Telefonaktiebolaget LM Ericsson
Ladies and Gentlemen:
File No. S7-02-03
Telefonaktiebolaget LM Ericsson ("Ericsson") appreciates the opportunity to comment on the Commission's release entitled Standards Relating To Listed Company Audit Committees, Release Nos. 33-8173; 34-47137; IC-25885 (the "Release"). Our comments set forth below are both general and specific in nature. All comments are submitted with equal prominence; the more specific and detailed comments are not meant to diminish the strength of our more general comments.
At the outset, we strongly urge the Commission to exempt from Section 301 of Sarbanes-Oxley Act of 2002 all non-U.S. companies subject to corporate governance systems different than those in the U.S. The Sarbanes-Oxley Act was a necessary response to failures of corporate governance in the U.S. In Europe, there have been far fewer instances of such failures, and we believe that one principal reason for this is because the governance systems of checks and balances established in the corporate laws of many European countries, such as Sweden or Germany, have structural protections which, while different than those in the Sarbanes-Oxley Act, are no less effective and indeed, have proven to be very effective. To require foreign private issuers from jurisdictions with effective but different corporate governance systems from those in the U.S. to comply with Section 301 of the Sarbanes-Oxley Act would, in our view, adversely affect these foreign private issuers, such as Ericsson, without any tangible, additional benefit.
More specifically, this letter addresses two issues in the Release:
First, the application of proposed Rule 10A-3(b)(2) to foreign private issuers, such as Ericsson, whose home country rules require the shareholders, and not the audit committee, to ultimately elect, approve or ratify the selection of the issuer's independent auditor. Although we agree with the Commission that proposed Rule 10A-3(b)(2) should not conflict with, and should not affect the application of, such home country rules, we do not believe that the instruction to the proposed rule effectively resolves the problem faced by foreign private issuers which must comply with different bodies of potentially conflicting laws. We propose that a general and explicit exemption from Rule 10A-3(b)(2) is warranted for foreign private issuers in these circumstances.
Second, this letter addresses the proposed independence requirements for audit committee members of foreign private issuers. We believe that the proposed rules unnecessarily and unfairly focus on share ownership in determining whether an individual is eligible to serve on the audit committee. We propose changes that, in our view, more effectively implement the policy behind the proposed rules. This comment letter first describes Ericsson and the requirements under the Swedish Companies Act before addressing proposed Rule 10A-3(b)(2) and the proposed audit committee member independence requirements.
Ericsson is incorporated in Sweden and is a foreign private issuer under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), with equity securities registered under Section 12 of the Exchange Act and traded on the Nasdaq Stock Market as well as the Stockholm Stock Exchange and other exchanges throughout Europe. Ericsson has two principal shareholders: Investor AB, with 38.7% of the voting rights, and AB Industrivärden, with 28% of the voting rights. As a Swedish corporation, Ericsson is subject to the Swedish Companies Act, including its provisions with respect to the selection and oversight of the independent auditor:
Auditors shall be selected by the general meeting of shareholders. Where several auditors are to be appointed, the articles of association may, however, provide that more than one of them, but not all, shall be appointed in another way. Chapter 10, Section 8.
An auditor shall observe instructions given by the general meeting of shareholders provided that these instructions are not contrary to law, the articles of association or generally accepted auditing standards. Chapter 10, Section 4.
Application of Proposed Rule 10A-3(b)(2) to Foreign Private Issuers
Because the Swedish Companies Act fully and exclusively vests the shareholders of the corporation - and not the board of directors or the audit committee - with the authority to appoint, nominate, compensate and oversee the independent auditor, it conflicts with Section 10A(m)(2) of the Exchange Act and proposed Rule 10A-3(b)(2), which provide that the audit committee shall be directly responsible for the appointment, compensation and oversight of the independent auditor. The instruction to proposed Rule 10A-3(b)(2) addresses this conflict by stating that the rule "does not conflict with, and does not affect the application of," home country rules, like Sweden's, requiring shareholders to ultimately elect, approve or ratify the selection of the auditor. In such circumstances, the proposed rule "relates [only] to the assignment of responsibility to oversee the auditor's work as between the audit committee and management."
Although the effect of the instruction is to exempt foreign private issuers in such circumstances from the requirement in proposed Rule 10A-3(b)(2) that the audit committee be directly responsible for the appointment, compensation, retention and oversight of the work of the auditor - which we strongly endorse - the instruction is unsatisfactory, in our view, for two reasons. First, the directive assigning the responsibility to oversee the auditor's work to the audit committee vis-à-vis management has no application in countries such as Sweden, in which the oversight of the auditor is vested by law in the shareholders, and not the audit committee or the management of the corporation. Second, given the importance of this issue to the corporate governance of foreign private issuers in these jurisdictions, we believe that the exemption from the proposed rule should be explicit and not indirect, particularly because the proposed rule, as drafted, contains a separate subparagraph (c) for exemptions.
We support the Commission's efforts to coordinate the application of the Sarbanes-Oxley Act to foreign private issuers in order to minimize unnecessary conflicts between different bodies of law, particularly in circumstances where countries, like Sweden, have addressed corporate governance issues such as auditor oversight by regulatory means different from, but no less effective than, those in the Sarbanes-Oxley Act. Because the Swedish Companies Act vests the shareholders with the duties and responsibilities that proposed Rule 10A-3(b)(2) vests in the audit committee, and the instruction to the proposed rule has no effect in Sweden or similar countries because neither the audit committee nor management is charged with overseeing the auditor, we propose that a more effective method for coordinating these conflicting bodies of laws is to provide for a general and explicit exemption from proposed Rule 10A-3(b)(2) for foreign private issuers from Sweden and similar jurisdictions.
Accordingly, we propose the following language to be included as a subparagraph to proposed Rule 10A-3(c), as follows:
"(#)(i) The listing of securities of a foreign private issuer will not be subject to the requirements of paragraphs (b)(1) or (b)(2) of this section if the foreign private issuer meets the following requirements:
Independence Requirements for Audit Committee Members of Foreign Private Issuers
In order to be considered "independent" under the proposed rules, a member of the audit committee cannot, among other things, be an "affiliated person" of the issuer. The definition of an "affiliated person" includes any director, executive officer, partner, member, principal or designee of an "affiliate," and an "affiliate" of the issuer is defined as any "person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with" the issuer.
The Commission has proposed a safe harbor in proposed Rule 10A-3(e)(1) by providing that an individual who is not an executive officer or a director or is the beneficial owner of no more than 10% of any class of equity securities of the issuer (the "10% safe harbor") would be deemed not to control the issuer. Anyone unable to rely on the 10% safe harbor may rely on a facts and circumstances analysis to determine the question of control of the issuer. In addition, the Commission has proposed a qualified exemption in proposed Rule 10A-3(b)(iv)(D) from the audit committee independence requirements for the beneficial owner of more than 50% of the voting common equity of a foreign private issuer (the "50% qualified exemption"). Although such beneficial owner or its representative may serve on the audit committee, such member has observer status only and cannot chair or vote with the committee.
We believe the proposed requirements are inconsistent with the spirit of Section 301 of the Sarbanes-Oxley Act, which is independence from management. Many of the problems encountered under the prevailing corporate governance systems in the U.S. stem, in our view, from conflicts of interest between management and the board - from the CEO being a member of the board and from the offices of CEO and Chairman being held by the same person. In contrast, the Swedish Companies Act provides express conflict of interest provisions and prohibits the CEO from being the Chairman of the board of directors. Moreover, it is considerably rare in Sweden that the CEO is also a member of the board.
Accordingly, we believe that audit committee independence should be focused on the relationships between the board and the management only and not on levels of share ownership. In our view, even significant shareholders are not "control" relationships that could affect the independent judgment of their representatives on the audit committee and are therefore not the types of relationships that should be treated as affiliates under the proposed rules for purposes of audit committee eligibility. We request that the Commission expressly confirm that this is the intended result of the proposed rules.
With respect to the proposed rules as drafted, we are concerned about the interplay between the 10% safe harbor and the 50% qualified exemption. On the one hand, the 10% safe harbor effectively would make it considerably more difficult for a shareholder with a greater than 10% holding to argue that it does not exercise control over an issuer based on a facts and circumstances analysis. On the other hand, the 50% qualified exemption would adversely affect long-term shareholders who, for legal, accounting and other reasons relevant in their jurisdiction, have decided that ownership levels of less than 50% - for example, in the 25% to 45% range - are optimal. Both of Ericsson's significant shareholders have greater than 10% but less than 50% voting equity ownership.
Although we support the Commission's effort to accommodate the fact that controlling shareholders or shareholder groups are more prevalent among foreign issuers than in the United States, we believe the Commission has not fully appreciated corporate governance outside the United States and, in particular, the role that long-term strategic shareholders play in many large European companies. In Sweden and other countries in Europe, there is a rich tradition of long-term strategic ownership of public companies. Often, such ownership is between 10% and 50%, and the shareholder may have held its shares for a long period of time.
We believe that these shareholders should have the opportunity to serve on the audit committee. Accordingly, we propose that the Commission adopt the traditional analysis for determining "affiliate" or "affiliated" person status - i.e., without the 10% safe harbor - and in the context of determining independence from management. The board's determination of independence, and the bases therefor, would be disclosed in the company's annual report. This proposal would result, we believe, in a more flexible and fairer determination of independence.
Correspondingly, with respect to the 50% qualified exemption, if an individual is unable to serve as a member of the audit committee because of a finding that such individual is an affiliate or affiliated person, then such individual should be permitted to serve as a qualified member of the audit committee, so long as the "no compensation" requirement is satisfied and the individual has observer status only and does not chair or vote with the committee. There is no justification, in our view, for treating affiliates or affiliated persons differently than beneficial owners of more than 50% of the voting common equity for the purpose of serving as a qualified member of the audit committee.
We appreciate the opportunity to comment. Should the Commission or its Staff have any questions concerning the comments in this letter, please do not hesitate to contact me at
TELEFONAKTIEBOLAGET LM ERICSSON (publ)
cc: Hon. Harvey L. Pitt
Hon. Harvey Goldschmid
Hon. Paul Atkins
Jeffrey J. Minton