29 January 2003
Dear Mr. Katz:
This letter relates to the proposed adoption by the Securities and Exchange Commission of rules under Section 301 of the Sarbanes-Oxley Act of 2002 (the "S-O Act") and is addressed to you on behalf of Royal Dutch Petroleum Company ("Royal Dutch") and The "Shell" Transport and Trading Company ("Shell Transport"). We are providing these comments, because certain aspects of the proposed rules would be incompatible with important features of Royal Dutch's and Shell Transport's overall corporate governance structure, and could require changes that would weaken, rather than strengthen, the audit committee structure.
Royal Dutch and Shell Transport (the "Parent Companies") are each foreign private issuers under the Securities Exchange Act of 1934 (the "Exchange Act") which have equity securities registered under Section 12 of the Exchange Act and traded on the New York Stock Exchange (the "NYSE"). The Parent Companies collectively own numerous operating and service companies that are referred to as the Royal Dutch/Shell Group of Companies or the "Group". Royal Dutch and Shell Transport formed an alliance in 1907, when they agreed to merge their interests while remaining separate entities at the Parent Company level. As a result, they do not directly engage themselves in operational activities. The Parent Companies have formed joint, or "Group", committees to oversee management and to carry out other important corporate governance functions for the Parent Companies and the Group, including a Group Audit Committee since 1976 as well as a Group Remuneration and Succession Review Committee since 1967. This structure is responsive to the applicable requirements of Dutch and English law and has been accepted by the respective stock exchanges in The Netherlands and the UK, which are the home country markets where the Parent Companies' securities are traded.
As proposed, the rules would require the Group Audit Committee to be divided into two parts, with each part associated with only one of the Parent Companies. As described below, we believe that such a requirement would give rise to needless potential conflicts and duplication of effort and would not be in the best interest of the respective shareholders of the Parent Companies. In the release for the proposed rules, the SEC has sought to avoid unintended consequences for foreign private issuers where features of the audit committee are appropriately tailored to their corporate governance structures and home country legal requirements. We believe that Royal Dutch's and Shell Transport's Group Audit Committee structure reflects the economic reality of the Group. It conforms to the highest global standards of corporate governance best practices, and fully meets the goals of the S-O Act because it strengthens the audit committee's effectiveness.
Group Audit Committee Structure. As applied separately to each of Royal Dutch and Shell Transport, the Group Audit Committee would not satisfy the requirement of the proposed rules that the audit committee of an issuer be comprised exclusively of persons who are "members of the board of directors of the issuer," although the Group Audit Committee structure does not present the type of circumstances the proposed rules are designed to protect against. The Group Audit Committee is currently responsible for supervising the preparation of the financial accounts and reports of the Royal Dutch/Shell Group of Companies and will be responsible for Parent Company accounts as well. It also performs the other typical audit committee functions. The Group Audit Committee currently consists of six persons, three of whom are non-executive members of the Supervisory Board of Royal Dutch and three of whom are non-executive members of the Board of Directors of Shell Transport. However, Royal Dutch and Shell Transport do not have overlapping directors. Accordingly, each member of the Group Audit Committee is a member of the relevant board of only one, but not both, of the Parent Companies. In order to satisfy this aspect of the proposed rules, the Parent Companies would have to divide the Group Audit Committee into two separate committees, one composed solely of the members who serve on the Supervisory Board of Royal Dutch and one composed solely of the members who serve on the Board of Directors of Shell Transport. We do not believe that the rules should require this result.
We believe that dividing the Group Audit Committee into two separate audit committees could generate possible conflicts between the authorities and functions of the two audit committees, because each audit committee would be required to review the Group accounts (in addition to the relevant Parent Company accounts, which in all material respects merely reflect the interests in the Group), oversee the same external auditors of those accounts and resolve disputes with management. This creates the potential for needless conflicts between the separate audit committees, which would be better addressed within the existing framework of a single audit committee. On account of analogous concerns, the proposing release provides an exemption from the independence requirements for "boards of auditors and similar bodies", and explains that "[t]he establishment of an audit committee in addition to these bodies, with duplicative functions, might not only be costly and inefficient, but it also could generate possible conflicts of powers and duties."1
In addition, two separate audit committees for the Royal Dutch/Shell Group of Companies would be inefficient, because their overlapping responsibilities would result in needless duplication of effort and expense. In contrast, by maintaining the Group structure, the audit committee would be able to pool expertise, resources and insights from all the Group Audit Committee members, which is in the best interest of shareholders of both Parent Companies and consistent with the purposes of the S-O Act.2
We are therefore requesting that the SEC provide an exception to permit members of an audit committee to include non-directors in this exceptional case. The text of our proposed exception is contained in Annex A to this letter. The importance of an exception at this stage is further underscored by the fact that the SEC has proposed that it will not, and will not permit the NYSE to, grant exemptions or waivers on a case-by-case basis after final rules are effective in this area.
Independence and "Affiliated Persons". We believe that, for purposes of the audit committee rules, members of the Group Audit Committee should not be treated as "affiliated persons" solely on account of the relationship of the Parent Companies to each other, and we request that the SEC confirm that the corporate structures of Royal Dutch and Shell Transport would not cause the members of the board of directors to fail to meet the "independence" test.
In order to be considered "independent" under the proposed rules, a member of the audit committee cannot, among other things, be an "affiliated person" of the issuer. The definition of an "affiliated person" includes any director, executive officer, partner, member, principal or designee of an "affiliate," and an "affiliate" of the issuer is defined as any "person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with" the issuer. Neither of Royal Dutch or Shell Transport controls the other. Further, the collective ownership of the Group companies, and the oversight of those companies through representation on board and management committees of these companies, are not "control" relationships that could affect the independent judgment of Group Audit Committee members, and are therefore not types of relationships that should cause two entities to be treated as affiliates under the proposed rules. We are requesting that the SEC expressly confirm that this is the intended result of the proposed rules. In our view, the term "affiliated persons" should be directed at disqualifying persons with improper relations with management of the issuer, which would be in the spirit of the S-O Act by focusing on conflicts of interest with management, rather than disqualifying persons with relations with shareholders, whose interests the audit committee is designed to promote.3 The text of our proposed provision is contained in Annex A to this letter.
Because of the importance of this matter to Royal Dutch and Shell Transport, we would appreciate the opportunity to meet with Alan Beller, Paul Dudek, Jeffrey Minton and Elizabeth Murphy to discuss these comments at your earliest convenience.
We have been assisted by our US counsel, Cravath, Swaine & Moore, in the preparation of this letter. Please feel free to contact the undersigned (at +44 207 934 3003 and Judith.Boynton@Shell.com), or William P. Rogers (at +44 207 453 1071 and WRogers@Cravath.com) or Christopher S. Harrison (at +44 207 453 1071 and CHarrison@Cravath.com) of Cravath, regarding these comments.
Very truly yours,
Shell International Limited
By Judith G Boynton,
Suggested Provisions Relating to Dual Holding Companies
Add to the end of Rule 10A-3(b)(1)(i):
Add to Rule 10A-3(e)(1) as a new clause (iii):
Add new paragraph 9 to Rule 10A-3(e):