Comments of Davis Polk & Wardwell on S7-40-02

DAVIS POLK & WARDWELL

November 29, 2002

Re:

File No. S7-40-02 - Disclosure Required by Sections 404, 406 and 407 of the Sarbanes-Oxley Act of 2002 (the "Proposed Rule")

Mr. Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington D.C. 20549

Dear Mr. Katz:

Davis Polk & Wardwell is an international law firm that represents over 50 foreign private issuers with respect to their capital markets activities in the United States. We are writing with comments on the proposed definition of a "financial expert" as that definition is applied to foreign private issuers by the Proposed Rule.

We have serious concerns about the financial expert definition as applied to both foreign private issuers and U.S. companies and believe that, in general, the definition is unnecessarily narrow and will increase the risk that many companies, especially foreign private issuers and the smaller U.S. companies, will decide that they will not have a financial expert. Although this letter focuses principally on the definition as it relates to foreign private issuers, we urge the SEC to substantially broaden the definition for both foreign private issuers and U.S. companies.

The Proposed Rule provides an option to SEC reporting companies, including foreign private issuers, with respect to financial experts. A company must either (1) disclose the names and number of persons on its audit committee determined by its board of directors to be "financial experts" or (2) if there are no such financial experts on the audit committee, disclose that fact and the reasons why. As the SEC has not yet published proposed rules with respect to audit committees, the extent to which provisions with respect to audit committees in Sarbanes-Oxley will be applicable to foreign private issuers remains unclear. We expect to comment on those rules, including the appropriateness of exporting U.S. corporate governance principles to foreign countries, when the rules are published. For the purposes of the comments in this letter only, we will assume that the audit committee rules will apply in some form to foreign private issuers.

We believe the definition of "financial expert" with respect to foreign private issuers should be broadened so that foreign private issuers have a reasonable opportunity to decide to have a qualifying financial expert on their audit committees. More specifically, while we support the concept of public company experience as an important characteristic of a financial expert, we believe that the definition should not be limited to people with experience with U.S. public companies. In the case of a foreign private issuer, we believe the definition should include people with experience with public companies whose securities are listed on a foreign securities exchange and that are subject to the relevant country's laws regarding periodic public reporting.

Prior SEC - Reporting Company Experience. The proposed definition of a "financial expert" would require any audit committee member so designated either (1) to have "experience as a public accountant or auditor, or a principal financial officer, controller, or principal accounting officer, of a company that, at the time such person held such position," was an SEC reporting company or (2) to have "experience in one or more positions that involve the performance of similar functions".[1] In addition, in considering education and experience, among the eleven factors to be considered by the board of directors, four involve some level of experience with SEC reporting companies (Regulation S-K, Item 309, Instructions 3d, 3f, 3g and 3h; Form 20-F, Item 15(b), Instructions 4d, 4f, 4g and 4h).

Since in most foreign jurisdictions the number of companies which are SEC reporting companies remains relatively small, we believe that the pool of people with sufficient qualifications to be a board member on a major committee in those foreign jurisdictions who could also meet the SEC reporting company requirement in the Proposed Rule would be extremely limited.[2] Finding appropriate people to serve as financial experts will likely be very difficult even in the United States and in the relatively small number of foreign countries with a large number of SEC reporting companies. It will be even more of a challenge for those companies in the majority of foreign countries which have only a very small number of SEC reporting companies. When one takes account of the need for specific industry experience, the need to avoid too many overlapping board memberships, the time commitment required to be a member of an audit committee and the requirement of independence, the pool of potential candidates becomes very small indeed.

Critically, at the moment they first list or offer in the United States, many foreign private issuers are already established public reporting companies and are already engaged in a continuous cycle of making market disclosures and communicating with investors. As a result, even though a foreign private issuer approaching the U.S. public markets for the first time would most likely not have on its board any people who had experience with SEC reporting companies, it would certainly already have board members with experience in preparing financial statements and participating in the disclosure cycles of public companies. Even for seasoned foreign private issuers, the definition as proposed unduly limits a foreign private issuer's choice of new candidates it could choose to sit on its audit committee.

We therefore suggest that the definition of "financial expert", for purposes of foreign private issuers, be broadened to include people with experience with public companies with securities listed on a foreign securities exchange. This would be in line with the SEC's stated intent that a financial expert "have been exposed to the reporting requirements of public companies"[3] without unduly restricting the concept of "public company" to companies which are public in the United States. Our drafted language is meant to also cover a person with experience in International Accounting Standards ("IAS") who sits on the board of a company from another country that also prepares its primary financial statements in IAS. We believe that, after 2005 when IAS will be used by European Union companies, a financial expert should be able to come from any country within Europe. To take an example, a German bank should be free to decide that the best person to be a financial expert is someone with prior experience with a French bank that is quoted in France but not in the United States. We do not think that the SEC's rules should unduly limit the project of cross-border common rules and practices which is part of the European project.

U.S. GAAP Reconciliation. Similarly, in the case of foreign private issuers, the Proposed Rule cites as a factor indicating financial expertise the level of a board member's experience in reconciling financial statements to U.S. GAAP (Regulation S-K, Item 309, Instruction 3k; Form 20-F, Item 15(b), Instruction 4k). While admittedly only a factor in the board's evaluation, the fact that this criterion is singled out for foreign private issuers suggests that it carries additional weight. We suggest that it would be sufficient for a new foreign private issuer to decide that it will educate itself about U.S. GAAP reconciliation through the use of consultants.

We do not believe that experience with U.S. GAAP reconciliation is a realistic factor for a foreign private issuer seeking a U.S. listing. First, as discussed above, the pool of potential candidates in most foreign countries with SEC reporting experience and as a consequence, experience with U.S. GAAP reconciliation remains small.

Second, a person who is an expert in local GAAP (or IAS) - presumably the most important expertise required - will certainly be able to assess the implications to the company of reconciling to U.S. GAAP, even if he or she relies on the auditors or other consultant experts to explain any particular U.S. GAAP treatment. While different GAAP systems have different standards, concepts such as recognition, measurement and materiality are all concepts with which an expert in local GAAP (or IAS) rules will be intimately familiar, and he or she can be expected to ask the right questions to reach the appropriate financial judgments with respect to reconciliation.

Third, to require a foreign private issuer's audit committee expert to have U.S. GAAP experience would be to place foreign private issuers at a disadvantage compared to U.S. issuers. We are not aware of any comparable requirement - at least in Europe - that U.S. issuers whose securities are listed on foreign exchanges have audit committees staffed with experts in IAS or the local GAAP. While this may be the result of an absence of a reconciliation requirement in these foreign jurisdictions, a U.S. requirement to reconcile to U.S. GAAP should not invalidate the expertise of someone who is well-versed in the local GAAP or IAS.

Finally, as countries increasingly move towards the adoption of IAS, experience with U.S. GAAP reconciliation may become less relevant. This is particularly true for the European Union which has mandated that by 2005 the majority of public companies in EU member countries use IAS in preparing their financial statements. Members of the SEC staff have recognized that if certain improvements are made by 2005, "it may be appropriate ... to reconsider the need for foreign private issuers from EU member countries to continue to reconcile from IAS to U.S. GAAP."[4]

Market Consequences. If the Proposed Rule is adopted with a definition of "financial expert" which requires U.S. public company experience, foreign private issuers may not realistically be able to satisfy the rule and may therefore have no option but to disclose why their audit committees do not have financial experts. We do not believe that this is the desired market effect of Section 407, given the investor protection goals of the Sarbanes-Oxley Act. We believe that a preferable market standard for foreign private issuers would be one in which they could determine that a board member is a "financial expert" in accordance with SEC rules and therefore would have options comparable to those available to U.S. companies. Like U.S. companies, they could choose not to have a financial expert on the audit committee, and there may, in fact, be a number of good reasons to choose this option. But a rule drafted so that it is virtually impossible for foreign private issuers to find experts in non-U.S. jurisdictions who both satisfy SEC reporting experience requirements and are also the type of person who would be an appropriate board member for that company should not be the reason.

Since Section 407 of the Sarbanes-Oxley Act does not require that financial experience be limited to U.S. experience, we suggest that the final rule not define "financial expert" so narrowly. We attach as Annex A proposed modifications to the definition of "financial expert" to this effect.

Liability Issues. We believe the SEC should also take into account the enhanced liability risk that a person designated as a financial expert might incur. The increased risk may discourage qualified people from accepting the designation as a financial expert and may drive some companies to choose the disclosure option rather than the financial expert option.

If you have any questions please contact Meg Tahyar (tel.: 011-33-1-56-59-36-70), Jeffrey Oakes (tel.: 011-44-20-7418-1386), or Richard Sandler (tel.: 212-450-4224). Davis Polk & Wardwell

_______________________________

[1] We note that this definition excludes academics who may have significant experience in this area as well as former CEOs who were not previously accountants. In addition, it is likely that under the proposed definition many foreign partners of major foreign accounting firms would not even qualify as having SEC-reporting company experience. We believe all of these types of people should be included in an expanded definition for both private foreign issuers and U.S. companies.
[2] As of December 31, 2001, 42 of the 59 foreign countries where SEC registered and reporting companies are incorporated each have less than 15 SEC registered and reporting companies. See SEC Division of Corporation Finance: International Registered and Reporting companies at http://www.sec.gov/divisions/corpfin/internatl/companies.shtml.
[3] SEC Release Nos. 33-8138, 34-46701, IC-25775; File No. S7-40-02, page 7.
[4] See, Speech by SEC Chairman: A Single Capital Market in Europe: Challenges for Global Companies, Remarks by Chairman Harvey L. Pitt, U.S. Securities and Exchange Commission, Conference of the Institute of Chartered Accountants of England and Wales, Brussels, Belgium, October 10, 2002, pg. 4 and with virtually identical remarks, Speech by SEC Chairman: Remarks at the Financial Times' Conference on Regulation & Integration of the International Capital Markets by Chairman Harvey L. Pitt, U.S. Securities and Exchange Commission, London, U.K., October 8, 2002 pg. 7.

Annex A

We suggest that the definition of a financial expert as it appears in proposed Instructions to Item 309 of Regulation S-K be modified as follows (modifications in bold):

"1. For purposes of the determination by the board of directors under this Item 309, the term "financial expert" means a person who has (A) through education and experience as a public accountant or auditor, or a principal financial officer, controller, or principal accounting officer, of a company, that, at the time the person held such position, (i) was required to file reports pursuant to Section 13(a) or 15(d) of the Exchange Act (15 U.S.C. 78m(a) and 78o(d)) or (ii) in the case of a foreign private issuer, had securities traded on a foreign securities exchange and was required to make periodic public reports pursuant to the laws of the relevant jurisdiction or (B) experience in one or more positions that involve the performance of similar functions (or that results, in the judgment of the board of directors, in the person's having similar expertise and experience), the following attributes:

a. An understanding of generally accepted accounting principles and financial statements;

b. Experience applying such generally accepted accounting principles in connection with the accounting for estimates, accruals and reserves that are generally comparable to the estimates, accruals and reserves, if any, used in the registrant's financial statements;

c. Experience preparing or auditing financial statements that present accounting issues that are generally comparable to those raised by the registrant's financial statements;

d. Experience with internal controls and procedures for financial reporting; and

e. An understanding of audit committee functions.

2. If the board of directors has determined that a person is a financial expert because, in the board's judgment, he or she has similar expertise and experience to those enumerated, the registrant must disclose the basis for that determination.

3. In evaluating the education and experience of a person, the board of directors should consider the following factors in the aggregate:

a. The level of the person's accounting or financial education, including whether the person has earned an advanced degree in finance or accounting;

b. Whether the person is a certified public accountant, or the equivalent, in good standing, and the length of time that the person actively has practiced as a certified public accountant, or the equivalent;

c. Whether the person is certified or otherwise identified as having accounting or financial experience by a recognized private body that establishes and administers standards in respect of such expertise, whether that person is in good standing with the recognized private body, and the length of time that the person has been actively certified or identified as having this expertise;

d. Whether the person has served as a principal financial officer, controller or principal accounting officer of a company that, at the time the person held such position, (i) was required to file reports pursuant to section 13(a) or 15(d) of the Exchange Act or (ii) in the case of a foreign private issuer, had securities traded on a foreign securities exchange and was required to make periodic public reports pursuant to the laws of the relevant jurisdiction, and in each case, if so, for how long;

e. The person's specific duties while serving as a public accountant, auditor, principal financial officer, controller, principal accounting officer or position involving the performance of similar functions;

f. The person's level of familiarity and experience with all applicable laws and regulations regarding the preparation of financial statements that must be included in (i) reports filed under Section 13(a) or 15(d) of the Exchange Act or (ii) in the case of a foreign private issuer, periodic public reports required by the laws of the relevant jurisdiction;

g. The level and amount of the person's direct experience reviewing, preparing, auditing or analyzing financial statements that must be included in (i) reports filed under Section 13(a) or 15(d) of the Exchange Act or (ii) in the case of a foreign private issuer, periodic public reports required by the laws of the relevant jurisdiction;

h. The person's past or current membership on one or more audit committees of companies that, at the time the person held such membership, (i) were required to file reports pursuant to Section 13(a) or 15(d) of the Exchange Act or (ii) in the case of a foreign private issuer, had securities traded on a foreign securities exchange and were required to make periodic public reports pursuant to the laws of the relevant jurisdiction;

i. The person's level of familiarity and experience with the use and analysis of financial statements of public companies;

j. Whether the person has any other relevant qualifications or experience that would assist him or her in understanding and evaluating the registrant's, financial statements and other financial information and to make knowledgeable and thorough inquiries whether:

i. The financial statements fairly present the financial condition, results of operations and cash flows of the registrant in accordance with generally accepted accounting principles; and

ii. The financial statements and other financial information, taken together, fairly present the financial condition, results of operations and cash flows of the registrant; and

k. In the case of a foreign private issuer, the person's level of experience in respect of public companies in the foreign private issuer's home country and generally accepted accounting principles used by the issuer."

We suggest that the definition of a financial expert as it appears in proposed Instructions to Item 15(b) of Form 20-F be modified as follows (modifications in bold):

"2. For purposes of the determination by the board of directors under this Item 15(b), the term "financial expert" means a person who has, (A) through education and experience as a public accountant or auditor, or a principal financial officer, controller, or principal accounting officer, of a company that, at the time the person held such position, (i) was required to file reports pursuant to Section 13(a) or 15(d) of the Exchange Act, or (ii) had securities traded on a foreign securities exchange and was required to make periodic public reports pursuant to the laws of the relevant jurisdiction or (B) experience in one or more positions that involve the performance of similar functions (or that result, in the judgment of the board of directors, in the person's having similar expertise and experience), the following attributes:

a. An understanding of financial statements and generally accepted accounting principles used by the registrant in its primary financial statements;

c. Experience preparing or auditing financial statements that present accounting issues that are generally comparable to those raised by the registrant's financial statements;

d. Experience with internal controls and procedures for financial reporting; and

e. An understanding of audit committee functions.

3. If the board of directors has determined that a person is a financial expert because in the board's judgment he or she has similar expertise and experience to those enumerated, the registrant must disclose the basis for that determination.

4. In evaluating the education and experience of a person, the board of directors should consider the following factors in the aggregate:

a. The level of the person's accounting or financial education, including whether the person has earned an advanced degree in finance or accounting;

d. Whether the person has served as a principal financial officer, controller or principal accounting officer of a company that, at the time the person held such position, (i) was required to file reports pursuant to section 13(a) or 15(d) of the Exchange Act or (ii) had securities traded on a foreign securities exchange and was required to make periodic public reports pursuant to the laws of the relevant jurisdiction, and in each case, if so, for how long;

f. The person's level of familiarity and experience with all applicable laws and regulations regarding the preparation of financial statements that must be included in (i) reports filed under Section 13(a) or 15(d) of the Exchange Act or (ii) periodic public reports required by the laws of the relevant jurisdiction;

g. The level and amount of the person's direct experience reviewing, preparing, auditing or analyzing financial statements that must be included in (i) reports filed under Section 13(a) or 15(d) of the Exchange Act or (ii) periodic public reports required by the laws of the relevant jurisdiction;

h. The person's past or current membership on one or more audit committees of companies that, at the time the person held such membership, (i) were required to file reports pursuant to Section 13(a) or 15(d) of the Exchange Act or (ii) had securities traded on a foreign securities exchange and were required to make periodic public reports pursuant to the laws of the relevant jurisdiction;

i. The person's level of familiarity and experience with the use and analysis of financial statements of public companies;

j. Whether the person has any other relevant qualifications or experience that would assist him or her in understanding and evaluating the registrant's financial statements and other financial information and to make knowledgeable and thorough inquiries whether:

i. The financial statements fairly present the financial condition, results of operations and cash flows of the registrant in accordance with generally accepted accounting principles; and

ii. The financial statements and other financial information, taken together, fairly present the financial condition, results of operations and cash flows of the registrant; and

k. the person's level of experience with generally accepted accounting principles used by the issuer."