February 18, 2003
Mr. Jonathan G. Katz
Dear Mr. Katz:
This letter relates to the proposed adoption by the Securities and Exchange Commission of rules under Section 301 of the Sarbanes-Oxley Act of 2002. We are providing these comments because of our concern that proposed rule 10A-3 (the "Rule") may make it impossible for many companies that come to market for the first time, that emerge from bankruptcy, that are spin-offs which remain as significantly owned subsidiaries or that are otherwise similarly situated, to comply with the Rule's independence requirements.
Paragraph (b)(1)(i) of the Rule provides that each member of the audit committee must be a member of the board of directors of the listed issuer, and must otherwise be independent. Paragraph (b)(1)(ii)(B) of the Rule generally provides that members of audit committees of listed issuers must not be "affiliated" with the issuer. Paragraph (e)(1)(i)(A) of the Rule provides that 10% holder(s) who may be deemed to control the issuer ("10% Holder(s)") are affiliates. Paragraph (e)(1)(ii) of the Rule provides that a director, executive officer, partner, member, principal or designee of an affiliate will be deemed to be an affiliate. As explained in footnote 21 of Release Nos. 33-8177; 34-47235, these concepts would also apply for purposes of determining "independence" of audit committee financial experts for listed and unlisted companies.
Because all directors of the companies described above may be deemed to have been selected by 10% Holder(s), or by directors who were their designees, the Rule appears to preclude these companies from meeting the Rule's requirements or concluding that any of it's directors are an "independent" audit committee financial expert.
The Rule seems to try to avoid these harsh consequences by providing (x) that a director will not be deemed an affiliated person of the issuer solely by reason of being a director (paragraph (b)(1)(ii) of the Rule), (y) a 90 day exemption from the independence requirements for one member of the audit committee (paragraph (b)(1)(iv)(A) of the Rule), and (z) that otherwise independent directors of a listed issuer and its majority owned subsidiary will not be deemed afflicted persons solely by reasons of being directors of both (paragraph (b)(1)(iv)(B) of the Rule).
But the provisos do not adequately address the broad range of issues introduced by including the word "designee" in the definition of an "affiliate". Directors who have been designated by 10% Holder(s) are affiliated persons* under the Rule both because they are directors (which alone does not disqualify independence) and because they were designated by 10% Holder(s) (which alone does disqualify independence). Further, since the Rule deems any persons these directors designate as directors to be affiliates, the Rule does not allow any means for these directors to subsequently designate other directors who meet the independence standard.
The inclusion of "designee" of an affiliate within the definition of an "affiliate" is an expansion of the affiliate concept beyond its traditional meaning and beyond similar state law concepts. We respectfully suggest that "designee" be deleted from the Rule's definition of "affiliate".
Thank you for considering these comments.