The Business Roundtable
November 29, 1999
The Honorable Jonathan G. Katz
U. S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549-0609
RE: File No. S7-22-99
The following comments are submitted on behalf of The Business Roundtable, an association of chief executive officers of leading U.S. corporations. We appreciate the opportunity to provide you with our views on the proposed rules implementing the recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees. As the Blue Ribbon Committee stated in its Report and Recommendations:
"A starting point for the development of audit committee guidelines is a recognition of the audit committee's position in the larger governance process as it relates to the oversight of financial reporting.
Certainly, it is not the role of the audit committee to prepare financial statements or engage in the myriad of decisions relating to the preparation of those statements. The committee's job is clearly one of oversight and monitoring, and in carrying out this job it acts in reliance on senior financial management and the outside auditors."
The position of The Business Roundtable, which presented testimony to the Blue Ribbon Committee, has consistently been that continuing to raise the effectiveness of audit committees is a proper and laudable goal, but it must be accomplished within the scope of the role of the audit committee as overseer.
We agree with the decision of the Commission to eliminate those recommendations of the Blue Ribbon Committee that would have had the audit committee stating its belief "that the company's financial statements are fairly presented in conformity with Generally Accepted Accounting Principles (GAAP) in all material respects." We believed throughout the deliberations of the Blue Ribbon Committee that this requirement went beyond the proper role of the audit committee and would, if adopted, expose the committee members to substantial additional liability. As noted below, we continue to be concerned about the content of any report by the audit committee.
With respect to the specific proposals we submit the following comments:
A. Pre-Filing Review of Quarterly Financial Statements
We agree with the proposal to amend Rule 10-01 (d) of Regulation SX to require a pre-filing review of interim financial statements by the independent auditor. While a number of our member companies have expressed reservations concerning the practicality of this proposal, many of our other member companies are currently having such a review conducted by their outside auditor. We believe that a requirement for such a review would not impose a substantial burden and would help to improve the investor's comfort with interim statements. In response to the question raised in the release, we would not expect such a review to result in lower fees for the year end audit because of the difference in character of the year-end audit that leads to an opinion. In fact, we would expect the outside auditors to include in their yearly fees provision for the expenses and profit on the review of interim financial statements.
We believe that the present provisions of SAS 71 are adequate to provide for a reasonable review and do not require any further amendment. Since some of our members believe that a pre-filing review is impracticable even on the present filing schedule, we would oppose any shortening of the filing deadline for interim reports. Many of our member companies are global companies that require time to assemble and verify the financial information and extensive disclosures necessary for the interim reports. It also follows that a review prior to the release of earnings would be impracticable for all of our member companies and we would strongly oppose such a requirement. It would run counter to the Commission's goal of having prompt financial information provided to the investment community after the end of an interim period.
Clearly such a review of the interim financial statements should result in a report by the outside auditors that describes what they have done and the conclusions they have reached. Such a report should be filed so that the position of the auditors is known. As stated above, the audit committee function is that of oversight and the members of the committee are not auditors, nor are they preparers of financial statements and, therefore, audit committees cannot reach conclusions concerning the interim financial statements. They must rely on management and on a review by and report from the outside auditors.
B. The Audit Committee Report
There is no agreement among our member companies concerning the requirement for an audit committee report. Some believe that no report of any type is necessary or desirable, and, despite the safe harbors proposed, a report would lead to additional liability and restrict their ability to recruit members for their audit committees. Other members are not concerned with the requirement of a report and, in fact, some now include some type of report in their filed documents, but have concerns about the content of any such report.
If the Commission decides to require a report, we have two primary concerns with the content of the report as proposed. The first is the requirement to disclose whether the audit committee has discussed with the auditors the matters required by SAS 61 as proposed to be amended in the AICPA Exposure Draft dated October 1, 1999. The exposure draft states that, "the auditor should discuss with the audit committee the auditor's judgments about the quality, not just the acceptability, of the entity's accounting principles as applied in its financial reporting." The draft then goes on to state, "some of the terms used in this paragraph are not susceptible to precise definition and objective criteria have not been developed to aid in the consistent evaluation of the quality of an entity's accounting measures and disclosures." It then concludes, "Furthermore, given this lack of precision and to facilitate an open and frank discussion, the auditor's judgments should not be communicated in writing." If the auditors themselves cannot define "quality" in this context, then it is unreasonable to require the audit committee to, even implicitly, make a judgement in that subject. If auditors are not required to discuss the subject in writing, the audit committee should not be required to refer to it either.
The second concern with the audit committee report relates to the formulation of the statement to be made by the audit committee after its discussions with management and the auditors. While we applaud the Commission's decision to revise the Blue Ribbon Committee's recommendation, the revised proposal does not resolve our concerns. The proposed formulation is a legal construct, which is clearly outside the competence of the audit committee to make and is directed at fraud rather than "quality" financial statements. It is language commonly found in auditor "cold comfort" letters and it appears to shift part of the responsibility that GAAP imposes on independent auditors to audit committees and would make audit committee members prime defendants in securities fraud lawsuits. We strongly oppose adoption of that formulation. We would, however, support the alternative formulation referred to in footnote 61 of the release to the effect that, based on the review and discussions with management and the auditors, the audit committee recommended that the audited financial statements be included in the Annual Report on Form 10K. We believe that this formulation would achieve the purpose of the Blue Ribbon Committee to raise the effectiveness of audit committees while not extending their responsibilities beyond their competence.
Our support for the formulation referred to in footnote 61 is contingent upon the modification of the AICPA Exposure Draft noted above and the adoption of the safe harbors proposal discussed below. Absent any change in the report as proposed, the AICPA Exposure Draft or the proposed safe harbors, we would oppose the adoption of a requirement for an audit committee report.
With respect to the questions raised concerning the content of the report, we believe it unnecessary to include any of the substance of the discussions but only the fact that the discussions have been held. A more extensive disclosure requirement may well have the effect of chilling rather than encouraging candid discussions. The provision for printed signatures on the report has been effective with respect to the compensation committee report and we would see no reason to require anything different for the audit committee. Publication of the report in one filed document is sufficient. While it could be included in the proxy statement, it may be that the audit committee report would more appropriately be included in the Annual Report on Form 10K, since it relates to the financial statements rather than election of directors.
C. Audit Committee Charters
We support the proposed disclosure of whether or not the audit committee has a charter. We believe that this is one indication of the effectiveness of the audit committee. Some members have expressed concerns about increased liability resulting from the disclosures relating to the charter provisions, and therefore it is vitally important that the safe harbors extend to these disclosures and that the safe harbors be as broad as possible, as recommended below. We would recommend that the charter be included in the proxy statement only one time, when adopted, and that no further publication be required unless there has been a substantive amendment. In this day of electronic filing and availability, it simply is not necessary to repeatedly publish the charter.
D. Disclosure about the "Independence" of Audit Committee Members
We support the proposed disclosure if a member of the audit committee is not "independent" under the relevant stock exchange and NASD rules. There is a value to giving the board of directors the flexibility to include a member on the audit committee who does not meet the stock exchange/NASD definition of independence, but investors should be advised. However, we feel strongly that the definitions of independence included in the proposed listing standards should be clearly limited to qualification for listing and not set a precedent for any other context in which actions by directors are judged.
E. Proposed Safe Harbors
We support the adoption of safe harbors that would relate to all of the disclosures proposed to be made by the audit committee. These safe harbors should be as broad as possible since many of our members remain concerned about their potentially expanded liability for disclosure of the additional information. Specifically, the Commission should use its power under the Private Securities Litigation Reform Act and the National Securities Markets Improvement Act to provide safe harbors that extend to anti-fraud liability under the federal securities laws. The Commission's purpose is to raise audit committee effectiveness, not to create more liability traps for directors. Any potential increased liability of audit committee members, whether real or perceived, will reduce the willingness of qualified individuals to serve as directors, and particularly as audit committee members, and this would be the opposite result from that intended by the Blue Ribbon Committee. Broad safe harbors will enable us to assure present and potential directors that service on the audit committee will not result in increased liability. It is vital that we be able to do so if we are to raise the effectiveness of audit committees.
We appreciate your consideration of these comments and we would be happy to discuss these matters further or meet with you, if that would be helpful.
William C. Steere, Jr.
Chairman & CEO
Chairman, Corporate Governance Task Force
The Business Roundtable