SEC Proposes Listing Standards Rule, Adopts Investment Company Exemptive Provisions


Washington, D.C., January 8, 2003 -- The Securities and Exchange Commission today voted to publish for comment a rule proposal that would direct national securities markets to prohibit the listing of any security of an issuer not complying with audit committee requirements set out in the Sarbanes-Oxley Act of 2002. It also took action to adopt provisions to exempt transactions between investment companies and affiliated persons.

1. Transactions of Investment Companies With Portfolio and Subadviser Affiliates

The Commission voted to adopt a new rule and several rule amendments governing exemptions for transactions between investment companies and their affiliated persons. The Investment Company Act contains a number of provisions that prevent persons who may be in a position to take advantage of an investment company (fund) from entering into transactions or arrangements with the fund. These include prohibitions on "affiliated transactions" and "joint transactions" with affiliated persons.

The Act, however, gives the SEC authority to issue orders and adopt rules permitting these transactions when the SEC determines that an exemption is "necessary or appropriate in the public interest and consistent with the protection of investors." In a new rule and amendments to several rules, the Commission will codify a number of orders that have been issued to funds permitting affiliated and joint transactions with two types of affiliates described below. The rule and rule amendments will eliminate the need for funds to obtain individual exemptive orders in circumstances that are not likely to raise the concerns that the Act was intended to address.

Transactions with Portfolio Affiliates.   Currently, SEC rules permit a fund to enter into transactions with companies 5% or more of whose voting securities are owned by the fund. This type of affiliated person is unlikely to be in a position to take advantage of the fund. The amendments will expand the rules to permit funds to enter into transactions and arrangements with companies 5% or more of whose securities are owned by other funds in the fund complex. This is a technical change necessitated because the current exemptive rule pre-dated the widespread organization of mutual funds into fund complexes.

Transactions with Subadviser Affiliates.   Fund advisers are also "affiliated persons" of a fund. As a result, an adviser to a fund cannot engage in transactions with the fund (or any other fund in the fund complex) such as selling securities to the fund, which would be a form of self-dealing. The SEC has, however, issued a number of orders permitting subadvisers to enter into transactions and arrangements with other funds in the complex that other subadvisers advise. These transactions do not involve self-dealing because the subadviser participating in the transaction is not the subadviser making the decision on behalf of the fund to enter into the transaction. The SEC orders and the amendments will prohibit the subadvisers from discussing securities transactions with each other to prevent reciprocal arrangements. This relief is important because many advisers today are (or are affiliated with) broker-dealers and underwriters. Currently, once such an adviser becomes a subadviser of a fund, all of the other funds in the fund complex (even if they are advised by a different subadviser) are precluded from entering into a range of transactions with the adviser/broker-dealer unless they obtain an exemptive order from the SEC, or can rely on the SEC's exemptive rules.

The rule and rule amendments will go into effect 30 days after publication in the Federal Register.

2. Standards Relating to Listed Company Audit Committees

The Commission voted to propose a rule that would direct the national securities exchanges and national securities associations to prohibit the listing of any security of an issuer that is not in compliance with the audit committee requirements established by the Sarbanes-Oxley Act of 2002. The proposals would implement the requirements of Section 10A(m)(1) of the Securities Exchange Act of 1934, as added by Section 301 of the Sarbanes-Oxley Act of 2002.

Under the proposed rule, national securities exchanges and national securities associations would be required to prohibit the listing of any security of an issuer that is not in compliance with the following.

  • Each member of the audit committee of the issuer must be independent according to the specified criteria in Section 10A(m).
  • The audit committee must be directly responsible for the appointment, compensation, retention and oversight of the work of any registered public accounting firm engaged for the purpose of preparing or issuing an audit report or related work or performing other audit, review or attest services for the issuer, and the registered public accounting firm must report directly to the audit committee.
  • The audit committee must establish procedures for the receipt, retention and treatment of complaints regarding accounting, internal accounting controls or auditing matters, including procedures for the confidential, anonymous submission by employees of concerns regarding questionable accounting or auditing matters.
  • The audit committee must have the authority to engage independent counsel and other advisors, as it determines necessary to carry out its duties.
  • The issuer must provide appropriate funding for the audit committee.

The proposed rule would apply to both domestic and foreign listed issuers. It is important to note that, based on significant input from and dialogue with foreign regulators and foreign issuers and their advisers, several provisions have been included that seek to address the special circumstances of particular foreign jurisdictions. These provisions include, under conditions specified in the proposed rule:

  • allowing non-management employees to serve as audit committee members, consistent with "co-determination" and similar requirements in some countries;
  • allowing shareholders to select or ratify the selection of auditors, also consistent with requirements in many foreign countries;
  • allowing alternative structures such as boards of auditors to perform auditor oversight functions where such structures are provided for under local law; and
  • addressing the issue of foreign government shareholder representation on audit committees.
The proposed rule would also make several updates to the Commission's current disclosure requirements regarding audit committees, including:

  • disclosure of the use of any exemptions to the recommendations;
  • the identification of the audit committee in annual reports; and
  • updates to the audit committee independence disclosure in proxy statements.
The proposed new requirements would need to be operative no later than the first anniversary of the publication of the Commission's final rule. Comments on the proposed rule should be received by the Commission within 30 days of publication in the Federal Register.

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The full text of detailed releases concerning each of these items will be posted to the SEC Web site as soon as possible.


Last modified: 1/8/2003