hensive power is embodied in the Investment Company Act 62 and the Public Utility Holding Company Act.

66

63

Pursuant to the broad rule-making power thus conferred with respect to the preparation and presentation of financial statements, the Commission has prescribed uniform systems of accounts for companies subject to the Holding Company Act; has adopted rules under the Securities Exchange Act governing accounting and auditing of securities brokers and dealers; 65 and has promulgated rules contained in a single comprehensive regulation, identified as Regulation S-X, which govern the form and content of financial statements filed in compliance with the several Acts. This regulation is supplemented by the Commission's Accounting Series Releases, of which 93 have so far been issued. These releases were inaugurated in 1937 and were designed as a program for making public, from time to time, opinions on accounting principles for the purpose of contributing to the development of uniform standards and practice in major accounting questions. The rules and regulations thus established, except for the uniform systems of accounts which are regulatory reports, prescribe accounting principles to be followed only in certain limited areas. In the large area of financial reporting not covered by such rules, the Commission's principal means of providing investors protection from inadequate financial reporting, fraudulent practices and over-reaching by management is by requiring a certificate of an independent public accountant based on an audit performed in accordance with generally accepted auditing standards which expresses an opinion as to whether the financial statements are presented fairly in conformity with accounting principles and practices which are recognized as sound and which have attained general acceptance.

The Securities Act provides, that the financial statements required to be made available to the public through filing with the Commission shall be certified by "an independent public or certified accountant." 67 The other three statutes permit the Commission to require that such statements be accompanied by a certificate of an independent public accountant, and the Commission's rules require, with minor excep

62 Sections 30, 31.

Sections 14, 15.

es Uniform System of Accounts for Mutual Service Companies and Subsidiary Service Companies (effective August 1, 1936); Uniform System of Accounts for Public Utility Holding Companies (effective January 1, 1937; amended effective January 1, 1943; revised November 24, 1959). (Accounting Series Release No. 84).

Rule 17a-5 and Form X-17A-5 thereunder.

Adopted February 21, 1940 (Accounting Series Release No. 12); revised December 20, 1950 (Accounting Series Release No. 70).

67 Sections 7 and 10(a) (Schedule A, pars. 25, 26).

Securities Exchange Act, Section 13(a)(2); Investment Company Act, Section 30 (e); Holding Company Act, Section 14.

tions, that they be so certified. The value of certification by qualified accountants has been conceded for many years, but the requirement as to independence, long recognized and adhered to by some individual accountants, was for the first time authoritatively and explicitly introduced into law in 1933. The Commission's rules accept an accountant who is qualified to practice in his own state as qualified to practice before the Commission unless he has entered into disqualifying relationships with a particular client, such as becoming a promoter, underwriter, voting trustee, director, officer, employee, or stockholder; or, in rare cases, has demonstrated incompetence, subservience to the management, or has engaged in unethical or improper professional conduct. The Commission endeavors to encourage and foster the independence of the accountant in his relationships with his client so that he may better be able to perform the service to the public contemplated by the Congress in the various Acts.

70

71

69

The Commission had occasion during the year to issue for the first time an opinion " regarding the independence of a certifying accountant who also acts as counsel for the registrant. The Commission's opinion included the following statements:

Though owing a public responsibility, an attorney in acting as the client's advisor, defender, advocate and confidant enters into a personal relationship in which his principal concern is with the interests and rights of his client. The requirement of the Act of certification by an independent accountant, on the other hand, is intended to secure for the benefit of public investors the detached objectivity of a disinterested person. The certifying accountant must be one who is in no way connected with the business or its management and who does not have any relationship that might affect the independence which at times may require him to voice public criticisms of his client's accounting practices. In our opinion, the partner's relationship as attorney for the registrant here during the same period covered by his firm's certification disqualified him and the firm of which he was a partner from certifying registrant's financial statements as independent accountants.

The Commission is vigilant in its efforts to assure itself that the audits which it requires are performed by independent accountants; that the information contained in the financial reports represents full and fair disclosure and that appropriate auditing and accounting practices and standards have been followed in their preparation. In addition it recognizes that changes and new developments in financial and economic conditions affect the operations and financial status of the several thousand commercial and industrial companies required

See, for example, Rule 2-01 of Regulation S-X.

To See, for example, Securities Exchange Act Release No. 3073 (1941); 10 S.E.C. 982 (1942); Accounting Series Release No. 68 (1949); Accounting Series Release No. 82 (1959); and Accounting Series Release No. 88 (1961). See also Accounting Series Release Nos. 91 and 92 (1962) which are discussed at page 154, infra.

American Finance Company, Inc., Securities Act Release No. 4465 (March 19, 1962).

to file statements with the Commission and that accounting and auditing procedures cannot remain static and continue to serve well a dynamic economy. The Commission's accounting staff, therefore, studies the changes and new developments for the purpose of establishing and maintaining appropriate accounting and auditing policies, procedures and practices for the protection of investors. The primary responsibility for this program rests with the Chief Accountant of the Commission, who has general supervision with respect to accounting and auditing policies and their application.

Progress in these activities requires continuing contact and consultation between the staff and accountants both individually and through such representative groups as, among others, the American Accounting Association, the American Institute of Certified Public Accountants, the American Petroleum Institute, the Financial Analysts Federation, the Financial Executives Institute, and the National Association of Railroad and Utilities Commissioners, as well as many Government agencies. Recognizing the importance of cooperation in the formulation of accounting principles and practices, adequate disclosure and auditing procedures which will best serve the interests of investors, the American Institute of Certified Public Accountants, the Financial Analysts Federation and the Financial Executives Institute appoint committees which maintain liaison with the Commission's staff. The Commission on its part has authorized its Chief Accountant to continue to serve as a member of an advisory committee to the accounting principles board of the American Institute of Certified Public Accountants.

The many daily decisions to be made require the attention of some of the Chief Accountant's staff. These include questions raised by each of the operating divisions of the Commission, the regional offices, and the Commission. As a result of this day-to-day activity of the Commission and the need to keep abreast of current accounting problems, the Chief Accountant's staff continually reexamines accounting and auditing principles and practices. From time to time members of the staff are called upon to assist in field investigations, to participate in hearings and to review opinions insofar as they pertain to accounting matters.

Prefiling and other conferences, in person or by telephone, with officials of corporations, practicing accountants and others are also an important part of the work of the staff. Resolution of questions and problems in this manner saves registrants and their representatives both time and expense.

Many specific accounting and auditing problems are disclosed in the examination of financial statements required to be filed with the

Commission. Where examination reveals that the rules and regulations of the Commission have not been complied with or that applicable generally accepted accounting principles have not been adhered to, the examining division usually notifies the registrant by an informal letter of comment. These letters of comment and the correspondence or conferences that follow continue to be a most convenient and satisfactory method of effecting corrections and improvements in financial statements, both to registrants and to the Commission's staff. Where particularly difficult or novel questions arise which cannot be settled by the accounting staff of the divisions and by the Chief Accountant, they are referred to the Commission for consideration and decision.

These procedures are particularly appropriate in resolving the problems which arise in connection with initial filings made by new corporate entities and by corporations whose securities had been closely held or traded over the counter. During the past year many such filings were made by companies whose business is closely associated with rapidly growing technological and scientific developments and with our expanding population, as in real estate and recreational activities.

Certain special problems related to real estate filings and the increase in their number indicated the need for a new form designed to provide adequate disclosure of the problem areas. The Chief Accountant and his staff cooperated with other divisions of the Commission in the preparation of a new Form S-11 for this purpose which was adopted effective December 1, 1961.72

The Commission also adopted, on June 12, 1962, new Rules 13a-15 and 15d-15 under the Securities Exchange Act, and new Form 7-K to require real estate companies to file quarterly reports of gross income, expense and net income; cash available for distribution; and distributions to shareholders.73

Difficulties often arise in connection with initial filings because accountants and other advisers who serve the registrant have not had any prior experience with the Commission. In some cases these persons have not familiarized themselves with the rules and regulations of the Commission-particularly the instructions as to financial statements required by the forms, the rules relating to independence of the certifying accountant, and those relating to the form and content of financial statements as set forth in Regulation S-X.

Some of the current problems in initial filings are created because audits had not been made in years preceding the filing of a registration

72 Securities Act Release No. 4422.

73 Securities Exchange Act Release No. 6820 and Securities Act Release No. 4499 (June 12, 1962).

statement or the audits for prior years did not measure up to generally accepted auditing standards and procedures, particularly with respect to verification of inventories and receivables. These standards require the observation of inventory taking and the confirmation of receivables where practicable and reasonable if either of these assets represents a significant proportion of the current assets. Where these procedures have not been applied, the auditor must satisfy himself as to the reasonableness of inventories for prior years by other appropriate auditing procedures. In some instances this is very difficult because the client may not have taken an inventory at the end of any prior year or because inventory records for such years are incomplete or may have been destroyed. Failure to adequately verify inventories and receivables may preclude expression of an opinion as to the fairness of the financial statements taken as a whole since discrepancies may exist which would materially affect the income, earned surplus, and working capital.

During the year it came to the attention of the Commission that wide variations had developed in the certificates of independent accountants with respect to representations concerning the verification of inventories of prior years in first audits. In some cases such representations have raised a question as to whether the certifying accountant intended to limit his opinion regarding the fairness of presentation of the income statements. Accordingly, an Accounting Series Release 7 was issued to reemphasize that our rules under the Securities Act require that registration statements contain a certificate of an independent accountant based on an audit conducted in accordance with generally accepted auditing standards and procedures. The Chief Accountant and his staff cooperated with other divisions of the Commission and the industry in the preparation of proposals to amend Articles 7 and 12 of Regulation S-X governing the form and content of financial statements and schedules filed by insurance companies other than life and title insurance companies. The revision of Articles 7 and 12 which was adopted July 26, 1961,75 reflects changes in requirements of the annual statement filed with state regulatory authorities and developments in insurance reporting since those articles were originally adopted. Details of these changes were discussed in last year's report. Similar cooperative effort during the year resulted also in the development of a proposed amendment to Regulation S-X which would add to that regulation provisions governing the form and content of financial statements and related schedules to be filed by life insurance companies.76

74 Accounting Series Release No. 90 (March 1, 1962).

75 Accounting Series Release No. 89.

7 Securities Act Release No. 4525 (August 20, 1962).