February 18, 2003
Mr. Jonathan G. Katz
Comments on Proposed Rules Implementing Section 301 of the Sarbanes-Oxley Act of 2002 (Release Nos. 33-8173; 34-47137; IC-25885)
File No. S7-02-03
We are pleased to submit this letter on behalf of France Telecom, a société anonyme organized under the laws of France in response to the request of the Securities and Exchange Commission (the "Commission") for comments on the proposed Rule 10A-3 on Listing Standards Relating To Audit Committees, under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The proposed Rule 10A-3 would implement Section 10A(m)(1) of the Exchange Act, as added by Section 301 of the Sarbanes-Oxley Act of 2002 (P.L. 107-204, sec. 3, 116 Stat. 745).
The proposed Rule 10A-3 has the stated aim of making the audit committee more effective in protecting shareholder interests and in particular addressing the risk that management self-interest may diverge from shareholder interest. We note that the Commission has taken particular care to identify legal and practical difficulties that foreign listed issuers may have implementing the proposed Rule 10A-3, and has attempted to accommodate foreign listed issuers in several instances. France Telecom strongly supports the Commission's efforts in this respect and appreciates this opportunity to comment on certain issues raised by the proposed Rule.
Our comments are addressed to paragraph (b)(1)(iv)(E) of proposed Rule 10A-3, which would provide foreign private issuers with an exemption from specified audit committee independence requirements, and to paragraph (b)(2) of proposed Rule 10A-3, which would require that a listed issuer's audit committee be responsible for the appointment and retention of its registered public accounting firm subject to the qualifications set out at Instruction 1 to the proposed Rule.
1. The final Rule should maintain the exemption allowing foreign government representatives to serve on the listed issuer's audit committee.
Proposed Rule 10A-3 seeks to ensure the independence of a listed issuer's audit committee by restricting membership to persons deemed independent from that listed issuer's management. The proposed Rule 10A-3 contains several exceptions that recognize that this goal may be met while including persons not otherwise meeting the Rule's technical definition of "independence", notably paragraph (b)(1)(iv)(E) which allows a representative of a foreign government or foreign governmental entity to sit on the audit committee of a foreign private issuer notwithstanding that foreign government or foreign governmental entity's "affiliate" status.
We believe that such an exception is crucial to the ability of many foreign private issuers, including France Telecom, to maintain the listing or quotation of their securities in the United States. Outside the United States, it is common for governments or governmental entities to maintain interests in publicly traded companies, whether as a result of privatization initiatives or for other reasons. In the specific case of France Telecom, French Law No. 96-660 of July 26, 1996 requires that a substantial plurality of France Telecom's directors be named by State Decree. France Telecom is not an isolated example. Many other foreign private issuers in France and elsewhere have substantial government representation on their Boards of Directors or equivalent governing bodies. Representation of the foreign government on the foreign private issuer's audit committee is a vital part of the foreign government's ability to ensure that companies in which it holds an interest are being run in the public interest and not in the private interest of management. This goal is both of elemental importance to the foreign government and consistent with what we understand to be the overarching objectives of the proposed Rule 10A-3.
We note that, according to the proposing release, the prohibitions found in proposed Rule 10A-3 on audit committee membership by affiliates or their representatives presume that an affiliate will not properly manage "conflicts of interests [between the issuer and] management" and will not be "objective when evaluating financial disclosure and internal controls." We do not feel that it is appropriate to make such presumption with respect to the representatives of a foreign government or foreign governmental entity. As a result, we strongly support the exception proposed by the Commission. We do question, however, whether this exception is overly restrictive as proposed, insofar as it is available to only one member of the audit committee.
2. The final Rule should provide a clear exemption to allow auditors to be appointed and retained in accordance with the home country law of a foreign listed issuer.
Proposed Rule 10A-3 would invest the audit committee of a French listed issuer's Board of Directors or Supervisory Board with sole authority for the appointment and retention of that listed issuer's registered public accounting firm. As explained below, this requirement would conflict both with specific provisions of French law applicable to France Telecom in particular and to requirements of French law applicable to French corporations in general.
Legal regime specific to France Telecom
The corporate governance of France Telecom, including the appointment and retention of its auditors, is subject to a specific legal regime. In this connection, we note that French Law No. 96-660 of July 26, 1996 provides that the auditors of France Telecom be named by State Decree. The audit committee of France Telecom's Board of Directors has no legal authority to take any action in this respect.
Legal regime applicable to French corporations generally
In addition to the specific legal situation of France Telecom, we would like to remind you of the difficulty that proposed Rule 10A-3 poses for French corporations generally, because of mandatory French procedures for the appointment and retention of auditors and the limited authority of a committee of a Board of Directors or Supervisory Board.
French law generally provides that a corporation's shareholders appoint its auditors at an ordinary general shareholders meeting. The French corporation's Board of Directors or Supervisory Board may present reports or recommendations to the shareholders at this meeting, including recommendations as to the choice of auditors. However, the audit committee of a French corporation may not substitute itself for the shareholders in the appointment of the auditors, nor may it substitute itself for the Board of Directors or Supervisory Board in their presentation of reports or recommendations to the shareholders. The audit committee's permissible role under French law is limited to issuing recommendations to either the Board of Directors or the Supervisory Board.
French law generally provides that the auditors of a French corporation may be removed prior to the expiration of the legal term of appointment (six fiscal years), but only through defined legal procedures in which the audit committee has no standing. Here again, the audit committee's permissible role under French law is limited to issuing recommendations to either the Board of Directors or the Supervisory Board.
Proposed Instruction 1 does not provide an adequate exemption
Instruction 1 to proposed Rule 10A-3 appears to recognize that the requirements of paragraph (b)(2) may conflict with the controlling law of a foreign listed company, as is the case in France and elsewhere in Europe, and particularly in the case of France Telecom which is subject to a specific legal regime. However, the instruction attempts to redress this conflict by asserting that the conflict does not exist, or at least not for issuers the shareholders of which appoint the auditors.1 The instruction then goes on to impose an additional requirement which in fact creates further conflict with French law, by stating that the audit committee of the issuer is responsible for recommending or nominating the auditors to the shareholders. (As described above, the audit committee of a French corporation may only make such a recommendation to the Board of Directors or Supervisory Board.)
We recognize that the Commission's intent in proposed Instruction 1 was to accommodate foreign legal requirements relating to the appointment and retention of auditors. Our view, however, is that Instruction 1 does not operate to realize this intent. Moreover, in the specific case of France Telecom, because authority to appoint the company's auditors is invested by law in the French state and not the company's shareholders, Instruction 1 is not available to it.
An unintended but disturbing consequence of proposed Rule 10A-3 and its Instruction 1, as currently drafted, is that they do not appear to contemplate the continued listing of France Telecom's securities in the United States. By limiting the exemption to foreign listed issuers the shareholders of which appoint the auditors, the proposed Rule would create an arbitrary distinction among foreign issuers that are prohibited by foreign law from complying with proposed Rule 10A-3. Caught between foreign legal requirements and proposed Rule 10A-3, issuers that fell on the wrong side of this distinction would no longer be allowed to list or quote their securities in the United States, harming both those issuers and the U.S. investing public. Such a result does not appear justifiable, particularly in the case of France Telecom where the appointment of the auditors by State Decree seems no less effective a method of ensuring the auditors' independence from management than appointment by an audit committee or shareholders meeting. It would appear that general deference to the mandatory provisions of "home country"2 law applicable to a foreign listed issuer would be a more appropriate accommodation of foreign law.
Additionally, it is not clear to us why an exemption upon which the continued U.S. listing or quotation of all French corporate securities depends is relegated to an instruction, rather than incorporated directly into the proposed Rule itself. Even if the language of the instruction clearly established an exemption for French issuers generally and France Telecom in particular, which it currently does not, we believe that consignment of the exemption to an instruction raises unwarranted interpretive questions as to the intended hierarchy of legal norms. In this connection, we note that, elsewhere, the proposed Rule 10A-3 does provide an explicit exemption in the Rule itself from the application of paragraph (b)(2) where the listed issuer "has a board of auditors (or similar body) ... separate from the board of directors that are established and selected pursuant to home country legal or listing provisions....".3
We believe that it is important that the final Rule include an explicit exemption to the requirement that the listed issuer's registered public accounting firm be appointed and retained by the audit committee, making clear (i) that a foreign listed issuer's auditors are to be appointed by the persons or organs specified by mandatory provisions of its home country law and (ii) that where a foreign listed issuer's home country law subjects the removal of auditors to mandatory procedures, Rule 10A-3's only additional requirement for the audit committee in this regard is that the audit committee issue a recommendation to the Board of Directors or Supervisory Board to which it reports.
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We thank you for your attention to this matter. If you would like to discuss the issues raised in this letter, we invite you to contact either of the undersigned.