Financial Services Agency of Japan
November 29, 2002
Mr. Jonathan G. Katz
Re : Proposed Disclosure about Financial Experts Serving on a Company's
Dear Mr. Katz:
As the Director for International Financial Markets of the Financial Services Agency of Japan ("FSA"), I am pleased to submit this letter in response to the request of the Securities and Exchange Commission ("SEC") for comments on its proposed rule under Section 407 of the Sarbanes-Oxley Act of 2002 ("S&O Act") on disclosure about financial experts serving on a company's audit committee, as contained in Release No. 34-46701. I would like to add that I have consulted with related Japanese government ministries on this letter.
The S&O Act is an important accomplishment for restoring investor confidence in the United States securities markets. Japan also has been tackling the reform of its securities markets for the same purpose, considering also the international developments including those relating to the IOSCO (International Organization of Securities Commissions) and the S&O Act. The FSA announced on August 6 the "New Comprehensive Program for Promoting Securities Markets Reform", and based on this program, important concrete reform measures are being implemented, in addition to various reforms measures that have been put into place particularly for last several years.
At the same time, since the S&O Act could affect Japanese institutions, we have a strong interest in how the S&O Act is being, and will be, implemented. We have concerns with some provisions of the S&O Act, which are in direct conflict with the Japanese legal system. Section 106 (Foreign Public Accounting Firms) and Section 301 (Public Company Audit Committees) are the provisions with which we have the most serious concerns. Therefore, we respectfully request the SEC to provide appropriate exemptions from Section 106 to Japanese auditing firms and from Section 301 to Japanese "issuers" within the meaning of the S&O Act.
In this letter, we would like to make some comments on the proposed rule implementing Section 407 (Disclosure of audit committee financial expert) of the S&O Act.
The term "audit committee" is defined by Section 2(a)(3) of the S&O Act as well as by Section 3(a)(58) of the Exchange Act, as added by the S&O Act, as "(A) a committee (or equivalent body) established by and amongst the board of directors of an issuer for the purpose of overseeing the accounting and financial reporting processes of the issuer and audits of the financial statements of the issuer; and (B) if no such committee exists with respect to an issuer, the entire board of directors of the issuer." The proposed rule clearly provides that "in the case of foreign private issuers with two-tier boards of directors, for purposes of this Item 15(b), the term `board of directors' means the supervisory or non-management board." We appreciate that the SEC has given careful consideration to the different corporate governance systems of foreign jurisdictions.
Section 407 prescribes the disclosure requirement and does not require the existence of financial experts. Nevertheless, the difference between the Japanese corporate governance system and the public company audit committee system under the S&O Act remains a serious issue.
The Japanese Law for Special Exceptions to the Commercial Code concerning Audits, etc. of Corporations ("Special Law") provides "large corporations" (which all Japanese issuers registered with the SEC are) with two options for the corporate governance system. It is an essential proposition under the Special Law that large corporations are free to choose between the two systems. One option, which is the only available option at this time (because the other option will not become available until April 2003), is to have within the corporation the board of corporate statutory auditors, separately from the board of directors. The other option is the establishment by and among the board of directors of the nominating committee, the audit committee and the compensation committee. The serious problem for us is that neither the board of corporate statutory auditors nor the audit committee satisfies the requirements for and qualifications of an "audit committee" under Section 301 of the S&O Act. For example, in the case of both corporate governance systems, auditing firms must be appointed or dismissed by shareholders' meetings under the Special Law, whereas Section 301 requires that such power reside with the "audit committee" itself.
Section 407 and the proposed rule assume the existence of the "audit committee" defined by the S&O Act by requiring disclosure of the existence of financial experts in the "audit committee". Thus, issues on Section 407 are related with the issues on Section 301. From this viewpoint, it is very important for us that under Section 407 a Japanese issuer, whether it has the board of corporate statutory auditors or (as will become permissible from April 2003) an audit committee defined by the Special Law, should be recognized as having an "audit committee" in addition to the entire board of directors of the issuer as prescribed by Section 3(a)(58) of the Exchange Act. We respectfully request the SEC to formulate its rules with respect to Section 407 so that a Japanese issuer that has a "financial expert" on its board of corporate statutory auditors or audit committee will be permitted, for purposes of such rules, to disclose that it has a "financial expert" on its "audit committee". We believe that this would fulfill the policy considerations behind Section 407 and avoid a situation in which Japanese companies active in the U.S. securities markets would be at an unfair disadvantage.
Since the board of corporate statutory auditors of a Japanese issuer is the "non-management board", it seems that for Japanese issuers that adopt the board of corporate statutory auditor system that board could be the body which is to decide whether a person is a financial expert or not. We would also be grateful for the SEC's confirmation on this point.