State Education Department Revises Proposed Rule on Record Retention

By Dennis O’Leary, Director of Governmental Relations

New York —State authorities have made significant changes to a proposed seven-year work paper retention rule originally released in August for public comment. Concerns and issues raised by a special task force of the New York State Society of CPAs, among other business organizations, appear to have played a key role in the New York State Education Department’s decision to revise the proposal.

If the revisions, which were announced in the Oct. 23 issue of the New York State Register, are adopted at the December meeting of the New York State Board of Regents, the rule will take effect on Jan. 3, 2003.

“Practitioners should be aware that this record retention rule will apply to all audits, reviews, compilations, forecasts and projections, and is not limited to publicly traded audit clients,” NYSSCPA Executive Director Louis Grumet said. “Also, failure to comply will be chargeable as unprofessional conduct.”

As recommended by the Society’s task force chaired by Vincent J. Love, the revised proposal no longer would require CPA firms to keep non-attestation documents including “tax returns” and “special reports” for a minimum of seven years following an engagement. The revised proposal also now provides a definition of the critical phrase, “substantial alterations to work papers,” which would trigger certain documentation requirements for work papers. The Society had noted the absence of a definition for this phrase in the original proposal.

During its meeting on Sept. 25, 2002, the New York State Board for Public Accountancy unanimously agreed to recommend a change in the proposed rule to require that a complete set of work papers be retained within 45 days after issuance of the work product. According to the education department’s assessment of public comment on the rule, “This timeframe will give licensees needed time to gather the materials.” However, all substantive alterations to work papers made subsequent to the issuance of the work product would have to be clearly documented by indicating the subject of the alteration, the date and reason for the alteration.

Though the Society’s task force contended that there was no need to require licensees to establish a formal written documentation and retention policy because the new rule itself would set the standards, the education department disagreed. It did, however, change the proposed rule to essentially provide that licensees employed by a CPA firm would meet the formal written policy requirement by virtue of a formal written policy on record documentation and retention established by the firm.

The Society’s task force currently is reviewing the revised proposal and may offer additional comments to the education department during the public comment period that ends Nov. 22, 2002.

For New York state firms that audit publicly traded companies, special care will be needed to assure compliance not only with New York’s record retention rule, but also two new criminal statutes on records destruction under the Sarbanes-Oxley Act.

To avoid conflicting and inconsistent rules for auditors of publicly traded companies, there appears to be cause for New York state to postpone implementation of its own record retention regulations until such rules at the federal level are clearly established.

Under Sarbanes-Oxley, a new federal provision (18 U.S.C. §1519) makes it a crime punishable by fine and up to 20 years imprisonment, or both, for “whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies or makes a false entry in any record, document or tangible object with intent to impede, obstruct or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such matter or case.”

Additionally, under Sarbanes-Oxley, new Section 1520(a)(1) of title 18 chapter 73 of the United States Code currently requires auditors to retain all audit or review work papers for five years “from the end of the fiscal period in which the audit or review was completed.” (New York state’s rule would impose a seven-year retention). Furthermore, Section 1520(a)(2) directs the Securities and Exchange Commission to adopt within 180 days “such rules and regulations, as are reasonably necessary, relating to the retention of relevant records such as work papers, documents that form the basis of an audit or review, memoranda, correspondence, communications, other documents, and records (including electronic records) which are created, sent or received in connection with an audit or review and contain conclusions, opinions, analyses or financial data relating to such an audit or review...”

The penalties for non-compliance under section 1520(a)(1) and (2) could be a fine or a maximum of up to 10 years imprisonment for knowing and willful violations of either the five-year retention requirement or the retention rules expected from the SEC.

Beyond these rules, the new Public Company Accounting Oversight Board is directed under Sarbanes-Oxley section 103(a)(2)(A)(i) to include in it’s auditing standards a requirement that “audit work papers and other information related to any audit report” be maintained “for a period of not less than seven years…in sufficient detail” to support the conclusions in the audit report.

The criminal provisions and required record retention regulations in Sarbanes-Oxley and the new New York state record retention and documentation regulation must all be complied with to avoid the risk of severe penalty for the New York auditor of the publicly traded company.