SEC RULES ON FUNDS' RESPONSIBILITIES FOR CERTIFICATIONS OF INTERNAL CONTROL OVER FINANCIAL REPORTING AND SECTION 906 DISCLOSURES

[16204] June 13, 2003 TO: ACCOUNTING/TREASURERS MEMBERS No. 29-03 CLOSED-END INVESTMENT COMPANY MEMBERS No. 51-03 COMPLIANCE ADVISORY COMMITTEE No. 46-03 INTERNAL AUDIT ADVISORY COMMITTEE No. 4-03 PRIMARY CONTACTS - MEMBER COMPLEX No. 47-03 SEC RULES MEMBERS No. 74-03 SMALL FUNDS MEMBERS No. 26-03 RE: SEC RULES ON FUNDS’ RESPONSIBILITIES FOR CERTIFICATIONS OF INTERNAL CONTROL OVER FINANCIAL REPORTING AND SECTION 906 DISCLOSURES The Securities and Exchange Commission has issued a release adopting changes to its rules and forms implementing Section 302 of the Sarbanes-Oxley Act of 2002 for registered investment companies related to management’s responsibilities regarding certification of internal control over financial reporting and the submission of Section 906 certifications as exhibits to the periodic reports to which they relate.1 The Adopting Release also provides an explanation of the distinction between internal control over financial reporting and disclosure controls and procedures. Changes of interest to investment companies are summarized below. I. CERTIFICATION OF DISCLOSURES IN EXCHANGE ACT REPORTS A. Section 906 Certification The Commission has adopted, largely as proposed,2 amendments to its rules and forms under the Securities Exchange Act of 1934 and the Investment Company Act of 1940 related to filings of certifications under Section 906 of the Sarbanes-Oxley Act. The Commission has also 1 See SEC Release Nos. 33-8238; 34-47986; IC-26068, dated June 5, 2003 (“Adopting Release”). The Adopting Release is available from the SEC’s website at http://www.sec.gov/rules/final/33-8238.htm. In the same release, the Commission also adopted rules that require corporate issuers to file their Section 302 certifications as an exhibit to the periodic reports to which they relate; however, such rules do not affect registered investment companies since they are already required by Form N-CSR to file their Section 302 certifications as an exhibit to a report on Form N-CSR. 2 See Certification of Disclosure in Certain Exchange Act Reports, SEC Release Nos. 33-8212, 34-47551, and IC-25967 (March 21, 2003). The release is available from the SEC’s web site at http://www.sec.gov/rules/proposed/33- 8212.htm. The Institute submitted a comment letter generally supporting the Commission’s proposal. See Letter from Barry E. Simmons, Associate Counsel, ICI, to Jonathan G. Katz, Secretary, SEC, dated May 15, 2003. 2 amended Exchange Act Rules 13a-14 and 15d-14 and Investment Company Act Rule 30a-2 to require registered investment companies, among other issuers, to “furnish” their Section 906 certifications as an exhibit to the periodic reports to which they relate.3 Thus, the final rules require funds to furnish their Section 906 certifications as an exhibit to their reports on Form N-CSR. The Adopting Release makes clear that, unlike the Section 302 certifications, the Section 906 certifications may take the form of a single statement signed by a company’s chief executive and financial officers. B. Status of Interim Guidance In its proposing release, the Commission provided interim guidance urging issuers to submit their Section 906 certifications as exhibits to the periodic reports to which they relate pending the Commission’s final adoption of the rules. As noted above, the Commission has adopted this requirement,4 but the interim guidance remains in effect until the rules become effective.5 II. MANAGEMENT’S CERTIFICATION RESPONSIBILITIES REGARDING INTERNAL CONTROL OVER FINANCIAL REPORTING The Commission has adopted rules concerning management’s report on internal control over financial reporting as required by Section 404 of the Sarbanes-Oxley Act.6 Because Section 405 of the Act specifically exempts registered investment companies from the internal control reporting provisions of Section 404, the Commission’s final rules implementing Section 404 do not extend to registered investment companies.7 As summarized below, however, the 3 The Adopting Release explains that because Section 906 requires that the certifications “accompany” the periodic report to which they relate, as opposed to Section 302, which requires the certification to be included “in” the periodic report, the Commission’s final rules require issuers to “furnish,” rather than “file,” the Section 906 certifications with the Commission. Also, to coordinate the rules requiring an evaluation of “disclosure controls and procedures” and “internal control over financial reporting,” the Commission has moved the definition of “disclosure controls and procedures” from Exchange Act Rules 13a-14(c) and 15d-14(c) and Investment Company Act Rule 30a-2(c) to new Exchange Act Rules 13a-15(c) and 15d-15(c) and Investment Company Act Rule 30a-3(c), respectively. 4 The Adopting Release has modified the interim guidance slightly. Consistent with the Institute’s recommendation, to address a technical flaw in the interim guidance, the Adopting Release clarifies that interim Section 906 certifications should include a legend after the text of each certification stating that: “A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to [name of issuer] and will be retained by [name of issuer] and furnished to the SEC or its staff upon request.” (Emphasis added.) 5 The Adopting Release clarifies that for funds filing reports on Form N-CSR, the EDGAR document type should be EX-99.906CERT for the Section 906 certifications. 6 Section 404 requires the Commission to adopt rules requiring public companies that file reports under Section 13(a) or 15(d) of the Exchange Act to provide in their annual report an internal control report that states management’s responsibility for establishing and maintaining an internal control structure and procedures for financial reporting, and that assesses the effectiveness of such controls and procedures. Section 404 also requires the independent accountant to attest to, and report on, management’s assessment of internal control. 7 Thus, the provisions that would not extend to funds include amendments that would require: (i) an annual evaluation of the effectiveness of internal control over financial reporting; (ii) a quarterly evaluation of any change in 3 Commission has adopted certain technical changes to its rules and forms implementing Section 302 of the Act relating to the certification of internal control over financial reporting.8 A. Requirement to Establish, Maintain and Design Internal Control Over Financial Reporting The Commission’s final rules modify Rule 30a-3 under the Investment Company Act and Form N-CSR to parallel amendments it has adopted for operating companies. As modified, Rule 30a-3 requires every registered management investment company to maintain internal control over financial reporting.9 The Commission similarly has adopted several modifications to Form N-CSR. Specifically, the Commission has modified Item 10 of the form to require the Section 302 certifications to include a statement of the certifying officers that they are responsible for establishing and maintaining internal control over financial reporting, and that they have designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under their supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Commission has also amended Item 10 to require disclosure of any change in the fund’s internal control over financial reporting that occurred during the most recent fiscal half- year that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting. Finally, the Commission’s amendments further require the signing officers to state that they have disclosed to the fund’s auditors and the audit committee all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting that are reasonably likely to adversely affect the fund’s ability to record, process, summarize, and report financial information. B. Evaluation Periods for Disclosure Controls and Procedures As recommended by the Institute, the Commission has decided to retain the current requirement that a fund’s management must conduct an evaluation of the effectiveness of its disclosure controls and procedures within 90 days prior to the filing date of the report. internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting; (iii) an annual report by management on internal control over financial reporting; and (iv) an attestation report prepared by the independent accountant on management’s evaluation of internal control over financial reporting. 8 The Commission had proposed these amendments at the same time it proposed rules to implement Sections 406 (code of ethics) and 407 (financial expert) of the Sarbanes-Oxley Act. See SEC Release No. IC-25775 (October 22, 2002). The release is available from the SEC’s website at http://www.sec.gov/rules/proposed/33-8138.htm. The Institute submitted a comment letter opposing the proposal to require certifying officers to certify that they are responsible for “establishing, maintaining and designing” internal controls and procedures for financial reporting, because it appeared to result in a “back door” application of Section 404 to investment companies. See Letter from Craig S. Tyle, General Counsel, ICI, to Jonathan G. Katz, Secretary, SEC, dated November 27, 2002. 9 The Commission has adopted the term “internal control over financial reporting” in place of the term “internal control procedures for financial reporting,” because it is the predominant term used by companies and auditors and because its use here would parallel the rules it has adopted for operating companies in Exchange Act Rules 13a-15(f) and 15d-15(f). 4 Although the final rules require operating companies to conduct their evaluation as of the end of the period covered by the report, the Commission decided against adopting a similar requirement for funds. The Commission agreed with the Institute’s view that adopting such a requirement would cause fund complexes that have funds with staggered fiscal year-ends to perform monthly evaluations, which would have been a costly, inefficient, and operationally disruptive process, with little if any benefit to shareholders. III. DISTINCTION BETWEEN INTERNAL CONTROL OVER FINANCIAL REPORTING AND DISCLOSURE CONTROLS AND PROCEDURES The Adopting Release defines “internal control over financial reporting” for purposes of Section 404 and 302 of the Sarbanes-Oxley Act. 10 Because of confusion surrounding the differences between a firm’s disclosure controls and procedures and its internal control over financial reporting, the Adopting Release provides further guidance on the distinction between the two. Briefly summarized, the Adopting Release explains that there is substantial overlap between internal control over financial reporting and disclosure controls and procedures, and as such, many companies will design their disclosure controls and procedures so that they include some, but not all, components of internal control over financial reporting. For example, a firm may design its disclosure controls and procedures to include those aspects of internal control over financial reporting that provide reasonable assurance that transactions are recorded as necessary to permit the preparation of financial statements in accordance with GAAP. It may, however, choose not to include internal controls over financial reporting relating to safeguarding of assets, such as dual signature requirements or limitations on check signing authority. IV. EFFECTIVE DATES; COMPLIANCE DATES The Adopting Release notes that the Commission’s rules become effective 60 days after publication in the Federal Register. In addition, funds must comply with the Commission’s rule and form amendments applicable to them on and after 60 days after publication in the Federal Register, except with respect to certain internal control provisions. Specifically, the Adopting Release requires funds to comply with the amendments to Exchange Act Rules 10 In doing so, the Commission decided to adopt a more narrow definition of “internal control” than it had proposed, focusing mainly on internal control over financial reporting, rather than the broader internal control objectives associated with enterprise risk management and corporate governance. As adopted, the Commission defines “internal control over financial reporting” as a process designed by, or under the supervision of, the registrant’s principal executive and principal financial officers, or persons performing similar functions, and effected by the registrant’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the registrant; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the registrant are being made only in accordance with authorizations of management and directors of the registrant; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the registrant’s assets that could have a material effect on the financial statements. 5 13a-15(a) and 15d-15(a) and Investment Company Act Rule 30a-3(a) that require them to maintain internal control over financial reporting with respect to fiscal years ending on or after June 15, 2004. Similarly, funds must also comply with the portion of the introductory language in paragraph 4 of the certification in Item 10(a)(2) of Form N-CSR that refers to the certifying officers’ responsibility for establishing and maintaining internal control over financial reporting, as well as paragraph 4(b) of the certification, beginning with the first annual report filed on Form N-CSR for a fiscal year ending on or after June 15, 2004. The Adopting Release notes, however, that in the meantime, a fund’s certifying officers may temporarily modify the content of their Section 302 certifications to eliminate such references to internal control over financial reporting. Barry E. Simmons Associate Counsel