American Institute of Certified Public Accountants

February 18, 2003

Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington DC 20549-0609

Re: SEC File No. S7-02-03
Standards Relating to Listed Company Audit Committees

Members and Staff of the Commission:

The American Institute of Certified Public Accountants (the "AICPA") respectfully submits the following written comments on the Securities and Exchange Commission's (the "SEC" or the "Commission") proposed rules regarding standards relating to listed company audit committees (the "Proposal"). The AICPA is the largest professional association of certified public accountants in the United States, with more than 350,000 members in business, industry, public practice, government and education.

The AICPA acknowledges the enormous effort put forth by the members and staff of the Commission to implement the provisions of the Sarbanes-Oxley Act of 2002 (the "Act"). We are firmly committed to working with the Commission in accomplishing the timely and effective implementation of the Act and rebuilding the faith of investors who depend on accounting professionals for accurate, clear, timely and relevant financial information.

Questions regarding the proposed independence requirements:

  • Is additional clarification necessary regarding the consulting, advisory or other compensatory fee prohibition? For example, should we clarify whether "compensatory fees" would include compensation under a retirement or similar plan in which a former officer or employee of the issuer participates? Should there be an exception for a de minimis amount of payments? If so, what amount would be appropriate? How would such an exception be consistent with the purposes of the prohibition?

    We believe that an audit committee member should understand the intent of this rule with respect to consulting, advisory or other compensatory fees. We believe that compensation under a retirement or similar plan should not be included in this prohibition, which would allow a former employee to participate on the audit committee if they meet other requirements, including the cooling-off period of three years.

    With respect to retired or former employees of the company's audit firm serving on the audit committee, we propose a two-tier approach:

    1. If the retired or former employee of the audit firm was a member of the engagement team for the audit of the company, then the same rules should apply to audit committee service as apply to employment in the Commission's recently released rules on auditor independence, which has the effect of a one-year cooling-off period.

    2. If the retired or former employee of the audit firm had no involvement in the audit of the company, they should be permitted to serve on the audit committee with no cooling-off period. However, if the individual continues to receive retirement or other payments from the firm that are material to the individual's annual income, the person should (a) not influence the firm's operations or financial policies, or participate, or appear to participate, in any manner with the firm (e.g., as a consultant to the firm), and (b) recuse themselves from any deliberations or decision-making about non-audit services to be provided by the audit firm.

    We also believe there should be a de minimis exception to the prohibition about other compensatory fees (i.e., in addition to the fees paid for service on the audit committee), and this exception should permit fees not exceeding $20-25,000 per year. In recommending this amount, we considered that audit committee members, themselves having significant experience in areas that may be of interest to the company, should be able to spend a minimal number of days on a consultative basis outside their board duties, and should be fairly compensated for that time. For example, an audit committee member may have experience doing business in China, which may be an area of interest to management. Management should be free to engage the audit committee member for a few days of time for more in-depth discussion of the issue than might be possible with the full board. In fairness, the audit committee member should be compensated for that time, but should not be permitted to engage in a full scale consulting project with the company. Further, we believe the fee should be paid only in relation to a specific situation or need; it should not be an annual fee, nor a retainer paid to the audit committee member.

  • Is the proposed extension of the compensatory prohibition to spouses, minor children or stepchildren or children or stepchildren sharing a home with the member appropriate? Should it be expanded or narrowed? For example, should there be an exception for non-executive family members employed by the issuer? Is the extension to payments accepted by 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 appropriate? Should we extend the prohibition further, such as to ordinary course business relationships?

    The extension of the compensation prohibition to combat against indirect payments is entirely appropriate. However, we are concerned that naming individual relationships could be construed as limiting the prohibition to those named individuals. We believe a principles-based approach should be taken here, and we propose that the limitation apply to all members of the audit committee member's household, as well as others with a relationship to the audit committee member that could pose significant influence over the member.

    With respect to relationship in the ordinary course of business, we believe that an exception should be permitted if the terms of business given to the company are the same as terms for an arms-length deal between the service provider and any non-affiliated customer or client of the company. Any ordinary course business relationship involving organizations with which an audit committee member is affiliated should be disclosed annually in the proxy statement. Finally, we believe the Commission should specifically prohibit persons currently employed by the issuer's accountants and lawyers from participating on the board and audit committee of the issuer.

  • Is the proposed definition of "affiliated person" for non-investment companies appropriate? Is the proposed safe harbor from the definition of affiliated person appropriate? Should it include fewer or more persons? In responding to these questions, please keep in mind that, by its very nature, it would be difficult to create a safe harbor covering all individuals who are non-affiliates without inadvertently covering affiliates as well. The safe harbor would not create a presumption that those outside the safe harbor are affiliates. Rather, the safe harbor is designed to cover only those individuals whom we reasonably believe would not be affiliates. Is this assumption accurate? Can we reliably assume that people who own less than 10% of a company and are not officers or directors are not in control of the company? Should this threshold be higher (e.g., 20%) or lower (e.g., 5%)? Should the exclusion from the definition of affiliate include an express presumption that those persons not so excluded are affiliates, unless rebutted by a majority of independent directors?

    The issue of this safe harbor is a difficult one. It is not possible to create rules that will cover every circumstance at all issuers, and the arbitrary setting of percentages might not get the desired effect. We propose that the Commission's rules address the total wealth portfolio of the individual. For some, a 10% stake in the issuer could be all of their wealth, and we believe that would create a dependent affiliate that should not be permitted to serve on the audit committee. However, in another case, a 10% stake in the issuer might be a small percent of the person' total wealth, and therefore the risks associated with being an affiliated person are mitigated. We urge the Commission to create a rule based in principles, and allow the board of directors to interpret the rule within those principles in applying it to individuals being appointed to the audit committee. Further, since the Commission also states that it will not entertain exemptions or waivers for particular relationships, decision-making is put back on the full board to make the final determination of independence of its audit committee members. Finally, if the board were to permit an individual that has an immaterial affiliation with the company to serve on the audit committee, that fact should be disclosed in the annual proxy statement.

  • Should we rely exclusively on retaining a subjective test for determining affiliate status, given the varied contractual arrangements with a control feature entered into by issuers, particularly smaller companies? A person might employ specified thresholds to conceal a control relationship. Should a facts and circumstances test be retained in order to reflect the different ways a control relationship can be established with an issuer?

    As stated in our answer to the previous group of questions, we believe a subjective test (or principles-based methodology) is more appropriate when determining affiliate status of an issuer. Broad principles should be stated, and boards should be left to meet those principles in appointing members to the audit committee. Boards are and should be responsible to make the final determination based on facts and circumstances. Shareholders are able to review the relationships through disclosures and decide with their investment dollars whether their personal threshold for independence has been met. The Commission cannot be expected to anticipate all facts and circumstances. Boards of directors are better equipped to make the determination locally, and in doing so should keep the spirit and letter of the law at their top of mind.

  • Should the board of directors be required to determine whether an audit committee member is independent? Should the board be required to disclose this determination? If so, when? If the board should not make the determination, who should?

    The board of directors should make the determination that the audit committee is independent just as it would oversee compliance with all laws and regulation. The Board should annually indicate whether they are aware of anything that causes any member of the audit committee to lack independence.

  • The proposed independence requirements relate to current relationships with the audit committee member and related persons. Should the prohibition also extend to a "look back" period before the appointment of the member to the audit committee? If so, what period (e.g., three years or five years) would be appropriate? Should there be different look-back periods for different relationships or different parties? If so, which ones?

    In general, we are opposed to look back periods in determining an individual's suitability to serve on a corporate audit committee. We advocate that the Commission adopt a principles-based approach to audit committee qualifications, which includes a look back period as point of consideration, but not the key to the decision. The board is in the best position to weigh a variety of factors that could impact the suitability of a particular audit committee candidate. To mandate a look back period would further limit the pool of available and qualified candidates, and this limitation will be felt hardest by the smallest companies.

  • Should there be additional criteria for independence apart from the two proposed criteria? For example, in addition to the proposed prohibitions, should there be a prohibition on any transactions or relationships with the audit committee member or an affiliate of the audit committee member apart from the committee member's capacity as a member of the board and any board committee?

    We do not think it is necessary to create additional criteria for independence in addition to the requirements proposed. To do so will further limit the number of people qualified and willing to serve on audit committees, while it is unknown whether any additional rules will have any impact on the performance of audit committees.

  • Should additional relationships be exempted from the independence requirements at this time? If so, which relationships should be exempted, why should they be exempted, and how would such an exemption be consistent with maintaining the independence of the audit committee?

    We believe that every issuer will face circumstances at times that jeopardize the independence of its audit committee. Boards and audit committees should be able to cure such independence problems within a specified, reasonable time period such as six months, provided they disclose such non-compliance via Form 8-K. For example, suppose one member of a three person audit committee must resign from the board because of personal issues. The remaining board members in this example are either not qualified for audit committee service, or do not meet the independence requirements for a variety of reasons. One individual is qualified, but due to a look-back, will not be considered independent for another 5 months. The board is faced with two choices: (1) put an unqualified but independent person on the audit committee, or (2) recruit a new member to the board, that is qualified and independent for the audit committee. While the second choice is in compliance with the letter of the law, the board is faced with the long process of recruiting a new member, and is limited as far as skillset, to the kind of individual they can recruit. The first choice, while not meeting the letter of the law as it currently stands, may well be in the best interest of the company and its shareholders. However, if the Commission would permit one member of the audit committee to be exempted from the independence requirements for a period of time such as six months (similar to its current rule) then the most qualified person in this example could be appointed to the audit committee, that person's look back could be cured within the appropriate time frame, and the audit committee would perform at its maximum level during the period.

  • Is the proposed exemption for new public companies appropriate? Should more than one audit committee member be exempted from the requirements? Should a specific percentage of audit committee members be exempted? Should the exemption be conditioned on there being at least a majority of independent directors on the audit committee? Should the exemption period be longer (e.g., 1 year) or shorter (e.g., 30 days)? We are not proposing to apply this exemption to investment companies. Should this exemption apply to investment companies?

    We fully support the proposed exemption for new public companies. Further, we advocate that rather than specifying one member of the audit committee to be exempted, it would be better to specify a minority of members of the audit committee may be exempted for a new public company. This would retain the Commission's proposal of one member in the case of a three person audit committee, but permit more than one person to be exempted if the new public company includes five or more people on its audit committee, while still maintaining the voting influence of the majority. In addition, we would like to see the 90 day period extended, because we are concerned that 90 days is not enough time (especially for a smaller public company) to engage an individual to serve on its board and audit committee. We propose that this exemption be extended to six months or longer.

  • Is the proposed exemption for independent board members that sit on both a parent's and consolidated majority-owned subsidiary's board of directors appropriate? Is the requirement that the board member also is otherwise independent of the subsidiary necessary? Should the exemption be limited only to wholly owned subsidiaries or other specified level of ownership? Should the exemption be denied if the subsidiary maintains a listing for its own securities? Is there any need for a similar exemption from the "interested person" test for investment companies?

    We agree with the proposed exemption for an independent board member that sits on both a parent's and majority-owned subsidiary's board of directors, and with the requirement that the board members is also otherwise independent of the parent and the subsidiary.

    We would like to see boards go one step further and explicitly consider whether the board of the subsidiary should be identical to the board of the parent. The parent board should consider whether operations between the parent and subsidiary are aligned, whether they are both part of a larger strategy, or if they are not necessarily aligned and not sharing the same strategy. Depending on the answers to these and other questions, the parent board should conclude whether all or some of the members of the subsidiary board should be independent of the parent. We believe there are times when it is important that the boards of the parent and subsidiary not be identical; that is, the board of the parent and the board of the subsidiary should include some members that have the interest of only the parent or only the subsidiary in mind. This is most important when a sale or spin-off of the subsidiary is being considered, or other major event that could impact the relationship between the parent and subsidiary company. Finally, we believe this rule should apply whether or not the subsidiary is consolidated.

  • Should there be an exception to the independence requirements based upon exceptional and limited circumstances, if the board determines that membership on the committee by the individual is required by the best interests of the corporation and its shareholders? If so, should the board be required to disclose the nature of the relationship and the reasons for that determination? Should there be a time limit for these appointments?

    We support permitting exceptions to the independence requirements based on exceptional and limited circumstances. Many times, small companies, and even large companies, might not be able to fulfill the objectives of the audit committee due to unforeseen circumstances. Returning to an example addressed earlier in this letter, if an audit committee member resigns from the board and there is no one else on the board that could fill that position, it might be more effective to allow an otherwise qualified member of the board that is not independent to sit on the audit committee for a short period of time, for example: up to six months. This exception period would allow the individual to cure their independence problem if possible, or allow the board additional time to recruit a new member. Further, the judgment as to the individuals in question should be left to the board rather than prescribing regulation in the Commission's rules.

  • Should companies be allowed to request exemptive relief on a case-by-case basis? If so, what procedures should be used for submitting and evaluating applications for exemptive relief? What factors should the Commission consider in considering such requests? How would such a case-by-case process be consistent with the policy and purposes of Section 10A(m)? How would such a process be coordinated between the Commission and the SROs? Should companies be required to disclose publicly any exemption they receive? Should SROs be permitted to grant exemptions within defined parameters? What should those parameters be?

    Companies should not need to request exemptive relief on a case-by-case basis. If the Commission created principles-based independence requirements, and permitted boards a period of time where one member of the audit committee may be exempt from the independence requirements for a period of time such as six months, it would permit the board some time to cure the independence issue of the member, or recruit a new board member for that position.

    The Commission may wish to consider establishing a process to allow companies to apply for an exemption for longer than six months. However, we believe that permitting an exemption for up to six months will minimize the number of companies requesting a longer exemption period.

Questions regarding the proposed auditor responsibility requirement:

  • We request comment on implementation of this proposed requirement. Is additional specificity needed?

    For many years, the auditor's report on the fairness of an entity's financial statements has been addressed to the board of directors of the company. The requirement that the audit committee of the board own the relationship between the auditor and the company is in that same spirit and we fully support this change. It is entirely appropriate, and in the interest of restoring investor confidence that the proposed requirement be approved.

  • Should the audit committee also be directly responsible for the appointment, compensation, retention and oversight of an issuer's internal auditor? Should other responsibilities be under the supervision of the audit committee?

    There are many new responsibilities on audit committees as a result of the Sarbanes-Oxley Act and the new SEC rules to implement the Act. We have been careful to advise the Commission to maintain the oversight role of the board and audit committee, and to keep management activities with management. In continuing with that theme we encourage opportunities to strengthen the relationship between the internal chief audit executive and the audit committee. We believe the chief audit executive should have a reporting relationship to the audit committee as well as a member of the executive team such as the CEO or general counsel. Company executives should not be able to hire, fire or reassign the chief audit executive without the consent of the audit committee. Practices like this will ensure the independence (from management) of the chief audit executive, which we believe is a corporate governance best practice. In addition, the audit committee should be involved in discussions relating to the chief audit executive's compensation as a further means to create stronger ties between the chief audit executive and the audit committee.

  • Does the proposed instruction that the requirement does not conflict with, and is not affected by, any requirement that requires shareholders to ultimately elect, approve or ratify the selection of the issuer's auditor adequately address the concerns of issuers whose governing law or documents requires shareholder selection of the auditor? Are additional accommodations necessary? Please explain how any accommodation would be consistent with the Sarbanes-Oxley Act.

    We believe that the board should be the body making the recommendation to shareholders on the appointment of external auditors. The board should be making its recommendation based on a recommendation to it from the audit committee.

Questions regarding the proposed complaint procedures requirement:

  • Should the proposed rule require a company to disclose the procedures that have been established or any changes to those procedures? If so, where and how often should the disclosure appear and what should it look like?

    The company should annually disclose whether or not they have a system in place, and whether that system relies on internal resources, or they have engaged an external service provider. If substantive changes are made to the procedures during the year, that fact should be reported via Form 8-k and the next annual disclosure should provide similar detail.

  • Should specified procedures be prescribed or encouraged? For example, should we specify how long complaints must be retained? Should we specify who could or could not be designated by the audit committee for the receipt and treatment of complaints?

    We discourage the Commission from specifying or even encouraging specific procedures to achieve this objective. Given the wide variety of public companies, any prescribed or even encouraged procedures will be good for some and difficult for many. We believe the Commission should stay the course of a principles-based approach, requiring companies to create a system that is appropriate in their circumstances.

Questions regarding the proposed authority to engage advisors requirement:

  • Is any additional specificity needed for this requirement? For example, should we define what constitutes an "independent advisor?"

    We support the Commission's position that the audit committee have the privilege to engage independent advisors as it considers necessary. We believe that the rule as presented is clear and no further clarification is necessary. Any specificity contained in the rule may be later used to limit the kinds of independent advisors the audit committee could engage.

Questions regarding the proposed funding requirement:

  • Is any additional specificity needed for this requirement? For example, should a specific agreement or arrangement be required to provide for the appropriate funding?

    No additional specificity is needed for this requirement. The audit committee is subject to oversight by the full board of directors of the company.

  • Should there be any limit on the amount of compensation that could be requested by the audit committee? If so, who should set these limits (e.g., the full board)? Should the audit committee's request be limited to "reasonable" compensation? Who would determine what is "reasonable?" How would such limits be consistent with the policy and purposes of the Sarbanes-Oxley Act? Is the fact that the audit committee members ultimately are elected by, and answerable to, shareholders sufficient to address any concern over compensation limits?

    Any limit on the amount of compensation for outside advisors to the audit committee members should be set by the board.

Thank you for the opportunity to respond to this Proposed Rule.

Respectfully submitted,
William F. Ezzell, CPA
Chairman, Board of Directors
  Barry C. Melancon, CPA
President and CEO