records. Recalculation may
be performed manually or electronically.
Reperformance
20.
Reperformance involves the independent execution of procedures
or controls that were originally performed by company personnel.
Analytical Procedures
21. Analytical procedures consist of evaluations of financial
information made by a study of plausible relationships among
both financial and nonfinancial data.
Analytical procedures also encompass the investigation
of significant differences from expected amounts.
Selecting Items for Testing
to Obtain Audit Evidence
22. Designing substantive tests of details and tests
of controls includes determining the means of selecting items
for testing from among the items included in an account or the
occurrences of a control.
The auditor should determine the means of selecting
items for testing to obtain evidence that, in combination with
other relevant evidence, is sufficient to meet the objective of
the audit procedure.
The alternative means of selecting items for testing
are:
• Selecting all items;
• Selecting specific items; and
• Audit sampling.
23. The particular means or combination of means
of selecting items for testing that is appropriate depends on
the nature of the audit procedure, the characteristics of the
control or the items in the account being tested, and the
evidence necessary to meet the objective of the audit procedure.
Selecting All Items
24. Selecting all items (100 percent examination)
refers to testing the entire population of items in an account
or the entire population of occurrences of a control (or an
entire stratum within one of those populations).
The following are examples of situations in which 100
percent examination might be applied:
• The population constitutes a small number of large
value items;
• The audit procedure is designed to respond to a
significant risk, and other means of selecting items for testing
do not provide sufficient appropriate audit evidence; and
• The audit procedure can be automated effectively and
applied to the entire population.
Selecting Specific Items
25. Selecting specific items refers to
testing all of the items in a population
that have a specified characteristic, such as:
• Key items. The auditor
may decide to select specific items within a population because
they are important to accomplishing the objective of the audit
procedure or exhibit some other characteristic, e.g., items that
are
suspicious, unusual, or particularly risk-prone or items
that have a history of error.
• All items over a certain
amount. The auditor may decide to examine items whose
recorded values exceed a certain amount to verify a large
proportion of the total amount of the items included in an
account.
26. The auditor also might select specific items to
obtain an understanding about matters such as the nature of the
company or the nature of transactions.
27. The application of audit procedures to items that
are selected as described in paragraphs 25-26 of this standard
does not constitute audit sampling, and the results of those
audit procedures cannot be projected to the entire population.
Audit Sampling
28.
Audit sampling is the application of an audit procedure to less
than 100 percent of the items within an account balance or class
of transactions for the purpose of evaluating some
characteristic of the balance or class.
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