America's Community Bankers
February 19, 2003
Jonathan G. Katz
Re: Standards Relating to Listed Company Audit Committees
Dear Mr. Katz:
America's Community Bankers (ACB)1 is pleased to comment on the proposed rule issued by the Securities and Exchange Commission (SEC) to establish standards for listed company audit committees, 2 as required by section 301 of the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley).3 The rule would require national securities exchanges and associations (SROs) to adopt listing standards that conform to the requirements of section 301 and the SEC rule. The listing standards would have to address the composition of an audit committee; the responsibilities of the audit committee; the requirement that an audit committee establish procedures for the receipt, retention and treatment of complaints regarding accounting and auditing matters; and the ability of audit committees to hire advisers and to receive appropriate funding.
The SROs would be required to submit proposed listing standards to the SEC within 60 days after publication of a final rule in the Federal Register, and the listing standards would have to be operative no later than one year after publication of the final rule. A company would not be able to list its securities if it could not meet the listing standards. For a company that already has listed securities, it would have those securities delisted if it did not meet the standards and failed to correct any violation within a designated period of time. The SROs covered by the rule would be the nine national securities exchanges registered under the Securities Exchange Act of 1934 and the Nasdaq Stock Market. The OTC Bulletin Board, the Pink Sheets and the Yellow Sheets would not be affected by the proposed requirements.
Section 301 of Sarbanes-Oxley requires that members of listed company audit committees be independent. The law states that in order to be considered independent, a member can not, other than in his or her capacity as a member of the audit committee, the board or any other board committee, (i) accept any consulting, advisory, or other compensatory fee from the issuer; or (ii) be an affiliated person of the issuer or any subsidiary. The rule expands upon and clarifies these requirements.
Increasing the independence and authority of a public company's audit committee was one of the main objectives of Sarbanes-Oxley. As recent corporate events have shown, it is incredibly important to the integrity of public markets that the members of the audit committee independently and thoroughly fulfill their role of overseeing the preparation and audit of the company's financial statements. Section 301 helps to achieve that goal by indicating that the audit committee is responsible for the appointment, compensation, and oversight of the work of the company's auditor. In order to facilitate communication between the audit committee and individuals who are independent of management, section 301 requires that audit committees establish procedures for the receipt of complaints and concerns about the company's accounting policies, internal controls and auditing process. Furthermore, Congress ensured that audit committees would be able to hire appropriate experts and advisers and have the necessary funding to do so.
ACB supports the approach the SEC is taking in the rule to set forth the specific requirements of section 301 of Sarbanes-Oxley and allow companies the flexibility to establish processes and procedures that best fit the company's circumstances. Also, the SEC is giving the SROs the flexibility to determine the procedures for allowing a listed company to cure any violations of the audit committee standards.
ACB also supports the proposed criteria for establishing independence. The proposal will allow community banks to continue to attract competent and independent-minded audit committee members from the local community. While we recognize that the SROs can establish additional and more stringent criteria, we are hopeful that they, too, will recognize the practical problems in attracting potential audit committee members and will be reasonable in their approach. As discussed below, we do have some suggestions for revising the language addressing an audit committee member's indirect receipt of payments.
After passage of Sarbanes-Oxley, ACB was particularly concerned that implementing rules under section 301 would severely hamper the efforts of community banks in finding qualified board and audit committee members. Community banks currently have to undertake substantial efforts to find qualified directors willing to serve on the board and its various committees. Bank directors not only have responsibilities under applicable corporate and securities laws, but they also must understand and enforce a full range of banking laws and regulations. Unlike other corporate directors who act under the principles of the business judgment rule, bank directors have the additional responsibility of adhering to the regulatory principles of safety and soundness. Many otherwise qualified individuals do not want to put in the necessary time and effort that is required. Furthermore such individuals may not be willing to assume the liability that flows from these requirements.
The effort to find qualified directors would become even more difficult if the criteria for establishing independence limited the types of banking relationships that a director or companies in which the director has an interest may have with the bank. Many directors of community banks are successful business executives and it is likely that the companies for which these directors serve as directors, executive officers and/or shareholders have loans and other banking relationships with the bank. When Congress passed significant banking legislation in 1989 and 1991 to govern many aspects of the banking industry, it left in place the regulatory scheme that placed certain restrictions, but did not prohibit, loan and other banking relationships between bank directors and the banks they serve. Congress recognized that access to credit and other banking products and services is extremely important for individuals and businesses and did not want to cut off access to those individuals who take on the huge responsibility of serving as a bank director.
Banking relationships with directors and executive officers are highly regulated and the current system works well. Congress recognized the value of this system by creating an exception for banking institutions to the general prohibition on personal loans in section 402 of Sarbanes-Oxley
Community bank directors could decide not to continue serving if they had to forego obtaining financing for household or business needs from the bank, particularly in smaller communities where banking resources may be scarce and the director may be unwilling to look for financing outside of the community. Banks would confront the loss of directors who provide business and financial expertise, as well as customer perspective and continuity. This would lead community banks to have to go outside their immediate market area to find qualified individuals willing to serve. But this also may prove difficult. An individual from outside the community does not know the bank, the bank's community or the other board members, so may not be interested in serving as a director. Also, current directors are sometimes reluctant to bring in a director who is not familiar with the community because a focus on the community is what community banking is all about.
For these reasons, we are pleased to see that the criteria for establishing independence set forth in the rule would allow these banking relationships to continue without affecting the status of a director's independence. As the SEC states in the preamble, "Our proposal would not, for example, preclude independence on the basis of ordinary course commercial business relationships between an issuer and an entity with which a director had a relationship."4 We urge the SROs to take the same reasoned approach.
Restrictions on Consulting, Advisory or other Compensatory Fees
We do have reservations about the broad language that would prohibit indirect compensatory payments. Under the proposal, an audit committee member would not be considered independent if he or she is a partner in a law firm or accounting firm and that firm accepts payments for legal, accounting, consulting or other similar services provided to the issuer. There is no de minimis exception to the prohibition. The SEC has requested comment on whether this aspect of the proposal is appropriate.
We believe that the SEC should delete this language and instead require that the board be notified of any such relationships and make a determination as to whether the payments would affect the ability of the individual to act independently. As an alternative, the SEC should at least allow for some level of payment that could be set at a specific percentage, 15 percent for example, of the revenues of the firm providing the service. The way the language is written in the proposal, a partner of an accounting or law firm that provides services to an issuer, regardless of the amount of the fee paid or whether that partner participates in or benefits financially from the services, would not be able to serve on the audit committee. Also, in the banking context, it is possible that the bank would arrange for a local legal or accounting firm to provide tax-related services to trust or other bank customers. The question would arise as to whether any partner of the firm could serve as an independent audit committee member even when the bank's customers ultimately pay the fees. There may be many other similar situations that could arise where the connection of the audit committee member to the service being provided is so tenuous, or the service is so insignificant, that questions of independence would not be an issue. Accordingly, we request that the SEC consider our suggestions for revising this aspect of the proposal.
Definition of Affiliate
ACB is pleased that the proposed definition of affiliate will permit an individual to serve on the board of both a parent company and a direct or indirect, majority-owned subsidiary and be considered independent, provided that the individual otherwise meets the independence criteria with regard to each company. Many banks and savings associations operating in a holding company structure have the same independent directors serving on both boards. This is the case because it is important for the directors of each entity to have the same understanding of the regulatory scheme that governs the activities and operations of banks and savings associations. Service on both boards should not affect the ability of the individual to act independently of management. An individual serving on both boards represents the interests of the parent holding company as majority shareholder when serving on the board of the subsidiary bank. There is no reason to think that this individual would be any more aligned with management than any other independent director.
ACB appreciates the opportunity to comment on this important matter. If you have any questions, please contact the undersigned at (202) 857-3121 or via e-mail at firstname.lastname@example.org, or Diane Koonjy at (202) 857-3144 or via e-mail at email@example.com.