Baker & McKenzie
Sadovaya Plaza, 11 Floor
7 Dolgorukovskaya St.
Moscow 127006
Russa
February 18, 2003
Mr. Jonathan G. Katz
Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: Proposed Rules for Standards Relating to Listed
Company Audit Committees (File No. S7-02-03)
Dear Mr. Katz:
We are responding to Release Nos. 33-8173; 34-47137 (the "Proposing Release") in which the Commission solicited comments on its proposed rules for standards relating to listed company audit committees issued pursuant to Section 10A(m)(1) of the Securities Exchange Act of 1934, as amended, as added by Section 301 of the Sarbanes-Oxley Act of 2002 (the "Act").1
We wish to comment on: (1) the exemption provided for foreign private issuers in proposed Rule 10A-3(c)(2); and (2) the funding provision in Rule 10A-3(b)(5) (read in the light of proposed Rule 10A-3(c)(2)(ii)) as they relate to Russian issuers.
Proposed Rule 10A-3(c)(2)
Proposed Rule 10A-3(c)(2) provides an exemption from the requirements of Rule 10A-3(b)(1) and (b)(2) for foreign private issuers that have a board of auditors (or similar body) or statutory auditors and that satisfy certain other requirements of the rule. In accordance with the Russian Joint-Stock Company Law (the "JSC Law"), all Russian open joint-stock companies are required to establish and maintain an auditing commission.2 We equate this body with the "board of auditors (or similar body)" referred to in the Proposing Release and the rules proposed therein.
We believe that Russian issuers may not be able to claim the exemption afforded by proposed Rule 10A-3(c)(2)(i) because they will be unable to satisfy the requirements of paragraphs (D) and (E) of that rule.
We note that, if Russian issuers are unable to satisfy the requirements of proposed Rule 10A-3(c)(2)(i), they will be required to implement a dual audit body structure. This will result in Russian issuers establishing a separate audit committee of the board of directors (in addition to the auditing commission mandated by the JSC Law) in order to obtain or maintain a listing in the United States. We also note, and agree with, your comment in the Proposing Release that: "The establishment of an audit committee in addition to...[a board of auditors or statutory auditors], with duplicative functions, might not only be costly and inefficient, but it also could generate possible conflicts of powers and duties." We therefore believe that it is important for Russian issuers and their shareholders that the Commission's rules pursuant to Section 301 of the Act be structured to permit an auditing commission to perform the same role as would be required of a separately established audit committee, to the extent permitted by Russian law.
Paragraph (D) of proposed Rule 10A-3(c)(2)(i) provides that:
"Home country legal or listing provisions set forth standards for the independence of such board or body, or statutory auditors, from the foreign private issuer or the management of such issuer [emphasis supplied];"
We believe that Russian law and listing provisions3 do not clearly prescribe standards for the independence of the auditing commission. The JSC Law contains a number of provisions that relate to matters of independence.4 However, we believe that it is unclear whether these provisions would be interpreted as setting forth clearly identifiable standards for the independence of the auditing commission as required by paragraph (D). Russian listing provisions do not set forth any relevant independence standards or provide any direct guidance on the independence of the auditing commission of a Russian issuer.
In our view, the provisions of the JSC Law referred to above adequately address the concepts that underlie the independence requirements contained in proposed Rule 10A-3(b)(1)(ii) that would otherwise be applicable in the case of a US listed issuer with a separately established audit committee. To remove any doubt as to the eligibility of Russian issuers to rely on proposed Rule 10A-3(c)(2)(i), we suggest that paragraph (D) be rephrased to the effect that:
"Home country legal or listing provisions provide for the independence of such board or body, or statutory auditors, from the foreign private issuer or the management of such issuer [emphasis supplied];"
Paragraph (E) of proposed Rule 10A-3(c)(2)(i) provides that:
"Such board or body, or statutory auditors, are directly responsible, in accordance with standards prescribed by home country legal or listing provisions, for the oversight of the work of any registered public accounting firm engaged (including resolution of disagreements between management and the auditor regarding financial reporting) for the purpose of preparing or issuing an audit report or related work or performing other audit, review or attest services for the issuer [emphasis supplied];"
The JSC Law sets out the powers and duties of the auditing commission.5 Among other things, the auditing commission is empowered to initiate a review or audit of the issuer's finances at least once a year,6 prepare a report on the state of the issuer's financial documents,7 and verify the accuracy of the data included in the issuer's annual report and financial statements.8 However, neither the JSC Law nor Russian listing provisions provide that the auditing commission or, indeed, any other body within a Russian issuer shall be directly responsible for the oversight of the work of the public accounting firm performing the audit for the issuer. Furthermore, and as a consequence of this silence, there are no prescribed standards in the JSC Law or in Russian listing provisions for any oversight responsibility generally or in connection with the resolution of disagreements between management and the issuer's auditor regarding financial reporting.
The JSC Law provides that matters relating to the "competence" of the auditing commission that are not covered in the JSC Law itself may be included in the issuer's charter.9 The JSC Law also permits the audit commission of a Russian issuer to adopt its own charter or terms of reference, which are subject to the approval of the shareholders of the issuer.
We believe that a Russian issuer should be permitted to include standards with respect to the direct responsibility of its auditing commission for the oversight of the auditors in its charter or in the charter or terms of reference of its auditing commission. While such standards will not have the same status as a legal or listing provision, any such charter or terms of reference will be required to be approved by the shareholders of the company in accordance with the JSC Law. The shareholders of the company constitute a significant portion of those that Section 301 of the Act and the Commission's implementing rules are designed to benefit. As a result, we suggest that paragraph (E) be amended to the effect that:
"Such board or body, or statutory auditors, are directly responsible, in accordance with standards prescribed by home country legal or listing provisions or contained in the charter or other organizational documents of the issuer, for the oversight of the work of any registered public accounting firm engaged (including resolution of disagreements between management and the auditor regarding financial reporting) for the purpose of preparing or issuing an audit report or related work or performing other audit, review or attest services for the issuer [emphasis supplied];"
Proposed Rule 10A-3(b)(5)
The relevant portion of proposed Rule 10A-3(b)(5) provides that:
"Each listed issuer must provide for appropriate funding, as determined by the audit committee, in its capacity as a committee of the board of directors, for payment of compensation:
(i) To any registered public accounting firm engaged for the purpose of rendering or issuing an audit report or related work or performing other audit, review or attest services for the listed issuer..."
Proposed Rule 10A-3(c)(2)(ii) provides that for foreign private issuers relying on the exemption in proposed Rule 10A-3(c)(2)(i) the term "audit committee" in proposed Rule 10A-3(b)(5) refers to the foreign private issuer's board of auditors or similar body, or to its statutory auditors. Consequently, in the case of a Russian issuer relying on the exemption afforded by proposed Rule 10A-3(c)(2)(i), the proposed rules require the auditing commission to determine the appropriate funding for the payment of compensation to, among others, the Russian issuer's auditors. In contrast, Section 86.2 of the JSC Law provides that the amount of compensation to be paid to the external auditor must be determined by a Russian issuer's board of directors or supervisory board. Accordingly, as a result of the conflict between the proposed rules and Russian law, we request that Russian issuers be given an exemption from this requirement. Without such an exemption, a Russian issuer relying on the exemption in proposed Rule 10A-3(c)(2) may not be able to obtain or maintain a listing in the United States.10
We are grateful to have the opportunity to provide comments to the Commission on the proposed rules, and would be happy to discuss any questions that the Commission may have with respect to this comment letter. Any questions concerning this letter may be directed to Mitchell M. Gitin at the address and telephone number listed above or, alternatively, at +44 7771 541502 or +7 (095) 410 1184.
Very truly yours,
BAKER & McKENZIE
cc: Giovanni Prezioso
General Counsel
Alan L. Beller
Director, Division of Corporation Finance
Paul M. Dudek
Chief, Office of International Corporate Finance
Annette L. Nazareth
Director, Division of Market Regulation
____________________________
| 1 | We submitted a previous comment letter to the Commission on December 10, 2002, regarding the possible impact on Russian issuers of Section 301 of the Sarbanes-Oxley Act of 2002.
| | 2 | We use the term "auditing commission" to refer to the statutory auditing body mandated under Russian law and referred to in Russian as the "revizionnaya komissiya."
| | 3 | We have reviewed the rules and regulations of the three leading Russian stock exchanges: the Moscow Interbank Currency Exchange, the St. Petersburg Currency Exchange and the Russian Trade System.
| | 4 | At least two sections of the JSC Law give the auditing commission authority to take independent action. Section 85.4 gives the auditing commission authority to require "persons holding positions in the company's governing bodies . . . to provide documentation on the company's financial and economic activities," and Section 85.5 empowers the auditing commission to "require the calling of an extraordinary general shareholders meeting." Under Section 55.4, the board of directors or supervisory board of the company may not alter the wording of the proposed issues that the auditing commission advances for shareholder approval at an extraordinary general meeting. At least one section of the JSC Law helps ensure independence in the auditing commission's composition. Section 85.6 states that the members of the auditing commission "may not simultaneously be members of the company's board of directors/supervisory board or hold other positions in the company's governing bodies." This same section also states, with respect to the election of members of the auditing commission, that "[s]hares owned by members of a company's board of directors/supervisory board or by persons holding positions in the company's governing bodies may not participate in voting." Section 85.1 provides that any compensation or reimbursement of expenses for members of the auditing commission shall be decided upon by the shareholders of the company in a general meeting.
| | 5 | See Sections 85, 87 and 88 of the JSC Law.
| | 6 | See Section 85.3 of the JSC Law.
| | 7 | See Section 87 of the JSC Law.
| | 8 | See Section 88.3 of the JSC Law.
| | 9 | See Section 85.2 of the JSC Law.
| | 10 | In this context, we note that the conflict between Section 86.2 of the JSC Law and proposed Rule 10A-3(b)(5) injects an element of uncertainty into any analysis under Russian law of whether a Russian issuer with a separate audit committee, viewed as a committee of the board of directors, would be able to meet the requirements of both the JSC Law and the rules promulgated under the Act.
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