The Business Roundtable
BY E-MAIL Mr. Jonathan Katz
Re: Release No. 33-8138, Comments on Proposed Item 406 of Regulations S-B and S-K and Related Changes ("Code of Ethics") and Proposed Amendments to Item 307 of Regulations S-B and S-K and Related Changes ("Management's Internal Control Reports") under Sections 406 and 404 of the Sarbanes-Oxley Act of 2002, File No. S7-40-02 Dear Mr. Katz: The following comments are submitted on behalf of The Business Roundtable, an association of chief executive officers of leading corporations with a combined workforce of more than 10 million employees in the United States and $3.5 trillion in revenues. The Business Roundtable strongly supported enactment of the Sarbanes-Oxley Act of 2002 (the "S-O Act"), and we support the Securities and Exchange Commission's efforts to implement the S-O Act. We believe the law will go a long way toward establishing new, higher standards for America's corporations. As CEOs, we are committed to maintaining a strong economy, a vibrant workforce, and creating new jobs. We appreciate the opportunity to provide you with our views on recent Securities and Exchange Commission ("Commission") proposals to implement S-O Act provisions relating to codes of ethics and management's internal control reports. Our comments on the Commission's audit committee "financial expert" proposal, also included in Release No. 33-8138, will be submitted separately. I. Code of Ethics (Section 406) Section 406 of the S-O Act directs the Commission to issue rules requiring all reporting companies to disclose whether they have a code of ethics applicable to senior financial officers. The Commission has proposed to require each company to disclose in its annual report whether it has adopted a code that applies not only to its senior financial officers but also to its principal executive officer. In addition, the proposed rule would require prompt disclosure of any changes to, or waivers from, the code of ethics. Scope of the code of ethics The Commission's proposal goes beyond Section 406 in a number of ways, most significantly by setting forth a detailed, six-part definition of the term "code of ethics." As you know, the New York Stock Exchange ("NYSE") and the NASDAQ Stock Market ("NASDAQ") already have proposed new listing standards that would require listed companies to adopt comprehensive codes of conduct for officers, directors and employees. The Roundtable has long advocated strong corporate codes of conduct and ethics, and we support the NYSE and NASDAQ proposals. We are concerned, however, that the Commission's imposition of an additional set of code of ethics requirements - requirements that overlap with and to some extent duplicate NYSE and NASDAQ standards - may force companies to create multiple codes of conduct for different groups of officers, directors and employees. We urge the Commission to coordinate its code of ethics rulemaking with the proposed NYSE and NASDAQ standards so as to avoid duplication of code provisions and enforcement mechanisms. We believe that this can be done most efficiently by conforming the list of code attributes in proposed Instruction 1 to Section 406 and the descriptions of ethical codes in the proposed market listing standards, and by noting in the instructions that a registrant need not have a separate code of ethics for senior financial officers (or for the principal executive officer) if its code of ethics, applying to officers or employees generally, covers such officers and contains the described attributes. Definition of the term "waiver" We believe it would be premature for the Commission to adopt a precise definition of the term "waiver" at this time. In many cases, whether a waiver has occurred will depend on how a particular code of ethics has been drafted, and it would be very difficult to craft a definition of "waiver" that works in every circumstance. Rather than committing to a detailed definition of the term at this time, we suggest that the Commission allow its staff time to observe the new code of ethics requirements in practice and determine, based on experience, whether such a definition is needed. II. Management's Internal Control Reports (Section 404) Annual Evaluation of Internal Controls Section 404 requires management to include in its internal control report a statement that it is responsible for establishing and maintaining internal controls and that it has assessed the effectiveness of the internal controls for financial reporting. Section 404 also expressly provided that these statements and the internal control report be included in each annual report filed by a company. The Commission's proposal, however, would amend its recently adopted Section 302 rules, effectively expanding the statutory mandate for an annual report on internal controls to also include a quarterly requirement to evaluate and assess internal financial controls, and to do so as of the end date of each quarter. It would be exceptionally difficult for management to evaluate and certify as to all internal controls and procedures for financial reporting for each quarterly report. Based on our recent experience with the Section 302 certification requirements, we can say that it would be enormously burdensome to attempt to comply with the proposed amendments to the Section 302 quarterly certification requirements, which would require an assessment at the end of each quarter of the full panoply of financial controls, in addition to disclosure controls. We would experience substantial increases in internal compliance costs given the intensity of work necessary to comply with the proposed amendments. In addition, the proposed amendments would likely cause a company's independent auditor to extend its interim review process, thereby leading to substantial increases in quarterly review fees charged by the independent auditor. The concerns we have about the proposed amendments are only magnified when considered against the backdrop of the Commission's already adopted accelerated periodic reporting requirements, which, within a few years, will require reports to be filed within 35 days of the end of each quarter. Most companies have already designed and established their systems based on the certification requirements just adopted in August, and have built in procedures to assess the effectiveness of disclosure controls and procedures within 90 days of quarter end. The new requirement will not only add a required review and certification of all financial controls, but also will require it to be done at the end of the quarter - in the same soon-to-be 35-day period when financial statements, the auditor's timely review and the Form 10Q disclosures all must be prepared. This is not workable. In short, we believe the Commission's existing quarterly certification requirements coupled with the statutory mandate for the annual report on internal controls provide ample assurance that management is taking appropriate steps to establish, maintain and evaluate internal controls and procedures for financial reporting. Disclosure of Significant Deficiencies and Material Weaknesses The certification rules under Section 302 currently require CEOs and CFOs to certify that "based on [their] most recent evaluation," they have disclosed to the company's auditors and audit committees (1) all significant deficiencies and material weaknesses in the design or operation of internal controls or procedures, and (2) any fraud that involves management or other employees who have a significant role in the company's internal controls. The proposed amendments to the certification rules under Section 302 would eliminate the "based on [their] most recent evaluation" qualification, and the required certification would have to be made as of the filing date. If the existing qualification is removed, it will be difficult for CEOs and CFOs to make the required certifications on a timely basis because the CEO and CFO will need to update their review as of the date of filing. Also, it is not appropriate for CEOs and CFOs to give absolute assurance. We therefore strongly suggest that the qualifying statement "based on our most recent evaluation" be re-inserted in the final amendments to the certification requirements. We appreciate your consideration of these comments, and we would be happy to discuss these matters further or to meet with you if it would be helpful.
cc: Hon. Harvey L. Pitt Hon. Paul Atkins Hon. Roel Campos Hon. Cynthia A. Glassman Hon. Harvey Goldschmid Alan L. Beller Paul F. Roye Giovanni P. Prezioso Jackson M. Day |
The Business Roundtable
BY E-MAIL Mr. Jonathan Katz
Re: Release No. 33-8138, Comments on Proposed Item 309 of Regulations S-K and
Dear Mr. Katz: The following comments are submitted on behalf of The Business Roundtable, an association of chief executive officers of leading corporations with a combined workforce of more than 10 million employees in the United States and $3.5 trillion in revenues. The Business Roundtable strongly supported enactment of the Sarbanes-Oxley Act of 2002 (the "S-O Act"), and we support the Securities and Exchange Commission's efforts to implement the S-O Act. We believe the law will go a long way toward establishing new, higher standards for America's corporations. As CEOs, we are committed to maintaining a strong economy, a vibrant workforce, and creating new jobs. We appreciate the opportunity to provide you with our views on a recent Securities and Exchange Commission ("Commission") proposal to implement S-O Act provisions relating to audit committee "financial experts." Our comments on the Commission's proposals regarding codes of ethics and management's internal control reports, which also are included in Release No. 33-8138, will be submitted separately. Definition of "financial expert" Section 407 of the S-O Act directs the Commission to issue rules requiring each reporting company to disclose whether its audit committee is comprised of at least one member who is a "financial expert." Section 407 also specifies several attributes, gained through a person's education and experience as an accountant or senior financial officer, that the Commission should consider in crafting the definition of "financial expert." However, the Commission's proposal would mandate that any person deemed to be an audit committee "financial expert" satisfy each of the attributes listed in Section 407 for the Commission to consider. The proposal also would require financial experts to have experience in the accounting for estimates, accruals and reserves that are "generally comparable" to those used in the company's financial statements, a requirement that might be read as requiring experience in the same or similar industries as those of the issuer. This requirement goes beyond Section 407, which indicates only that a financial expert should have experience with the financial statements of "generally comparable issuers," i.e., publicly traded companies. The Commission's proposed definition is significantly more restrictive than Section 407. Under the proposal, we are concerned that many companies will not have audit committee members who qualify as "financial experts," despite maintaining effective audit committees with members who meet or exceed current New York Stock Exchange ("NYSE") and NASDAQ Stock Market ("NASDAQ") financial expertise standards. Directors who do qualify as "financial experts" may find themselves designated as permanent audit committee members, unable to serve on and provide valuable insight to other board committees. In addition, we believe that the language in subsections b. and c. of proposed Item 309, requiring the designated expert or experts to have experience with "generally comparable" estimates, accruals and reserves and accounting issues, if read as requiring experience in the same industry as the company, may raise serious antitrust and independence concerns because such a requirement could restrict the pool of eligible experts to those who are working or have worked for competitors, suppliers or customers of the company. Finally, we are concerned that the proposal would not permit boards to consider candidates who - though not certified public accountants or senior financial officers - have other experience that qualifies them as financial experts. For example, a chief executive officer with years of experience supervising the preparation of financial reports might not meet the rule's requirement that a financial expert have experience "preparing or auditing" financial statements. We suggest that the Commission replace its list of mandatory attributes with a more flexible standard that will allow boards to consider candidates with supervisory and other relevant experience, and that the Commission clarify that experience in the same industry as the company is not required. In our view, this will better satisfy Section 407's direction that the Commission consider the listed attributes. For example, consistent with the purpose and language of Section 407, the Commission could delete subsections b. and c. of its proposal and replace them with a sentence indicating that the required disclosure should describe what factors have been considered by the board in determining financial expertise, including the items listed in subsections b. and c. and any additional factors (including those enumerated in Section 3 of the proposal) as factors the board "should" consider. The goal of the statute, and of any standard to be adopted by the Commission, should be to assure that audit committees have appropriate financial expertise, not to so tightly circumscribe the requirements that it will be difficult, if not impossible, to obtain committee members who meet the standard. Transition period The Commission has requested comment on whether it should provide companies with a transition period to find qualifying audit committee "financial experts." We believe the Commission should provide a transition period of at least one year, making the rule effective no earlier than for Forms 10-K filed for years ending after December 15, 2003. The statutory deadline for final rulemaking (January 26, 2003) falls close to the 2003 annual meetings for most companies, and it would be very difficult for companies to recruit, nominate and elect qualifying "financial experts" within such a short timeframe. Equally important, to avoid the possibility of confusing and conflicting requirements, the effective date of the "financial expert" disclosure requirements should be coordinated with the effective dates of the proposed NYSE and NASDAQ listing standards for audit committee membership. Companies need clear and uniform guidance as to what both the market listing requirements and the SEC disclosure requirements on audit committee membership will be, before corporate nominating committees and boards recommend director nominees to stockholders. We appreciate your consideration of these comments, and we would be happy to discuss these matters further or to meet with you if it would be helpful.
cc: Hon. Harvey L. Pitt Hon. Paul Atkins Hon. Roel Campos Hon. Cynthia A. Glassman Hon. Harvey Goldschmid Alan L. Beller Paul F. Roye Giovanni P. Prezioso Jackson M. Day |