The Association of the Bar
of the City of New York
42 West 44th Street
New York, NY 10036-6689
Committee on corporation Law
December 6, 2002
Via email: firstname.lastname@example.org
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Attention: Jonathan G. Katz, Secretary
Re: File No. S7-40-02: Proposed Rule-Disclosure Required by
Sections 404, 406 and 407 of the Sarbanes-Oxley Act of 2002
Ladies and Gentlemen:
This letter is submitted on behalf of the Committee on Corporation Law of the Association of the Bar of the City of New York (the "Committee") in response to Release Nos. 33-8138, 34-46701 and IC-25775, dated October 22, 2002 (the "Release"), in which the Securities and Exchange Commission (the "Commission") announced proposed rules (the "proposed rules" or "proposals") implementing Sections 404, 406 and 407 of the Sarbanes-Oxley Act of 2002 (the "Act").
Our Committee is composed of lawyers with diverse perspectives on corporate law issues, including members of law firms and in-house counsel at government agencies, corporations, investment banks and investors.
The Committee commends the Commission and its staff for the very high standards of quality they have applied in addressing the extraordinary regulatory agenda imposed by the Act. The Committee has determined that three matters fall within the Committee's areas of concern and merit comment.
A. The Definition of Financial Expert Should be Expanded
The Committee believes that the definition of "financial expert" should be sufficiently broad to permit corporations to attract and retain board members who meet the definition and who have the requisite business experience to be effective board members. The Committee asserts that good corporate governance goals are not achieved by adding a board member whose only contribution to the management of the corporation will be to act as the audit committee's designated financial expert. Such a person would serve the corporation and good corporate governance better as a consultant than as a board member.
The Committee submits that the majority of audit committees of corporations that file period reports under Sections 13 or 15 of the Exchange Act function effectively and are comprised of directors who perform the audit committees function satisfactorily. The Committee sees no public interest in the adoption of a definition of "financial expert" that would exclude many well-rounded and otherwise capable board members who did not meet the rather narrow "financial expert" criteria. Indeed, barring an increase in the size of a corporation's board or audit committee, many qualified and experienced current audit committee members may no longer qualify to sit as audit committee members. In particular, the Committee does not believe the definition of "financial expert" should require experience (i) in preparing or auditing financial statements that present accounting issues that are generally comparable to those raised by the corporation's financial statements, (ii) in applying generally accepted accounting principals in connection with estimates, accruals and reserves generally comparable to the estimates, accruals and reserves in the corporation's financial statements or (iii) with internal controls and procedures. The Committee believes that the term "financial expert" should be broadly defined and not include any mandatory requirements. Financial expertise can be gained from many different types of experience, including, for example, long-standing service as a member of the audit committee of the corporation or experience with complex financial statements.
B The Commission should adopt its proposed definition of "internal controls and procedures for financial reporting".
The Committee believes that corporations will benefit from a definition of "internal control and procedures for financial reporting" and that the AICPA's Codification of Statements on Auditing Standards Section 319 is the best alternative that the Commission offers in the Release. The Committee believes that adding concepts such as compliance with law and regulation (such as the 1992 Treadway Commission and the AICPA's SAS 78), while laudable goals, will dilute the definition and turn internal controls away from their appropriate focus on financial reporting. We are also concerned about the implications that such an expansive definition will have on the internal responsibilities of a corporation's financial and internal auditing professionals. Those professionals are not responsible for advising on or monitoring compliance with law or regulations and, more importantly, are not qualified to do so. Such responsibility properly rests with a corporation's Legal and Compliance staff.
C. The Commissions should require only Annual Evaluation of Internal Controls and Procedures for Financial Reporting.
The Committee recommends that Exchange Act Rules 13a-14, 13a-15, 15d-14 and 15d-15 require only annual evaluations of both the corporation's disclosure controls and procedures and its internal controls and procedures for financial reporting (collectively, the "Controls and Procedures").
In the Committee's experience, corporations that file reports under Exchange Act sections 13 and 15 have existing Controls and Procedures. Those corporations that do not have any (or satisfactory) Controls and Procedures will shortly adopt them as mandated by the Act and the rules promulgated thereunder. The Controls and Procedures change infrequently and, pursuant to revised Exchange Act Rules 13a-14 and 15d-14 recently adopted to implement section 302 of the Sarbanes-Oxley Act, the principal executive and financial officers of reporting companies will be required to disclose whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of their last evaluation on internal controls. Quarterly evaluations of the effectiveness of the Controls and Procedures will not be necessary to reasonably insure that the Controls and Procedures remain effective for the entire fiscal year. Under the new rules such certifying officers are also required to disclose that they have disclosed to the issuer's auditors and audit Committee all significant deficiencies and material weaknesses in the design or operation of internal controls. The existence of an annual evaluation of internal controls coupled with the present existing quarterly certifications should allay the Commission's concerns.
The Commission's suggestion that quarterly review of internal controls and procedures would create symmetry with the Commission's requirement for quarterly evaluation of disclosure controls and procedures is not a sufficient basis for imposing additional burdens. The burden of reviewing internal controls and procedures is likely to involve far greater interaction with the issuer's independent auditors than a review of disclosure controls and procedures and, accordingly, is likely to entail far greater expenditure of time and financial expense. The Commission's assessment of the limited burden that quarterly reviews of internal controls and procedures would entail both in terms of time and expense is, in the Committee view, unrealistically low. In short it is the Committee's view that there is no need for the quarterly reviews and the burdens they would entail are not justified.
To allay the Commission's concerns that a quarterly evaluation of the Controls and Procedures may be required to provide a basis for the required quarterly disclosure of significant changes to the Controls and Procedures, we would recommend in the alternative revising the requirement for both a corporation's internal controls and procedures and its disclosure controls and procedures to include required procedures precluding any significant change to either from being made without prior notice to, and approval from, either the chief financial officer or the chief executive officer. In addition, the corporation's auditors annual review of the corporation's internal controls and procedures will cover both whether there have been significant changes as well as whether the internal controls and procedures have been designed so that they could be changed significantly without prior disclosure to and approval from the CEO or the CFO.
This letter does not necessarily reflect the individual views of members of the Committee or the views of any of the member's employers.
The undersigned would be pleased to answer any questions you might have regarding our comments, and to meet with the Staff if that would assist the Commission's efforts.
/s/ Mark Wojciechowski
Mark Wojciechowksi, Chair
Committee on Corporation Law
/s/ Arnold Levine
on behalf of the Committee's subcommittee on corporate governance
/s/ Peter Vogelsang
on behalf of the Ad-hoc working group on internal controls
/s/ Michael Zuckert
on behalf of the Ad-hoc working group on internal controls