November 27, 2002
Mr. Jonathan G. Katz
Re: File No. S7-40-02
Dear Mr. Katz:
We appreciate the opportunity to provide you with our views on the Securities and Exchange Commission's (the "SEC") Proposed Rule: Disclosure Required by Sections 404, 406 and 407 of the Sarbanes-Oxley Act of 2002 (the "Proposed Rules") relating to audit committee financial experts, code of ethics and management's internal control reports.
We support the SEC's efforts to implement provisions of the Sarbanes-Oxley Act of 2002 (the "Act") and its corporate governance reform efforts. We also understand the difficulty in balancing the specific mandates of the Act with practical application of the Securities Exchange Act. However, we believe certain provisions of the Proposed Rules are too restrictive and arduous than may be necessary to achieve the Act's intended goals. Specifically,
The remainder of our letter discusses each of our concerns in more detail.
Proposed Disclosure About Financial Experts Serving on a Company's Audit Committee
We support the Proposed Rules requiring disclosure of whether a financial expert serves on a company's audit committee. Audit committees play an essential role in corporate governance and are pivotal to regaining investor confidence, as demonstrated by recent media attention and rule promulgation governing the role of the audit committee. To fulfill its responsibilities, audit committees must be comprised of individuals who possess demonstrated business acumen, leadership and judgment. They must operate with a high degree of integrity and without conflicts of interests. As indicated in the Proposed Rules, "without some level of financial competence, members of an audit committee may be unable to adequately perform their vital corporate duties." As a result of their critical role, we believe investors would be interested in knowing whether a financial expert serves on a company's audit committee.
We understand that the Act requires the SEC to provide a definition of a financial expert. We support the SEC's view that a company's board of directors is best suited to determine whether its members are financial experts. We are concerned, however, that the definition of a financial expert in the Proposed Rules is too restrictive and may not be practical to meet the intent of the Act. In particular, issuers that operate in specialized industries, such as insurance, may find the pool of individuals that would qualify as financial experts under the Proposed Rule to be extremely limited, as experience obtained in a "comparable industry" is required. We also believe that an individual with similar experiences "reviewing or analyzing" financial statements should be considered eligible for this role, as should someone (for example, a CEO) who, as part of his or her responsibilities, supervised persons who actually prepared or audited financial statements. (We note that under new rules and regulations, CEOs must be familiar enough with financial statements and disclosures to certify as to the accuracy of SEC filings.) We also believe that the SEC should revise its Proposed Rules to provide the board of directors with broader discretion to determine the attributes of the financial expert. We note that the Act provides attributes of a person's experiences that should be "considered" when defining a financial expert. Since the function of an audit committee is oversight, we believe, as mentioned above, that adequate attributes should include experience in reviewing or analyzing financial statements, and not just individuals that have directly prepared or audited financial statements. As written, the Proposed Rules would suggest that, although an individual may have financial expertise relevant to serve on a company's audit committee through a combination of long-standing senior executive experience in business or government and perhaps long-standing audit committee service at the issuer or other companies, they would not qualify unless they also possessed some other narrow attribute, as set forth in the Proposed Rules. Further, as the financial expert would also be a Board member, the more narrow the definition of financial expert, the more difficult it will be to find individuals who meet this criteria, and also have the broader managerial business experience sought by companies for directors generally.
We support disclosure of whether a company's audit committee members have financial expertise. However, we are concerned that disclosing the name of the individuals serving as financial experts may discourage some from serving on the audit committee due to actual or perceived heightened responsibility and potential liability as a director identified as possessing special expertise. This disclosure may have the consequences of further limiting the pool of potential recruits willing to serve. Therefore, we believe the Proposed Rules should not require companies to disclose the names of the persons the board of directors determines to be the financial experts. Rather, we believe disclosure of whether there is at least one financial expert on the audit committee should be sufficient without naming such persons. The SEC should also consider what appropriate safe harbors from federal and state liability it could provide to the financial expert so that they do not become the inappropriate focus of plaintiff's lawyers in securities lawsuits, and therefore shun away from Board service in this capacity. We also believe that the term "financial expert" should be changed to refer to this individual as "a committee member with a background in financial and accounting matters". Further, we do not believe a company should report the arrival or departure of a financial expert on Form 8-K, which could result in disclosure of the financial expert.
Using the current proposed definition of financial expert, many companies may determine they do not currently have a financial expert serving on its audit committee. Failure to disclose that a company has a financial expert could have an unwarranted negative impact on investor confidence, since the marketplace may not understand how narrow the definition is. We therefore believe the Proposed Rules should allow a transition period of at least one-year to allow companies to fully evaluate the rules and recruit, if necessary, new directors to serve as its audit committee's financial expert
Proposed Code of Ethics Disclosure
We believe that all senior financial professionals should adhere to a strong ethical code of conduct and therefore, we support the SEC's Proposed Rules requiring companies to disclose whether the company has adopted a written code of ethics for its senior financial officers. We believe that disclosing the existence of a code of ethics and filing it as an exhibit to the annual report is relevant information for investors. Albeit changes to the code of ethics or waivers thereto should occur relatively infrequently, we agree that these events should be disclosed to investors on a timely basis and support the Proposed Rules allowing companies to disclose such events on its own Internet website as an alternative to reporting this information on Form 8-K.
Management's Internal Controls and Procedures for Financial Reporting
We support the Proposed Rules requiring disclosure in a company's annual report of a report regarding management's responsibilities for establishing and maintaining adequate Internal Controls and an assessment of effectiveness of that system. We agree that the preparation of complete and accurate financial information relies upon effective Internal Controls. These Internal Controls must be established and maintained throughout the reporting periods. However, performing a quarterly evaluation of Internal Controls required by the Proposed Rules, in addition to the evaluation of disclosure controls and procedures generally may become cost prohibitive. We believe a more thorough evaluation of a company's Internal Controls can be achieved if performed annually. We therefore believe the Proposed Rules regarding management's evaluation of the effectiveness of Internal Controls should be modified to 1) be required annually versus quarterly and 2) cover the entire period of the report rather than as of the end of the company's most recent fiscal year. In addition, we believe the proposed modifications of the CEO/CFO certifications should be revised accordingly.
We appreciate the Proposed Rules requiring attestation to, and reporting on, management's internal control report by a company's independent accountant is required by the Act. We believe such procedures could provide a valuable service to investors, by providing an independent evaluation of management's procedures. We note, however, that standards for such attestation procedures and reporting have not been established, but will be "issued or adopted" by the PCAOB. Without established attestation procedures and reporting standards, we are concerned that companies will incur substantial increases in professional fees from their independent accountants. The cost of complying with this aspect of the Proposed Rules may significantly exceed the benefits to investors. As the PCAOB has yet to formally commence operations and establish such standards, we respectfully request that the SEC modify the Proposed Rules to delay the implementation of the attestation requirements until the SEC has the opportunity to propose rules addressing the form and content of the attestation report, (i.e., after the PCAOB has established such standards). This timeframe will provide an opportunity for issuers and investors to evaluate and comment on the critical issue of cost versus benefit.
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We appreciate your consideration of our views on the Proposed Rules. We would be pleased to discuss our comments further with you or members of your staff. If you have any questions regarding this letter, please feel free to contact me.