November 25, 2002
VIA EMAIL (email@example.com)
Mr. Jonathan G. Katz, Secretary
Re: Proposed Rule: Improper Influence on Conduct of Audits [Release Nos. 34-46685; IC-25773; File No. S7-39-02]
Dear Mr. Katz:
I am the General Counsel of Plains All American Pipeline, L.P., a publicly traded master limited partnership. I have been monitoring the various initiatives with respect to corporate governance reforms. I applaud the efforts of the Commission in the monumental task of rendering a meaningful set of rules and regulations to implement such reforms. On October 18, 2002, the Commission issued the above captioned Release (the "Release") in connection with proposed amendments to Regulation 13B-2. The proposed amendments are responsive to the mandate under the Sarbanes-Oxley Act of 2002 (the "Act") for the Commission to promulgate rules to implement Section 303(a) of the Act, which states:
In the Release, the Commission poses specific questions and solicits comments to such questions. I have set forth below my comments to certain of those questions. For ease of reference, I have copied the questions preceding each response, assigning a number to each question.
The definition of "officer" in rule 3b-2 appears adequate to describe those individuals in a position to influence the auditors or audit process, or with necessary authority to direct others to do so.
The Release notes that the term "direction" should include a broader category of behavior than "supervision." Logically, "under the direction" would include (i) actions taken while under supervision, whether or not the specific actions were sanctioned and (ii) actions taken in accordance with or in response to direction or instruction. In either case, the language in Section 303(a) demands some nexus between an officer or director of the registrant and the individual taking the action. Further, the logical reading of Section 303(a) would connect "acting under the direction thereof" to "for the purpose of rendering such financial statements materially misleading." A suggested approach to defining "any other person acting under the direction thereof" is offered under item 5.a. below.
The rule should cover any conduct undertaken to fraudulently influence,1 coerce, manipulate or mislead, but only if undertaken for the purpose of rendering materially misleading financial statements. Thus, the types of conduct that "might" constitute actions to fraudulently influence are not relevant. If specific types of conduct are offered as examples in the rule, the list should encompass only those activities presumptively undertaken for the purpose of rendering materially misleading financial statements, such as bribery, blackmail or physical threats. Offering a contract for non-audit services could (and most likely would) be totally innocuous.2
As noted in the Release, management (not the auditor) prepares financial statements. Thus, it is not readily apparent how exerting influence on the auditor could "render the financial statements materially misleading." It is helpful to set forth in the rule examples of how fraudulent influence on the auditor could indirectly result in materially misleading financial statements. The examples given in the release are adequate.
The rule should include clarification to the effect that "any other person acting under the direction thereof" means any person acting (i) under the supervision of an officer or director or (ii) in accordance with, in response to or as a result of direction or instruction given by an officer or director, in either case, when such action is taken for the purpose of rendering the subject financial statements materially misleading.
The use of the word "fraudulently" and the phrase "for the purpose of" in Section 303(a) clearly indicates that scienter is the requisite mental state to constitute a violation. Moving away from the clear import of the Act toward a strict liability formulation does nothing to make the rule more "effective in preventing improper influence."
The language in Section 303(a) requires no elaboration in this case. The referenced phrase "if the person knew or was unreasonable in not knowing that such action could, if successful, result in rendering such financial statements materially misleading" should be replaced with "for the purpose of rendering the financial statements materially misleading." As mentioned under 5.b. above, scienter must be included as an element of the offense. In the Release, the Commission expresses the view that the amended rules should proscribe certain types of conduct, even if such conduct does not produce an undesirable result. That is, certain actions will be unlawful, even if they do not result in materially misleading financial statements. This is a logical interpretation of the intent of Section 303(a). This interpretation cannot, however, be coupled with an interpretation that removes scienter as an element of the offense. Such a combination would render unlawful an innocent action with no consequences.
Thank you for the opportunity to comment on the proposed rule.