November 24, 1999
Mr. Jonathan G. Katz, Secretary
U. S. Securities and Exchange Commission
450 Fifth Street, N. W.
Washington, D.C. 20549-0609
Subject: File No. S7-22-99
Dear Secretary Katz,
We wish to commend the Commission and its staff for the thought and work in developing Proposed Rule: 34-41987, "Audit Committee Disclosure." H.S. Grace & Company, Inc. ("HSG & Co.") provides specialized and financial and operational advisory services to a broad range of firms and pension funds, and often consults on complex commercial litigation. In addition to its own resources, HSG & Co. draws on the extensive senior management and professional experience of the Board of Advisors of Grace & Co. Consultancy, Inc.
Speaking generally, we believe that it is important that members of senior management, boards of directors, and audit committees recognize that Proposed Rule: 34-41987 has not been independently derived by the Blue Ribbon Committee and/or the Commission but, instead, is part of the continuing evolvement of the roles and responsibilities of audit committees, which in turn is a component of the ongoing corporate governance evolution. We see the ultimate responsibility of audit committees being the oversight of the risk and control environment of their respective firms. Proposed Rule: 34-41987 addresses issues we believe are associated with the fulfillment of this responsibility.
The terms of the proposed settlement in the Sensormatic Electronics Corp. Derivative Litigation (Consolidated Civil Action No. 14523, Court Of Chancery Of The State Of Delaware) appear to support our view. The proposed settlement sets out detailed operating procedures for the Audit Committee including the adoption of a written charter, a minimum of four meetings per year, and meetings with external auditors and the purposes of such meetings; and, goes on to stipulate a mission statement and workplan for the Internal Audit Department and other terms. We believe the terms of this proposed settlement are reflective of the increased recognition of and attention to the roles and responsibilities of audit committees in the governance process.
As called for in numerous studies and addresses, continued emphasis of and focus on the "tone at the top" of firms is important. However, we believe there is an increased recognition that, while the focus on the "tone at the top" is a necessary condition, it is not sufficient to insure the interests of the broadly based ownership of many corporations. Instead, these investor interests are best served by an appropriate system of checks and balances. We see Proposed Rule: 34-41987 as contributing to an improved set of checks and balances.
(1) Responding to your question on page 8, we believe the proposed disclosures would reinforce audit committees' awareness and acceptance of their responsibilities. In our experience, the proposed disclosures, even with modification, may in addition precipitate an awareness of responsibilities as well as reinforcing such an awareness in the case of certain audit committees. The Sensormatic matter discussed above makes clear that shareholders and members of the legal community understand and are focused on the roles and responsibilities of audit committees. At the same time, we believe it is important to recognize that there are firms with talented, pro-active board and audit committee members, who will have to be reminded that they are part of the governance process, and that the proposed disclosures are not meant to propel them into the management process.
(2) We agree (page 8) that it is appropriate to require disclosure of the adoption of a charter, and recommend that a copy of the charter either be publicly available, or included with the appropriate material every two years. Our sense is that these charters will evolve and be subject to modification, particularly in the early years, and that their more frequent publication will be useful to the shareholders, management and boards of firms as this evolution occurs. We think it would be more appropriate for the charter to be filed as an exhibit to annual reporting documents as a more appropriate disclosure than the somewhat overburdened proxy statement.
(3) In response to your question on page 10 concerning required disclosure about any material deviations by the audit committee from their charter obligations, we believe that audit committees must be very thoughtful in addressing material deviations from their respective charters. Audit committees must examine the potential impact of any contemplated or actual material deviations on the interests of their shareholders, and must consider the manner in which such deviations will be interpreted by those scrutinizing audit committee operations. In the case of firms with a broad base of ownership, it would appear that the interests of all involved parties would be better served by disclosure of material deviations.
(4) As set out in (2) above, in response to your question on page 10 regarding a three year time frame, our sense is that the charter either be made publicly available or communicated every two years at least. If the latter course is chosen, we believe three years is too long.
(5) In response to your question on page 11 regarding "safe harbors" in connection with the proposed amendments, we believe it is critical that audit committee members, specifically, and board members, in general, understand that their responsibility for overseeing the risk and control environment of their firm is only addressed in a limited manner by the safe harbors proposed here. As Sensormatic demonstrated, board and audit committee liability derives from their responsibility to provide appropriate governance in a much broader sense.
(6) Your request for comments on page 12 concerning the size of a small business issuer, highlights a number of complex issues. There are firms today with small or even non-existent revenues which have a broad base of ownership; therefore a simple revenue standard would appear to be insufficient. More problematic to us are those start-up companies, who prior to going public, have boards comprised of management and venture capital partners/investors. Such a makeup is quite appropriate; however, once the firm goes public, the board consists of only insiders, whose interests are not necessarily totally aligned with the new shareholders. For the foregoing reasons we believe that some minimal level of revenue and market capitalization would be appropriate.
Again, we commend the Commission on the quality of Proposed Rule: 34-41987 and the depth of the work performed on the issues of Audit Committee Disclosure.
H. Stephen Grace, Jr., Ph.D.