American Federation of Labor and
Congress of Industrial Organizations (AFL-CIO)
Deutscher Gewerkschaftsbund (DGB)
February 19, 2003
Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Re: File No. S7-02-03
Dear Mr. Katz:
On behalf of the American Federation of Labor and Congress of Industrial Organizations ("AFL-CIO") and the Federation of German Unions, Deutscher Gewerkschaftsbund ("DGB"), we welcome this opportunity to offer our comments on the Securities and Exchange Commission's (the "Commission") proposed rule, File No. S7-02-03, to strengthen the Commission's requirements regarding audit committee independence.
The AFL-CIO is the federation of America's labor unions, representing more than 66 national and international unions and their membership of more than 13 million working women and men. Union members participate in the capital markets as individual investors and through a variety of benefit plans. Union members' benefit plans have over $5 trillion in assets. Pension plans sponsored by unions affiliated with the AFL-CIO account for over $400 billion of that amount.
The DGB is the federation of German labor unions, representing 8 national unions and their membership of more than 7.8 million working women and men. Last year German unions affiliated with the DGB began sponsoring pension plans based on a new law promoting private retirement savings.
The AFL-CIO and the DGB have actively sought to ensure the independence of the board of directors' the audit committee. The AFL-CIO and worker pension funds have supported the independence of the audit function and the independence of the audit committee before the collapse of Enron exposed, with devastating consequences for investors, major weaknesses in public company boards of directors. In addition, worker funds have for several years submitted shareholder proposals seeking to ensure companies they invest in have truly independent board members.
The DGB, its member unions and its foundation, the Hans-Böckler-Stiftung, provide education and legal services to the worker representatives on German supervisory boards, and fund as well as publish research on co-determination, the German system of corporate governance. The DGB also participates in the German Government Commission on Corporate Governance, which issued the German Corporate Governance Code last year. The Code recommends, for example, that German exchange-listed companies establish an audit committee.
The AFL-CIO and the DGB recognize that there are a wide variety of successful corporate governance systems worldwide. Relationships between various corporate constituencies-shareholders, debt holders, employees, communities, customers and lenders-differ significantly. For this reason, the AFL-CIO and the DGB participate in a global corporate governance dialogue to identify shared values and best practices among the full variety of successful corporate governance systems.
One result of that global dialogue are the Corporate Governance Principles of the Organization for Economic Co-operation and Development (OECD). The document rests on core principles that should command widespread agreement: transparency and accountability by company managers to the constituencies that depend on them. The document recognizes the wide variety of approaches to achieving these goals among the world's largest economies, including the U.S. and Germany.
Germany is the largest economy with a corporate governance system that includes company directors elected directly by the company's workforce. German companies have a two-tier board structure comprised of a management board and a supervisory board. Each board has a different role. The management board is responsible for the day-to-day management of the company while the supervisory board monitors management behavior. Under the German Stock Corporation Act, a member of the management board cannot be a member of the supervisory board. Accordingly, for the purposes of the proposed rule, the supervisory board is the German equivalent to the U.S. board of directors.
2. Standards for Audit Committee Member Independence
After the series of corporate scandals, restoring confidence in the capital markets requires that directors are held to the highest standards of independence, accountability and performance. Both the German and the U.S. systems of corporate governance rely heavily on an independent audit committee to ensure the integrity of a company's financial statements. We are therefore pleased to see that the proposed rule would require that all members of a company's audit committee be completely independent.
The proposed rule specifies two criteria that define the independence of an audit committee member. First, the rule would bar any audit committee member from accepting any direct or indirect compensatory fee. Second, the rules would require that an audit committee member could not be an "affiliate person" of the issuer. While we recognize that the Sarbanes-Oxley Act only specifies these two criteria, we suggest that the Commission consider requiring more comprehensive independence standards such as the definition endorsed by the Council of Institutional Investors ("CII"): "An independent director is someone whose only nontrivial professional, familial or financial connection to the corporation, its chairman, CEO or any other executive officer is his or her directorship." Attached is CII's complete explanation of its independent director definition.
Because of its important role in management oversight, the board of directors should be required to determine that an audit committee member is independent according to this definition. The listed issuers should disclose the board's determination in their proxy statement and annual report.
We also ask the Commission to require a five-year "cooling off" period for any former service provider and any of its employees before being deemed independent for the purposes of the proposed rule. This requirement would help eliminate conflicts of interests an accountant formerly employed by the company's auditor would face when nominated to that company's board.
3. Stock Exchange Listing Standards
We also suggest the Commission specify one audit independence standard for all self-regulatory organizations. The self-regulatory organizations currently endorse very different definitions for "independent director," many of which do not adequately protect investors. Because of the different and often weak standards, an investor cannot evaluate the independence of board and key committees such as the audit committee without spending significant sums for investigative research.
Requiring one standard set by the Commission would also eliminate the conflicts of interests the self-regulatory organizations face when developing their own independence standards. Stock exchanges receive funding from the listed companies and are therefore vulnerable to a "race to the bottom" dynamic. Although some of the exchanges recently proposed new rules, those proposals have not lead to a more uniform and sufficiently strict standard.
4. Additional Disclosure
We suggest the Commission require additional disclosure of director conflicts of interest. As the AFL-CIO stated in a rulemaking petition (4-449) submitted to the Commission on December 12, 2001, Enron's meltdown was caused, among other factors, by a cavalier attitude towards disclosure. Investors were not able to make informed decision about the independence of an Enron board candidate because Enron did not disclose all of the nominee's conflicts of interests.
For this reason we urged the Commission to amend the rules to require disclosure of the following relationships that the proposed rule has not adequately addressed:
- Relationships between the registrant or any executive officer of the registrant and any not-for-profit organization on whose board a director or immediate family member serves or of which a director or immediate family member serves as an officer or in a similar capacity. Disclosable relationships should be defined to include contributions to the organization in excess of $10,000 made by the registrant or any executive officer in the last five years and any other activity undertaken by the registrant or any executive officer that provides a material benefit to the organization. "Material benefit" should be defined to include lobbying efforts and fundraising activities undertaken by the registrant or any executive officer on the organization's behalf.
- Relationships in which the registrant or any executive officer exercises significant control over an entity in which a director or immediate family member owns an equity interest or to which a director or immediate family member has extended credit. Significant control should be defined with reference to the contractual and governance arrangements between the registrant or executive officer, as the case may be, and the entity. For example, in most cases, a general partner exercises significant control over a partnership, while a limited partner may exercise significant control depending on the terms of the partnership agreement.
It may be necessary to provide that the existence of significant control may depend, in part, on the overall ownership structure of the entity and not just the stake held by the registrant or executive officer. For example, the owner of less than a majority of a corporation's stock may nonetheless exercise significant control if the other stockholders are numerous and fragmented.
- Joint ownership by a registrant or executive officer and a director or immediate family member of any real or personal property.
- The provision of any professional services, including legal, financial advisory or medical services, by a director or immediate family member to any executive officer of the registrant in the last five years.
5. Exemption For Foreign Issuers
Under the proposed rule the Commission has sought to avoid unintended consequences for foreign issuers based on this issuer's home country corporate governance and legal system. We commend the Commission for recognizing the wide variety of successful corporate governance systems worldwide. It is vital for the U.S. capital markets to be open to foreign issuers from countries with their own successful corporate governance systems. This can and must be done while at the same time maintaining the principles of transparency and independence embodied in the Sarbanes-Oxley Act. For his reason, we strongly support the exemption of worker representatives from the proposed definition of independence. Furthermore, we believe that all non-management worker representatives on a board of directors should be deemed independent as long as they are nominated and elected by the workforce acting independently of management.
We share the view of the Commission that the objectivity of worker representatives on board of directors is not compromised by their role as employees. In Germany, for example, non-management worker representatives are independent monitors of management because they are nominated and elected without management involvement. While the annual general meeting of shareholders elects one half of the supervisory board members, the workforce nominates and elects the other half. In addition, the worker representatives who are part of the company work force are often members of the company's works councils. Under German co-determination laws, works council members enjoy special protections against discrimination and retaliation by management such as special lay-off protection.
Moreover, depending on the size of the supervisory board, two or three worker representatives on a supervisory board are union representatives not employed by the company. Therefore, these trade union representatives are also independent of management.
6. Audit Responsibilities of the German Supervisory Board
The German Corporate Governance Code recommends the establishment of an audit committee. Following that recommendation, an increasing number of supervisory boards have established audit committees. However, the audit committee can only conduct preparatory activities. The German Stock Company Act requires the Supervisory Board as a whole to approve decisions related to the company's auditor. Given the exemptions for foreign issuers, we agree with the Commission's view that under the proposed rules the entire supervisory board of a German company would be considered as the audit committee.
The AFL-CIO and the DGB commend the Commission for taking an important step towards formulating comprehensive rules to strengthen audit committee independence. We urge these rules be adopted, together with our proposed stricter independence criteria and a uniform listing standard for all self-regulatory organizations. We strongly support the exemption for worker representatives on the audit committee of foreign-listed issuers. We believe that implementation of the proposed rules will go a long way toward restoring investor confidence in the quality and reliability of audited financial statements.
|Richard L. Trumka
Member of the Managing Board
cc (U.S. Mail only)
William H. Donaldson, Chairman
Cynthia A. Glassman, Commissioner
Harvey J. Goldschmid, Commissioner
Paul S. Atkins, Commissioner
Roel C. Campos, Commissioner
Paul F. Roye, Director, Division of Investment Management
COUNCIL of INSTITUTIONAL INVESTORS
INDEPENDENT DIRECTOR DEFINITION
An independent director is someone whose only nontrivial professional, familial or financial connection to the corporation, its chairman, CEO or any other executive officer is his or her directorship.
NOTES: Independent directors do not invariably share a single set of qualities that are not shared by non-independent directors. Consequently no clear rule can unerringly describe and distinguish independent directors. However, members of the Council of Institutional Investors believe that the promulgation of a narrowly drawn definition of an independent director (coupled with a policy specifying that at least two-thirds of board members should meet this standard) is in the corporation's and all shareholders' ongoing financial interest because:
- independence is critical to a properly functioning board,
- certain clearly definable relationships pose a threat to a director's unqualified independence in a sufficient number of cases that they warrant advance identification,
- the effect of a conflict of interest on an individual director is likely to be almost impossible to detect, either by shareholders or other board members,
- while an across-the-board application of any definition to a large number of people will inevitably miscategorize a few of them, this risk is sufficiently small that it is far outweighed by the significant benefits.
Stated most simply, an independent director is a person whose directorship constitutes his or her only connection to the corporation. The definition approved by members of the Council contains this basic formulation. It then adds to it a list of the relationships members believe pose the greatest threat to a director's independence. The existence of any such relationship will remove a director from the independent category.
The following notes are supplied to give added clarity and guidance in interpreting the specified relationships.
A director will not generally be considered independent if he or she:
- is, or in the past five years has been, employed by the corporation or an affiliate in an executive capacity;
NOTES: The term "executive capacity" includes the chief executive, operating, financial, legal and accounting officers of a company. This includes the president, treasurer, secretary, controller and any vice-president who is in charge of a principal business unit, division or function (such as sales, administration or finance) or performs a major policymaking function for the corporation.
An "affiliate" relationship is established if one entity either alone or pursuant to an arrangement with one or more other persons, owns or has the power to vote more than 25 percent of the equity interest in another, unless some other person, either alone or pursuant to an arrangement with one or more other persons, owns or has the power to vote a greater percentage of the equity interest. For these purposes, equal joint venture partners meet the definition of an affiliate, and officers and employees of equal joint venture enterprises are considered affiliated.
Affiliates include predecessor companies. A "predecessor" of the corporation is a corporation that within the last ten years represented more than 80 percent of the corporation's sales or assets when such predecessor became part of the corporation. Recent merger partners are also considered predecessors. A recent merger partner is a corporation that directly or indirectly became part of the corporation or a predecessor within the last ten years and represented more than 50 percent of the corporation's or predecessor's sales or assets at the time of the merger.
A subsidiary is an affiliate if it is at least 80 percent owned by the corporation and accounts for 25 percent of the corporation's consolidated sales or assets.
- is, or in the past five years has been, an employee or owner of a firm that is one of the corporation's or its affiliate's paid advisers or consultants;
NOTES: Advisers or consultants include, but are not limited to, law firms, accountants, insurance companies and banks.
- is, or in the past five years has been, employed by a significant customer or supplier;
NOTES: A director shall be deemed to be employed by a significant customer or supplier if the director:
-- is, or in the past five years has been, employed by or has had a five percent or greater ownership interest in a supplier or customer where the sales to or by the corporation represent more than one percent of the sales of the customer or supplier or more than one percent of the sales of the corporation,
-- is, or in the past five years has been, employed by or has had a five percent or greater ownership interest in one of the corporation's debtors or creditors where the amount owed exceeds one percent of the corporation's or the third party's assets,
Ownership means beneficial or record ownership, not custodial ownership.
- has, or in the past five years has had, a personal services contract with the corporation, its chairman, CEO or other executive officer or any affiliate of the corporation;
NOTES: Council members believe that even small personal services contracts, no matter how formulated, can threaten a director's complete independence. This includes any arrangement under which the director borrows or lends money to the corporation at rates better (for the director) than those available to normal customers -- even if no other services from the director are specified in connection with this relationship.
- is, or in the past five years has been, an employee, officer or director of a foundation, university or other non-profit organization that receives significant grants or endowments from the corporation or one of its affiliates;
NOTES: This relationship includes that of any director who is, or in the past five years has been, an employee, officer or director of a non-profit organization to which the corporation or its affiliate gives more than $100,000 or one percent of total annual donations received (whichever is less), or who is, or in the past five years has been, a direct beneficiary of any donations to such an organization.
- is, or in the past five years has been, a relative of an executive of the corporation or one of its affiliates;
NOTES: Relatives include spouses, parents, children, siblings, mothers and fathers-in-law, sons and daughters-in-law, brothers and sisters-in-law, aunts, uncles, nieces, nephews and first cousins. Executives include those serving in an "executive capacity."
- is, or in the past five years has been, part of an interlocking directorate in which the CEO or other executive officer of the corporation serves on the board of another corporation that employs the director.
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