Deloitte & Touche LLP
February 18, 2003
Mr. Jonathan G. Katz
RE: Release Nos. 33-8173; 34-47137; IC-25885
Dear Mr. Katz:
Deloitte & Touche LLP is pleased to respond to the request for comments from the Securities and Exchange Commission (the "Commission") on its proposed rule regarding Standards Relating to Listed Company Audit Committees, File No. S7-02-03.
We strongly support the goals of the President of the United States, the United States Congress, and the Commission to strengthen corporate audit committees. The Sarbanes-Oxley Act of 2002 (the "Act") is the primary vehicle by which positive changes will come about and we are committed to assisting the Commission in the adoption of responsible rules to strengthen corporate audit committees and help restore investor confidence in our capital markets. One element of the implementation of the Act is the Commission's proposed rule concerning Standards Relating to Listed Company Audit Committees. The following are our comments with respect to this proposed rule for your consideration prior to the adoption of the final rule. We have organized our response into general comments on the proposal, followed by more specific comments, which include responses to many of the questions the Commission has posed for comment.
Deloitte & Touche believes the proposed rule addresses the need for audit committees to protect shareholder interests more effectively. We agree with the Commission's efforts to promote frank, open and clear communication between the audit committee and the registered public accounting firm. In order for Section 240.10A-3 of the Securities Exchange Act of 1934 to be implemented consistently and effectively, we also believe that certain aspects of Standards Relating to Listed Company Audit Committees should be addressed and clarified by the Commission as it completes its rule-making process. Below is a summary of those areas that we believe require clarification or attention by the Commission prior to adopting a final rule. Our most significant comments relate to:
Further discussion of these matters, as well as other comments related to the proposed release, are included below.
Responsibilities Relating to Registered Public Accounting Firms
We believe the proposed rule, as written, poses a number of practical implementation issues. Specifically, the proposal is not clear as to which auditor relationships the audit committee has direct responsibility, the level of involvement contemplated by the term "oversight," and the role of the audit committee in resolving disagreements between management and the auditor.
1. There is a range of relationships that an issuer may have with an auditor, including some that may involve more than one audit firm. We believe the Commission needs to clarify in which instances the audit committee must exercise its responsibilities under Proposed Rule 10A-3(b)(2) when the audit relationship involves more than one audit firm. The proposed rule states:
The audit committee of each listed issuer, in its capacity as a committee of the board of directors, must be directly responsible for the appointment, compensation, retention and oversight of the work of any registered public accounting firm engaged (including resolution of disagreements between management and the auditor regarding financial reporting) for the purpose of preparing or issuing an audit report or related work or performing other audit, review or attest services for the listed issuer, and each such registered public accounting firm must report directly to the audit committee.
As noted above, there are various auditor relationships that exist in practice, including some that involve more than one audit firm. For example:
The Commission should take account of these various auditor relationships that exist in practice, and the final rules should identify for which of these relationships the audit committee is directly responsible. To oversee effectively the audit process as a whole, we believe the audit committee generally should be required to exercise its oversight responsibilities with respect to all the firms involved in the audit, including not only the principal auditor but also other firms that perform a portion of the audit. (The determination of whether a firm will report on the financial statements as the principal auditor is based on the auditor's judgment, as described in Auditing Standards Board Statement AU.543, Part of the Audit Performed by Other Independent Auditors.) We read the proposed text of the rule as consistent with that view.
However, in instances where the work of another auditor is clearly inconsequential, the administrative burden placed on the audit committee may outweigh the benefit of the audit committee providing direct oversight. We therefore suggest that while it is appropriate and beneficial for the audit committee to oversee the work of other audit firms that report on the financial statements of a subsidiary that constitutes twenty percent or more of the assets and revenues of the issuer, the audit committee should not be tasked with the responsibilities set forth in Proposed Rule 10A-3(b)(2) with respect to audit firms other than the principal auditor that report on the financial statements of a subsidiary that constitutes less than twenty percent of the assets and revenues of the issuer. This threshold is consistent with that provided for audit partner rotation in the Commission's Final Rule Release 33-8183, Strengthening the Commission's Requirements Regarding Auditor Independence. The audit committee of course could choose to be directly responsible for other audit firms involved in the audit.
2. We also recommend further definition of the responsibilities that are embodied within the term "oversight." In the discussion of the proposed rule, the Commission states that oversight includes the authority to retain, or not to retain, the audit firm, as well as the authority to approve all audit engagement fees and terms. Additional specificity regarding the requirement that the audit committee oversee the work of the registered public accounting firm in connection with the audit should be clearly stated if the Commission intends "oversight" to include other matters. We suggest that audit committee oversight should include understanding matters required to be communicated to the audit committee by the auditors under AICPA Statements on Auditing Standards (SASs), Communications with the Audit Committee, (AU 380) and Regulation S-X §210.2-07, Communications with Audit Committees.
3. While the proposed rule refers to the audit committee's responsibility to oversee the resolution of disagreements between management and the auditor regarding financial reporting, it is not clear what level of involvement is implied. For example, we presume that it is not intended for the audit committee to be involved in discussions and debates between the auditor and management that occur throughout the audit process and are resolved to the satisfaction of both the auditor and management once all the facts and circumstances have been considered. Rather, we suggest that the audit committee should be required to understand those disagreements between management and the auditor that are communicated as required by SAS No. 61 (as amended), Communications with Audit Committees, as well as other important matters communicated to the audit committee pursuant to AU 380 and the Commission's final Rule Release 22-8187, Strengthening the Commission's Requirements Regarding Auditor Independence.
4. In addition to the items identified for clarification above, the proposed rule's reference to the audit committee's approval of "significant" non-audit engagements of the independent auditor may cause confusion. We believe the audit committee's responsibilities to preapprove non-audit engagements are addressed adequately in the Commission's Final Rule Release 33-8183, Strengthening the Commission's Requirements Regarding Auditor Independence, and the limited reference as included in this proposal is unnecessary. In our view, it is sufficient to indicate that the audit committee's oversight responsibilities include the preapproval of audit and non-audit services in compliance with the Commission's final rules to implement Section 202 of the Act.
Audit Committee Member Independence
Direct compensatory payments to audit committee members: We concur with the Commission's prohibition of direct compensatory relationships. A director who actively serves the issuer in an advisory capacity as an accountant, attorney, investment banker, or service provider should not serve on the audit committee. Subject to the discussion below, we believe that retired investment bankers, chief financial officers, and audit partners should be permitted to serve as independent directors on the audit committee.
Indirect payments considered to be compensatory: In order to identify potential audit committee members, issuers may need to consider numerous candidates, including retired investment bankers, chief financial officers, partners in public accounting firms, and others. We believe that these retired professionals can offer the financial expertise that the Act sought to bring to corporate audit committees.
We suggest that the final rule clarify what is meant by the term "similar positions" as used in the proposed rule. For example, would the requirements related to indirect payments extend to executives and principals of law firms, investment banks, and accounting firms only, or would it also include other employees at other levels of the firm or company, such as associates, and senior managers?
Further, issuers could interpret the term to include retired partners and principals. We do not believe it was the Commissions intent to include post-retirement benefit payments made to retired partners or principals whose previous employer continues to provide non-audit services to the issuer as indirect compensation. While the board still should be required to determine affirmatively that the director is truly retired from the entity and does not influence his or her former company's operations or financial policies, as a general matter, we strongly suggest the final rules clearly exclude retired partners or principals of advisory or other professional services firms from the definition of "similar positions." Failure to do so could unnecessarily restrict an issuer's ability to include retired audit partners on its audit committee. We believe retired audit partners provide a unique breadth and depth of financial experience to the audit committee, and care should be taken not to restrict public companies' ability to choose from this valuable resource for audit committee members. To be clear, partners who retired from the firm that serves as the principal auditor for the issuer would be allowed to serve on the audit committee if the requirements set forth in the Commission's Final Rule Release 33-8183, Strengthening the Commission's Requirements Regarding Auditor Independence, were satisfied.
Exemptive Relief for New Public Companies: Given the unique challenges facing new public companies, we concur with the Commission's decision to provide limited exemptive relief to these issuers. Many of these companies will have been closely controlled by insiders as private companies, and may need additional time to structure an independent and effective audit committee, as defined.
We believe, however, that the exemptive period may need to be longer than the proposed 90 days for several reasons. First, smaller, less-established issuers may have greater difficulty recruiting qualified, independent audit committee members than larger, well-known issuers. This is due to a number of factors, including the inability to pay significant fees associated with seeking committee members, as well as large retainers or committee fees; the incremental reputational risk a potential audit committee member may perceive resulting from the company's inexperience in managing a publicly traded entity; and the lower level of prestige that comes with serving on the board of a relatively unknown company. Over time, these influences diminish as an issuer matures and establishes itself in the marketplace, making it easier for the company to attract qualified board and audit committee members. It is unlikely that a three-month period is enough time for a new public company to overcome these challenges.
Secondly, new audit committee members require a certain amount of information to perform their responsibilities effectively. For well-established public companies, one of the main sources of this information is the historical public filings of the issuer. The same level and quality of information may not be available to directors of newly public entities. In addition, many or all of the directors appointed to the audit committee may be new to the board if the company was closely held as a private entity. In these cases, access to the non-independent individual may be imperative for the audit committee members to learn about the company's business, industry, operations, financial reporting and internal control systems, management dynamics, etc. It may be unreasonable to assume that this crucial information can be transferred to the independent directors in a 90-day period.
For these reasons, we recommend extending the exemptive period to one year to include a complete annual reporting cycle.
With regard to the question of whether more than one audit committee member should be exempted, it has been our experience that audit committees of newly public companies tend to be smaller than audit committees of larger, more established public companies. Therefore, the impact of revising the rule to provide for a majority of independent directors for the exemption period is not likely to have a significant impact. For example, a newly public company with three or four audit committee members would be unaffected by a proposal to provide for a majority of independent directors. In either scenario, only one member of the audit committee is exempted from the proposed rule.
The Ability of SROs to Adopt Additional Independence Requirements: In the discussion of the proposed rules, the Commission states, "Our proposal would allow the SROs to adopt further requirements...but they would do so within the more flexible environment of listing standards. We encourage SROs that do not currently have separate independence policies to adopt appropriate requirements in connection with their implementation of the Exchange Act Section 10A(m)."
We recognize the intent of the Commission to allow the SROs to raise the standards for audit committee independence as they see fit; however, we believe the cost and confusion associated with providing for multiple standards may outweigh the benefits. In an effort to provide a swift, certain resolution to the issues addressed by the Act, we encourage the Commission to work further with SROs to capture the concerns raised by their thoughtful and thorough consideration of audit committee independence, so that the SROs adopt a harmonized set of requirements that could be applied consistently to all public companies. We believe this aligns with the intention of the Act, and would result in a more transparent rule that will be more consistently and easily implemented by boards.
A major objective of the Act is to restore confidence in the capital markets. The short timeframe offered for the development of rules to address the Act's provisions implies that Congress intended for the legislation to be implemented swiftly. Boards may not begin implementing the provisions of the final rule until the Commission approves the SROs' independence provisions. Boards that do so may be required to reassess audit committee independence based on any additional provisions provided in the SROs' separate standards, placing an undue burden on boards. We do not believe that the concept of multiple audit committee member independence standards is aligned with the intention of the Act to enhance investor protection in the near term.
Based on the timeframe outlined in the proposed rule, the SROs could propose their own standards at any time, provided they become operative by the first anniversary of the publication of the Commission's final rules in the Federal Register. However, this could result in a relatively short transition period, depending on when the Commission approves the SROs' listing standards. While some may suggest that the transition period could be extended to address this situation, this places undue burden on the board by requiring it to comply with the Commission's final rules and then later comply with the SROs' listing standards.
If the SROs adopt a harmonized set of requirements for audit committee independence, the understanding of the independence requirements by issuers and investors will be improved. The provisions related to multiple listings and multiple transition periods could be eliminated. Directors who serve on the audit committee of companies with securities listed or traded on different SROs would not be required to monitor compliance with multiple standards.
While it is not practical to debate all the SROs' proposed listing standards in this comment letter, we do believe that the Commission should consider these proposals prior to finalizing this rule. If the Commission does believe that the SROs' proposed listing standards would assist in achieving the overall goal of strengthening corporate audit committees, these requirements should be incorporated in the rule-making process. We did respond to the NYSE's request for comments related to its proposed listing standards in a letter dated July 16, 2002, and we encourage the Commission to consider our comments therein as it moves forward in the rule-making process.
Exemptions for Foreign Issuers
We believe that a complete exemption of foreign private issuers from the proposed rule would not be consistent with the letter or the spirit of the Act. The Act demonstrated the belief of Congress that an effective audit committee is a critical factor in promoting high-quality financial reporting for all issuers, domestic and foreign. We note that the Commission has taken extraordinary steps to understand the concerns expressed by certain foreign private issuers and their advisors, and we strongly support the Commission's actions to consider the impact of proposal rules on issuers from jurisdictions other than the United States.
Generally, we believe that the limited exemptions for certain foreign private issuers are appropriate and address the concerns raised. The Commission appears to have struck the appropriate balance between the legitimate issues raised by foreign private issuers and others, and the Commission's mandate to protect U.S. investors.
We ask the Commission to recognize that conflicts between the proposed rule and home country law may not become fully known until after the final rules are approved. Given that the legal framework of the international community, like our own legal framework, continues to change and evolve, issues that cannot be contemplated or adequately addressed at this time will likely surface in the future.
Therefore, we encourage the Commission to continue to address any significant concerns raised by foreign private issuers whose local laws may conflict with the requirements of the final rule. We believe this will allow an appropriately high governance standard to be set at this time, while allowing for future flexibility. We support the Commission's continued commitment to encourage foreign investment opportunities for U.S. investors, while maintaining adequate protections for those investors. The Commission's policy to listen and consider concerns further demonstrates that commitment.
This section provides our views on selected areas for which comments were requested in the proposing release.
1-A. Audit Committee Member Independence
Should we extend the prohibition further, such as to ordinary course business relationships?
The proposed rules do not extend to "ordinary course commercial business relationships." We believe that significant relationships that arise in the ordinary course of business could impact a director's independence. For example:
As long as the relationship between these two companies arose in the ordinary course of business, the chief executive officer of Company B would be considered to be independent under the proposed rule. However, is it realistic to assume that this director is independent in both fact and appearance given the importance of the issuer's products to his or her own company's manufacturing processes? We suggest that the final rules include a requirement for the board of directors to consider the nature and significance of ordinary course commercial business relationships that have existed between the issuer and any director who serves on the audit committee.
Should the board of directors be required to determine whether an audit committee member is independent? Should the board be required to disclose this determination? If so, when?
The board should be required to determine whether an audit committee member is independent. Consistent with Item 7(d)(3)(iv)(A), which already provides that an issuer must disclose whether the members of its audit committee are independent as defined by the applicable listing standard requirements, annual disclosure of the board's determination would be appropriate in the issuer's proxy statement or annual report, as appropriate.
The proposed independence requirements relate to current relationships with the audit committee member and related persons. Should the prohibition also extend to a "look back" period before the appointment of the member to the audit committee? If so, what period (e.g., three years or five years) would be appropriate? Should there be different look-back periods for different relationships or different parties? If so, which ones?
Regardless of whether a director with a previous relationship with the issuer could exercise objectivity in carrying out his or her audit committee duties, investors and other stakeholders may not have confidence in the member's independence. An appropriate cooling-off period may lessen the effects of the prior relationship on the appearance of independence.
We believe, however, that it is the responsibility of the board of directors to consider any previous relationships between the issuer and the audit committee member. We do not recommend requiring specific, arbitrary look-back periods for purposes of considering audit committee independence.
Should there be additional criteria for independence apart from the two proposed criteria?
We do not believe additional criteria are necessary.
Is the proposed exemption for independent board members that sit on both a parent's and consolidated majority-owned subsidiary's board of directors appropriate?
We believe the exemption for independent board members who sit on both a parent's and a consolidated majority-owned subsidiary's board of directors is appropriate as proposed.
Should there be an exception to the independence requirements based upon exceptional and limited circumstances, if the board determines that membership on the committee by the individual is required by the best interests of the corporation and its shareholders? If so, should the board be required to disclose the nature of the relationship and the reasons for that determination? Should there be a time limit for these appointments?
We do not believe that an exception to the independence requirements based on exceptional and limited circumstances is needed. The Commission will recall that the NYSE and Nasdaq both included this broad exemption in their respective listing standards adopted as a result of the Blue Ribbon Committee on the Effectiveness of Corporate Audit Committees' report. The exemption was intended to be used in limited circumstances; however, our experience would suggest that it may have been applied more broadly than intended in practice. Accordingly, we do not believe a broad exemption is appropriate.
Should companies be allowed to request exemptive relief on a case-by-case basis?
We believe companies should be allowed to request exemptive relief on a case-by-case basis. Given our current complex business environment, and the relatively short comment period for this proposed rule, it is difficult to anticipate all the facts and circumstances that should be considered for exemptive relief at this time.
Issuers should disclose any exemptive relief granted in their annual reports.
Are any modifications required to the consulting, advisory or other compensatory fee prohibition for investment companies? Is it appropriate to use the definition of "interested person" as set forth in Section 2(a)(19) of the Investment Company Act to test the independence of members of investment company audit committees, as proposed? If not, should the rule apply the affiliation test, which we propose to apply to operating companies, or a different test?
As mentioned in the proposing release, investment companies have followed a workable definition of who would be considered an "interested person" or conversely, a person who would not be independent of the fund, through the definition of interested person in Section 2(a) 19 of the Investment Company Act. This definition currently provides the safeguards that the Commission is attempting to establish in identifying an independent person and, therefore, should continue to be applied to investment companies.
1-B. Responsibilities Relating to Registered Public Accounting Firms
We request comment on implementation of this proposed requirement. Is additional specificity needed?
The majority of our concerns are included in the General Comments section of this letter. We suggest that the Commission consider whether it should require audit committees to periodically meet with the external auditor in private. The NYSE has recognized the benefit of such a requirement and has included this in its proposed listing standards. We agree with the Commission that open, frank dialogue is imperative to ensure information reaches the audit committee. Private sessions between the audit committee and the principal auditor enhance the opportunity for such communication.
Should the audit committee also be directly responsible for the appointment, compensation, retention and oversight of an issuer's internal auditor? Should other responsibilities be under the supervision of the audit committee?
The internal audit function is a critical component of a company's overall corporate governance structure, and we support any measure that strengthens the effectiveness and objectivity of the internal audit function. We recognize the additional responsibilities placed on the audit committee resulting from market pressures and the passage of the Act. We therefore encourage the Commission to consider the cost-benefit of instituting any requirements above and beyond what is contemplated by the Act.
To consider the audit committee's oversight role with respect to the internal auditor, it is necessary to examine the intended function of the internal auditor, and his or her relationship to the internal control structure of a company. Management is responsible for the design, development, and monitoring of internal controls. While there is no standard framework for the internal audit function, the internal auditor often acts as an extension of management to monitor the internal controls designed by management. Changing the reporting structure so the internal auditor reports to the audit committee may unintentionally erode management's sense of ownership of the company's internal controls.
The audit committee must have a thorough understanding of the internal audit scope and plan in order to effectively carry out its financial reporting oversight duties, and the internal auditor must have complete and open access to the audit committee. In addition, the audit committee should be informed by management of any intentions it may have to replace or significantly modify the purpose or structure of the internal audit function. We believe these objectives can be accomplished without the additional administrative burden associated with requiring the audit committee to have direct responsibility for the appointment, compensation, retention, and oversight of an issuer's internal auditor.
Does the proposed instruction that the requirement does not conflict with, and is not affected by, any requirement that requires shareholders to ultimately elect, approve or ratify the selection of the issuer's auditor adequately address the concerns of issuers whose governing law or documents requires shareholder selection of the auditor? Are additional accommodations necessary? Please explain how any accommodation would be consistent with the Sarbanes-Oxley Act.
We recognize the Commission's efforts to consider the concerns of foreign private issuers whose local laws and regulations are in direct conflict with the Act. We commend the Commission for its work with foreign private issuers and other interested parties to avoid circumstances whereby foreign private issuers believe they cannot contemporaneously comply with U.S. law and their home-country law. As noted in the proposed rule, the Commission has clarified the requirement that an audit committee be directly responsible for the appointment of the auditor via an instruction to the proposed rule. We believe the instruction adequately addresses the concerns raised by foreign private issuers and their advisors.
With that said, we bring to the Commission's attention two recent reports1 from the United Kingdom and request that the Commission consider the impact of those reports on the final rule. Specifically, Section 5.15 of the Smith Report states:
The audit committee should have primary responsibility for making recommendations on the appointment, reappointment and removal of the external auditors. This recommendation should be made to the board, and thence to shareholders for their approval in general meeting. If the board does not accept the audit committee's recommendation, it shall include in the directors' report a statement from the audit committee explaining its recommendation and shall set out reasons why the board has taken a different position.
The Commission should clarify if the proposed instruction adequately addresses the potential conflict with any resulting change in the requirements for foreign private issuers from the United Kingdom.
In addition, foreign private issuers in certain countries (e.g., France or Germany) may be subject to conflicting laws that govern the termination of auditors. The Commission's proposed rule states, in part, that oversight responsibilities include the authority to retain the outside auditor, which would include the power not to retain (or to terminate) the outside auditor. However, in Germany, the termination of an auditor prior to the completion of the statutory audit can only be accomplished upon the decision of a court to appoint another statutory auditor.2 In France, auditors are appointed for a six-year term, and may only be terminated, based on the decision of a court, prior to the conclusion of this six-year period in cases of gross misconduct or an incapacity to act.3 As such, French and German issuers may not be able to comply with the Commission's proposed rule.
1-C. Procedures for Handling Complaints
Should the proposed rule require a company to disclose the procedures that have been established or any changes to those procedures? If so, where and how often should the disclosure appear and what should it look like?
We believe a company should make general disclosures regarding the procedures that have been established and any changes to those procedures. Disclosure may be helpful in building investor confidence, and provides an additional venue for notifying employees and others of the process that exists to receive their complaints. Consistent with disclosure related to an issuer's code of conduct, the issuer's policy for receiving complaints should be disclosed on its Web site or as an exhibit to its annual report as required by the Commission's Final Rule 33-8177, Disclosure Required by Sections 406 and 407 of the Sarbanes-Oxley Act of 2002.
Should specified procedures be prescribed or encouraged? For example, should we specify how long complaints must be retained? Should we specify who could or could not be designated by the audit committee for the receipt and treatment of complaints?
It is impractical to provide specific guidance that applies equally to all issuers. We support the Commission's belief that companies should be provided with flexibility to develop and utilize procedures appropriate for their circumstances.
1-D. Authority to Engage Advisors
Is any additional specificity needed for this requirement? For example, should we define what constitutes an "independent advisor"?
We generally agree with the rule as proposed, and further agree that the rules should remain flexible to allow for varying circumstances. We discourage the adoption of any rule that specifically prohibits management from participating in the engagement of advisors by the audit committee. Management's participation can, in certain circumstances, be both appropriate and productive and should not be prohibited categorically.
Is any additional specificity needed for this requirement? For example, should a specific agreement or arrangement be required to provide for the appropriate funding?
We agree with the rule as proposed. We do not recommend providing for specific guidance on the types of arrangements or agreements to be provided, or limits on the amount of compensation that could be requested by the audit committee.
1-F. Application and Implementation of the Proposed Standards
Do the proposed implementation dates provide sufficient time for SROs to propose and obtain Commission approval for new or amended rules to meet the requirements of the proposals? Is the date by when the standards would need to be operative appropriate? If not, what other dates would be appropriate? What factors should the Commission consider in determining these dates?
The Commission should grant the SROs additional transition time to finalize their rules for foreign private issuers. Historically, the Commission has not imposed certain corporate governance standards on foreign private issuers. While the Commission notes that many foreign private issuers already maintain audit committees, the changes proposed by the Commission can be daunting for many foreign private issuers, as they may have to initiate radical changes to their corporate governance structures to comply with the final rule. Given the potentially significant changes that must take place for certain foreign private issuers, we believe the Commission should consider permitting SROs additional flexibility in implementing the Commission's proposal. The additional lead time for foreign private issuers should permit foreign private issuers to complete any changes necessary to comply with rules issued by the SROs without creating the need for certain foreign private issuers to call emergency meetings of shareholders to approve changes to their corporate governance structure.
3. Issuers Affected
Is the compliance burden for companies under a certain size disproportionate to the benefits to be obtained from the proposed requirements?
We agree that improvements in financial reporting and corporate governance for companies of all sizes are important for promoting investor confidence in our markets. We do not believe the burden for small companies to be disproportionate to the benefits obtained from the proposed requirements. While the duties and responsibilities required of audit committee members will be unaffected by the size of the issuer, the financial reporting for smaller companies may be less complex and would typically require less time and effort from the audit committee members than for those from larger companies.
Is the exclusion of asset-backed issuers appropriate? If not, how should these issuers be handled? Are there other types of issuers that should be handled differently?
We believe the exclusion of asset-backed issuers from the requirements of the proposed rule appropriately recognizes the unique circumstances associated with these issuers. We agree with the rule as proposed.
5. Opportunity to Cure Defects
Should the SROs be required to establish specific procedures for curing defects apart from those proposed? If so, what would these procedures look like? Should there be a specific course for redress other than the delisting process?
We agree with the Commission's preliminary conclusion that the existing continued listing or maintenance standards and delisting procedures of the SROs provide an appropriate framework for an issuer to have an opportunity to cure any defects on an ongoing basis.
C. Foreign Private Issuers and Request for Comments (File No. S7-40-02)
Foreign private issuers with boards of auditors or similar bodies or statutory auditors meeting the requirements of our proposals would be exempt from the requirements regarding the independence of audit committee members. We request comment on whether the disclosure requirements related to audit committee financial experts should apply to such issuers. To the extent they should apply to such issuers, should the requirements apply to the board of auditors or similar body? Should we apply different standards or disclosure requirements for such issuers? For example, should audit committee financial experts of such issuers be subject to the same disclosure requirement regarding independence as other foreign private issuers? One of the proposed requirements for the listing exemption would be that home country legal or listing provisions set forth standards for the independence of such board or body. Should we permit these issuers to use those independence standards for their independence disclosure?
Foreign private issuers that avail themselves of the exemption related to independence of audit committee members, as described above, should still be subject to the disclosure requirements related to an audit committee financial expert. There is a benefit to investors that a qualifying board of auditors or similar body maintains an audit committee financial expert, just as there is a benefit that an audit committee maintains an audit committee financial expert. As such, if the Commission permits a qualifying board of auditors or similar body to be exempt from the requirement to maintain an audit committee financial expert, the level of protection to U.S. investors will be lower for such issuers.
Because the Commission's exemption for those issuers with a qualifying board of auditors or similar body implicitly acknowledges that the qualifying board or auditors or similar body has attained an adequate level of independence, the Commission should not eliminate the exemption from the independence requirement for the audit committee financial expert. With that said, the disclosure requirements regarding the audit committee financial expert's independence should be maintained. The Commission should require that a foreign private issuer, as part of its requirement to disclose that it has availed itself of the exemption in 17 CFR 240.10A.3(c), should disclose in both Item 15(f) and Item 16(a) of Form 20-F (and the comparable sections of Form 40-F) that the audit committee financial expert has maintained his or her independence in accordance with home country legal or listing provisions.
We believe that the proposed rule to implement Section 301 of the Act will provide clarity regarding audit committee roles and responsibilities and will further the process to restore investor confidence. However, we also believe that in order for Section 240.10A-3 of the Securities Exchange Act of 1934 to be effectively and consistently implemented, the issues enumerated above should be addressed.
If you have any questions, please contact Robert J. Kueppers at (203) 761-3579.
cc: The Honorable William Donaldson, Chairman of the Securities and Exchange Commission