November 27, 2002
VIA EMAIL (firstname.lastname@example.org)
Mr. Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Re: File No. S7-40-02 Disclosure Required by Sections 406 and 407 of the Sarbanes-Oxley Act of 2002
Dear Mr. Katz:
I am writing on behalf of Centex Corporation to offer comments in response to the proposals of the Securities and Exchange Commission in Release No. 33-8138; 34-46701; IC-25775 (the "Release"). These comments relate to the proposed rules regarding disclosure of whether a financial expert is included on the audit committee and whether an issuer has adopted a code of ethics for certain officers of the issuer.
I. FINANCIAL EXPERT
As an overall comment, we believe that the definition of "financial expert" proposed by the Commission is too restrictive. As proposed, the resulting pool of "financial experts" available to public companies would be limited, particularly for smaller companies. The pressure from the marketplace to avoid a disclosure that there is no such expert on the audit committee will be strong. This may lead to companies' electing as directors persons who technically fulfill all the requirements of the proposed rule, but who have none of the other necessary and desirable traits of a good director, such as strong leadership, good judgment, and interpersonal skills. When we add the requirement that the person have the time to take on the responsibilities and potential liabilities involved in this type of position, the pool shrinks still further. We believe that the language of the Sarbanes-Oxley Act does not necessitate this restrictive definition. Specific suggestions follow.
- The Five Factor Test. The Sarbanes-Oxley Act directs that the Commission consider certain attributes in defining the term "financial expert". The proposed rule goes further by making all such attributes mandatory, and ties the definition of financial expert even more closely to the particular types of estimates, accruals, reserves and other accounting issues that the issuer in question must consider. We submit that this is far too restrictive.
The Commission could provide issuers some flexibility in meeting these requirements if it would permit a person to qualify as a financial expert if he or she met the first and fifth factors, an "understanding of generally accepted accounting principles and financial statements" and an "understanding of audit committee functions", and any two of the remaining three factors. The Sarbanes-Oxley Act requires only that the Commission "consider" four factors in developing the test, not that all such attributes are mandatory. Another possible approach would be to permit an issuer to disclose that the audit committee, when consideration is given to the attributes of all its members, has the necessary attributes of a "financial expert." An issuer making this disclosure should not have to state that no one member is a "financial expert". There is nothing in the stated benefits of financial expertise described in the Release that requires that all the expertise reside in one person.
The proposed rule requires that a financial expert have experience in accounting for estimates, accruals and reserves generally comparable to those used in the issuer's financial statements, and have experience in preparing or auditing financial statements that present comparable issues to those presented by the issuer's financial statements. Based on these requirements, the financial expert would almost have to be drawn from the same or very similar industry as the issuer, or have spent a good part of his or her career auditing such firms. Even in this restrictive case, it is possible that the literal terms of the definition may not be met. The problem is particularly acute for a diversified company which has significant interests in different industries. Finding a director with substantial experience in accounting for all these separate businesses will be extremely challenging. The Act requires only that the person have experience in preparing or auditing financial statements of "generally comparable issuers" and experience in applying accounting principles to estimates, accruals and reserves. This is far less narrow and in our view more appropriate. We suggest that "generally comparable issuers" be defined to mean those issuers of a generally similar size and complexity.
- Safe Harbor. The Commission has solicited comments on whether a bright-line test of "financial expert" should be adopted. Although we concur with the Commission in its view that a bright-line test is not appropriate, we believe that a safe harbor provision should be adopted that would ameliorate somewhat the difficulty in evaluating the numerous requirements and factors in arriving at a determination of expertise. As a practical matter, a person who has at least three years experience as the principal financial or accounting officer of a large public company or a partner with a registered public accountant who supervises audits for large public companies should possess the requisite expertise. Accordingly, we propose that the following safe harbor be adopted:
"A person is a financial expert, if he or she has served for at least three of the past ten years as either:
(i) the principal financial officer or principal accounting officer of an issuer whose securities are listed on a national securities exchange or the NASDAQ National Market who meets the $75 million "public float" requirement of General Instruction B.1 of Form S-3;
(ii) a partner of (or person serving in a similar capacity with) a firm of registered public accountants who has had primary responsibility for supervising the audit of the financial statements of one or more issuers of the type described in clause (i) above."
- The Term "Financial Expert". The Commission has specifically requested comment on whether the term "financial expert" is appropriate. In our view, it would be misleading to disclose that there is no financial expert on an audit committee which comprises, for example, an experienced investment banker, a financial analyst and a finance professor. We believe that since the requirements of the proposed rule relate exclusively to accounting matters, the terms "accounting expert" or "audit committee accounting expert" are much more appropriate.
- Independence. There is very little to be gained in adding yet another definition of "independence" to apply to the financial expert. Companies listed on a national securities exchange or NASDAQ must have audit committees composed solely of independent directors, with the definition of independence currently the subject of a separate rule-making proposal by the Commission. The Commission should not adopt a separate definition for "independence" which applies only to the financial expert, as this would create confusion for the readers of disclosure documents.
- Potential Liability. We are very concerned about the increased liability of the "financial expert" under state and federal law, and suggest that the Commission do everything it can to minimize this unintended consequence of what is supposed to be a disclosure requirement. Fear of potential liability may further reduce the pool of qualified applicants willing to serve as experts. Some potential actions which could ameliorate this problem are the following: (a) a separate Commission rule stating that the financial expert is not an expert for purposes of Section 11 of the Securities Act of 1933, and that his or her signature on a registration statement filed under that Act shall not be deemed to indicate that any financial statements included or incorporated by reference therein are statements made on his or her authority as an expert; (b) no requirement to identify the particular director or directors who serve as financial experts for the audit committee; (c) a very strong statement from the Commission, perhaps included in a preamble to the final rule, that the designation of "financial expert" is not intended to and does not, in the Commission's view, increase the responsibility or obligation of any person so designated.
- Transition Rule. We believe that an appropriate transition period should be adopted so that companies will have several months after adoption of the final rule before being required to disclose whether or not there is a "financial expert" on the audit committee. As stated above, companies will be under enormous pressure to avoid a negative disclosure and may appoint such a director without sufficient time to explore better alternatives. We suggest that the rules apply only to the Form 10-K's for fiscal years ending after September 30, 2003.
II. CODE OF ETHICS
We believe that the Commission's proposed rule covering codes of ethics is generally consistent with the requirements of the Sarbanes-Oxley Act. However, we believe that many companies include provisions in their codes of conduct which may be of lesser significance than the requirements covered in the proposed rule (or in the New York Stock Exchange's proposed rule on this topic). Changes to and waivers of these less significant provisions should not require public disclosure. For example, a code of conduct may contain provisions regarding personal internet use or describing appropriate business expenses, changes in which would be of scant interest to investors. We suggest that the Commission modify the new disclosure requirements of Form 8-K to relate only to amendments or waivers of those provisions which are required to be included in a code of ethics by the instructions to proposed Item 406 of Regulation S-K.
If you have any questions or would like to discuss the comments provided above, I can be reached by telephone at (214) 981-6606 or by email at email@example.com.
Richard J. Ressler