December 2, 2002
Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: File No. S7-40-02
Proposed Rule: Disclosure Required by Section 406 of the Sarbanes-Oxley Act of 2002
LRN, The Legal Knowledge Company is pleased to have the opportunity to comment on the proposal by the Securities and Exchange Commission to require an Exchange Act reporting company to disclose its code of ethics.
As a provider of online legal, ethics and compliance training for Global 1000 corporations, we have worked with some of the largest companies in the world in making their codes of ethics central to their enterprises. We believe that a code of ethics that applies to the entire organization is one of the most effective ways to educate and reinforce the company's values and policies. Although Section 406 of the Sarbanes-Oxley Act addresses the application of a code of ethics to the principal financial officer and the Commission's proposed rules extend such code to the principal executive officer, we believe the values and policies memorialized in a code of ethics should apply to the entire organization. This is consistent with the proposed rules of the New York Stock Exchange and the Nasdaq Stock Market for listed companies to adopt a code of business conduct or ethics applicable to all members of the organization.
In fact, nearly all of the companies we have worked with have codes of ethics that apply to all employees. Therefore, as a threshold matter, we suggest that the Commission clarify whether the proposed codes of ethics for CEOs and CFOs must be separate or whether they should be incorporated into codes of ethics applicable to the entire organization.
We have the following comments to certain specific questions the Commission poses in the proposed rules:
- Should the rules address whether a company has a code of ethics that applies to its principal executive officer, as proposed, or should the rules track the language of Section 406 of the Sarbanes-Oxley Act and require a company only to disclose whether it has a code of ethics that applies to its senior financial officers?
The proposed rules should address whether the company has a code of ethics that applies to its principal executive officer because of the message it sends to the entire organization.
It is our experience that the efficacy of a code of ethics in an organization is often determined by the "tone at the top" set by the senior management of the company. This is a principle that the Commission has long recognized, as well. If other members of the organization do not perceive the upper ranks of the company as fully supporting and enforcing its code of ethics, or perhaps that they are not even subject to its edicts, the code's effectiveness to guide and proscribe is lost. This approach is consistent with the Commission's recently imposed certification requirements for both the CEOs and CFOs and the certification requirements of the Sarbanes-Oxley Act itself for financial reports.
As noted above, the central edicts of a code of ethics should apply to the CEO and CFO and to all other members of the organization. However, the company's disclosure obligation with respect to its applicability may be appropriate only for the management ranks of the organization. We address disclosure items more fully in item 4 below.
- Should we expand the definition of "code of ethics," as proposed, or should the definition adhere to the language in Section 406(c) of the Sarbanes-Oxley Act? Are there other ethical principles that should be included in the definition?
While we fully support the efforts to inculcate an ethical culture, there is an inherent risk in developing a long prescriptive list of principles. Once ethics is mandated, it is no longer about ethics, it is about compliance with a requirement. As a result, there is an inherent risk of downgrading the ethics discussion from one about doing right to one about formulaic satisfaction with requirements.
- Should we require the company to describe its procedures to ensure compliance with the code of ethics?
We believe a code of ethics is only effective to the extent that it is actively communicated and reinforced within the organization. We suspect that most Exchange Act reporting companies have already adopted a code of ethics in one form or another. Simply requiring a company to disclose whether it has adopted a code of ethics without describing its procedures to ensure compliance may result in the mere adoption of a boilerplate document.
To inform and infuse the principles of the code of ethics within the organization is central to having an effective code of ethics. In this regard, we recommend that the Commission propose rules requiring disclosure of the description of measures and procedures taken by the company to communicate and ensure compliance with the code of ethics. Examples of such measures and procedures may include whether the company has adopted certification requirements indicating that the recipient has received and understood the code of ethics. Another disclosure could be what non-retaliatory resources the company has made available to its employees for addressing or reporting ethical problems or suspected wrongdoing. For example, some leading companies have made available 1-800 ethics hotline telephone numbers.
A company should be free to implement or not implement any measures and procedures that it deems appropriate for itself; however, such measures and procedures should be generally disclosed to ensure that the words of the code of ethics are being turned into deeds.
- Should the company have to file the code of ethics as an exhibit to its annual report as proposed? If not, should we also require the company to describe the principal topics that the code addresses?
While there is a great virtue in transparency, in this area there is significant risk as well. For example, it is likely that certain elements of a code of ethics could include trade secrets, business practices and other confidential matters.
In a litigious society, the code of ethics may be the starting point in many securities related lawsuits. Knowing this, companies will likely seek to protect themselves by creating nebulous documents that are not illuminating either to their own management nor the public.
Consequently we do not support filing the code of ethics as an exhibit to the annual report, but suggest that the principal topics be disclosed.
LRN appreciates the opportunity to comment on the Commission's proposed rules. If you have any questions or would like to discuss the comments set forth above, please do not hesitate to contact me.
Chairman and Chief Executive Officer