ATTORNEYS AT LAW
VINSON & ELKINS L.L.P.
Mr. Jonathan G. Katz, Secretary
Dear Mr. Katz:
We are writing this letter to comment on the proposed rules on standards relating to listed company audit committees (the "Proposed Rules") particularly as they apply to master limited partnerships ("MLPs"). MLPs, as well as other controlled entities, could be dramatically and adversely impacted by the Proposed Rules. We appreciate the opportunity to submit these comments and your taking them into account in drafting the final rules.
MLPs have been proven to be an efficient tool of capital formation. In 2001 and 2002, which were extremely difficult years for the capital markets, ten MLPs completed their initial public offerings. In addition, in 2002, other MLPs raised more than $6 billion in secondary offerings. There are more than thirty MLPs currently listed on the New York Stock Exchange, American Stock Exchange or NASDAQ. Substantially all of the MLPs were formed by a sponsor who owns the general partner of the MLP ("General Partner") as well as some percentage of the limited partner interests ("Units") in the MLP, usually well in excess of 10%. The public owns the remaining Units. The typical MLP has no directors or officers. Instead, the General Partner has the sole responsibility for conducting the MLP's business and for managing its operations. In most MLPs, the officers and directors of the General Partner are, in effect, the officers and directors of the MLP1. The rights of unitholders (limited partners) are defined in the MLP's partnership agreement. Under the partnership agreement, unitholders do not directly or indirectly participate in management or operations. Although the unitholders have voting rights under certain limited circumstances2, they do not elect a board of directors. The board of directors of the General Partner serves as the board of directors of the MLP. This board is elected by the equity owners of the General Partner, in accordance with the terms of the General Partner's governing documents. As a result, the General Partner controls and governs the MLP. The General Partner, in turn, is typically controlled by its equity owner or owners (the "Control Person"). Thus, the General Partner and the MLP are affiliates of the Control Person.
The Proposed Rules
The Proposed Rules3 require that each member of an issuer's audit committee be "independent." Under the proposed independence requirements, a person elected by a Control Person to the board of directors of the MLP's General Partner will likely be deemed not to be independent and, therefore, will be ineligible to serve on the audit committee of the MLP because such a person could be deemed to be a "designee" of the Control Person. Since the structure of an MLP results in a Control Person or Persons electing the members of the MLP's General Partner, we believe that persons not otherwise affiliated with the Control Person, the General Partner or the MLP itself should satisfy the criteria for independence.
More specifically, the definition of "affiliate" in the Proposed Rules deems "a director, executive officer, partner, member, principal or designee of an affiliate" to be an affiliate of the issuer. Thus, any person elected to the board of directors of an MLP's General Partner by a Control Person, given the concept of "control" in the definition of affiliate, will likely be considered a designee of a Control Person and, therefore, an affiliate of the MLP. As such, a designee of a Control Person would not be considered independent under the proposed independence requirements and would be ineligible to serve on the audit committee of the MLP.
In view of the structure of the typical MLP, where the Control Person elects the board of directors of the General Partner of the MLP, the Proposed Rules may effectively prevent any person from being eligible to serve on the audit committee of an MLP.4 We believe that the word "designee" would likely include anyone nominated by, and elected, by the vote of a Control Person, regardless of whether the person elected is subject to the control and direction of that Control Person. But it is the control and direction of the designee by the Control Person that should be the relevant factor in denying a person eligibility to serve on the audit committee of a General Partner.
The Proposed Rules acknowledge that many companies operate in a holding company structure. Accordingly, the Commission has proposed to exempt from the definition of "affiliated person," as used in connection with determining independence of audit committee members of a publicly traded subsidiary that is majority-owned, an audit committee member that serves on the board of both a parent and a subsidiary if that member otherwise meets the independence requirements for both entities. This exemption does not solve the problem because many MLPs are not majority-owned by their Control Person. Further, if the Control Person has any business dealings with the MLP, the listing requirements of the applicable exchange or the NASDAQ may very well prohibit an audit committee member elected or designated by the Control Person from being considered independent for purposes of serving on the board of directors of the General Partner of the MLP. We believe the concept introduced in the Proposed Rules' discussion of the exemption for parent entities that "if an audit committee member .... is otherwise independent"5 should be extended to apply to persons designated by, but otherwise independent of, a Control Person, whether that Control Person is a majority owner of the MLP or not. We understand the Commission seeks to achieve flexibility by way of proposed exemptions from the definition of "Affiliated Person." We believe that additional flexibility will be needed to account for the small but important market segment of MLPs. This flexibility can be achieved in a manner consistent with the Commission's overall objective of ensuring independence without unnecessarily impeding the efficient formation of capital through this important vehicle.
Although we are hesitant to speculate as to the full universe of entities that will be impacted by the Proposed Rules, we note that the Proposed Rules will affect many other controlling shareholders or groups of controlling shareholders as dramatically and adversely as Control Persons of MLPs.
Suggested Amendments to Proposed Rules
In our view, the act of designation by a Control Person should not alone render a person ineligible to serve on the audit committee of an MLP. To address this, we suggest the Proposed Rules be amended to:
We also suggest that the proposed 90-day exemption from the audit committee independence requirements for new public issuers, including new MLPs, be lengthened and made consistent with the current requirements of the New York Stock Exchange, which provide that two of the three independent audit committee members be appointed within 90 days of the initial public offering and the third member be elected within one year of the initial public offering. We believe that issuers will need this amount of time to identify appropriate independent audit committee members because of the heightened financial literacy requirements and increased responsibilities that the Commission's new rules on audit committees will require as well as a perceived increase in such members' exposure to liability. Furthermore, we believe issuers involved in an initial public offering will have particular difficulty in attracting independent directors (and potential audit committee members) due to the uncertainty surrounding the consummation of the offering as well as potential liability concerns. By utilizing the time periods which require that two independent audit committee members be appointed within 90 days of an initial public offering, it is likely the new issuer will have a functioning audit committee prior to the issuance of its second quarterly report, and even more likely that it will have a functioning audit committee prior to the issuance of its first annual report, which seems to provide a reasonable balance between the needs of investors and the difficulty of finding qualified audit committee members.
Once again, thank you for the opportunity to submit these suggestions and taking them into account in drafting the final rules. If you have any questions regarding our comments, please do not hesitate to call Dan Fleckman at (713) 758-3706, Bill Finnegan at (713) 758-3704, or Paul Maco at (202) 639-6705.