[Federal Register Volume 68, Number 12 (Friday, January 17, 2003)]
[Proposed Rules]
[Pages 2638-2664]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-690]



[[Page 2637]]

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Part II





Securities and Exchange Commission





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17 CFR Parts 228, et al.



Standards Relating to Listed Company Audit Committees; Proposed Rule

  Federal Register / Vol. 68, No. 12 / Friday, January 17, 2003 / 
Proposed Rules  

[[Page 2638]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 228, 229, 240, 249 and 274

[Release Nos. 33-8173; 34-47137; IC-25885; File No. S7-02-03]
RIN 3235-AI75


Standards Relating to Listed Company Audit Committees

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: As directed by the Sarbanes-Oxley Act of 2002, we are 
proposing a new rule to 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 established by the Sarbanes-Oxley Act of 2002. 
These requirements relate to: the independence of audit committee 
members; the audit committee's responsibility to select and oversee the 
issuer's independent accountant; procedures for handling complaints 
regarding the issuer's accounting practices; the authority of the audit 
committee to engage advisors; and funding for the independent auditor 
and any outside advisors engaged by the audit committee. The new rule 
must become effective by April 26, 2003, and under our 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 our final rule in the Federal 
Register. The proposals would implement the requirements of Section 
10A(m)(1) of the Securities Exchange Act of 1934, as added by Section 
301 of the Sarbanes-Oxley Act of 2002.

DATES: Comments should be received on or before February 18, 2003.

ADDRESSES: To help us process and review your comments more 
efficiently, comments should be sent by hard copy or e-mail, but not by 
both methods. Comments sent by hard copy should be submitted in 
triplicate to Jonathan G. Katz, Secretary, Securities and Exchange 
Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. Comments 
also may be submitted electronically at the following electronic mail 
address: [email protected]. All comment letters should refer to 
File No. S7-02-03. This file number should be included in the subject 
line if electronic mail is used. Comment letters will be available for 
public inspection and copying in the Commission's Public Reference 
Room, 450 Fifth Street, NW., Washington, DC 20549. Electronically 
submitted comment letters will be posted on the Commission's Internet 
Web site (http://www.sec.gov).\1\
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    \1\ We do not edit personal identifying information, such as 
names or electronic mail addresses, from electronic submissions. You 
should submit only information that you wish to make available 
publicly.

FOR FURTHER INFORMATION CONTACT: Jeffrey J. Minton, Special Counsel, or 
Elizabeth M. Murphy, Chief, Office of Rulemaking, Division of 
Corporation Finance, at (202) 942-2910, or, with respect to investment 
companies, Christopher P. Kaiser, Senior Counsel, Office of Disclosure 
Regulation, Division of Investment Management, at (202) 942-0724, U.S. 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
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DC 20549.

SUPPLEMENTARY INFORMATION: We are proposing to add new Rule 10A-3 \2\ 
under the Securities Exchange Act of 1934 (the ``Exchange Act''),\3\ to 
amend Forms 10-K,\4\ 10-KSB,\5\ 20-F \6\ and 40-F \7\ and Items 7 and 
22 of Schedule 14A \8\ under the Exchange Act, to amend Item 401\9\ of 
Regulation S-B \10\ and Items 401\11\ and 601\12\ of Regulation S-K 
\13\ under the Securities Act of 1933 (the ``Securities Act'')\14\ and 
to amend proposed Form N-CSR \15\ under the Exchange Act and the 
Investment CompanyAct of 1940 (the ``Investment Company Act'').\16\
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    \2\ 17 CFR 240.10A-3.
    \3\ 15 U.S.C. 78a et seq.
    \4\ 17 CFR 249.310.
    \5\ 17 CFR 249.310b.
    \6\ 17 CFR 249.220f.
    \7\ 17 CFR 249.240f.
    \8\ 17 CFR 240.14a-101.
    \9\ 17 CFR 228.401.
    \10\ 17 CFR 228.10 et seq.
    \11\ 17 CFR 229.401.
    \12\ 17 CFR 229.601.
    \13\ 17 CFR 229.10 et seq.
    \14\ 15 U.S.C. 77a et seq.
    \15\ 17 CFR 249.331 and 17 CFR 274.128.
    \16\ 15 U.S.C. 80a-1 et seq.
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Table of Contents

I. Background and Overview of the Proposals
II. Proposed Changes
    A. Audit Committee Member Independence
    B. Responsibilities Relating to Registered Public Accounting 
Firms
    C. Procedures for Handling Complaints
    D. Authority to Engage Advisors
    E. Funding
    F. Application and Implementation of the Proposed Standards
    1. SROs Affected
    2. Securities Affected
    a. Multiple Listings
    b. Security Futures Products and Standardized Options
    3. Issuers Affected
    a. Foreign Issuers
    b. Small Businesses
    c. Issuers of Asset-Backed Securities
    d. Investment Companies
    4. Determining Compliance with Proposed Standards
    5. Opportunity to Cure Defects
    G. Disclosure Changes Regarding Audit Committees
    1. Disclosure Regarding Exemptions
    2. Identification of the Audit Committee in Annual Reports
    3. Updates to Existing Audit Committee Disclosure
    H. General Request for Comment
III. Paperwork Reduction Act
IV. Cost-Benefit Analysis
V. Consideration of Impact on the Economy, Burden on Competition and 
Promotion of Efficiency, Competition and Capital Formation
VI. Initial Regulatory Flexibility Analysis
VII. Statutory Authority and Text of Rule Amendments

I. Background and Overview of the Proposals

    Accurate and reliable financial reporting lies at the heart of our 
disclosure-based system for securities regulation, and is critical to 
the integrity of the U.S. securities markets. Investors need accurate 
and reliable financial information to make informed investment 
decisions. Investor confidence in the reliability of corporate 
financial information is fundamental to the liquidity and vibrancy of 
our markets.
    Effective oversight of the financial reporting process is 
fundamental to preserving the integrity of our markets. The board of 
directors, elected by and accountable to shareholders, is the focal 
point of the corporate governance system. The audit committee, composed 
of members of the board of directors, plays a critical role in serving 
as a check and balance on a company's financial reporting system. The 
audit committee provides independent review and oversight of a 
company's financial reporting processes, internal controls and 
independent auditors. It provides a forum separate from management in 
which auditors and other interested parties can candidly discuss 
concerns. By effectively carrying out its functions and 
responsibilities, the audit committee helps to ensure that management 
properly develops and adheres to a sound system of internal controls, 
that procedures are in place to objectively assess management's 
practices and internal controls, and that the outside auditors, through 
their own review, objectively assess the company's financial reporting 
practices.
    Since the early 1940s, the Commission, along with the auditing

[[Page 2639]]

and corporate communities, has had a continuing interest in promoting 
effective and independent audit committees.\17\ It was largely with the 
Commission's encouragement, for instance, that the self-regulatory 
organizations, or SROs, first adopted audit committee requirements in 
the 1970s.\18\ Over the years, others have expressed support for 
strong, independent audit committees,\19\ including the National 
Commission on Fraudulent Financial Reporting, also known as the 
Treadway Commission,\20\ and the General Accounting Office.\21\
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    \17\ In 1940, the Commission investigated the auditing practices 
of McKesson & Robbins, Inc., and the Commission's ensuing report 
prompted action on auditing procedures by the auditing community. In 
the Matter of McKesson & Robbins, Accounting Series Release (ASR) 
No. 19, Exchange Act Release No. 2707 (Dec. 5, 1940).
    \18\ For example, in 1972, the Commission recommended that 
companies establish audit committees composed of outside directors. 
See ASR 123 (Mar. 23, 1972). In 1974 and 1978, the Commission 
adopted rules requiring disclosures about audit committees. See 
Release No. 34-11147 (Dec. 20, 1974) and Release No. 34-15384 (Dec. 
6, 1978).
    \19\ See, e.g., Preliminary Report of the American Bar 
Association Task Force on Corporate Responsibility (July 16, 2002). 
The report is available on the American Bar Association's website at 
www.abanet.org/buslaw/.
    \20\ The Treadway Commission was sponsored by the American 
Institute of Certified Public Accountants, the American Accounting 
Association, the Financial Executives Institute (now Financial 
Executives International), the Institute of Internal Auditors and 
the National Association of Accountants. Collectively, these groups 
were known as the Committee of Sponsoring Organizations, or COSO. 
The Treadway Commission's report, the Report of the National 
Commission on Fraudulent Financial Reporting (October 1987), is 
available at www.coso.org.
    \21\ GAO, ``CPA Audit Quality: Status of Actions Taken to 
Improve Auditing and Financial Reporting of Public Companies,'' at 5 
(GAO/AFMD-89-38, March 1989).
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    In 1998, the New York Stock Exchange (the ``NYSE'') and the 
National Association of Securities Dealers, Inc. (the ``NASD'') 
sponsored a committee to study the effectiveness of audit committees. 
This committee became known as the Blue Ribbon Committee on Improving 
the Effectiveness of Corporate Audit Committees (the ``Blue Ribbon 
Committee''). In its 1999 report, the Blue Ribbon Committee recognized 
the importance of audit committees and issued ten recommendations to 
improve their effectiveness.\22\ In response to these recommendations, 
the NYSE and the NASD, among others, revised their listing standards 
relating to audit committees,\23\ and we adopted new rules requiring 
disclosure relating to the functioning, governance and independence of 
corporate audit committees.\24\ Earlier this year, at the Commission's 
request,\25\ the NYSE and the NASD again reviewed their corporate 
governance standards, including their audit committee rules, in light 
of several high-profile corporate failures, and have proposed changes 
to their rules to provide more demanding standards for audit 
committees.\26\
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    \22\ See Report and Recommendations of the Blue Ribbon Committee 
on Improving the Effectiveness of Corporate Audit Committees 
(February 1999). The Blue Ribbon Committee Report is available at 
www.nyse.com.
    \23\ See, for example, Exchange Act Release No. 42231 (Dec. 14, 
1999) [64 FR 71523] (Nasdaq rules) and Exchange Act Release No. 
42233 (Dec. 14, 1999) (NYSE rules) [64 FR 71529]. See also Exchange 
Act Release No. 42232 (Dec. 14, 1999) [64 FR 71518] (American Stock 
Exchange rules) and Release No. 34-43941 (Feb. 7, 2001) [66 FR 
10545] (Pacific Exchange rules).
    \24\ See Exchange Act Release No. 42266 (Dec. 22, 1999) [64 FR 
73389].
    \25\ See Press Release No. 2002-23 (Feb. 13, 2002).
    \26\ See File Nos. SR-NASD-2002-141 and SR-NYSE-2002-33 (pending 
before the Commission).
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    Recent events involving alleged misdeeds by corporate executives 
and independent auditors have damaged investor confidence in the 
financial markets.\27\ They have highlighted the need for strong, 
competent and vigilant audit committees with real authority.\28\ In 
response to the threat to the U.S. financial markets posed by these 
events, Congress passed, and the President signed into law on July 30, 
2002, the Sarbanes-Oxley Act of 2002 (the ``Sarbanes-Oxley Act'').\29\ 
The Sarbanes-Oxley Act mandates sweeping corporate disclosure and 
financial reporting reform to improve the responsibility of public 
companies for their financial disclosures. This release is one of 
several that we are issuing to implement provisions of the Sarbanes-
Oxley Act.\30\
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    \27\ See, for example, John Waggoner and Thomas A. Fogarty, 
``Scandals Shred Investors' Faith: Because of Enron, Andersen and 
Rising Gas Prices, the Public is More Wary Than Ever of Corporate 
America,'' USA Today, May 5, 2002; and Louis Aguilar, ``Scandals 
Jolting Faith of Investors,'' Denver Post, June 27, 2002.
    \28\ See, for example, John Good, ``After Enron, Beef Up Those 
Audit Committees,'' The Commercial Appeal, Apr. 26, 2002; and ``FT 
Comment After Enron: Giving Meaning to the Codes of Best Practice: 
Corporate Governance: Companies Need Truly Independent Directors, 
Strong Audit Committees, an Outlet for Whistleblowers and Tight 
Controls on Share Options,'' The Financial Times, Feb. 19, 2002.
    \29\ Pub. L. 107-204, 116 Stat. 745 (2002).
    \30\ For example, see Release No. 34-46421 (Aug. 27, 2002) [67 
FR 56462] (Ownership reports and trading by officers, directors and 
principal security holders); Release No. 33-8124 (Aug. 28, 2002) [67 
FR 57276] (Certification of disclosure in companies' quarterly and 
annual reports); Release No. 33-46685 (Oct. 18, 2002) [67 FR 65325] 
(Improper influence on conduct of audits); Release No. 33-8138 (Oct. 
22, 2002) [67 FR 66208] (Disclosure regarding internal control 
reports, audit committee financial experts and company codes of 
ethics); Release No. 33-8144 (Nov. 4, 2002) [67 FR 68054] 
(Disclosure about off-balance sheet arrangements, contractual 
obligations and contingent liabilities and commitments); Release No. 
33-8145 (Nov. 4, 2002) [67 FR 68790] (Conditions for use of non-GAAP 
financial information); Release No. 34-46778 (Nov. 6, 2002) [67 FR 
69430] (Insider trades during pension plan blackout periods); 
Release No. 33-8150 (Nov. 21, 2002) [67 FR 71670] (Implementation of 
standards of conduct for attorneys); Release No. 33-8151 (Nov. 21, 
2002) [67 FR 71018] (Retention of records relevant to audits and 
reviews); Release No. 33-8154 (Dec. 2, 2002) [67 FR 76780] 
(Strengthening the Commission's requirements regarding auditor 
independence); and Release No. 33-8170 (Dec. 20, 2002) [67 FR 79466] 
(Mandated electronic filing and website posting for Forms 3, 4 and 
5).
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    In this release, we propose to implement Section 10A(m)(1) of the 
Exchange Act,\31\ as added by Section 301 of the Sarbanes-Oxley Act, 
which requires us to direct, by rule, the national securities exchanges 
\32\ and national securities associations \33\ to prohibit the listing 
of any security of an issuer that is not in compliance with several 
enumerated standards regarding issuer audit committees. The new rule 
must become effective by April 26, 2003, which is 270 days after the 
date of enactment of the Sarbanes-Oxley Act and Section 10A(m) of the 
Exchange Act.\34\ Under our proposals, the new requirements would need 
to be operative by the SROs no later than the first anniversary of the 
publication of our final rule in the Federal Register. In addition, our 
proposals would make

[[Page 2640]]

several changes to our current disclosure requirements regarding audit 
committees.
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    \31\ 15 U.S.C. 78j-1(m)(1).
    \32\ A ``national securities exchange'' is an exchange 
registered as such under Section 6 of the Exchange Act (15 U.S.C. 
78f). There are currently nine national securities exchanges 
registered under Section 6(a) of the Exchange Act: American Stock 
Exchange (AMEX), Boston Stock Exchange, Chicago Board Options 
Exchange (CBOE), Chicago Stock Exchange, Cincinnati Stock Exchange, 
International Securities Exchange, New York Stock Exchange (NYSE), 
Philadelphia Stock Exchange and Pacific Exchange. In addition, an 
exchange that lists or trades security futures products (as defined 
in Exchange Act Section 3(a)(56) (15 U.S.C. 78c(56))) may register 
as a national securities exchange under Section 6(g) of the Exchange 
Act solely for the purpose of trading security futures products. 
Regarding security futures products, see Section II.F.2.b.
    \33\ A ``national securities association'' is an association of 
brokers and dealers registered as such under Section 15A of the 
Exchange Act (15 U.S.C. 78o-3). The National Association of 
Securities Dealers (NASD) is the only national securities 
association registered with the Commission under Section 15A(a) of 
the Exchange Act. The NASD partially owns and operates The Nasdaq 
Stock Market (Nasdaq). Nasdaq has filed an application with the 
Commission to register as a national securities exchange. In 
addition, Section 15A(k) of the Exchange Act (15 U.S.C. 78o-3(k)) 
provides that a futures association registered under Section 17 of 
the Commodity Exchange Act (7 U.S.C. 21) shall be registered as a 
national securities association for the limited purpose of 
regulating the activities of members who are registered as broker-
dealers in security futures products pursuant to Section 15(b)(11) 
of the Exchange Act (15 U.S.C. 78o(b)(11)). Regarding security 
futures products, see Section II.F.2.b.
    \34\ See Exchange Act Section 10A(m)(1)(A).
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    Under proposed Exchange Act Rule 10A-3,\35\ SROs would be 
prohibited from listing any security of an issuer that is not in 
compliance with the following standards, as discussed in more detail 
below:
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    \35\ Exchange Act Rule 10A-2 (17 CFR 240.10A-2) was proposed in 
Release No. 33-8154 (Dec. 2, 2002).
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    [sbull] Each member of the audit committee of the issuer must be 
independent according to specified criteria;
    [sbull] The audit committee of each issuer must be directly 
responsible for the appointment, compensation, retention and oversight 
of the work of any registered public accounting firm \36\ engaged for 
the purpose of preparing or issuing an audit report or related work or 
performing other audit, review or attest services for the issuer, and 
each such registered public accounting firm must report directly to the 
audit committee;
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    \36\ The term ``registered public accounting firm'' is defined 
in Section 2(a)(12) of the Sarbanes-Oxley Act. See 15 U.S.C. 
78c(b)(59). Until the Public Company Accounting Oversight Board that 
is contemplated under the Sarbanes-Oxley Act has established the 
registration of public accounting firms, the proposed requirement 
relating to the audit committee's oversight would refer to the 
public accounting firm employed by the issuer for the purposes 
indicated.
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    [sbull] 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 issuer 
of concerns regarding questionable accounting or auditing matters;
    [sbull] Each audit committee must have the authority to engage 
independent counsel and other advisors, as it determines necessary to 
carry out its duties; and
    [sbull] Each issuer must provide appropriate funding for the audit 
committee.
    The standards articulated in Section 10A(m) of the Exchange Act 
will provide a framework in which audit committees can be more 
effective in protecting shareholder interests and in addressing the 
risk that management self-interest may diverge from shareholder 
interest. The audit committee is more likely to be effective in 
performing its oversight role when it has adequate resources and is 
empowered to accomplish its responsibilities independently of 
management, especially when potential conflicts of interests with 
management may be apparent. Independent audit committee members also 
are more likely to be objective when evaluating financial disclosure 
and internal controls. There must also be frank, open and clear 
channels of communication so that information can reach the audit 
committee.

II. Proposed Changes

    Under Section 3(a)(58) of the Exchange Act,\37\ as added by Section 
205 of the Sarbanes-Oxley Act, the term audit committee is defined as:
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    \37\ 15 U.S.C. 78c(a)(58).
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    [sbull] A committee (or equivalent body) established by and amongst 
the board of directors of an issuer for the purpose of overseeing the 
accounting and financial reporting processes of the issuer and audits 
of the financial statements of the issuer; and
    [sbull] If no such committee exists with respect to an issuer, the 
entire board of directors of the issuer.
    Accordingly, an issuer either may have a separately designated 
audit committee composed of members of its board or, if it chooses to 
do so or if it fails to form a separate committee, the entire board of 
directors would constitute the audit committee. If the entire board 
constituted the audit committee, our proposals for the new SRO rules, 
including the independence requirements, would apply to the issuer's 
board as a whole.
    In addition, because proposed Exchange Act Rule 10A-3 would impose 
requirements that only would apply to issuers listed on a national 
securities exchange or listed in an automated inter-dealer quotation 
system of a national securities association,\38\ the requirements of 
proposed Exchange Act Rule 10A-3 only would apply to issuers that are 
so listed. None of the requirements of Section 10A(m) of the Exchange 
Act or proposed Exchange Act Rule 10A-3 apply to other reporting 
companies under Section 13(a) \39\ or 15(d) \40\ of the Exchange Act.
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    \38\ In this release, we refer to issuers that are listed on one 
or more of these markets as ``listed issuers.''
    \39\ 15 U.S.C. 78m(a).
    \40\ 15 U.S.C. 78o(d).
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A. Audit Committee Member Independence

    As early as 1940, the Commission encouraged the use of audit 
committees composed of independent directors.\41\ An audit committee 
comprised of independent directors is better situated to assess 
objectively the quality of the issuer's financial disclosure and the 
adequacy of internal controls than a committee that is affiliated with 
management. Management may face market pressures for short-term 
performance and corresponding pressures to satisfy market expectations. 
These pressures could be exacerbated by the use of compensation or 
other incentives focused on short-term stock appreciation, which can 
promote self-interest rather than the promotion of long-term 
shareholder interest. An independent audit committee with adequate 
resources helps to overcome this problem and to align corporate 
interests with those of shareholders. An independent audit committee 
also would likely be better equipped to satisfy several other new 
requirements mandated by the Sarbanes-Oxley Act and the Exchange Act, 
such as overseeing a sound system of internal controls, approving any 
non-audit services by the outside auditor and enhancing the 
independence of the audit function.
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    \41\ See note 17 above.
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    The proposed requirements would enhance audit committee 
independence by implementing the two basic criteria for determining 
independence enumerated in Section 10A(m) of the Exchange Act. First, 
audit committee members would be barred 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 and any board committee.\42\ This prohibition would 
preclude payments to a member as an officer or employee, as well as 
other compensatory payments. To prevent evasion of this requirement, 
disallowed payments to an audit committee member would include payments 
made either directly or indirectly. We believe that barring indirect as 
well as direct compensatory payments is necessary to implement the 
intended purposes of Section 10A(m) of the Exchange Act. For example, 
payments to spouses of members raise questions regarding independence 
comparable to those raised by payments to members themselves. In 
addition, we believe that payments for services to law firms, 
accounting firms, consulting firms, investment banks or similar 
entities in which audit committee members are partners or hold similar 
positions are the kinds of compensatory payments that were intended to 
be precluded by Exchange Act Section 10A(m). We therefore propose that 
indirect

[[Page 2641]]

acceptance of compensatory payments includes payments to spouses, minor 
children or stepchildren or children or stepchildren sharing a home 
with the 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 which provides accounting, consulting, legal, 
investment banking, financial or other advisory services or any similar 
services to the issuer.\43\
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    \42\ See Section 10A(m)(3)(B)(i) of the Exchange Act and 
proposed Exchange Act Rule 10A-3(b)(1)(ii)(A) and (iii)(A). If the 
committee member is also a shareholder of the issuer, payments made 
to all shareholders generally, such as dividends, would not be 
prohibited by this provision.
    \43\ See proposed Exchange Act Rule 10A-3(e)(6).
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    In seeking to ensure appropriate levels of independence, we 
recognize that some SROs currently restrict additional business or 
personal relationships,\44\ and that some SROs are seeking to add to 
these requirements, in particular in the additional listing standards 
that are currently under consideration.\45\ We support the goals the 
SROs are trying to achieve through these ongoing efforts, and we are 
committed to working with the SROs to ensure the success of these 
proposals. We believe that our mandate under Section 10A(m) of the 
Exchange Act, where independence is evaluated by reference to payments 
of compensatory fees, is best fulfilled by our current proposal. Our 
proposal would not, for example, preclude independence on the basis of 
ordinary course commercial business relationships between an issuer and 
an entity with which a director had a relationship. Our proposal also 
would not extend to the broad categories of family members that may be 
reached by SRO listing standards. Instead, our proposals build and rely 
on the SROs standards of independence that cover additional 
relationships not specified in Exchange Act Section 10A(m). Our 
proposal would allow the SROs to adopt further requirements of these 
sorts, but they would do so within the more flexible environment of 
listing standards. We encourage SROs that do not currently have 
separate independence requirements to adopt appropriate requirements in 
connection with their implementation of the standards in Exchange Act 
Section 10A(m).
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    \44\ See note 23 above.
    \45\ See note 26 above.
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    As the second basic criterion for determining independence, a 
member of the audit committee of an issuer that is not an investment 
company may not be an affiliated person of the issuer or any subsidiary 
of the issuer apart from his or her capacity as a member of the board 
and any board committee. We would clarify that a director, executive 
officer, partner, member, principal or designee of an affiliate would 
be deemed to be an affiliate. For purposes of the proposed rule, we 
propose to define the terms ``affiliate'' and ``affiliated person'' 
consistent with our other definitions of these terms under the 
securities laws, such as in Exchange Act Rule 12b-2 \46\ and Securities 
Act Rule 144,\47\ with an additional safe harbor.\48\ We propose 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.'' \49\ We propose to define the 
term ``control'' consistent with our other definitions of this term 
under the Exchange Act \50\ 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.'' \51\
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    \46\ 17 CFR 240.12b-2.
    \47\ 17 CFR 230.144.
    \48\ Exchange Act Section 3(a)(19), in defining several terms in 
relation to investment companies, includes a definition of 
``affiliated person'' by reference to the Investment Company Act. 
Because that definition is tailored to investment companies, our 
proposed definition would use a definition for non-investment 
companies consistent with our other definitions of ``affiliate'' for 
non-investment companies.
    \49\ See proposed Exchange Act Rule 10A-3(e)(1).
    \50\ See, e.g., Exchange Act Rule 12b-2.
    \51\ See proposed Exchange Act Rule 10A-3(e)(3).
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    Similarly, a member of the audit committee of an issuer that is an 
investment company could not be an ``interested person'' of the 
investment company as defined in Section 2(a)(19) \52\ of the 
Investment Company Act.\53\ We have substituted the Section 2(a)(19) 
test for the affiliation test applied to operating companies because 
the Section 2(a)(19) test is tailored to capture the broad range of 
affiliations with investment advisers, principal underwriters, and 
others that are relevant to ``independence'' in the case of investment 
companies.
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    \52\ 15 U.S.C. 80a-2(a)(19).
    \53\ See proposed Exchange Act Rule 10A-3(b)(1)(iii)(B). The 
``interested person'' test would apply to business development 
companies, as well as registered investment companies. See note 95.
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    Our proposed definition of ``affiliated person'' for non-investment 
companies, like our existing definitions of this term for these 
issuers, would require a factual determination based on a consideration 
of all relevant facts and circumstances. However, because we recognize 
that it can be difficult to determine whether someone controls an 
issuer, we are proposing to create a safe harbor from this aspect of 
the proposed definition of ``affiliated person.'' \54\ Under the 
proposed safe harbor, a person who is not an executive officer, 
director or 10% shareholder of the issuer would be deemed not to 
control the issuer. This test is similar to the test used for 
determining insider status under Section 16 of the Exchange Act.\55\
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    \54\ See proposed Exchange Act Rule 10A-3(e)(1). Note that this 
safe harbor does not address the question of whether a person ``is 
controlled by, or is under common control with'' the issuer. We 
proposed a similar safe harbor from the definition of ``affiliate'' 
for Securities Act Rule 144 in 1997. See Release No. 33-7391 (Feb. 
20, 1997) [62 FR 9246].
    \55\ 17 U.S.C. 78p. However, unlike our rules under Section 16, 
for purposes of determining who is an executive officer and 
calculating beneficial ownership, we propose to refer to Exchange 
Act Rule 3b-7 [17 CFR 240.3b-7] for the definition of ``executive 
officer'' and Exchange Act Rule 13d-3(d)(1) [17 CFR 240.13d-3(d)(1)] 
for calculating beneficial ownership.
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    This safe harbor should cover most non-affiliates without including 
people who control an issuer. Moreover, our proposal would create only 
a safe harbor position. Therefore, an audit committee member that would 
not be eligible to rely on the safe harbor would not be deemed an 
affiliated person by virtue of those facts. Those who would be 
ineligible to rely on the safe harbor, but believe that they do not 
control an issuer, still could rely on a facts and circumstances 
analysis.
    Under Exchange Act Section 10A(m)(3)(C), we have the authority to 
exempt from the independence requirements particular relationships with 
respect to audit committee members, if appropriate in light of the 
circumstances. Companies coming to market for the first time may face 
particular difficulty in recruiting members that meet the proposed 
independence requirements. Before a company's initial public offering, 
the board of directors often will consist primarily, if not 
exclusively, of representatives of venture capital investors and 
insiders. Such representation is entirely consistent with the desire of 
these parties to have representation in their private venture. The 
difficulty of recruiting independent directors before an initial public 
offering, coupled with the uncertainty of whether the initial public 
offering will be completed, may discourage companies from accessing the 
public markets to grow their business and provide liquidity, as well as 
from achieving the other benefits of being a public company, if all of 
their audit committee members must be independent at the time of the 
initial public offering. Further, the audit committee of some new 
public companies may function more

[[Page 2642]]

effectively if one director has historical knowledge and experience 
with the company. Accordingly, we propose 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 under Section 12 of the Exchange Act or a 
registration statement under the Securities Act covering an initial 
public offering of securities of the issuer.\56\
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    \56\ See proposed Exchange Act Rule 10A-3(b)(1)(iv)(A).
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    Further, many companies, particularly financial institutions and 
other entities with a holding company structure, operate through 
subsidiaries. For these companies, the composition of the boards of the 
parent company and the subsidiary are sometimes similar given the 
control structure between the parent and the subsidiary. If an audit 
committee member of the parent is otherwise independent, merely serving 
also on the board of a controlled subsidiary should not adversely 
affect the board member's independence, assuming that the board member 
also would be considered independent of the subsidiary except for the 
member's seat on the parent's board. Accordingly, we propose to exempt 
from the ``affiliated person'' requirement a committee member that sits 
on the board of directors of both a parent and a direct or indirect 
consolidated majority-owned subsidiary, if the committee member 
otherwise meets the independence requirements for both the parent and 
the subsidiary, including the receipt of only ordinary-course 
compensation for serving as a member of the board of directors, audit 
committee or any other board committee of the parent or subsidiary.\57\
---------------------------------------------------------------------------

    \57\ See proposed Exchange Act Rule 10A-3(b)(1)(iv)(B).
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    As discussed in Section II.G.1 below, any issuer availing itself of 
any of these exceptions would have to disclose that fact. Apart from 
the two limited exemptions discussed above, and the exemptions for 
controlling shareholders, foreign governmental board representatives 
and non-management employee members of foreign private issuers 
discussed in Section II.F.3.a below, we do not propose to exempt any 
other particular relationships from the independence requirements at 
this time. In this regard, we note that Section 10A(m) of the Exchange 
Act does not, and therefore our proposed rule does not, contain any 
exemptions based on exceptional and limited circumstances similar to 
those that exist currently under several SRO rules.\58\ Also, given the 
policy and purposes behind the Sarbanes-Oxley Act, as well as to 
maintain consistency and to ease administration of the requirements by 
the SROs, we do not currently propose to entertain exemptions or 
waivers for particular relationships on a case-by-case basis.\59\
---------------------------------------------------------------------------

    \58\ See, for example, Section 303.01 of the NYSE's listing 
standards; Rule 4350(d) of the NASD's listing standards and Section 
121B of the AMEX's listing standards. The rules of the NYSE, NASD 
and AMEX are available on their Web sites at www.nyse.com, 
www.nasd.com and www.amex.com, respectively.
    \59\ Similarly, Commission staff would not entertain no-action 
letter or exemption requests in this area.
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    Questions regarding the proposed independence requirements:
    [sbull] Is additional clarification necessary regarding the 
consulting, advisory or other compensatory fee prohibition? For 
example, should we clarify whether ``compensatory fees'' would include 
compensation under a retirement or similar plan in which a former 
officer or employee of the issuer participates? Should there be an 
exception for a de minimis amount of payments? If so, what amount would 
be appropriate? How would such an exception be consistent with the 
purposes of the prohibition?
    [sbull] Is the proposed extension of the compensatory prohibition 
to spouses, minor children or stepchildren or children or stepchildren 
sharing a home with the member appropriate? Should it be expanded or 
narrowed? For example, should there be an exception for non-executive 
family members employed by the issuer? Is the extension to payments 
accepted by an entity in which an audit committee member is a partner, 
member or principal or occupies a similar position and which provides 
accounting, consulting, legal, investment banking, financial or other 
advisory services or any similar services to the issuer appropriate? 
Should we extend the prohibition further, such as to ordinary course 
business relationships?
    [sbull] Is the proposed definition of ``affiliated person'' for 
non-investment companies appropriate? Is the proposed safe harbor from 
the definition of affiliated person appropriate? Should it include 
fewer or more persons? In responding to these questions, please keep in 
mind that, by its very nature, it would be difficult to create a safe 
harbor covering all individuals who are non-affiliates without 
inadvertently covering affiliates as well. The safe harbor would not 
create a presumption that those outside the safe harbor are affiliates. 
Rather, the safe harbor is designed to cover only those individuals 
whom we reasonably believe would not be affiliates. Is this assumption 
accurate? Can we reliably assume that people who own less than 10% of a 
company and are not officers or directors are not in control of the 
company? Should this threshold be higher (e.g., 20%) or lower (e.g., 
5%)? Should the exclusion from the definition of affiliate include an 
express presumption that those persons not so excluded are affiliates, 
unless rebutted by a majority of independent directors?
    [sbull] Should we rely exclusively on retaining a subjective test 
for determining affiliate status, given the varied contractual 
arrangements with a control feature entered into by issuers, 
particularly smaller companies? A person might employ specified 
thresholds to conceal a control relationship. Should a facts and 
circumstances test be retained in order to reflect the different ways a 
control relationship can be established with an issuer?
    [sbull] Should the board of directors be required to determine 
whether an audit committee member is independent? \60\ Should the board 
be required to disclose this determination? If so, when? If the board 
should not make the determination, who should?
---------------------------------------------------------------------------

    \60\ See, e.g., note 26 above.
---------------------------------------------------------------------------

    [sbull] The proposed independence requirements relate to current 
relationships with the audit committee member and related persons. 
Should the prohibition also extend to a ``look back'' period before the 
appointment of the member to the audit committee? If so, what period 
(e.g., three years or five years) would be appropriate? Should there be 
different look-back periods for different relationships or different 
parties? If so, which ones?
    [sbull] Should there be additional criteria for independence apart 
from the two proposed criteria? For example, in addition to the 
proposed prohibitions, should there be a prohibition on any 
transactions or relationships with the audit committee member or an 
affiliate of the audit committee member apart from the committee 
member's capacity as a member of the board and any board committee?
    [sbull] Should additional relationships be exempted from the 
independence requirements at this time? If so, which relationships 
should be exempted, why should they be exempted, and how would such an 
exemption be consistent with maintaining the independence of the audit 
committee?
    [sbull] Is the proposed exemption for new public companies 
appropriate? Should

[[Page 2643]]

more than one audit committee member be exempted from the requirements? 
Should a specific percentage of audit committee members be exempted? 
Should the exemption be conditioned on there being at least a majority 
of independent directors on the audit committee? Should the exemption 
period be longer (e.g., 1 year) or shorter (e.g., 30 days)? We are not 
proposing to apply this exemption to investment companies. Should this 
exemption apply to investment companies?
    [sbull] Is the proposed exemption for independent board members 
that sit on both a parent's and consolidated majority-owned 
subsidiary's board of directors appropriate? Is the requirement that 
the board member also is otherwise independent of the subsidiary 
necessary? Should the exemption be limited only to wholly owned 
subsidiaries or other specified level of ownership? Should the 
exemption be denied if the subsidiary maintains a listing for its own 
securities? Is there any need for a similar exemption from the 
``interested person'' test for investment companies?
    [sbull] Should there be an exception to the independence 
requirements based upon exceptional and limited circumstances, if the 
board determines that membership on the committee by the individual is 
required by the best interests of the corporation and its shareholders? 
If so, should the board be required to disclose the nature of the 
relationship and the reasons for that determination? Should there be a 
time limit for these appointments?
    [sbull] Should companies be allowed to request exemptive relief on 
a case-by-case basis? If so, what procedures should be used for 
submitting and evaluating applications for exemptive relief? What 
factors should the Commission consider in considering such requests? 
How would such a case-by-case process be consistent with the policy and 
purposes of Section 10A(m)? How would such a process be coordinated 
between the Commission and the SROs? Should companies be required to 
disclose publicly any exemption they receive? Should SROs be permitted 
to grant exemptions within defined parameters? What should those 
parameters be?
    [sbull] Are any modifications required to the consulting, advisory 
or other compensatory fee prohibition for investment companies? Is it 
appropriate to use the definition of ``interested person'' as set forth 
in Section 2(a)(19) of the Investment Company Act to test the 
independence of members of investment company audit committees, as 
proposed? If not, should the rule apply the affiliation test, which we 
propose to apply to operating companies, or a different test?

B. Responsibilities Relating to Registered Public Accounting Firms

    One of the audit committee's primary functions is to enhance the 
independence of the audit function, thereby furthering the objectivity 
of financial reporting. The Commission has long recognized the 
importance of an auditor's independence in the audit process.\61\ The 
auditing process may be compromised when a company's outside auditors 
view their main responsibility as serving the company's management 
rather than its full board of directors or its audit committee. This 
may occur if the auditor views management as its employer with hiring, 
firing and compensatory powers. Under these conditions, the auditor may 
not have the appropriate incentive to raise concerns and conduct an 
objective review. Further, if the auditor does not appear independent 
to the public, then investor confidence is undermined and one purpose 
of the audit is frustrated. One way to help ensure that the auditor is 
truly independent, then, is for the auditor to be hired, evaluated and, 
if necessary, terminated by the audit committee. This would help to 
align the auditor's interests with those of shareholders.
---------------------------------------------------------------------------

    \61\ The federal securities laws recognize the importance of 
independent auditors. See, e.g., Items 25 and 26 of Schedule A of 
the Securities Act and Sections 12(b)(1)(J) and 13(a)(2) of the 
Exchange Act [15 U.S.C. 78l(b)(1)(J) and 78m(a)(2)]. See also Title 
II of the Sarbanes-Oxley Act.
---------------------------------------------------------------------------

    Accordingly, under the proposed rule, an audit committee would have 
to be directly responsible for the appointment, compensation, retention 
and oversight of the work of the independent auditor engaged (including 
resolution of disagreements between management and the auditor 
regarding financial reporting) for the purpose of preparing or issuing 
an audit report or related work or performing other audit, review or 
attest services for the issuer,\62\ and the independent auditor would 
have to report directly to the audit committee. We propose to clarify 
that these oversight responsibilities include the authority to retain 
the outside auditor, which would include the power not to retain (or to 
terminate) the outside auditor. In addition, in connection with these 
oversight responsibilities, the audit committee would need to have 
ultimate authority to approve all audit engagement fees and terms, as 
well as all significant non-audit engagements of the independent 
auditor. In this regard, the proposed requirement would reinforce the 
new requirement in section 10A(i) of the Exchange Act, as added by 
section 202 of the Sarbanes-Oxley Act, that auditing and non-auditing 
services be pre-approved by the audit committee. The proposed 
requirement, like the other proposed requirements, also would promote 
compliance with an issuer's internal control requirements.
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    \62\ For a further discussion of the scope of audit, review and 
attest services, which are broader than those services required to 
perform an audit pursuant to generally accepted auditing standards, 
see Release No. 33-8154 (Dec. 2, 2002). For example, Section 
10A(i)(1)(A) of the Exchange Act [15 U.S.C. 78j-1(i)(1)(A)] 
identifies services related to the issuance of comfort letters and 
services related to statutory audits required for insurance 
companies for purposes of state law as audit services.
---------------------------------------------------------------------------

    The proposed requirement does not conflict with, and would not be 
affected by, any requirement under a company's governing law or 
documents or other home country requirements that requires shareholders 
to elect, approve or ratify the selection of the issuer's auditor. The 
proposed requirement instead relates to the assignment of 
responsibility to oversee the auditor's work as between the audit 
committee and management. We propose to add an instruction to the new 
rule to reflect this intention. In such an instance, however, if the 
issuer provides a recommendation or nomination of an auditor to its 
shareholders, the audit committee of the issuer would need to be 
responsible for making the recommendation or nomination.\63\
---------------------------------------------------------------------------

    \63\ Similarly, the proposed requirement does not conflict with 
any requirement in a company's home jurisdiction that prohibits the 
full board of directors from delegating the responsibility to select 
the company's auditor. In that case, the audit committee would need 
to be granted advisory and other powers with respect to such matters 
to the extent permitted by law, including submitting nominations to 
the full board.
---------------------------------------------------------------------------

    In addition, we are proposing to exempt investment companies from 
the requirement that the audit committee be responsible for the 
selection of the independent auditor. Section 32(a) of the Investment 
Company Act,\64\ which requires that independent auditors of registered 
investment companies be selected by majority vote of the disinterested 
directors, already addresses the concerns behind this requirement. 
Investment companies

[[Page 2644]]

generally would remain subject to the proposed requirements regarding 
audit committee responsibility in all other areas, including 
compensation and oversight of the auditors.\65\
---------------------------------------------------------------------------

    \64\ 15 U.S.C. 80a-31(a). The exemption would apply to business 
development companies because they are subject to the requirements 
of Section 32(a) of the Investment Company Act pursuant to Section 
59 of the Investment Company Act [15 U.S.C. 80a-58]. Business 
development companies are a category of closed-end investment 
company that are not registered under the Investment Company Act, 
but are subject to certain provisions of that Act. See Sections 
2(a)(48) and 54-65 of the Investment Company Act [15 U.S.C. 80a-
2(a)(48) and 80a-53-64].
    \65\ Section 32(a) applies to management investment companies 
and face-amount certificate companies. It does not apply to unit 
investment trusts, which do not have boards of directors and which 
we propose to exclude entirely from the requirements that we are 
proposing. See Section II.F.3.d. concerning unit investment trusts. 
There are three types of investment companies: face-amount 
certificate companies, unit investment trusts and management 
companies. See Section 4 of the Investment Company Act [15 U.S.C. 
80a-4]. The Investment Company Act divides management companies into 
two sub-categories, defining an open-end company as a management 
company that offers for sale or has outstanding any redeemable 
securities of which it is the issuer and a closed-end company as any 
management company other than an open-end company. See Section 5(a) 
of the Investment Company Act [15 U.S.C. 80a-5(a)]. A unit 
investment trust is an investment company that is organized under a 
trust indenture, contract of custodianship or agency, or similar 
instrument; does not have a board of directors; and issues only 
redeemable securities, each of which represents an undivided 
interest in a unit of specified securities, but does not include a 
voting trust. See Section 4(2) of the Investment Company Act of 1940 
[15 U.S.C. 80a-4(2)].
---------------------------------------------------------------------------

    Questions regarding the proposed auditor responsibility 
requirement:
    [sbull] We request comment on implementation of this proposed 
requirement. Is additional specificity needed?
    [sbull] Should the audit committee also be directly responsible for 
the appointment, compensation, retention and oversight of an issuer's 
internal auditor? Should other responsibilities be under the 
supervision of the audit committee?
    [sbull] Does the proposed instruction that the requirement does not 
conflict with, and is not affected by, any requirement that requires 
shareholders to ultimately elect, approve or ratify the selection of 
the issuer's auditor adequately address the concerns of issuers whose 
governing law or documents requires shareholder selection of the 
auditor? Are additional accommodations necessary? Please explain how 
any accommodation would be consistent with the Sarbanes-Oxley Act.
    [sbull] Should the requirements relating to independent auditor 
selection of Section 32(a) of the Investment Company Act be retained 
with respect to registered investment companies falling within the 
scope of the proposed rule? If so, why? Should the Commission instead 
exempt registered investment companies from the requirements relating 
to independent auditor selection in Section 32(a) of the Investment 
Company Act, when such investment companies fall within the scope of 
the proposed rule, and require that their independent auditors be 
selected by the audit committee? If so, why?
    [sbull] Should the Commission require registered investment 
companies to comply with the requirements of both Section 32(a) of the 
Investment Company Act and the proposed rule with respect to the 
selection of independent auditors? If so, should we interpret these 
provisions to require that the audit committee nominate the independent 
auditor and the majority of disinterested directors approve the 
independent auditor?
    [sbull] We note that our recent release regarding auditor 
independence proposes that the audit committee of a registered 
investment company separately approve the independent auditor.\66\ How 
should the Commission reconcile proposed Rule 10A-3, the auditor 
independence proposal, and Section 32(a) of the Investment Company Act?
---------------------------------------------------------------------------

    \66\ See Exchange Act Release No. 46934 (Dec. 2, 2002).
---------------------------------------------------------------------------

C. Procedures for Handling Complaints

    The audit committee must place some reliance on management for 
information about the company's financial reporting process. Since the 
audit committee is dependent to a degree on the information provided to 
it by management and internal and outside auditors, it is imperative 
for the committee to cultivate open and effective channels of 
information. Management may not have the appropriate incentives to 
self-report all questionable practices. A company employee or other 
individual may be reticent to report concerns regarding questionable 
accounting or other matters for fear of management reprisal.\67\ The 
establishment of formal procedures for receiving and handling 
complaints could serve to facilitate disclosures, encourage proper 
individual conduct and alert the audit committee to potential problems 
before they have serious consequences.
---------------------------------------------------------------------------

    \67\ The Sarbanes-Oxley Act provides additional protections for 
employees who provide evidence of fraud. See, for example, Section 
806 of the Sarbanes-Oxley Act.
---------------------------------------------------------------------------

    Accordingly, under the standards contemplated by the proposals, 
each audit committee would need to establish procedures for: \68\
---------------------------------------------------------------------------

    \68\ The Commission's proposals are not intended to preempt or 
supersede any other Federal or State requirements relating to 
receipt and retention of records.
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    [sbull] The receipt, retention and treatment of complaints received 
by the issuer regarding accounting, internal accounting controls or 
auditing matters, and
    [sbull] The confidential, anonymous submission by employees of the 
issuer of concerns regarding questionable accounting or auditing 
matters.
    We do not propose to mandate specific procedures that the audit 
committee must establish. Given the variety of listed issuers in the 
U.S. capital markets, we believe companies should be provided with 
flexibility to develop and utilize procedures appropriate for their 
circumstances. We expect each audit committee to develop procedures 
that work best consistent with its company's individual circumstances.
    Questions regarding the proposed complaint procedures requirement:
    [sbull] Do most listed issuers have procedures for the receipt, 
retention and treatment of complaints or for the confidential, 
anonymous submission by employees of concerns regarding questionable 
accounting or auditing matters? If so, how do these procedures work? 
Are they effective in their purpose?
    [sbull] Should the proposed rule require a company to disclose the 
procedures that have been established or any changes to those 
procedures? If so, where and how often should the disclosure appear and 
what should it look like?
    [sbull] Should specified procedures be prescribed or encouraged? 
For example, should we specify how long complaints must be retained? 
Should we specify who could or could not be designated by the audit 
committee for the receipt and treatment of complaints?

D. Authority To Engage Advisors

    To be effective, an audit committee must have the necessary 
resources and authority to fulfill its function. The audit committee 
likely is not equipped to self-advise on all accounting, financial 
reporting or legal matters. To perform its role effectively, therefore, 
an audit committee may need the authority to engage its own outside 
advisors, including experts in particular areas of accounting, as it 
determines necessary apart from counsel or advisors hired by 
management, especially when potential conflicts of interest with 
management may be apparent.
    The advice of outside advisors may be necessary to identify 
potential conflicts of interest and assess the company's disclosure and 
other compliance obligations with an independent and critical eye. 
Often, outside advisors can draw on their experience and knowledge to 
identify best practices of other companies that might be appropriate 
for the issuer. The assistance of outside advisors also may be needed 
to independently investigate

[[Page 2645]]

questions that may arise regarding financial reporting and compliance 
with the securities laws. Accordingly, the proposed rule would 
specifically require an issuer's audit committee to have the authority 
to engage outside advisors, including counsel, as it determines 
necessary to carry out its duties.\69\
---------------------------------------------------------------------------

    \69\ The proposed requirement would not preclude access to or 
advice from the company's internal counsel or regular outside 
counsel. It also would not require an audit committee to retain 
independent counsel.
---------------------------------------------------------------------------

    Questions regarding the proposed authority to engage advisors 
requirement:
    [sbull] Is any additional specificity needed for this requirement? 
For example, should we define what constitutes an ``independent 
advisor?'

E. Funding

    An audit committee's effectiveness may be compromised if it is 
dependent on management's discretion to compensate the independent 
auditor or the advisors employed by the committee, especially when 
potential conflicts of interest with management may be apparent. 
Accordingly, the proposed rule would require the issuer to provide for 
appropriate funding, as determined by the audit committee, in its 
capacity as a committee of the board of directors, for payment of 
compensation:
    [sbull] 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 
issuer; and
    [sbull] To any advisors employed by the audit committee.
    This proposed requirement would further the proposed standard 
relating to the audit committee's responsibility to appoint, 
compensate, retain and oversee the outside auditor. It also would add 
meaning to the proposed standard relating to the audit committee's 
authority to engage independent advisors. Not only could an audit 
committee be hindered in its ability to perform objectively its duties 
by not having control over the ability to compensate these advisors, 
but the role of the advisors also could be compromised if they are 
required to rely on management for compensation. Thus, absent such a 
provision, both the audit committee and the advisors could be less 
willing to address disagreements or other issues with management.
    Questions regarding the proposed funding requirement:
    [sbull] Is any additional specificity needed for this requirement? 
For example, should a specific agreement or arrangement be required to 
provide for the appropriate funding?
    [sbull] Should there be any limit on the amount of compensation 
that could be requested by the audit committee? If so, who should set 
these limits (e.g., the full board)? Should the audit committee's 
request be limited to ``reasonable'' compensation? Who would determine 
what is ``reasonable''? How would such limits be consistent with the 
policy and purposes of the Sarbanes-Oxley Act? Is the fact that the 
audit committee members ultimately are elected by, and answerable to, 
shareholders sufficient to address any concern over compensation 
limits?

F. Application and Implementation of the Proposed Standards

1. SROs Affected
    Section 10A(m) of the Exchange Act by its terms applies to all 
national securities exchanges and national securities associations. 
These entities, to the extent that their listing standards do not 
already comply with the proposals, will be required to issue or modify 
their rules, subject to Commission review, to conform their listing 
standards.\70\ Under our proposals, the new requirements would need to 
be operative by the SROs no later than the first anniversary of the 
publication of our final rule in the Federal Register. The SROs are not 
precluded from adopting additional listing standards regarding audit 
committees, as long as they are consistent with the proposed rule.
---------------------------------------------------------------------------

    \70\ An SRO that wished to do so could satisfy the requirements 
of the rule by requiring that a listed issuer must comply with 
Exchange Act Rule 10A-3.
---------------------------------------------------------------------------

    To facilitate timely implementation of the proposals, we propose 
that each SRO must provide to the Commission, no later than 60 days 
after publication of our final rule in the Federal Register, proposed 
rules or rule amendments that comply with our final rule. Further, each 
SRO would need to have final rule or rule amendments that comply with 
our final rule approved by the Commission no later than 270 days after 
publication of our final rule in the Federal Register. We request 
comment below on the appropriateness of these periods.
    The OTC Bulletin Board (OTCBB), the Pink Sheets and the Yellow 
Sheets would not be affected by the proposed requirements, and 
therefore issuers whose securities are quoted on these interdealer 
quotation systems similarly would not be affected, unless their 
securities also are listed on an exchange or Nasdaq.\71\ Each of these 
quotation systems does not provide issuers with the ability to list 
their securities, but is a quotation medium for the over-the-counter 
securities market that collects and distributes market maker quotes to 
subscribers. These interdealer quotation systems do not maintain or 
impose listing standards, nor do they have a listing agreement or 
arrangement with the issuers whose securities are quoted through them. 
Although market makers may be required to review and maintain specified 
information about the issuer and to furnish that information to the 
interdealer quotation system,\72\ the issuers whose securities are 
quoted on such systems do not have any filing or reporting requirements 
with the system.\73\
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    \71\ The OTCBB is operated by The Nasdaq Stock Market, Inc., 
which is owned by the NASD. Information about the OTCBB can be found 
at www.otcbb.com. The Pink Sheets and the Yellow Sheets (as well as 
the corresponding Electronic Quotation Service) are operated by Pink 
Sheets LLC. Information about the Pink Sheets, the Yellow Sheets and 
the Electronic Quotation Service can be found at www.pinksheets.com.
    \72\ See 17 CFR 240.15c2-11.
    \73\ However, under OTCBB rules, issuers of securities quoted on 
the OTCBB must be subject to periodic filing requirements with the 
Commission or other regulatory authority. See NASD Rule 6530.
---------------------------------------------------------------------------

    Questions regarding the proposed application to SROs
    [sbull] Do the proposed implementation dates provide sufficient 
time for SROs to propose and obtain Commission approval for new or 
amended rules to meet the requirements of the proposals? Is the date by 
when the standards would need to be operative appropriate? If not, what 
other dates would be appropriate? What factors should the Commission 
consider in determining these dates?
2. Securities Affected
    In enacting Section 10A(m) of the Exchange Act, Congress made no 
distinction regarding the type of securities to be covered. Section 
10A(m)(1)(A) of the Exchange Act prohibits the listing of ``any 
security'' of an issuer that does not meet the new standards for audit 
committees. Accordingly, the proposed rule would apply not just to 
voting equity securities, but to any listed security, regardless of its 
type, including debt securities, derivative securities and other types 
of listed securities. We believe investors in all securities of an 
issuer, whether common equity or fixed income, would benefit from the 
increased financial oversight of an issuer that would result from a 
strong and effective audit committee.

[[Page 2646]]

a. Multiple Listings
    Many companies today issue multiple classes of securities through 
various ownership structures on various markets. For example, a company 
may have a class of common equity securities listed on one market, 
several classes of debt listed on one or more other markets, and 
derivative securities listed on yet another market. If a company 
already was subject to the proposed standards as a result of one 
listing, there would be little or no additional benefit from having the 
requirements imposed on the company due to an additional listing. 
Further, once one national securities exchange or national securities 
association is responsible for monitoring the compliance of a company 
with the standards, there would be little or no additional benefit, and 
much overlap and duplicative effort, from requiring more than one of 
these SROs to monitor compliance.
    In addition, issuers often issue non-equity securities through a 
wholly owned or majority-owned subsidiary for various reasons. 
Requiring these subsidiaries, which often have no purpose other than to 
issue or guarantee the securities, to be subject to the proposed audit 
committee requirements would add little additional benefit if the 
subsidiary is closely controlled by a parent issuer that is subject to 
the proposed requirements. Instead, imposing the requirement on these 
subsidiaries could create an onerous burden on the parent to recruit 
and maintain an audit committee meeting the requirements for each 
specific subsidiary.
    Accordingly, we propose an exemption from the proposed requirements 
for additional listings of securities by a company at any time the 
company is subject to the proposed requirements as a result of the 
listing of a class of common equity or similar securities. The 
additional listings could be on the same market or on different 
markets. We condition this exemption on the listing of a class of 
common equity or similar securities because these securities would most 
likely represent the primary public listing of the company. Companies 
that do not have a class of common equity or similar securities listed 
would be subject to the proposed requirements in each affected market 
where its securities were listed.
    We also propose to extend this exemption to listings of non-equity 
securities by a direct or indirect consolidated majority-owned 
subsidiary of a parent company, if the parent company is subject to the 
proposed requirements as a result of the listing of a class of its 
equity securities. However, if the subsidiary were to list its own 
equity securities (other than non-convertible, non-participating 
preferred securities \74\) the subsidiary would be required to meet the 
proposed requirements to protect its own public shareholders.
---------------------------------------------------------------------------

    \74\ Trust-preferred and similar securities also would fall 
within this category.
---------------------------------------------------------------------------

b. Security Futures Products and Standardized Options
    The enactment of the Commodity Futures Modernization Act of 2000, 
or CFMA,\75\ addressed the regulation of security futures products.\76\ 
It permits national securities exchanges registered under Section 6 of 
the Exchange Act \77\ and national securities associations registered 
under Section 15A(a) of the Exchange Act \78\ to trade futures on 
individual securities and on narrow-based security indices (``security 
futures'') without being subject to the issuer registration 
requirements of the Securities Act and Exchange Act as long as they are 
cleared by a clearing agency that is registered under Section 17A of 
the Exchange Act \79\ or that is exempt from registration under Section 
17A(b)(7)(A) of the Exchange Act. In December 2002, we adopted rules to 
provide comparable regulatory treatment for standardized options.\80\
---------------------------------------------------------------------------

    \75\ Pub. L. No. 106-554, 114 Stat. 2763 (2000).
    \76\ Securities Act Section 2(a)(16) [15 U.S.C. 77b(a)(16)], 
Exchange Act Section 3(a)(56) [15 U.S.C. 78c(a)(56)], and 
Commodities Exchange Act Section 1a(32) [7 U.S.C. 1a(32)] define 
``security futures product'' as a security future or an option on a 
security future.
    \77\ 15 U.S.C. 78f.
    \78\ 15 U.S.C. 78o-3(A).
    \79\ 15 U.S.C. 78q-1.
    \80\ See Release No. 33-8171 (Dec. 23, 2002) [68 FR 188]. In 
that release, we exempted standardized options issued by registered 
clearing agencies and traded on a registered national securities 
exchange or on a registered national securities association from all 
provisions of the Securities Act, other than the Section 17 
antifraud provision of the Securities Act, as well as the Exchange 
Act registration requirements. Standardized options are defined in 
Exchange Act Rule 9b-1(a)(4) [17 CFR 240.9b-1(a)(4)] as option 
contracts trading on a national securities exchange, an automated 
quotation system of a registered securities association, or a 
foreign securities exchange which relate to option classes the terms 
of which are limited to specific expiration dates and exercise 
prices, or such other securities as the Commission may, by order, 
designate.
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    The role of the clearing agency for security futures products and 
standardized options is fundamentally different from a conventional 
issuer of securities. For example, the purchaser of these products does 
not, except in the most formal sense, make an investment decision 
regarding the clearing agency. As a result, information about the 
clearing agency's business, its officers and directors and its 
financial statements is less relevant to investors in these products 
than to investors in the underlying security. Similarly, the investment 
risk in these products is determined by the market performance of the 
underlying security rather than the performance of the clearing agency. 
Moreover, the clearing agencies are self-regulatory organizations 
subject to regulatory oversight. Furthermore, unlike a conventional 
issuer, the clearing agency does not receive the proceeds from sales of 
security futures products or standardized options.\81\
---------------------------------------------------------------------------

    \81\ However, the clearing agency may receive a clearing fee 
from its members.
---------------------------------------------------------------------------

    Recognizing these fundamental differences, we propose to exempt 
from our proposed rule the listing of a security futures product 
cleared by a clearing agency that is registered under Section 17A of 
the Exchange Act or exempt from registration under Section 17A(b)(7) of 
the Exchange Act. We propose a similar exemption for the listing of 
standardized options issued by a clearing agency registered under 
Section 17A of the Exchange Act.
    Questions regarding proposed application to listed securities:
    [sbull] Is the proposed exemption for the listings of other classes 
of securities of an issuer appropriate? Would the benefit of having 
multiple SROs monitoring compliance outweigh the potential duplicative 
and administrative burdens that would be imposed on issuers and SROs if 
there was not such an exemption? Should the exemption be conditioned on 
having a class of common equity or similar securities listed, or should 
any class of securities be sufficient?
    [sbull] Similarly, is the proposed exemption of listings of non-
equity securities by consolidated majority-owned subsidiaries 
appropriate? Instead, should all issuers of securities be required to 
maintain an audit committee meeting the proposed standards? What would 
be the burden on companies from mandating such a requirement? Should 
the exemption be limited to wholly owned subsidiaries or some other 
specified level of ownership? Is limiting the exemption to non-equity 
securities (other than non-convertible, non-participating preferred 
securities) of the subsidiary appropriate?
    [sbull] Is the exclusion for securities futures products and 
standardized options appropriate? If not, how should these securities 
be handled?
    [sbull] Although we do not propose to exempt other types of 
securities from

[[Page 2647]]

coverage of the proposed rule, we request comment on the propriety of 
either a complete or partial exemption from the requirements for other 
types of securities? For example, should the rule apply only to classes 
of voting common equity of an issuer? What would be the basis for such 
an exclusion, and how would it be consistent with the purposes of the 
Sarbanes-Oxley Act? In responding to this request, commenters should 
specifically address how such an exemption would be consistent with 
investor protection.
3. Issuers Affected
a. Foreign Issuers
    For many years, U.S. investors increasingly have been seeking 
opportunities to invest in a wide range of securities, including the 
securities of foreign issuers, and foreign issuers have been seeking 
opportunities to raise capital and effect equity-based acquisitions in 
the U.S. using securities as the ``acquisition currency.'' The 
Commission has responded to these trends by seeking to facilitate the 
ability of foreign issuers to access U.S. investors through listings 
and offerings in the U.S. capital markets. We have long recognized the 
importance of the globalization of the securities markets both for 
investors who desire increased diversification and international 
companies that seek capital in new markets.
    Section 10A(m) of the Exchange Act makes no distinction between 
domestic and foreign issuers. With the growing globalization of the 
capital markets, the importance of maintaining effective oversight over 
the financial reporting process is relevant for listed securities of 
any issuer, regardless of its domicile. Many foreign private issuers 
\82\ already maintain audit committees, and the global trend appears to 
be toward establishing audit committees.\83\ The proposed rule, 
therefore, would apply to foreign private issuers as well as domestic 
issuers.
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    \82\ The term ``foreign private issuer'' is defined in Exchange 
Act Rule 3b-4(c) [17 CFR 240.3b-4(c)]. A foreign private issuer is a 
non-government foreign issuer, except for a company that (1) has 
more than 50% of its outstanding voting securities owned by U.S. 
investors and (2) has either a majority of its officers and 
directors residing in or being citizens of the U.S., a majority of 
its assets located in the U.S., or its business principally 
administered in the U.S.
    \83\ See, for example, ``Principles of Auditor Independence and 
the Role of Corporate Governance in Monitoring an Auditor's 
Independence,'' Statement of the IOSCO Technical Committee (Oct., 
2002) (available at www.iosco.org); Egon Zehnder International, 
Board of Directors Global Study (2000) (available at 
www.zehnder.com); and KPMG LLP, Corporate Governance in Europe: KPMG 
Survey 2001/2002 (2002) (available at www.kpmg.com).
---------------------------------------------------------------------------

    However, we are aware that the proposed requirements may conflict 
with legal requirements, corporate governance standards and the methods 
for providing auditor oversight in the home jurisdictions of some 
foreign issuers. Several foreign issuers and their representatives have 
expressed concerns about the possible application of Exchange Act 
Section 10A(m).\84\ In our proposal, we attempt to address these 
concerns in specific areas in which foreign corporate governance 
arrangements differ significantly from general practices among U.S. 
corporations.
---------------------------------------------------------------------------

    \84\ See, e.g., Petition for Rulemaking submitted by the 
Organization for International Investment, File No. 4-462 (Aug. 19, 
2002).
---------------------------------------------------------------------------

    For example, we understand that some countries, such as Germany, 
require that non-management employees, who would not be viewed as 
``independent'' under the proposed requirements, serve on the 
supervisory board or audit committee.\85\ Having such employees serve 
on the board or audit committee can provide an independent check on 
management, which itself is one of the purposes of the independence 
requirements under the Sarbanes-Oxley Act. Accordingly, we are 
proposing a limited exemption from the independence requirements to 
address this concern. We would provide that non-management employees 
could sit on the audit committee of a foreign private issuer if the 
employee is elected or named to the board of directors or audit 
committee of the foreign private issuer pursuant to home country legal 
or listing requirements.
---------------------------------------------------------------------------

    \85\ See, e.g., Co-Determination Act of 1976 
(Mitbestimmungsgesetz).
---------------------------------------------------------------------------

    We also note that certain foreign private issuers have a two-tier 
board, with one tier designated as the management board and the other 
tier designated as the supervisory or non-management board. In this 
circumstance, we believe that the supervisory or non-management board 
would be the body within the company best equipped to comply with the 
proposed requirements. We propose to clarify that in the case of 
foreign private issuers with two-tier boards of directors, the term 
``board of directors'' means the supervisory or non-management board. 
As such, the supervisory or non-management board could either form a 
separate audit committee or, if the entire supervisory or non-
management board was independent within the provisions and exceptions 
of the proposed rule, the entire board could be designated as the audit 
committee.\86\
---------------------------------------------------------------------------

    \86\ See note 37 above and the accompanying text.
---------------------------------------------------------------------------

    Controlling shareholders or shareholder groups are more prevalent 
among foreign issuers than in the United States, and those controlling 
shareholders have traditionally played a more prominent role in 
corporate governance. In jurisdictions providing for audit committees, 
representation of controlling shareholders on these committees is 
common. We believe that a limited exception from the independence 
requirements can accommodate this practice without undercutting the 
fundamental purposes of the proposed rule. In particular, we would 
propose that one member of the audit committee could be a shareholder, 
or representative of a shareholder or group, owning more than 50% of 
the voting securities of a foreign private issuer, if the ``no 
compensation'' prong of the independence requirements is satisfied, the 
member in question has only observer status on, and is not a voting 
member or the chair of, the audit committee, and the member in question 
is not an executive officer of the issuer.\87\ This limited exception 
is designed to accommodate foreign practices, would assure independent 
membership and an independent chair of the audit committee and would 
still exclude management from the committee.
---------------------------------------------------------------------------

    \87\ Exchange Act Rule 3b-7 defines the term ``executive 
officer'' as an issuer's president, any vice president of the 
registrant in charge of a principal business unit, division or 
function (such as sales, administration or finance), any other 
officer who performs a policy-making function or any other person 
who performs similar policy-making functions for the registrant. 
Executive officers of subsidiaries may be deemed executive officers 
of the issuer if they perform such policy-making functions for the 
issuer.
---------------------------------------------------------------------------

    Similarly, foreign governments may have significant shareholdings 
in some foreign private issuers or may own special shares that entitle 
the government to exercise certain rights relating to these issuers. 
However, due to their shareholdings or other rights, these 
representatives may not be considered independent under our proposals. 
To accommodate foreign practices, we believe that foreign governmental 
representatives should be permitted to sit on audit committees of 
foreign private issuers. As a result, we propose a limited exception 
that one member of the audit committee could be a representative of a 
foreign government or foreign governmental entity, if the ``no 
compensation'' prong of the independence requirement is satisfied and 
the member in question is not an executive officer of the issuer. As 
with

[[Page 2648]]

the proposed exemption for controlling shareholder representatives, 
this limited exception is designed to accommodate foreign practices and 
still exclude management from the committee.
    Finally, while as noted above there is a trend toward having audit 
committees in foreign jurisdictions, several foreign jurisdictions 
require or provide for auditor oversight through a board of auditors or 
similar body, or groups of statutory auditors, that are separate from 
the board of directors.\88\ We believe that these boards of auditors or 
statutory auditors are intended to be independent of management, 
although their members may not in all cases meet all of the 
independence requirements set forth in Section 10A(m) of the Exchange 
Act. In addition, while these bodies provide independent oversight of 
outside auditors, they may not have all of the responsibilities set 
forth in our proposals.
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    \88\ For example, under current Japanese law, we understand that 
large Japanese corporations must maintain a board of corporate 
statutory auditors, a legally separate and independent body from the 
corporation's board of directors that is elected by shareholders. 
See, e.g., Law for Special Exceptions to the Commercial Code 
Concerning Audits, etc. of Corporations (Law No. 22, 1974, as 
amended). Further, we understand that effective April 1, 2003, 
Japanese corporations will have the option to elect either a 
governance system with a separate board of directors and board of 
corporate auditors or a system based on nominating, audit and 
compensation committees under the board of directors.
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    The establishment of an audit committee in addition to these 
bodies, with duplicative functions, might not only be costly and 
inefficient, but it also could generate possible conflicts of powers 
and duties. Accordingly, we propose an exemption from certain of the 
requirements for audit committees for boards of auditors or statutory 
auditors of foreign private issuers that fulfill the remaining 
requirements of the rule, if those boards operate under legal or 
listing provisions that are intended to provide oversight of outside 
auditors that is independent of management, membership on the board 
excludes executive officers of the issuer and certain other 
requirements are met. Specifically, foreign private issuers with boards 
of auditors or similar bodies or statutory auditors meeting these 
requirements would be exempt from the requirements regarding the 
independence of audit committee members and the audit committee's 
responsibility to oversee the work of the outside auditor. The 
remaining proposed requirements regarding procedures for handling 
complaints, access to advisors and funding for advisors would apply to 
these issuers, with the requirements being applicable to the board of 
auditors or statutory auditors instead of an audit committee. Also, 
such board or body would need to be, to the extent permitted by law, 
responsible for the appointment and retention of any registered public 
accounting firm engaged by the listed issuer.\89\
---------------------------------------------------------------------------

    \89\ Such responsibility could be vested in such board or body, 
or statutory auditors, in any manner, including without limitation 
by law or listing requirement or delegation.
---------------------------------------------------------------------------

    A foreign private issuer availing itself of any of these exemptions 
would be subject to specific disclosure requirements discussed in 
Section II.G.1 below. In proposing these exemptions, we recognize that 
some foreign jurisdictions continue to have historical structures that 
may conflict with maintaining audit committees meeting the requirements 
of Section 10A(m) of the Exchange Act. We encourage foreign issuers 
that access the U.S. capital markets to continue to move toward 
internationally accepted best practices in corporate governance.\90\
---------------------------------------------------------------------------

    \90\ See, e.g., IOSCO Principles of Auditor Independence and the 
Role of Corporate Governance in Monitoring an Auditor's Independence 
(2002); OECD Principles of Corporate Governance (1999).
---------------------------------------------------------------------------

    As mentioned below, we request comment on whether there are other 
areas, in either one country or in many countries, in which the rules 
we are proposing are inconsistent or inappropriate in a significant way 
with foreign corporate governance arrangements. If there are other 
areas, do those arrangements adequately address the problems to be 
addressed under Exchange Act Section 10A(m)? As proposed, there would 
be no other ability for an SRO to exempt or waive foreign issuers from 
the proposed requirements.
b. Small Businesses
    Section 10A(m) of the Exchange Act makes no distinction based on an 
issuer's size. We think that improvements in the financial reporting 
process for companies of all sizes are important for promoting investor 
confidence in our markets. In this regard, because we have seen 
instances of financial fraud at small companies as well as at large 
companies, we think that improving the effectiveness of audit 
committees of small and large companies is important.\91\ The proposed 
rule, therefore, would apply to listed issuers of all sizes.
---------------------------------------------------------------------------

    \91\ See Beasley, Carcello and Hermanson, Fraudulent Financial 
Reporting: 1987-1997, An Analysis of U.S. Public Companies (Mar. 
1999) (study commissioned by the Committee of Sponsoring 
Organizations of the Treadway Commission).
---------------------------------------------------------------------------

    We recognize that because the proposals apply only to listed 
issuers, quantitative listing standards applicable to listed 
securities, such as minimum revenue, market capitalization and 
shareholder equity requirements, will limit the size of issuers that 
will be affected by the requirements.\92\ However, we are sensitive to 
the possible implication for smaller issuers and for SROs that would 
like to specialize in securities of these issuers. We request comment 
below on these topics.
---------------------------------------------------------------------------

    \92\ Examples of the types of quantitative standards necessary 
for initial and continued listings on the NYSE, Nasdaq and AMEX are 
available on their respective websites.
---------------------------------------------------------------------------

c. Issuers of Asset-Backed Securities
    In several of our releases implementing provisions of the Sarbanes-
Oxley Act,\93\ we have noted the special nature of asset-backed 
issuers.\94\ Because of the nature of these entities, such issuers are 
subject to substantially different reporting requirements. Most 
significantly, asset-backed issuers are generally not required to file 
the financial statements that other companies must file. Also, such 
entities typically are passive pools of assets, without an audit 
committee or board of directors or persons acting in a similar 
capacity. Accordingly, we propose to exclude asset-backed issuers from 
the proposed requirements.
---------------------------------------------------------------------------

    \93\ See note 30 above.
    \94\ The term ``Asset-Backed Issuer'' is defined in 17 CFR 
240.13a-14(g) and 240.15d-14(g).
---------------------------------------------------------------------------

d. Investment Companies
    There are essentially two categories of investment companies that 
have shares listed for trading on exchanges: closed-end investment 
companies and so-called ``exchange-traded funds'' (``ETFs''). Closed-
end investment companies are actively managed investment companies, 
which do not issue redeemable securities. ETFs are investment companies 
that are registered under the Investment Company Act as open-end 
investment companies or unit investment trusts (``UITs''). Unlike 
typical open-end funds or UITs, ETFs do not sell or redeem their 
individual shares (``ETF shares'') at net asset value (``NAV''). 
Instead, ETFs sell and redeem ETF shares at NAV only in large blocks 
(such as 50,000 ETF shares). In addition, national securities exchanges 
list ETF shares for trading, which allows investors to purchase and 
sell individual ETF shares among themselves at market prices throughout 
the day. Unlike open-end ETFs or closed-end investment companies, UITs, 
including those that operate as ETFs, are

[[Page 2649]]

not actively managed and do not have boards of directors from which 
audit committee members could be drawn. Accordingly, our proposed rules 
would cover closed-end investment companies and exchange-traded open-
end investment companies, but we are proposing to exclude exchange-
traded UITs from the proposed requirements.\95\
---------------------------------------------------------------------------

    \95\ Business development companies would be covered by the 
proposed rules.
    Investment companies may avail themselves of the general 
exemptions in proposed Exchange Act Rule 10A-3(c) [17 CFR 240.10A-
3(c)], if applicable, and, except in the case of reliance on the 
exemption for UITs contained in paragraph (c)(5)(ii) or the 
exemption contained in paragraph (c)(1), would have to disclose such 
use of a general exemption on proposed Form N-CSR and in proxy 
statements. The independence exemptions of proposed Exchange Act 
Rule 10A-3(b)(1)(iv)(A)-(E) [17 CFR 240.10A-3(b)(1)(iv)(A)-(E)] 
would not apply to investment companies.
---------------------------------------------------------------------------

    Questions regarding the proposed application to issuers:
    [sbull] Although we do not propose a complete exemption for foreign 
issuers from coverage of the proposed rule, and question whether such 
an exemption would be consistent with the policies underlying the 
Sarbanes-Oxley Act, we solicit comment on the propriety of either a 
complete or broader exemption from the requirements for foreign 
issuers. Given the exemptions that are proposed, would the proposals 
conflict with local law or local stock exchange requirements? If so, 
how? Are the problems that the proposals are intended to address dealt 
with in alternative ways in other jurisdictions? Would any foreign 
issuers not consider a listing solely because of these requirements? 
Would any foreign issuers that currently maintain a U.S. listing seek 
to delist their securities because of these requirements?
    [sbull] Is the proposed special accommodation to the independence 
requirements adequate for issuers in countries with a dual board 
structure where employee representatives sit on the supervisory board 
or are required to be on the audit committee? If not, how should we 
accommodate these issuers, if at all?
    [sbull] Are the proposed special accommodations for foreign issuers 
with controlling shareholder or shareholder groups or foreign 
government representation appropriate? Do the proposed exemptions 
provide appropriate accommodations for foreign private issuer 
practices, consistent with the purposes of Section 10A(m) of the 
Exchange Act and the protection of investors? Are there alternative 
approaches that would be preferable to address the issue? Should any of 
the conditions of the proposed exemption be changed? For example, for 
controlling shareholders, should the level of shareholder ownership 
proposed be higher (e.g., 80%) or lower (e.g., 10%)? Is the limitation 
for controlling shareholders to observer status and not being a voting 
member or chair of the audit committee appropriate?
    [sbull] Is the proposed special accommodation for issuers from 
jurisdictions that operate with boards of auditors or similar bodies 
appropriate? Does the proposed exemption provide appropriate 
accommodation for these issuers, consistent with the purposes of 
Section 10A(m) of the Exchange Act and the protection of investors? Are 
there alternative approaches that would be preferable to address the 
issue? Should we provide a ``sunset'' date for this provision to allow 
the Commission to reconsider its effectiveness and to reexamine the 
trend towards audit committees in other jurisdictions? If so, what date 
should we use (e.g., December 31, 2005)?
    [sbull] Is the compliance burden for companies under a certain size 
disproportionate to the benefits to be obtained from the proposed 
requirements? Would any smaller issuers not consider a listing solely 
because of these requirements? Would any smaller issuers that currently 
maintain a listing seek to delist their securities because of these 
requirements? How can we minimize the burden consistent with the 
purposes of the Sarbanes-Oxley Act?
    [sbull] Should the scope of one or more of the proposed 
requirements be narrowed to exclude or apply differently to companies 
under a certain size? If so, which requirements should be changed? How 
would such accommodations be consistent with the purposes of Section 
10A(m) and the protection of investors? Should there be special 
accommodations for companies considered under our rules to be ``small 
business issuers'' (companies that have revenues and public float of 
less than $25 million)? \96\ Should there be a higher cutoff, such as 
$100 million or $200 million public float and/or revenues? If there 
should be a different standard for determining the level of issuer 
affected, should it be based on additional or alternative criteria, 
such as total assets, shareholder equity or reporting history? What 
alternate means exist that would provide the same protections to 
shareholders?
---------------------------------------------------------------------------

    \96\ The term ``small business issuer'' is defined in Exchange 
Act Rule 12b-2.
---------------------------------------------------------------------------

    [sbull] Is the exclusion of asset-backed issuers appropriate? If 
not, how should these issuers be handled? Are there other types of 
issuers that should be handled differently?
    [sbull] Is the exclusion for ETFs that are structured as unit 
investment trusts appropriate? If not, how should these ETF UITs be 
handled? Exchange-traded UITs typically provide audited financial 
information in shareholder reports although these reports are not 
required by Commission rules. How should this affect whether exchange-
traded UITs are covered by the proposed requirements? Should the 
sponsor, depositor, or trustee of the UIT be required to comply with 
the proposed rule? Are there other types of investment companies that 
should be excluded from the proposed rule? If so, why?
    [sbull] We propose to make the general exemptions of Exchange Act 
Rule 10A-3(c) available for use by investment companies. Would 
investment companies ever fall within any of these exemptions? Should 
some exemptions be available to investment companies and others 
unavailable? If so, which ones should be available and why?
4. Determining Compliance With Proposed Standards
    Apart from the general requirement to prohibit the listing of a 
security not in compliance with the enumerated standards, Section 
10A(m) of the Exchange Act does not establish specific mechanisms for a 
national securities exchange or a national securities association to 
ensure that issuers comply with the proposed standards on an ongoing 
basis. SROs are required to comply with Commission rules pertaining to 
SROs and to enforce their own rules, including rules that govern 
listing requirements and affect their listed issuers. To further the 
purposes of Section 10A(m), we propose to direct the 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.\97\
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    \97\ We encourage the SROs to impose a similar requirement for 
noncompliance with other SRO listing standards that pertain to 
corporate governance standards apart from the audit committee 
requirements in proposed Exchange Act Rule 10A-3, to the extent SROs 
do not already provide for such a notice requirement.
---------------------------------------------------------------------------

    Questions regarding determining compliance with the proposed 
standards:
    [sbull] Should a listed issuer be required to notify the SRO if it 
has failed to comply with our proposed requirements? Is it sufficient 
for the notification to be made ``promptly?'' Should the direction to 
the SROs on this point be more specific

[[Page 2650]]

(e.g., notification must occur no later than two business days after an 
executive officer of the issuer becomes aware of any material 
noncompliance)?
    [sbull] Is the proposed triggering event for notification (i.e., 
that an executive officer of the issuer has become aware of any 
material noncompliance) appropriate? For example, should the standard 
also include any audit committee member becoming aware of any material 
noncompliance?
    [sbull] In addition to, or in lieu of, notification in the event of 
noncompliance, should a listed issuer be required to disclose 
periodically to the SROs whether they have been in compliance with the 
standards? If so, how often?
    [sbull] Should a listed issuer be required to notify the SRO if it 
has failed to comply with listing standards apart from our proposed 
requirements for audit committees? Should this requirement apply only 
to particular listing standards?
5. Opportunity To Cure Defects
    Section 10A(m)(1)(B) of the Exchange Act specifies that our rules 
must provide for appropriate procedures for an issuer to have an 
opportunity to cure any defects that would be the basis for a 
prohibition of the issuer's securities as a result of its failure to 
meet the proposed audit committee standards, before imposition of such 
a prohibition. To effectuate this mandate, our proposals would require 
the SROs to establish such procedures before they prohibit the listing 
of or delist any security of an issuer.\98\ Preliminarily, we believe 
that existing continued listing or maintenance standards and delisting 
procedures of the SROs would suffice as procedures for an issuer to 
have an opportunity to cure any defects on an ongoing basis. These 
procedures already provide issuers with notice and opportunity for a 
hearing, an opportunity for an appeal and an opportunity to cure any 
defects before their securities are delisted.\99\ However, we do expect 
that the rules of each SRO will provide for definite procedures and 
time periods for compliance with the proposed requirements to the 
extent they do not already do so.
---------------------------------------------------------------------------

    \98\ These procedures, of course, could not include an extended 
exemption or waiver of the requirements apart from those proposed.
    \99\ See, e.g., NASD Rule 4800 Series and NYSE Listed Company 
Manual Section 804.
---------------------------------------------------------------------------

    We also expect that our final rule will have a delayed 
implementation date before companies would initially be subject to the 
standards to provide affected companies with time to conform to the new 
standards. We recognize that companies may need to conduct shareholder 
elections to elect independent directors for their audit committees. We 
envision that the standards contemplated by our proposals would need to 
be operative by the SROs no later than the first anniversary of the 
publication of our final rule in the Federal Register. This should give 
listed issuers enough time to go through an annual meeting election 
cycle to elect any new directors that would be necessary to meet the 
new requirements.
    Questions regarding the opportunity to cure defects:
    [sbull] Should the SROs be required to establish specific 
procedures for curing defects apart from those proposed? If so, what 
would these procedures look like? Should there be a specific course for 
redress other than the delisting process?
    [sbull] Should our final rule include specific provisions that set 
maximum time limits for an opportunity to cure defects? If so, what 
time limits would be appropriate?
    [sbull] Beyond the limited exemption we propose for the 
independence requirements, should companies that have just completed 
their initial public offering be given additional time to comply with 
the requirements?
    [sbull] Is the proposed date for when the SROs rules must be 
operative appropriate for companies that must comply with the new 
standards? If not, what date would be appropriate and what factors 
should we consider in setting any such date? Would a period beyond the 
proposed date be necessary or appropriate for compliance by smaller 
companies? Are there special considerations that we should take into 
account for foreign private issuers?

G. Disclosure Changes Regarding Audit Committees

1. Disclosure Regarding Exemptions
    Our proposals provide for certain exemptions. Because these 
exemptions would distinguish certain issuers from most other listed 
issuers, we believe that it is important for investors to know if an 
issuer is availing itself of one of these exemptions. Accordingly, we 
propose that these issuers would need 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 
committee to act independently and to satisfy the other requirements of 
proposed Exchange Act Rule 10A-3. Such disclosure would need to appear 
in, or be incorporated by reference into, annual reports filed with the 
Commission.\100\ The disclosure also would need to appear in proxy 
statements or information statements for shareholders' meetings at 
which elections for directors are held.
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    \100\ This disclosure is proposed to be included in Part III of 
annual reports on Form 10-K and 10-KSB (through an addition to Item 
401 of Regulations S-K and S-B). Consequently, companies subject to 
the proxy rules would be able to incorporate the required disclosure 
from a proxy or information statement that involves the election of 
directors into the annual report, if the issuer filed such proxy or 
information statement within 120 days after the end of the fiscal 
year covered by the report. See General Instruction G.(3) of Form 
10-K and General Instruction E.3. of Form 10-KSB.
    For foreign private issuers that file their annual reports on 
Form 20-F, the disclosure requirement would appear in new paragraph 
(f) to Item 15. The additions of paragraphs (c)-(e) to Item 15 of 
Form 20-F were proposed in Release No. 33-8138 (Oct. 22, 2002), 
Release No. 33-8154 (Dec. 2, 2002), and Release No. 33-8160 (Dec. 
10, 2002) [67 FR 77594] (Rule 10b-18 and purchases of certain equity 
securities by the issuer and others), respectively.
    For foreign private issuers that file their annual reports on 
Form 40-F, the disclosure requirement would appear in paragraph (11) 
to General Instruction B. The additions of paragraphs (9) and (10) 
to General Instruction B. of Form 40-F were proposed in Release No. 
33-8138 (Oct. 22, 2002) and Release No. 33-8154 (Dec. 2, 2002), 
respectively.
    For registered investment companies, the disclosure would appear 
in Item 8 of proposed Form N-CSR and Item 22(b)(14) of Schedule 14A.
---------------------------------------------------------------------------

    Because of the nature of the exemption for boards of auditors or 
similar structures of foreign private issuers discussed in Section 
II.F.3.a., we also are proposing that foreign private issuers availing 
themselves of that exemption be required to file an exhibit to their 
annual reports stating that they are doing so.\101\ Because the 
presence of exhibits can be easily identified in electronic filings, we 
believe this requirement will facilitate monitoring of the use of this 
exemption by investors.
---------------------------------------------------------------------------

    \101\ The exhibit requirement would appear in new paragraph 11 
to the Instructions as to Exhibits of Form 20-F. The addition of 
paragraph 10 to the Instructions as to Exhibits of Form 20-F was 
proposed in Release No. 33-8138 (Oct. 22, 2002).
---------------------------------------------------------------------------

    As discussed in Section II.F.3.d., we are proposing a general 
exemption for unit investment trusts from the requirements of the 
proposed rule. In addition, we are proposing that UITs be excluded from 
the disclosure requirements relating to their use of the 
exemption.\102\ As a passive investment vehicle, a UIT has no board of 
directors, and there is little reason why investors would expect a UIT 
to have an audit committee. In addition, there is no appropriate 
disclosure document required by Commission rules where a UIT could 
include this disclosure.\103\
---------------------------------------------------------------------------

    \102\ See proposed Exchange Act Rule 10A-3(d).
    \103\ UITs file annual reports with the Commission on Form N-SAR 
[17 CFR 249.330 and 274.101] under Investment Company Act Rule 30a-1 
[17 CFR 270.30a-1]. However, these N-SAR reports are regulatory 
reports to the Commission and are not intended primarily as 
disclosure documents for investors.

---------------------------------------------------------------------------

[[Page 2651]]

    We also are proposing to exclude issuers availing themselves of the 
multiple listing exemption from the disclosure requirements relating to 
their use of that exemption. These issuers, or their controlling 
parents, would be required to comply with the proposed audit committee 
requirements as a result of a separate listing. Accordingly, disclosure 
of the use of that exemption would not serve the purpose of 
highlighting for investors those issuers that are different from most 
other listed issuers. However, if such an issuer also was availing 
itself of another exemption from the proposed requirements (i.e., the 
temporary exemption from the independence requirements for new listed 
issuers), disclosure of the use of that exemption would be required.
2. Identification of the Audit Committee in Annual Reports
    An issuer subject to the proxy rules of Section 14 of the Exchange 
Act \104\ is currently required to disclose in its proxy statement or 
information statement, if action is to be taken with respect to the 
election of directors, whether the issuer has a standing audit 
committee, the names of each committee member, the number of committee 
meetings held by the audit committee during the last fiscal year and 
the functions performed by the committee.\105\ We believe it is 
important for investors to be able to readily determine basic 
information about the composition of a listed issuer's audit committee. 
To foster greater availability of this basic information, we are 
proposing to require disclosure of the members of the audit committee 
to be included or incorporated by reference in the listed issuer's 
annual report.\106\ Also, because the Exchange Act now provides that in 
the absence of an audit committee the entire board of directors will be 
considered to be the audit committee, we propose to require a listed 
issuer that has not separately designated or has chosen not to 
separately designate an audit committee to disclose that the entire 
board of directors is acting as the issuer's audit committee.
---------------------------------------------------------------------------

    \104\ 15 U.S.C. 78n.
    \105\ See Item 7(d)(1) of Schedule 14A. Identical information is 
required with respect to nominating and compensation committees of 
the board of directors.
    \106\ Because this information is proposed to be included in 
Part III of annual reports on Forms 10-K and 10-KSB, companies 
subject to the proxy rules would be able to incorporate the required 
disclosure from a proxy or information statement that involves the 
election of directors, where it is already required to appear, into 
their annual reports. Information regarding the number of meetings 
of the audit committee and the basic functions performed by the 
audit committee, as well as the information regarding nominating and 
compensation committees, would continue to be required only in proxy 
or information statements that involve the election of directors.
---------------------------------------------------------------------------

    We propose similar changes for foreign private issuers that file 
their annual reports on Form 40-F. Foreign private issuers that file 
their annual reports on Form 20-F already are required to identify the 
members of their audit committee in their annual reports. For these 
listed issuers, however, we do propose that they disclose if the entire 
board of directors is acting as the audit committee. We also propose 
similar changes for registered management investment companies.\107\
---------------------------------------------------------------------------

    \107\ Item 22(b)(14) of Schedule 14A and proposed Item 8 of 
proposed Form N-CSR. Proposed Form N-CSR would be used by registered 
management investment companies to file certified shareholder 
reports with the Commission under the Sarbanes-Oxley Act. See 
Investment Company Act Release No. 25723 (Aug. 30, 2002) [67 FR 
57298]. The Commission proposed amendments to Form N-CSR in 
Investment Company Act Release No. 25739 (Sep. 20, 2002) [67 FR 
60828]; Investment Company Act Release No. 25775 (Oct. 22, 2002) [67 
FR 66208]; Investment Company Act Release No. 25838 (Dec. 2, 2002); 
Investment Company Act Release No. 25845 (Dec. 10, 2002); and 
Investment Company Act Release No. 25870 (Dec. 18, 2002).
---------------------------------------------------------------------------

3. Updates to Existing Audit Committee Disclosure
    An issuer subject to the proxy rules is currently required to 
disclose additional information about its audit committee in its proxy 
statement or information statement, if action is to be taken with 
respect to the election of directors.\108\ First, the audit committee 
must provide a report disclosing whether the audit committee has 
reviewed and discussed the audited financial statements with management 
and discussed certain matters with the independent auditors.\109\ 
Second, issuers must disclose whether the audit committee is governed 
by a charter, and if so, include a copy of the charter as an appendix 
to the proxy statement at least once every three years.\110\ Finally, 
the issuer must disclose whether the members of the audit committee are 
independent. Under the existing requirements, issuers whose securities 
are listed on the NYSE or AMEX or quoted on Nasdaq must disclose 
whether the audit committee members are independent, as defined in the 
applicable listing standards.\111\ These issuers also must disclose if 
its board of directors has determined to appoint one director to its 
audit committee due to an exceptional and limited circumstances 
exception in the applicable listing standards.\112\ Issuers whose 
securities are not listed on the NYSE or AMEX or quoted on Nasdaq also 
are required to disclose whether its audit committee members are 
independent. These issuers may choose which definition of independence 
to use from any of the NYSE, AMEX or Nasdaq listing standards.\113\
---------------------------------------------------------------------------

    \108\ See Item 7(d)(3) of Schedule 14A. These disclosure 
requirements were adopted in Release No. 34-42266 (Dec. 22, 1999).
    \109\ See Item 7(d)(3)(i) of Schedule 14A. The requirements for 
the audit committee report are specified in Items 306 of Regulations 
S-B [17 CFR 228.306] and S-K [17 CFR 229.306]. Under the existing 
requirements, if the company does not have an audit committee, the 
board committee tasked with similar responsibilities, or the full 
board of directors, is responsible for the disclosure.
    \110\ See Items 7(d)(3)(ii) and (iii) of Schedule 14A.
    \111\ See Item 7(d)(3)(iv)(A)(1) of Schedule 14A.
    \112\ See Item 7(d)(3)(iv)(A)(2) of Schedule 14A.
    \113\ See Item 7(d)(3)(iv)(B) of Schedule 14A. Whichever 
definition is chosen must be applied consistently to all members of 
the audit committee.
---------------------------------------------------------------------------

    Regarding the independence disclosure, all national securities 
exchanges and national securities associations under our proposals 
would need to have independence standards for audit committee members, 
not just the NYSE, AMEX and Nasdaq. The specification in the existing 
requirements to listings on these three markets would therefore no 
longer be necessary. Further, our proposals would not allow for an 
exception to the independence requirements due to exceptional and 
limited circumstances. As a result, disclosure regarding use of this 
exception would be unnecessary.
    Accordingly, we propose to update the disclosure requirements 
regarding the independence of audit committee members to reflect the 
new SROs rules to be adopted under Exchange Act Rule 10A-3. If the 
registrant was a listed issuer, it would still be required to disclose 
whether the members of its audit committee were independent. The listed 
issuer would need to use the definition of independence for audit 
committee members included in the listing standards applicable to the 
listed issuer. Further, because the Exchange Act now provides that in 
the absence of an audit committee the entire board of directors will be 
considered to be the audit committee, we propose to clarify that if the 
registrant does not have a separately designated audit committee, or 
committee performing similar functions, the registrant must provide the 
disclosure with respect to all members of its board of directors.
    Non-listed issuers that have separately designated audit committees 
would still be required to disclose whether their audit committee 
members were independent. In determining whether a member was 
independent,

[[Page 2652]]

these registrants would be allowed to choose any definition for audit 
committee member independence of a national securities exchange or 
national securities association that has been approved by the 
Commission.\114\
---------------------------------------------------------------------------

    \114\ Such definition would include the requirements of proposed 
Exchange Act Section 10A-3. These issuers would still be required to 
state which definition was used. Further, the requirement that the 
same definition must be applied consistently to all members of the 
audit committee would be retained.
---------------------------------------------------------------------------

    Questions regarding the proposed disclosure changes:
    [sbull] Should companies be required to disclose publicly if they 
are taking advantage of an exemption to the proposed SRO requirements? 
If so, are the proposed locations of this disclosure appropriate? 
Should we permit incorporation by reference into the company's annual 
report? Should the disclosure be required as an exhibit to the 
company's filing? Is the disclosure of the company's assessment of 
whether and if so, how, such reliance would materially adversely affect 
the ability of the audit committee to act independently and to satisfy 
the other proposed requirements appropriate?
    [sbull] Should foreign private issuers that avail themselves of the 
exemption for boards of auditors or similar structures be required to 
file an exhibit to their annual reports stating that they are doing so?
    [sbull] Should a UIT be required to disclose that it is availing 
itself of the exemption from the audit committee requirements? If so, 
where should such disclosure be made? Exchange-traded UITs typically 
provide audited financial information in shareholder reports although 
these reports are not required by Commission rules.\115\ Should 
disclosure of the exemption from audit committee requirements be 
required in these reports?
    [sbull] Should an issuer relying on the multiple listing exemption 
be required to disclose that it is availing itself of that exemption? 
Should the disclosure only be required for subsidiaries relying on the 
exemption for their own listed securities?
---------------------------------------------------------------------------

    \115\ See, e.g., SPDR Trust, Series 1, Investment Company Act 
Release Nos. 18959 (Sept. 17, 1992) (notice) and 19055 (Oct. 26, 
1992) (order) and Fourth Amended and Restated Application, filed 
Aug. 7, 1992, File No. 812-7545, at 35.
---------------------------------------------------------------------------

    [sbull] Should we require disclosure of basic information about an 
issuer's audit committee in its annual report, or is the current 
location of this disclosure for issuers subject to the proxy rules 
sufficient? Would disclosure of whether the entire board is acting as 
the audit committee be helpful?
    [sbull] Given the new definition of audit committee in the Exchange 
Act, is it appropriate to clarify in the current disclosure 
requirements for audit committees that if the issuer does not have a 
separately designated audit committee, or committee performing similar 
functions, the issuer must provide the disclosure with respect to all 
members of its board of directors? How many issuers will this change 
affect?
    [sbull] Are our proposed changes to the disclosure requirements 
regarding the independence of audit committee members appropriate? Is 
there a reason to continue to require non-listed issuers to choose from 
one of the NYSE's, AMEX's or Nasdaq's definitions for audit committee 
members?
    [sbull] Listed issuers that are foreign private issuers are 
generally not subject to the proxy rules. Should we require disclosure 
regarding the independence of audit committee members for these 
issuers? If so, where should this disclosure appear?
    [sbull] Is there any additional disclosure concerning audit 
committees that would be beneficial to investors? With the new 
requirements we propose for audit committees, is any existing 
disclosure we require regarding audit committees no longer needed?

H. General Request for Comment

    We request and encourage any interested person to submit comments 
on the proposals, on any additional or different changes, and on any 
other matters that might have an impact on the proposals. We request 
comment from the point of view of national securities exchanges and 
national securities associations that would be required to comply with 
the proposals. We also request comment from the point of view of 
companies that would be subject to the listing requirements that would 
result from the proposals. We also request comment from the point of 
view of investors in the securities of these companies on their views 
of the proposals and any possible changes to the proposals. With regard 
to any comments, we note that such comments are of greatest assistance 
to our rulemaking initiative if accompanied by supporting data and 
analysis of the issues addressed in those comments.

III. Paperwork Reduction Act

A. Background

    Our proposals contain ``collection of information'' requirements 
within the meaning of the Paperwork Reduction Act of 1995 
(``PRA'').\116\ We are submitting our proposals to the Office of 
Management and Budget (``OMB'') for review in accordance with the 
PRA.\117\ The titles for the collection of information are:
---------------------------------------------------------------------------

    \116\ 44 U.S.C. 3501 et seq.
    \117\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.
---------------------------------------------------------------------------

    (1) ``Proxy Statements--Regulation 14A (Commission Rules 14a-1 
through 14a-15 and Schedule 14A)'' (OMB Control No. 3235-0059);
    (2) ``Information Statements--Regulation 14C (Commission Rules 14c-
1 through 14c-7 and Schedule 14C)'' (OMB Control No. 3235-0057);
    (3) ``Form 10-K'' (OMB Control No. 3235-0063);
    (4) ``Form 10-KSB'' (OMB Control No. 3235-0420);
    (5) ``Form 20-F'' (OMB Control No. 3235-0288);
    (6) ``Form 40-F'' (OMB Control No. 3235-0381);
    (7) ``Regulation S-K'' (OMB Control No. 3235-0071);
    (8) ``Regulation S-B'' (OMB Control No. 3235-0417); and
    (9) ``Form N-CSR'' (OMB Control No. 3235-0570).
    These regulations and forms were adopted pursuant to the Securities 
Act, the Exchange Act and the Investment Company Act and set forth the 
disclosure requirements for periodic reports, registration statements 
and proxy and information statements filed by companies to ensure that 
investors are informed. The hours and costs associated with preparing, 
filing and sending these forms constitute reporting and cost burdens 
imposed by each collection of information. An agency may not conduct or 
sponsor, and a person is not required to respond to, a collection of 
information unless it displays a currently valid OMB control number.
    Under our proposals, we would direct SROs to prohibit the listing 
of any security of an issuer that is not in compliance with several 
enumerated standards relating to the issuer's audit committee. We are 
making these proposals pursuant to the legislative mandate in Section 
10A(m) of the Exchange Act, as added by Section 301 of the Sarbanes-
Oxley Act. As part of our proposals, we are proposing several limited 
exemptions from the requirements to address the special circumstances 
of particular issuers. If an issuer was to avail itself of one of these 
exemptions, we propose that it would need to disclose this fact and its 
assessment of whether, and if so, how, such reliance would materially 
adversely affect the ability of the audit committee to act 
independently and to satisfy the other requirements of

[[Page 2653]]

proposed requirements. Such disclosure would need to appear in its 
proxy or information statement for shareholders' meetings at which 
elections for directors are held. The disclosure also would need to 
appear in, or be incorporated by reference into, the annual reports of 
these companies filed with the Commission. In addition, a foreign 
private issuer that availed itself of the board of auditors exception 
would need to file a brief exhibit. We have proposed an exemption from 
these proposed disclosure requirements for exchange-traded UITs and 
issuers relying on the multiple listing exemption. We call these 
proposed changes the ``Exemption Disclosure.''
    Under our proposals, listed issuers also would be required to 
disclose the members of their audit committee, or that their entire 
board of directors is acting as their audit committee, in their annual 
reports. We call these proposed changes the ``Identification 
Disclosure.''
    Finally, we are proposing several updates to existing disclosure 
requirements regarding audit committees to reflect our proposals and 
changes made by the Sarbanes-Oxley Act. We call these proposed changes 
the ``Disclosure Updates.''
    These disclosure changes are designed to alert investors of basic 
information about an issuer's audit committee, including the identity 
of the issuer's audit committee, whether the issuer is availing itself 
of an exemption and whether the members of the audit committee are 
independent. Compliance with the revised disclosure requirements would 
be mandatory. There would be no mandatory retention period for the 
information disclosed, and responses to the disclosure requirements 
would not be kept confidential. We do not believe that the imposition 
of these proposed disclosure changes would alter significantly the 
number of respondents that file on the affected forms.
    In addition to the above, we propose to direct the 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. We 
believe that any burden imposed by this collection of information would 
be minimal. For the most part, we believe that listed issuers are 
already required to make the type of disclosure contemplated by the 
proposal, either pursuant to existing SRO rules or as a requirement of 
existing listing agreements. We therefore believe that any reporting 
and recordkeeping requirements imposed by this aspect of the proposals 
are ``usual and customary'' activities for listed issuers.\118\
---------------------------------------------------------------------------

    \118\ See 5 CFR 1320.3(b)(2).
---------------------------------------------------------------------------

B. Revisions to PRA Reporting and Cost Burden Estimates

    For purposes of the PRA, we estimate that the annual incremental 
paperwork burden for all companies to prepare the disclosure that would 
be required under our proposals would be approximately 685 hours of 
personnel time and a cost of approximately $99,600 for the services of 
outside professionals. We derived these estimates first by estimating 
the total amount of time it would take for a company to prepare the 
proposed disclosure. The Disclosure Updates simply update the 
disclosure requirements to reflect our proposals and changes to 
terminology made by the Sarbanes-Oxley Act. We do not believe these 
changes would change the burden required by this disclosure. The 
Exemption Disclosure would require only a minimal additional statement 
by issuers that avail themselves of one of our proposed exemptions. In 
addition, foreign private issuers availing themselves of the board of 
auditors exception would need to file a brief exhibit. We estimate that 
the Exemption Disclosure would add 0.25 hours per affected filing. The 
Identification Disclosure would require a company to disclose either 
the members of its audit committee, or a brief statement that the board 
of directors of the issuer is acting as the audit committee. We 
estimate that the Identification Disclosure would add 0.25 hours per 
affected filing.
    The Exemption Disclosure and Identification Disclosure apply only 
to listed issuers. Accordingly, not all issuers would be required to 
make the proposed disclosure. We estimate that there are approximately 
7,250 issuers that are listed on a national securities exchange or 
traded on the Nasdaq National Market or the Nasdaq Smallcap 
Market.\119\ Each of these listed companies, except exchange-traded 
UITs, would be required to at least provide the basic Identification 
Disclosure in their annual report. Some of these listed issuers also 
would need to make the Exemption Disclosure.\120\
---------------------------------------------------------------------------

    \119\ We derived this estimate from the Standard & Poors 
Research Insight Compustat Database and the Commission's annual 
report.
    \120\ With respect to investment companies, the independence 
exemptions would not be available. A general exemption would be 
applicable to UITs, but UITs would be excluded from Exemption 
Disclosure requirements. We anticipate that only a negligible number 
of investment companies would fall under the other general 
exemptions. Accordingly, we anticipate that the reporting burden 
imposed by the Exemption Disclosure requirements on listed 
investment companies would be negligible.
---------------------------------------------------------------------------

    Further, since the disclosure in the annual report may be 
incorporated by reference from an issuer's proxy or information 
statement, we assume that the disclosure would appear in a maximum of 
one report per affected issuer. As the information would appear in Part 
III of an issuer's Form 10-K or 10-KSB (which can be incorporated by 
reference from the issuer's proxy statement if where directors are to 
be elected), or in Item 8 of Form N-CSR, which may also be incorporated 
by reference, we assume that affected issuers will follow the general 
practice of most issuers of including the disclosure in their proxy or 
information statement where directors are elected and incorporating by 
reference the disclosure into their annual report. Accordingly, we are 
reducing the number of affected reports on Forms 10-K, 10-KSB and N-CSR 
to account for this assumption.\121\ Further, we assume that the 
Identification Disclosure is already required in these proxy or 
information statements,\122\ and the burden hours for this disclosure 
by these filers therefore has already been assigned to Schedules 14A 
and 14C. Accordingly, we estimate that the Identification Disclosure 
will not affect the burden for Schedules 14A and 14C.
---------------------------------------------------------------------------

    \121\ Foreign private issuers are exempt from the requirements 
to provide proxy materials, so we assume no adjustment to the number 
of affected annual reports on Forms 20-F and 40-F.
    \122\ See Item 7(d)(1) of Schedule 14A.
---------------------------------------------------------------------------

    The tables below illustrate the incremental annual compliance 
burdens of the collections of information in hours and in cost for 
annual reports and proxy and information statements under the Exchange 
Act. The burden was calculated by multiplying the estimated number of 
affected responses by the estimated average number of hours each entity 
spends preparing the proposed disclosure. We have based our estimates 
on the number of affected responses on the actual number of filers 
during the 2002 fiscal year and our estimates of the number of listed 
issuers that may be affected by the disclosure changes.\123\ For 
Exchange Act annual reports and proxy and information statements, we 
estimate that 75% of the burden of preparation is carried by the 
company internally and that 25% of the burden of preparation is carried 
by outside professionals retained by the company

[[Page 2654]]

at an average cost of $300 per hour.\124\ The portion of the burden 
carried by outside professionals is reflected as a cost, while the 
portion of the burden carried by the company internally is reflected in 
hours.
---------------------------------------------------------------------------

    \123\ We estimate that 5% of listed issuers would be required to 
provide disclosure regarding the new issuer exemption in proposed 
Exchange Act Rule 10A-3(b)(iv)(A) and 20% of listed issuers would be 
required to provide disclosure regarding use of the holding company 
exemption in proposed Exchange Act Rule 10A-3(b)(iv)(B).
    \124\ This allocation of the burden is consistent with our 
recent PRA submissions for Exchange Act periodic reports and proxy 
and information statements. See, e.g., Release No. 33-8144 (Nov. 4, 
2002). Traditionally, we have estimated that the company carried 25% 
of the burden internally and 75% of the burden of preparation was 
carried by outside professionals retained by the company. We believe 
that the new allocation more accurately reflects current practice 
for annual reports and proxy and information statements. We 
estimate, however, that the traditional 25% company and 75% outside 
professional allocation remains applicable for Forms 20-F and 40-F 
because those forms are prepared by foreign private issuers who rely 
more heavily on outside counsel for their preparation.
    \125\ For convenience, the estimated PRA hour burdens have been 
rounded to the nearest whole number, and the estimated PRA cost 
burdens have been rounded to the nearest $100. As a result of 
rounding, the sum of the entries in columns (D) and (E) of the 
tables may not exactly equal the corresponding entry in column (C).
    \126\ This figure is based on our estimate of the total number 
of affected responses by listed issuers.
    \127\ This figure is based on our estimate of the total number 
of affected responses by listed issuers.
    \128\ This figure is based on our estimate of the total number 
of affected responses by listed issuers, as adjusted for the number 
of responses where Part III information would be incorporated by 
reference from a proxy or information statement.
    \129\ This figure is based on our estimate of the total number 
of affected responses by listed issuers, as adjusted for the number 
of responses where Part III information would be incorporated by 
reference from a proxy or information statement.
    \130\ This figure is based on our estimate of the total number 
of affected responses by listed issuers.
    \131\ This figure is based on our estimate of the total number 
of affected responses by listed issuers.

                                         Calculation of the Incremental Burden of the Exemption Disclosure \125\
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                  Affected   Incremental       Total        75% Company         25%            $300
                                                                  responses   hours/form    incremental  ----------------  Professional    professional
                                                                -------------------------     burden                     ----------------    cost ($)
                                                                                         ----------------  (D)=(C)*0.75                  ---------------
                                                                     (A)         (B)        (C)=(A)*(B)                    (E)=(C)*0.25     (F)=(E)*300
--------------------------------------------------------------------------------------------------------------------------------------------------------
20-F...........................................................   \126\ 438         0.25             110              28              83       24,900.00
40-F...........................................................    \127\ 35         0.25               9               2               7        2,100.00
10-K...........................................................   \128\ 269         0.25              67              50              17        5,100.00
10-KSB.........................................................   \129\ 108         0.25              27              20               7        2,100.00
14A............................................................       \130\         0.25             339             254              85       25,000.00
                                                                      1,356
14C............................................................    \131\ 86         0.25              22              17               6        1,800.00
                                                                -------------
    Total......................................................  ..........  ...........             574             371             205       61,500.00
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                         Calculation of the Incremental Burden of the Identification Disclosure
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                  Affected   Incremental       Total        75% Company         25%            $300
                                                                  responses   hours/form    incremental  ----------------  Professional    Professional
                                                                -------------------------     burden                     ----------------    cost ($)
                                                                                         ----------------  (D)=(C)*0.75                  ---------------
                                                                     (A)         (B)        (C)=(A)*(B)                    (E)=(C)*0.25     (F)=(E)*300
--------------------------------------------------------------------------------------------------------------------------------------------------------
20-F...........................................................     \132\ 0         0.25               0               0               0            0.00
40-F...........................................................   \133\ 134         0.25              34               9              26        7,800.00
10-K...........................................................       \134\         0.25             268             201              67       20,100.00
                                                                      1,073
10-KSB.........................................................   \135\ 430         0.25             108              81              27        8,100.00
N-CSR..........................................................   \136\ 113         0.25              28              21               7        2,100.00
14A............................................................     \137\ 0         0.25               0               0               0            0.00
14C............................................................     \138\ 0         0.25               0               0               0            0.00
                                                                -------------
    Total......................................................  ..........  ...........             438             312             127       38,100.00
--------------------------------------------------------------------------------------------------------------------------------------------------------

    Regulation S-K includes the requirements that a registrant must 
provide in filings under both the Securities Act and the Exchange Act. 
Regulation S-B includes the requirements that a small business issuer 
must provide in the Securities Act and the Exchange Act. The proposed 
disclosure changes would include changes to items under Regulation S-K 
and Regulation S-B. However, the filing requirements themselves are 
included in Form 10-K, Form 10-KSB, Form 20-F, Form 40-F, Schedule 14A 
and Schedule 14C. We have reflected the burden for the new requirements 
in the burden estimates for those firms. The items in Regulation S-K 
and Regulation S-B do not impose any separate burden. We previously 
have assigned one burden hour each to Regulations S-B and S-K for 
administrative convenience to reflect the fact that these regulations 
do not impose any direct burden on companies.
---------------------------------------------------------------------------

    \132\ Issuers that file their annual report on Form 20-F are 
already required to identify the members of their audit committee.
    \133\ This figure is based on our estimate of the total number 
of affected responses by listed issuers.
    \134\ This figure is based on our estimate of the total number 
of affected responses by listed issuers, as adjusted for the number 
of responses where Part III information would be incorporated by 
reference from a proxy or information statement.
    \135\ This figure is based on our estimate of the total number 
of affected responses by listed issuers, as adjusted for the number 
of responses where Part III information would be incorporated by 
reference from a proxy or information statement.
    \136\ This figure is based on our estimate of the total number 
of affected responses by listed issuers, as adjusted for the number 
of responses where Item 8 information would be incorporated by 
reference from a proxy or information statement.
    \137\ We estimate that proxy statements on Schedule 14A are 
already required to identify the members of their audit committee.
    \138\ We estimate that information statements on Schedule 14C 
are already required to identify the members of their audit 
committee.
---------------------------------------------------------------------------

C. Request for Comment

    We request comment in order to (a) evaluate whether the proposed 
collections of information are necessary for the proper performance of 
the functions of the Commission, including whether the information will 
have practical utility; (b) evaluate the accuracy of our estimates of 
the burden

[[Page 2655]]

of the proposed collections of information; (c) determine whether there 
are ways to enhance the quality, utility, and clarity of the 
information to be collected; (d) evaluate whether there are ways to 
minimize the burden of the collections of information on those who 
respond, including through the use of automated collection techniques 
or other forms of information technology; and (e) evaluate whether the 
proposals will have any effects on any other collections of information 
not previously identified in this section.
    Any member of the public may direct to us any comments concerning 
the accuracy of these burden estimates and any suggestions for reducing 
the burdens. Persons who desire to submit comments on the collection of 
information requirements should direct their comments to the OMB, 
Attention: Desk Officer for the Securities and Exchange Commission, 
Office of Information and Regulatory Affairs, Washington, DC 20503, and 
send a copy of the comments to Jonathan G. Katz, Secretary, Securities 
and Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-
0609, with reference to File No. S7-02-03. Requests for materials 
submitted to the OMB by us with regard to these collections of 
information should be in writing, refer to File No. S7-02-03, and be 
submitted to the Securities and Exchange Commission, Records 
Management, Office of Filings and Information Services, 450 Fifth 
Street, NW., Washington, DC 20549. Because the OMB is required to make 
a decision concerning the collections of information between 30 and 60 
days after publication, your comments are best assured of having their 
full effect if the OMB receives them within 30 days of publication.

IV. Cost-Benefit Analysis

    The proposals represent the implementation of a Congressional 
mandate. We recognize that implementation of the Sarbanes-Oxley Act 
will likely create costs and benefits to the economy. We are sensitive 
to the costs and benefits imposed by our rules, and we have identified 
certain costs and benefits of these proposals.

A. Background

    Section 10A(m)(1) of the Exchange Act, as added by Section 301 of 
the Sarbanes-Oxley Act, requires us to direct, by rule, the national 
securities exchanges and national securities associations to prohibit 
the listing of any security of an issuer that is not in compliance with 
several enumerated standards regarding issuer audit committees. The new 
rule must become effective by April 26, 2003, which is 270 days after 
the date of enactment of the Sarbanes-Oxley Act and Section 10A(m) of 
the Exchange Act.
    In general, according to the standards listed in Section 10A(m) of 
the Exchange Act, SROs would be prohibited from listing any security of 
an issuer that is not in compliance with the following standards:
    [sbull] Each member of the audit committee of the issuer must be 
independent according to specified criteria;
    [sbull] The audit committee of each issuer 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 listed 
issuer, and each such registered public accounting firm must report 
directly to the audit committee;
    [sbull] 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 issuer 
of concerns regarding questionable accounting or auditing matters;
    [sbull] Each audit committee must have the authority to engage 
independent counsel and other advisors, as it determines necessary to 
carry out its duties; and
    [sbull] Each issuer must provide appropriate funding for the audit 
committee.
    Our proposals would respond directly to the requirements in Section 
10A(m) of the Exchange Act. In addition, our proposals would include 
several additional provisions, such as:
    [sbull] Our proposals would revise existing disclosure requirements 
regarding the composition of audit committees by also requiring this 
disclosure in annual reports of listed issuers filed with the 
Commission;
    [sbull] Our proposals would require a company availing itself of 
one of our proposed exemptions from the requirements to disclose 
publicly that it is doing so; and
    [sbull] Our proposals would update existing disclosure requirements 
regarding audit committees to reflect changes made by the proposals and 
the Sarbanes-Oxley Act.

B. Potential Benefits

    One of the main goals of the Sarbanes-Oxley Act is to improve 
investor confidence in the financial markets. The proposals in this 
release are among many required by the Sarbanes-Oxley Act.\139\ They 
seek to help achieve the Act's goals by promoting strong, effective 
audit committees to perform their oversight role. By increasing the 
competence of audit committees, the proposals are designed to further 
greater accountability and quality of financial disclosure and 
oversight of the process by qualified and independent audit committees. 
Vigilant and informed oversight by a strong, effective and independent 
audit committee could help to counterbalance pressures to misreport 
results and impose increased discipline on the process of preparing 
financial information. Improved oversight may help detect fraudulent 
financial reporting earlier and perhaps thus deter it or minimize its 
effects. All of these benefits imply increased market efficiency due to 
improved information and investor confidence in the reliability of a 
company's financial disclosure and system of internal controls. These 
benefits are not readily quantifiable. However, as the Blue Ribbon 
Committee on Improving the Effectiveness of Corporate Audit Committees 
summarized regarding its own recommendations for audit committees:
---------------------------------------------------------------------------

    \139\ See note 30 above.

    Improving oversight of the financial reporting process 
necessarily involves the imposition of certain burdens and costs on 
public companies. Despite these costs, the Committee believes that a 
more transparent and reliable financial reporting process ultimately 
results in a more efficient allocation of and lower cost of capital. 
To the extent that instances of outright fraud, as well as other 
practices that result in lower quality financial reporting, are 
reduced with improved oversight, the benefits clearly justify these 
expenditures of resources.\140\
---------------------------------------------------------------------------

    \140\ See note 22 above.

    In addition, we are proposing to require basic information about 
the composition of an issuer's audit committee in a listed issuer's 
annual report. The disclosure is currently only required in proxy or 
information statements where directors are being elected, and not all 
listed issuers are subject to the proxy rules or elect directors each 
year. Also, because the Exchange Act now provides that in the absence 
of an audit committee the entire board of directors will be considered 
to be the audit committee, we propose to require a listed issuer that 
has not or has chosen not to separately designate an

[[Page 2656]]

audit committee to disclose that the entire board of directors is 
acting as the issuer's audit committee. Also, if a company relied on 
one of the exemptions we propose to the requirements, some minimal 
additional disclosure would be required in its proxy or information 
statements where directors are elected and in their annual report 
(unless incorporated by reference). We also propose several updates to 
existing disclosure requirements regarding audit committees to reflect 
the proposals and changes made by the Sarbanes-Oxley Act.
    As a result of these disclosure changes, investors would receive 
more detailed information on a consistent basis about the basic 
composition of an issuer's audit committee. These disclosures will 
afford investors greater visibility about the issuer's audit committee. 
Providing this information on a more widespread basis also may allow 
investors to ask more direct and useful questions of management and 
directors regarding the composition and role of the audit committee.

C. Potential Costs

    SROs not in compliance with the standards would need to spend 
additional time and incur additional costs in modifying their rules to 
comply. There also may be ongoing costs in monitoring compliance with 
the standards and taking appropriate remedial steps. We request comment 
on the type, amount and duration of these costs. If the proposed 
standards had the effect of causing companies to delist or forego 
listing of their securities, SROs would lose trading volume. The 
proposed standards could have the effect of discouraging the formation 
of trading markets that specialize in particular types of issuers 
(i.e., small issuers or foreign issuers), if those issuers found the 
proposed requirements too burdensome to seek a listing on those 
markets. The possibility of these effects and their magnitude if they 
were to occur are difficult to quantify.
    Issuers would need to comply with the proposed audit committee 
standards if they wished to have their securities listed on a national 
securities exchange or national securities association. This may 
require companies to spend additional time and incur additional costs 
in establishing and modifying their audit committees (or full boards if 
they do not have a separate audit committee) to comply with the 
standards. There may be search costs involved in locating independent 
directors willing to serve on a company's audit committee, including 
the costs of preparing proxy statements and holding shareholder 
meetings to elect those directors. If the requirements reduce the pool 
of candidates that would be willing to serve on an issuer's audit 
committee, these search costs may increase. Convincing directors to 
serve on an audit committee may require additional compensation or 
increased liability insurance coverage due to the new requirements 
imposed on audit committees. Companies may decide to increase the size 
of their boards to accommodate new directors meeting the proposed 
requirements. If additional independent directors are added to the 
board, or if existing non-independent directors are replaced, this may 
increase the percentage of the board that is independent from 
management. If a company had previously received services from an audit 
committee member of the type that would be prohibited under the 
proposals, the company may incur costs in locating an alternative 
provider for these services.
    There also may be ongoing costs in monitoring compliance with the 
standards or maintaining any additional procedures established by the 
standards, such as the procedures for handling complaints. To the 
extent the audit committee engages independent counsel or other 
advisors where it could not do so previously, there would be additional 
costs for the payment of compensation to these advisors. Companies also 
may incur additional ongoing expenses if they decide to increase the 
size of their boards in response to the requirements.
    We believe that as a result of many current SRO listing 
standards,\141\ the Commission's audit committee disclosure 
requirements adopted in 1999,\142\ the prior disclosures related to the 
involvement of the audit committee in recommending or approving changes 
in auditors and the resolution of disagreements between management and 
the auditors,\143\ and professional standards that require 
communications between the auditor and audit committees on auditor 
independence issues,\144\ many companies currently have audit 
committees. However, these audit committees may not meet all of our 
proposed requirements. Smaller companies may constitute a larger 
representative share of issuers that do not meet the proposed 
requirements, particularly the independence requirements. However, we 
recognize that because the proposals apply only to listed issuers, the 
quantitative listing standards applicable to listed securities, such as 
minimum revenue, market capitalization and shareholder equity 
requirements, will limit the size of issuers that will be affected by 
the requirements. Companies that do not currently meet our proposed 
requirements would face all of the costs described above. However, 
these entities, because they currently lack the protections provided by 
the standards, may bear a disproportionately greater risk of fraudulent 
financial reporting, and thus may reap proportionately greater 
benefits.
---------------------------------------------------------------------------

    \141\ See note 23 above.
    \142\ See note 24 above.
    \143\ See, e.g., Item 4 of Form 8-K [17 CFR 249.308] and Item 
304 of Regulation S-K [17 CFR 229.304].
    \144\ See, e.g., American Institute of Certified Public 
Accountants (``AICPA'') ``Communications with Audit Committees,'' 
Statements of Auditing Standards (``SAS'') 61, as amended by SAS 89 
and 90; AICPA, Codification of Statements on Auditing Standards 
(``AU'') Sec.  380; Independence Standards Board, ``Independence 
Discussion with Audit Committees,'' Independence Standard No. 1 
(Jan. 1999).
---------------------------------------------------------------------------

    We also have proposed limited exemptions to the requirements, such 
as an exemption for multiple listings, a limited exemption for new 
public companies and exemptions for certain foreign issuers, to 
alleviate some of the burdens companies may face where consistent with 
investor protection. Companies that perceived the proposals as too 
onerous could be dissuaded from seeking or maintaining a listing for 
their securities, which could impact capital formation and negatively 
impact the liquidity for its securities. We have no reliable basis for 
estimating the number of companies that would face increased costs as a 
result of the proposals or the amount of such costs.
    Regarding the disclosure changes we propose regarding audit 
committees, issuers subject to the proxy rules are already required to 
compile most of this information for proxy or information statements 
where directors are being elected. Foreign private issuers that file 
their annual reports on Form 20-F also are already required to identify 
the members of their audit committee. The disclosure regarding if a 
listed issuer is availing itself of an exemption to the requirements 
should result in minimal additional disclosure. Using estimates derived 
from our Paperwork Reduction Act analysis, we estimate that the 
incremental impact of our proposed disclosure changes will result in a 
total cost of $185,225 for all affected companies.\145\
---------------------------------------------------------------------------

    \145\ The estimate is based on the burden hour estimates 
calculated under the Paperwork Reduction Act. For purposes of the 
Paperwork Reduction Act, we estimate that the additional disclosure 
will result in 685 internal burden hours and $99,600 in external 
costs. Assuming a cost of $125/hour for in-house professional staff, 
the total cost for the internal burden hours would be $85,625. Hence 
the aggregate cost estimate is $185,225 ($99,600 + 85,625). The 
$125/hour cost estimate is based on data obtained from The SIA 
Report on Management and Professional Earnings in the Securities 
Industry (Oct. 2001).

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[[Page 2657]]

    In formulating our proposals, we considered several regulatory 
alternatives that would be consistent with the specific mandate 
required by Section 10A(m) of the Exchange Act. We considered the 
propriety of excluding all foreign issuers or issuers of a particular 
size, but such an exclusion may not be appropriate or consistent with 
the policies underlying the Sarbanes-Oxley Act. We think that 
improvements in the financial reporting process for all listed issuers 
are important for promoting investor confidence in our markets. We also 
considered whether we should provide objective guidance for determining 
who is an ``affiliated person'' for purposes of the proposed 
independence requirement. In considering the uncertainty that may arise 
in determining whether a person is an ``affiliated person,'' we have 
proposed a safe harbor from the definition of affiliate for non-
investment companies. We have also proposed other limited exemptions to 
alleviate some of the burdens companies may face where consistent with 
investor protection.

D. Request for Comments

    We request that commenters provide views and supporting information 
as to the benefits and costs associated with the proposals. We seek 
estimates of these costs and benefits, as well as any costs and 
benefits not already identified. We also request comment regarding the 
relative costs and benefits of pursuing alternative regulatory 
approaches that are consistent with the Sarbanes-Oxley Act's statutory 
mandate.

V. Consideration of Impact on the Economy, Burden on Competition and 
Promotion of Efficiency, Competition and Capital Formation

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996, or ``SBREFA,'' \146\ we solicit data to determine whether 
the proposals constitute a ``major'' rule. Under SBREFA, a rule is 
considered ``major'' where, if adopted, it results or is likely to 
result in:
---------------------------------------------------------------------------

    \146\ Pub. L. No. 104-121, Title II, 110 Stat. 857 (1996) 
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note 
to 5 U.S.C. 601).
---------------------------------------------------------------------------

    [sbull] An annual effect on the economy of $100 million or more 
(either in the form of an increase or a decrease);
    [sbull] A major increase in costs or prices for consumers or 
individual industries; or
    [sbull] Significant adverse effects on competition, investment or 
innovation. We request comment on the potential impact of the proposals 
on the economy on an annual basis. Commenters are requested to provide 
empirical data and other factual support for their views if possible.
    Section 23(a)(2) of the Exchange Act \147\ requires us, when 
adopting rules under the Exchange Act, to consider the impact that any 
new rule would have on competition. In addition, Section 23(a)(2) 
prohibits us from adopting any rule that would impose a burden on 
competition not necessary or appropriate in furtherance of the purposes 
of the Exchange Act.
---------------------------------------------------------------------------

    \147\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    The proposals represent the implementation of a Congressional 
mandate. They are intended to increase the independence and 
effectiveness of listed company audit committees. We anticipate these 
proposals would enhance the proper functioning of the capital markets 
by increasing the quality and accountability of financial reporting and 
restoring investor confidence. This increases the competitiveness of 
companies participating in the U.S. capital markets. However, our 
specific proposals relate only to companies listed on a national 
securities exchange or national securities association. Competitors not 
subject to the standards specified in Section 10A(m) of the Exchange 
Act may be subject to less corporate governance burdens. Similarly, to 
the extent foreign exchanges or other markets do not impose these 
standards, competitors could, all things being equal, migrate to those 
markets to avoid compliance. This could cause U.S. exchanges and 
securities associations to lose trading volume. Competitors and markets 
not subject to the standard, however, also may suffer from decreased 
investor confidence compared to those that do comply with the new 
standards.
    We request comment on whether the proposed amendments, if adopted, 
would impose a burden on competition. Commenters are requested to 
provide empirical data and other factual support for their views if 
possible.
    Section 2(b) of the Securities Act,\148\ Section 3(f) of the 
Exchange Act \149\ and Section 2(c) of the Investment Company Act \150\ 
require us, when engaging in rulemaking where we are required to 
consider or determine whether an action is necessary or appropriate in 
the public interest, to consider, in addition to the protection of 
investors, whether the action will promote efficiency, competition, and 
capital formation. The proposals would enhance the quality and 
accountability of the financial reporting process and may help increase 
investor confidence, which implies increased efficiency and 
competitiveness of the U.S. capital markets. Increased market 
efficiency and investor confidence also may encourage more efficient 
capital formation. As noted above, however, the proposals could have 
certain indirect negative effects, such as inconsistent application 
across all competitors. In addition, the proposed standards, while 
providing great flexibility for implementation, do remove a certain 
amount of individual control over the corporate governance process, 
which could have the possible effect of stifling more efficient 
approaches from being implemented if they were to develop.
---------------------------------------------------------------------------

    \148\ 17 U.S.C. 77b(b).
    \149\ 15 U.S.C. 78c(f).
    \150\ 15 U.S.C. 80a-2(c).
---------------------------------------------------------------------------

    If a company found the proposed requirements too onerous, it could 
be dissuaded from accessing the public capital markets, which could 
impact capital formation. The possibility of these effects and their 
magnitude if they were to occur are difficult to quantify. We have 
proposed several limited exemptions from the requirements to alleviate 
some of the burdens companies may face where consistent with investor 
protection. For example, the proposed limited exemption for new public 
companies is intended to counteract any disincentive the proposed 
requirements may have on a company's willingness to access the public 
capital markets.
    We request comment on whether the proposed amendments, if adopted, 
would promote efficiency, competition, and capital formation. 
Commenters are requested to provide empirical data and other factual 
support for their views if possible.

VI. Initial Regulatory Flexibility Analysis

    This Initial Regulatory Flexibility Analysis, or IRFA, has been 
prepared in accordance with the Regulatory Flexibility Act.\151\ This 
IRFA involves proposals to 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 several enumerated 
standards relating to the issuer's audit committee.
---------------------------------------------------------------------------

    \151\ 5 U.S.C. 603.
---------------------------------------------------------------------------

A. Reasons for, and Objectives of, Proposed Amendments

    We are proposing new Exchange Act Rule 10A-3 to comply with the 
mandate

[[Page 2658]]

of the Sarbanes-Oxley Act and new Section 10A(m)(1) of the Exchange 
Act. The proposals are intended to enhance investor confidence in the 
fairness and integrity of the securities markets by increasing the 
competence and independence, and hence effectiveness, of listed company 
audit committees. In addition, our proposals would make several changes 
to our current disclosure requirements regarding audit committees to 
increase the transparency of these committees. We believe that these 
proposals will help to improve the quality and accountability of 
financial disclosure and oversight of the process by qualified and 
independent audit committees.

B. Legal Basis

    We are proposing the new rule and amendments under the authority 
set forth in Sections 2,\152\ 6,\153\ 7,\154\ 8,\155\ 10,\156\17 \157\ 
and 19 \158\ of the Securities Act, Sections 3(b), 10A, 12, 13, 14, 15, 
23 and 36 \159\ of the Exchange Act, Sections 8,\160\ 20,\161\ 
24(a),\162\ 30 \163\ and 38\164\ of the Investment Company Act of 1940 
and Sections 3 and 301 of the Sarbanes-Oxley Act.
---------------------------------------------------------------------------

    \152\ 15 U.S.C. 77b.
    \153\ 15 U.S.C. 77f.
    \154\ 15 U.S.C. 77g.
    \155\ 15 U.S.C. 77h.
    \156\ 15 U.S.C. 77j.
    \157\ 15 U.S.C. 77q.
    \158\ 15 U.S.C. 77s.
    \159\ 17 U.S.C. 78mm.
    \160\ 15 U.S.C. 80a-8.
    \161\ 15 U.S.C. 80a-20.
    \162\ 15 U.S.C. 80a-24(a).
    \163\ 15 U.S.C. 80a-29.
    \164\ 15 U.S.C. 80a-37.
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C. Small Entities Subject to the Proposed Amendments

    The proposals will directly affect the national securities 
exchanges that trade listed securities, none of which is a small entity 
as defined by Commission rules. Exchange Act Rule 0-10(e) \165\ states 
that the term ``small business,'' when referring to an exchange, means 
any exchange that has been exempted from the reporting requirements of 
Exchange Act Rule 11Aa3-1.\166\ The proposals also will directly affect 
national securities associations. No national securities association is 
a small entity, as defined by 13 CFR 121.201.
---------------------------------------------------------------------------

    \165\ 17 CFR 240.0-10(e).
    \166\ 17 CFR 240.11Aa3-1.
---------------------------------------------------------------------------

    The proposals may have an indirect effect on some small entities. 
We also have defined the term ``small business'' in Exchange Act Rule 
0-10(a) to be an issuer, other than an investment company, that, on the 
last day of its most recent fiscal year, had total assets of $5 million 
or less and when used with reference to an investment company, an 
investment company together with other investment companies in the same 
group of related investment companies with net assets of $50 million or 
less as of the end of its most recent fiscal year.\167\ Under these 
limits, depending on other restrictions imposed by the various SROs, 
such as quantitative listing standards, a small entity may be listed on 
a national securities exchange or a national securities association. We 
estimate that 7,250 issuers are listed on a national securities 
exchange or traded on Nasdaq, and we estimate that 6,640 of these 
issuers are not investment companies.\168\ We estimate that less than 
225, or approximately 3%, of the issuers that are not investment 
companies,\169\ and less than 25, or approximately 4% of the issuers 
that are investment companies,\170\ are ``small entities'' for purposes 
of the Regulatory Flexibility Act that possibly could be restricted by 
the proposals.
---------------------------------------------------------------------------

    \167\ See Exchange Act Rule 0-10(a).
    \168\ See note 119 above.
    \169\ We derived this estimate from the Standard & Poors 
Research Insight Compustat Database.
    \170\ We derived this estimate from information compiled by 
Commission staff.
---------------------------------------------------------------------------

    We request comment on the number of small entities that would be 
impacted by our proposals, including any available empirical data.

D. Reporting, Recordkeeping, and Other Compliance Requirements

    Under the proposals, national securities exchanges and national 
securities associations are directed to prohibit the listing of any 
security of an issuer, both large and small, that is not in compliance 
with certain enumerated standards regarding the issuer's audit 
committee. These standards relate to: the independence of audit 
committee members; the audit committee's responsibility to select and 
oversee the issuer's independent accountant; procedures for handling 
complaints regarding the issuer's accounting practices; the authority 
of the audit committee to engage advisors; and funding for the 
independent auditor and any outside advisors engaged by the audit 
committee.
    Small entities would need to comply with these standards if they 
wished to have their securities listed on a national securities 
exchange or a national securities association. The rules would not 
require an entity to maintain an audit committee. However, the Exchange 
Act now provides that in the absence of an audit committee the entire 
board of directors will be considered to be the audit committee. There 
are reasons to believe that many small entities currently have 
separately-designated audit committees.\171\ However, not all of the 
audit committees of these small entities may comply with the 
requirements of the proposed rule. A small entity whose board or audit 
committee did not comply with the proposed rules would need to spend 
additional time and incur additional costs in modifying their audit 
committees or board to comply with the standards. Small entities may 
face particular difficulties in recruiting directors that meet the 
independence requirements of the proposed rules.
---------------------------------------------------------------------------

    \171\ See, e.g., NACD, 2001-2002 Public Company Governance 
Survey (Nov. 2001).
---------------------------------------------------------------------------

    There also may be ongoing costs in monitoring compliance with the 
standards or maintaining any additional procedures established by the 
standards, such as the procedures for handling complaints. To the 
extent the audit committee engages independent counsel or other 
advisors where it could not do so previously, there would be additional 
costs for the payment of compensation to these advisors. Due to the 
small size of these small entities, these additional costs may have a 
larger proportional impact on these entities than larger listed 
issuers.
    In addition, the small entity may need to make additional 
disclosure about its audit committee in its annual report as well as 
its proxy or information statement if directors are being elected. This 
may require additional costs in order to collect, record and report the 
information to be disclosed under the proposed rules. Small entities 
subject to the proxy rules are already required to disclose most of the 
information affected by our proposals in proxy or information 
statements where directors are being elected. This information should 
be readily available to small entities. Further, the disclosure 
regarding any exemption from the listing standards should entail only a 
minimal additional statement.
    We have little data to determine how many small entities do not 
already comply with the proposals or how much it would cost to comply. 
We recognize that because the proposals apply only to listed issuers, 
the quantitative listing standards applicable to listed securities, 
such as minimum revenue, market capitalization and shareholder equity 
requirements, will limit the size of issuers that will be affected by 
the requirements. We request comment on the ability of affected small 
entities to meet the proposals. How many small entities already comply 
with the

[[Page 2659]]

proposals? What are the burdens and costs that small entities would 
face? Would the proposal disproportionately impact small entities? 
Would the proposals have any effect on the willingness or ability of 
small entities to seek or maintain a listing for their securities?

E. Duplicative, Overlapping or Conflicting Federal Rules

    The rules of several existing SROs contain minimum standards 
relating to audit committees.\172\ To the extent any of these standards 
are in conflict with our proposals, our proposals would supercede these 
requirements. SROs would not be precluded from adopting additional 
listing standards regarding audit committees, as long as they were 
consistent with the proposed rule. We believe that there are no other 
rules that duplicate, overlap or conflict with the proposals, except 
for the inconsistency between proposed Rule 10A-3 and Section 32(a) of 
the Investment Company Act regarding the selection of auditors. That 
inconsistency would be resolved if the rule is adopted as proposed.
---------------------------------------------------------------------------

    \172\ See note 23 above.
---------------------------------------------------------------------------

F. Significant Alternatives

    The Regulatory Flexibility Act directs us to consider significant 
alternatives that would accomplish our stated objectives, while 
minimizing any significant adverse impact on small entities. In 
connection with our proposals, we considered the following 
alternatives:
    [sbull] Establishing different compliance or reporting requirements 
or timetables that take into account the resources available to small 
entities;
    [sbull] Clarifying, consolidating or simplifying compliance and 
reporting requirements under the rules for small entities;
    [sbull] Using performance rather than design standards; and
    [sbull] Exempting small entities from all or part of the 
requirements.
    The coverage of Section 10A(m) of the Exchange Act, as added by 
Congress in Section 301 of the Sarbanes-Oxley Act, makes no distinction 
based on an issuer's size. We think that improvements in the financial 
reporting process for listed issuers of all sizes are important for 
promoting investor confidence in our markets. For example, a 1999 
report commissioned by the organizations that sponsored the Treadway 
Commission found that the incidence of financial fraud was greater in 
small companies.\173\ However, we are sensitive to the costs and 
burdens that would be faced by small entities.
---------------------------------------------------------------------------

    \173\ See note 91 above.
---------------------------------------------------------------------------

    Although we preliminarily believe that an exemption for small 
entities from coverage of the proposals is not appropriate and 
inconsistent with the policies underlying the Sarbanes-Oxley Act, we 
solicit comment on the propriety of a complete or partial exemption 
from the requirements for small entities. We preliminarily believe that 
different compliance requirements or timetables for small entities also 
would interfere with achieving the primary goal of the proposals of 
increasing the competency and effectiveness of audit committees for all 
companies with listed securities. In addition, we are not aware of how 
to further clarify, consolidate or simplify these proposals for small 
entities. We recognize that because the proposals apply only to listed 
issuers, the quantitative listing standards applicable to listed 
securities, such as minimum revenue, market capitalization and 
shareholder equity requirements, already serve somewhat as a limit on 
the size of issuers that will be affected by the requirements. We do, 
however, solicit comment on these views and whether different 
compliance requirements or timetables for small entities would be 
appropriate, consistent with the mandate and purposes of Section 10A(m) 
of the Exchange Act.
    The proposals use performance standards in a number of respects. We 
do not propose to specify the procedures or arrangements an issuer or 
audit committee must develop to comply with the standards. For example, 
we do not propose to specify the procedures that an audit committee 
must establish for handling complaints, as we believe companies should 
have the flexibility to develop procedures most efficient for their 
individual circumstances. We do provide design standards regarding 
audit committee member independence, as these are the standards we are 
directed to implement by Congress. Accordingly, we believe that design 
standards are necessary to achieve the objectives of the proposals. We 
do have the authority under Section 10A(m)(3)(C) to exempt particular 
relationships with respect to audit committee members, although, for 
the reasons discussed above, we do not propose to use that authority at 
this time for small entities. We request comment on these views.

G. Request for Comments

    We encourage the submission of comments with respect to any aspect 
of this IRFA. In particular, we request comment on the number of small 
entities that would be affected by the proposals, the nature of the 
impact, how to quantify the number of small entities that would be 
affected, and how to quantify the impact of, the proposals. Commenters 
are requested to describe the nature of any effect and provide 
empirical data and other factual support for their views if possible. 
These comments will be considered in preparing the Final Regulatory 
Flexibility Analysis, if the proposals are adopted, and will be placed 
in the same public file as comments on the proposals.

VII. Statutory Authority and Text of Rule Amendments

    The proposals contained in this document are being proposed under 
the authority set forth in Sections 2, 6, 7, 8, 10, 17 and 19 of the 
Securities Act, Sections 3(b), 10A, 12, 13, 14, 15, 23 and 36 of the 
Exchange Act, Sections 8, 20, 24(a), 30 and 38 of the Investment 
Company Act of 1940 and Sections 3 and 301 of the Sarbanes-Oxley Act.

Text of Proposed Amendments

List of Subjects in 17 CFR Parts 228, 229, 240, 249 and 274

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

    In accordance with the foregoing, Title 17, Chapter II of the Code 
of Federal Regulations is proposed to be amended as follows:

PART 228--INTEGRATED DISCLOSURE SYSTEM FOR SMALL BUSINESS ISSUERS

    1. The authority citation for Part 228 is amended by adding the 
following citation in numerical order to read as follows:

    Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 77k, 77s, 77z-2, 
77z-3, 77aa(25), 77aa(26), 77ddd, 77eee, 77ggg, 77hhh, 77jjj, 77nnn, 
77sss, 78l, 78m, 78n, 78o, 78u-5, 78w, 78ll, 78mm, 80a-8, 80a-29, 
80a-30, 80a-37 and 80b-11.
* * * * *
    Section 228.401 is also issued under secs. 3(a) and 301, Pub. L. 
No. 107-204, 116 Stat. 745.

    2. Amend Sec.  228.401 by adding paragraph (e) to read as follows:


Sec.  228.401 (Item 401)  Directors, Executive Officers, Promoters and 
Control Persons.

* * * * *
    (e) Identification of the audit committee. If you are a listed 
issuer, as defined in Sec.  240.10A-3 of this chapter, filing an annual 
report on Form 10-KSB (17 CFR 249.310b) or a proxy statement or 
information statement pursuant to the

[[Page 2660]]

Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.) if action is to 
be taken with respect to the election of directors:
    (1) State whether or not the small business issuer has a 
separately-designated standing audit committee established in 
accordance with section 3(a)(58)(A) of the Exchange Act (15 U.S.C. 
78c(a)(58)(A)), or a committee performing similar functions. If the 
small business issuer has such a committee, however designated, 
identify each committee member. If the entire board of directors is 
acting as the small business issuer's audit committee as specified in 
section 3(a)(58)(B) of the Exchange Act (15 U.S.C. 78c(a)(58)(B)), so 
state.
    (2) If applicable, provide the disclosure required by Sec.  
240.10A-3(d) of this chapter regarding an exemption from the listing 
standards for audit committees.
    3. Amend Sec.  228.601 by removing the last sentence of paragraph 
(a)(1).

PART 229--STANDARD INSTRUCTIONS FOR FILING FORMS UNDER SECURITIES 
ACT OF 1933, SECURITIES EXCHANGE ACT OF 1934 AND ENERGY POLICY AND 
CONSERVATION ACT OF 1975--REGULATION S-K

    4. The authority citation for Part 229 is amended by adding the 
following citations in numerical order to read as follows:

    Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 77k, 77s, 77z-2, 
77z-3, 77aa(25), 77aa(26), 77ddd, 77eee, 77ggg, 77hhh, 77iii, 77jjj, 
77nnn, 77sss, 78c, 78i, 78j, 78l, 78m, 78n, 78o, 78u-5, 78w, 
78ll(d), 78mm, 79e, 79n, 79t, 80a-8, 80a-29, 80a-30, 80a-31(c), 80a-
37, 80a-38(a), and 80b-11, unless otherwise noted.
* * * * *
    Section 229.401 is also issued under secs. 3(a) and 301, Pub. L. 
No. 107-204, 116 Stat. 745.
    Section 229.601 is also issued under secs. 3(a) and 301, Pub. L. 
No. 107-204, 116 Stat. 745.
    5. Amend Sec.  229.401 by adding paragraph (h) to read as follows:


Sec.  229.401 (Item 401)  Directors, executive officers, promoters and 
control persons.

* * * * *
    (h) Identification of the audit committee. If you are a listed 
issuer, as defined in Sec.  240.10A-3 of this chapter, filing an annual 
report on Form 10-K or 10-KSB (17 CFR 249.310 or 17 CFR 249.310b) or a 
proxy statement or information statement pursuant to the Securities 
Exchange Act of 1934 (15 U.S.C. 78a et seq.) if action is to be taken 
with respect to the election of directors:
    (1) State whether or not the registrant has a separately-designated 
standing audit committee established in accordance with section 
3(a)(58)(A) of the Exchange Act (15 U.S.C. 78c(a)(58)(A)), or a 
committee performing similar functions. If the registrant has such a 
committee, however designated, identify each committee member. If the 
entire board of directors is acting as the registrant's audit committee 
as specified in section 3(a)(58)(B) of the Exchange Act (15 U.S.C. 
78c(a)(58)(B)), so state.
    (2) If applicable, provide the disclosure required by Sec.  
240.10A-3(d) of this chapter regarding an exemption from the listing 
standards for audit committees.
    6. Amend Sec.  229.601 by:
    a. Removing the second sentence of paragraph (a);
    b. Revising the phrase ``Notwithstanding the provisions of 
paragraphs (b)(27) and (c) of this Item, registered investment 
companies'' at the beginning of the third sentence of paragraph (a) to 
read ``Registered investment companies'';
    c. In the Exhibit Table, adding a designation for exhibit (27) 
entitled ``Statement re audit committees for registrants with boards of 
auditors or similar bodies'';
    d. In the Exhibit Table, adding an ``X'' corresponding to exhibit 
(27) under the caption ``Exchange Act Forms'', ``10-K'';
    e. In the Exhibit Table, reserving exhibits (28) through (98);
    f. Adding the text of paragraph (b)(27); and
    g. Reserving paragraphs (b)(28) through (b)(98).
    The addition of paragraph (b)(27) reads as follows:


Sec.  229.601 (Item 601)  Exhibits.

* * * * *
    (b) Description of exhibits. * * *
    (27) Statement re audit committees for registrants with boards of 
auditors or similar bodies. If you are availing yourself of the 
exemption in Sec.  240.10A-3(c)(2) of this chapter from the listing 
standards for audit committees because you have a board of auditors or 
similar body, a statement that you are availing yourself of that 
exemption and a reference to the section of the report to which the 
exhibit relates disclosing information regarding your use of that 
exemption.
* * * * *

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    7. The authority citation for Part 240 is amended by adding the 
following citations in numerical order to read as follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 
78w, 78x, 78ll, 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-
3, 80b-4 and 80b-11, unless otherwise noted.
* * * * *
    Section 240.10A-3 is also issued under secs. 3(a) and 301, Pub. 
L. No. 107-204, 116 Stat. 745.
    Section 240.14a-101 is also issued under secs. 3(a) and 301, 
Pub. L. No. 107-204, 116 Stat. 745.
* * * * *
    8. Add Sec.  240.10A-3 to read as follows:


Sec.  240.10A-3  Listing standards relating to audit committees.

    (a) Pursuant to section 10A(m) of the Act (15 U.S.C. 78j-1(m)) and 
section 3 of the Sarbanes-Oxley Act of 2002 (Pub. L. No. 107-204, sec. 
3, 116 Stat. 745):
    (1) National securities exchanges. The rules of each national 
securities exchange registered pursuant to section 6 of the Act (15 
U.S.C. 78f) must prohibit the initial or continued listing of any 
security of an issuer that is not in compliance with the requirements 
of any portion of paragraph (b) or (c) of this section.
    (2) National securities associations. The rules of each national 
securities association registered pursuant to section 15A of the Act 
(15 U.S.C. 78o-3) must prohibit the initial or continued listing in an 
automated inter-dealer quotation system of any security of an issuer 
that is not in compliance with the requirements of any portion of 
paragraph (b) or (c) of this section.
    (3) Opportunity to cure defects. The rules required by paragraphs 
(a)(1) and (a)(2) of this section must provide for appropriate 
procedures for an issuer to have an opportunity to cure any defects 
that would be the basis for a prohibition under paragraph (a) of this 
section, before the imposition of such prohibition.
    (4) Notification of noncompliance. The rules required by paragraphs 
(a)(1) and (a)(2) of this section must include a requirement that a 
listed issuer must notify the applicable national securities exchange 
or national securities association promptly after an executive officer 
of the listed issuer becomes aware of any material noncompliance by the 
listed issuer with the requirements of this section.
    (5) Implementation. (i) The rules of each national securities 
exchange or national securities association meeting the requirements of 
this section must be operative no later than the first

[[Page 2661]]

anniversary of the publication of this section in the Federal Register.
    (ii) Each national securities exchange and national securities 
association must provide to the Commission, no later than 60 days after 
publication of this section in the Federal Register, proposed rules or 
rule amendments that comply with this section.
    (iii) Each national securities exchange and national securities 
association must have final rule or rule amendments that comply with 
this section approved by the Commission no later than 270 days after 
publication of this section in the Federal Register.
    (b) Required standards.
    (1) Independence. (i) Each member of the audit committee must be a 
member of the board of directors of the listed issuer, and must 
otherwise be independent.
    (ii) Independence requirements for non-investment company issuers. 
In order to be considered to be independent for purposes of this 
paragraph (b)(1), a member of an audit committee of a listed issuer 
that is not an investment company may not, other than in his or her 
capacity as a member of the audit committee, the board of directors, or 
any other board committee:
    (A) Accept directly or indirectly any consulting, advisory, or 
other compensatory fee from the issuer; or
    (B) Be an affiliated person of the issuer or any subsidiary 
thereof.
    (iii) Independence requirements for investment company issuers. In 
order to be considered to be independent for purposes of this paragraph 
(b)(1), a member of an audit committee of a listed issuer that is an 
investment company may not, other than in his or her capacity as a 
member of the audit committee, the board of directors, or any other 
board committee:
    (A) Accept directly or indirectly any consulting, advisory, or 
other compensatory fee from the issuer; or
    (B) Be an ``interested person'' of the investment company as 
defined in section 2(a)(19) of the Investment Company Act of 1940 (15 
U.S.C. 80a-2(a)(19)).
    (iv) Exemptions from the independence requirements.
    (A) One member of a listed issuer's audit committee may be exempt 
from the independence requirements of paragraph (b)(1)(ii) of this 
section for 90 days from the date of effectiveness of a registration 
statement under section 12 of the Act (15 U.S.C. 78l), or a 
registration statement under the Securities Act of 1933 (15 U.S.C. 77a 
et seq.) covering an initial public offering of securities of the 
issuer, if the issuer was not immediately prior to such effective date 
required to file reports with the Commission pursuant to section 13(a) 
or 15(d) of the Act (15 U.S.C. 78m(a) or 78o(d)).
    (B) An audit committee member that sits on the board of directors 
of both a listed issuer and its direct or indirect consolidated 
majority-owned subsidiary (or that sits on the board of both a listed 
issuer and its parent, if the listed issuer is a direct or indirect 
consolidated majority-owned subsidiary of the parent) is exempt from 
the requirements of paragraph (b)(1)(ii)(B) of this section if the 
member, except for sitting on both boards, otherwise meets the 
independence requirements of paragraph (b)(1)(ii) of this section for 
both the parent and the subsidiary, including the receipt of only 
ordinary-course compensation for serving as a member of the board of 
directors, audit committee or any other board committee of the parent 
or subsidiary.
    (C) An employee of a foreign private issuer who is not an executive 
officer of the foreign private issuer is exempt from the requirements 
of paragraph (b)(1)(ii) of this section if the employee is elected or 
named to the board of directors or audit committee of the foreign 
private issuer pursuant to home country legal or listing requirements.
    (D) One member of the audit committee of a foreign private issuer 
may be exempt from the requirements of paragraph (b)(1)(ii)(B) of this 
section if that member meets the following requirements:
    (1) The member is a beneficial owner of more than 50% of the voting 
common equity of the foreign private issuer or is a representative or 
designee of such an owner or a group of owners that collectively are 
the beneficial owner of more than 50% of the voting common equity of 
the foreign private issuer;
    (2) The member has only observer status on, and is not a voting 
member or the chair of, the audit committee; and
    (3) The member is not an executive officer of the foreign private 
issuer.
    (E) One member of the audit committee of a foreign private issuer 
may be exempt from the requirements of paragraph (b)(1)(ii)(B) of this 
section if that member meets the following requirements:
    (1) The member is a representative or designee of a foreign 
government or foreign governmental entity that is an affiliate of the 
foreign private issuer; and
    (2) The member is not an executive officer of the foreign private 
issuer.
    (F) In addition to paragraphs (b)(1)(iv)(A) through (E) of this 
section, the Commission may exempt from the requirements of paragraphs 
(b)(1)(ii) or (b)(1)(iii) of this section a particular relationship 
with respect to audit committee members, as the Commission determines 
appropriate in light of the circumstances.
    (2) Responsibilities relating to registered public accounting 
firms.
    (i) Except as provided in paragraph (b)(2)(ii) of this section, the 
audit committee of each listed issuer, in its capacity as a committee 
of the board of directors, must be directly responsible for the 
appointment, compensation, retention and oversight of the work of any 
registered public accounting firm engaged (including resolution of 
disagreements between management and the auditor regarding financial 
reporting) for the purpose of preparing or issuing an audit report or 
related work or performing other audit, review or attest services for 
the listed issuer, and each such registered public accounting firm must 
report directly to the audit committee.
    (ii) Paragraph (b)(2)(i) of this section does not apply in the case 
of the selection of a registered public accounting firm engaged by a 
listed issuer that is an investment company.
    (3) Complaints. Each audit committee must establish procedures for:
    (i) The receipt, retention, and treatment of complaints received by 
the listed issuer regarding accounting, internal accounting controls, 
or auditing matters; and
    (ii) The confidential, anonymous submission by employees of the 
listed issuer of concerns regarding questionable accounting or auditing 
matters.
    (4) Authority to engage advisers. Each audit committee must have 
the authority to engage independent counsel and other advisers, as it 
determines necessary to carry out its duties.
    (5) Funding. Each listed issuer must provide for appropriate 
funding, as determined by the audit committee, in its capacity as a 
committee of the board of directors, for payment of compensation:
    (i) 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 
issuer; and
    (ii) To any advisers employed by the audit committee under 
paragraph (b)(4) of this section.
    (c) General exemptions.
    (1) At any time when an issuer has a class of common equity 
securities (or similar securities) that is listed on a national 
securities exchange or national securities association subject to the 
requirements of this section, listing of

[[Page 2662]]

other classes of securities of the issuer, and other classes of 
securities of a direct or indirect consolidated majority-owned 
subsidiary of the issuer (except classes of equity securities, other 
than non-convertible, non-participating preferred securities, of the 
majority-owned subsidiary), is not subject to the requirements of this 
section.
    (2)(i)The listing of securities of a foreign private issuer will 
not be subject to the requirements of paragraphs (b)(1) or (b)(2) of 
this section if the foreign private issuer meets the following 
requirements:
    (A) The securities of the foreign private issuer are also listed or 
quoted on a securities exchange or inter-dealer quotation system 
outside the United States;
    (B) The foreign private issuer has a board of auditors (or similar 
body), or has statutory auditors, separate from the board of directors 
that are established and selected pursuant to home country legal or 
listing provisions requiring or permitting such a board or similar 
body;
    (C) The board or body, or statutory auditors, are not elected by 
management of such issuer and no executive officer of the foreign 
private issuer is a member of such board or body, or statutory 
auditors;
    (D) Home country legal or listing provisions set forth standards 
for the independence of such board or body, or statutory auditors, from 
the foreign private issuer or the management of such issuer;
    (E) Such board or body, or statutory auditors, are directly 
responsible, in accordance with standards prescribed by home country 
legal or listing provisions, for the oversight of the work of any 
registered public accounting firm engaged (including resolution of 
disagreements between management and the auditor regarding financial 
reporting) for the purpose of preparing or issuing an audit report or 
related work or performing other audit, review or attest services for 
the issuer; and
    (F) Such board or body, or statutory auditors, are responsible, to 
the extent permitted by law, for the appointment and retention of any 
registered public accounting firm engaged by the issuer. Such 
responsibility may be vested in such board or body, or statutory 
auditors, in any manner, including without limitation by law or listing 
provision or delegation.
    (ii) For purposes of foreign private issuers relying on the 
exemption in this paragraph (c)(2), the term audit committee in 
paragraphs (b)(3), (b)(4) and (b)(5) of this section refers to the 
foreign private issuer's board of auditors or similar body, or its 
statutory auditors.
    (3) The listing of a security futures product cleared by a clearing 
agency that is registered pursuant to section 17A of the Act (15 U.S.C. 
78q-1) or that is exempt from the registration requirements of section 
17A pursuant to paragraph (b)(7)(A) of such section is not subject to 
the requirements of this section.
    (4) The listing of a standardized option, as defined in Sec.  
240.9b-1(a)(4), issued by a clearing agency that is registered pursuant 
to section 17A of the Act (15 U.S.C. 78q-1) is not subject to the 
requirements of this section.
    (5) The securities of the following listed issuers are exempt from 
the requirements of this section:
    (i) Asset-Backed Issuers (as defined in Sec.  240.13a-14(g) and 
Sec.  240.15d-14(g)); and
    (ii) Unit investment trusts (as defined in 15 U.S.C. 80a-4(2)).
    (d) Disclosure. Any listed issuer availing itself of any exemption 
from the independence standards contained in paragraph (b)(1)(iv) of 
this section, or any general exemption contained in paragraph (c) of 
this section, other than the exemptions contained in paragraphs (c)(1) 
and (c)(5)(ii) of this section, must:
    (1) Disclose its reliance on the exemption and its assessment of 
whether, and if so, how, such reliance would materially adversely 
affect the ability of the audit committee to act independently and to 
satisfy the other requirements of this section in any proxy or 
information statement for a meeting of shareholders at which directors 
are elected that is filed with the Commission pursuant to the 
requirements of section 14 of the Act (15 U.S.C. 78n); and
    (2) Disclose the information specified in paragraph (d)(1) of this 
section in, or incorporate such information by reference from such 
proxy or information statement filed with the Commission into, its 
annual report filed with the Commission pursuant to the requirements of 
section 13(a) or 15(d) of the Act (15 U.S.C. 78m(a) or 78o(d)).
    (e) Definitions. Unless the context otherwise requires, all terms 
used in this section have the same meaning as in the Act. In addition, 
unless the context otherwise requires, the following definitions apply:
    (1)(i) The term affiliate of, or a person affiliated with, a 
specified person, means a person that directly, or indirectly through 
one or more intermediaries, controls, or is controlled by, or is under 
common control with, such issuer. A person will be deemed not to be in 
control of the issuer for purposes of this section if the person:
    (A) Is not the beneficial owner, directly or indirectly, of more 
than 10% of any class of equity securities of the issuer;
    (B) Is not an executive officer of the issuer; and
    (C) Is not a director of the issuer.
    (ii) A director, executive officer, partner, member, principal or 
designee of an affiliate will be deemed to be an affiliate.
    (2) In the case of foreign private issuers with two-tier boards of 
directors, the term board of directors means the supervisory or non-
management board.
    (3) The term control (including the terms controlling, controlled 
by and under common control with) means 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.
    (4) The term executive officer has the meaning set forth in Sec.  
240.3b-7.
    (5) The term foreign private issuer has the meaning set forth in 
Sec.  240.3b-4(c).
    (6) The term indirect acceptance by a member of an audit committee 
of any consulting, advisory or other compensatory fee includes 
acceptance of such a fee by a spouse, a minor child or stepchild or a 
child or stepchild sharing a home with the member or by an entity in 
which such member is a partner, member or principal or occupies a 
similar position and which provides accounting, consulting, legal, 
investment banking, financial or other advisory services or any similar 
services to the issuer.
    (7) The terms listed and listing refer to securities listed on a 
national securities exchange or listed in an automated inter-dealer 
quotation system of a national securities association or to issuers of 
such securities.
    (8) Until the Public Company Accounting Oversight Board has 
established the registration of independent public accountants, the 
term registered public accounting firm means an independent public 
accountant engaged for the purposes indicated in this section.

Instructions to Sec.  240.10A-3

    1. The requirement in paragraph (b)(2) or (c)(2)(i)(F) of this 
section does not conflict with, and does not affect the application of, 
any requirement under an issuer's governing law or documents or other 
home country requirements that requires shareholders to ultimately 
elect, approve or ratify the selection of the issuer's auditor. The 
requirement instead relates to the assignment of responsibility to 
oversee the auditor's

[[Page 2663]]

work as between the audit committee and management. In such an 
instance, however, if the issuer provides a recommendation or 
nomination of an auditor to its shareholders, the audit committee of 
the issuer, or body performing similar functions, must be responsible 
for making the recommendation or nomination. Also, the requirement in 
paragraph (b)(2) or (c)(2)(i)(F) of this section does not conflict with 
any requirement in a company's home jurisdiction that prohibits the 
full board of directors from delegating the responsibility to select 
the company's auditor. In that case, the audit committee, or body 
performing similar functions, must be granted advisory and other powers 
with respect to such matters to the extent permitted by law, including 
submitting nominations or recommendations to the full board.
    2. For the purposes of paragraph (e)(1) of this section, the 
determination of a person's beneficial ownership must be made in 
accordance with Sec.  240.13d-3(d)(1).
    9. Amend Sec.  240.14a-101 by:
    a. Adding a sentence to the end of paragraph (d)(1) of Item 7;
    b. Revising paragraph (d)(3)(iv) of Item 7; and
    c. Revising the introductory text of paragraph (b)(14) of Item 22.
    The additions and revisions read as follows:


Sec.  240.14a-101 Schedule 14A.  Information required in proxy 
statement.

Schedule 14A Information

* * * * *
    Item 7. Directors and executive officers. * * *
    (d)(1) * * * Such disclosure need not be provided to the extent it 
is duplicative of disclosure provided in accordance with Item 401(h) of 
Regulation S-K (Sec.  229.401(h) of this chapter).
* * * * *
    (3) * * *
    (iv)(A) If the registrant is a listed issuer, as defined in Sec.  
240.10A-3, disclose whether the members of the audit committee are 
independent, as independence for audit committee members is defined in 
the listing standards applicable to the listed issuer. If the 
registrant does not have a separately designated audit committee, or 
committee performing similar functions, the registrant must provide the 
disclosure with respect to all members of its board of directors.
    (B) If the registrant, including a small business issuer, is not a 
listed issuer, disclose whether the registrant has an audit committee 
established in accordance with section 3(a)(58)(A) of the Act (15 
U.S.C. 78c(a)(58)(A)) and, if so, whether the members of the committee 
are independent. In determining whether a member is independent, the 
registrant must use a definition for audit committee member 
independence of a national securities exchange or national securities 
association that has been approved by the Commission (as such 
definition may be modified or supplemented), and state which definition 
was used. Whichever definition is chosen must be applied consistently 
to all members of the audit committee.
* * * * *
    Item 22. Information required in investment company proxy 
statement. * * *
    (b)(14) State whether or not the Fund has a separately designated 
audit committee established in accordance with section 3(a)(58)(A) of 
the Act (15 U.S.C. 78c(a)(58)(A)). If the entire board of directors is 
acting as the Fund's audit committee as specified in section 
3(a)(58)(B) of the Act (15 U.S.C. 78c(a)(58)(B)), so state. If 
applicable, provide the disclosure required by Sec.  240.10A-3(d) 
regarding an exemption from the listing standards for audit committees. 
Identify the other standing committees of the Fund's board of 
directors, and provide the following information about each committee, 
including any separately designated audit committee:
* * * * *

PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934

    10. The authority citation for Part 249 is amended by revising the 
following citations in to read as follows:

    Authority: 15 U.S.C. 78a, et seq., unless otherwise noted.
* * * * *
    Section 249.220f is also issued under secs. 3(a), 301, and 302, 
Pub. L. No. 107-204, 116 Stat. 745.
    Section 249.240f is also issued under secs. 3(a), 301, and 302, 
Pub. L. No. 107-204, 116 Stat. 745.
    Section 249.331 is also issued under secs. 3(a) and 301, Pub. L. 
No. 107-204, 116 Stat. 745.
* * * * *
    11. Amend Form 20-F (referenced in Sec.  249.220f) by:
    a. Revising the Instruction to Item 6.C;
    b. Adding paragraph (f) to Item 15;
    c. Redesignating paragraph 11 of ``Instructions as to Exhibits'' as 
paragraph 12; and
    d. Adding new paragraph 11 to ``Instructions as to Exhibits''.
    The additions and revisions read as follows:

    Note: The text of Form 20-F does not, and this amendment will 
not, appear in the Code of Federal Regulations.

Form 20-F

* * * * *
    Item 6. Directors, Senior Management and Employees
* * * * *
    Instructions to Item 6.C:
    1. The term ``plan'' is used very broadly and includes any type of 
arrangement for compensation, even if the terms of the plan are not 
contained in a formal document.
    2. If the company is a listed issuer as defined in Exchange Act 
Rule 10A-3 (17 CFR 240.10A-3) and its entire board of directors is 
acting as the company's audit committee as specified in section 
3(a)(58)(B) of the Exchange Act (15 U.S.C. 78c(a)(58)(B)), so state.
* * * * *
    Item 15. Certain Disclosures
* * * * *
    (f) Exemptions from the Listing Standards for Audit Committees.
    If applicable, provide the disclosure required by Exchange Act Rule 
10A-3(d) (17 CFR 240.10A-3(d)) regarding an exemption from the listing 
standards for audit committees. You do not need to provide the 
information called for by this Item 15(f) unless you are using this 
form as an annual report.
* * * * *

Instructions as to Exhibits

* * * * *
    11. If you are availing yourself of the exemption in Exchange Act 
Rule 10A-3(c)(2) (17 CFR 240.10A-3(c)(2)) from the listing standards 
for audit committees because you have a board of auditors or similar 
body, a statement that you are availing yourself of that exemption and 
a reference to the section of the report to which the exhibit relates 
disclosing information regarding your use of that exemption. You do not 
need to provide the information called for by this paragraph 11 unless 
you are using this form as an annual report.
* * * * *
    12. Amend Form 40-F (referenced in Sec.  249.240f) by adding 
paragraph (11) to General Instruction B to read as follows:

    Note: The text of Form 40-F does not, and this amendment will 
not, appear in the Code of Federal Regulations.

Form 40-F

* * * * *

General Instructions

* * * * *

[[Page 2664]]

B. Information To Be Filed on This Form.

* * * * *
    (11) Identification of the Audit Committee. If you are a listed 
issuer subject to Exchange Act Rule 10A-3 (17 CFR 240.10A-3) that is 
using this form as an annual report:
    (a) State whether or not the registrant has a separately-designated 
standing audit committee established in accordance with section 
3(a)(58)(A) of the Exchange Act (15 U.S.C. 78c(a)(58)(A)), or a 
committee performing similar functions. If the registrant has such a 
committee, however designated, identify each committee member. If the 
entire board of directors is acting as the registrant's audit committee 
as specified in section 3(a)(58)(B) of the Exchange Act (15 U.S.C. 
78c(a)(58)(B)), so state.
    (b) If applicable, provide the disclosure required by Exchange Act 
Rule 10A-3(d) (17 CFR 240.10A-3d)) regarding an exemption from the 
listing standards for audit committees.
* * * * *

PART 274--FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940

    13. The authority citation for Part 274 continues to read, in part, 
as follows:

    Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l, 78m, 
78n, 78o(d), 80a-8, 80a-24, 80a-26, and 80a-29, unless otherwise 
noted.
* * * * *
    14. Form N-CSR (referenced in Sec. Sec.  249.331 and 274.128) is 
amended by:
    a. Redesignating Items 8 and 9 as Items 9 and 10;
    b. Removing the phrase ``and 7(b)'' from General Instruction D and 
in its place adding ``8, and 10(b)'';
    c. Removing the phrase ``The information required by Item 5'' from 
General Instruction D and in its place adding ``The information 
required by Items 5 and 8''; and
    d. Adding new Item 8 to read as follows.

    Note: The text of Form N-CSR does not, and this amendment will 
not, appear in the Code of Federal Regulations.

Form N-CSR

* * * * *
    Item 8. Audit Committee of Listed Registrants
    (1) If the registrant is a listed issuer subject to Rule 10A-3 
under the Exchange Act (17 CFR 240.10A-3), state whether or not the 
registrant has a separately-designated standing audit committee 
established in accordance with Section 3(a)(58)(A) of the Exchange Act 
(15 U.S.C. 78c(a)(58)(A)). If the registrant has such a committee, 
however designated, identify each committee member. If the entire board 
of directors is acting as the registrant's audit committee as specified 
in Section 3(a)(58)(B) of the Exchange Act (15 U.S.C. 78c(a)(58)(B)), 
so state.
    (2) If applicable, provide the disclosure required by Rule 10A-3(d) 
under the Exchange Act (17 CFR 240.10A-3(d)) regarding an exemption 
from the listing standards for audit committees.
    Instruction. The information required by this Item 8 is only 
required in a report on this Form N-CSR that is required by Item 10(a) 
to include a copy of an annual report transmitted to stockholders.

    Dated: January 8, 2003.

    By the Commission.
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 03-690 Filed 1-16-03; 8:45 am]
BILLING CODE 8010-01-P