October 11, 2002
Giovanni P. Prezioso, General Counsel,
Dear Mr. Prezioso:
We are submitting this letter in advance of the publication of proposed rules for comment by the Securities and Exchange Commission ("Commission") pursuant to the direction given to it under the Sarbanes-Oxley Act of 2002 (the "Act").
Direct Conflicts with Section 301. Our firm represents a large number of non-U.S. companies that have securities registered under the Securities Exchange Act of 1934 and therefore are subject to the provisions of the Act and the related rules and regulations to be issued by the Commission. Although we have not undertaken a full review of legal requirements in relevant jurisdictions, in the course of evaluating compliance issues with our clients, we have identified two significant conflicts between the legal requirements of a number of countries and the provisions of Section 301 of the Act that we believe merit immediate attention as the Commission formulates rule proposals. We believe these direct conflicts can be adequately addressed in the rules to be issued by the Commission while still adhering to the basic principles underlying the Act. In this letter we make suggestions for doing so.
Other Conflicts with the Act. We also note that our suggestions reflect only the minimum steps necessary to address those direct legal conflicts we have identified to date, and that it is likely that additional areas of conflict with legal requirements in other countries will be identified in the course of implementing the Act and the rules to be issued thereunder. Therefore, we would suggest that the Commission retain flexibility in its final rules to deal with such issues as they arise on a country-by-country or a case-by-case basis.1
In addition, we expect to address other matters that raise broader policy issues under the Act (including under Section 301 of the Act), as well as issues raised by duplicative or overlapping legal requirements, in response to Commission requests for comments on relevant rules as they are proposed.2 We are also aware that various representatives of foreign private issuers and foreign regulatory bodies have communicated or intend to communicate directly to the Commission their views with respect to the need for broader relief from the Act in light of home country practice and expectations and principles of comity. For example, foreign private issuers are concerned about disruption to customary home country compensation arrangements caused generally by the Section 402 prohibition on loans to directors and executive officers, as well as the particular absence of an exemption for affiliated lending by foreign financial institutions corresponding to the exemption for loans by FDIC-insured banks to their executive officers and directors. Foreign private issuers may also face issues under home country laws in complying with the whistleblower provisions of Section 806 and the benefit plan blackout provisions of Section 306. There will also be issues for non-U.S. companies and their auditors raised by the auditor registration requirements under the Act. We have in this letter not addressed these matters and have instead generally confined our suggestions to those involving direct legal conflicts of Section 301 with home country law.
We have identified direct conflicts between the requirements of Section 301 of the Act and home country legal requirements and respectfully suggest solutions to address these conflicts and to provide flexibility to address other matters.
In addition, for foreign issuers the requirements of Section 301 of the Act should be phased-in over a transition period, with appropriate exceptions to grandfather current audit committee or board members, to permit these issuers to take the corporate steps necessary to establish an audit committee compliant with Section 301 of the Act to the extent permissible under local law.
Other Conflicts or Incompatibility with Home Country Law
Because we believe it is likely that additional areas of conflict or incompatibility will be identified, the Commission should retain flexibility in its final rules to consider on an ongoing basis requests for exemptions for foreign issuers in particular jurisdictions to enable such issuers to comply with the applicable provisions of the Act without violating home country law.
CONFLICTS WITH FOREIGN LAW UNDER SECTION 301 OF THE ACT
Since the Act was adopted, we have been engaged in a continuous dialogue with our non-U.S. clients to evaluate compliance issues under the Act and, as appropriate or necessary, to develop policies or procedures that respond to the Act's new requirements. In the course of this evaluation, which has also involved consultation with legal practitioners in a number of jurisdictions where we do not have local law expertise, we have identified two principal conflicts between Section 301 of the Act and local legal requirements. These conflicts concern the independence requirement for members of the audit committee and the responsibilities of audit committees relating to registered public accounting firms.
Independence Requirement for Members of the Audit Committee
Section 301 of the Act requires that each member of the audit committee of the issuer (or the entire board of directors, if no such committee exists) be independent. The criteria for being independent, as stated in the Act, are that the committee member cannot accept any consulting, advisory or other compensatory fee from the issuer and cannot be an "affiliated person" of the issuer. The Act gives specific exemptive authority to the Commission to exempt particular relationships as the Commission determines appropriate in light of the circumstances.
It is a requirement under the laws of a number of European countries, including Germany, France, Norway, Finland and Sweden, for the board of directors (or the supervisory board in the case of companies with a two tier board structure) of certain companies to include a number of directors elected by the company's employees ("employee representatives"). In Germany, for example, if a company has more than 2,000 employees, the supervisory board must comprise an equal number of shareholder representatives (i.e., directors elected by shareholders) and employee representatives. Furthermore, if the supervisory board delegates significant decision-making authority to a committee, that committee must also include employee representatives. A company's employees generally elect their representatives from among the employees of the company and its subsidiaries, although union representatives may also be chosen under certain circumstances to represent the employees. In almost all cases, employees elected as employee representatives do not hold senior management positions. Absent an exemption or clarification in the rules to be issued by the Commission, employee representatives who are also employees of the company would not satisfy the independence criteria set out in the Act since they receive compensation in the form of salary or wages from the company in addition to any fees they receive in their capacity as board members.
In our view, even though employee representatives receive compensation from the company as employees, they should nevertheless be considered "independent" for purposes of the Act. It is generally understood that employee representatives represent interests that do not necessarily coincide with those of management. Moreover, jurisdictions that require employee board representation often provide for special safeguards designed to ensure the independence of employee representatives from management. For example, in Germany, employee representatives may not be laid off during the period they serve on the board, to protect them from possible retaliation by management. Accordingly, we respectfully suggest that in order to avoid a direct conflict with legal requirements in jurisdictions which require employee board representation, the Commission should provide in the rules to be issued under Section 301 of the Act that an employee representative elected as such and serving on an audit committee (or if no audit committee exists, while serving on the board) of a foreign issuer will not be considered "non-independent" for purposes of the Act (and similar rules of stock exchanges) as a result of an employment relationship with the issuer provided the employee is elected to the board pursuant to provisions of law of the registrant's jurisdiction or domicile that entitle employees to board representation and is not an executive officer of the issuer.
Responsibilities of Audit Committees Relating to Registered Public Accounting Firms
Section 301 of the Act also provides that the audit committee of the issuer "shall be directly responsible for the appointment, compensation, and oversight of the work of any registered public accounting firm employed by that issuer".
Under the laws of many jurisdictions outside the United States, such as France, Germany, the United Kingdom, Australia, Japan and Brazil, the authority to appoint, remove or supervise the company's auditors is reserved by statute to the shareholders, the supervisory board or the board of directors itself, or a separate body independent of management.3 In certain of these jurisdictions, while committees are permitted and may perform advisory functions, the supervisory board or a board of directors, as the case may be, is not entitled to delegate its responsibilities, and accordingly, the requirement of the Act for the audit committee to have the direct responsibility to appoint, remove or supervise the auditors is directly in conflict with the laws of these countries. Therefore, we respectfully suggest that the rules of the Commission to be issued under Section 301 of the Act should provide that, in the case of foreign issuers, if the law of the registrant's jurisdiction of incorporation or domicile vests the authority to appoint, remove or supervise the company's auditors in the shareholders or a particular body, then such issuers would be exempt from the requirement of the Act and rules issued thereunder that the audit committee have responsibility for these matters, provided that the audit committee (if an audit committee exists) is granted advisory or other powers in respect of such matters to the maximum extent permitted by law.4
Transition Period to Adopt Changes to Corporate Structures
In order to enable a non-U.S. company to bring the composition of its audit committee into line with Section 301 or to adopt appropriate changes to its constituent corporate documents to establish an audit committee or modify its duties insofar as these changes or modifications may be done in compliance with local law, we respectfully suggest that the Commission should provide for a transition period sufficient to allow these changes or modifications to occur. For example, in the case of German companies, supervisory board members, including employee representatives, are generally elected for a five year term. For companies in other jurisdictions, shareholder meetings will need to be called to approve amendments to charter documents in order to implement these changes. Accordingly, we respectfully suggest that for foreign issuers, the requirements of Section 301 be phased-in over a three year period. Furthermore, a person who, at the time the rules become effective, is a member of the audit committee and who does not meet the independence criteria should be permitted to carry out the remainder of his or her term of office.
OTHER CONFLICTS OR INCOMPATIBILITY WITH HOME COUNTRY LAW
As noted, we have not attempted to undertake an exhaustive review of legal requirements in all relevant jurisdictions with a view to identifying potential conflicts or incompatibility with the Act. Nevertheless, we believe it is likely that additional areas of conflict or incompatibility will be identified as foreign issuers review their policies and procedures in light of the Act and any rules proposed by the Commission. If such issues are not adequately addressed by the Commission in the rules ultimately adopted, their foreign issuers may be faced with the option of complying with the Act and violating their home country law or of complying with their home country law and violating the Act. Accordingly, we respectfully suggest that the Commission retain flexibility in its final rules to consider on an ongoing basis requests for exemptions from issuers or on behalf of issuers in particular jurisdictions to the extent required to enable such issuers to comply with the applicable provisions of the Act without violating local law.
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We would be happy to discuss any questions the Commission or its staff may have with respect to this letter. Any such questions may be directed to John T. Bostelman (212-558-3840) in our New York office, David F. Morrison (011-331-4450-6006) in our Paris office or Kathryn A. Campbell (011-44-20-7959-8580) in our London office.