1 Securities Exchange Act Release No. 41987 (October 7, 1999), 64 FR 55648 (October 14, 1999).
2 Securities Exchange Act Release Nos. 41980 (October 6, 1999) and 41981 (October 6, 1999). The National Association
of Securities Dealers also filed similar proposed rule changes with the SEC. Securities Exchange Act Release No.
41982 (October 6, 1999). Because the NASD’s proposal is virtually identical to the Amex’s proposal, the Institute’s
comments on the Amex’s proposal also apply to the NASD’s proposal.
3 See Memorandum to Accounting/Treasurers Committee No. 36-99, Closed-End Investment Company Committee
No. 36-99, and SEC Rules Committee No. 81-99, dated October 30, 1999.
4 The SEC Proposal and Exchange Proposals would apply to closed-end investment companies. The SEC Proposal,
however, requests comment on whether any or all of the SEC Proposal should apply to open-end investment
companies.
5 See Role of Independent Directors of Investment Companies, Investment Company Act Release No. 24082 (October
14, 1999).
[11440]
December 1, 1999
TO: ACCOUNTING/TREASURERS COMMITTEE No. 47-99
CLOSED-END INVESTMENT COMPANY COMMITTEE No. 47-99
SEC RULES COMMITTEE No. 101-99
RE: INSTITUTE COMMENT LETTERS ON AUDIT COMMITTEE PROPOSALS
______________________________________________________________________________
The Institute has filed comment letters (attached) with the Securities and Exchange
Commission ("SEC") in connection with the SEC’s proposed new rules and rule amendments
related to the functioning of corporate audit committees1 ("SEC Proposal") and proposed rule
changes filed by the New York Stock Exchange ("NYSE") and the American Stock Exchange
("Amex") relating to their audit committee requirements for listed companies2 ("Exchange
Proposals") (collectively, the "Proposals")3.
In general, the Institute’s letters state that while the Institute supports the overall
objective of the Proposals - to promote quality financial reporting and investor confidence in
the integrity of the financial reporting process - we strongly oppose their application to
investment companies.4 Investment companies are structured and regulated very differently
from public operating companies. As a consequence, the potential financial reporting abuses
the Proposals are intended to address do not exist in the context of investment companies and
the proposed disclosure requirements would not provide meaningful information to fund
shareholders. In addition, the Institute’s letter noted that the SEC’s recently issued Fund
Governance Proposals,5 which are designed to enhance the effectiveness of
2independent directors of investment companies, include a proposal specifically focusing on
audit committees. The Institute’s letters also had several specific comments on the Proposals.
SEC Proposal
The SEC Proposal requested comment on whether a closed-end fund's semi-annual
financial statements should be reviewed by independent auditors before being sent to
shareholders. The Institute letter states that even if the SEC determines not to exclude closed-
end investment companies from the SEC Proposal generally, it should not adopt such a
requirement.
The comment letter notes that while closed-end funds do not issue and redeem shares
on a daily basis like open-end funds, they do typically calculate daily the mark-to-market value
of their holdings and distribute a net asset value to the media and others. The dissemination of
mark-to-market net asset values and the availability of related total return performance
information substantially decreases the impact that the release of closed-end fund financial
statements would otherwise have in the marketplace. Closed-end fund semi-annual financial
reports therefore have much less significance than quarterly earnings releases by operating
companies. The letter states that the Institute believes, therefore, that the value to fund
shareholders of requiring closed-end funds’ semi-annual financial statements to be reviewed by
independent auditors before being sent to shareholders would be insignificant.
The SEC Proposal also would require that the audit committee provide a report in the
company's proxy statement that would disclose, among other things, whether anything came to
the attention of the members of the audit committee that caused them to believe that the
audited financial statements included in the company's annual report on Form 10-K contain an
untrue statement of material fact, or omit to state a material fact necessary to make the
statements therein not misleading. The Institute’s letter notes that investment companies are
not required to file Form 10-K and it is unclear from the proposing release whether the SEC
intended to exclude them from this requirement. Nevertheless, the comment letter states that
the Institute opposes the proposed requirement as it would be superfluous, for operating
companies as well as investment companies. Auditors are already under an obligation to
disclose in their reports any policies related to an issuer’s financial statements. Thus, the
proposed disclosure would, in substance, simply duplicate this information.
Exchange Proposals
The Institute’s comment letter states that as part of the SEC’s Fund Governance
Proposals, the SEC has proposed a new rule under the Investment Company Act, Rule 32a-4, to
exempt funds from the requirement that shareholders ratify the board’s selection of the fund’s
independent auditors. Proposed Rule 32a-4 is tailored specifically for investment companies,
including closed-end funds. In contrast, the Exchange Proposals include certain requirements
that may not be necessary for investment companies. For example, the Amex’s proposal would
require that at least one member of the audit committee have past employment experience in
finance or accounting, professional certification in accounting, or other comparable experience
or background. The Institute’s letter states that financial reporting and the application of
3appropriate accounting policies in the public operating company context is a complex process
that requires oversight by board members who possess financial management expertise. In
contrast, the accounting policies employed by investment companies are relatively straight-
forward (e.g., investment securities are valued at the current market-value) and audit
committee oversight does not require the same degree of accounting expertise.
The comment letter states that based on the foregoing, the Institute recommends that
closed-end funds be excluded from the Exchange Proposals. If it is determined that listed
closed-end funds should be subject to enhanced audit committee requirements, the Institute
recommends that they be subject only to the conditions set forth in Rule 32a-4, in the form it is
adopted. This would avoid closed-end funds being subject to inappropriate, duplicative, and
potentially conflicting regulatory requirements.
In addition, in the event the SEC determines that there is a need to proceed with the
Exchange Proposals as they relate to closed-end funds, the Institute urges that there be a single
standard for closed-end funds to follow and that it be the NYSE standard. One of the
significant distinctions between the NYSE’s and the Amex’s proposals relates to the financial
literacy requirements for audit committee members. The NYSE would permit directors to
exercise their business judgment to determine the ability of board members to satisfy the
financial management expertise requirement, while the Amex proposal would require past
employment in the financial arena to qualify. The letter states that the NYSE’s standard is more
consistent with the manner in which closed-end fund boards conduct their business.
Ari Burstein
Assistant Counsel
Attachments