December 14, 1999

Mr. Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, NW, Mail Stop 6-9
Washington, DC 20549

Re: File No. S7-22-99, Audit Committee Disclosure

Dear Mr. Katz:

The National Association of Real Estate Investment Trusts (NAREIT®) welcomes this opportunity to respond to the request for comments from the Securities and Exchange Commission (the Commission) on various proposals contained in Release No. 34-41987, Audit Committee Disclosure (the Release). NAREIT is the national trade association for real estate investment trusts (REITs) and publicly traded real estate companies. Members are REITs and other businesses that own, operate, and finance income-producing real estate, as well as those firms and individuals who advise, study and service those businesses. NAREIT's SEC Subcommittee of the Government Relations Committee is pleased to provide its comments.

General Comments

NAREIT agrees with the Commission that a vigilant and informed audit committee is an important element in ensuring investor protection and confidence. Generally, we are pleased that the Commission is working with other regulatory and self-regulatory bodies to improve the effectiveness of corporate audit committees. We believe that certain of the Release's proposals should be modified to ensure that qualified individuals would continue to serve on audit committees and understand clearly the scope and nature of their duties. We will comment on the following proposals: audit committee reports, the safe harbor, and review of interim financial statements.

Specific Comments

Audit Committee Reports

1. Summary of Proposal.

Perhaps the most significant proposal in the Release is the proposed audit committee report. An audit committee would be required to provide a report in the company's proxy statement or information statement relating to an annual meeting of shareholders. The report would appear over the printed names of all the audit committee members. Among other things, the audit committee would be required to state whether, based on its review and discussions with the auditors, it believes that the audited financial statements in the company's annual report contain any untrue statement of material fact or omits a material fact necessary to make the statements made, in light of the circumstances under which they were made, not misleading.
2. Overall Comment.

We fully support the intent of the proposal, encouraging audit committees to ask tough questions of the outside auditors and management. We believe, however, that the proposal may make the scope of audit committees' duties less clear. We also believe that, notwithstanding the safe harbor, the proposal as drafted may be interpreted as burdening audit committees with additional liability. Further, we are concerned that the prospect of additional liability may dissuade persons from serving on audit committees. Finally, we believe that there are some practical issues affecting the proposal. Each of these concerns is addressed below.

3. Unclear Scope of Audit.

We believe that the audit committee report proposal may make the scope of the audit committee's duties less clear. The function of an audit committee should be to discuss frankly with the auditors any issues the auditors are aware of and to confirm that the auditors are aware of the board's concerns. Audit committees should not be held to any higher duties than the board. Otherwise, investors could have false confidence that the audit committee's "report" is in fact a "guarantee."

Obviously, no audit committee member would want to make the proposed statement without discussing the financial statements with the auditors. However, the Release does not propose that an audit committee make its statements based solely on its review and discussions with the auditors. This may lead an audit committee to believe that an extra layer of investigation is required before it can make such a statement. For example, it is unclear whether an audit committee must hire its own accountants and/or lawyers to "audit the auditors." The level of investigation that may be required of an audit committee is also unclear. Although SAS 61 and ISB No. 1 provide some guidance, the level of dialogue with the auditors--and the level of scrutiny required of the auditors--is uncertain under the proposals in the Release.

We believe that the scope of the audit committee's duties is, and should be limited to, oversight of the process regarding a company's financial disclosure and frank discussion with the auditors. Audit committees must be able to rely on management to prepare the financial disclosures and on the auditors' discussion, analysis, and opinion of the disclosures. We believe that an audit committee should not be held to a standard that would require them to second-guess the management or auditors, as they simply will not have the resources to do so.

4. Liability Issues.

The fear of liability may be compounded by the requirement that the audit committee state whether it has found any material misstatement or omission. Such a statement implies an exhaustive examination. Audit committees, although committed to their function and composed of highly qualified individuals, simply may not have the resources necessary to perform an exhaustive reexamination of the company's financial statements and auditors' reports. Further, it is conceivable that the discussion with the auditors will devolve into a "checklist" yes-or-no session, instead of the wide-ranging, probing discussion we believe the Commission intended. This devolution would occur for fear of missing "any" untrue statement or omission and the attendant liability.

5. Practical Issues.

There are also some practical issues to consider. For example, there is usually a fifteen- to thirty-day delay between the filing of a company's Form 10-K and the proxy statement. Consider whether the audit committee could be incorrect in its assessment of the company's financial statements. For example, the audit committee may believe that they should make a statement regarding an issue that the auditors believe is immaterial or do not affect the financial statements in any material manner. We question whether the auditors may feel compelled to make a separate statement in such a situation. We also query whether, if the auditors make such a statement, the company still has a "clean" opinion letter.

Although we do not endorse the audit committee proposal as proposed, we believe that if there is an audit committee report, it should be placed with the Form 10-K, as an exhibit, since the audit committee report relates to the company's financial statements. The Commission may wish to consider whether it would be appropriate to include the audit committee charter as an exhibit to the Form 10-K as well.

6. Alternative Proposal.

The Commission proposes, as an alternative, that the audit committee would state whether, based on its review and discussions with management and auditors, it is aware of any material modifications that should be made to the audited financial statements. In our view, this alternative contains many of the same difficulties as the Commission's main proposal. The alternative, in our view, appears to imply that the audit committee could have additional investigative and certification duties of unclear bounds. The additional liability that could attach to such a statement is also unclear to us.

We would prefer no audit committee report. As an alternative, if an audit committee report is implemented, we suggest that the required statements in the report be modified. Although we do not presume to suggest specific language to the Commission, we believe that the following issues should be considered: 1) clarify that the audit committee is not being held to a higher standard than the board; 2) clarify that the audit committee is able to rely solely on its communications with the auditors, who are the true "experts" in accounting matters, no matter how experienced or qualified the audit committee members may be; 3) consider a more general statement of review rather than attestation to individual misstatement or omission; 4) consider placing the report with the Form 10-K as discussed above; 5) modify the safe harbor as discussed below; and 6) delay implementation for one year, reevaluating the necessity of such a report at that time, as discussed below.

7. Deferral of Elective Date.

Some commenters have suggested delaying consideration of whether to require an audit committee report for one year and reevaluating the necessity of such a report at that time. We believe that such a course of action is prudent in this case. In the event that the Commission does not impose such a delay, we would prefer modification of the required statements, as stated above. Further, we believe that it is critical that the Commission modify the proposed safe harbor, as discussed below.

8. Transition Rule.

In addition, as a transition rule, we suggest that the Commission allow companies six months from the effective date of the rules to implement any new requirements. We understand that this transition rule is in keeping with the transition rules proposed by the New York Stock Exchange.

Safe Harbor

Although the safe harbor does provide significant protection to audit committee members, it does not provide protection against federal antifraud claims or state securities and state corporate law claims. It is unclear whether the protections of the business judgement rule actually would be available to audit committee members under state law. The audit committee also may be unprotected against private class action and derivative suits. We believe the Commission should include language in the safe harbor designed to provide audit committee members further protection, especially under the Private Securities Litigation Reform Act. Any safe harbor should clarify that the new rules with respect to audit committees are not intended by the Commission to impose any additional fiduciary obligations on audit committee members or hold audit committee members to any higher standard of care than generally required of directors under applicable law.

Review of Interim Financial Statements

The Release proposes that a company's interim financial statements in its quarterly reports be "reviewed" by an independent public accountant in accordance with SAS 71 before filing with the SEC. Although many companies already are performing such a review, we are concerned about the costs such a requirement would impose upon smaller companies. We also are concerned that the timing of such review may impose a "speed bump" in the process of filing quarterly reports, especially if the AICPA proposal requiring an "attempt" at discussion between the auditors and the audit committee is implemented. The time crunch could be exacerbated further if the filing deadlines are accelerated as proposed in the "Aircraft Carrier" release.


NAREIT thanks the Commission for this opportunity to comment on its Audit Committee Disclosure Release. Please contact Anna Chason, NAREIT's Public Affairs Counsel, at (202) 739-9400 or at if you have any questions regarding this letter.


Katheryn E. Surface
Co-Chair, NAREIT Government Relations Committee