Financial Executives International
February 19, 2003
Mr. Jonathan G. Katz
Subject: File No. S7-02-03
Dear Mr. Katz:
The Committee on Corporate Reporting ("CCR") of Financial Executives International ("FEI") appreciates the opportunity to respond to the Securities and Exchange Commission's (the "Commission") Proposed Rule on Standards Relating To Listed Company Audit Committees ("Proposed Rules"). FEI is a leading international organization of 15,000 members including Chief Financial Officers, Controllers, Treasurers, Tax Executives, and other senior financial executives. CCR is a technical committee of FEI, which reviews and responds to research studies, statements, pronouncements, pending legislation, proposals, and other documents issued by domestic and international agencies and organizations. This document represents the views of CCR and not necessarily the views of FEI.
In general we are in agreement with the Proposed Rules on standards relating to listed company audit committees. We feel that the Commission has generally been true to the letter and substance of the Sarbanes - Oxley Act ("the Act") and that audit committee independence and responsibility will be enhanced through the issuance of these Proposed Rules.
Because of our strong working relationships with audit committees, and support of their responsibilities to the full Board and shareholders, we have first-hand knowledge on the execution of audit committee responsibilities and can offer insight into several areas under consideration in these Proposed Rules. Specifically, we believe our relationship provides a background to comment on auditor responsibilities, complaint procedures, other advisors and funding. With regard to these four areas, we generally find the Proposed Rules to be succinct and complete and would suggest no further specificity in the implementation of the rules. We believe that audit committees can use their own discretion in these areas, in a way that is suitable in the specific circumstances. We would suggest leaving the execution of their responsibilities in the hands of the audit committees themselves and the boards on which they serve.
In order to be responsive to your request for comment on the areas indicated, we have attached answers to specific questions that the Commission has raised about these four areas.
In addition to providing input on the above-mentioned areas, we are requesting clarification on the proposed independence criteria for audit committee members. Section 301 of the Act allows the Commission to exempt certain relationships from the independence criteria. We believe such an exemption should be provided for listings of non-equity securities issued by joint ventures and partnerships where none of the partners exert control, but all have significant influence over the entity's operations. Specifically, we believe providing an exemption to listings of 50-50 joint ventures where both parents list public securities and are subject to the proposed rule would be consistent with the definition of independence.
The proposed independence rules prohibit audit committee members from being affiliates, defined as, "a person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with the person specified." We believe an audit committee member representing a partner that does not exert control but does exert significant influence over the partnership should not be considered an affiliate. As one of the partnership's shareholders' representatives, it would be in such an audit committee member's interests to ensure fully audited financial statements are properly prepared in accordance with generally accepted accounting principles. We believe such audit committee members are generally not management, nor are they involved in the daily operations of these partnerships. Therefore, such an audit committee member would be able to represent the independent interests of the shareholders.
From a practical standpoint, a parent company's oversight responsibilities regarding a fully consolidated subsidiary and a 50-50 joint venture are similar. The financial results of the joint venture are included in the parent companies' financial statements via the equity method of accounting. Therefore, those results are also subject to the review of the parent companies' independent audit committee members. We believe this relatively narrow, yet important, distinction should be made in determining the independence of audit committee members.
We request the Commission provide clarity to the criteria for independence to address such relationships.
We appreciate the Commission's consideration of these important matters and welcome the opportunity to discuss any and all issues with the Commission at its convenience. If you have any questions regarding this letter, please feel free to call Frank Brod at (989) 636-1541 or David Sidwell at (212) 270-1892.
Proposed Rule: Standards Relating To Listed Company Audit Committees
Specific Questions Raised by The Commission
Questions regarding the proposed auditor responsibility requirement:
This proposed requirement is specific enough in its delineation of responsibilities of the audit committee relating to the public accounting firm. Additionally it leaves to the discretion of the audit committee the execution of those responsibilities in a manner that is appropriate in individual circumstances, without rigid rules.
Additional direct responsibilities beyond that of the independent auditors, like full direct responsibility of the internal auditors, are not necessary and would be potentially burdensome to an already taxed committee. The ultimate responsibility of the audit committee is the acceptance of the audited financial statements for inclusion in the annual report to shareholders. Its primary source of independent reliance on those financial statements will be through the attestation by the independent auditors, whose report is also included in the same public document as the audited financial statements. Additional full direct responsibility, including appointment, compensation and retention, for internal auditors will distract the committee from its primary responsibility.
However, since the internal auditors have a role that has similarities to the independent auditors, although not an identical role, participation in the oversight of the internal audit function by the audit committee is desirable. That oversight would include reviewing the internal audit scope, planning, staffing and resulting reports on internal controls and audit results.
Does the proposed instruction that the requirement does not conflict with, and is not affected by, any requirement that requires shareholders to ultimately elect, approve or ratify the selection of the issuer's auditor adequately address the concerns of issuers whose governing law or documents requires shareholder selection of the auditor? Are additional accommodations necessary? Please explain how any accommodation would be consistent with the Sarbanes-Oxley Act.
First, the significance of shareholder ratification is really a legal question arising under state law, not federal law. Some states may require that, for corporations organized under the law of that state, the shareholders must "appoint" the independent auditors. Other states may say that the shareholders must "ratify" the appointment made by the audit committee. Still other states may require nothing at all from the shareholders, leaving it up to each corporation's own discretion. So it is hard to say generically that there is no problem with state law in this regard. In fact, there could be a real conflict with the laws of some states.
Secondly, despite the point raised above, the legislatures and courts of the various states would be well advised to fix any such conflicts, in order to have their state laws fall into line with the Sarbanes-Oxley model. If we are ever to restore investor confidence in this process, we need to empower the audit committee (being uniquely independent and uniquely sophisticated) to appoint the independent auditors, oversee their work, compensate them, etc.
Questions regarding the proposed complaint procedures requirement:
Many companies have procedures in place for the receipt, log, retention and treatment of complaints. These processes, however, have not been for the express purpose of raising and dealing with concerns regarding questionable accounting or auditing matters. Many of the existing processes have also allowed for anonymous submissions.
FEI/CCR has taken a survey of practice in this area and found that companies generally use existing ombudsman, compliance or security departments, third party security vendors, such as Kroll, or a combination of both, to address any employee concerns or potential whistleblower issues. These infrastructures will be or have been expanded now to address accounting and audit related issues, thus providing employees with a confidential and anonymous vehicle for filing complaints via a helpline or hotline. Any accounting and finance complaints will then be passed to the head of audit, the audit committee chair, the entire audit committee, the board of directors, legal, ethics or to a combination of some or all of these parties via a formal report or summary. However, whistleblowers do have the ability to contact audit committees directly. Since Sarbanes-Oxley has been enacted, companies still estimate that about 90-95% of employee complaints pertain to human resource issues.
We feel that these procedures outlined above, as an extension of practice already in place, should prove to be an effective means of surfacing complaints in an anonymous fashion.
The proposed rules do not need to require public disclosure of the internal company procedures in Commission filings. The procedures will be made public within companies in order to properly notify employees of the appropriate means available to employees for surfacing complaints about the financial reporting process.
The rules as drafted purposefully remain silent on mandating specific procedures, to allow for diversity of practice, given the variety of companies and options available for implementing such requirements. We wholeheartedly embrace this stance by the Commission to allow for flexibility of process and allow the audit committee to execute its responsibilities in the best way it sees fit, given the specific company circumstances.
Questions regarding the proposed authority to engage advisors requirement:
The proposed audit committee authority to engage advisors seems defined enough to allow for implementation and for appropriate discretion on the part of the committee. No additional specificity is needed.
Questions regarding the proposed funding requirement:
With respect to funding for the public accounting firm as determined by the audit committee, no additional specificity is required, as the audit committee can execute its own procedures and mandates without rules to effect the appropriate funding level and oversight. Many audit committees already provide oversight and review of the audit process and fees covering such processes, so the Proposed Rules as drafted will merely codify action already being taken by the audit committee.
The compensation that would be paid to public accounting firms or any other advisors should be left to the discretion of the audit committee, with natural oversight by the full board of directors. In the execution of its duties, the audit committee would seek counsel from management, as well, on appropriate funding levels, unless there was an adversarial and contentious situation, in which case the audit committee should have full authority for funding levels. Any limits, as suggested in the question above, would be arbitrary and artificial. Only a sitting audit committee, in its own discretion, would be able to determine the appropriate circumstances for setting funding for the independent accountant and other experts.