1345 Avenue of the Americas
19th Floor
New York, NY 10105
Telephone 212 424 9000
Facsimile 212 424 9100

U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549
E-mail address:

Attention: Jonathan G. Katz, Secretary

February 18, 2003

Re: File No. S7-02-03
Standards Relating to Listed Company Audit Committees,
Release Nos. 33-8173; 34-47137

Ladies and Gentlemen:

We are submitting this letter in response to a request of the Securities and Exchange Commission (the "Commission" or the "SEC") for comments in respect of the Commission's Proposed Rule 10A-3 regarding standards relating to a listed company audit committee ("Audit Committee") as directed by the Sarbanes-Oxley Act of 2002 (the "Act").

We want, initially, to thank the Commission for considering the position of foreign private issuers prior to issuing the rule proposals, which resulted in several significant accommodations being included in Proposed Rule 10A-3. These accommodations have, we believe, contributed to a subtle shift in attitude toward the U.S. securities regulatory regime generally, and towards the Act in particular, among certain foreign regulators and in some of the foreign media. We encourage the continued consideration of the position of foreign private issuers, particularly as regards corporate governance matters, in future rulemakings by the Commission and the national securities exchanges in the coming months.

We represent a large number of non-U.S. companies and global financial institutions, and, in response to the Commission's requests for further input from non-US issuers, the focus of our comments will be on those aspects of Proposed Rule 10A-3 which remain of concern for our non-U.S. clients.

Pursuant to Proposed Rule 10A-3 under the U.S. Securities Exchange Act of 1934 (the "Exchange Act"), national securities markets, or "SROs", would be required to prohibit the listing of any issuer that is not in compliance with the following standards:

  • each member of the Audit Committee must be independent;

  • the Audit Committee must be directly responsible for the appointment, compensation, retention and oversight of the work of audit firms, which audit firms must report directly to the audit committee;

  • the Audit Committee must establish procedures for the receipt, retention and treatment of complaints, including confidential anonymous employee complaints, regarding accounting, internal accounting controls or auditing matters;

  • the Audit Committee must have the authority to engage independent counsel and other advisors, as necessary; and

  • the issuer must provide appropriate funding for the Audit Committee.

A. The Commission Should Strictly Limit the Designation of the Supervisory or Non-Management Board as the Board of Directors to Audit Committee Functions

With respect to foreign private issuers who have a two-tier board structure, in the Proposing Release the Commission stated, "we believe that the supervisory or non-management board would be the body ... best equipped to comply with the proposed requirements." The Proposing Release went on to clarify that, for these foreign private issuers, the term "board of directors" means the supervisory or non-management board.1, 2

The Commission should clarify that this designation of the supervisory board as the "board of directors" applies only to audit committee independence requirements. Other references to "directors" in the federal securities laws and regulations, such as disclosure requirements related to a company's "directors and senior management," arguably encompass the management board. On the other hand, as the role of the supervisory board is more limited in certain jurisdictions (for instance, in Germany, as discussed below) than is the role of a board of directors for U.S. companies, it may not be appropriate for all disclosure and liability purposes to treat members of the supervisory board as directors. We would urge the Commission to address this ambiguity in a comprehensive manner in the future.

For the present, we urge the Commission to limit applicability of this clarification to Rule 10A-3 by modifying clause (e)(2) of Rule 10A-3 as follows:

(2) In the case of foreign private issuers with two-tier boards of directors, the term board of directors means, for the purposes of this Rule 10A-3 only, the supervisory or non-management board.

If the Commission were to accept this proposal, equivalent clarifications would be required for the new rules regarding audit committee responsibilities (including those that relate to auditor communications and independence) and the designation of an audit committee financial expert.

B. The Exemption for Dual-Listed Foreign Private Issuers Should Be Extended to All Foreign Private Issuers Subject to a Qualifying Set of Regulations Regarding Appointment of an Audit Board

Proposed Rule 10A-3(c)(2) provides for a general exemption from the Rule 10A-3(b)(1) and (2) independence requirements for dual-listed foreign private issuers who are subject to home-country audit-board requirements that set forth standards for independence. The rationale for this exemption is that "[t]he establishment of an audit committee in addition to these bodies, with duplicative functions, might not only be costly and inefficient, but it also could generate possible conflicts of powers and duties".3

We agree with this rationale but note that it should apply in any situation where a foreign private issuer is subject to local rules regarding establishment of an audit board, even where that company has not listed its securities in its home country. In some jurisdictions (for instance, Germany), provisions regarding audit boards arise by operation of home-country corporation law rather than under or in addition to local listing requirements. The rationale given above should equally apply to such situations, even in the absence of a dual listing.

Accordingly, we propose that clause (A) of Rule 10A-3(c)(2) be deleted.

C. The Definition of Certain Terms Used in the Independence Requirements Should Be Added or Expanded

Proposed Rule 10A-3(b)(1)(ii) provides, in relevant part, that in order to be considered independent, a member of an audit committee of a listed issuer may not accept directly or indirectly any consulting, advisory or other compensatory fee from the issuer. Proposed Rule 10A-3(e)(6) provides, in relevant part, that

The term indirect acceptance by a member of an audit committee of any consulting, advisory or other compensatory fee includes acceptance of such a fee . . . by an entity in which such member is a partner, member or principal or occupies a similar position and which provides accounting, consulting, legal, investment banking, financial or other advisory services or any similar services to the issuer.

There are in our view several ambiguities that arise under this language.

(1) The term "partner, member or principal" requires further definition. We understand these terms to indicate a relationship with one's company that includes both equity ownership and a substantial voice in management of the company (as is the case, for instance, with the partner of a law firm or accounting firm). What if a company (the "Relationship Company") receiving payments from an issuer is represented on the audit committee of an issuer by an employee who owns no equity stake in the Relationship Company? In our reading of the definition above, the existence of that employee on the audit committee will not result in the independence requirement being violated. What if the audit committee member carries a title of Vice President at the Relationship Company and holds an insignificant amount of stock options in the Relationship Company, but is otherwise not a member of senior management of the Relationship Company? Or if she is a member of senior management of the Relationship Company? Or holds a 6% equity interest in the Relationship Company? At which point does she become a principal of the Relationship Company?

To clarify this ambiguity, we would propose the following definition of "partner, member or principal":

A natural person will be considered a partner, member or principal of a company if he or she holds an equity interest in that company that entitles him or her to participate in the management of the company or, in the case of a stock corporation, if he or she has been appointed as a member of the senior management of the company.

In addition, we respectfully request that the Commission clarify, in either general instructions to or the adopting release for Rule 10A-3, that in the case of companies with a dual board structure, being a "member of the senior management" will normally involve membership in the company's management board.

(2) The Proposing Release states, "[o]ur proposal would not, for example, preclude independence on the basis of ordinary course commercial business relationships between an issuer and an entity with which a director had a relationship".4 We are unable to find, however, this clarification codified in the text of Proposed Rule 10A-3. We submit that this clarification should be codified in the final rule.

Thus, to avoid ambiguity, we propose the addition of the following to the end of Rule 10A-3(e)(6):

The payment by an issuer to a company in which a member of the issuer's audit committee is a partner, member or principal shall not be deemed to constitute an indirect acceptance by that audit committee member of any compensatory fee where the relationship between the issuer and that other company constitutes an ordinary course commercial business relationship.

(3) Even if the requested clarification outlined in the preceding paragraph is included in the final rule, there are situations where its application will result in ambiguities. For instance, a commercial-banking relationship would normally, in our reading, constitute an ordinary-course commercial business relationship. In Germany, by way of example, it is customary for a representative of a long-term relationship bank to sit on the supervisory board and audit board (if any) of a client corporation. On occasion, these relationship banks will engage in investment-banking or financial-advisory work for these long-term clients in circumstances that do not fundamentally alter the commercial relationship between the company and the bank.

In our view, these long-term relationships are in the nature of the ordinary-course commercial relationships proposed by the Commission to be permitted. Not treating such bank representatives as "independent" for purposes of Rule 10A-3 would have the unintended effect of requiring companies to hire banks other than their relationship banks for certain services if the relationship bank is to continue to have a representative on the supervisory board and audit committee.

Thus, to avoid ambiguity, and to avoid unintended changes to market practice in jurisdictions outside the United States that could arise by application of an ambiguous rule, we respectfully request that the Commission clarify, in either general instructions to or in the adopting release for Rule 10A-3, that ordinary course commercial business relationships include, for these purposes, long term relationships with commercial banks, even if those relationships also include on occasion the ancillary providing of investment banking or financial advisory services.

D. The Accommodation for Controlling Shareholders Should Allow for Voting Rights In the Case of Two-Tier Boards.

Proposed Rule 10A-3 is intended to guarantee the audit committee's independence from management to enable the audit committee to provide "independent review and oversight of a company's financial reporting processes, internal controls and independent auditors".5 In recognition of the fact that foreign corporate governance arrangements differ significantly from general practices among U.S. corporations, the Commission proposed certain accommodations to the audit committee requirements for foreign private issuers. In particular, Proposed Rule 10A-3 would allow one member of the audit committee to be a shareholder, or a representative of a shareholder or group, owning more than 50% of the voting securities of the foreign private issuer; however, the rule proposal provides that the member could only sit on the audit committee as an observer with no voting rights.

The balance the Commission has struck between ensuring independence and accommodating home country corporate governance structures has, without respect to two-tier boards, failed to take account of the fact that in some jurisdictions those governance structures already ensure the independence of the management and oversight of a company from its controlling shareholders. For example, Section 311 of the German Corporations Act prohibits a controlling company from acting to the disadvantage of its subsidiaries. Management of the controlling company are personally liable to the controlled company and its shareholders for damages arising from any breach of this duty6, and controlled companies are required to prepare an annual report describing their relationships to their shareholders in which the chief executive officer must certify as to the absence of actions that are detrimental to the Company7,8. Likewise, under the German Corporations Act, management decisions generally cannot be made by the supervisory board.9 Furthermore, although it is not explicit in the statute, all leading legal commentators that address the issue state that a supervisory board member who cannot reconcile a conflict between the controlling shareholder that he represents and the company in question would need to resolve the conflict in a way that does not disfavor of the company, with many commentators arguing for resignation or self-recusal from voting and others speaking of the need to resolve the conflict in favor of the company.10

We believe that shareholder representatives on audit committees should not be deprived of their right to vote when their independence is mandated by law. Accordingly, we would propose modifying the exception contained in Rule 10A-3(b)(1)(iv)(D) to provide for the following amended condition in sub-clause (2) thereof:

(2) Except where the member or designee thereof is prohibited by law in its jurisdiction of organization or under listing rules to which it is subject from putting the interests of the member above the interests of the foreign private issuer, the member has only observer status on, and is not a voting member or the chair of, the audit committee.

* * *

We would be pleased to respond to any inquiries regarding this letter or our views on the Proposing Release generally. Please feel free to contact any of Edward Fleischman, Bill Hobbs or Peter Ruhlin in New York at 212-424-9000, Raymond Fisher in Frankfurt at +49 69 7100 3186 or Brigid Rentoul, Jason Manketo, Cecil Quillen, Jennifer Schneck, Steve Thierbach or Larry Vranka in London at +44 20 7456 2000.

Very truly yours


1 Standards Relating to Listed Company Audit Committees, Exchange Act Release No. 34-47137, 68 Red. Reg. 2688, 2647 (2003) (the "Proposing Release").
2 The Instructions to new Item 16A of Form 20-F similarly specify that the non-management, or supervisory, board should make this determination.
3 Proposing Release at 2648.
4 Proposing Release at 2641.
5 Proposing Release at 2638.
6 German Corporations Act, Sections 317 and 318.
7 German Corporations Act, Section 312(3).
8 German law provides for an exemption from this principle if the controlling company and the controlled company enter into a control agreement in accordance with statutory requirements. These requirements include supermajority approval by the shareholders of both companies, publication of notice of and public filing of the agreement and payment of compensation to non-controlling shareholders. See Section 291 et seq. of the German Corporations Act. Our proposed modification of clause (b)(1)(iv)(D) of Section 10A-3 below is intended to retain the prohibition on voting by representatives of these controlling companies.
9 German Corporations Act, Section 111(4).
10 See, e.g., Uwe Hüffer, Aktiengesetz (C.H. Beck, 2002), Section 116, paragraph 5; see also Kölner Kommentar zum Aktiengesetz (Carl Heymanns, 1996), Volume 2, Section 116, paragraph 23; Münchener Handbuch des Gesellschaftsrechts (C.H. Beck, 1999), Volume 4, Section 33, paragraph 7; Thomas Heidel, Aktienrecht (Deutscher Anwalt Verlag, 2003), Section 116, paragraph 4; Johannes Semler, Arbeitshandbuch für Aufsichtsratsmitglieder (C.H. Beck, 1999), paragraphs A178 - A182; Günter Henn, Handbuch des Aktienrechts (C.F. Müller, 2002), Section 19, paragraph 681; Peter Ulmer, "Aufsichtsratsmandat und Interessenkollision", Neue Juristische Wochenschrift 1980, Volume 30, pages 1603-1607.