Shearman & Sterling
Mr. Jonathan G. Katz
Release Nos. 33-8177, 34-47235; File No. S7-40-02
Dear Mr. Katz:
We welcome the opportunity to comment on certain issues raised in the captioned final rule (the "Final Rule"). This letter is addressed to you on behalf of Toyota Motor Corporation, Advantest Corporation and Pioneer Corporation (the "Companies"). We support and appreciate the efforts of the Securities and Exchange Commission (the "Commission") to modify the audit committee financial expert requirements for foreign private issuers. While we expect that the Final Rule will facilitate compliance with the audit committee financial expert requirements by most foreign private issuers, it remains inconsistent with major aspects of the Japanese corporate governance system and places a disproportionate burden on Japanese private issuers, including the Companies, as discussed below. In support of Japan Business Federation's comment letter dated February 18, 2003 submitted to the Commission regarding Section 407 of the Sarbanes-Oxley Act of 2002 (the "Act"), we are writing to urge the Commission to extend the board of auditors exemption set forth under 10A-3(c)(2) of the proposed rule for implementing Section 301 of the Act (the "Proposed Rule") to the audit committee financial expert disclosure requirements under Section 407 of the Act.
A. Japanese Issuers with a Board of Auditors Should be Exempt from the Disclosure Requirements under Section 407 of the Act
As we discuss in our comment letter submitted to the Commission as of even date herewith relating to Section 301 of the Act, the duties of the Japanese board of corporate auditors ("Board of Auditors") are defined by Japanese corporate governance standards. Statutory auditors constituting the Japanese Board of Auditors are already subject to various eligibility standards under Japanese law, including independence requirements. We believe the same reasons that underlie the Commission's proposal to exempt Boards of Auditors meeting the standards specified in Proposed Rule 10A-3(c)(2) justify exclusion of those issuers relying on such exemption from the audit committee financial expert disclosure requirements.
The designation of an audit committee financial expert is inconsistent with the function of the Japanese Board of Auditors as it operates as part of the Japanese corporate governance system, and inclusion of an audit committee financial expert as defined in the Final Rule would be inconsistent with the nature and responsibilities of the members of the Board of Auditors envisaged by Japanese law. Under Japanese corporate law, the Japanese Board of Auditors, or each statutory auditor comprising the Board of Auditors, is given the following principal powers and duties:
Accordingly, the statutory auditors comprising the Japanese Board of Auditors are required to perform a wide range of functions including but beyond the oversight of the work of the registered public accountants. The inclusion of a specialized audit committee financial expert would be incompatible with the overall role of the Board of Auditors within the Japanese corporate governance system.
In addition, the requirement to discuss the "independence" of an audit committee financial expert is inconsistent with the exemption provided by Proposed Rule 10A-3, which exempts the Board of Auditors from the independence standard of the rule and relies on home country law or listing standard. Moreover, if the Commission intends to suggest, through this disclosure requirement, that an issuer with a qualifying exempt Board of Auditors should have a member that meets U.S. defined independence standards, we believe this would be truly intrusive into the Board of Auditors system under Japanese law and would create the implication that one member of the Board of Auditors is more independent than the others.
For these reasons, we believe Japanese issuers with a Board of Auditors should be exempt from the disclosure requirements under Section 407 of the Act.
B. Japanese Issuers Should be Permitted to Designate an Expert Familiar with Local GAAP
If the Commission determines nonetheless not to exempt companies relying on the Board of Auditors' exemption of Proposed Rule 10A-3 from the Section 407 disclosures, we urge the Commission to extend to Japanese Companies the same right to have the expert qualify under home country generally accepted accounting principles ("GAAP"), rather than require U.S. GAAP expertise.
We concur with the Commission's change in the Final Rule, under the Instructions to Item 16A, permitting foreign private issuers who reconcile to U.S. GAAP to appoint audit committee financial experts who are familiar with the GAAP used by the issuer in its primary financial statements filed with the Commission. However, unlike most foreign private issuers, Japanese issuers cannot qualify their expert under home country GAAP, as essentially all Japanese issuers, including the Companies, elect to prepare their financial statements filed with the Commission under U.S. GAAP.
For almost all Japanese issuers electing to report under U.S. GAAP, their Japanese GAAP accountants are the financial experts most familiar with the company and its accounting and controls. Most Japanese issuers prepare the U.S. GAAP financial statements primarily for Form 20-F reporting, while still using Japanese GAAP for purposes of managing the company. Generally, Japanese issuers prepare their Japanese GAAP financial statements first. The Japanese statements are then used as a basis to convert to U.S. GAAP statements.
As a result of such accounting practices, the number of experts resident in Japan who are familiar with U.S. GAAP is extremely limited and those familiar with both U.S. and Japanese GAAP are even rarer. While there are a growing number of persons in Japan who are either U.S.-qualified accountants or otherwise familiar with U.S. GAAP, the overwhelming majority of them are relatively inexperienced and do not yet possess the specialized knowledge and professional experience required under the Final Rule.
Accordingly, if the Final Rule remains unchanged, we expect many, if not a majority of, Japanese issuers to be unable to appoint an audit committee financial expert as currently defined. These Japanese issuers, whose Boards of Auditors are proposed to be recognized by the Commission as meeting the purposes of Section 301 of the Sarbanes-Oxley Act, would nonetheless be required to disclose their lack of audit committee financial experts despite their compliance with the requirements of Japanese corporate law. Considering that Japanese issuers have assumed the extra burden and cost of preparing their primary financial statements filed with the Commission under U.S. GAAP for the benefit of U.S. investors rather than relying on a U.S. GAAP reconciliation as most other foreign private issuers do, we believe that they should not be disproportionately burdened by the audit committee financial expert requirements relative to most other foreign private issuers, given that both categories of issuers are managing principally on a home country basis.
C. Request for Exemption for Japanese Issuers
For these reasons, we agree with Japan Business Federation's comment letter submitted to the Commission regarding Section 407 of the Sarbanes-Oxley Act of 2002, and recommend the Commission to exempt Japanese issuers with a Board of Auditors from the disclosure requirements under Section 407 of the Act.
In the event that the Commission determines that Japanese private issuers should continue to be subject to disclosure requirements under the Final Rule, we would suggest that the Instructions to Item 16A be amended to permit foreign private issuers to designate an audit committee financial expert who is expert in the GAAP such issuer uses to manage the company, even if the issuer voluntarily elects to report under U.S. GAAP for purposes of filing with the Commission.
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We appreciate the opportunity to comment on the Final Rule. If the Commission or its staff have any questions concerning the foregoing, please call Masahisa Ikeda at (011-813) 5251-1601 or Linda C. Quinn at (212) 848-8747.