SEC Proposes Rule Regarding Listed Company Audit Committees Pursuant to Sarbanes-Oxley Act
 
January 13, 2003
 

On January 8, 2003, the Securities and Exchange Commission (the SEC) proposed Exchange Act Rule 10A-3, which directs the national securities exchanges and the national securities associations to prohibit the listing of any security of a company that is not in compliance with certain audit committee standards relating to:

• the independence of audit committee members

• the audit committee’s responsibility to select and oversee the company’s independent accountant

• procedures for handling complaints regarding company accounting practices

• the audit committee’s authority to engage independent advisors, and

• adequate funding for the audit committee

The proposed rule would implement the requirements of Section 10A(m)(1) of the Exchange Act, added by Section 301 of the Sarbanes-Oxley Act. 

Because Section 10A(m)(1) of the Exchange Act applies only to issuers whose securities are listed on national securities exchanges and by national securities associations, those whose securities are quoted on the OTC Bulletin Board, the Pink Sheets and the Yellow Sheets would not be affected by the proposed requirements, unless their securities also are listed on an exchange or Nasdaq.

The proposed rule would apply equally to foreign and domestic companies, except that the SEC has provided limited exceptions for some foreign companies more fully described in the proposed rule.

The proposed rule must become final and effective by April 26, 2003, pursuant to the Sarbanes-Oxley Act, and would need to become operative by the national securities exchanges and national securities associations no later than one year from the publication of the final rule in the Federal Register.

Audit Committee Member Independence

Each member of the audit committee of the issuer must be independent according to two basic criteria for determining independence described in the proposed rule.

First, audit committee members may not accept any consulting, advisory or other compensatory fee from the company or an affiliate of the company, other than in the member's capacity as a member of the board of directors and any board committee.  This would preclude payments made either directly or indirectly to an audit committee member, including payments to spouses, minor children or stepchildren or children or stepchildren sharing a home with a member, as well as payments accepted by an entity in which an audit committee member is a partner, member or principal or occupies a similar position and that provides accounting, consulting, legal, investment banking, financial or other advisory services or any similar services to the company.

Second, a member of the audit committee of a company that is not an investment company may not be an affiliated person of the company or any subsidiary of the company apart from his or her capacity as a member of the board and any board committee. The SEC proposes to define "affiliate" of, or a person "affiliated" with, a specified person, to mean "a person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, the person specified."  In addition, it proposes to define the term "control" as "the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise."  The proposed rule creates a safe harbor from this aspect of the proposed definition of "affiliated person." Under this safe harbor, a person who is not an executive officer, director or 10% shareholder of the company would not be deemed to control the issuer.

The proposed rule authorizes the SEC under limited circumstances to exempt from the independence requirements particular relationships with respect to audit committee members.

Responsibilities Relating to Registered Public Accounting Firms

Under the proposed rule, the audit committee of each company must be directly responsible for the appointment, compensation, retention and oversight of the work of any registered public accounting firm engaged for the purpose of preparing or issuing an audit report or related work or performing other audit, review or attest services for the company, and each such registered public accounting firm must report directly to the audit committee.

In connection with these oversight responsibilities, the audit committee must have ultimate authority to approve all audit engagement fees and terms, as well as all significant non-audit engagements of the independent auditor.

This requirement does not conflict with, and would not be affected by, any requirement for shareholders to elect, approve or ratify the selection of the company’s auditor. Instead, it relates to the assignment of responsibility to oversee the auditor's work as between the audit committee and management.

Procedures for Handling Complaints

Each audit committee must establish procedures for the receipt, retention and treatment of complaints regarding accounting, internal accounting controls or auditing matters, including procedures for the confidential, anonymous submission by employees of the company of concerns regarding questionable accounting or auditing matters.

Although the proposed rule does not mandate specific procedures that the audit committee must establish, the SEC expects each audit committee to develop procedures that work best with its company’s individual circumstances.

Authority to Engage Advisors

Recognizing that the audit committee likely will require advice with respect to some accounting, financial reporting or legal matters, the SEC would require that each audit committee have the authority to engage outside advisors, including counsel, as it determines necessary to carry out its duties.

Funding

The proposed rule also requires each company to provide appropriate funding for the audit committee, as determined by the audit committee, in its capacity as a committee of the board of directors, for payment of compensation:

To any registered public accounting firm engaged for the purpose of rendering or issuing an audit report or related work or performing other audit, review or attest services for the listed company; and

To any advisors employed by the audit committee.

The proposed rule, together with the SEC's introduction and comments, are available at the SEC web site. Interested persons are invited to submit comments on the proposed rule, which must be received at the SEC no later than 30 days after the proposed rules are published in the Federal Register.

Holland & Knight will be tracking this and other developments in the implementation of the Sarbanes-Oxley Act. For further information, please contact Michael Jamieson or Steve Sonberg at 1-888-688-8500.