Comments of Osler, Hoskin & Harcourt LLP on S7-02-03

Osler, Hoskin & Harcourt LLP

February 18, 2003

SENT BY E-MAIL TO: rule-comments@sec.gov

U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549-0609

Attention: Jonathan G. Katz, Secretary

Ladies and Gentlemen:

File No. S7-02-03
Proposed Rule: Standards Relating To Listed Company Audit Committees (Release Nos. 33-8173; 34-47137; IC-25885)

This letter sets forth our comments on the proposed rule titled "Standards Relating to Listed Company Audit Committees", as published in the releases referred to above (the "Proposed Rule"). We are a Canadian law firm, and we are limiting our comments in this letter to the provisions of proposed §240.10A-3(b)(1)(iv)(D), which creates a limited exemption from the audit committee composition requirements for foreign private issuers.

The Proposed Independence Requirements

The Proposed Rule requires, among other things, that each member of the audit committee be "independent". In order to satisfy that requirement, an audit committee member may not:

Accept directly or indirectly any consulting, advisory, or other compensatory fee from the issuer [proposed §240.10A-3(b)(1)(ii)(A)]; or
Be an affiliated person of the issuer or any subsidiary thereof [proposed §240.10A-3(b)(1)(ii)(B)].

Limited Exemption from Independence Requirements for Foreign Private Issuers

The Proposed Rule contains a limited exemption from the independence requirements available to one member of the audit committee of a foreign private issuer if specified conditions are met. Proposed §240.10A-3(b)(1)(iv)(D) states:

(D) One member of the audit committee of a foreign private issuer may be exempt from the requirements of paragraph (b)(1)(ii)(B) of this section [i.e., the requirement not to be an affiliated person] if that member meets the following requirements:
(1) The member is a beneficial owner of more than 50% of the voting common equity of the foreign private issuer or is a representative or designee of such an owner or a group of owners that collectively are the beneficial owner of more than 50% of the voting common equity of the foreign private issuer [emphasis added];
(2) The member has only observer status on, and is not a voting member or the chair of, the audit committee; and
(3) The member is not an executive officer of the foreign private issuer.

Voting Common Equity vs. Voting Rights

As recognized in the proposing release:

Controlling shareholders or shareholder groups are more prevalent among foreign issuers than in the United States, and those controlling shareholders have traditionally played a more prominent role in corporate governance.

This is particularly the case in Canada, where it is relatively common for widely-held public companies to have a controlling shareholder or shareholder group. It is quite common for Canadian public companies to have a two-tiered structure for their common equity. There are some which have a class of non-voting equity shares and a class of voting equity shares. It is more common, however, for Canadian companies to have a class of subordinate voting shares and a class of multiple voting shares. The multiple voting shares, which may be entitled to ten, twenty, or in some cases even 500 votes per share, are often held by the company's founders as a means of allowing them to retain control while also allowing the public to participate in equity ownership. The Canadian securities regulators impose rigid disclosure requirements on companies adopting a two-tiered voting structure in order to ensure that all investors in non-voting or subordinate-voting equity shares are making a fully-informed investment decision. Further, these issuers are required to provide "coat-tail" protection to holders of their non-voting or subordinate voting shares, which is a mechanism designed to ensure that the holders of those securities can participate equally with the controlling shareholder in any "control premium" that might be offered to the controlling shareholder in a public tender offer.

Proposed §240.10A-3(b)(1)(iv)(D) would allow one non-voting member of an audit committee to be a beneficial owner, or representative of a beneficial owner, of more than 50% of the issuer's voting common equity. Because of the dual-class voting structure so prevalent in Canada, many Canadian controlling shareholders possess more than 50% of the voting rights attaching to all of the issuer's outstanding equity securities, but do not possess more than 50% of the number of voting equity securities that the issuer has outstanding. We believe that it was the intention of the Proposed Rule to allow a controlling shareholder, as determined on the basis of its voting rights, to have the benefit of the exemption. We therefore request that the Commission consider amending the text of proposed §240.10A-3(b)(1)(iv)(D)(1) to read:

The member is a beneficial owner of securities carrying more than 50% of the voting rights attaching to all of the outstanding voting securities of the foreign private issuer or is a representative or designee of such an owner or a group of owners that collectively are the beneficial owner of securities carrying more than 50% of the voting rights attaching to all of the outstanding voting securities of the foreign private issuer [emphasis added]...

Compensation of Controlling Shareholder's Representative

The exemption in proposed §240.10A-3(b)(1)(iv)(D) provides relief from only one of the two aspects of the otherwise applicable independence requirements. That section states that one member of the audit committee of a foreign private issuer may, subject to specified conditions, be exempt from paragraph (b)(1)(ii)(B), which is the requirement that an audit committee member may not be an affiliated person of the issuer or any subsidiary thereof. It does not provide an exemption from paragraph (b)(1)(ii)(A), which is the requirement that an audit committee member may not accept directly or indirectly any consulting, advisory, or other compensatory fee from the issuer. Further, it appears to be the Commission's view, as stated in the last paragraph on page 6 of the proposing release, that this requirement extends to "...any consulting, advisory or other compensatory fee [received] from the issuer or an affiliate of the issuer". If this is the case, paragraph (b)(1)(ii)(A) would prevent the controlling shareholder from providing any compensation (including salary as an employee) to its representative or designee who is serving as a non-voting audit committee member of the issuer. Further, the proposing release states (in the second full paragraph on page 20) that one of the conditions of the availability of the exemption is that the "no compensation" prong of the independence requirements must be satisfied.

It is unclear to us why, as a policy matter, a non-voting audit committee member representing the interests of a controlling shareholder should not be allowed to receive compensation from the controlling shareholder for so doing. As a practical matter, we believe it would be difficult, if not impossible, for a controlling shareholder to find an individual, other than an employee, who would be willing to act as its representative or designee on an audit committee (and not even be entitled to full voting participation as a member of the committee), without receiving any compensation except for committee member's fees.

We therefore request that the Commission consider revising the exemption contained in §240.10A-3(b)(1)(iv)(D) of the Proposed Rule to provide relief from both (b)(1)(ii)(A) and (b)(1)(ii)(B) of the section, so that it would state:

(D) One member of the audit committee of a foreign private issuer may be exempt from the requirements of paragraph (b)(1)(ii) of this section if that member meets the following requirements...

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If you have any questions or would like to discuss further any aspect of this comment letter, please contact Robert Lando at (212) 907-0504 or rlando@osler.com.

Yours very truly,

Osler, Hoskin & Harcourt LLP
Canadian Lawyers