January 23, 2003
Mr. Jonathan G. Katz, Secretary
Subject: File No. S7-02-03, "Standards Relating to Listed Company Audit Committees"
Dear Mr. Katz:
By way of background, I am a retired partner from KPMG LLP after a 37-year career, which included election to that Firm's Board, appointment to its Management Committee, and managing a major office and audit practice. Today, I am a CPA and investor who has not accepted public board service pending the SEC's adoption of final rules relating to board service.
My purpose in responding to the subject File No. S7-02-03 is to applaud the SEC for the professional manner in which it addressed these issues in this Proposed Rule. On balance, the proposed changes seem fair, reasonable, and workable to help in the long journey of restoring investor confidence. In connection with the Proposed Rule, I have the following specific comments in certain areas.
Audit Committee Member Independence
The SEC's proposal would not preclude independence on the basis of ordinary course of commercial business relationships between an issuer and an entity with which a director had a relationship. Thus, the proposed independence requirements relate to current relationships with the audit committee member and related persons.
In response to the SEC's question of whether a "look-back" period (also referred to as a cooling off period) before the appointment of the member to the audit committee, my response is that the SEC made the correct decision by not requiring any such period. When one leaves an entity, a new phase of his/her life begins which does not include any ownership in or obligation to that former enterprise. No magical number of years (e.g. three or five years) will erase the appearance that one was once associated with that entity. Independence is a cornerstone of the public accounting profession and likewise should be viewed as such for an independent director of a public company. There is too much risk and hard work required for public board service in today's business environment for a director to have other than the proper attitude about his/her independence, regardless of prior affiliations.
If the SEC decides that a cooling off period is necessary, it would also seem inconsistent to the investing public that a former partner or employee of an accounting firm could join an issuer in an accounting role or financial reporting oversight role after participating in its audit and be considered acceptable for independence purposes after one year (SEC's proposed rule on strengthening auditor independence, File No. S7-49-02, which was adopted as a final rule on January 22, 2003) whereas a former partner or employee of an accounting firm considered for a directorship would be subjected to a longer period. Bear in mind, in that proposed rule the SEC included directors in its definition of financial reporting oversight role, and the Sarbanes-Oxley Act specified that the cooling off period must be one year. Accordingly, if any cooling off period is appropriate for a director, the maximum should be the same one-year period.
Audit Committee Member Independence, continued
Under this Proposed Rule, the SEC specified two basic criteria for enhancing audit committee independence namely the barring of acceptance of fees other than that of a board and committee member and prohibition of an affiliated person. However, the text of this Proposed Rule is silent regarding a former partner or employee of an accounting firm who might be considered for directorship for an issuer that is a client of his/her former firm. Since these type of professionals would seem desirable to the SEC and the public for board and audit committee service, it would seem appropriate that the SEC have the same requirements in this Proposed Rule as were specified in the proposed rule in File No. S7-49-02. These requirements include having no influence on the accounting firm's operations or financial policies, no capital balances in that firm, and no financial arrangement with that firm other than one provided for regular payment of a fixed dollar amount (not based on revenues or profits of that firm) pursuant to a fully funded retirement plan or rabbi trust. Many partners and possibility employees would have retirement plans from their former firms and adding this clarification would assist them and the issuers in making determinations for board and audit committee service.
Let me give you one example of how independence can be interpreted today without specific rules. A company informally contacted a national exchange and asked about consideration of a former audit partner of its current accounting firm to serve on its board. Incidentally, the issuer was not even a client when that audit partner was with his former firm The advice given was that a partner would have to be separated form his/her accounting firm for five years, and further, the same rule would apply to any former partner whose firm is performing internal audit outsourcing for the issuer. Clarification of the SEC's rules would eliminate any further ambiguity in this important area of independence.
The board of directors can determine whether an audit committee member is independent under the SEC's Proposed Rule, especially with the suggested changes in the second preceding paragraph. Required disclosure of that determination apart from presentation of that candidate to the shareholders for election should not be necessary.
Responsibilities Relating to Registered Public Accounting Firms
Since the SEC's Proposed Rule addresses standards relating to listed company audit companies, it would seem that a bit more specificity on the preapproval requirements of non-audit services would be appropriate. While it is recognized that this area is aptly discussed in Sections 201 and 202 of the Sarbanes-Oxley Act that amends the Securities Exchange Act of 1934 and in the SEC's File No. S7-49-02, adding the requirement for preapproval of non-audit services to Part 240.10A-3 under "(2) Responsibilities relating to registered public accounting firms" in the Proposed Rule would seem helpful.
The SEC has raised the question, "Should the audit committee also be directly responsible for the appointment, compensation, retention and oversight of an issuer's internal auditor?" In my view, the internal audit role in an enterprise is far different than that of the independent audit firm. There are many projects and ongoing activities that internal audit performs on behalf of its management that can be most beneficial to the enterprise. While internal audit also can also be most helpful to the public accounting firm and the audit committee serving the issuer, its primary emphasis should be serving management on a day-to-day basis. Therefore, the audit committee should not have the direct responsibility for internal audit. Internal audit should report to the highest level of the issuer, preferably to the Chief Executive Officer, with a dotted reporting line to the audit committee. Under this reporting, the audit committee can have free access to internal audit for meetings and any special projects. Certainly the audit committee should provide input to the CEO on internal audit performance. In practice, internal audit may feel it has two masters, but that is workable.
Thanks for the opportunity to comment on this Proposed Rule.