Mr. Jonathan G. Katz
Re:Request for Comments on Proposed Rules Concerning Improper Influence on Conduct of Audits -- File No. S7-39-02
Dear Mr. Katz:
The Financial Services Practice Group of Dechert is pleased to have this opportunity to comment on the new rules the Commission is proposing to adopt pursuant to Section 303 of the Sarbanes-Oxley Act of 2002 (the "Act"). We do so in response to the Commission's request for comment as set forth in Release No. 34-46685 dated October, 18, 2002. Our comments are addressed solely to proposed new rule 13b2-2(b) and (c) to Regulation 13B-2 under the Securities Exchange Act of 1934 (the "Proposed Rule")1.
Dechert is an international law firm with a wide-ranging practice that serves clients in the United States and worldwide. Among these are many U.S. publicly traded companies, as well as registered open-end funds and closed-end funds.
Dechert strongly supports the Commission in its ongoing efforts to implement the provisions of the Act and to accomplish the important reforms in corporate governance, disclosure, accountability and accounting practices that are mandated by the Act.
We believe the wording of the Proposed Rule should closely follow the spirit and wording of Section 303 of the Act. The conduct proscribed by Section 303 of the Act was characterized by Congress as unlawful. Consistent with this characterization, the Section prohibits actions to "fraudulently influence, coerce, manipulate, or mislead" any independent public or certified accountant...for the purpose of rendering...financial statements materially misleading."
Senator Paul Sarbanes had this to say about Section 3032:
The Senate Committee Report3 was equally straightforward. Under the caption, "Prohibited Influence," it said Section 303 "makes it unlawful for any officer or director of an issuer, or person acting under the direction thereof, to fraudulently influence, coerce, manipulate or mislead any accountant engaged in preparing an account for that issuer, for the purpose of rendering the audit report misleading.
Proposed Rule subparagraphs (b)(1) and (c)(2) departs sharply from the Senate Committee Report formulation. The language of the Proposed Rule changes the requirement of purposeful intent to a requirement that the actor simply know or be "unreasonable in not knowing" that his action, "could, if successful, result in rendering such financial statements materially misleading."
The Commission is clear in the proposing release that the suggested rephrasing would have the effect of obviating a need to prove one's purpose was to render financial statements misleading. The proposed standard introduces a very different and lower threshold for finding liability that is inconsistent with the thrust of Section 303.
We also strongly believe that the word, "fraudulently", as used in subparagraphs (b)(1) and (c)(2), should not be replaced with the word "improperly" or any other word that would convey a mental state short of scienter. In other contexts, when Congress has intended to prohibit conduct for actions that fall short of scienter based fraud, it has specifically done so4. We submit that Congress was seeking to prohibit conduct it believed to be fraudulent and for that reason we further believe that the appropriate mental state is scienter5.
We also disagree strongly with the assertion made in footnote 16 in the proposing release that the adverb "fraudulently" modifies only the word, "influence". There is no evidence that this was the intent of Congress. Indeed, had that been the intended meaning, then the phrase "fraudulently influencing, coercing, manipulating, or misleading" could have been written to read "coercing, manipulating, misleading or fraudulently influencing."
We agree that persons acting "under the direction" of an officer or director of an issuer include those who, while not formally subject to supervision, nevertheless take action at the instruction of an officer or director to so act. However, it needs to be made very clear in the adopting release (or by an instruction or note to the Proposed Rule) that the mere fact that an employee has been hired by the issuer or that counsel, forensic accounting specialists, securities professionals or other advisers have been engaged by the issuer's staff or by a particular officer or director, does not establish that they have been directed to take any particular action.
Both employees and agents of the issuer acting at their own volition, should be able to vigorously advocate accounting treatments and, even, to urge an auditor not to withdraw an issued opinion. Action taken by customers, vendors, creditors, employees, counsel and others that falls within the meaning of action taken "under the direction" of an officer or director must be action that is taken at the instruction of an officer or director of the issuer which the actor then takes for the purpose of making the issuer's financial statements materially misleading.
Having said this, we do not believe that the language of the proposed rule should be modified to indicate, as the Commission has suggested, "that no specific direction by an officer or director is required to violate the proposed rules."
Subparagraph (c) of the Proposed Rule seeks to make the officers and directors of the traditional entities that provide services to registered investment companies, such as investment advisers and administrators, subject to the Section 303 prohibited conduct6. It should also be noted that in the case of investment companies, generally speaking, all of the officers of the investment company are employees (and often, senior employees) of the investment adviser. Because the investment adviser acts, in effect, in an executive capacity with a fund, it may be appropriate to extend the scope of the proposed rule to the officers and directors of the investment adviser. We do not believe other service providers have such authority over an investment company or its officers and employees, or for that matter, any interest in subverting the integrity of an investment company's financial statements. Therefore, we do not believe they should be included in paragraph (c).
Given the SEC's exclusive power to enforce the final regulation adopted under Section 303 of the Act in civil proceedings, making the SEC, in effect, the sole interpreter of the regulations as adopted, it is particularly important that the final regulation remain faithful to the intent of Congress. The danger otherwise exists that broadly interpreted regulations will be even more broadly interpreted through enforcement proceedings.
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We appreciate the opportunity to comment on the rules proposed to be adopted by the Commission pursuant to Section 202. If we can be of any further assistance in this regard, please do not hesitate to contact Margaret A. Bancroft (212) 698-3590, Ruth S. Epstein (202) 261-3322, Jack W. Murphy (202) 261-3303 or John V. O'Hanlon (617) 728-7111.