The New York Clearing House Association L.L.C.
December 2, 2002
U.S. Securities and Exchange Commission,
Attention: Jonathan Katz, Secretary
Re: Release No. 33-8138, Comments on Proposed Item 309 of
Dear Mr. Katz:
The New York Clearing House Association L.L.C. (the "Clearing House")1 appreciates the opportunity to comment on the proposal (the "Proposal") of the Securities and Exchange Commission (the "Commission") to promulgate regulations on the definition of "financial expert" under Section 407 of the Sarbanes-Oxley Act of 2002 (the "Act"). Our member banks fully endorse the goal of the Act and the Commission to foster confidence in the securities markets by improving corporate governance. At the same time, we believe that the Proposal is seriously flawed, and will not be effective in furthering that goal.
The Act places considerable emphasis on the role of the audit committee. As part of that emphasis, Section 407 directs the Commission to promulgate regulations requiring issuers to disclose whether their audit committees include one or more "financial experts", and lists four specific factors the Commission should "consider" in defining "financial expert".
The Proposal would adopt a highly restrictive standard by requiring an individual to satisfy all four of the statutory considerations to be deemed a financial expert. Moreover, the Proposal arguably transmutes the criterion relating to experience with comparable issuers into a narrower and more onerous requirement that the individual have experience in the accounting for estimates, accruals and reserves that are generally comparable to those used in the issuer's financial statements (i.e., issuers with similar businesses).
We respectfully submit that the Proposal's approach is neither mandated by, nor even consistent with, Section 407. The statute did not impose required criteria, but rather provided flexibility by setting forth a non-exclusive list of factors to consider in the context of a rulemaking process.
We believe that application of the Proposal would result in a significant number of - perhaps even a substantial majority of - major corporations not having any financial expert on their board. We doubt this is the result Congress would have expected when enacting Section 407. Even more disturbing, under the Proposal a number of highly qualified directors with true financial expertise would not qualify as financial experts. By way of example, we submit that under the Proposal it is questionable that any of the following would qualify as a financial expert for a banking organization:
(1) A leading accounting professor who has written and advised extensively on financial institution accounting issues, but does not have audit or managerial experience;
(2) A former bank chief executive officer with extensive experience with bank financial statements and who has overseen the principal financial officer of his institution, but does not have experience as an accountant, principal financial officer or principal accounting officer;
(3) A former senior bank regulator whose career has focused on analyzing and assessing the financial performance of banks, but who has never functioned as an accountant or a financial officer of a firm; and
(4) The chief financial officer of a nonfinancial (or even a nonbank financial) firm who does not have experience with the estimates, accruals and reserves that are generally comparable to those utilized by a bank.
Although we have focused on the impact of the Proposal in the context of a banking institution, we believe that similar examples could be provided for virtually any industry. Therefore, the Clearing House is compelled to conclude that a regulation that could produce the foregoing conclusions is fundamentally flawed.
The degree of the problem with the Proposal's approach is magnified when one considers the pool of available directors for a banking institution. Because of the specific restrictions on director and officer interlocks among banking institutions embodied in the Depository Institution Management Interlocks Act (12 U.S.C. 3201 et seq.), as well as general antitrust law considerations, it is not feasible to draw directors from other banking organizations. Consequently, the pool of people that would satisfy the requirements of the Proposal is very limited. Moreover, as the Commission must acknowledge, satisfying the Proposal's requirements is not alone a sufficient reason for an individual to be selected as a director; there are numerous criteria for a director. Therefore, the eligible pool of eligible directors is in fact even smaller.
A much better approach is to go back to the statutory language and let each board take into account the factors specifically enumerated in the statute, as well as other considerations it deems relevant in determining whether an individual is a financial expert. The issuer could then be required to articulate the factors the board considered beyond those enumerated in the statute. This more flexible approach is fully consistent with the statute, which merely requires that the Commission consider the enumerated factors in defining the term "financial expert". Section 407 does not say these are the only relevant factors.
Given the large number of boards that we believe will not now have a financial expert as defined in the Proposal and the need to approach board recruitment in a manner that takes account of all the corporate governance initiatives under way, the Clearing House urges the adoption of a transition period of at least one year before any requirements under Section 407 become effective so as to enable institutions to consider any appropriate changes in the composition of their boards. For many companies now approaching the proxy season, there is simply not enough time to deal with these issues of board composition effectively before the next annual meeting.
Finally, we urge the Commission to codify in a formal rule the proposition that no additional potential liability attaches to a director determined to be a financial expert. To further this objective, we also suggest that the disclosure required strictly follow the language of Section 407 by requiring only that the issuer state whether there is at least one financial expert on its audit committee, and if not, the reasons therefore. It should not be required to name the individual or individuals.
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The Clearing House appreciates the opportunity to comment on the Proposal, and would be pleased to discuss any of the points made in this letter in more details. Should you have any questions, please contact Norman Nelson, General Counsel of the Clearing House, at (212) 612-9205.