MFS/Compass Group of Funds
500 Boylston Street
Boston, Massachusetts 02116
November 27, 2002
Mr. Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
We are all of the members of the Boards of Trustees that oversee one group of funds sponsored by MFS Investment Management (MFS). Our group of funds comprises 38 MFS funds with combined assets of approximately $11 billion. These funds serve as underlying funding vehicles for variable annuity and life insurance products sponsored by Sun Life Assurance Company of Canada and its subsidiaries. We are writing to provide our comments on the Commission's proposed rules to implement the requirements of Section 407 of the Sarbanes-Oxley Act of 2002, which would require investment companies to provide disclosure with respect to members of their audit committees determined by the board of trustees to be "financial experts."
The Commission's proposal would define the term "financial expert" to mean a person who has -- through education and experience as a public accountant or auditor or a principal financial officer, controller, or principal accounting officer of a company that, at the time the person held such position, was required to file reports pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, or experience in one or more positions that involve the performance of similar functions (or that results, in the judgment of the company's board of directors, in the person's having similar expertise and experience) -- the following five attributes:
- an understanding of generally accepted accounting principles ("GAAP") and financial statements;
- experience applying such principles in connection with the accounting for estimates, accruals, and reserves that are generally comparable to the estimates, accruals, and reserves, if any, used in the registrant's financial statements;
- experience preparing or auditing financial statements that present accounting issues that are generally comparable to those raised by the registrant's financial statements;
- experience with internal controls and procedures for financial reporting; and
- an understanding of audit committee functions.
We believe that this definition is too narrow and would exclude many individuals with financial sophistication who are well qualified to serve as a resource in this regard for the audit committee as a whole in carrying out its functions, which, according to the Commission's proposing release, is the primary benefit of having a financial expert on an audit committee.1 Although there would be no requirement to have a financial expert on a fund's audit committee, we believe that the marketplace or media may attach a negative stigma to a board's decision notto have a financial expert, and therefore believe that it is important for the definition of financial expert to include those individuals who are well qualified to serve this function.
We believe that, under the current proposed definition, many fund boards (and many other non-investment company issuers as well) would not have a member who meets the definition, and therefore, if they chose to have a member that meets the definition, would need to identify and select a new member to join the board. Depending upon the board's composition, the addition of a new member may, under Section 16 of the Investment Company Act of 1940, require shareholder approval, which would entail the costs associated with holding a special meeting of shareholders (a fund expense). In any event, the addition of a new board member would result in the fund's having to request a current member to resign or to bear the ongoing expenses associated with this additional member (e.g., annual retainer and meeting fees), and may result in a board being larger than intended for its optimal operation.
Unlike operating companies which could include the proposal to elect a new board member in its annual proxy statement, this proposal would be an extraordinary event for mutual funds as they do not generally hold annual shareholder meetings, and unlike operating companies, the expense of holding shareholder meetings and the ongoing fees associated with the new board member would be directly reflected in the funds' share price or performance results (i.e., net asset value or yield). We note that the funds we supervise held special shareholder meetings in 2001 to elect board members and to approve various other proposals. The costs associated with these meetings approximated $900,000, which approximated 0.56 basis points based on the aggregate net assets of the funds under our supervision at December 31, 2000. These factors also cause us to believe that a broader definition of "financial expert" is warranted.
In order to qualify as a financial expert, the board member would need to possess each of the five attributes outlined above -- i.e., these attributes are not merely factors to be considered by the board in assessing a member's financial expertise. The requirement to satisfy each of these attributes severely limits the pool of eligible candidates, as three of these attributes require experience in certain defined areas, namely:
- experience applying GAAP principles;
- experience preparing or auditing financial statements; and
- experience with internal controls and procedures.
We note that the other two attributes require an "understanding" of GAAP and of audit committee functions, and we believe this is the more appropriate standard for the three attributes that require experience -- i.e., an understanding of how GAAP principlesare applied, an understanding of the preparation or auditing of financial statements and an understanding of internal controls. Alternatively, we recommend that these attributes employ a "proficiency" standard -- which may be viewed as a higher standard than one of "understanding," but not requiring actual experience in each of these areas - i.e. proficiency in the application of GAAP principles, proficiency in the preparation or auditing of financial statements and proficiency in the operations of internal controls.
The requirement to have actual experience in these areas would essentially limit the pool of eligible candidates to those who have served as a public accountant or auditor or in an accounting function within a comparable public company. While this pool of candidates may possess the relevant financial experience, they may not possess other attributes which are important to serving as an effective trustee -- such as sound judgment, integrity and a wide range of business experience that provides perspective and unique insight. We are aware of no other circumstance where a specific type of experience is required to serve as a trustee, and believe such a requirement to be inappropriate. Nor are we aware of any major or systematic problems in the manner in which fund audit committees (serving over 8,000 funds) have historically functioned that would warrant the addition of a member with such a specialized and narrow focus. The proposed definition of financial expert would eliminate from eligibility a wide range of candidates who may be well versed in financial matters and have these other essential qualities, including persons who have experience as chief executive officers, chief operating officers, chief administrative officers, chief investment officers, financial analysts and other senior officers of public companies, as well as business school professors and other members of academia. Even the Commission's own Commissioners and members of the Commission staff who have many years of experience regulating public companies would likely not meet the definition of financial expert.
We believe many of these individuals would be well qualified to serve for the purpose specified in the Commission's rule proposal as a resource for fund audit committees in carrying out their functions, assuming they had an understanding (or alternatively proficiency) in the areas addressed by the required attributes. We note that while the attributes proposed by the Commission reflect the wording of Section 407 of the Sarbanes-Oxley Act, that Section directs the Commission to take into consideration these attributes in defining a "financial expert," and therefore the Commission has discretion to implement these factors as it believes necessary or appropriate. We submit that the changes we propose are necessary, appropriate and in the best interest of fund shareholders.
We note that an alternative approach the Commission could consider is making some or all of the attributes factors for a board to consider in assessing a candidate's financial expertise -- rather than absolute requirements. While we would support this approach, we believe that, if followed, the change from using an "experience" standard to an "understanding" or "proficiency" standard should also be made. Just as numerous qualified candidates would not satisfy the three attribution requirements because of lack of actual experience, these candidates may not qualify as "financial experts" if actual experience is an element to the factors the board must consider.
Our final recommendation concerns the potential liability to which a board member may be subjected if designated as a "financial expert." We believe that any incremental exposure from this designation under federal or state law would likely have a chilling effect on those who would be eligible to serve in this capacity, and would make it difficult to find qualified and willing candidates.
While we appreciate that the proposing release states that the financial expert designation should not impose a higher degree of responsibility under the federal securities laws, we believe courts would be more willing to accept this directive if this statement appeared in a Commission rule, as opposed to merely a proposing release.
We also recommend that the Commission permit funds to use a designation other than "financial expert" to identify the member so qualified, as the term "expert" may result in increased exposure under state law. For example, we suggest permitting funds to either designate the qualified member as a "financial expert" or "principal financial member" serving on an audit committee.
* * *
Thank you for your consideration of our comments.
Very truly yours,
C. James Prieur, Chairman
J. Kermit Birchfield, Lead Independent Trustee
and Chairman of the Audit Committee
Robert C. Bishop
Frederick H. Dulles
David D. Horn
Derwyn F. Phillips
Ronald G. Steinhart
|1 The proposing release states on page 6 that "[t]he primary benefit of having a financial expert serving on a company's audit committee is that the person, with his or her enhanced level of financial sophistication or expertise, can serve as a resource for the audit committee as a whole in carrying out its functions."