American Corporate Counsel Association
December 4, 2002
Jonathan G. Katz, Secretary
Re: S7-40-02 (Release Nos. 33-8138 and 34-46701)
Dear Mr. Katz:
The Corporate and Securities Law Committee of the American Corporate Counsel Association ("ACCA") is pleased to provide comments on the Securities and Exchange Commission's proposed rules on "Disclosure Required by Sections 404, 406 and 407 of the Sarbanes-Oxley Act of 2002" in Release Nos. 33-8138 and 34-46701 (the "Release").
ACCA is the only global bar association exclusively serving the professional needs and interests of in-house counsel to corporations and other private sector organizations. ACCA has more than 14,000 individual members who act as in-house counsel to more than 6,000 business entities. The Corporate and Securities Law Committee is the largest of ACCA's committees, with over 4,500 attorney members, most of whom work in public companies subject to the Commission's disclosure requirements. We believe our comments provide the Commission with a perspective that is particularly important regarding the issues raised in the Release.
Overall, we generally are supportive of the Commission's initiatives in the area of reforming corporate governance and internal controls and procedures for financial reporting. However, below we outline certain issues that we believe could be problematic. To address these issues, we have provided some suggestions that we believe will make the proposed rules more practical, while still achieving the Commission's goals.
I. Definition of "Financial Experts" Serving on Audit Committees
We are concerned that the proposed rules defining "financial expert" have far exceeded the original intent of Congress when the Sarbanes-Oxley Act of 2002 was enacted. The proposed rule appears to have the effect of requiring a "financial expert" to be an accountant with experience in a public company in an industry comparable to the registrant's industry (in addition to having the general attributes that would qualify the expert to be a director). This very strict definition appears to make compliance unnecessarily difficult. According to anecdotal evidence based on conversations with many of our members, the Commission's restrictive language would lead many companies to disclose that their audit committees do not have a "financial expert,." which would, ironically, dilute the impact of such disclosures.
We therefore suggest that the Commission revise its proposed rules in the following respects:
First, allow for relevant experience obtained in functions outside those narrowly defined by the factors listed in the proposal to qualify audit committee members as financial experts. For example, we believe that experience as a chief executive officer should fall within the definition.
Next, we do not believe that experience with a public company should be a requirement for designation as a financial expert. We believe that the expertise necessary to perform the financial expert role effectively can be developed from experience evaluating, selecting, and applying critical accounting estimates in many contexts. As long as the individual has experience that has provided the requisite understanding of GAAP and its underlying principles, the source of that experience should be irrelevant.
Finally, we believe that experience in the application of GAAP in an industry comparable to the registrant's is not essential to achieving the level of financial expertise necessary to fulfill the role of the financial expert. We acknowledge that some industries have critical accounting policies and estimates that are unique and complex. However, while we believe that companies in certain industries, e.g., banking or technology, would certainly want to consider an audit committee member's industry experience, we do not believe that comparable industry experience should be required to designate an individual as a financial expert.
We do agree with the Commission that the board of directors is the appropriate body to make the determination of whether an audit committee member meets the definition of a financial expert. As indicated in the proposal, it would not be appropriate for management to make this determination since they prepare the financial statements. The determination will have more validity if it is the consensus of the entire board of directors.
2. Disclosure of the Identities of "Financial Experts"
Regarding disclosure, we believe disclosure of whether there is at least one financial expert on the audit committee should be sufficient without identifying the individual. The information that should be most important to investors is whether the company has a financial expert on the audit committee.
Current proxy requirements, as elicited under Item 401(e) of Regulation S-K, to disclose the names and biographies of the audit committee members provide sufficient information for investors to understand the financial expertise of audit committee members. We are concerned that disclosure of the identities of financial experts may discourage some qualified individuals from serving on audit committees.
This concern is partially based on the inevitable increased risk of being personally named in shareholder lawsuits due to being identified as an "expert" in a document filed with the Commission. If, as mentioned in the proposal, the Commission does not intend for the financial expert to have Section 11 liability, it should state this fact in the final rules, or at least the adopting release. It will be important to communicate to investors and the courts what the Commission intended when adopting these rules. The Commission should also preempt state law in this area and provide that this financial expert is not held to a higher standard of liability than other members who are not experts. Without this assurance, there likely will be much uncertainty over this matter that will be unsettled as it winds its way through many courts.
We believe that there should be a transition period to provide time for companies to attempt to recruit directors who meet the final definition of financial expert. If the rule is effective immediately, investors may be confused by disclosure from many companies that they are in the process of searching for a financial expert.
3. Disclosure about Changes in Codes of Ethics
We believe that the Commission's proposed code of ethics requirements already overlaps and duplicates outstanding NYSE and Nasdaq proposals. We believe that it is better if the Commission limit its rulemaking to those matters set forth in Section 406 and permit the NYSE and Nasdaq to address broader code of conduct requirements.
Many public companies already maintain comprehensive codes of conduct covering any number of issues, from employment discrimination to conflicts of interest to confidentiality policies. Requiring the prompt disclosure of any change to a company's code of ethics would implicate changes to all parts of the code or codes, not merely the narrow provisions covered by Section 406. As written, the proposal would mandate disclosure of changes to code sections that have nothing to do with financial accountability, the intended focus of Section 406.
It would be impracticable for companies to promptly report changes to all parts of their codes of conduct. Instead, a company likely would elect to adopt a separate Section 406 Code of Ethics, which would permit the company to report changes made to the relevant provisions. We are concerned that this would make compliance with codes of conduct needlessly complicated for officers and employees as they would be expected to comply with multiple codes of conduct. We suggest that the Commission revise its proposal to require prompt disclosure of changes to the particular provisions of a code of conduct with which Section 406 is concerned so that companies could continue to maintain a single code of ethics for officers and employees.
4. Waivers of Provisions in Codes of Ethics
In the Release, the Commission requests comment on whether the term "waiver" is a sufficiently distinct and formal event that the obligation to disclose waivers will not present any difficulties of interpretation. We believe that the term "waiver" is sufficiently ambiguous so as to present significant problems of interpretation, and the term "implicit waiver" provides still greater ambiguity. For example, a decision not to discipline a person for a code violation, a decision to reprimand a person for a code violation, or a decision that particular conduct does not constitute a code violation should not be deemed "waivers," but might be under the proposal.
The Release solicits comment on whether there are any privacy concerns that would warrant narrowing the disclosure requirements regarding code waivers. We believe that the proposal, which requires disclosure of the name of the officer to whom a waiver is granted and the nature of the waiver, does raise privacy concerns and is unnecessary.
5. Management's Internal Controls and Procedures for Financial Reporting
We generally support the Commission's proposed rules concerning management's internal controls and procedures for financial reporting. However, we have significant concerns about the extent of work that will be required for the public accounting firms to attest to management's evaluation. We are most concerned that the cost of this attestation will significantly exceed the benefit to investors.
Because the specific attestation standards to be used in reporting on management's evaluations have yet to be issued or adopted by the Public Company Accounting Oversight Board, we request that the Commission plan in the future to propose rules addressing the form and content of the attestation report. This will allow companies with the opportunity to comment on the key issue of costs versus benefits.
We oppose the requirement for quarterly evaluations of the effectiveness of disclosure controls and procedures and internal controls and procedures for financial reporting. Such a requirement would be prohibitively expensive to perform and would trigger substantial increases in quarterly review fees charged by independent auditors, who would need to expand their interim review process. We suggest that the Commission clarify that the disclosure related to a quarterly evaluation merely address any updates in a company's evaluation that has occurred since the last period.
* * *
We appreciate the opportunity to comment on the Commission's proposals, and would be pleased to provide additional information to the Staff upon request.
cc: Hon. Harvey L. Pitt, Chairman