Summary of Comments:
Related to Proposed
Standards Relating to Listed Company Audit Committees

Securities Act Release No. 8173
Exchange Act Release No. 47137
Investment Company Act Release No. 25855
File No. S7-02-03

Prepared by:
Jeffrey J. Minton
Special Counsel
Office of Rulemaking
Division of Corporation Finance

March 25, 2003

TABLE OF CONTENTS

1. List of Commenters

2. Overview

3. General Applicability of the Proposals

4. Audit Committee Member Independence

   1. General Comments

   2. Consulting, Advisory or Other Compensatory Fee Prohibition

   3. Affiliated Person Prohibition

   4. New Issuer Exemption

   5. Holding Company Exemption

   6. Requests for Other Exemptions

5. Responsibilities Relating to Registered Public Accounting Firms

   1. General Comments

   2. Proposed Instruction Regarding Shareholder Approval of the Auditor

   3. Audit Committee Responsibility for the Internal Auditor

6. Procedures for Handling Complaints

7. Authority to Engage Advisors

8. Funding

9. Implementation

10. Securities Affected

    1. Multiple Listings and Non-Equity Listings by Subsidiaries

    2. Security Futures Products and Standardized Options

    3. Requests for Other Exemptions

11. Issuers Affected

    1. Foreign Issuers

       1. General Comments

       2. Two-Tier Boards of Directors

       3. Employee Exemption

       4. Controlling Shareholder Exemption

       5. Foreign Government Representative Exemption

       6. Board of Auditors Exemption

       7. Requests for Other Foreign Exemptions

    2. Small Businesses

    3. Issuers of Asset-Backed Securities

    4. Investment Companies

    5. Comments Regarding Other Issuers

12. Determining Compliance with Proposed Standards

13. Opportunity to Cure Defects

14. Disclosure Changes Regarding Audit Committees

    1. Disclosure Regarding Exemptions

    2. Identification of the Audit Committee in Annual Reports

    3. Updates to Existing Audit Committee Disclosure

    4. Audit Committee Financial Expert Disclosure for Foreign Private Issuers

    5. Other Disclosure Comments

15. Cost-Benefit Analysis

16. Miscellaneous Comments

17. Pre-Proposal Comments

I. List of Commenters

II. Overview

We received over 185 responses regarding the proposals. Commenters expressed general overall support for the Commission's approach to implementing Section 10A(m) of the Exchange Act. Advocates of investors in particular endorsed the Commission's proposals, though not all believed Section 10A(m) and the Commission's proposals went far enough, particularly with respect to independence.

Commenters provided general overall support for the independence requirements. As noted above, several investors supported having the Commission mandate additional independence criteria, as compared to leaving such responsibility to the self-regulatory organizations (SROs). However, a greater number of commenters did not support having the Commission impose additional criteria, preferring to leave additional requirements to the SROs.

Several commenters requested additional clarification on the independence standards, particularly the impact of several terms used by the Commission. Several commenters also requested greater clarification regarding the types of commercial relationships that would not be prohibited. While many supported the proposed definition of "affiliate" with minimal modifications, several expressed concern regarding the impact of the proposal on significant shareholders and their designees. A large number of commenters also expressed concern about the impact of the proposals on master limited partnerships. Commenters overall supported the limited exemptions from the independence requirements proposed by the Commission, such as the holding company exception, multiple listing exception and the new issuer exception, although several requested extensions for these exemptions.

Commenters were mixed on several requests for comment regarding independence, with commenters representing investors generally advocating against weakening the proposals and commenters representing issuers generally requesting more flexibility. For example, commenters were mixed whether there should be a de minimis exception to payments and whether issuers should be allowed to request case-by-case exemptions.

Commenters generally supported the proposals regarding Section 10A(m)'s remaining audit committee responsibilities, such as responsibility relating to accounting firms, although several commenters representing predominately accounting firms requested clarification on the oversight requirement and believed the proposal should be limited. In addition, commenters were mixed on whether the Commission should mandate specific procedures regarding handling complaints. The majority preferred the Commission's proposal of leaving authority and flexibility to the audit committee to develop appropriate procedures in light of a company's circumstances. However, a significant minority representing some investor groups and several providers of complaint outsourcing services argued that specific procedures are necessary to ensure a sufficiently independent procedure.

The application of the proposals to foreign issuers attracted the largest number of commenters, including comments directly from many foreign issuers and their representatives. The commenters expressed overwhelming support for the Commission's approach of providing tailored exemptions where the requirements of Section 10A(m) would result in a direct conflict with home country legal or listing requirements. In accordance with the Commission's request for comment, many outlined refinements to the Commission's proposals, with the majority of comments directed to the board of auditors exception and the proposed instruction regarding possible conflicts with shareholder approval requirements. Several commenters also came forth with additional areas they believed should be accommodated to avoid conflicts with home country requirements.

While several commenters believed the proposed implementation periods were adequate, a majority requested additional time to comply, particularly because the operative date for the requirements would fall before or during the 2004 annual meeting period for many issuers. Several commenters also recommended delayed implementation for foreign issuers. Commenters were nearly unanimous that there should not be different requirements for smaller issuers, although a few did support accommodations, such as a delayed implementation period.

Commenters overall supported the Commission's proposed disclosure changes with few suggested refinements. Apart from the Commission's proposals, several commenters expressed support for expanded disclosure on the determination of an audit committee member's independence. Several commenters representing foreign issuers did not support the proposed disclosure that an issuer relying on an exemption disclose its assessment of whether such reliance would materially adversely affect the ability of the audit committee to act independently and satisfy the other requirements.

The responses are discussed in more detail below. The Commission received several comments before the proposals were issued by the Commission, the majority of which related to application to foreign issuers. These comments are summarized in a separate section at the end of the comment summary.

III. General Applicability of the Proposals

• One commenter urged the Commission to steer away from specificity where possible to give companies and their boards flexibility to apply the requirements in good faith.¹

• Two commenters urged the Commission to use specificity and bright line tests where possible for consistency, investor confidence and to avoid evasion and gamesmanship.²

• Three commenters supported that in the absence of a separate committee, the full board must comply with the proposals.³

• One commenter believed that in the absence of a separate committee, the audit committee should be deemed to be all non-executive directors, not the full board.⁴ To do otherwise forces an issuer to have a separate audit committee.

• One commenter recommended a provision, similar to the safe harbor provision in the audit committee financial expert rule, to the effect that the rule shall not be deemed the basis for a private civil action and is not intended to increase the responsibilities of audit committee members under state law.⁵

• One commenter believed that the board of directors should be fully informed about the actions and deliberations of the audit committee, continue to monitor all aspects of a listed company's business and affairs, including the performance of the audit committee, and be in a position to take whatever steps necessary should an audit committee fail to perform its duties or undertake actions the board determines are contrary to the best interests of the company and its shareholders.⁶

IV. Audit Committee Member Independence

A. General Comments

• Ten commenters supported independence criteria beyond in Section 10A(m), such as:⁷

  • Additional independence standards endorsed by the Council of Institutional Investors, requiring all SROs to observe the same definition.⁸ Allowing different definitions is confusing and encourages a race to the bottom. The CII definition allows only nontrivial professional, familial or financial connections to the issuer, its chairman and its executive officers.

  • Otherwise adding relationships with an audit committee member or an affiliate apart from board service (some advocating a cap on such relationships), including affiliations with a significant customer, supplier, tax-exempt entity or other entity in which the member has significant business, financial or other interests, as well as personal service contracts.⁹

  • Restrictions on service by former audit partners or employees.¹⁰

• Thirteen commenters did not support expanding beyond the criteria in Section 10A(m) (including ordinary course commercial relationships), preferring to leave additional requirements to the SROs.¹¹

• Seventeen commenters believed the board of directors is the appropriate body to determine audit committee member independence.¹² Two suggested the board be required to consider the nature and significance of ordinary course commercial relationships.¹³

• One commenter believed that instead of board determination, independence should be determined by strict bright-line tests, with disclosure of how they were followed.¹⁴

• One commenter said it should be left to the SROs to decide whether the board should be required to determine independence.¹⁵

• Two commenters supported a more principles based approach to independence as opposed to detailed rules.¹⁶

• One commenter suggested that independence could be viewed less as a series of qualifications considered at the beginning of tenure but instead as an annual examination required for continued service based on the member's actions.¹⁷

B. Consulting, Advisory or Other Compensatory Fee Prohibition

• Four commenters expressed specific support for the formulation of the restriction, including the extension to indirect payments and family members.¹⁸

• Three advocated an extension to more family members, such as all children, siblings, parents and parents-in-law.¹⁹

• Two urged deleting the "sharing of home" requirement.²⁰ One would apply it to all children,²¹ and the other would not apply it to legally emancipated children.²²

• One commenter suggested that the limitation should apply to all household members, as well as others with a relationship that could pose significant influence over the audit committee member.²³ The commenter also believed all persons currently employed by the issuer's accountants and lawyers should be prohibited from any board service.

• Seven commenters expressed support for an exception for non-executive family members employed by the issuer.²⁴ One and an additional commenter urged that if there is an exception, it should be limited to non-management, not just non-executive, employees.²⁵

• One commenter did not believe a non-executive family member exception is necessary given the narrow application to family members.²⁶

• Fourteen commenters supported applying the prohibitions only to current relationships and did not support a look back or cooling off period, instead preferring to leave any additional requirements to SROs.²⁷ In particular, two believed retired audit partners, investment bankers, attorneys, etc. should be permitted, consistent with the auditor independent rules.²⁸ Some offered suggestions if there was such a period, such as (1) it should be no longer than one year,²⁹ (2) there should be a phase-in,³⁰ and (3) there should be a one year exemption of a look back period for new issuers.³¹

• Nine commenters supported a look back period.³² One advocated one year,³³ four advocated three years³⁴ and three advocated five years.³⁵ One argued that the same logic justifying a cooling off period before audit partners can assume issuer management and audit partner rotation argues for a cooling off period for audit committees.³⁶

• Two commenters mentioned that if there is a look-back period, it should not be applicable to affiliation based on share ownership.³⁷

• One commenter recommended prohibiting consulting, advisory or compensatory fees from any affiliate thereof.³⁸ Another commenter noted that the release discussion describes the prohibition this way, but the rule text refers to just the issuer and requested clarification of whether this refers to fees on behalf or for the benefit of the issuer.³⁹

• Sixteen commenters supported clarifying that "compensatory fees" or "indirect" fees do not include compensation received under a retirement or similar plan (some specified non-contingent or non-discretionary plans) in which a former officer or employee participates.⁴⁰ An additional commenter supported leaving it to the SROs to decide.⁴¹ Several noted that the NYSE and Nasdaq have such clarifications in their proposed listing standards. Two supported incorporating wording from the auditor independence rules.⁴²

• Two commenters requested payments made to a director arising from or in connection with direct or indirect investments by the director in the issuer are not considered consulting, advisory or compensatory fees.⁴³

• One commenter believed "indirect" payments should include payments made to any employees-not just partners or similar high level executives-working for companies that receive consulting, advisory or other consulting fees from the issuer.⁴⁴

• One commenter recommended against any prohibition on "indirect" payments.⁴⁵

• Two commenters believed the term "partner, member or principal" is over inclusive (i.e., captures limited partners and non-managing members).⁴⁶ One believed it should not be applied to any member of an organization providing a service if the audit committee member's compensation was not directly affected by payments received from the issuer for the relevant services.⁴⁷ The other believed indirect payments should be limited to entities in which an audit committee member is an executive officer, rather than a partner, member or principal.⁴⁸ In the absence of ability to control the associated entity, no policy purpose is served by applying the indirect prohibition beyond executive officers. In the alternative, limit to either (2) executive officers and persons with more than 10% interest in the profits or capital of the entity, or (2) limit partner and member to a general partner and managing member and delete the vague reference to principal.

• Four commenters believed the term "partner, member or principal" requires further definition.⁴⁹ Two questioned the application to large, diversified corporation organizations that do not have partners or members (i.e., is an executive officer of an investment bank owned by a conglomerate covered).⁵⁰ One requested confirmation that services as a non-management director or supervisory board member would not constitute a partner, member, principal or similar position.⁵¹ One would define it as a natural person if he or she holds an equity interest in the issuer that entitles him or her to participate in the management of the company, or in the case of a stock corporation, if he or she has been appointed as a member of senior management (which in the case of dual board companies normally involves membership on the management board).⁵²

• One commenter asked for clarity of the meaning of "similar positions."⁵³ Does it include associates or senior managers? Retired partners or principals should be permitted.

• One commenter was unsure of the phrase "or any other similar services" and believed it should be eliminated as it raises more questions than it answers.⁵⁴

• Three commenters expressed support that the proposal would continue to allow ordinary course commercial business relationships, including allowing issuers that are banks to continue ordinary course loans and other banking relationships with directors and their related entities, consistent with existing Federal and Sarbanes-Oxley Act provisions.⁵⁵

• Six commenters believed more guidance is required on the types of ordinary course commercial relationships that are not prohibited.⁵⁶ One requested more examples.⁵⁷ One gave an example of an audit committee member's firm that repossesses cars for a bank when loans default. If the member suggests that certain cars be towed first, the commenter assumes this is not an "advisory" service⁵⁸ One encouraged a definition.⁵⁹ One commenter recommended confirmation that routine services, such as custodial, cash management and stock brokerage services in the case of an investment banking firm constitute ordinary course commercial relationships.⁶⁰

• Seven commenters requested more clarification regarding relationships with banks.⁶¹ For U.S. issuers that are banks, independence should not be impaired as a result of banking relationships between the issuer's banking affiliate and a director or his/her related interests, if the relationships are made in the ordinary course of business and on the same terms as comparable transactions with non-affiliates, and any extensions of credit comply with applicable law, including Regulation O and Exchange Act Section 13(k). Two recommended a specific exception for banks,⁶² and one provided a definition of "banking relationship."⁶³ In addition, in some foreign jurisdictions, it is customary for a representative of a long-term relationship bank to sit on the audit committee. These banks occasionally engage in investment banking or financial advisory work as part of ordinary-course commercial relationships. But these relationships arguably would fall under "advisory" or "financial services" in the proposed rule. For example, would the prohibition include a bank that participates in a syndicate of banks which provides a revolving credit facility (even if the bank is not the arranger)? Would it include a member of an underwriting syndicate (even if the bank is not a lead underwriter)? Commenters suggested clarifying that these relationships are acceptable.⁶⁴ To do otherwise unnecessarily restricts the pool of available candidates. One believed the advisory prohibition should be limited to advisors to the issuer in its role as a securities issuer.⁶⁵

• Four commenters recommended codifying that independence would not be precluded on the basis of ordinary course business relationships.⁶⁶ One would include a statement that a director who would otherwise be considered independent should not be disqualified from service because he or she is associated with an entity which supplies consulting, advisory or similar services where such services, in the ordinary course of commercial business relationships, are supplied incidental to the supply of goods or other kinds of services or are otherwise part of an ordinary course commercial relationship.⁶⁷ One believed no relationships should be precluded unless the director is directly or indirectly compensated based on such transactions of business relationships, similar to the cross-selling compensation prohibition in the auditor independence rules.⁶⁸ An additional commenter believed there should be a specific exception for arms-lengths relationships, with annual disclosure.⁶⁹

• One commenter believed the test for indirect law firm relationships should be whether a director shares in legal fees paid by the issuer to the firm.⁷⁰ The commenter is of counsel at a firm that represents an issuer of which the commenter is a director. While a firm employee, the commenter does not share in billed fees. The commenter may need to resign from the firm, which would make him more dependent on the issuer for compensation.

• One commenter requested that the rule make clear that only compensation for advisory services are covered by the restrictions on direct and indirect compensation.⁷¹

• One commenter noted that without further clarification, the following should be acceptable as long as they are accorded directors by virtue as their status as directors:⁷²

  • Participation in employee purchase discount plans;

  • Maintenance of life insurance policies

  • Loans to directors permissible under Section 402 of the Sarbanes-Oxley Act

  • Participation in company health and welfare benefit plans.

• Four commenters recommended clarification of the scope of permissible compensation as a director.⁷³ For example, could a director's compensation consist of a fixed monthly fee, and a percentage contingent on profits? One recommended explicit statements that reimbursements of reasonable and necessary director expenses are permitted. One believed independence should address share-based compensation, such as stock options. [Note: The proposal does not apply to compensation paid for capacity as a director]

C. Affiliated Person Prohibition

• One commenter recommended that the prohibition be modified to prohibit an audit committee member from being an affiliated person of the issuer or any affiliate thereof (vs. the proposed prohibition which applies to the issuer or any subsidiary thereof).⁷⁴

• Eight commenters supported the proposed definition of affiliate.⁷⁵ Two specifically agreed with the 10% shareholder threshold.⁷⁶

• One commenter, while supporting some objective criteria to aid in determining affiliate status, believed it cannot be reliably assumed that less than 10% owners are not affiliates, and recommended a lower threshold, perhaps 5% or lower.⁷⁷

• One commenter believed all owners over a 20% threshold should be disqualified.⁷⁸

• Four commenters supported a 20% threshold if there will be a safe harbor.⁷⁹

• One commenter recommended that a control criterion based on ownership should be a 30% threshold or the majority of voting rights for the last three shareholder meetings.⁸⁰ The 30% threshold in many European jurisdictions is the threshold for a mandatory take-over bid.

• One commenter believed the safe harbor test relating to beneficial ownership be available to: (1) a person who beneficially owns no more than 10% of the voting power in the election of the issuer's directors and (2) a person who owns more than 10% but less than 20% of the voting power in the election of the listed issuer's directors and who does not have a right to designate any of the company's directors.⁸¹ Regarding (2), a shareholder would not be deemed to have the right to designate a director merely because it possesses up to 20% of the voting power.

• Two commenters did not support relying on a definition similar to Exchange Act Rule 12b-2 or Securities Act Rule 144, believing it is overly broad.⁸² Instead, the focus should be on improper relations with management. It is inappropriate to prohibit in all cases significant stockholder representatives when the focus should be on independence from management. The 10% threshold could become viewed as a ceiling for ownership. One would eschew any threshold in the safe harbor and leave affiliate status to the board.⁸³ According to the other commenter, a majority stockholder should be presumed to be an affiliate (which could be rebutted by the board) and all other stockholders should be presumed to be not affiliates.⁸⁴ Any safe harbor threshold should be far higher than 10%. The fact that a shareholder can elect a minority of directors should not preclude independence. The release should state venture capital and other private equity investors qualify so long as they otherwise meet the requirements.

• Six commenters were concerned that the proposal may impact the opportunity of significant (but non-controlling) shareholders or their representatives to serve as members of audit committees.⁸⁵ These commenters believed significant stockholders enhance, not impair, director independence and increase shareholder value.

  • One argued that independence should not be based just on an ownership level that indicates control under conventional affiliate analysis.⁸⁶ Venture capital fund directors pose no material risk of control abuse and instead bring benefit to issuers and shareholders. While in theory a significant owner could wield control, in practice there are mitigating facts (checks and balances and lack of motive and opportunity) that would prevent abuse. Several studies show that large shareholder directors enhance corporate performance and increase value. A facts and circumstances approach is urged. In the alternative, provide a safe harbor for directors like venture capital fund directors to reflect their minimal risk of abuse.

  • One urged removing the 10% shareholder aspect of the safe harbor altogether and leave affiliate as traditionally defined by non-quantitative concepts of control.⁸⁷ Any quantitative level will in practice become a ceiling and 10% is too low.

  • Two, while supporting the adoption of a Rule 12b-2 definition and a safe harbor, believed the 10% threshold is too limiting because many will feel uncomfortable serving if they do not meet the safe harbor.⁸⁸

  • One suggested defining affiliate so as not to disqualify persons who are otherwise unaffiliated but who are associated with entities that beneficially own less than 50% of voting power and do not have to power to designate and do not in fact constitute a majority of the board.⁸⁹ In the alternative, owners of between 10% and 49% should be permitted to serve on the audit committee. If neither approach is followed, grant issuers formal liability relief from determinations or judgments made by the independent audit committee of equity investees.

• One commenter supported the clarification that a director, executive officer, partner, member, principal or designee of an affiliate would be presumed to be an affiliate.⁹⁰

• One commenter believed the clarification that a director, executive officer, partner, member, principal or designee of an affiliate would be presumed to be an affiliate should be removed as it contrasts with the facts and circumstances analysis contemplated by the definition of affiliate.⁹¹ It is over inclusive and captures those who may not control the affiliate (for example, would "partner" include a limited partner?). If it is to be retained, it should be limited to executive officers of the affiliate, which are the only ones said to control the affiliate. "Principal" and "designee" are undefined and unclear.

• Another commenter requested clarification that passive ownership positions that do not involve management or control (such as limited partner status) should not be presumed to be disqualifying.⁹²

• Three commenters were concerned with the specification that any director of an affiliate is an affiliate.⁹³ One requested clarification that a non-management director or supervisory board member of an affiliate should not be deemed an affiliate based solely on such relationship.⁹⁴ One believed the specification should be removed since the director may be otherwise independent and not an affiliate of such entity under a facts and circumstances analysis.⁹⁵ The language is inconsistent with the justification for the holding company exemption. Another requested the Commission make clear that outside directors of a controlling shareholder who would otherwise qualify as independent are excluded from the "presumed to be an affiliate" requirement.

• One commenter requested a modification for the clarification that a "partner" and "member" would be presumed to be an affiliate to deal with limited partnerships and limited liability companies.⁹⁶ The commenter would limit the formulation to general partners, managing members and anyone owning more than 10% of the limited partnership or non-managing member interests.

• Fifteen commenters believed the safe harbor requirement of not being a director is ambiguous as audit committee members are directors.⁹⁷ Eight recommended deleting it.⁹⁸

• One commenter suggested that the safe harbor be clarified to make clear that it applies to entities other than the issuer and not just the issuer.⁹⁹

• Two commenters believed safe harbor also should refer to beneficial ownership of any class of "voting equity securities" rather than any class of "equity securities."¹⁰⁰

• One commenter recommended a rebuttable presumption that those who cannot rely on the safe harbor are considered affiliates.¹⁰¹ The presumption could be rebutted by a consideration of individual facts and circumstances on the ability to exercise control.

• Six commenters recommended against a rebuttable presumption that those who can not rely on the safe harbor are considered affiliates.¹⁰² One requested a stronger statement on this point.¹⁰³ Boards should have discretion to determine that even a greater than 10% shareholder is independent based on all facts and circumstances.

• One commenter believed the inclusion of the term "designee" in the definition of affiliate is an expansion of the affiliate concept beyond its traditional meaning and beyond similar state law concepts and requested that it be deleted.¹⁰⁴ For new and significantly owned issuers, all directors could be deemed designees of an affiliate and not independent.

• One commenter requested clarity on whether the term "director" in the definition of affiliate refers to a director of a management board (preferred) and/or a director of the supervisory board (not preferred).¹⁰⁵

• One commenter believed the rules should adopt a principles-based approach for affiliate status and address the total wealth portfolio of the individual.¹⁰⁶

D. New Issuer Exemption

• One commenter did not believe the exemption was necessary and believed audit committees should consist solely of independent directors, without exception.¹⁰⁷

• One commenter supported the 90 day period, arguing it would achieve an adequate balance between the need for independence and the need for historical experience.¹⁰⁸

• One commenter believed it should not extend beyond one member, at least a majority of the committee must be independent and the period should not exceed 180 days.¹⁰⁹

• An additional commenter did not support an extension beyond one member.¹¹⁰

• Two commenters recommended an 180 day period,¹¹¹ with one advocating an extension to a minority of the committee.¹¹²

• One commenter believed the exemption should be for one member provided that (1) the member is not a member of management and (2) at least one member does meet the independence criteria for the period from the date on which the issuer's initial registration statement becomes effective until the date of the annual meeting of the issuer following the first anniversary of the date on which the issuer's initial registration becomes effective (but in no event more than 180 days after the first anniversary of the date on which the issuer's initial registration statement becomes effective), with a longer transition period for a companies with a public float of less than $75 million.¹¹³

• Eight commenters recommended a one-year period,¹¹⁴ with one advocating application to the full committee,¹¹⁵ and another advocating application to a minority of the committee.¹¹⁶

• Three commenters recommended the historical approach of the NYSE's listing standards that two of three independent members must be appointed within 90 days and the third must be elected within one year.¹¹⁷

• One commenter requested a two-year period for all audit committee members.¹¹⁸

• Another commenter requested an extension of time, but did not provide specifics.¹¹⁹

• Two commenters recommended an extension to issuers listed in their home jurisdiction at the time they first become listed in the U.S.¹²⁰ One advocated an extension for the whole committee until the first annual meeting following the U.S. listing.¹²¹

E. Holding Company Exemption

• One commenter did not believe the exemption was necessary and believed audit committees should consist solely of independent directors, without exception.¹²²

• Eleven commenters expressed specific support for the exemption as proposed.¹²³

• Four commenters recommended extending the exemption to any subsidiary of a holding company.¹²⁴ The exemption should not be limited to just majority owned or consolidated subsidiaries, and the commenters did not see the relevance of these qualifications. One of the commenters instead recommended using the definition of "subsidiary" in Exchange Act Rule 12b-2 that defines subsidiary of a specified person as "an affiliate controlled by such person directly, or indirectly through one or more intermediaries."¹²⁵ Alternatively, replace "consolidated, majority-owned subsidiary" with "controlled subsidiary." One of the commenters was concerned about accommodating master limited partnerships.¹²⁶

• One commenter recommended extending the exemption to any entity supported by the holding company's credit.¹²⁷ An entity whose securities are fully and unconditionally guaranteed by a parent should be exempted, regardless of ownership level or consolidation status, as investors will be looking to the parent because of the guarantee.

• One commenter urged an extension to unconsolidated 50% owned joint ventures.¹²⁸

• One commenter recommended eliminating the consolidation requirement and requiring boards to make a determination of whether the operations and strategy of the parent and subsidiary are aligned.¹²⁹ If they are not, the exemption should be unavailable.

• Four commenters recommended expanding the exemption to not just parent/subsidiary situations but also to directors that sit on sister subsidiaries (or in the case of a master limited partnership, a subsidiary and a general partner) under common control of a parent, regardless of whether the parent is listed.¹³⁰ One would modify the language to include directors that sit on the board of both a listed issuer and any affiliate.¹³¹

• One commenter did not believe the qualification that the audit committee member receives only ordinary course compensation for board service is necessary.¹³²

• One commenter believed that representatives of parents of consolidated subsidiaries should be allowed to constitute a minority of the subsidiary's audit committee as long as the representative is otherwise independent of the subsidiary (but not of the parent).¹³³

• One commenter believed the exception disfavors natural persons since they cannot consolidate accounts of entities.¹³⁴

• One commenter recommended an accommodation for mutual insurance companies that are not required to prepare or publish GAAP financial statements.¹³⁵ While the exemption would permit an audit committee member to sit on the boards of both a listed issuer and its parent, the parent may not be required to prepare or publish GAAP financial statements that would reflect subsidiary consolidation. The exemption should be modified to apply also to a direct or indirect majority owned subsidiary of a parent if the financial statements of the listed issuer would be consolidated with those of its parent if the parent were required to prepare GAAP financial statements. There would still be a unity of interest contemplated by the original consolidation requirement.

• Two commenters questioned whether the parent could use the audit committee members of a subsidiary without the members themselves being parent directors.¹³⁶

F. Requests for Other Exemptions

• Six commenters did not believe any additional relationships should be exempted, including any de minimis exceptions or exceptional and limited circumstances exceptions.¹³⁷ Several believed the existing exceptional and limited circumstances exceptions have been applied in practice more broadly than intended.

• Six commenters supported an exceptional and limited circumstances exception.¹³⁸ One suggested a one-year term,¹³⁹ another six months,¹⁴⁰ and another two years.¹⁴¹ Two of the commenters requested the exception for smaller issuers.¹⁴² A commenter that did not recommend such an exception urged that if there is one, it should be one year and disclosure should be required.¹⁴³

• Seventeen commenters supported some form of de minimis or immaterial exception, at least with respect to the indirect fee prohibition.¹⁴⁴ One supported a 1% limit of annual fees received by the entity,¹⁴⁵ three supported a 5% limit,¹⁴⁶ one supported a 15% limit,¹⁴⁷ and one supported $20-25,000.¹⁴⁸ Four referred to the standards in Item 404 of Regulation S-K.¹⁴⁹ Others supported a materiality standard.¹⁵⁰ One supported such an exception for small issuers only.¹⁵¹ Precluding an advisor from service simply because his/her firm received immaterial compensation for services seems unfair, overly restrictive and narrows the pool of candidates. One commenter supported disclosure of any materiality determinations by the board.¹⁵²

• One commenter believed SROs should be permitted to develop criteria or procedures to allow incidental or immaterial compensatory payments to a relative of a director.¹⁵³ The commenter did not support a de minimis or immaterial exemption for payments directly made to a director. An additional commenter recommended a de minimis exception for payments to firms of family members.¹⁵⁴

• Eight commenters did not believe companies should be permitted to request exemptive relief on a case-by-case basis.¹⁵⁵ However, one recommended delegation to the Director of the Division of Corporation Finance if new foreign conflicts arise.¹⁵⁶

• Eight commenters supported case-by-case exemptions by the Commission or SROs.¹⁵⁷ Two urged SRO authority to exempt small businesses on a case-by-case basis.¹⁵⁸ One requested case-by-case exemptions for alternative governance structures, but not for issuers who believe they have extenuating circumstances.¹⁵⁹

• Seven commenters believed the rule should provide built-in flexibility to adapt to evolving standards of corporate governance throughout the world, and should allow SROs or the Commission to accept, on a case-by-case basis, foreign corporate governance rules and practices when they conflict with or are equally or more protective of investors.¹⁶⁰

• One commenter believed the SROs should be able to decide if there should be de minimis exceptions, case-by-case exceptions and exceptional and limited circumstances exceptions.¹⁶¹ Another commenter believed SROs should be primarily charged with interpreting the new standards.¹⁶² In recognition of this role, the SROs should publish their interpretations, similar to Commission staff no-action letters.

• Fifteen commenters requested accommodations for master limited partnerships, or MLPs (or LLCs with managing and non-managing members).¹⁶³ One of these commenters and four additional commenters raised this concern generally where any issuer is controlled by a large shareholder.¹⁶⁴ An MLP, whose common limited partner interests are generally listed for trading, is governed by a general partner. The general partner's directors, including its independent directors, are selected by an affiliate (the owner or controller of the general partner) commonly called the sponsor. The limited partner has no employees or directors, and the limited partner interests generally have no right to elect the directors of the general partner. It could be argued that the directors of the MLP's general partner, because they are selected by the sponsor, are "designees" of an affiliate and therefore not independent. The commenters requested clarification as to the application of the rule to MLPs. As possible solutions:

• Clarify that for purposes of limited partnerships, the relevant board of directors is the board of directors of the general partner. This could be done by including the parenthetical (or equivalent body) after the term "board of directors" in Rule 10A-3(b)(1)(i).

  • Delete designee from the definition of affiliate

  • Define designee to clarify that something more than mere nomination and election by a sponsor is required to render a person ineligible (should instead exclude only directors who are under the control or direction of another person)

  • Expand the holding company exemption to also include persons designated by, but otherwise independent of, an affiliate, whether that affiliate is listed or not, a majority owner or not, or consolidates or not. The exemption should be available regardless of the source of control.

  • Create an affiliate exemption for MLPs allowing a sponsor to designate audit committee members who are independent of the sponsor (not an executive officer or employee, or 10% stockholder of the general partner or its other affiliates)

  • In addition, accommodations should be made where an intermediate management company exists between the MLP and the general partner or if the MLP is a limited liability company with its own board. The proposed specification that a director of an affiliate is an affiliate would disqualify service. The holding company exemption would not be not available because of no consolidation.¹⁶⁵

• One commenter believed the rules should provide that a director who is independent in all other respects should not be disqualified based solely on association with a 20% shareholder.¹⁶⁶ SROs should be able to review the totality of the circumstances in such case. If circumstances indicate the director is under management's influence or likely to abuse its power, SROs should have the authority to deem the director not independent.

• One commenter requested an exception for attorneys that serve on audit committees if the law firm with which that attorney is associated receives compensation, if such compensation was not the result of voluntary action on the part of, or otherwise caused by, the issuer.¹⁶⁷ For example, an issuer that is sued turns the complaint over to its insurance carrier, which in turn selects a law firm to represent the insured. A member of that law firm is on the audit committee of a separate carrier. The law firm searches for other insurance coverage that could be implicated by the suit. Additional carriers may be required to participate, which may include the carrier on which the attorney serves as director. Court rules may prohibit the carrier from hiring separate attorney, and it may need to contribute its portion of legal fees to the original carrier's law firm. While the commenter admitted this is rare, it would render the attorney not independent.

V. Responsibilities Relating to Registered Public Accounting Firms

A. General Comments

• Five commenters supported the proposal as written, believing additional specificity is not needed and flexibility should be given to the audit committee regarding the execution of those responsibilities, without rigid rules.¹⁶⁸

• One supported the proposal, but asked for clarity that the rule is limited to responsibility only for the auditor of the issuer's financial statements and any audit or attest reports provided by other auditors included or required in a Commission filing.¹⁶⁹ An additional commenter believed the rules should cover only the auditor of the issuer's financial statements and not other accounting firms.¹⁷⁰

• One commenter focused on the extension in the rule to oversight of "other audit, review or attest services."¹⁷¹ The commenter believed that Section 10A(m) was only intended to cover the engagement of the principal auditor for the audit and related work (review of interim financials, assessment of internal controls, etc.). For other services by the principal auditor or other accounting firms (i.e., tax services), the audit committee's responsibilities should be limited to engagement pre-approval consistent with Regulation S-X Rule 2-01(c)(7) and no further oversight should be required.

• One commenter requested a statement by the Commission that the auditor responsibility requirement extends only to auditors that are in fact required to be registered with the Public Company Accounting Oversight Board, and Rule 10A-3 itself imposes no independent registration requirement for foreign public accounting firms.¹⁷² The commenter also encouraged clarification that the audit committees responsibilities are not inconsistent with, and are not intended to undermine, the committee's responsibility to report regularly to the full board so as not to interfere with the oversight function of the full board.

• One commenter was concerned that the release's reference to ultimate authority to approve of all "engagement fees and terms" may cause some to infer that the audit committee must execute the contractual engagement letter."¹⁷³ The commenter requested clarity that while the audit committee may have ultimate authority, the Commission is not suggesting that the committee must, or even should, review and approve the terms of individual engagements, or execute engagement letters.

• Three commenters requested guidance regarding the level of audit committee oversight required.¹⁷⁴ One noted that given that the audit committee meets only periodically, day-to-day oversight is not feasible.¹⁷⁵ One recommended the rule clearly delineate management's responsibility for financial reporting practices, policies and procedures and coordinating day-to-day work of the outside auditor from the audit committee's oversight responsibility.¹⁷⁶ To do otherwise runs the risk that the audit committee ends up managing such day-to-day affairs. The other commenter noted the following:¹⁷⁷

  • The audit process may involve more than one firm. The rules should identify for which firms the audit committee is directly responsible. Firms (other than the principal auditor) that report on financial statements of a subsidiary that constitutes less than 20% of assets or revenues should be excluded (consistent with the partner rotation rules), although the audit committee should be free to choose to be directly responsible for these firms if it wants.

  • Additional clarity should be provided if oversight is intended to mean more than retention and authority to approve engagements (which are the only specific points mentioned in the release). Oversight should include matters required to be communicated under AU 380 and Rule 2-07 of Regulation S-X.

  • Additional clarity should be given to what level of involvement is implied for resolution of disagreements. It should not be debates resolved by the auditor and management during the audit process, but rather SAS 61, AU 380 and Rule 2-07 of Regulation S-X.

  • Consider whether audit committees should meet periodically with external auditors in private.

  • The release reference to approval of "significant" non-audit engagements should be deleted. The auditor independence pre-approval rules should be sufficient.

• One commenter requested clarity whether "related work" is used in the same sense as "audit-related" in the auditor independence rules and whether "audit," "review" and "attest" services are used as defined in GAAS.¹⁷⁸

• One commenter believed that, despite the language in the statute, the responsibility for resolving disagreement between management and the auditor should be eliminated.¹⁷⁹ Also, oversight of consulting services by the principal auditor should not be covered.

• One commenter believed internal auditors should manage the external audit contract for the committee under SPPIA 2050 and SPPIA Practice Advisories 2050-01 and 2050-2.¹⁸⁰

• One commenter noted that in engaging the outside auditor, the audit committee or full board, not the issuer, should be designated as the client.¹⁸¹ The board or audit committee should seek competitive bids for outside auditors no less frequently than every five years.

• One commenter believed that in addition to the auditor independence rules, audit committee pre-approval for non-audit services should be added to Rule 10A-3.¹⁸²

• One commenter believed the full board should be required to ratify the audit committee's auditor decisions.¹⁸³

B. Proposed Instruction Regarding Shareholder Approval of the Auditor

• Fourteen commenters expressed specific support for the instruction as proposed.¹⁸⁴

• Eight commenters recommended extending the instruction to also include auditor compensation and termination.¹⁸⁵ Some foreign laws (i.e., Canada, Italy, UK) rest these powers with shareholders, but the proposed instruction only relates to appointment. One recommended also extending the instruction to auditor oversight.¹⁸⁶

• Five commenters believed the instruction should be turned into an explicit exemption.¹⁸⁷

• One commenter expressed specific support for the position that if local law requires the auditor to be appointed by a body other than the audit committee, the audit committee be required to make a recommendation on such appointment.¹⁸⁸

• Eight commenters believed the instruction does not address a conflict in some countries that prohibit the board from delegating power to make nominations or recommendations to shareholders.¹⁸⁹ Several requested accommodations, such as (1) expanding the part of the instruction dealing with instances where directors are prohibited from delegating responsibility to also include the responsibility to make a recommendations to shareholders (with the audit committee having advisory powers to the extent permitted by law), or (2) exempting foreign issuers from the requirement that the audit committee must provide a recommendation to shareholders in such instances.

• One commenter believed management boards of French companies are prohibited from delegating oversight of external auditors to the supervisory board of any of its committees.¹⁹⁰ It proposed that it should be sufficient for French companies to have the audit committee pilot the external auditor selection process, express an opinion on nomination/removal to the full supervisory board (which in turn makes corresponding recommendations to the management board), and have the ability to require the outside auditors to provide reports and information to the audit committee upon request.

• One commenter noted that some jurisdictions allow shareholder to make counter-proposals for the appointment of the auditor, and believed the instruction should state that it will not conflict with such requirements.¹⁹¹

• One commenter recommended extending the instruction to also cover voluntary selections of the auditor by shareholders (i.e., not just where local law or listing requirements require it).¹⁹²

• Three commenters noted that some jurisdictions allow the outside auditor to only be removed by court order upon specified circumstances.¹⁹³ Thus, there would be a conflict with the requirement that the audit committee be responsible for the outside auditor's termination. One suggested the instruction should be clarified that the requirement is satisfied by the ability to recommend against reappointment at the end of the auditor's term. Alternatively, the instruction should clarify that the committee be given this responsibility to the extent permitted by law.

• One commenter noted that the French government is required to select its auditor, not shareholders or the board of directors.¹⁹⁴ The proposed instruction would not provide relief. The final rule should include an explicit exemption (1) that a foreign issuer's auditors are to be appointed by the persons or organs specified by mandatory provisions of its home country law, and (2) that where a foreign issuer's home country law subjects the removal of auditors to mandatory procedure, Rule 10A-3's only additional requirement in this regard is that the committee issue a recommendation to the board.

• One commenter believed the rules should make clear that, in cases where an audit committee does not have legal power to act, it will make a recommendation or report, and that report will be communicated to the body that is legally empowered to act.¹⁹⁵

• One commenter believed the language of the instruction should be improved to state affirmatively that where home country law requires shareholder selection of the auditor, the issuer will satisfy Exchange Act Rule 10A-3's requirements when the auditor recommended by the audit committee is presented to shareholders.

• One commenter requested clarification that the instruction does not conflict with the U.K. Smith Report that the audit committee provides a recommendation to the board, and thence to shareholders for approval.¹⁹⁶ If the board does not accept the committee's recommendation, it shall disclose in its report a statement from the committee's recommendation and why the board has taken a different position.

• One commenter noted that to the extent U.S. state law requires shareholder appointment, states would be well advised to fix any such conflicts to fall in line with the Sarbanes-Oxley model that gives audit committees this responsibility.¹⁹⁷

C. Audit Committee Responsibility for the Internal Auditor

• Six commenters believed the audit committee should be directly responsible for the appointment, compensation, retention and oversight of the internal auditor, or at least the chief audit executive.¹⁹⁸ Only through this relationship would the internal auditor be sufficiently independent to bring malfeasance to the appropriate parties.

• One commenter believed professional literature and most charters already include oversight responsibility as a matter of best practice and would not object to codifying this responsibility.¹⁹⁹

• Ten commenters did not support requiring the audit committee to be directly responsible for the internal auditor, as it may overwhelm the audit committee, although many did support access and broad oversight of the function.²⁰⁰

• Four commenters recommended a dual reporting structure both to management and the audit committee.²⁰¹ The internal auditor should not report to the CFO. The audit committee should determine who the chief audit executive reports to administratively.

VI. Procedures for Handling Complaints

• Eighteen commenters did not support mandating specific procedures, but instead preferred the proposal of leaving flexibility to the audit committee to develop appropriate procedures in light of a company's circumstances.²⁰² Several mentioned issuers have in place procedures and that such procedures are being modified to address the specific requirements of the proposal. Four believed the audit committee should have the flexibility to utilize an issuer's existing internal compliance infrastructure (i.e., those established under the United States Sentencing Commission's Guidelines for Organizations and its progeny), including internal employees.²⁰³ One did suggest guidance on typical practices such as employee training and a rigorous process for reporting questionable accounting or auditing matters.²⁰⁴ Another believed the complaint mechanism should include allegations of management fraud.²⁰⁵ Another believed a telephone hotline should be an example of a preferred procedure.²⁰⁶

• Ten commenters believed the Commission should mandate specific procedures, arguing that complete flexibility should not be left to the audit committee and the proposal does not establish a sufficiently independent procedure.²⁰⁷ Examples included:

  • Independent third party systems should be required for receiving complaints.²⁰⁸

  • The rule should clarify the period of retention. Three requested at least seven years.²⁰⁹

  • Companies should at least be required to provide the opportunity to file written complaints, protect employees from retaliation, offer an avenue for submitting complaints to independent directors not on the audit committee, provide an avenue for follow-up communications, and retain complaints and records for three years and make them available to the SEC and the PCAOB upon request.²¹⁰ Also, the regulation should extend to complaints "relating to" (not just "regarding") accounting, internal accounting controls or auditing matters.

  • There must be a widely publicized, confidential and anonymous process that provides employees with reassurance that they will have unfettered access to the audit committee independent of management without fear of reprisal and with an opportunity for employee follow-up where possible.²¹¹

  • People providing complaints must be ensured that their confidentiality will be protected.²¹² Accurate reports of complaints must be quickly generated and maintained by audit committees, independent of management.

  • Monitoring for complaints must occur weekly (and daily before filings), a log of complaints and their treatment (with standardized codes) should be required and made available for periodic Commission inspection. In addition, voluntary guidelines should be issued for employee education and certifications as well as employee rewards for submitting complaints. Disclosure would be required only if an issuer complies with the voluntary guidelines.²¹³

  • Procedures should be standardized for all issuers by the Commission.²¹⁴

• An additional commenter urged further guidance, including:²¹⁵

  • Defining anonymity as providing complaint channels such that no one at the issuer can become aware of the complainant's identity solely be virtue of the complainant's use of the channel; nor solely of any identifying content in the complaint received by the audit committee (e.g., gender, position, location, etc.).

  • Not mandating use of outsourcing or any other particular form of compliance.

  • Treating as a complaint (to avoid confusion between "complaint" and "concern" in the Act) any communication regarding accounting, internal accounting controls or auditing matters that reach the audit committee, whether from the mandated anonymous employee channels or from other direct or indirect channels-and regardless of known, presumed or unknown source.

  • All employees, including part time and contract employees, are covered.

  • Treatment of complaints includes both investigative actions and disposition of the complaint, and that all records be retained for seven years.

  • Providing a safe harbor based on an issuer's use of external complaint handling channels, at least with respect to compliance with the proposed requirement.

  • Treating complaint procedures as part of a system of internal accounting controls.

• Two commenters recommended an earlier implementation date for the requirement.²¹⁶

• One commenter recommended that despite the statutory language, the rule should restrict those who can submit complaints to employees in the financial reporting area.²¹⁷ The proposal may have the effect of elevating every employment dispute, including from disgruntled employees, into an audit committee matter. Customers, vendors and others should not be permitted to submit complaints because to do so could overwhelm the committee. Similarly, audit committees should be permitted to receive a report that provides a summary of complaints received, instead of actual complaints. In the alternative, clarify that the committee may utilize one or more administrative officers of the issuer for receiving complaints. Requiring third party systems will increase costs.

• Two commenters believed that any third party organization used for complaints should forward them directly to a member of the audit committee upon receipt.²¹⁸

• One commenter believed audit committees should be required to communicate information received regarding questionable accounting, internal accounting controls or auditing matters to the outside auditor.²¹⁹ An additional commenter believed the outside auditor should have unfettered access to complaints, providing anonymity is protected.²²⁰

• Seven commenters recommended disclosure of the complaint reporting procedures.²²¹ One recommended website or Commission disclosure similar to codes of conduct.²²²

• Four commenters recommended against requiring disclosure of procedures.²²³ One said that if any disclosure is required, it should be part of the Section 302 certification.²²⁴

• Two commenters did not support disclosure of the procedures in Commission filings, but believed the procedures should and would be published within the issuer.²²⁵

• One commenter believed the Commission should require and compile data from issuers concerning the effectiveness of their procedures, with an eye to public disclosure.²²⁶

• One commenter recommended an explicit statement that complaints about potential violations of applicable laws and regulations are included by the requirement.²²⁷

• One commenter believed the phrase "internal accounting controls" in the rule should be interpreted consistent with the COSO report "Internal Control - Integrated Framework." This should include compliance with laws and regulations, unless the issuer has established a qualified legal compliance committee under the attorney conduct rules.²²⁸

• One commenter believed a similar complaint procedures requirement should be mandated for accounting firms regarding their audit clients.²²⁹

VII. Authority to Engage Advisors

• Eight commenters expressed specific support for the requirement as proposed, believing no additional specificity is needed.²³⁰

• Two commenters suggested defining the term "independent" counsel or providing guidance that it is meant to be independent from the issuer.²³¹

• One commenter supported the Commission's statement that the requirement does not preclude access to a company's regular counsel if the committee so chooses.²³²

• One commenter believed the release discussion is pejorative toward outside auditors.²³³

VIII. Funding

• Seven commenters expressed specific support for the requirement, believing no additional specificity is needed.²³⁴ One advocated re-examining the issue in three years.²³⁵

• Six commenters did not support compensation limits, arguing there would be natural oversight by the full board.²³⁶ To do otherwise would subvert the Act's intent. One advocated that if there are such limits, they should be set by the board.²³⁷

• One commenter recommended allowing the board to set reasonable funding limits.²³⁸ Fiduciary obligations do not allow the board to completely relinquish oversight.

• Two commenters recommended adding that compensation be "reasonable," with the full board determining reasonableness.²³⁹

• One commenter believed the full board should be required to ratify compensation.²⁴⁰

• One commenter believed the rule should also include a requirement that the issuer provide appropriate funding, as determined by the audit committee, for ordinary administrative expenses necessary for the audit committee to carry out its duties.²⁴¹

• One commenter focused on the extension to also include compensation for "other audit, review or attest services."²⁴² For the same reasons regarding this extension of oversight responsibility, the audit committee should not be responsible for determining compensation for services by the principal auditor or other accounting firms other than those required under the securities laws (i.e., should not have compensation authority for tax services).²⁴³ Also, while the committee is responsible for determining funding, the Commission should clarify that actual payment could continue to be made by an authorized corporate officer.

• One commenter noted that under Chilean law, the budget of the audit committee and its advisors is set by shareholders and not by the audit committee.²⁴⁴ The audit committee is allowed to recruit advisors within those limits. However, this does not hinder the committee's ability to engage independent counsel since compensation does not rely on management, but on shareholders.

• One commenter recommended conforming the language which uses "rendering or issuing an audit report" with the oversight language which uses "preparing or issuing an audit report," preferring the latter.²⁴⁵ The requirement should also be limited to the firm auditing the issuer's financial statements and not other firms.

IX. Implementation

• Five commenters believed the proposed implementation dates are adequate for issuers to make necessary changes to their audit committees.²⁴⁶ Timely implementation is key to restoring investor confidence and public trust.

• One national securities exchange requested additional time to submit proposals to the Commission because it does not have a regularly scheduled board meeting until June.²⁴⁷

• One commenter requested allowing "smaller exchanges" an extra 30 days to submit proposed changes after publication of the Commission's final rule.²⁴⁸ Another commenter believed the proposed deadlines for SROs are sufficient.²⁴⁹

• Ten commenters recommended additional time for issuers to comply specifically because the proposed requirements would become operative before or during the 2004 annual meeting period.²⁵⁰ Some requested until late June²⁵¹ or July, 2004.²⁵² Others suggested no later than an issuer's first annual meeting after adoption.²⁵³ Two were concerned that issuers will not know the full scope of independence requirements until additional SRO listing requirements are approved, and requested a coordinated implementation date.²⁵⁴ One recommended keeping the one year timeframe if SROs adopt their rules by November 1, 2003, but an additional year delay if they do not.²⁵⁵ Another recommended a delay until 15 months after the adoption of the additional standards (or, if the operative date needs to be linked to the Commission's rule, 15 months after its publication).²⁵⁶ Another recommended compliance by a company's first annual meeting occurring after January 1, 2004.

• One commenter recommended delaying application until a company's first annual meeting of shareholder or other shareholder meeting at which directors are elected following the first anniversary of the approval of applicable securities exchange or association rules, plus 30 days.²⁵⁷

• Two commenters requested a significant implementation period to allow companies to locate and recruit new audit committee members meeting the independence standards.²⁵⁸ One recommended 18 months after Commission approval of the SRO rules, possibly including an additional year for companies with classified boards.²⁵⁹

• Six commenters recommended delaying implementation for foreign issuers.²⁶⁰ Three recommended two years.²⁶¹ One also supported extending the comment period for foreign issuers.²⁶²

• Two commenters recommended delaying implementation for small issuers,²⁶³ with one commenter advocating an additional year from that proposed.²⁶⁴

• One commenter believed companies should be given at least 90 extra days in addition to the proposed year to comply, as this would provide at least 180 days from the proposed date the SROs must have final rules in place.²⁶⁵

• One commenter believed the rules should give greater flexibility to SROs during their drafting period to come up with either (1) a more thoroughly vetted "one-size-fits-all" framework for foreign exemptions, or (2) a framework that includes case-by-case exemptions if examination of home country procedures determines they accomplish similar protections.²⁶⁶

• One commenter believed issuers not in compliance with the rules as of the implementation date not be subject to delisting but instead required to disclose the extent to which they are not in compliance and what steps they are taking to come into compliance.²⁶⁷

X. Securities Affected

A. Multiple Listings and Non-Equity Listings by Subsidiaries

• Fifteen commenters expressed specific support for the exemption.²⁶⁸ One requested clarification that it applies to subsidiaries that file their own financial statements, despite also reporting on a consolidated basis with their parent.²⁶⁹

• Seven commenters recommended an extension for unconsolidated joint ventures with only listed debt securities (such as 50-50 joint ventures), so long as one or more parents are subject to the rule.²⁷⁰ Consolidation should not be a requirement for a subsidiary or joint venture with only non-equity listings where one or more parents have a complying audit committee. Not doing so would discourage listings by joint ventures. Among other factors, the interest of the parents, through their audit committees, in having accurate financial statements that will be included in their equity accounting should provide sufficient protection. One went as far to say that a joint venture partner should not be considered an affiliate.²⁷¹

• Two commenters recommended expanding the exemption to apply regardless of majority-ownership or consolidation, so long as one or more parents are subject to the rule.²⁷² One recommended using the definition of "subsidiary" in Exchange Act Rule 12b-2 that defines subsidiary of a specified person as "an affiliate controlled by such person directly, or indirectly through one or more intermediaries."²⁷³ Alternatively, replace "consolidated, majority-owned subsidiary" with "controlled subsidiary." Also, an entity whose outstanding securities are fully and unconditionally guaranteed by a parent should also be covered by the exemption, regardless of ownership or consolidation, as investors will be looking to the parent because of the guarantee.

• Three commenters argued that the exemption should at least be extended to consolidated subsidiaries even if the consolidating parent is not a majority owner.²⁷⁴ One commenter believed the proposed exemption would not cover trust preferred securities because the issuer is consolidated but not majority owned.²⁷⁵

• Three commenters did not think the exemption needed to be keyed to a parent equity listing.²⁷⁶

• One commenter believed the exemption should also extend to equity listings by a subsidiary.²⁷⁷

• One commenter suggested clarifying that if a foreign issuer is relying on one of the foreign exemptions, U.S. subsidiaries can still rely on the multiple listing exemption.²⁷⁸

• One commenter supported either a full or partial exemption for any listing by a company that has a shareholder owning more than 50% of the voting control of the issuer where the controlling shareholder is itself subject to Commission reporting requirements.²⁷⁹ Minority shareholders have full awareness of the degree of control exercised by the controlling shareholder. Failure to provide such an accommodation could result in difficulties in the ability of the parent company to exercise control or prepare its own consolidated financial statements if there are disagreements with the controlled subsidiary's independent audit committee. [Note: The Commission's proposing release includes an exemption for non-equity listings by direct or indirect consolidated majority-owned subsidiaries where the parent company is subject to the proposed requirements]

B. Security Futures Products and Standardized Options

• Two commenters expressed support for the exemption as proposed.²⁸⁰

• One commenter believed these securities should be treated like any other security.²⁸¹

C. Requests for Other Exemptions

• Three commenters did not believe that other securities should be exempted.²⁸²

• Four commenters believed that despite the statutory reference to "any security of an issuer," debt securities and non-convertible preferred securities should be exempted because they have historically not been subject to corporate governance listing standards and issuers have different fiduciary duties to these securityholders than to equity holders.²⁸³ The Sarbanes-Oxley Act was directed at equity securities. The compliance burden outweighs the benefits. Application to these securities furthers the regulatory disparity between over-the-counter trading and exchange trading. One national securities exchange mentioned it has received delisting applications from debt-only issuers citing unwillingness to comply with the proposed provisions of the Sarbanes-Oxley Act.²⁸⁴

• Four commenters recommended exempting debt securities of issuers registered under Schedule B or that file on Form18-K.²⁸⁵

XI. Issuers Affected

A. Foreign Issuers

1. General Comments

• Four commenters appreciated that certain exemptions may be necessary to accommodate foreign conflicts, although several did not believe a complete exemption for foreign issuers would be consistent with the letter and spirit of Section 10A(m).²⁸⁶ Two urged monitoring of the exemptions, including when foreign laws change, to ensure that investors continue to be adequately protected and new conflicts are resolved.²⁸⁷ One in general did not support foreign exemptions unless absolutely necessary.²⁸⁸

• Seven additional commenters expressed general support for appropriate exemptions for foreign issuers,²⁸⁹ although one would have preferred a general exemption.²⁹⁰ Others expressing support for particular exemptions are described below.

• Three commenters recommended complete exemptions for foreign issuers.²⁹¹

• One commenter believed foreign issuers should comply with Rule 10A-3 but not with any additional SRO audit committee requirements.²⁹² The commenter did support SRO-required disclosure when home-country practices differ.

2. Two-Tier Boards of Directors

• Six commenters expressed support for the Commission's handling of this issue.²⁹³ However, one asked modifying the reference to "two-tier boards of directors" because these companies have a two-tier board system, not a two-tier board of directors.

• One commenter urged clarifying that the designation of the supervisory board as the board of directors applies only for Rule 10A-3 (as well as similar changes to auditor independence and audit committee financial expert rules), and not to other securities law or disclosure references.²⁹⁴

3. Employee Exemption

• Seven commenters expressed specific support for the exemption.²⁹⁵ Three particularly made reference to German employees that are "leitende Angestellte," which are mid-level managers or "superior employees."²⁹⁶ These employees should not be disqualified and this should be clarified. One suggested clarifying that the term "executive officer" has the same meaning as in Exchange Act Rule 3b-7.²⁹⁷ [Note: the proposals already define the term "executive officer" by reference to Exchange Act Rule 3b-7]

• One commenter recommended not limiting the exemption to employee directors elected or appointed pursuant to legal or listing requirements.²⁹⁸ In some countries, such directors are not required by any legal or listing requirements, but rather have evolved as common practice or may be required by governing documents or labor agreements.

4. Controlling Shareholder Exemption

• One commenter expressed specific support for the 50% threshold, observer status, non-executive requirement and non-chair requirement.²⁹⁹

• One commenter believed the exemption should allow more than one observer (but no more than one observer per shareholder), without regard to shareholder ownership level.³⁰⁰ Any significant shareholder with less than 50% ownership should have the right to monitor its investment. Each observer would need to satisfy the independence requirements, and the voting