Department of Finance
Government of Canada
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, NW
Washington DC 20549-0609
Dear Mr. Katz:
SUBJECT: File No. S7-02-03
I am writing you concerning the Securities and Exchange Commission's (SEC) proposed rule, "Standards Relating to Listed Company Audit Committees", issued on January 8 (File No. S7-02-03) (Proposed Rule). On behalf of the Department of Finance, I would like to provide specific comments on the proposed audit responsibility requirement contained in the Proposed Rule, to ensure its consistency with Canadian corporate law and federal financial institution statutes, which require that shareholders be responsible for the appointment of the auditor.
Section 301 of the Sarbanes-Oxley Act requires audit committees to be directly responsible for the appointment, compensation, and oversight of the company's auditor. As you know, concerns have been raised regarding the application of this requirement to companies in jurisdictions where shareholders are responsible for the appointment of the auditor, given the potential for conflict with other national law. The Proposed Rule recognizes that the goal of enhancing audit committee control over the appointment of the auditor can be met through different approaches, and provides a number of accommodations for home country requirements of foreign private issuers.
The particular requirement of concern to Canada is contained in s. 240.10A-3(b)(2)(i) (Requirement) and the accompanying instructions to the Requirement (Instruction). Paragraph 1 of the Instruction provides that the Requirement does not conflict with, and is not affected by, any requirement that requires shareholders to ultimately elect, approve or ratify the auditor selection. The Instruction indicates that, where an issuer provides a recommendation or nomination of an auditor to its shareholders, the audit committee must be responsible for making the recommendation or nomination. The Instruction also states that the Requirement does not conflict with any requirement in a company's home jurisdiction that prohibits the full board of directors from delegating the responsibility to select the company's auditors to a committee of the board; in that case, the audit committee must be granted advisory and other powers with respect to such matters to the extent permitted in law, including the submitting of nominations or recommendations to the full board.
Under the federal Canada Business Corporations Act (CBCA) and federal financial institution statutes (e.g., Bank Act), shareholders are responsible for appointing, at their annual meeting, the company's auditor. In addition, shareholders may fix the remuneration of the company auditor and have the power to remove the auditor at a special meeting of shareholders. The Ontario Business Corporations Act and a number of other provincial corporate statutes contain identical or very similar auditor appointment provisions. In the case of a number of these federal and provincial statutes, the company nominates or recommends the auditor to shareholders through a management proxy circular, which must be approved by the board of directors.
An important feature of these statutes is that the board of directors cannot delegate to a committee of directors the authority to submit to shareholders any question or matter requiring the approval of shareholders. For example, the CBCA states that the directors of a corporation may appoint from their number a committee of directors and delegate to such committee any of the powers of the directors (s. 115(1)). However, specific limitations are placed on this delegation power; the relevant limitation in the current context is that no committee of directors can "submit to the shareholders any question or matter requiring the approval of the shareholders" (s. 115(3)(a)). Consequently, the audit committee cannot submit any question or matter relating to the appointment of the auditor directly to shareholders for approval. This limitation on delegation is meant to ensure that the board of directors is ultimately accountable to shareholders for all critical decisions.
Clarification of the proposed Instruction is therefore needed in order to ensure that Canadian corporate law and federal financial institution statutes do not conflict with the proposed Requirement. As mentioned, the Instruction indicates that, where an issuer provides a recommendation or nomination of an auditor to its shareholders, the audit committee must be responsible for making the recommendation or nomination; however, the Instruction does not specify whether the committee's recommendation must be made directly to shareholders, or whether the recommendation can be provided indirectly to shareholders, through advice to the board and a subsequent recommendation from the board to shareholders. If the audit committee must provide the recommendation or nomination directly to shareholders, then there would be a conflict with Canadian law.
The proposed Instruction appears to accommodate the Canadian system by recognizing the potential barriers on the delegation of authority from boards of directors to audit and other committees of the board, and by proposing, in this case, that the audit committee must provide an advisory function. The Instruction describes a system of corporate law in which the board of directors has responsibility for selecting the auditor. However, this system is not fully consistent with Canadian corporate law and federal financial institution statutes, since boards of directors do not have the power under these statutes to appoint the auditor.
We would recommend clarification to ensure that the Canadian system of corporate governance is adequately recognized. Language could be added to the Instruction to clarify that, "if the issuer provides a recommendation or nomination of an auditor to its shareholders, the audit committee of the issuer, or body performing similar functions, must be responsible for making the recommendation or nomination, either directly to shareholders or indirectly to shareholders through the full board of directors". We believe that this clarification is consistent with the objectives of the Proposed Rule while avoiding any potential conflicts with Canadian legal requirements.
We would also recommend clarification regarding the consistency of the Proposed Rule with Canadian corporate law and federal financial institution statutes in respect of the ability of shareholders to fix the remuneration of the auditor and to remove an auditor. The Proposed Rule should, in our view, recognize the powers of shareholders in these areas under national law. Such recognition would be consistent with the objectives of the Rule.
Fostering investor confidence is a goal the Canadian government shares with the United States Congress and the SEC. Given the similarity of policy objectives and capital market regulatory frameworks in our countries, we are confident that we can achieve co-operative solutions to the concerns of foreign issuers that have arisen in implementing the Sarbanes-Oxley Act. We therefore look forward to receiving clarification on the proposed Instruction. We also look forward to a favourable resolution on Section 402 (prohibition on loans to directors and officers) in respect of Canadian financial institutions, an issue that the Canadian government raised with the SEC in its letter of October 8. In addition, we are continuing to follow U.S. developments on auditor oversight and will shortly be providing additional information on the Canadian system, including the operations of the new Canadian Public Accountability Board.
Thank you for considering these comments. We look forward to a constructive dialogue in the ongoing implementation of the Sarbanes-Oxley Act.
Financial Sector Policy Branch