Nasdaq Stock Market, Inc.
January 14, 2003
Mr. Jonathan G. Katz
Re: File No. S7-40-02
Dear Mr. Katz:
The Nasdaq Stock Market, Inc. ("Nasdaq") is grateful for this opportunity to comment on the proposed rules under Section 407 of the Sarbanes-Oxley Act (the "Act"), which define the term "financial expert" and require disclosure of the number and names of the persons determined to be the financial experts on a registrant's audit committee. Nasdaq strongly supports the efforts of the Securities and Exchange Commission (the "Commission") to reform corporate disclosure and financial reporting. However, we believe that the proposed definition of a financial expert is unduly restrictive, which will make compliance unnecessarily difficult. As set forth below, we believe that Congress gave the Commission the responsibility to provide guidance on key interpretative issues, and the ability to provide necessary flexibility to companies, but the Proposed Rule fails to do so, and indeed in at least one respect is narrower than the requirements of the Act. We also believe that the proposed disclosure of the names of the financial experts on the audit committee, particularly without legal protection for them, will discourage people that qualify as a financial expert from serving, thus making it more difficult for issuers to attract qualified audit committee members.
Since 1999, Nasdaq has required that the audit committee of each issuer have at least one member with "past employment experience in finance or accounting, requisite professional certification in accounting, or any other comparable experience or background which results in the individual's financial sophistication, including being or having been a chief executive officer, chief financial officer or other senior officer with financial oversight responsibilities."1 Following the enactment of the Act in July, Nasdaq proposed to modify this requirement so that it would conform with the Act's definition of a financial expert.2 Under this proposed modification, issuers that do not have a financial expert, as defined in the Act and the rules thereunder, would be delisted. However, as described herein, Nasdaq has concluded that issuers will have substantial difficulty attracting individuals who meet the definition in the Proposed Rules. Accordingly, Nasdaq plans to withdraw this pending proposal that would result in the delisting of issuers who are unable to comply with the definition in the Proposed Rules and will instead maintain our current rule.3
In the Act, Congress gave the Commission significant discretion to adjust the requirements necessary to be a financial expert. The Commission has not sufficiently exercised this discretion in the Proposed Rules. For example, the Proposed Rule echoes the Act in allowing a financial expert to gain the required experience not only through having served in certain specified positions, but alternatively through the "performance of similar functions." However, the rule provides no guidance on what this ambiguous term means. For this broadly worded alternative to be viable, as Congress intended, the Commission must provide such guidance so companies and individuals can feel confident in relying on it. We think a relatively broad definition of "similar functions" is most consistent with Congress' intent. In this regard, we agree with the comments of Financial Executives International that the Commission should revise the Proposed Rules to allow individuals with relevant experience "obtained in functions outside those narrowly defined by the factors listed in the proposal" be eligible to serve as financial experts.4 For example, experience reviewing or analyzing financial statements can provide an adequate foundation for an individual to perform this function. Further, a chief executive officer responsible for supervising the preparation of complex financial statements, and under the Act certifying the accuracy of those financial statements, might well qualify as being a financial expert. As the Commission notes in the Proposing Release, the role of the financial expert "is to assist the audit committee in overseeing the audit process, not to audit the company."
Similarly, the Act requires an expert to have experience in the preparation or auditing of financial statements of "generally comparable issuers." The Proposed Rule repeats this vague and ambiguous requirement without providing any guidance as to what a "generally comparable issuer" might be. The lack of such guidance chills both companies and would-be experts. The Commission needs to exercise the discretion Congress provided, and do so in a way that gives companies necessary latitude.
In addition, other provisions of the Act and Nasdaq's proposals make actual experience preparing or auditing financial statements less critical. New Section 10A(m) of the Exchange Act, added by Section 301 of the Act, requires that the Commission adopt rules requiring the national securities exchanges and national securities associations to prohibit listing of any issuer unless that issuer's audit committee has the authority to engage independent counsel and other advisers, as it determines necessary to carry out its duties, and the issuer must provide funding for such advisers. In that regard, Nasdaq has proposed a requirement that each audit committee have the authority to engage and determine funding for independent advisors as it determines necessary.5 Accordingly, if the necessary experience to address a certain issue does not exist on the audit committee, the audit committee can seek an independent advisor with that experience.
We also note that the Proposed Rules exceed the requirements of the Act in at least one significant respect: the Proposed Rules would require a financial expert to have previous experience with a reporting company, whereas the statute only requires prior experience with an "issuer." Thus, experience with a private company could qualify under the Act but not under the Proposed Rules. Nasdaq believes that the stricter requirement of the Proposed Rules will serve to restrict the universe of financial experts and create difficulties for companies, especially smaller ones, in identifying and recruiting a financial expert.
Finally, we note that the Proposed Rules would require disclosure of the number and names of the persons determined to be the financial experts serving on the audit committee. Nasdaq is concerned that, at least in the absence of protections from additional liability as a result of the designation, disclosure of the names of financial experts will discourage people from serving on an audit committee, thus further reducing the pool of qualified individuals and depriving issuers and their investors of these individuals valuable service - a particular problem for smaller companies. As pointed out by Financial Executives International, "[t]he information that should be most important to shareholders is that the company has a financial expert on the committee."6
In view of the above, Nasdaq urges the Commission to broaden the attributes necessary for an individual to be considered a financial expert and not to require disclosure of the names of the financial experts on the audit committee. Expansion of the pool of eligible individuals will better facilitate the creation of strong audit committees, essential to implementation of the Congressional intent behind the adoption of the Act. Please contact me if you would like Nasdaq to provide any further information or answer any questions with regard to these comments.