Sarah A. Miller
Center for Securities, Trust
and Investments

February 21, 2003

Jonathan G. Katz


Securities and Exchange Commission

450 Fifth Street, N.W.

Washington, D.C. 20549-0609

Re: Standards Relating to Listed Company Audit Committees, File No. S7-02-03, 68 Federal Register 2638 (January 17, 2003).

Dear Mr. Katz:

The American Bankers Association ("ABA") welcomes the opportunity to offer its views on proposed Rule 10A-3, implementing the requirements of Section 10A(m)(1) of the Securities Exchange Act of 1934, as added by Section 301 of the Sarbanes-Oxley Act of 2002 ("the Act"). That Section of the Act directs the Securities and Exchange Commission ("Commission") to adopt a rule directing the national securities exchanges and national securities associations (hereinafter collectively referred to as "exchanges") to prohibit the listing of any security of any issuer that does not meet certain audit committee requirements, including the requirement that each member of the audit committee be independent.

Specifically, proposed Rule 10A-3 requires exchange rules to prohibit the listing of any security of an issuer that is not in compliance with the following audit committee requirements:

  • Each member of the audit committee must be a member of the board of directors of the listed issuer, and must otherwise be independent;

  • The audit committee is to be directly responsible for the appointment, compensation, retention and oversight of the work of any registered public accounting firm engaged (including resolution of disagreements between management and the auditor regarding financial reporting) for the purpose of preparing or issuing an audit report or related work or performing other audit, review or attest services for the listed issuer, and each such registered public accounting firm must report directly to the audit committee;

  • Each audit committee is to establish procedures for the receipt, retention and treatment of complaints regarding accounting, internal accounting controls or auditing matters, including procedures for the confidential, anonymous submission by employees of the issuer of concerns regarding questionable accounting or auditing matters;

  • Each audit committee is to have the authority to engage independent counsel and other advisors, as it determines necessary to carry out its duties, and

  • Each issuer is to provide appropriate funding for the audit committee.

Proposed Rule 10A-3 is of great interest to the ABA and its members. The ABA brings together all categories of banking institutions to best represent the interests of this rapidly changing industry. Its membership-which includes community, regional and money center banks and holding companies, as well as savings associations, trust companies and savings banks-makes ABA the largest banking trade association in the country. Many of our larger members are listed on one of the exchanges and, thus, are directly impacted by this proposal. Publicly traded banks and bank holding companies not listed on any of the exchanges are also very interested in certain aspects of the Commission's proposal as they must disclose in their annual proxy statements whether their audit committee members meet certain exchange listing requirements regarding audit committee independence. Finally, banks and bank holding companies that are not publicly traded are also interested in the Commission's proposal as federal banking laws require banks with assets in excess of $500 million and strongly encourage banks with assets under $500 million to establish independent audit committees.1 To the extent the Commission and the exchanges' rules collectively redefine independence as it relates to audit committee membership, all non-publicly traded banks and bank holding companies will likely be impacted.


Audit Committee Independence

In order to be considered independent for purposes of membership on an issuer audit committee, the member must satisfy two criteria. First, he or she may not, other than in his or her capacity as a member of the audit committee, accept directly or indirectly any consulting, advisory, or other compensatory fee from the issuer. Second, the member must not be an affiliated person of the issuer or any subsidiary of the issuer.

Ordinary course of business transactions

With respect to the first criterion, proposed Rule 10A-3 makes clear that the prohibition on receiving indirect compensation would preclude issuer payments to spouses, minor children or stepchildren or children or stepchildren sharing a home with a member. The narrative portion of the release also provides that payments made to an entity in which an audit committee 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 would impair an audit committee's independence. However, payments made in the ordinary course of commercial business relationships between an issuer and an entity with which the audit committee member had a relationship would not.

As a general matter, the ABA believes that proposed Rule 10A-3 fairly comports with the independence requirements outlined by the Congress in Section 301. Further, we strongly endorse the Commission's statement that payments made in the ordinary course of commercial business do not impair a director's independence. We assume, however, that there is no discernible difference between the "ordinary course of commercial business" standard articulated in the proposing release and the very similar "ordinary course of business" standard provided in Item 404 of Regulation S-K and the "substantially similar" standard outlined under federal banking regulations requiring credit extensions made to directors and their affiliates to be on substantially the same terms and conditions as comparable credit extensions made to comparable borrowers on an arm's-length basis.2 It is imperative that banks be permitted to make loans on a non-preferential basis to directors and their affiliated firms.

Consulting, advisory, or other compensatory fee

We are concerned about the broad and somewhat imprecise terms used to explain what types of payments to directors are prohibited. Specifically, the statute provides that "consulting, advisory, or other compensatory fee" payments would impair an audit committee member's independence. The narrative portion of the release explains that the prohibition includes "accounting, legal, investment banking, financial or other advisory services or any similar services" provided to the issuer. We assume that if advice, financial or otherwise, were offered as an adjunct or incidental to a non-advisory ordinary course of business transaction between the issuer and the audit committee member or his company that the member's independence would not be impaired. For example, an audit committee member's firm may be hired to tow cars used as collateral for loans when the loans go into default. If the car towing company were to suggest to the bank that it have certain makes and models towed first on the basis of the vehicle's resale value, we would assume that because the advice is only incidental to the ordinary course business transaction that the member's independence would not be impaired.

Finally, we are unsure of the meaning of the term "any other similar services" and believe that it may raise more questions than it answers. For that reason, we would suggest eliminating the term from the discussion of what consulting, advisory and other compensatory fees impair an audit committee member's independence.

Compensation paid to certain family members is viewed as indirect compensatory fees that would impair an audit committee member's independence. We would endorse, as the Commission has suggested, narrowing the prohibition to permit non-executive family members to be employed by the issuer.3 This would permit a director to continue serving on the audit committee even though his or her spouse or child is employed as a teller, non-executive loan officer at a subsidiary bank, or a registered representative at an affiliated broker-dealer.

We also believe that clarification is needed to ensure that prohibited compensation does not include payments from retirement and other employee benefit plans made to former officers and employees. Directors that meet general exchange listing standards for independence, i.e., they have been separated from service for greater than three years, should not be precluded from serving on the audit committee simply because they receive payments from various retirement and other employee benefit plans established by the issuer for its employees. The directors' employment ties with the issuer have long been severed and sufficient time has passed to ensure that the directors' independence is not impaired. In addition, we would suggest that both director and shareholder interests are aligned as both have an interest in ensuring the continued profitability of the company to make dividend payments as well as retirement and deferred compensation plan payments.4

We also believe that the term "compensation" should not preclude current directors from receiving, as part of their compensation for services rendered as a director, payments from various deferred compensation plans. Again, shareholder and director interests are aligned in ensuring the continuing profitability of the issuer.

Finally, we would support an exception from the prohibition on compensation for a de minimis amount of payments. A de minimis exception would be particularly helpful to the banking industry as it would protect banking organizations from being delisted as a result of an inadvertent and unintended transfer of money between the banking organization and the director. A de minimis exception would also require issuers to trigger the exchanges' cure procedures on a less frequent basis-a collateral benefit to both issuers and the exchanges alike. Finally, a de minimis amount would be particularly helpful if the Commission determined not to limit the payment of indirect compensation to family members employed at the executive level. We do not favor bright lines regarding the amount of compensation permitted under a de minimis exception; rather we would prefer a materiality standard.

Affiliated person

For an audit committee member to maintain his or her independence, he or she may not be an affiliated person of the issuer or any subsidiary of the issuer. The Commission has provided an exemption from this requirement for audit committee members that sit on the board of directors of both a listed issuer and its direct or indirect consolidated majority-owned subsidiary, if the committee members otherwise meet the independence requirements for both the parent and the subsidiary, including the receipt of only ordinary course compensation for serving as a member of the board of directors, audit committee or any other board committee of the parent or subsidiary. This exemption is of particular importance to the banking industry. Many bank directors also serve as directors of the holding company and vice versa. This exemption will allow these type of arrangements to continue so long as the audit committee member otherwise meets all the requirements for independence as specified under the proposed rule. Moreover, as discussed below, bank directors must also satisfy director independence requirements separately mandated by federal banking regulations. This exemption is consequently most appropriate for audit committee directors that serve at both the holding company and bank level.

A somewhat related question is whether an issuer holding company can use the audit committee members of its subsidiary banks without the bank audit committee members themselves being holding company directors and still satisfy the listing requirements that will be promulgated in accordance with proposed Rule 10A-3. Specifically, many banks have independent audit committees as required under the Federal Deposit Insurance Act. Section 36 of that Act and the Part 363 implementing regulations require bank audit committees to be composed entirely of independent directors. In addition, banks with assets over $3 billion are required to have audit committee members with banking or related financial management expertise; are required to give audit committee members access to their own outside counsel, and are precluded from having any large customers of the bank sit on the bank's audit committee. Other duties and responsibilities of bank audit committees are also specified.5 It is not uncommon for some of our members that are not listed on the NYSE or the NASDAQ to use the services of the bank audit committee at the holding company level. Because proposed Rule 10A-3 specifies that each audit committee member must be a member of the board of directors of the listed issuer, we question whether this practice would still be permissible.

Finally, we question the utility of the safe harbor from the definition of affiliated person.6 We note that the terms "affiliate of" and "affiliated" are defined for purposes of Rule 10A-3, a rule dealing with, among other things, audit committee director independence. In order to use the rule's safe harbor exception from the definition of affiliate, an individual cannot be a director. Yet, a prerequisite to triggering the inquiry as to whether the safe harbor can be employed in the first place is that the individual must be a director. A circular result, it would seem.

Other independence issues

In response to several questions the Commission has posed, we have the following thoughts:

  • The full Board should make the determination as to whether an audit committee member is independent. Disclosure of the Board's determination could be added to existing proxy statement disclosures regarding audit committee independence.

  • No "look back" on independence requirements should be required. It should be sufficient that the issuer's current relationships with the audit committee member and his or her affiliates meet the independence requirements specified in Section 301, proposed Rule 10A-3 and whatever implementing exchange listing standards are put in place. Banking regulations promulgated by the Federal Deposit Insurance Corporation require a one year "look back" for all bank audit committee directors. Consequently, if a director has been an officer or employee of the bank or any affiliate within the preceding year or, alternatively, owned or controlled 10% or more of the outstanding voting stock of the bank within the last year, that director will not be considered independent for purposes of audit committee membership. Banks have a difficult enough time attracting qualified directors to sit on their boards. A "look back" requirement on audit committee independence extended to an issuer parent would only further exacerbate the problem.

  • There should not be any additional criteria for audit committee member independence over and above those specified in Section 301. A prohibition on any transactions or relationships between the issuer and an audit committee member or an affiliate of the audit committee member would preclude banks and their holding companies from engaging in ordinary course of business transactions with their directors. As we discuss above, we believe ordinary course of business transactions conducted on a non-preferential basis between banking organizations and their directors would be permissible under the current proposal. If, however, such a prohibition were adopted, our members would be put in the untenable position of being unable to serve the basic banking needs of their directors and forcing company directors to seek banking services from competitors.


Proposed Rule 10A-3 reiterates the requirements of Section 301 by requiring each audit committee to establish procedures for the receipt, retention, and treatment of complaints received by the issuer regarding accounting, internal accounting controls, or auditing matters; and the confidential, anonymous submission by employees of the issuer of concerns regarding questionable accounting or auditing matters. The Commission has not mandated specific procedures for compliance, a position the ABA strongly endorses. A one-size-fits-all approach is not desirable given the wide disparity of banking institutions impacted by the proposal. It is our experience that detailed regulations drafted with large, complex, geographically dispersed banking organizations in mind do not work well for small, publicly-owned banks operating within a few contiguous counties and vice versa.


In conclusion, the ABA appreciates the opportunity to comment on the Commission's proposed rule directing the exchanges to promulgate listing standards addressing, among other things, the composition, roles and responsibilities of audit committees. Should you wish to discuss these matters further, please do not hesitate to contact the undersigned.

Sincerely yours,

Sarah A. Miller

cc: Jeff Minton

1 See 12 CFR Part 363, implementing Section 36 of the Federal Deposit Insurance Act, 12 U.S.C. Section 1831m.
2 Further, Regulation O requires interest rates, collateral requirements, credit underwriting standards and repayment terms to be no more favorable for insider borrowers than those prevailing for comparable transactions with non-insider borrowers. 12 CFR 215.4.
3 "Executive Officer" would be defined by reference to Rule 3b-7, 15 CFR 240.3b-7, which defines the term to mean the registrant's president, any vice president of the registrant in charge of a principal business unit, division or function (such as sales, administration, or finance), any other officer who performs a policy making function or any other person who performs similar policy making functions for the registrant.
4 Director and shareholder interest would be even further aligned if the director received payments from an employee benefit plan invested in securities of the issuer company, e.g., 401(k) defined contribution plans.
5 See 12 CFR 363.0 et seq.
6 We understand fully that persons ineligible to rely on the safe harbor could still be deemed not to be an affiliated person by virtue of a facts and circumstances analysis.