Phone 317 276 2000

November 27, 2002

Mr. Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, NW
Washington, D.C. 20549

Re: Proposed Rule: File No. S7-40-02. Disclosure Required by Sections 404, 406 and 407 of the Sarbanes-Oxley Act of 2002

Dear Mr. Katz:

Eli Lilly and Company appreciates the opportunity to respond to the Proposed Rule: File No. S7-40-02, Disclosure Required by Sections 404, 406 and 407 of the Sarbanes-Oxley Act of 2002 (referred to as the "Proposed Rule").

Overall, we are supportive of the Commission's initiatives in establishing appropriate procedures for disclosures by registrants related to financial experts on audit committees, internal control effectiveness, and an appropriate code of ethics. However, upon review of the Proposed Rule, we noted a couple of areas where we believe suggestions with respect to the Proposed Rule are warranted. These suggestions will provide practicality to the Proposed Rule, while still maintaining the intent. Below is a brief summary of each of our suggestions, while the remainder of this letter addresses each of our suggestions in more detail.

  • The Proposed Rule has very narrowly defined the term "financial expert". The narrowness of this definition will restrict certain qualified individuals from serving as the "financial expert." We believe many registrants will find it difficult to recruit a "financial expert" who is otherwise qualified to serve as a director. We strongly believe that this definition should be reexamined by the Commission and altered to be less restrictive. In addition, we are concerned with the direct labeling and disclosure of a specific audit committee member as a "financial expert" in registration filings. This will add a perceived higher level of legal responsibility, which will add to the difficulty of obtaining qualified "financial experts."

  • We believe that a transition period should be established within the Proposed Rule for complying with the "financial expert" rules. We anticipate that this search process will take considerable time to identify quality candidates who will agree to serve given the required increased responsibility and time commitment. Our own experience has demonstrated that it could take over a year to find a qualified candidate.

  • We agree with the Commission regarding the disclosure requirements related to internal controls and procedures for financial reporting responsibilities. However, we are opposed to requiring the completion of an extensive attestation engagement by the registrant's public accounting firm. We believe the likely procedures needing to be performed under an interpretation of the Proposed Rule would be significant and would represent a costly expense to registrants. We believe the Commission should clarify its internal control evaluation requirements to be less extensive under the Proposed Rule. It is our opinion that the cost of these procedures would outweigh any ultimate perceived benefit.

The remainder of our letter discusses our suggestions in more detail.

Definition and Disclosure of "Financial Expert"

In 1999, the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees (BRC) recommended that the NYSE require companies to have an audit committee consisting of at least three members (each financially literate) and one to be a "financial expert." The definition of "financial expert" under the BRC was largely left to the judgment of the registrants, which we do not support. We believe the Commission should define "financial expert"; however, we believe that the definition included in the Proposed Rule is too restrictive.

As currently proposed, a former FASB staff member, a former SEC staff member, an accounting professor of a large academic institution, and a chief financial officer of a large, private company would not be considered a "financial expert". These individuals are likely to be very qualified and would be appropriate representatives for many audit committees; however, according to the Proposed Rule, these individuals could not serve as "financial experts." In addition, according to the Proposed Rule, the "financial expert" also has to have "experience in: (a) the preparation or auditing of financial statements of generally comparable issuers; and (b) the application of such principles in connection with the accounting for estimates, accruals, and reserves that are generally comparable to the estimates, accruals and reserves used in the registrant's financial statements."

Consider a large pharmaceutical company like Lilly. In theory, the registrant must find a "financial expert" to serve on the audit committee who is familiar with the accounting for pharmaceutical companies; has experience as a public accountant or auditor for pharmaceutical companies or as a principal financial officer, controller or principal accounting officer of a pharmaceutical company. Practically and legally, the registrant cannot have an officer of a competitor on its audit committee. Therefore, the pool of candidates is likely limited to retired CFO's, controllers, and CAO's of competitors and external auditors with prior experience auditing the registrant's competitors. With this definition, a junior auditor of one of our competitors would be a "financial expert" but a chief executive officer of a US-based multinational industrial corporation with years of experience heading a publicly traded company would not.

This represents an extremely narrow definition that will likely be very difficult for a registrant to comply with. We do not believe Sarbanes-Oxley requires such a narrow definition.

We believe that more flexibility should be granted to the registrant in determining a "financial expert." This Proposed Rule should allow registrants to select qualified "financial experts" by objective determination and that those individuals have a prerequisite understanding of GAAP and its underlying principles regardless of the source of the experience. For example, a chief financial officer of a private company, an accounting professor, a former SEC staff member, or a former FASB staff member should not be restricted from serving as a "financial expert."

In addition, we do not believe that the names and the number of financial experts should be specifically identified in the registration filings. Inclusion of this information will add a perceived additional liability to those individuals that are identified as "financial experts." We believe the biographical information included in the proxy statements provide enough information about the members of the audit committee. Specific disclosure of the "financial expert" does not seem warranted. We believe that disclosure that "at least one member of the audit committee has been identified as a `financial expert'" is sufficient for registration filings.

Transition Period

We are concerned that many registrants may not be able to locate a "financial expert" to serve on the audit committee unless a substantial transition period is established. Based upon our past experiences in obtaining qualified board members, the search time can be lengthy, often well over a year. Audit committee members now will have increased responsibilities and, whether justified or not, will perceive that they are subject to significantly greater risk of personal legal exposure. Thus, we anticipate that recruitment time will be even longer in the post Sarbanes-Oxley environment. The negative publicity of a registrant disclosing that it doesn't have a "financial expert" on its board could be damaging, despite disclosure that the registrant is actively searching for a "financial expert".

Therefore, even if the definition of "financial expert" is revised, we believe registrants should be afforded a transition period of at least one year to obtain a "financial expert" to serve on its audit committee should they desire to do so.

Internal Control Effectiveness

We agree with the disclosure requirements regarding the effectiveness of a registrant's internal control structure. However, the highly publicized business failures of recent months appear to be, at least in part, a result of internal control overrides by senior management representatives of the internal control structure. These overrides could still occur even though an audit firm issued a successful attestation report.

We believe the Proposed Rule is vague as to the expectation that is being created. Based upon initial discussion with our auditors, they have stated that the extent of the procedures to be performed may be more extensive than those performed for a SAS 70 review. Under this interpretation, significant work would need to be completed by the auditors, and the cost of the audit would increase substantially. Estimates for the completion of this extensive attestation report could increase the cost of the audit by twenty-five to fifty percent of already existing fees. We do not believe that this interpretation of the Proposed Rule is in the spirit of Sarbanes-Oxley. In addition, we do not believe that this cost will likely translate to value received by shareholders. We request that the Commission clarify its internal control evaluation requirements under the Proposed Rule.

We appreciate the opportunity to express our views and concerns in regards to this Proposed Rule. If you have any questions regarding our response or would like to discuss our comments, please feel free to call me at (317) 276-2024.



Arnold C. Hanish
Executive Director, Finance and
Chief Accounting Officer