From: Donald P. Gallop (firstname.lastname@example.org)
Date: November 29, 1999
Re: File No. S7-22-99
I am directing this to you in my individual capacity as a practicing corporate lawyer representing publicly owned as well as privately held corporations. I do serve on the audit committee of one public corporation and I have had discussions with members of other audit committees of other publicly held corporations.
Concurring with the conclusion that something needs to be done, I am, however, concerned that what is ultimately done contributes more good than harm.
In reviewing a number of other comments that have been forwarded to you I would add my concurrence to the comments of Boris Feldman, who states:
"The principal defect in the proposed regulations, in my opinion, is proposed Section 228.306(a)(3). This section would require the following disclosure in the annual proxy statement: "(a) The audit committee must state whether: ... (4) Based on the review and discussions referred to in paragraphs (a)(1) through (a)(3) of this Item [with management and with the outside auditors], anything has come to the attention of the members of the audit committee that caused the audit committee to believe that the audited financial statements included in the company's Annual Report on Form 10-KSB (17CFR 249.310b) for the year then ended contain an untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which they were made, not misleading."
Although the current proposal changes the certification requirement from a positive to a negative requirement, if enacted, it will, in my opinion, cause many capable outside directors to refuse to serve on audit committees and further cause many who are presently serving to resign.
I believe that the proposed certification will cause plaintiffs to routinely name members of the corporation's audit committees as defendants based in their certification on the proxy. I further believe that derivative plaintiffs would rely on the certification to bring derivative suits now routinely accompanying class actions asserting accounting fraud.
The recommendations of the Blue Ribbon Committee on independent, financial literacy and accounting will narrow the pool of directors permitted to serve on audit committees and the certification requirement will in all probability cause many of those who do satisfy the qualifications to decline service.
Section 228.306(c) of the proposed regulations is not in reality a safe harbor. It does not address exposure to private class actions or derivative suits.
Again, quoting from the comments of Boris Feldman, wherein he states the following is a more appropriate safe harbor:
"The information required by paragraphs (a) and (b) of this Item may not be cited, or form the basis directly or indirectly for liability, in any private action by shareholders, whether individual, class, or derivative in nature."
Further, I agree with Feldman's other initiatives which he states as follows:
"The Commission might consider two other measures to enhance audit committee effectiveness. First, the Commission should require public companies to file, confidentially, the schedule of passed adjustments prepared by the outside auditors. This document details items as to which the auditors disagree with the company's accounting treatment, but which do not in the aggregate prevent the auditors from issuing a "clean" audit opinion. These schedules sometimes reflect overly aggressive accounting decisions made by management. If the members of the audit committee know that the company must file the schedule with the Commission, I believe that most directors would require management to conform the accounting for the items in question to what the outside auditors believe is correct, or would at least subject the disagreement to close scrutiny. The filing should be made exempt from subpoena and from FOIA requests. By permitting confidential filing, the requirement would avoid confusing the market with respect to accounting issues as to which the company, after full consideration in light of the possibility of Commission review, continued to believe that its treatment was proper.
Second, the Commission should promote education of audit committee members as to how best to discharge their duties. In my experience, a substantial component in the failure of many audit committees to detect fraud is lack of training, not lack of desire. SEC staff members, securities litigators, forensic accountants -they know what to look for. Outside directors often do not. It is not enough for the Commission to order directors to detect fraud: it should help them learn how. Given their expertise in the area, the staff could devise training materials that would form a checklist for audit committee members: Which employees should they interview? What should they ask? Which documents should they review? Which metrics should they examine? Although it may sound naïve to advocate "more education" instead of "more disclosure," it is my belief that this could go a long way toward enhancing the real-world effectiveness of audit committees."
I appreciate your time and consideration.