Hermes Investment Management

Jonathan Katz,
US Securities & Exchange Commission,
450 Fifth Street, NW,
DC 20549-0609,

January 8th 2003

Dear Mr Katz,

Re: Release No 33-8154 File No S7-49-02

Hermes Investment Management is grateful to be able to comment on the proposed rule changes with regard to auditor independence.

By way of background, Hermes Investment Management is owned by, and is the principal fund manager for, the British Telecom Pension Scheme, the UK's largest. Hermes also manages portfolios for the Royal Mail Pension Scheme and a number of other major corporate and public pension schemes. In total, Hermes currently manages over $65 billion, of which about $2.5 billion is invested in the US. As well as intervening directly, Hermes participates in the governance debate in the US through our international membership of the Council of Institutional Investors (CII) and through an informal corporate governance alliance with CalPERS.

Hermes supports the SEC's proposed reforms. In particular, we believe that board audit committees need to play a greater role in ensuring that the independence of the outside auditors is maintained. As the proposed reforms detail, this will involve the committee having oversight of the hiring of the auditors, managing the relationship with them and approving the provision of any non-audit services by them. Furthermore, we believe that the disclosure proposals will provide investors with a degree of comfort that the proper procedures are in place and that the resulting dealings with the auditors do not challenge their independence.

Together with a number of other major institutional investors in the UK and worldwide, Hermes has developed the attached paper on auditor independence best practice, which may be of interest to you in the context of your current consultation.

Yours sincerely,

Shareholder Engagement Manager


We, as large institutional investors, regard the independence of auditors, both in reality and perception, as of paramount importance to maintaining both the confidence of shareholders, who rely on audited financial statements, and the stability of global financial markets.

In this regard, we expect the corporations in whose securities we invest, or might invest, to give careful consideration to the following guidelines.

  • Corporations should have effective audit committees, which are genuinely independent of both management and auditors. Such committees should:

    • annually conduct a meaningful evaluation of the audit services and the relationship between the auditor and the corporation's directors and officers.

    • ensure they establish and maintain independent channels of communication with the auditors, including other members of the audit team in addition to the engagement partner when appropriate.

    • have a clear policy, supported by effective processes, to ensure the provision of non-audit services by the auditor and its affiliates does not affect the auditors' independence, perceived or real.

    • annually consider the re-appointment of the auditors, and make an appropriate recommendation to the Board and or to the shareholders as appropriate.

    • consider the benefits of seeking tenders for the audit at regular and appropriate intervals. In evaluating such tenders we expect audit committees to pay particular regard to the quality of the audit and not just its cost.

    • have access to independent sources of advice, including but not limited to technical accounting advice. This advice should be sought and obtained when the audit committee deems it necessary.

    • approve employment policies designed to prevent conflicts of interest arising from the interchange of personnel between the audit team and corporation's audit related staff.

  • Corporations should, subject to constraints of commercial confidentiality, disclose:

    • the nature and quantum of audit and non-audit services provided by the auditor, analysed in sufficient detail to enable shareholders to make an informed decision in respect of the resolution to re-elect the auditors.

    • a summary of the audit committee's charter

    • a commentary on the audit committee's composition and activities, up to and including the date of the audit report. This could include

      • the number of meetings held;

      • the factors that influenced the balance of the committee and the selection of its members;

      • a summary of the process used to control the provision of non-audit services by the auditor and its affiliates.

  • Corporations should promptly inform investors when there has been a change of auditors, and explain why the change was made.

  • Corporations should have processes designed to ensure the competence of their audit committee and its members and when appropriate, they should provide independent training to ensure that competence is maintained.

  • When appointing new auditors, regard should be had to any conflicts of interest arising from pre-existing relationships between the corporation and the proposed new firm of auditors.

At our discretion, we will use best endeavours to communicate to corporations when we have concerns about the independence of the auditors. We may reinforce our concerns, especially if such concerns have not been addressed to our satisfaction.