November 27, 2002
Jonathan G. Katz, Secretary
Re: File No. 7-40-02
Dear Mr. Katz:
Public Service Enterprise Group Incorporated (PSEG), a New York Stock Exchange (NYSE) listed company registered under the Securities Exchange Act of 1934, with approximately 225 million shares of common stock outstanding, submits the following comments on the rule regarding audit committee financial experts proposed by the Securities and Exchange Commission (Commission or SEC) under Section 407 of the Sarbanes-Oxley Act (Act).
For many years, PSEG has had an audit committee consisting of independent directors, as required by current rules of the NYSE. Also as required by the current NYSE rules, all members of the audit committee are "financially literate" and, at least one member has "financial expertise" as defined pursuant to the NYSE rules.
PSEG agrees with the Commission that a well functioning audit committee with a financial expert or experts, as contemplated by Section 407 of Sarbanes-Oxley, is an extremely important governance element in assuring that an issuer's financial statements are not misleading and fairly present its financial condition. Obviously, the individual audit committee members are the key ingredients to a successful audit committee. In carrying out the requirements of Section 407, PSEG asks the Commission to carefully consider the impact of its rule on the pool of talent available for this important duty. PSEG's comments below are premised upon an interest to assure that the best quality individuals are available to serve in the important role of audit committee members.
Section 407 of Sarbanes-Oxley imposes a new disclosure requirement with respect to any "financial experts" on an issuer's audit committee:
With respect to responsibility and potential liability of audit committee members, the Commission states:
The SEC has requested comment on whether it should 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.
PSEG believes that the Commission should address the responsibility and liability of persons designated as financial experts to provide certainty and encouragement to competent persons to serve on audit committees. PSEG agrees with the Commission that the benefit of having financial expertise serving on an audit committee is that the persons with such expertise can serve as a resource for the audit committee as a whole in carrying out its functions. This must be accomplished without creating a two-tiered class structure within the audit committee, which could destroy the collegiality within the committee and impair its ability to function as a committee. Committee decisions will become difficult to make in some instances if there are different legal standards applicable to individual members.
Thus, it is important for the Commission to state clearly in the body of the final rule that designation as a financial expert will neither increase the responsibility or potential legal liability of the individual members so designated, nor increase the responsibility, obligation or liability of the board of directors as a whole in appointing such "financial expert" to the audit committee. Otherwise, the rule will chill the prospects of qualified members being willing to be designated as financial experts or to serve as audit committee members at all.
This result conforms to the many areas of inquiry and experience required of an audit committee. Among other things, members must understand the business, the future trends for the business and the industry, the principal areas of risk in the business, the strengths and weaknesses of the management, internal controls, legal obligations of the company and other matters for which "financial expertise" is not the only, and may not be the most important, qualification. Such a legal standard is also consistent with the fact that, as the Commission has recognized, no board or committee can or should manage the daily operations of a large corporation or audit its financial statements.
One corporate remedy to mitigate potential increased responsibility for designated "financial experts" would be for a board of directors to require the right mix of experience and expertise to serve on an issuer's audit committee, but to not designate any members as "financial experts" under Section 407 of Sarbanes-Oxley. Section 407 creates a disclosure requirement, not a governance requirement. While this may seem to be an extreme approach, in the end, the responsibility of the board of directors is to establish the most effective audit committee. PSEG believes that the Commission's interest is the same.
In its draft rule, the SEC has proposed to expand the disclosure mandated by the Act by requiring that issuers specify the number and names of any audit committee members determined to be "financial experts". PSEG expects that directors who have the qualifications for being "financial experts" will carefully consider whether they are willing to be named as such in documents filed with the SEC. The Commission can certainly mitigate this concern by adopting a uniform standard for all audit committee members as recommended above.
Nevertheless, PSEG submits that the additional disclosure proposed by the Commission is not information that a reasonable investor would want to know and may cause some individuals to decline to be named as financial experts. As stated by the Commission:
The proposed disclosure of the number and names of financial experts on the audit committee implies that an audit committee with more financial experts will be stronger than a committee with fewer financial experts. PSEG submits that this is not the case. Would an audit committee with one financial expert be weaker than a committee with two financial experts? This proposed disclosure also implies that an otherwise competent director who is not a "financial expert" would be less valuable as an audit committee member. PSEG submits this also is not the case. It is thus unclear how such disclosure will be useful to investors.
Certainly, financial expertise is an important competency on any audit committee. The Act mandates disclosure that will convey the requisite information if there is no financial expert on an audit committee. It is extremely important that the disclosure requirements not impede retention of the most highly qualified individuals to serve on audit committees. There is a balance here that the Commission needs to be careful to strike.
Financial Expert Requirements
PSEG agrees with the Commission that the board of directors should be able to consider as financial experts, persons who do not have a formal education and experience as a public accountant or auditor, or a principal financial officer, controller or principal accounting officer. For example, in PSEG's experience, many chief executive officers, chief operating officers and other senior executives have an understanding of generally accepted accounting principles and financial statements, and experience with internal controls and procedures for financial reporting. It is important that such individuals be included within the universe of people who may be considered as financial experts in order to populate audit committees with the best talent. In this sense, a "bright line" test is not appropriate. PSEG agrees with the Commission that such individuals should meet the basic requirements for a financial expert, as established in Instruction 1 to Item 309 of Regulation S-K.
PSEG submits that a final rule with the following attributes will accomplish the mutual objective of the SEC and PSEG to have effectively functioning audit committees with financial expertise:
PSEG appreciates the opportunity to comment on the Commission's proposed rule on financial experts.