American Association of Bank Directors
March 4, 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:
The American Association of Bank Directors, a non-profit trade association representing the interests of bank and savings institution directors nationwide, hereby submits the following comments.
Definition of "affiliate"
Your proposed definition of "affiliate" follows the definition of "affiliate" for purposes of Section 16 of the Exchange Act. Yet, the purposes of Section 16 and Section 301 of the Sarbanes-Oxley Act are entirely inapposite. Section 16 is a disclosure requirement for the investing public to be aware of the change in ownership of insiders of public companies. Section 301 adopts substantive rules requiring that each member of the audit committee of a listed company be a member of the board of directors of the listed company and independent. But independence means, in the context of Section 301, independence from those who manage the company on a day-to-day basis.
Thus, it serves on regulatory or statutory purpose for an outside director of the listed company who has no management or employee functions or authority to be barred from serving on the audit committee of the company or an affiliate of the company simply by virtue of owning a certain percentage of stock of the issuer. Yet that is the effect of the proposed rules, which define "independence" in terms of whether the person is affiliated with the issuer or any subsidiary of the issuer, and then define "affiliate" as a person who "controls" the issuer. The proposed rule then creates a "safe harbor" (the person is deemed not to be in control of the issuer) for persons who are not the beneficial owner, directly or indirectly, of more than 10% of any class of equity securities of the issuer.
The stock of many bank holding companies, even those whose stock is listed on one of the national exchanges, is owned in significant amounts by outside directors. It is common for individual directors who do not serve in management as officers or directors to own, directly or indirectly, at least 10% of the outstanding shares, and often much more than 10%. Their interests are aligned more with shareholder interests than those who own less than 10% of the outstanding shares. In fact, AABD encourages our members, most of whom are outside, non-management bank directors, to own significant amounts of stock because we believe that the investment will motivate them to think and act independently of management. Why should these large shareholders who do not serve in management be disqualified to serve on the audit committee?
Another problem with the "safe harbor" is the requirement that the person not serve as a director of the issuer or affiliate of the issuer. This does not make sense since the safe harbor is of use only to those who are directors since only directors of the issuer may serve as audit committee members.
AABD suggests that the "safe harbor" rule be amended so that it is available to directors of the issuer and its affiliates. In addition, individuals or entities that they control should not be deemed "affiliates" solely based on ownership of stock.
Disclosures relating to audit committees
Under the provisions of Section 301, members of the audit committee of a listed company must be members of the board of directors of the issuer. There is no equivalent substantive requirement for members of the audit committee of a non-listed company.
However, the proposed rules in several different sections require that non-listed public companies to disclose either in their proxy statements or annual reports information about the members of the audit committee and the audit committee established in accordance with section 3(a)(58)(A) of the Exchange Act. See, for example, proposed Section 229.401(h) (Item 401) and proposed Section 240.14a-101(d)(3)(iv)(A) and (B). Section 3(a)(58) defines "audit committee" to mean one which is "established by and amongst" the board of directors of the issuer.
There are many bank holding companies that, other than the bank subsidiary, are corporate shells. It is common for the audit committees of a bank to be functionally audit committees of the company because the bank subsidiary will have virtually all of the assets, liabilities, and earnings of the consolidated entity. It is also common that bank holding company boards consist of a much smaller number of directors than bank subsidiary boards. That is because the real business is operating at the bank level and because some holding company boards have limited functions, such as calling and establishing agendas for shareholder meetings, and periodically meeting to discuss the strategic direction of the company. Because of this common corporate structure, audit committees of a bank holding company consist of bank directors, in part or in whole, who do not serve as bank holding company directors.
Our members also need clarification as to the meaning and significance of the definition of "audit committee" in section 3(a)(58) of the Exchange Act. Unlike Section 301, it does not expressly limit the members to only issuer board members. However, it is not clear how the definition might affect the disclosures required under proposed sections 229.401(h) and 240.14a-101 Item 7(d). For those bank holding company audit committees with one or more bank board members who do not serve as bank holding company members, should the company be disclosing that it does not have a separately designated "audit committee" as defined in section 3(a)(58), and, therefore, the "audit committee" for purposes of the disclosure is the full board of the bank holding company? Alternatively, section 3(a)(58) can be read to define "audit committee" in terms only of its establishment, and not on who may serve as members of the audit committee and, consequently, the company would be able to disclose that the audit committee it has established is the company's audit committee for purposes of disclosure, even if one or more of the audit committee are not company directors.