January 30, 2003
Via e-mail - email@example.com
Securities and Exchange Commission
Re: File No. S7-02-03
Ladies and Gentlemen:
We are submitting this letter in response to the request for comments of the Securities and Exchange Commission ("SEC") in the above described proceeding regarding implementation of Section 301 of the Sarbanes-Oxley Act of 2002 (the "Act"). Our comments pertaining to the prohibition of listing securities of issuers that are not in compliance with the audit committee requirements established by the Act. In general, we are supportive of the proposed rules. We write to suggest that the SEC consider a slight modification to one of the exceptions described in subsection (c)(1) of proposed rule 10A-3 (the "Proposed Rule") to accommodate unconsolidated joint ventures. We believe that this modification is consistent with the general purpose of the Act and the Proposed Rule.
We concur with the SEC that it is not necessary or appropriate for the protection of investors to impose the independent director and other audit committee requirements on private subsidiaries of issuers that have complying audit committees, and the (c)(1) exceptions demonstrate that the SEC accepts the need to provide relief for these entities. As proposed, an exception from the listing prohibition would be allowed for most traditional debt securities of consolidated majority-owned subsidiaries of listed issuers that have complying audit committees.
We are jointly owned by two unaffiliated public companies that equally control us. Accordingly, neither consolidates our results with their financial statements, and the proposed exception would not work for us.
While the exemption accommodates issuers that are majority-owned and whose financial statements are consolidated with those of their parents, it would not provide an exemption from the listing prohibition for jointly-controlled companies in a joint venture because consolidation is not required or appropriate for such entities. We suggest therefore that consolidation not be a requirement for the exemption in the case of a subsidiary or joint venture without any public stockholders (but having listed debt) where one or more of its parents has a complying audit committee.
We note that, as a practical matter, private joint ventures simply will not add independent directors, the most financially burdensome and operationally cumbersome effect of imposition of Section 301 of the Act and the Proposed Rules on private companies. While independent directors impose good discipline, it is unrealistic to think that parent companies, who themselves have independent directors, will want to cede any measure of control or add to the cost and bureaucracy of an additional layer of governance over what they rightfully regard as a private sub-set of their operations that they share with another enterprise. This being the practical reality, it is likely that the narrow exception will have the effect only of prohibiting some issuers from taking advantage of the benefits of listing - pre-emption of blue sky registrations under the National Securities Markets Improvement Act of 1996, greater trading liquidity, etc. While the approach appears designed to assist investors by encouraging issuers to add independent directors through the denial of listing benefits, ironically, the result will be the opposite for holders of joint venture debt securities. These investors will be denied the potential economic benefits of having the debt they hold listed on a national stock exchange. For joint ventures that have listed debt, holders of that listed debt will face loss of transparency and liquidity of their investments, because those issuers will in all likelihood de-list if the proposed rule is adopted.
Secondly, the SEC's Proposed Rules will require issuers to disclose whether they are taking advantage of an exception and discuss the characteristics of their audit committees, so investors will be fully informed. Therefore, there will be no mistaken assumption that the issuer of an exchange-listed security has independent directors on its board by virtue of its listing.
Thirdly, many ventures today are taking advantage of more modern and flexible forms of organization, such as limited liability company structures, under state law. Under such laws, these entities may elect to be governed by managers, not traditional boards of directors. Typically, the venture parents will jointly manage the venture through a committee, which has few of the characteristics of a corporate board of directors because there are no public shareholders and the purpose of the management committee is to create a structure where management decisions of the two venture partners can be coordinated. Such a structure clearly does not lend itself to the framework presupposed by the Proposed Rule, with the adverse result that debt of that entity could never be listed. We do not believe this result was contemplated, nor is necessary to protect an entity's debt investors or the market.
Fourthly, even where an entity is majority- or jointly-owned by one or more parent entities, those entities will reflect in their financial statements the financial assets and results of operations of the venture, whether by full consolidation in the case of controlling ownership or equity accounting in the case of joint-control. Accordingly, the audit committees of the parents bear responsibility for the entire scope and detail of the financial statements of the parents, which include the impacts of the venture's operations and assets. If the audit committees of the parents comply with the mandates of the Proposed Rule, the benefits will flow through to the venture and its debt investors. There is nothing particular about being subject to consolidation rules that will bring a greater assurance to these investors or the market than the fact that parent audit committee oversight is involved in the venture's financial reporting process.
Finally, exempting entities with no public shareholders from independent director requirements is consistent with the paradigm of state corporation law. Directorships are creations of state corporation laws, and directors are charged with duties to manage the enterprise, with rigorous fiduciary duties to shareholders who elect them. They do not, except in extremely limited circumstances (e.g., insolvency) have duties to debt holders. Therefore, federal law imposing (indirectly, through a listing standard) independent director requirements on entities that have no public shareholders to whom they are responsible seems intrinsically inappropriate.
We note, by analogy, that Rule 3a-5 under the Investment Company Act of 1940, which exempts qualifying finance company subsidiaries, specifically contemplates the possibility that a joint venture owned by multiple parents could utilize the Rule to issue debt or non-convertible preferred stock. We believe such an entity should similarly be permitted to list that debt as long as one or more of its parents has a qualifying audit committee. Also, we note that the FASB has just issued its interpretation on consolidation of variable interest entities, changing the consolidation rules for many entities from a control-based test to a risk-based test. This disconnect of consolidation from control appears to us to be a further noteworthy precedent for not including consolidation as one of the conditions of the exemption.
Therefore, we urge the SEC to modify slightly the exception to the independent director requirement as we have proposed to permit the listing of debt securities of private joint ventures where at least one of their parent entities is governed by a board of directors with an audit committee that complies with the Proposed Rules.