The News Corporation Limited
January 30, 2003
By email: email@example.com
Mr. Jonathan G. Katz
Re: Request for Comments on Proposed Rules Concerning Standards Relating to Listed Company Audit Committees File No. S7-02-03
Dear Mr. Katz:
I am writing to express our views regarding the Commission's proposal to adopt standards relating to listed company audit committees pursuant to Section 307 of the Sarbanes-Oxley Act of 2002 (SEC Release 33-8173; 34-47137) (the "Proposed Rules"). Certain of the views expressed in this letter parallel our comments to the Commission, by letter dated December 13, 2002, in connection with Commission's rulemaking pursuant to the financial experts provision of Section 407 of the Sarbanes-Oxley Act.
Application of the Proposed Rules to Subsidiaries of Public Companies.
Under the Proposed Rules, a shareholder owning more than 50% of the voting control of a public company (a "Controlling Shareholder") will not be entitled to any representation on the audit committee of the board of directors of its subsidiary (a "Controlled Company"). We note that the Proposed Rules contain a very limited exemption to permit a Controlling Shareholder or its representative to have non-voting observer status on the audit committees of foreign private issuers.
We ask that the Commission consider creating either a full or a partial exemption from the application of the Proposed Rules in the situation where a Controlling Shareholder is itself a public company subject to reporting obligations under Sections 13 or 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act")(such Controlling Shareholder, a "Public Controlling Shareholder"). For the reasons set forth in this letter, we believe that such an exemption would be in the best interests of the shareholders of both the Public Controlling Shareholder and the Controlled Company.
A Public Controlling Shareholder is required to include within its reports and other filings under the Exchange Act and the Securities Act of 1933 (the "Securities Act") financial statements and other disclosures, including management's discussion and analysis, prepared on a consolidated basis. In order to properly prepare and review such financial information, the Public Controlling Shareholder requires complete access to, and control of, the audit and financial review process of its Controlled Companies. In the absence of this degree of access and control, inaccurate or improper determinations of financial statement, disclosure or control issues by the Controlled Company with respect to its financial reporting could lead to inaccurate or improper reporting by the Public Controlling Shareholder, resulting in liability not only to the Public Controlling Shareholder, but also to the members of its board of directors, including members of its audit committee, and its principal executive officers, including its chief executive and chief financial officers, who in addition to their obligations as officers are required to certify personally as to the accuracy and completeness of such financial information.
Although we are hesitant to speculate as to the full scope of issues that may arise if the Public Controlling Shareholder is precluded from representation on the Controlled Company's Audit Committee, we believe that if this concern is not addressed by the Commission in its final rules, significant difficulties could occur in the following instances:
-The Proposed Rules would permit the audit committee of the Controlled Company to retain or dismiss auditors without any participation by the Public Controlling Shareholder, whose own reporting obligations could be directly affected by any such action. For example, a determination by a Controlled Company to terminate its auditors and retain new auditors could affect the ability of the Public Controlling Shareholder to file its own reports in a timely manner. Moreover, it would be possible for the Controlled Company to engage, or to continue the engagement of, an auditing firm that is objectionable to the Public Controlling Shareholder or its audit committee for substantive reasons, such as issues relating to past performance or independence, without the Public Controlling Shareholder having any opportunity to be involved in the decisionmaking process.
-If the Controlled Company represents a material portion of the Public Controlling Shareholder's business, the selection of an auditing firm by the audit committee of the Controlled Company may effectively preclude the audit committee of the Public Controlling Shareholder from selecting an auditor other than the firm selected by the Controlled Company, by reason of the application of Section 543 of the U.S. Auditing Standards or other applicable rules.
-The interposition of an independent audit committee at the Controlled Company level creates the potential for overlapping responsibilities and inconsistent reporting. It appears to us that the provisions of the Proposed Rules granting audit committees responsibility for the oversight of the work of auditors may result in the audit committees of both the Public Controlling Shareholder and the Controlled Company having overlapping duties with respect to the audit performed with respect to the Controlled Company. If differences between the auditor and management of the Controlled Subsidiary are resolved by the Controlled Subsidiary's audit committee differently than those same matters are resolved at the parent level, reporting by the two entities may be inconsistent. Moreover, the matters discussed between the auditors of the Controlled Subsidiary and its audit committee may also be subject to discussion by the auditors of the Public Controlling Shareholder and its audit committee, without any mechanism provided for resolving differences or disagreements resulting from such discussions.
-The interposition of an independent audit committee at the Controlled Company level may involve disputes as to financial reporting that will materially and adversely affect the Public Controlling Shareholder. Among the situations that may arise are (i) differences between the auditors of the Controlled Company and its audit committee and (ii) differences between the Commission and the audit committee of the Controlled Company. In either case, the resolution of these issues could have significant implications to the Public Controlling Shareholder and its own reporting obligations, but the Public Controlling Shareholder would be precluded from any participation in the deliberations of the Controlled Company's audit committee. A resolution that entails further procedures, such as a restatement, or even a delay in the resolution of these issues, could affect the Public Controlling Shareholder's compliance with its own Exchange Act obligations and its ability to access capital markets and perhaps as well compliance with covenants under credit and other agreements.
-The interposition of an independent audit committee at the Controlled Company level could result in a lack of cooperation between the Public Controlling Shareholder and the Controlled Company. For example, the auditors and audit committee of a Controlled Company may determine not to cooperate with the disclosure process associated with the periodic reporting obligations of the Public Controlling Shareholder, or an offering of securities by the Public Controlling Shareholder, effectively causing the Public Controlling Shareholder not to be in compliance with its Exchange Act obligations, or blocking access by the Public Controlling Shareholder to the capital markets.
We do not believe that an exemption from the application of the Proposed Rules in the context of Public Controlling Shareholders would be disadvantageous to the shareholders of the Controlled Company. In most instances, shareholders have invested in the Controlled Company with full awareness of the degree of control exercised by the Public Controlling Shareholder. In addition, because the audit committee of the Public Controlling Shareholder will be comprised exclusively of directors meeting the independence standards of the Proposed Rules, the integrity of the financials of the Controlled Company will be subject to their oversight. We fully agree that any conflicts of interest between the Public Controlling Shareholder and the Controlled Company should be resolved by directors fully independent of the Public Controlling Shareholder.
Because current stock exchange and Nasdaq listing rules provide for independent audit committees, we understand that the Proposed Rules may be viewed as an amplification of the existing independence requirements. We believe, however, that the significantly greater authority that would be granted to audit committees under the Proposed Rules, such as the elimination of the board of directors' power to vote on the retention, compensation or termination of auditors, or to have an oversight role, will significantly change current relationships relating to financial reporting and disclosure. Although the stock exchanges and Nasdaq have proposed rules that will exempt Controlled Companies from some of their proposed governance provisions, these rules will not affect the Proposed Rules relating to audit committees.
We understand the significant desire by Congress and by the Commission to enhance the integrity of the financial reporting and disclosure process, and the desire for greater independence by auditors and audit committees. For the reasons set forth above, however, we believe that the Proposed Rules should exempt from their application Controlled Companies that are controlled by Public Controlling Shareholders. Should the Commission not be amenable to a complete exemption, we suggest that the Proposed Rules be revised to permit the audit committee of a Controlled Company to include representatives of the Public Controlling Shareholder.
Application of the Proposed Rules to Significant Minority Shareholders
The Proposed Rules will also prevent representatives of significant minority shareholders from participation on audit committees. We ask that the Commission consider adopting a definition of "affiliated person" for an operating company that does not disqualify from service on an audit committee persons who are otherwise unaffiliated with the operating company but who are officers, directors, or other representatives of entities (a) that beneficially own equity securities of an issuer that in the aggregate represent less than 50% of the voting power with respect to the election of directors of the issuer at annual meetings of shareholders, (b) that do not through voting power, contract or otherwise, have the ability to designate more than 50% of the members of the board of directors of the issuer, and (c) whose officers, directors or other representatives on the board of directors of the issuer do not in fact constitute more than 50% of the members of the board of directors of the issuer, or whose officers, directors or representatives are not able to control the board by reason of limitations imposed by applicable stock exchange listing rules (provisions of (a), (b) and (c) being hereinafter referred to as "Non-Disqualifying Characteristics"). For example, Section 3.12 of the London Stock Exchange Listing Rules provides that "[a] company which has a controlling shareholder must be capable at all times of carrying on its business independently of such controlling shareholder . . . and all transactions and relationships between the company and the controlling shareholder (or associate) must be at arm's length and on a normal commercial basis."
We believe that the exclusion of representative of significant minority shareholders will leave audit committees less qualified to address fully and properly the matters audit committees will be responsible for overseeing pursuant to the Sarbanes-Oxley Act and the current rulemaking by the Commission and the securities exchanges and associations. Rather than being compromised, we believe that representatives of significant minority shareholders are often best able to represent the interests of all shareholders of the public company in order to assure correct and complete financial reporting and compliance by the public company with the highest ethical standards of conduct.
The intensive knowledge of the business and operations of the public company by representatives of significant minority shareholders (and the large investment in the public company by such shareholders) often results in the representatives of the minority shareholder having a significantly more profound and detailed understanding of the financial condition of the public company than any person outside the company itself. Generally, this understanding of the financial condition of a company will derive from the financial expertise and substantial resources that the significant minority shareholder devotes to its ownership interest in the public company, and the ongoing and often intensive dialogue that representatives of the public company may have with those representatives of the minority shareholder who sit on its board.
In addition, representatives of a significant minority shareholder on the audit committee of a public company may be in a better position than other directors to insure that the decisions of the audit committee are properly implemented by the public company. This influence is often enhanced in the case of a public company whose financial statements are required to be included in the Exchange Act reports of a significant minority shareholder pursuant to Rule 3-09 of Regulation S-X, because the minority shareholder may be subject to substantial liability of its own should it be determined that the financial statements of the investee public company were deficient or misleading.
All of the above reasons, including many of the reasons also expressed with respect to Public Controlling Shareholders, suggest that representatives of significant minority shareholders should not, solely by reason of share-ownership, be deemed to be "affiliates" and deemed not independent for the purposes of audit committee membership of operating companies. We believe that any definition of independence that would exclude representatives of significant minority shareholders from participating as members of an audit committee in instances in which Non-Disqualifying Characteristics are present would disenfranchise the minority shareholders (and even perhaps serve as a disincentive for an entity to invest or increase its investment), without any commensurate benefit being derived by any other shareholder.
Were the Commission not to agree that representatives of significant minority shareholders are not "affiliated persons" for the purpose of the Proposed Rules, we would, in the alternative, suggest that representatives of any significant equity investee owning between 10% and 49% of the voting power of the investee, be permitted to serve on the audit committee of the investee.
News Corporation's concerns about the possible effects of the Proposed Rules are not theoretical. News Corporation is a reporting company with securities listed on the New York Stock Exchange. News Corporation currently owns majority interests in publicly held subsidiaries, such as Fox Entertainment Group, Inc. and NDS Group plc, as well as significant minority interests in other public companies, such as British Sky Broadcasting Group plc and Gemstar-TV Guide International, Inc. The audited financial statements of News Corporation are required to consolidate the financial results of Fox Entertainment Group, Inc. and NDS Group plc, and News Corporation includes in its Form 20-F audited financial statements of equity investees to the extent that such investees meet the significance tests set forth in Rule 3-09 of Regulation S-X. Were News Corporation unable to participate in the deliberations of the audit committees of its consolidated subsidiaries and its significant equity investees, News Corporation could have liability to its shareholders for financial determinations that it may have had no opportunity to review or comment upon. Such a result would place public companies such as News Corporation in a highly disadvantaged position. Should the Commission determine not to revise the Proposed Rules in the manner suggested by this letter, we would ask the Commission to consider granting reporting companies formal relief from liabilities under the Securities Act and the Securities Exchange Act arising as a result of determinations or judgments made by the independent audit committees of Controlled Companies or equity investees.
We would be pleased to address this matter further with the members of the Staff at the convenience of the Staff.