[15543]
January 14, 2003
TO: ACCOUNTING/TREASURERS COMMITTEE No. 3-03
CLOSED-END INVESTMENT COMPANY COMMITTEE No. 5-03
SEC RULES COMMITTEE No. 6-03
RE: SEC PROPOSAL REGARDING LISTED COMPANY AUDIT COMMITTEE
STANDARDS
The Securities and Exchange Commission has proposed a new rule, Rule 10A-3, under
the Securities Exchange Act of 1934.∗ As proposed, Rule 10A-3 would direct the national
securities exchanges and national securities associations to prohibit the listing of any security of
an issuer that is not in compliance with the audit committee requirements in Rule 10A-3(b) and
(c). These requirements would apply to most listed issuers, including closed-end investment
companies and exchange-traded open-end investment companies.
Rule 10A-3’s requirements relate to: the independence of audit committee members; the
audit committee’s responsibility to select and oversee the issuer’s independent accountant; the
procedures for handling complaints regarding the issuer’s accounting practices; the authority of
the audit committee to engage advisors; and the funding for the independent auditor and any
other advisors engaged by the audit committee. The proposals are intended to enhance investor
confidence in the securities markets by increasing the effectiveness of listed company audit
committees.
Under the Sarbanes-Oxley Act, the SEC’s rule must become effective by April 26, 2003.
Under the SEC’s proposals, the new requirements would need to be operative by the national
securities exchanges and national securities associations no later than the first anniversary of the
publication of the SEC’s final rule in the Federal Register. The proposed delayed implementation
date is intended to give companies time to conform to the new standards. Further, as proposed,
the exchanges and associations would be required to submit to the Commission, no later than
60 days after publication of a final Rule 10A-3, proposals that comply with that rule.
Comments on the proposal are due to the SEC 30 days after publication in the Federal
Register. We have scheduled a conference call to discuss the proposal on Tuesday, January 21,
∗ SEC Release Nos. 33-8173, 34-47137, IC-25885 (January 8, 2003) (“Release”). A copy of the Release is available on the
SEC’s website at http://www.sec.gov/rules/proposed/34-47137.htm.
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2003 at 2:00 (Eastern Standard Time). Please contact me as soon as possible by phone (202/218-
3563), e-mail (ddonohue@ici.org), or fax (202/326-5827) if you plan on participating on the call.
Set forth below is a summary of the significant aspects of the proposal.
I. Audit Committee Member Independence
Proposed Rule 10A-3 would prohibit audit committee members of any listed issuer from
accepting any consulting, advisory or other compensatory fee from the issuer or an affiliate of
the issuer, other than in the member’s capacity as a member of the board of directors. The
Commission also has proposed prohibiting any indirect payments to audit committee members,
which would include, among other things, payments to a law firm in which an audit committee
member is a partner and which provides legal services to the issuer. In addition, under the
proposal, a member of an investment company’s audit committee could not be an “interested
person” of the investment company, as defined in Section 2(a)(19) of the Investment Company
Act of 1940.
The Release notes that the Commission has the authority to exempt from the
independence requirements particular relationships with respect to audit committee members.
Based on this authority, the Commission has proposed to exempt one member of a non-
investment company issuer’s audit committee from the independence requirements for 90 days
from the effective date of an issuer’s initial registration statement. The Release further notes
that the Commission does not propose to consider exemptions for particular relationships on a
case-by-case basis.
The Release requests comment on several aspects of the independence requirement including:
whether there should be a de minimis exception from the prohibition on advisory or other compensatory
fees; whether the board should be required to determine whether an audit committee member is
independent; whether the prohibition should extend to a “look back” period before the appointment of the
member to the audit committee; whether additional relationships should be exempted from the
independence requirements; whether the proposed exemption for new public companies should apply to
investment companies; whether there should be an exception to the independence requirement based on
exceptional and limited circumstances; whether companies should be allowed to request exemptive relief
on a case-by-case basis; and whether there should be any modifications to the consulting, advisory or
other compensatory fee prohibition for investment companies.
II. Responsibilities Relating to Registered Public Accounting Firms
Under the proposal, an issuer’s audit committee would be responsible for the
appointment, compensation, retention, termination, and oversight of the independent auditor
engaged for the purpose of preparing an audit report. The Commission has proposed
exempting investment companies that fall within the scope of the proposed rule from the
requirement that the audit committee be responsible for the selection of the independent
auditor, recognizing that Section 32(a) of the Investment Company Act requires a majority of
disinterested directors to select independent auditors. The Release specifically notes, however,
that investment companies would remain subject to the proposed requirements regarding audit
committee responsibility in all other areas.
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The Release seeks comment on several aspects of the proposed audit committee responsibilities
including: whether the Commission should exempt investment companies from the requirements relating
to independent auditor selection in Section 32(a) of the Investment Company Act and instead require that
their independent auditors be selected by the audit committee; whether the Commission should require
investment companies to comply with the requirements of both Section 32(a) and the proposed rule (i.e.,
the audit committee would nominate the independent auditor and the majority of disinterested directors
would approve the independent auditor); and how the Commission should reconcile Rule 10A-3, the
auditor independence proposal, and Section 32(a).
III. Procedures for Handling Complaints
The Commission has proposed requiring each audit committee to establish procedures
for the receipt, retention and treatment of complaints received by the issuer regarding
accounting, internal accounting controls or auditing matters, and the confidential, anonymous
submission by employees of the issuer of concerns regarding questionable accounting matters.
The proposal does not mandate specific procedures.
The Release requests comment on several aspects of the proposed requirements with respect to
complaints including: whether issuers should be required to disclose the procedures that have been
established and, if so, where such disclosure should appear; and whether the Commission should prescribe
specific procedures.
IV. Authority to Engage Advisors
The Commission has proposed requiring an issuer’s audit committee to have the
authority to engage outside advisors, including counsel, as it determines necessary to carry out
its duties. The Release notes that the proposed requirement would not preclude the audit
committee from seeking advice from the company’s internal counsel or regular outside
counsel. It also would not require an audit committee to retain independent counsel. The
Release requests comment on whether the Commission should define what constitutes an “independent
advisor.”
V. Funding
Under the proposal, issuers would be required to provide for appropriate funding, as
determined by the audit committee, for payment of compensation to any registered public
accounting firm engaged for the purpose of issuing an audit report or performing other audit
services for the issuer and to any advisors employed by the audit committee. The Release
requests comment on, among other things, whether there should be a limit on the amount of
compensation that could be requested by the audit committee.
VI. Exemptions for Certain Securities
According to the Release, several classes of securities would be exempt from the
proposed requirements, including listed security futures products, listed standardized options,
asset backed issuers, and, notably, exchange-traded unit investment trusts (“UITs”). The
Release requests comment on whether the exclusion for exchange-traded UITs is appropriate; whether a
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UIT’s sponsor, trustee, or depositor should be required to comply with the proposed rule; and whether
there are other types of investment companies that should be excluded from the proposed rule.
VII. Determining Compliance with the Proposed Standards
Proposed Rule 10A-3 would direct the self-regulatory organizations (“SROs”) to require
a listed issuer to notify the applicable SRO “promptly” after an executive officer of an issuer
becomes aware of any material noncompliance by the listed issuer with the proposed
requirements. According to the Release, the Commission encourages the SROs to impose a
similar requirement for noncompliance with other SRO listing standards that relate to corporate
governance standards. The Release requests comment on, among other things, whether the proposed
triggering event for notification is appropriate and whether a listed issuer should be required to disclose
periodically to the SROs whether they have been in compliance with the standards.
VIII. Disclosure Regarding Audit Committees
The Commission has proposed certain exemptions from proposed Rule 10A-3. The
Release explains that because issuers relying on the exemptions would be distinguished from
most other listed issuers, the Commission has proposed requiring issuers to disclose their
reliance on the exemption and their assessment of whether, and if so, how, such reliance would
materially adversely affect the ability of their audit committees to act independently. Such
disclosure would need to appear, or be incorporated by reference, in annual reports and proxy
statements for shareholder meetings at which directors are to be elected. Significantly, the
Commission has proposed exempting exchange-traded UITs from this disclosure requirement.
The Release requests comment on whether an exchange-traded UIT should be required to disclose that it
is availing itself of the exemption and, if so, where such disclosure should be made.
Dorothy M. Donohue
Associate Counsel