November 22, 1999
Mr. Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
RE: File No. S7-22-99; Audit Committee Disclosure
Dear Mr. Katz:
The Association for Investment Management and Research (AIMR)1 is pleased to comment on the U.S. Securities and Exchange Commission's proposed rules and rule amendments related to corporate audit committee disclosure. AIMR's Advocacy Advisory Committee2 (AIMR Committee) provides its comments below.Background
The SEC has proposed new rules and amendments to current rules to improve disclosure related to the functioning of corporate audit committees and enhancing the reliability and credibility of financial statements of public companies. These proposals are based on recommendations made by the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees.3
AIMR promotes the adoption of effective corporate governance practice and of accurate and reliable financial reporting. The AIMR Committee recognizes the significant effect that corporate governance can have on the quality of information presented in financial statements. Good corporate governance can also improve a company's share value and can be a catalyst for improved management and accountability.
AIMR is also a leader in setting standards for investment professionals in the U.S. and globally, as detailed in the AIMR Code of Ethics and Standards of Professional Conduct and its International Code of Ethics. Within this framework, AIMR promotes market efficiency and investor confidence in the industry by advocating certain fundamental principles, including enhanced disclosure. The SEC proposal similarly promotes good corporate governance practice and corresponds with AIMR principles. Therefore, the AIMR Committee generally supports the SEC's proposal to enhance corporate audit committee disclosures. However, the AIMR Committee makes several suggestions to improve disclosure further, as detailed below.Proposal Summary and AIMR Position
1. Independent Auditor Review of Quarterly Reports
Currently, a company's interim reports need not be reviewed or audited by independent auditors before filing with the SEC. The SEC proposes to require that an independent public accountant review a company's interim financial statements before filing them with the SEC. The proposal would require that independent auditors follow professional standards and procedures for conducting such reviews established by generally accepted auditing standards, as they do for annual reports.
Quarterly results can have a significant impact on a company's share values, particularly when earnings do not meet market expectations. Concern about a potential decrease in stock price may motivate a company to "manage" earnings reports during the year in order to reduce price volatility. The AIMR Committee supports the SEC's proposal because it will require auditor involvement throughout the year, which should help mitigate earnings management, as well as reduce the likelihood of restatements or other year-end adjustments. The AIMR Committee further believes that this requirement would not impose a heavy financial burden on clients because it entails a review rather than a full-scale audit. There should be no additional cost created by the proposal, given that the major international accounting firms ("Big Five"), among others, are already requiring their clients to have reviews of quarterly financial statements as a condition of their acceptance of the audit.
2. Prepare Audit Committee Reports to be Included in the Proxy Statement
The SEC proposal would require the audit committee to provide a report in the company's proxy statement disclosing whether it has (a) reviewed and discussed the audited financial statements with management, and (b) discussed certain matters with the independent auditors. The audit committee is not required to perform the review and hold the discussions, only to attest as to whether the review and discussions took place. The proposal also does not require disclosure of the details of deliberations between or among the audit committee members, independent auditors, and management. In addition, the proposal would require the audit committee report to state whether anything came to its attention that caused it to believe that the audited financial statements contained an untrue statement of material fact or omitted a material fact necessary to make the statements not misleading.
The AIMR Committee believes that the primary goal of an audit committee is to assist the Board of Directors in specific oversight functions. The audit committee should be viewed as a tool of the Board. Its authority should not surpass that of the Board. Therefore, the AIMR Committee believes that audit committee reports should be submitted only to the Board, and not to the SEC or to the public. The maintenance of this "hierarchy" will help to ensure that the audit committee retains a necessary level of candor in its communications with the Board of Directors.
The AIMR Committee believes that the audit committee should review on a regular basis throughout the fiscal year all internal audit reports that identify audit or internal control problems. It is not practicable for the audit committee to review all internal audit reports, particularly for large multinationals or conglomerates. The audit committee should also review the management letter prepared by the external auditor. The AIMR Committee believes that the focus of this review should be on internal control issues where existing deficiencies could have a material impact on the quality of the financial statements. The extent to which the audit committee responds to these reports would vary given the issue and level of materiality involved. If these deficiencies have a material impact on the financial statements, then the audit committee should also address these issues with the full Board, which, in turn, should require management to formulate a remedial plan of action.
The AIMR Committee does not believe that the audit committee should be required to report to either the SEC or to the public about the firm's internal controls. However, should the SEC choose to expand its public disclosure requirements, then the AIMR Committee suggests that the SEC focus on unresolved internal control deficiencies that have a material impact on a firm's financial statements. Preparation of a special report detailing these deficiencies should be the sole responsibility of the Board.
The AIMR Committee also believes that the audit committee should be required to review and discuss a company's interim and annual financial statements with the independent auditors and with management. However, such a review should not in any way obligate the audit committee to assess the accuracy or fairness of the interim statements, especially if the external auditors have not reviewed such financial reports. When the external auditor has reviewed the interim financial statements, the AIMR Committee believes that any adjustments to those statements or disagreements with management should be brought to the attention of both the audit committee and the Board.
3. Disclose in Proxy Statement Whether Audit Committee Has Adopted a Charter
The SEC proposes to require companies to disclose in their proxy statements whether a charter governs their audit committee. In addition, if the audit committee has a charter, a copy of the charter would have to be included as an appendix to the proxy or information statement at least once every three years. The proposal does not require any statements about whether the audit committee has complied with the charter. The proposal also does not require companies to adopt committee charters, or dictate the contents of the charter if one is adopted.
The AIMR Committee does not believe it would be appropriate for the audit committee to establish its own charter. If it were permitted to do so, then it may be empowered to create a "super" committee whose power and authority could exceed that of the Board's itself. This could also increase the potential liability of the audit committee. This liability exposure could deter highly qualified candidates from participating on the audit committee. The AIMR Committee, therefore, suggests that the SEC require the Board of Directors to formulate a charter outlining the responsibilities and authority of the audit committee. The audit committee should be responsible to the Board for fulfilling the responsibilities detailed in its charter.
The AIMR Committee supports the SEC's proposal to require inclusion of the charter in the company's proxy or information statement as useful investor information. The charter should be accompanied by disclosure of any material deviations by the audit committee from their charter obligations. The AIMR Committee suggests that the audit committee need not disclose mere compliance with its charter.
4. Disclosure About "Independence" of Audit Committee Members
The NYSE, AMEX, and NASD have proposed rules pertaining to the independence of a member firm's audit committee members. The SEC proposes to require companies whose securities are not listed on the NYSE or AMEX or quoted on NASDAQ, including small business issuers, to disclose in their proxy statements whether the members of their audit committee are "independent" within the definition of the NYSE's, AMEX's, or NASD's proposed amendments to their listing standards. Companies that are listed on the NYSE or AMEX or quoted on NASDAQ and whose boards have appointed an audit committee member who is not independent according to NYSE, AMEX, or NASD rules must disclose the nature of the relationship that makes that individual not independent and the reasons for the board's determination.
The AIMR Code of Ethics and Standards of Professional Conduct require AIMR members, CFA charterholders, and candidates in the CFA Program to maintain independence and objectivity so that their work and opinions are unaffected by any potential conflicts of interest or other circumstances that may adversely affect their judgment. Every member should endeavor to avoid situations that might cause, or be perceived to cause, a loss of independence or objectivity. The Code and Standards also require members to disclose fully all actual and potential conflicts of interest.
The AIMR Committee recognizes the importance of having audit committees that are comprised of independent directors and believes that shareholders should know when a director who is not independent is a member of an audit committee. Audit committees should be required to disclose that a committee member is not independent and the surrounding conditions, but it is not necessary to disclose that committee members are independent.
In addition, the AIMR Committee believes that there is a critical distinction between financial and intellectual independence. For example, it is extremely difficult, if not impossible, to ensure that directors retain a level of intellectual independence throughout their tenure. A director may begin his or her term of office with little or no relationship to corporate management or other directors on the audit committee. However, intellectual relationships between management and directors are healthy, and ongoing dialogues between these two groups are often essential to completing the tasks assigned to them. The AIMR Committee recommends that these relationships be reevaluated on a regular basis to prevent possible "tainting" of their independent status.
5. Safe Harbors for Proposed Disclosures
The SEC proposes to adopt liability "safe harbors" to cover the proposed audit committee disclosures. Under the safe harbor, the proposed additional disclosures would not be considered "soliciting material" that is subject to liabilities, except to the extent that the company specifically requests that it be treated as soliciting material, or specifically incorporates it by reference into a document filed under the Securities Act of 1933 or the Securities Exchange Act of 1934.
The AIMR Committee supports the proposed safe harbor for audit committee disclosure. The audit committee reports to the Board and it is management that ultimately has responsibility for the company's financial statements. Therefore, audit committee members should not be subject to any more or less liability, with respect to disclosures related to the financial statements, than other Board members, assuming that all audit committee members are not management.Conclusion
The AIMR Committee appreciates the opportunity to provide comments on this proposal to improve audit committee disclosure. Please do not hesitate to contact Philippa Hughes at 804.951.5332 or firstname.lastname@example.org should you have any questions or need additional information.
/s/ Deborah A. Lamb /s/ Philippa P.B. Hughes
Deborah A. Lamb Philippa P.B. Hughes, Esq.
AIMR Advocacy Advisory Committee AIMR Office of General Counsel
1 The Association for Investment Management and Research is a global, nonprofit organization of over 39,000 investment professionals from 91 countries. Through its headquarters in the U.S. and 89 Member Societies and Member Chapters throughout the world, AIMR provides global leadership in investment education, professional standards, and advocacy programs.
2 The Advocacy Advisory Committee coordinates the priorities of AIMR's Advocacy committees and reviews major new regulatory, legislative, and other developments affecting AIMR's global membership.
3 AIMR's Financial Accounting Policy Committee responded to the Blue Ribbons Committee request for comment on its project on improving the effectiveness of corporate audit committees (AIMR letter to Paula Lowitt from Gabrielle U. Napolitano, CFA, and Patricia D. McQueen, CFA, dated January 28, 1999).