Putnam Mutual Funds

Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609

Re: Comments on proposed rules regarding auditor independence
(File No. S7-49-02)

Dear Sir:

We are writing on behalf of the Trustees of the Putnam Mutual Funds to provide our comments on the Commission's proposed rules concerning auditor independence.1

As Trustees of mutual funds with assets in excess of $160 billion, we support the goals of the proposed rules. We believe that recent actions by Congress and the Commission to enhance the integrity and quality of financial reporting represent important steps in restoring public confidence in the financial markets.

There is, however, one aspect of the proposed rules that we believe may potentially weaken the quality of financial reporting. When applied to mutual funds, which depend upon independent auditors with specialized industry and regulatory knowledge, the provisions regarding mandatory rotation of audit partners (proposed paragraph (c)(6) of Rule 2-01 of Regulation S-X), some of which are more restrictive than those required by the Sarbanes-Oxley Act, may in practice reduce the quality of audit services.

Major mutual fund complexes such as the Putnam Funds require relatively large independent audit teams, a substantial number of whose members are partners. This is due in part to the large number of separate issuers within each fund complex (the Putnam Funds have 101 separate mutual funds for which financial statements must be prepared) and a virtually continuous audit cycle (at the end of each month one or more Funds close their fiscal year). For example, one of the Funds' two independent audit firms currently has as many as ten partners who could be subject to the proposed mandatory rotation requirement. Even if the rotations are staggered, this would result in constant change in the firm's partners servicing the Funds.

We are especially concerned that the proposed rules will make it necessary for at least one of our auditors to bring in partners without any familiarity with the auditing issues that arise in connection with mutual fund complexes like Putnam. As audit partners who lack familiarity with a particular client and, potentially, the mutual fund industry (and the unique accounting rules to which mutual funds are subject) rotate with increased frequency through audit engagement teams, the overall quality of audit services provided to mutual funds will likely suffer. Moreover, the Putnam Funds have long sought from our auditing firms the "best and brightest" of their partners to serve on the Putnam audit teams. The combination of the proposed broader-than-required application of the rotation rules and the longer-than-required "time out" period will likely thwart this goal as the best audit partners rotate off of the engagement and become unavailable to the Funds for five years.

In its release proposing the rules, the Commission correctly identified the impact that these aspects of its proposed rules could have:

A possible consequence of the auditor rotation requirement is that some firms may be unable to staff the audit engagement team with sufficient partners who are qualified to understand some of the difficult issues that the audit client faces. This may be particularly true in industries where there are specialized transactions, regulatory processes, or accounting principles.

Unfortunately, the Commission's solution to the problem - relying on the requirement that an independent auditor conduct an audit with "due professional care" - is not sufficient. We have always expected that the partners assigned to the Putnam audit teams meet a much higher standard. Exercising due professional care is not the same as providing highest quality audit services, and it is the latter that we have demanded from our auditors. A gap exists between these two standards, and mutual funds - and their shareholders - may suffer as a result. It is unclear to us why, given the important goal of improving the quality of financial reporting, the length and breadth of the proposed partner rotation provisions are in the best interests of investors.

We are also concerned about the adverse impact that the proposed rules may have on competition among audit firms that specialize in mutual fund audits. The Putnam Funds currently use two audit firms, believing that there are substantial benefits to our shareholders from the competition between the two firms to provide the highest quality services to the Funds, having two firms review the Funds' control environment and obtaining broader insights into "best practices." We have chosen, as a matter of policy, not to engage the independent audit firm employed by Putnam Investments and its affiliates. In light of this policy and the demise of Arthur Andersen, this leaves us with only three viable alternatives among audit firms. The increased need for a "deep bench" among an audit firm's partners in order to satisfy the proposed rotation requirements may further narrow our alternatives or force us to depart from our policy of using two audit firms, requiring us to select the firm that has the deepest talent pool. We do not want to be forced into a situation in which we must accept inexperienced partners on one of our audit teams in order to maintain the beneficial "two firm" policy, but we may be forced to do so if the rotation requirements make the kinds of experienced auditors we seek unavailable to us. We would then be forced to sacrifice the diversity of views, insights and experience that a second firm would have provided. In our view, this would be a loss. This is a tradeoff we hope that we are not forced to make.

In light of these concerns, we propose that the rotation provisions of the proposed rules that extend beyond those required by the Sarbanes-Oxley Act be revised. We propose that the mandatory "time out" period be reduced from five years to two years, which would still be one year longer than the Sarbanes-Oxley Act requires. We also propose that the Commission should apply its rotation requirements only to those partners mandated by the Sarbanes-Oxley Act, namely engagement and concurring partners. We believe these two modifications will promote auditor independence without unnecessarily adversely impacting the quality of audits and the continuity among an audit team.

Thank you for consideration of our comments.

Very truly yours,

John A. Hill
Trustee and Chairman, the
Putnam Funds
      Paul L. Joskow
Trustee and Chairman, Audit and
Pricing Committee of the
Putnam Funds

1 Release Nos. 33-8154, 34-46934, 35-27610, IC-25838 and IA-2088, "Strengthening the Commission's Requirements Regarding Auditor Independence."