American Institute of Certified Public Accountants
February 18, 2003
Jonathan G. Katz
Re: SEC File No. S7-02-03
Members and Staff of the Commission:
The American Institute of Certified Public Accountants (the "AICPA") respectfully submits the following written comments on the Securities and Exchange Commission's (the "SEC" or the "Commission") proposed rules regarding standards relating to listed company audit committees (the "Proposal"). The AICPA is the largest professional association of certified public accountants in the United States, with more than 350,000 members in business, industry, public practice, government and education.
The AICPA acknowledges the enormous effort put forth by the members and staff of the Commission to implement the provisions of the Sarbanes-Oxley Act of 2002 (the "Act"). We are firmly committed to working with the Commission in accomplishing the timely and effective implementation of the Act and rebuilding the faith of investors who depend on accounting professionals for accurate, clear, timely and relevant financial information.
Questions regarding the proposed independence requirements:
We believe that an audit committee member should understand the intent of this rule with respect to consulting, advisory or other compensatory fees. We believe that compensation under a retirement or similar plan should not be included in this prohibition, which would allow a former employee to participate on the audit committee if they meet other requirements, including the cooling-off period of three years.
With respect to retired or former employees of the company's audit firm serving on the audit committee, we propose a two-tier approach:
We also believe there should be a de minimis exception to the prohibition about other compensatory fees (i.e., in addition to the fees paid for service on the audit committee), and this exception should permit fees not exceeding $20-25,000 per year. In recommending this amount, we considered that audit committee members, themselves having significant experience in areas that may be of interest to the company, should be able to spend a minimal number of days on a consultative basis outside their board duties, and should be fairly compensated for that time. For example, an audit committee member may have experience doing business in China, which may be an area of interest to management. Management should be free to engage the audit committee member for a few days of time for more in-depth discussion of the issue than might be possible with the full board. In fairness, the audit committee member should be compensated for that time, but should not be permitted to engage in a full scale consulting project with the company. Further, we believe the fee should be paid only in relation to a specific situation or need; it should not be an annual fee, nor a retainer paid to the audit committee member.
The extension of the compensation prohibition to combat against indirect payments is entirely appropriate. However, we are concerned that naming individual relationships could be construed as limiting the prohibition to those named individuals. We believe a principles-based approach should be taken here, and we propose that the limitation apply to all members of the audit committee member's household, as well as others with a relationship to the audit committee member that could pose significant influence over the member.
With respect to relationship in the ordinary course of business, we believe that an exception should be permitted if the terms of business given to the company are the same as terms for an arms-length deal between the service provider and any non-affiliated customer or client of the company. Any ordinary course business relationship involving organizations with which an audit committee member is affiliated should be disclosed annually in the proxy statement. Finally, we believe the Commission should specifically prohibit persons currently employed by the issuer's accountants and lawyers from participating on the board and audit committee of the issuer.
The issue of this safe harbor is a difficult one. It is not possible to create rules that will cover every circumstance at all issuers, and the arbitrary setting of percentages might not get the desired effect. We propose that the Commission's rules address the total wealth portfolio of the individual. For some, a 10% stake in the issuer could be all of their wealth, and we believe that would create a dependent affiliate that should not be permitted to serve on the audit committee. However, in another case, a 10% stake in the issuer might be a small percent of the person' total wealth, and therefore the risks associated with being an affiliated person are mitigated. We urge the Commission to create a rule based in principles, and allow the board of directors to interpret the rule within those principles in applying it to individuals being appointed to the audit committee. Further, since the Commission also states that it will not entertain exemptions or waivers for particular relationships, decision-making is put back on the full board to make the final determination of independence of its audit committee members. Finally, if the board were to permit an individual that has an immaterial affiliation with the company to serve on the audit committee, that fact should be disclosed in the annual proxy statement.
As stated in our answer to the previous group of questions, we believe a subjective test (or principles-based methodology) is more appropriate when determining affiliate status of an issuer. Broad principles should be stated, and boards should be left to meet those principles in appointing members to the audit committee. Boards are and should be responsible to make the final determination based on facts and circumstances. Shareholders are able to review the relationships through disclosures and decide with their investment dollars whether their personal threshold for independence has been met. The Commission cannot be expected to anticipate all facts and circumstances. Boards of directors are better equipped to make the determination locally, and in doing so should keep the spirit and letter of the law at their top of mind.
The board of directors should make the determination that the audit committee is independent just as it would oversee compliance with all laws and regulation. The Board should annually indicate whether they are aware of anything that causes any member of the audit committee to lack independence.
In general, we are opposed to look back periods in determining an individual's suitability to serve on a corporate audit committee. We advocate that the Commission adopt a principles-based approach to audit committee qualifications, which includes a look back period as point of consideration, but not the key to the decision. The board is in the best position to weigh a variety of factors that could impact the suitability of a particular audit committee candidate. To mandate a look back period would further limit the pool of available and qualified candidates, and this limitation will be felt hardest by the smallest companies.
We do not think it is necessary to create additional criteria for independence in addition to the requirements proposed. To do so will further limit the number of people qualified and willing to serve on audit committees, while it is unknown whether any additional rules will have any impact on the performance of audit committees.
We believe that every issuer will face circumstances at times that jeopardize the independence of its audit committee. Boards and audit committees should be able to cure such independence problems within a specified, reasonable time period such as six months, provided they disclose such non-compliance via Form 8-K. For example, suppose one member of a three person audit committee must resign from the board because of personal issues. The remaining board members in this example are either not qualified for audit committee service, or do not meet the independence requirements for a variety of reasons. One individual is qualified, but due to a look-back, will not be considered independent for another 5 months. The board is faced with two choices: (1) put an unqualified but independent person on the audit committee, or (2) recruit a new member to the board, that is qualified and independent for the audit committee. While the second choice is in compliance with the letter of the law, the board is faced with the long process of recruiting a new member, and is limited as far as skillset, to the kind of individual they can recruit. The first choice, while not meeting the letter of the law as it currently stands, may well be in the best interest of the company and its shareholders. However, if the Commission would permit one member of the audit committee to be exempted from the independence requirements for a period of time such as six months (similar to its current rule) then the most qualified person in this example could be appointed to the audit committee, that person's look back could be cured within the appropriate time frame, and the audit committee would perform at its maximum level during the period.
We fully support the proposed exemption for new public companies. Further, we advocate that rather than specifying one member of the audit committee to be exempted, it would be better to specify a minority of members of the audit committee may be exempted for a new public company. This would retain the Commission's proposal of one member in the case of a three person audit committee, but permit more than one person to be exempted if the new public company includes five or more people on its audit committee, while still maintaining the voting influence of the majority. In addition, we would like to see the 90 day period extended, because we are concerned that 90 days is not enough time (especially for a smaller public company) to engage an individual to serve on its board and audit committee. We propose that this exemption be extended to six months or longer.
We agree with the proposed exemption for an independent board member that sits on both a parent's and majority-owned subsidiary's board of directors, and with the requirement that the board members is also otherwise independent of the parent and the subsidiary.
We would like to see boards go one step further and explicitly consider whether the board of the subsidiary should be identical to the board of the parent. The parent board should consider whether operations between the parent and subsidiary are aligned, whether they are both part of a larger strategy, or if they are not necessarily aligned and not sharing the same strategy. Depending on the answers to these and other questions, the parent board should conclude whether all or some of the members of the subsidiary board should be independent of the parent. We believe there are times when it is important that the boards of the parent and subsidiary not be identical; that is, the board of the parent and the board of the subsidiary should include some members that have the interest of only the parent or only the subsidiary in mind. This is most important when a sale or spin-off of the subsidiary is being considered, or other major event that could impact the relationship between the parent and subsidiary company. Finally, we believe this rule should apply whether or not the subsidiary is consolidated.
We support permitting exceptions to the independence requirements based on exceptional and limited circumstances. Many times, small companies, and even large companies, might not be able to fulfill the objectives of the audit committee due to unforeseen circumstances. Returning to an example addressed earlier in this letter, if an audit committee member resigns from the board and there is no one else on the board that could fill that position, it might be more effective to allow an otherwise qualified member of the board that is not independent to sit on the audit committee for a short period of time, for example: up to six months. This exception period would allow the individual to cure their independence problem if possible, or allow the board additional time to recruit a new member. Further, the judgment as to the individuals in question should be left to the board rather than prescribing regulation in the Commission's rules.
Companies should not need to request exemptive relief on a case-by-case basis. If the Commission created principles-based independence requirements, and permitted boards a period of time where one member of the audit committee may be exempt from the independence requirements for a period of time such as six months, it would permit the board some time to cure the independence issue of the member, or recruit a new board member for that position.
The Commission may wish to consider establishing a process to allow companies to apply for an exemption for longer than six months. However, we believe that permitting an exemption for up to six months will minimize the number of companies requesting a longer exemption period.
Questions regarding the proposed auditor responsibility requirement:
For many years, the auditor's report on the fairness of an entity's financial statements has been addressed to the board of directors of the company. The requirement that the audit committee of the board own the relationship between the auditor and the company is in that same spirit and we fully support this change. It is entirely appropriate, and in the interest of restoring investor confidence that the proposed requirement be approved.
There are many new responsibilities on audit committees as a result of the Sarbanes-Oxley Act and the new SEC rules to implement the Act. We have been careful to advise the Commission to maintain the oversight role of the board and audit committee, and to keep management activities with management. In continuing with that theme we encourage opportunities to strengthen the relationship between the internal chief audit executive and the audit committee. We believe the chief audit executive should have a reporting relationship to the audit committee as well as a member of the executive team such as the CEO or general counsel. Company executives should not be able to hire, fire or reassign the chief audit executive without the consent of the audit committee. Practices like this will ensure the independence (from management) of the chief audit executive, which we believe is a corporate governance best practice. In addition, the audit committee should be involved in discussions relating to the chief audit executive's compensation as a further means to create stronger ties between the chief audit executive and the audit committee.
We believe that the board should be the body making the recommendation to shareholders on the appointment of external auditors. The board should be making its recommendation based on a recommendation to it from the audit committee.
Questions regarding the proposed complaint procedures requirement:
The company should annually disclose whether or not they have a system in place, and whether that system relies on internal resources, or they have engaged an external service provider. If substantive changes are made to the procedures during the year, that fact should be reported via Form 8-k and the next annual disclosure should provide similar detail.
We discourage the Commission from specifying or even encouraging specific procedures to achieve this objective. Given the wide variety of public companies, any prescribed or even encouraged procedures will be good for some and difficult for many. We believe the Commission should stay the course of a principles-based approach, requiring companies to create a system that is appropriate in their circumstances.
Questions regarding the proposed authority to engage advisors requirement:
We support the Commission's position that the audit committee have the privilege to engage independent advisors as it considers necessary. We believe that the rule as presented is clear and no further clarification is necessary. Any specificity contained in the rule may be later used to limit the kinds of independent advisors the audit committee could engage.
Questions regarding the proposed funding requirement:
No additional specificity is needed for this requirement. The audit committee is subject to oversight by the full board of directors of the company.
Any limit on the amount of compensation for outside advisors to the audit committee members should be set by the board.
Thank you for the opportunity to respond to this Proposed Rule.