February 18, 2003
Mr. Jonathan G. Katz, Secretary
File No. S7-02-03
Dear Mr. Katz:
KPMG is pleased to submit its comments on the Commission's proposed rule, Standards Relating to Listed Company Audit Committees (the "Proposed Rule"), that directs the national securities exchanges and association with respect to the audit committee requirements established by the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley"). We believe that effective audit committees play a critical role in the oversight of the financial reporting process that is fundamental to preserving the integrity of our capital markets.
We present for your consideration our observations on the Proposed Rule, including suggestions we believe will improve the overall quality and effectiveness of the final rule issued by the Commission. These suggestions are summarized below and explained and supported in the remainder of this letter.
Determining the Independence of Audit Committee Members
The proposing release asks whether boards of directors should be required to determine whether an audit committee member is independent. We believe the requirement would be consistent with the board's responsibility under recently enacted provisions and existing listing standards to evaluate the qualifications of its audit committee members.
An audit committee is a committee of the board of directors. In terms of organizational forms, the board is the logical party to determine the composition of its audit committee within the constraints imposed by the independence requirements. Sarbanes-Oxley defines an audit committee as a body established by and amongst the board of directors, with the board as a whole as the alternative. From an organizational standpoint, the board therefore has a responsibility for the composition of its committees, including the audit committee.
Requiring the board of directors to determine the independence of its audit committee members is also consistent with its responsibility under recently enacted regulations to consider the qualifications of its audit committee members. The Commission recently adopted rules relative to Section 407 of Sarbanes-Oxley (the "Section 407 Rules") requiring a registrant to disclose whether an "audit committee financial expert" serves on its audit committee. The Section 407 Rules expressly indicate that the board of directors is responsible for determining whether a person qualifies as an audit committee financial expert. In addition, these rules indicate that registrants must disclose whether named audit committee financial experts are independent.
Requiring the board to determine the independence of its audit committee members is also consistent with both the existing, and in most cases, the proposed listing standards of the New York Stock Exchange, American Stock Exchange and National Association of Securities Dealers. These exchanges and association require a written affirmation from the issuer concerning the independence of an issuer's audit committee. The proposed new listing standards submitted to the Commission by the exchanges and association generally retain the notion of board determination of independence.
Overall, the existing rules and proposals support the notion that the board of directors is the appropriate body that should be required to determine the independence of its audit committee members.
Temporary Exemption for New Listed Issuers
The Proposed Rule would exempt from the independence requirements one audit committee member for 90 days after the effective date of a company's initial registration statement. The proposing release explains that prior to the offering, the board of directors often consists primarily of representatives of the venture-capital investors and insiders; and often there is difficulty in recruiting independent directors before an initial public offering, given the uncertainty that the offering will be completed. The release adds that this difficulty could discourage companies from accessing the public capital markets. These reasons argue for a more generous exemption.
We suggest an exemption of 180 days, instead of 90. Although it would double the period of the exemption, our suggestion is modest. An extended exemption would, at a minimum, allow an exempted individual with historical familiarity of the company, its business and related issues to assist the audit committee through the filing deadlines of the new listed issuer's initial periodic reports required under the Securities Exchange Act of 1934 (the "Exchange Act"). The release acknowledges that "the audit committee of some new public companies may function more effectively if one director has historical knowledge and experience with the company." Extending the exemption period to 180 days would ensure that the benefit of this "historical knowledge and experience" is available through a period during which a new listed issuer is preparing and reviewing its initial periodic Exchange Act reports. Additionally, the extended period of exemption would provide additional time for recruiting new board members of a recently listed entity. We believe that an extension of this temporary exemption to 180 days, or even a longer period, is consistent with the goal of investor protection.
Procedures for Handling Complaints and Communication of Matters to the Independent Auditor
We have two recommendations to the Commission's implementation of this requirement prescribed by Sarbanes-Oxley. First, the final rule should clarify the requirement to retain information relative to complaints. Second, the Commission should require audit committees informed of concerns pertinent to accounting, internal accounting controls, and auditing matters to communicate that information to the independent auditors.
The Proposed Rule incorporates language from Sarbanes-Oxley indicating that the audit committee must have established procedures for "the receipt, retention, and treatment of complaints received...regarding accounting, internal accounting controls, or auditing matters." The word "retention" raises unanswered questions. How long should the complaints be retained? Should some complaints be retained longer than others? Under what circumstances, if any, would it be permissible to discard some complaints immediately as immaterial? Some guidance is needed on these questions if practice is to be reasonably consistent and the requirement implemented in an orderly manner.
Communications between independent auditors and audit committees are recognized for their positive contribution to the financial reporting process. Auditors are required to communicate specific matters to the audit committee under professional standards and the final rules implementing Section 204, Auditor Reports to Audit Committees, of Sarbanes-Oxley. The Commission indicated its desire to "facilitate more open dialogue between auditors and audit committees" in the proposing release related to the Section 204 rules.1 Requiring that the audit committee also make certain communications to the auditor would further strengthen this open dialogue, contribute to overall audit effectiveness and support the ultimate goal of more effective financial reporting in the interests of investors. If the audit committee obtains information that could improve the effectiveness of the audit, there should be no question about the propriety and desirability of communicating that information to the independent auditor. For this reason, we believe the final rule should make communication of all complaints and/or concerns pertinent to accounting, internal accounting controls and auditing matters to the independent auditor mandatory.
Other General Comments-Foreign Jurisdictions
We acknowledge the Commission's efforts in proposing exemptions and accommodations that respond to certain circumstances in which its requirements may otherwise conflict with legal requirements and corporate governance standards in the home jurisdictions of some foreign private issuers. However, we suggest that in considering exemptions for various conflicts the Proposed Rule may create with various foreign requirements, the Commission also consider offering relief in areas in which similarities exist with regulatory provisions present in these jurisdictions.
Foreign private issuers and legal professionals will likely separately comment on matters arising from conflicts existing between the Proposed Rule and requirements existing in other jurisdictions. However, we offer a general suggestion that efficiencies may be gained by recognizing the breadth of regulations that may already exist in some jurisdictions where these regulations largely satisfy the provisions included in the Proposed Rule. In such cases, we suggest the Commission consider compliance with these regulations in lieu of compliance with aspects of the Proposed Rule.
The Commission's adoption in 1991of a multi-jurisdictional disclosure system for Canadian issuers is a case in point in which the recognition of commonalities in U.S. regulation and Canadian requirements allows eligible Canadian issuers to supplant compliance with Canadian provisions for certain U.S. requirements. As other governments and jurisdictions propose and adopt requirements and standards similar to those required by Sarbanes-Oxley (and related adopting Commission rules), the Commission should consider accepting compliance with certain non-U.S. requirements in lieu of those included in the Proposed Rule.
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We would be pleased to respond to any questions our comments raise. Questions should be directed to Sam Ranzilla at (212) 909-5837, firstname.lastname@example.org, or Darryl Briley at (212) 909-5680, email@example.com.