Compass Bancshares, Inc.
VIA ELECTRONIC MAIL
November 25, 2002
Securities and Exchange Commission
Re: Proposing Release Nos. 34-46685; IC-25773 (the "Proposing Release"); File No. S7-39-02
Compass Bancshares, Inc. ("Compass") appreciates the opportunity to comment on the proposed rule issued by the Securities and Exchange Commission (the "Commission") in the Proposing Release under Section 303(a) of the Sarbanes-Oxley Act (the "Act") relating to improper influence on the conduct of audits (the "Proposed Rule").
Compass is a financial services company that was organized in 1970 and operates approximately 344 full-service banking offices in Alabama, Arizona, Colorado, Florida, Nebraska, New Mexico and Texas. Compass has $23.7 billion in assets and is among the top forty (40) bank holding companies in the United States in terms of assets.
Section 303(a) of the Act is designed to generally prohibit officers and directors from subverting the auditor's responsibilities to investors to conduct a diligent audit of the financial statements and to provide a true report of the auditor's findings. Proposed Rule 13b2-2(b)(1) specifically would prohibit officers and directors, and persons acting under their direction, from fraudulently influencing, coercing, manipulating or misleading the auditor for the purpose of rendering the issuer's financial statements misleading.
Compass strongly supports the goals of the Act and the Commission's efforts to provide investors with financial statements that are complete and accurate. To this end, we support the Proposed Rule as ensuring that management makes open and full disclosures to, and has honest discussions with, the registered public accounting firm performing the audit of the issuer's financial statements. However, while we support the objectives of the Proposed Rule, in our view, the Proposed Rule raises a number of very significant issues. We have not addressed each request for comment in the Proposed Rule, but rather only those issues with which we have concerns or for which we have suggestions for improvement.
Scienter should be required for liability under Section 303(a) of the Act
The Commission proposes to adopt Proposed Rule 13b2-2(b)(1) which would mirror the language in Section 303(a) of the Act. However, the Commission plans to adopt a much lesser standard of liability for officers and directors of issuers under the Proposed Rule than those individuals have under other provisions of the Securities Exchange Act of 1934 (the "Exchange Act") that deal with fraud. Specifically, the Commission has stated its desire that the mental state necessary to violate the Proposed Rule would be short of scienter.
As a general matter we recommend that, to be actionable, an officer or director, or person acting under the director of the officer or director, must intend that his or her conduct would result in rendering the issuer's financial statements materially misleading. We believe that scienter must be required as an essential aspect of an individual's conduct to give rise to actions under Section 303(a) of the Act. We believe the mental state requirement of the Proposed Rule should be construed consistently with existing requirements of the other sections of the Exchange Act that require the intent to deceive, manipulate or defraud, particularly, Rule 10b-5. Despite the lack of a private right of action under Section 303(a) of the Act, the actions, statements, or conduct of an individual should not be culpable unless that individual intended to deceive or manipulate the auditors for the purpose of defrauding investors with materially misleading financial statements.
Subparagraph (b)(1) of Proposed Rule 13b2-2 should be amended to provide that an officer or director must intend to have third parties attempt to improperly influence an auditor
We agree with the Commission that the phrase "under the direction of" should not be defined to meaning an individual must be in a direct reporting relationship or under the supervision of, an officer or director in order to improperly influence an auditor. However, the Commission should make it clear that an individual is acting "under the direction of" an officer or director to the extent that such individual has received some form of instructions from the officer or director that would lead the individual to intend to improperly influence an auditor.
Subparagraph (b)(1) and (c) of Proposed Rule 13b-2b state that no person acting "under the direction" of an officer or director shall improperly influence the auditors of the issuer's financial statements. We would suggest the phrase "under the direction of" be defined as acting upon the direct or indirect instructions of an officer or director in order to give full effect to the Commission's intent to include persons who act under the direction of an officer or director even though such persons may not be under the supervision of such officer or director. While the Commission states that no specific direction by an officer or director is required to violate the Proposed Rule, it is clear that an officer or director must make some overt act or initiate a conversation with a third party in order to influence a third party to attempt to improperly influence an auditor. The Commission provides employees, customers, vendors or creditors, as examples of third parties who, under the direction of an officer or director, may provide false or misleading confirmations or other false or misleading information to auditors or engage in "side agreements." We would view employees, customers, vendors and creditors as the type of persons who would not typically have the motivation to act to improperly influence the conduct of an audit in the absence of instructions from an officer or director that such action would be beneficial to such employee, customer, vendor or creditor. Further examples presented by the Commission (employees of the auditor, investment bankers, attorneys and other advisors) also represent the type of third party that would not act to improperly influence an auditor without some overt instruction from an officer or director of the issuer.
The types of conduct the Commission believes might constitute improper influence are not well defined and could create a great deal of uncertainty
We agree that the Proposed Rule should provide examples of actions that improperly influence an auditor and could result in rendering the issuer's financial statements materially misleading. However the types of conduct listed in the Proposed Rule are very subjective. We are especially concerned with the examples pertaining to removal of an auditor or the cancellation of existing non-audit or audit engagements. An issuer may request to have an auditor removed due to poor service or incompetence or cancel non-audit work due to cost constraints or changing business strategy, among other legitimate business reasons. Despite the qualification that the issuer's action be related to an auditor's objection to the issuer's accounting, these examples may serve to give auditors too much power over the issuer. The auditor and issuer may have disagreed over an accounting issue, but it would be wrong to create what amounts to a rebuttable presumption that the disagreement must have been the reason for the issuer's action. While the facts and circumstances of each case would determine whether the conduct violated the Proposed Rule, an issuer's true intention behind a request to remove an auditor or cancel existing or future business can be grossly distorted and used by an unscrupulous or incompetent auditor to an unfair advantage.
We would therefore strongly recommend that these two examples be removed. In the alternative we would suggest that they be further qualified to indicate that an auditor must demonstrate there was a recent valid disagreement with a material accounting policy that led to the request for dismissal or cancellation of non-audit work. An issuer should not have to prove their innocence based upon a simply accusation by an auditor, especially one who was simply wrong.
Additionally, the Commission's statement that determining the "purpose" of the conduct would be relevant in determining whether the conduct violated the Proposed Rule strengthens our opinion that scienter is a necessary component of culpability under the Proposed Rule. In other words, to be actionable, the conduct of the officer or director must be purposeful (i.e. intent seems to be required). The Commission's example of culpability based upon an officer or director providing an auditor with inaccurate or misleading legal analysis would certainly require some intent on the part of the officer or director. In most cases a director or officer will not be in a position to know if a counsel's analysis is inaccurate or misleading unless the director or officer has supplied the counsel with inaccurate data or incomplete facts or instructed the counsel to provide a flawed analysis to the auditor with the intent that such analysis be used to deceive the auditor. We believe this gives additional support for our opinion that scienter should be required for culpability under this section of the Act.
An example of the type situation in which the lesser standard of liability proposed by the Commission could cause an officer or director to potentially violate the Act in the absence of any desire to fraudulently influence, coerce, manipulate or mislead an auditor, might include the Act's requirement that an issuer's CEO and CFO certify that the financial statements "fairly present" the financial condition of the issuer. However, the phrase "fairly present" is not qualified by a reference to GAAP. Should the CEO/CFO conclude that GAAP does not "fairly present" the results of operations or financial condition they would have to request the auditor not propose adjustments to conform the financial statements with GAAP. If the auditor refused to do so the CEO and CFO are left in the unenviable position of either certifying results that they do not believe represent the financial picture of the issuer or possibly requesting the removal of the auditor. The CEO and CFO would then violate the Act's prohibition of seeking to have an auditor removed because of an objection to the issuer's accounting. The CEO and CFO have violated the Proposed Rule even though they have acted with the desire to fairly present the financial condition and results of operations of the issuer. We would therefore strongly urge the Commission to adopt a standard of liability for Section 303 of the Act under which, an officer or director, or person acting under the instructions of the officer or director, must intend that his or her conduct would result in rendering the issuer's financial statements materially misleading.
We respectfully submit these comments with the hope that they are helpful to the Commission's consideration of the Proposed Rule. We would be happy to meet with representatives of the Commission to discuss our comments.