Transparency International-USA
The Coalition Against Corruption
1112 16th Street, N.W., Suite 500, Washington, D.C. 20036
Tel: 202-296-7730     Fax: 202-296-8125    tiusa@aol.com     www.transparency-usa.org

November 18, 2002

Mr. Jonathan G. Katz
Secretary
Securities and Exchange Commission
450 5th Street, NW
Washington, D.C. 20549-0609

Commission File No. S7-40-02
Disclosure Required by Sections 404, 406, and 407 of the Sarbanes-Oxley Act of 2002
Release Nos. 33-8138; 34-46701 and IC-25775

Dear Mr. Katz:

Transparency International-USA (TI-USA) is pleased to comment on the above referenced proposed rules and will follow with interest and comment on additional SEC rule proposals to implement the Sarbanes-Oxley Act of 2002 ("the Act"). TI-USA supports the SEC's efforts to improve the quality and transparency of disclosure.

We have enclosed a copy of TI-USA's July 22 statement on corporate governance and accounting reform (Attachment 1), submitted to the House-Senate conference committee considering reform legislation. We urge the SEC to consider this statement as the SEC proceeds with the rule-making process since the recommendations contained in this statement parallel many of the requirements of the Act.

TI-USA supports the efforts of the SEC to address the growing concerns about fraudulent financial reporting. In particular, we support the proposed rules implementing the Sarbanes-Oxley Act requirements that:

  • require management of a public company to present an internal control report providing management's conclusion about the effectiveness of the company's internal controls and procedures for financial reporting in each annual report and the requirement that the company obtain a report from its independent auditor providing an opinion as to whether management's assessment is fairly stated in all material respects;

  • require a public company to disclose annually whether it has adopted a code of ethics; and

  • require a public company to disclose annually the number and names of audit committee members that the board of directors has determined to be "financial experts."

Internal Control Reports (Section 404 of the Act)

Definition of Internal Controls and Procedures for Financial Reporting

We concur with the SEC's decision to refer to the Statement on Auditing Standards (AU) Section 319, Consideration of Internal Control in a Financial Statement Audit, to define the term "internal controls and procedures for financial reporting." We believe that AU 319 represents a widely recognized definition of internal controls as it relates to the preparation of financial statements. In particular, we would like to emphasize the importance of paragraph 11 of AU 319 (see Attachment 2) as it pertains to controls relating to operations and compliance objectives. We believe this paragraph should be referenced in the final rule since otherwise the proposal seems to imply operating and compliance controls do not have a bearing on the preparation of the financial statements.

Code of Ethics Disclosure (Section 406 of the Act)

Scope of Individuals Covered

As proposed, the rule requires a public company to disclose whether it has adopted a code of ethics that only covers its chief executive and senior financial officers. We believe that disclosure requirement should be extended to include all officers of an issuer, including the company's general counsel. In today's complex world, all corporate officers deal with matters that could have a material impact on the financial statements such as, terms of significant sales or purchase contracts, employee benefit liabilities, legal commitments and contingencies, etc. TI-USA believes such a disclosure would be relevant information for shareholders and potential investors. We also believe Congress intended Section 406 of the Act to cover those individuals within the issuer's organization that typically have influence over the preparation of financial statements. For this reason, we believe the definition should be expanded to cover all officers of an issuer, including the company's general counsel.

Disclosure of an Issuer's Procedures to Ensure Compliance with the Code of Ethics

We further believe it would be appropriate to expand the disclosure requirements currently included in the proposal to also require disclosure of a description of an issuer's procedures to ensure compliance with the code of ethics. TI-USA believes that compliance standards and procedures are critical to the effective implementation and operation of a code of ethics. To improve the effectiveness of the proposed rule, we recommend that the final rule require registrants to disclose a summary of the compliance processes in place to support the code, addressing such items as training, monitoring compliance, discipline, and evaluation of the effectiveness of processes. It is critical to the effective operation of the code of ethics that procedures be incorporated that allow for proper implementation, communication, training, and monitoring/enforcement and that brief summary disclosure of these requirements will help ensure that these important processes are established. A code of conduct without related compliance standards and procedures is not likely to be effective.

An example of such disclosure follows:

    The company has in place corporate compliance programs that address the implementation and operation of the code of ethics. The compliance programs include provisions for training, communication channels, monitoring, and evaluation of the effectiveness of the code of ethics. The compliance programs are under the oversight of the audit committee and are administered by the general counsel's office (or chief compliance officer). Operation of the compliance programs are monitored and evaluated by the internal audit department on an annual basis.

Disclosure of an Issuer's Procedures for Granting a Waiver from a Provision of its Code of Ethics

On its face, the waiver of a provision of company's code of ethics implies some sort of conflict of interest. For this reason, we believe it is important to investors that issuers be required to disclose their procedures for granting waivers from a provision of the company's code of ethics including the level of approval that is required for such waivers. We believe that the final rule should state that instances of granting waivers should be rare and should be disclosed.

Location of Disclosure

The proposing release currently requires that disclosure with respect to a company's code of ethics be made in Part III of Form 10-K. While General Instruction G also provides that information called for by Part III of Form 10-K may be incorporated by reference from the registrant's definitive proxy statement, we believe that the SEC should explicitly suggest that the required disclosure be located in a company's proxy statement. Inclusion in the proxy statement would provide shareholders and investors with a single location for relevant information on a company's officers and directors.

Disclosure About Audit Committee Financial Experts (Section 407 of the Act)

Definition of Financial Expert

We support the SEC's definition of a financial expert. We do not believe it would be possible to establish a "bright-line" test for purposes of meeting the objective of Section 407 of the Act. To include such a test could possibly exclude otherwise highly qualified candidates. We believe the fact that an issuer would be required to disclose when the board reached a decision that an audit committee member met the definition of a financial expert based on "similar expertise" and its rationale when doing so, will alleviate concerns that a board may be reaching inappropriate conclusions when designating an audit committee financial expert.

Disclosure of Independence of Director

We support the disclosure of whether the "financial expert" is independent as defined in Section 10A(m)(3) of the Exchange Act. However, TI-USA believes investors are entitled to this disclosure of director's independence for all directors not just the financial expert.

Disclosure of a Change in Audit Committee Financial Expert

As noted in the proposing release, the SEC's pending Form 8-K proposals already include a requirement for a company to disclose the election or departure of a director. As a result, we do not believe that this rule should cover such disclosure only with respect to the audit committee financial expert. TI-USA believes that the Form 8-K proposal should be amended such that, for each director the required disclosure include committee membership, chair positions and other responsibilities.

Location of Disclosure

The proposing release currently requires that disclosure with respect to a company's audit committee financial expert(s) be made in Part III of Form 10-K. While General Instruction G also provides that information called for by Part III of Form 10-K may be incorporated by reference from the registrant's definitive proxy statement, we believe that the SEC should explicitly suggest that the required disclosure be located in a company's proxy statement. Inclusion in the proxy statement would provide shareholders and investors with a single location for relevant information on a company's officers and directors.

Responsibility

Lastly, we believe that the text of the amendments to the existing rules and regulations included in the final rule should clearly state that the "mere designation of the financial expert does not impose a higher degree of individual responsibility or obligation an a member of the audit committee." Otherwise the emphasis given to the "financial expert" may mislead investors.

General

Since many of the proposed disclosures are related to existing rules and regulations (for example, disclosure about directors), we believe wherever possible, the new disclosures should be integrated with existing requirements rather than being presented as standalone items. While we recognize that the SEC has done this in certain instances, we believe that the summary information provided in the proposing releases could do a better job of depicting or highlighting this integration.

Conclusion

We believe the rules being proposed SEC that are addressed in this letter will contribute to the restoration of investor confidence and the credibility of the financial markets. In addition, we believe the rules are consistent with our July 22 statement on corporate governance and accounting reform.

We would be pleased to discuss the attached statement with the Commission or its staff at your convenience.

Fritz Heimann, Chairman
Transparency International-USA 		Thomas L. Milan, Director
Transparency International-USA

cc. Harvey L. Pitt, Chairman
Paul Atkins, Commissioner
Roel Campos, Commissioner
Cynthia A. Glassman, Commissioner
Harvey J. Goldschmid, Commissioner

Transparency International-USA
The Coalition Against Corruption
1112 16th Street, N.W., Suite 500, Washington, D.C. 20036
Tel: 202-296-7730     Fax: 202-296-8125    tiusa@aol.com     www.transparency-usa.org

TI-USA Statement on Corporate Governance and Accounting Reforms

Transparency International is an international anti-corruption organization headquartered in Berlin, Germany, with over 80 chapters promoting transparency and accountability in government and the private sector worldwide. In TI's view, US corporate governance and accounting scandals have impaired US leadership and raised questions about the US system as a model for disclosure and ethical business practices. They have made it more difficult for the United States to promote good governance internationally and serve as an excuse for countries resisting action to reform corporate governance and strengthen regulatory oversight.

Prompt, effective reform here at home is indispensable to US credibility abroad. The United States is setting an example by acknowledging weaknesses in its system. Adoption of needed reforms would serve as a model for similar reform efforts which are also needed in other countries.

The true test will be whether, over the next few months, the Administration, Congress, regulators, stock exchanges and key players in the private sector -- corporations, accountants, lawyers, securities analysts, underwriters and rating agencies -- actually take meaningful steps to strengthen integrity and accountability. Legislation is necessary for some aspects of reform, for example to ensure that the SEC has the appropriate legal basis to act. The Justice Department and SEC should forcefully prosecute offenders, and Congress should provide adequate resources for them to do so. At the same time, companies, listed and non-listed, must direct their efforts at ensuring an ethical corporate culture, going beyond the letter of the law and providing incentives that reward compliance, transparency and accountability.

From TI's perspective, it is essential for companies to have effective internal controls and for there to be strong, consistent international systems for corporate accounting and auditing. Transparency International-USA urges prompt action on the following:

Corporate Governance:

  • Companies should adopt effective corporate compliance programs, covering compliance with laws and regulations and with ethical standards. Such programs should have the active support and participation of senior management and be provided with adequate resources. Compliance programs should include training requirements, procedures for reporting illegal or unethical behavior, and strong monitoring and enforcement mechanisms.

  • Oversight over corporate compliance programs should be vested in an audit or governance committee comprised entirely of directors who are independent of management. This committee should have the requisite authority, expertise, time and support to carry out its mandate.

  • SEC should require companies to include in their annual reports an assessment by management, reviewed by the audit committee, of the adequacy of internal controls, including corporate compliance processes.

  • Companies should establish an internal audit function with a reporting channel directly to the audit committee. Among its responsibilities should be monitoring compliance programs and ensuring the adequacy of internal controls.

Accounting and Auditing:

  • SEC should require CEOs and CFOs to certify the accuracy of financial statements and disclosures in periodic reports. CEOs and CFOs should be subject to criminal penalties for misleading auditors or the public.

  • US generally accepted auditing standards should require auditors to treat a significant deficiency in corporate compliance processes as a matter reportable to the audit committee.

  • The audit committee should be comprised entirely of directors who are independent of management, and it should have the requisite authority, expertise, time and support to carry out its mandate. It should have sole responsibility for the selection of outside auditors, for their compensation, and for the scope of their duties; the auditors should report to the audit committee. The audit committee should ensure that auditors are independent and not impaired by conflicts of interest, including placing restrictions on hiring of external auditors by the company.

  • Congress should create an independently-funded public oversight board for the accounting profession, operating under the aegis of the SEC. The board should have confidentiality privilege and be protected against liability. It should have the power to set ethics standards and independence requirements, including conflict of interest rules, to conduct quality control reviews of firms, and to impose penalties. In addition, the public oversight board should have responsibility for setting auditing standards, which may be delegated to an expert body over which it has oversight.

  • FASB should be provided with independent funding and the ability to promptly bring rules up to date to respond to changing circumstances. Convergence to a stronger, internationally recognized set of accounting standards is essential. To that end, consideration should be given to achieving the best balance between the IASB principles-based approach and the US GAAP rules-based approach.

Fritz Heimann, Chairman
Nancy Zucker Boswell, Managing Director
July 22, 2002

Statement on Auditing Standards (AU) Section 319, Consideration of Internal Control in a Financial Statement Audit, Paragraph 11

The controls relating to operations and compliance objectives may be relevant to an audit if they pertain to data the auditor evaluates or uses in applying auditing procedures. For example, controls pertaining to nonfinancial data that the auditor uses in analytical procedures, such as production statistics, or pertaining to detecting noncompliance with laws and regulations that may have a direct and material effect on the financial statements, such as controls over compliance with income tax laws and regulations used to determine the income tax provision, may be relevant to an audit.