Equity Office Properties Trust
February 27, 2003
Via e-mail - firstname.lastname@example.org
Jonathan G. Katz
Re: Standards Relating to Listed Company Audit Committees -
Dear Mr. Katz:
We are pleased to submit this letter to the Securities and Exchange Commission (the "Commission") in response to the Commission's request for comments on its proposed rules implementing standards relating to listed company audit committees, as contained in Release Nos. 33-8173, 34-47137 and IC-25885 (the "Proposing Release"). We are writing to respectfully request that the Commission consider modifying an aspect of the proposed audit committee independence requirement that we believe will directly and materially decrease the number of board members of real estate investment trusts ("REITs") organized as umbrella partnership REITs ("UPREITs") that are eligible for service on audit committees.
What is an UPREIT?
In the typical UPREIT structure, substantially all of the REIT's direct assets consist of partnership interests in a limited partnership (the "Operating Partnership"), of which the REIT is the general partner. The REIT conducts substantially all of its operations, and owns all of its properties, through the Operating Partnership. Currently, approximately 50% of publicly traded REITs are organized as UPREITs.1 The UPREIT structure is commonly used because it provides significant advantages in terms of property acquisitions and growth strategy for REITs. Specifically, in the UPREIT structure, a property can be acquired by the Operating Partnership through a tax-deferred contribution of the property to the Operating Partnership in exchange for partnership interests in the Operating Partnership. Under the applicable federal income tax laws, a property owner that contributes property to a partnership, such as an Operating Partnership, in exchange for partnership interests generally does not recognize the taxable gain with respect to the property at the time of the contribution. By contrast, a contribution or a sale directly to the REIT would result in the immediate recognition of gain by the contributor/seller for federal income tax purposes.
In connection with property acquisitions by an Operating Partnership, it is typical that contributors of significant portfolios of real estate assets acquire representation on the board of directors of the UPREIT. For this reason, it is common among REITs organized as UPREITs that a significant number of the board members are limited partners in the related Operating Partnership. In the case of Equity Office Properties Trust, seven of the 15 members of our board of trustees are limited partners in EOP Operating Limited Partnership, which is Equity Office's Operating Partnership.
Typically, the REIT is the sole general partner of its Operating Partnership and, accordingly, limited partners in Operating Partnerships generally have no involvement in, or authority to direct, the operation or management of the Operating Partnership. The limited partners generally have only limited consent rights with respect to major transactions to be effected by the Operating Partnership, such as certain business combination transactions. Thus, limited partners in Operating Partnerships typically have no unique or special management rights that would provide them with indicia of control.
In the Proposing Release, proposed Rule 10A-3(b)(1)(i) would require that each member of the audit committee of a listed issuer be independent. Proposed Rule 10A-3(b)(1)(ii)(B) would prohibit any member of the audit committee from being "an affiliated person of the issuer or any subsidiary thereof." Proposed Rule 10A-3(e)(1)(ii) then specifically states that a "partner" of an affiliate will be deemed to be an affiliate. By virtue of the foregoing, each director of an UPREIT that owns limited partnership interests of the related Operating Partnership would not be independent. In our view, this will have the undesirable effect of precluding a significant number of board members from service on the audit committees of UPREITs. We also note that we are not aware of any previous instance in which the Commission has taken the position that a limited partner (as opposed to a general partner) would be deemed an affiliate absent ownership of a significant equity interest in the partnership.
A simple and modest modification to the definition of "affiliate" under proposed Rule 10A-3(e)(1)(ii) would permit UPREIT board members who are also holders of limited partner interests of the related Operating Partnership to qualify as independent. The proposed language would be as follows (additional language underlined):
. . .
The proposed language would cause each general partner of an affiliate of an issuer to be an affiliate of the issuer. However, under the proposed language, each limited partner of an affiliate of an issuer would only be an affiliate of the issuer if it owned more than 10% of the limited partnership interests of the affiliate. Under the proposed language, similar results would occur with respect to LLC members (based on the distinction between managing members and non-managing members).
We note that the proposed language closely corresponds to the measure of equity ownership of the issuer used to determine whether a person is an affiliate of the issuer under proposed Rule 10A-3(e)(1)(i)(A).
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We appreciate this opportunity to comment on the Commission's proposal, and would be happy to discuss any questions the Commission or its Staff may have with respect to this letter. Any such questions may be directed to the undersigned at (312) 466-3362.