Compass Bancshares, Inc.
VIA ELECTRONIC MAIL
November 27, 2002
Securities and Exchange Commission
Re: Release Nos. 33-8138, 34-46701 and IC-25775 (the "Proposing Release"); File No. S7-40-02
On behalf of Compass Bancshares, Inc. ("Compass"), we respectfully submit these comments relating the Commission's proposal to include new disclosures in a number of filings required under the Securities Exchange Act of 1934 (the "Exchange Act") relating to (i) the report of an issuer's management regarding its internal controls, (ii) an issuer's code of ethics for senior financial officers and (iii) "financial experts" serving on an issuer's audit committee. The proposals set forth in the Proposing Release (the "Proposals") are intended to implement the provisions of Sections 404, 406 and 407 of the Sarbanes-Oxley Act of 2002 (the "Act"), which was signed into law by President Bush on July 30, 2002.
Compass is a financial services company that was organized in 1970 and operates approximately 344 full-service banking offices in Alabama, Arizona, Colorado, Florida, Nebraska, New Mexico and Texas. Compass has $23.7 billion in assets and is among the top forty (40) bank holding companies in the United States in terms of assets. Shares of Compass' common stock are traded on the Nasdaq stock market under the symbol "CBSS." Compass is considered an issuer for purposes of the Act and, therefore, is subject to the provisions of Sections 404, 406 and 407 of the Act.
We have not addressed all of the specific requests for comment proposed by the Commission, but rather have limited our comments to those items with which we have concerns or for which we have suggestions for improvement. To the extent we have comments to the Commission's specific requests for comments, they are provided below.
INTERNAL CONTROL REPORT
Summary of Proposals. In order to implement the provisions of Section 404 of the Act,1 the Commission proposes to amend Item 307 of Regulations S-K and S-B and Forms 20-F and 40-F to require an issuer's annual report to include an internal control report of its management and a statement that the issuer's independent auditor has attested to management's evaluation of the issuer's internal controls. For purposes of the discussion below, we limit our comments to the proposed amendments to Item 307 of Regulation S-K, as Compass would be subject to its provisions. To the extent our comments are applicable to other proposed rules contained in the Proposing Release, we urge the Commission to consider them in those contexts.
Proposed Disclosure. The Commission proposes to amend Item 307 of Regulation S-K to require issuers to include, in their annual report, an internal control report of its management that contains the following:
We generally agree with the Commission's proposals implementing the provisions of Section 404; however, we have the following comments.
Attestation. We do not believe that investors are interested in knowing, nor is an issuer's management interested in preparing, a statement regarding the work and report of an issuer's independent auditor in respect of the attestation of management's internal control report. Rather, we believe that investors' interests are most appropriately served by providing them with a copy of the independent auditor's attestation report without an accompanying characterization of the report by management. Therefore, we encourage the Commission to make the following revisions to paragraphs (c)(3) and (c)(4) of proposed Item 307 of Regulation S-K and any other necessary revisions for the sake of continuity:2
Federal Deposit Insurance Corporation Improvements Act ("FDICIA"). In the Proposing Release, the Commission notes that it is "coordinating with the [Federal Deposit Insurance Corporation (the "FDIC")] and other federal banking regulators to eliminate, to the extent possible, any unnecessary duplication between [the Commission's] internal control report and the FDIC's internal control report." The meaning of this statement is not clear to us.
Compass Bank, the primary banking subsidiary of Compass, is an insured depository institution subject to the provisions of FDICIA. In accordance with the provision of FDICIA, Compass Bank conducts periodic internal control reviews (the "FDICIA Review") and provides applicable federal banking regulators with the requisite internal control reports. We view the FDICIA Review conducted by Compass Bank as complimentary to, not duplicative of, the processes that we are required to conduct under Sections 302 and 404 of the Act.
Compass' principal executive officer and principal financial officer rely heavily on the FDICIA Review conducted by Compass Bank, along with other procedures, to provide the certifications required under Section 302 of the Act. Absent guidance to the contrary, Compass, its principal executive officer and its principal financial officer expect to rely upon the FDICIA Review conducted by Compass Bank in connection with our compliance with the provisions of Section 404 of the Act and the rules promulgated by the Commission in connection therewith, as well as in connection with providing the certifications required under Section 302 of the Act.
Effective Date. The Commission proposes that the attestation and report required under Section 404 of the Act be made in accordance with the standards for attestation engagements adopted by the Public Company Accounting Oversight Board (the "Board"). We agree with this proposal and encourage the Commission to delay the effectiveness of the provisions relating to the attestation until the Board has had the opportunity to adopt the appropriate standards.3
Summary of Proposals. In an earlier release (Release Nos. 33-8124, 34-46427 and IC-25722) (the "Final Rule"), the Commission adopted its final rules adopting the provisions of Section 302 of the Act. The Final Rule requires an issuer's principal executive officer and principal financial officer to provide certain certifications regarding (i) the disclosures contained in the issuer's annual and quarterly reports and (ii) the issuer's internal controls. The Commission now proposes several changes in these certification requirements.
Definitions. Sections 302 and 404 of the Act require the Commission to adopt rules relating, in part, to certifications and disclosures regarding an issuer's "internal controls." Rather than attempt to provide a definition of the term "internal controls" that would, in the opinion of the Commission, appropriately reflect Congressional intent of Sections 302 and 404 of the Act, the Commission has adopted, or proposed to adopt, two new terms - "disclosure controls and procedures" and "internal controls and procedures for financial reporting."
Disclosure Controls and Procedures. In the Final Rule, the Commission adopted the term "disclosure controls and procedures" in an effort to differentiate the controls contemplated by Section 302 of the Act and the pre-existing concept of "internal controls" pertaining to an issuer's financial reporting and control of its assets as embodied in Section 13(b) of the Exchange Act. According to the Commission, the term "disclosure controls and procedures" was intended to cover controls pertaining to an issuer's non-financial information, as well as its financial information.
Internal Controls and Procedures for Financial Reporting. In the Proposing Release, the Commission proposes to adopt the term "internal controls and procedures for financial reporting." The term "internal controls and procedures for financial reporting" 4 is defined in proposed Rules 13a-14 as follows:
Confusion. There exists a great deal of confusion surrounding the terms "internal controls," "disclosure controls and procedures" and "internal controls and procedures for financial reporting." Some members of the Commission's staff have suggested that the term "internal controls" is broader than the term "internal controls and procedures for financial reporting" and that an issuer's internal controls and procedures for financial reporting are a subset of its internal controls. We agree and support the Commission's efforts to distinguish between the two terms; however, we suggest that the term "internal controls for financial reporting" is a better, and less cumbersome, term for the concept.
Some of the members of the Commission's staff have suggested that an issuer's disclosure controls and procedures and it's internal controls for financial reporting overlap, but that one is not a subset of the other. We disagree. We believe that an issuer's disclosure controls and procedures necessarily must include all of its internal controls for financial reporting, as financial disclosure cannot be presented in reports filed with the Commission without effective internal controls for financial reporting.
In order to avoid further confusion surrounding the terms "internal controls," "disclosure controls and procedures" and "internal controls and procedures for financial reporting," we propose that the Commission make the following revisions to sections (c) and (d) of proposed Rule 13a-14 and any corresponding revisions in other rules necessary for the sake of continuity:5
Quarterly Evaluation. In the Proposing Release, the Commission states that under current rules neither issuers nor management is required "to conduct periodic evaluations of [an issuer's] internal controls." We disagree. Provided that the Commission agrees with our assessment that an issuer's internal controls for financial reporting are necessarily a subset of its disclosures controls and procedures, Exchange Act Rule 13a-15 requires a quarterly evaluation of an issuer's internal controls for financial reports (as they require a quarterly evaluation of an issuer's disclosure controls and procedures).
Evaluation Procedures. The Commission declined to prescribe specific procedures to be followed by issuers in conducting evaluations of their disclosure controls and procedures. Further, the Commission's proposals do not distinguish between the procedures necessary for an appropriate evaluation of internal controls on a quarterly basis and those to be followed on an annual basis. Quarterly evaluations of all aspects of disclosure controls and procedures would be extremely burdensome, expensive and difficult to complete, particularly given the accelerated reporting deadlines for quarterly reports. We encourage the Commission to expressly provide that the quarterly evaluation should be conducted as an update to the annual evaluation, just as an issuer's quarterly report is viewed an as update to its annual report.6 We believe that this was the Commission's intent when it declined to issue specific guidelines for the conduct of such evaluations.
Evaluation Date. Exchange Act Rule 13a-157 currently requires that issuers conduct an evaluation of the effectiveness of the design and operation of the issuer's disclosure controls and procedures "[w]ithin the 90-day period prior to the filing date of each report requiring certification under Exchange Act Rule 13a-14." In the Proposing Release, the Commission proposes to modify Exchange Act Rule 13a-15 to require that such evaluation be made as of the end of the period covered by the report.
We understand that Section 404 of the Act requires that the evaluation conducted in connection with an issuer's annual report be conducted as of the end of the issuer's fiscal year; however, there is no such statutory requirement in connection with the evaluation to be conducted in connection with an issuer's quarterly reports. If issuers are required to conduct quarterly reviews of internal controls for financial reporting after the end of the reporting period, time constraints may prove to be extremely burdensome, particularly following the effectiveness of the accelerated reporting deadlines. Consequently, we encourage the Commission to dispense with its proposed amendments to Exchange Act Rule 13a-15 relating to the date on which evaluations of internal controls are performed in connection with quarterly reports.
Disclosure of Significant Changes and Material Weaknesses. In the Proposing Release, the Commission proposes to require issuers to indicate in its periodic reports "any significant changes in the registrant's internal controls and procedures for financial reporting or in other factors that could significantly affect internal controls and procedures for financial reporting." Such a disclosure would discourage issuers from making changes in their internal controls that are designed to improve their internal controls but are not necessarily in response to significant deficiencies and material weaknesses therein. We do not believe that this is the intent of Congress or of the Commission. Consequently, we encourage the Commission to revise proposed Rule 13a-14 as follows and to make any necessary revisions to other rules for the sake of continuity:
CODE OF ETHICS
Summary of Proposals. In order to implement the provisions of Section 406 of the Act,8 the Commission proposes to add new Item 406 to Regulations S-K and S-B, new Item 15(c) to Form 20-F and new Instruction B.(9) to Form 40-F. These new provisions would require issuers to disclose (i) whether the issuer has adopted a written code of ethics that applies to the issuer's principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions and (ii) if the issuer has not adopted a code of ethics, the reason therefor. For purposes of the discussion below, we limit our comments to Proposed Item 309 of Regulation S-K, as Compass would be subject to its provisions. To the extent our comments are applicable to other proposed rules contained in the Proposing Release, we urge the Commission to consider them in those contexts.
Definition / Principal Executive Officer. Proposed Item 406 defines the term "code of ethics" as follows:
(f) Accountability for adherence to the code.
We do not object to the definition of the term "code of ethics" as set forth in proposed Item 406 to Regulation S-K, as we believe the proposed definition is appropriate to implement the provisions of Section 406 of the Act. Further, we do not object to a disclosure regarding the applicability of the code of ethics to the principal executive officer of an issuer, as we believe it is consistent with the meaning of Section 406.
Attachment as Exhibit. The Commission proposes to amend Item 601 of Regulation S-K to require issuers to attach, as an exhibit to their annual report on Form 10-K, the code of ethics adopted by the issuer, if one has been adopted. In the Proposing Release, the Commission notes that "investors may be interested in examining the actual code itself, given that codes are likely to vary significantly from one company to another." We believe requiring the attachment of the code of ethics as an exhibit to an issuer's annual report will have a detrimental effect for investors.
(a) First, we see no useful purpose for investors to have the ability to examine the code itself.
(b) Second, we believe that attaching the code of ethics as an exhibit to an issuer's annual report runs the risk of overburdening investors with too much information that detracts from the useful information that issuer's provide in their periodic filings.
Disclosure of Waivers. The Commission proposes to add a new item to the list of triggering events for disclosure on Form 8-K. Proposed Item 5.05 requires issuers to file a current report on Form 8-K when they amend their codes of ethics or grant waivers to their codes of ethics. Issuers choosing to provide such information on a website maintained by the issuer within two business days of such an event are not required to file a current report on Form 8-K; provided that the information remains available on the issuer's website for twelve months and is maintained by the issuer for five years for inspection by the Commission.
While we generally do not disagree with the Commission's implementation of the provisions relating to the granting of waivers of an issuer's code of ethics, we encourage the Commission to require the filing of a current report on Form 8-K regardless of whether the issuer has provided the information relating to such a change or waiver on its website. As we have stated in the past, we do not believe that postings on several sites on the Internet necessarily lead to more widespread dissemination of information. In any event, the Commission should not require issuer's to maintain the information on its website for longer than three months.
Disclosure of Changes. Although required by the Act, we believe that requiring issuers to disclose "any changes" in their codes of ethics may have the unintended consequence of discouraging companies from changing their codes of ethics, for better or for worse. This requirement has the potential of creating very "stale" codes of ethics rather than codes of ethics that are continuously examined and re-examined by issuers and revised accordingly.
Disclosing a change to any document such as a code of ethics carries the concept of transparency to a ridiculous extreme. Issuers may be left with the obligation to explain minor changes made for purely editorial reasons.
Specific Questions. Below are our responses to certain specific questions posed by the Commission in the Proposing Release.
Should we require the company to describe its procedures for granting a waiver from a provision of its code of ethics?
No. Such a description will lead investors to the inevitable assumption that issuers will grant waivers from provisions of its code of ethics. This is not necessarily true.
Should we require the company to disclose the date of adoption of its code of ethics and the date of the most recent update or the company's frequency of review of the code?
No. This information is unnecessary and, along with certain other information, runs the risk of overwhelming investors with a raft of useless information.
Should companies that use the Internet for these disclosures also be required to have technology that allows investors to be notified by e-mail when necessary information is posted to the website?
No. Such a requirement is not only impractical but also entirely unnecessary. The only possible benefit of such a requirement is that it might encourage issuers to make disclosures only to the Commission.
The Commission developed the EDGAR system "to promote consistent and relative uniform access to Exchange Act reports." As we have stated in the past, we believe that the EDGAR system is the best and most efficient manner for disseminating information to investors. Educating investors to the existence and use of one system is more likely to succeed than training investors to use and understand the myriad of different systems provided by issuer-maintained websites.
Summary of Proposals. In order to implement the provisions of Section 407 of the Act,9 the Commission proposes to add new Item 309 to Regulations S-K and S-B, new Item 15(b) to Form 20-F and new Instruction B.(8) to Form 40-F. For purposes of the discussion below, we limit our comments to Proposed Item 309 of Regulation S-K, as Compass would be subject to its provisions. To the extent our comments are applicable to other proposed rules contained in the Proposing Release, we urge the Commission to consider them in those contexts.
Proposed Disclosure Requirements. Although the Act requires only that an issuer disclose whether its audit committee is comprised of at least one financial expert, the Commission proposes to require companies to disclose (i) the number and names of persons determined by the board of directors to be financial experts serving on the company's audit committee and (ii) whether such financial experts are independent, and, if not, an explanation as to why they are not. The Commission proposed these increased disclosure requirements because it believed that (i) investors would be interested in knowing how many financial experts are serving on a company's audit committee, (ii) disclosure of the names of a company's financial experts would assist investors in evaluating the company's annual report and proxy statement disclosure describing the background and business experience of the company's directors and (iii) investors may be interested in knowing if the company's financial expert is independent.
Disclosure of Number and Names. For the following reasons, we encourage the Commission to revise proposed Item 309 of Regulation S-K to require only that a company disclose whether it has a financial expert serving on its audit committee, and, if not, the reason therefor:
(a) First, as the Commission notes in the Proposing Release, the Act does not require the disclosure of the number or names of the financial experts. If Congress had intended that the identity of an issuer's financial expert be disclosed, it had ample opportunity to do so specifically. It did not.
(b) Second, we believe that the designation of, and disclosure of the identity of, an audit committee member as an issuer's financial expert would result in increased obligations, responsibilities and liabilities for the financial expert.
(c) Third, such increased obligations, responsibilities and liabilities would discourage individuals from serving on a company's audit committee, particularly as its financial expert.
(d) Finally, we believe the cost of the additional burdens placed upon financial expert far outweighs the benefit of satisfying the curiosity of investors as to the identity of an issuer's financial expert.
Disclosure of Independence. Regarding the disclosure of the independence of the financial expert, we believe that requiring such a disclosure potentially could be confusing to investors. Companies, such as Compass, that are listed on a national securities exchange or national securities association, are, or will soon be, required by those exchange or associations and by Section 301 of the Act to have audit committees that are composed entirely of independent directors. The disclosure of a financial expert's independence may lead investors to the erroneous determination that such independence is optional.
Proposed Definition of "Financial Expert". The Commission has proposed the following definition of "financial expert" in the proposed instructions to proposed Item 309:
We believe that proposed subsections (a), (d) and (e) appropriately implement the provisions of the Act; however, we believe that the language proposed in subsections (b) and (c) unnecessarily narrows the definition of the term "financial expert." If the definition is adopted as proposed, we believe that many issuers will find it unfeasible, if not virtually impossible, to find a financial expert to serve as a member of its audit committee. To that end, we propose that the Commission revise the language of subsections (b) and (c) as follows:
Determination of Financial Expert. Proposed Item 309 makes it the responsibility of an issuer's board of directors to determine whether the audit committee has, as one of its members, at least one financial expert. The Commission notes that it "seems inappropriate for management to assess the qualifications of audit committee members." We agree with the Commissions position in this regard.
"Bright-Line" Test. In the Proposing Release, the Commission notes that it did not propose a test regarding the determination of whether a person qualified as a financial expert that "eliminates all elements of subjectivity." We agree with the Commission that such bright-line tests are inappropriate and would not ensure that an individual has a level of experience or understanding necessary to fulfill the qualifications set forth in Section 407 of the Act. In addition, we encourage the Commission to avoid eliminating any further the subjectivity allowed under proposed Item 309.
Specific Questions. Below are our responses to certain specific questions posed by the Commission in the Proposing Release.
Should the Commission specifically address the issue of the degree of individual responsibility, obligation or liability under state or federal law of a person designated as a financial expert as a result of the designation? If the Commission should address the issue, how should it do so?
Yes. If issuers have any hope of attracting talented, well-qualified individuals to serve on their audit committees, particularly as a financial expert, the Commission must expressly limit such persons' individual responsibility, obligation and liability.
Should we also require the proposed financial expert disclosure to appear in the company's proxy or information statement? Is this information relevant to a security holder's decision to vote for a particular director or to elect, approve or ratify the choice of an independent public accountant?
No. As currently proposed, issuers would be required to disclose the information regarding financial expertise in Part III their annual reports on Form 10-K10 and not in their quarterly reports on Form 10-Q or proxy statements.
To the extent this information is relevant to a security holder, it is available to such security holder. Again, too much disclosure may have the effect of overburdening investors with unnecessary information.
Should we require the company to also disclose the information in its quarterly reports?
No. Such a disclosure is neither necessary nor appropriate.
We respectfully submit these comments with the hope that they are helpful to the Commission's consideration of its proposed rules implementing Section 404, 406 and 407 of the Act. We would be happy to meet with representatives of the Commission to discuss our comments.