American Association of Bank Directors
December 9, 2002
By Email firstname.lastname@example.org
Mr. Jonathan G. Katz
Re: Comment letter on proposed rule on disclosures required by Sections 404, 406, and 407 of the Sarbanes-Oxley Act of 2002 (the "Act"), File No. S7-40-02
Dear Mr. Katz:
I represent the American Association of Bank Directors, a non-profit trade association that represents the interests of bank and savings institution directors.
I am writing to express our concern about the proposed regulation's definition of "financial expert" in section 407. The definition is so narrowly drawn that Alan Greenspan would not qualify as one.
We urge the SEC to expand the definition of "financial expert" so that it will include many qualified people excluded from the proposed definition.
The effect of the definition of "financial expert" is substantially broader than simply a disclosure issue. The Act does not require that a public company appoint or elect a board member who qualifies as a "financial expert" to serve on its Audit Committee; rather, it requires disclosure of whether the company has a board member serving on the Audit Committee who has been designated and qualifies as a "financial expert" and if the company does not have such a person on its board serving on the Audit Committee, it must disclose why it does not. However, the proposed amendments to the listing requirements of the NASD now before the SEC require that every company whose stock is listed with Nasdaq have at least one director who qualifies as a "financial expert" as defined by SEC regulations to serve on the company's Audit Committee. See proposed Rule 4350(d)(2)(A)(ii), as submitted to the SEC on October 9, 2002.
For many bank holding companies that are listed on Nasdaq, the task of identifying and persuading a qualified person to serve in that capacity will be overwhelming, if not impossible. Nasdaq-listed companies include many community banking organizations with limited access to persons who may qualify under the exceedingly narrow proposed definition of "financial expert."
The SEC's definition essentially provides that only an accountant or auditor or chief financial officer with depository institution auditing or accounting experience or comparable experience and education be considered a "financial expert." This definition belies the title of the position ("financial" expert). The Act does not use the term "accounting" expert for a reason.
Another concern is that many persons who are qualified as financial experts may not be willing to serve on boards of public companies if they are designated as such because of fear of heightened liability. The SEC does not believe that a person who serves as a financial expert will increase his or her liability under the securities laws, but it has not addressed how the fiduciary standards in each of the fifty states may be applied to a "financial expert." AABD has concerns that anyone who serves in that capacity may have a heightened fiduciary duty that may subject the person to a higher standard of care and risk under state laws or under interpretations of state or federal courts in lawsuits filed against such directors for breach of fiduciary duty.
The Sarbanes-Oxley Act does not require the SEC to adopt such a narrow definition of "financial expert". Section 407(b) directs the SEC to "consider", in defining the term "financial expert", "whether a person has, through education and experience as a public accountant or auditor or a principal financial officer, comptroller, or principal accounting officer of an issuer, or from a position involving the performance of similar functions..." an understanding and/or experience in certain accounting issues, internal controls and related matters. However, the SEC's proposal does not merely "consider" these attributes; it adopts the proposed definition based almost entirely on these attributes. The proposed definition appears even to tighten the definition. The proposed regulation states (but the Act does not address) that the required attributes include experience applying generally accepted accounting principles in connection with the accounting for estimates, accruals and reserves that are generally comparable to those, if any, used in the company's financial statements, and experience preparing or auditing financial statements that present accounting issues that are generally comparable to those raised by the company's financial statements.
AABD urges the SEC to expand the definition of "financial expert" to include individuals who are well qualified to serve as financial experts. Defining the term must depend on an evaluation of the role and responsibilities of an audit committee member. An audit committee member does not audit the company, or normally second-guess the auditors. An audit committee member is not an employee of or consultant to the company. The Audit Committee typically meets once a quarter, or, at most, once a month, at meetings that ordinarily last approximately 2-4 hours. An audit committee member oversees the auditing process, but does not conduct it. An oversight role is one that requires an understanding of generally accepted accounting principles and financial statements, of how such principles should be applied, of audit committee duties and responsibilities, and of the role and nature of prudent internal accounting controls. In this context, a financial expert may or may not be or have been an accounting or auditing professional in a company in a similar business as the one on whose audit committee the person serves. Perhaps more importantly, a financial expert is someone with an elevated level of knowledge and experience than the average audit committee member appropriate for the oversight role that the audit committee serves in a public company.
In sum, the proposed regulations do not reflect the appropriate focus necessary for the SEC to develop a workable and useful definition of "financial expert." The starting point should be an appreciation of the important, but limited role of an audit committee member; one who is an overseer, not an active participant in the actual conduct of an audit. The skill sets that are required for someone in that capacity may be quite different than those required to conduct an audit of a public company. It is clear from a reading of the proposed regulations that the SEC started and ended its analysis by relying almost entirely on the Act's directive that the SEC "consider" certain attributes in establishing a workable definition of "financial expert." The SEC needs to return to an analysis of what kind of "financial expert" will be helpful to a public company audit committee by evaluating the skill sets that such a person, in his or her limited role, would need in order to be effective.