[Federal Register Volume 68, Number 73 (Wednesday, April 16, 2003)]
[Rules and Regulations]
[Pages 18788-18823]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-9157]



[[Page 18787]]

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

Part III





Securities and Exchange Commission





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



17 CFR Parts 228, et al.



Standards Relating to Listed Company Audit Committees; Final Rule

  Federal Register / Vol. 68, No. 73 / Wednesday, April 16, 2003 / 
Rules and Regulations  

[[Page 18788]]


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

SECURITIES AND EXCHANGE COMMISSION

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

[Release Nos. 33-8220; 34-47654; IC-26001; File No. S7-02-03]
RIN 3235-AI75


Standards Relating to Listed Company Audit Committees

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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

SUMMARY: As directed by the Sarbanes-Oxley Act of 2002, we are adopting 
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 
mandated 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 rule implements 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. Under 
the rule, listed issuers must be in compliance with the new listing 
rules by the earlier of their first annual shareholders meeting after 
January 15, 2004, or October 31, 2004. Foreign private issuers and 
small business issuers will have additional time to comply. In 
addition, we are adopting amendments to make several changes to our 
current disclosure requirements regarding audit committees.

DATES: Effective Date: April 25, 2003.
    Compliance Dates: Each national securities exchange and national 
securities association must provide to the Commission, no later than 
July 15, 2003, proposed rules or rule amendments that comply with the 
requirements of Exchange Act Rule 10A-3. Further, each national 
securities exchange and national securities association must have final 
rules or rule amendments that comply with Rule 10A-3 approved by the 
Commission no later than December 1, 2003. Listed issuers, other than 
foreign private issuers and small business issuers, must be in 
compliance with the new listing rules by the earlier of (1) their first 
annual shareholders meeting after January 15, 2004, or (2) October 31, 
2004. Foreign private issuers and small business issuers that are 
listed must be in compliance with the new listing rules by July 31, 
2005. See section II.F.1 for more information regarding implementation 
and compliance dates. Issuers must comply with the disclosure changes 
in Regulation S-B, Regulation S-K, Schedule 14A, Form 20-F, Form 40-F 
and Form N-CSR beginning with reports covering periods ending on or 
after (or proxy or information statements for actions occurring on or 
after) the compliance date for the listing standards applicable to the 
particular issuer. Until such date, issuers should continue to comply 
with existing Items 7(d)(3)(iv) and 22(b)(14) in their proxy and 
information statements, if applicable.

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, 
DC 20549.

SUPPLEMENTARY INFORMATION: We are adopting new Rule 10A-3 \1\ under the 
Securities Exchange Act of 1934 (the ``Exchange Act''),\2\ amendments 
to Forms 20-F \3\ and 40-F \4\ and Items 7 and 22 of Schedule 14A \5\ 
under the Exchange Act, amendments to Item 401 \6\ of Regulation S-B 
\7\ and Item 401 \8\ of Regulation S-K \9\ under the Securities Act of 
1933 (the ``Securities Act'') \10\ and amendments to Form N-CSR \11\ 
under the Exchange Act and the Investment Company Act of 1940 (the 
``Investment Company Act'').\12\
---------------------------------------------------------------------------

    \1\ 17 CFR 240.10A-3.
    \2\ 15 U.S.C. 78a et seq.
    \3\ 17 CFR 249.220f.
    \4\ 17 CFR 249.240f.
    \5\ 17 CFR 240.14a-101.
    \6\ 17 CFR 228.401.
    \7\ 17 CFR 228.10 et seq.
    \8\ 17 CFR 229.401.
    \9\ 17 CFR 229.10 et seq.
    \10\ 15 U.S.C. 77a et seq.
    \11\ 17 CFR 249.331 and 17 CFR 274.128.
    \12\ 15 U.S.C. 80a-1 et seq.
---------------------------------------------------------------------------

Table of Contents

I. Background and Overview of the New Rule and Amendments
II. Discussion
    A. Audit Committee Member Independence
    1. Scope of the Requirement
    2. Advising, Consulting or Compensatory Fees
    3. Affiliated Person of the Issuer or Any Subsidiary Thereof
    4. New Issuers
    5. Overlapping Board Relationships
    6. Other Requests for Independence Exemptions
    B. Responsibilities Relating to Registered Public Accounting 
Firms
    1. Scope of the Requirement
    2. Clarifications Regarding Possible Conflicts with Other 
Requirements
    3. Application to Investment Companies
    C. Procedures for Handling Complaints
    D. Authority to Engage Advisors
    E. Funding
    F. Application and Implementation of the Standards
    1. SROs Affected and Implementation Dates
    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 and Certain Other Passive 
Issuers
    d. Investment Companies
    4. Determining Compliance with the 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
    4. Audit Committee Financial Expert Disclosure for Foreign 
Private Issuers
    H. Application to the Commission's Auditor Independence Rules
III. Paperwork Reduction Act
IV. Cost-Benefit Analysis
V. Consideration of Burden on Competition and Promotion of 
Efficiency, Competition and Capital Formation
VI. Final Regulatory Flexibility Analysis
VII. Effective Date
VIII. Statutory Authority and Text of Rule Amendments

I. Background and Overview of the New Rule and Amendments

    In this release, we implement section 10A(m)(1) of the Exchange 
Act,\13\ as added by section 301 of the Sarbanes-Oxley Act of 2002 (the 
``Sarbanes-Oxley Act''),\14\ which requires us to direct, by rule, the 
national securities exchanges \15\

[[Page 18789]]

and national securities associations \16\ (or ``SROs'') to prohibit the 
listing of any security of an issuer that is not in compliance with 
several enumerated standards regarding issuer audit committees. We 
received over 185 comments in response to our release proposing to 
implement the directive in section 10A(m) of the Exchange Act.\17\ The 
final rule and form amendments we adopt today have been revised, as 
discussed in this release, to incorporate a number of changes 
recommended by commenters.
---------------------------------------------------------------------------

    \13\ 15 U.S.C. 78j-1(m)(1).
    \14\ Pub. L. 107-204, 116 Stat. 745 (2002).
    \15\ 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.
    \16\ 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.
    \17\ Release No. 33-8173 (Jan. 8, 2003) [68 FR 2638] 
(``Proposing Release''). The public comments we received, and a 
summary of the comments prepared by our staff (the ``Comment 
Summary''), can be viewed in our Public Reference Room at 450 Fifth 
Street, NW., Washington, DC 20549, in File No. S7-02-03. Public 
comments submitted by electronic mail and the Comment Summary also 
are available on our Web site, http://www.sec.gov.
---------------------------------------------------------------------------

    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 
providing oversight over and 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 and 
corporate communities, has had a continuing interest in promoting 
effective and independent audit committees.\18\ It was largely with the 
Commission's encouragement, for instance, that the SROs first adopted 
audit committee requirements in the 1970s.\19\ Over the years, others 
have expressed support for strong, independent audit committees,\20\ 
including the National Commission on Fraudulent Financial Reporting, 
also known as the Treadway Commission,\21\ and the General Accounting 
Office.\22\
---------------------------------------------------------------------------

    \18\ 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).
    \19\ For example, in 1972, the Commission recommended that 
companies establish audit committees composed of outside directors. 
See ASR No. 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).
    \20\ 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 Web site 
at http://www.abanet.org/buslaw/.
    \21\ 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 http://www.coso.org.
    \22\ 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).
---------------------------------------------------------------------------

    In 1998, the NYSE and 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.\23\ In 
response to these recommendations, the NYSE and the NASD, among others, 
revised their listing standards relating to audit committees,\24\ and 
we adopted new rules requiring disclosure relating to the functioning, 
governance and independence of corporate audit committees.\25\ 
Beginning last year, at the Commission's request,\26\ 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.\27\
---------------------------------------------------------------------------

    \23\ 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 
http://www.nyse.com.
    \24\ 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).
    \25\ See Exchange Act Release No. 42266 (Dec. 22, 1999) [64 FR 
73389].
    \26\ See Press Release No. 2002-23 (Feb. 13, 2002).
    \27\ See File Nos. SR-NASD-2002-141 and SR-NYSE-2002-33 (pending 
before the Commission).
---------------------------------------------------------------------------

    Recent events involving alleged misdeeds by corporate executives 
and independent auditors have damaged investor confidence in the 
financial markets.\28\ They have highlighted the need for strong, 
competent and vigilant audit committees with real authority.\29\ 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. The Sarbanes-Oxley Act mandates sweeping 
corporate disclosure and financial reporting

[[Page 18790]]

reform to improve the responsibility of public companies for their 
financial disclosures. This release is the most recent of several that 
we have issued to implement provisions of the Sarbanes-Oxley Act.\30\
---------------------------------------------------------------------------

    \28\ 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 2, 2002; and Louis Aguilar, ``Scandals 
Jolting Faith of Investors,'' Denver Post, June 27, 2002.
    \29\ 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.
    \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] 
(Proposals regarding improper influence on conduct of audits); 
Release No. 33-8138 (Oct. 22, 2002) [67 FR 66208] (Proposals 
regarding internal control reports); Release No. 33-8170 (Dec. 20, 
2002) [67 FR 79466] (Proposals regarding mandated electronic filing 
and Web site posting for Forms 3, 4 and 5); Release No. 33-8176 
(Jan. 22, 2003) [68 FR 4820] (Conditions for use of non-GAAP 
financial information); Release No. 34-47225 (Jan. 22, 2003) [68 FR 
4338] (Insider trades during pension plan blackout periods); Release 
No. 33-8177 (Jan. 23, 2003) [68 FR 5110] (Disclosure regarding audit 
committee financial experts and company codes of ethics); Release 
No. 33-8180 (Jan. 24, 2003) [68 FR 4862] (Retention of records 
relevant to audits and reviews); Release No. 34-47262 (Jan. 27, 
2003) [68 FR 5348] (Adoption of Form N-CSR); Release No. 33-8182 
(Jan. 28, 2003) [68 FR 5982] (Disclosure about off-balance sheet 
arrangements); Release No. 33-8183 (Jan. 28, 2003) [68 FR 6006] 
(Strengthening the Commission's requirements regarding auditor 
independence); Release Nos. 33-8185 (Jan. 29, 2003) [68 FR 6296] and 
33-8186 (Jan. 29, 2003) [68 FR 6324] (Implementation of standards of 
professional conduct for attorneys); and Release No. 33-8212 (Mar. 
21, 2003) [68 FR 15600] (Certification of disclosure in certain 
Exchange Act reports).
---------------------------------------------------------------------------

    Under new Exchange Act Rule 10A-3, SROs will be prohibited from 
listing any security of an issuer that is not in compliance with the 
following standards, as discussed in more detail in this release:
    [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 \31\ engaged for 
the purpose of preparing or issuing an audit report 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;
---------------------------------------------------------------------------

    \31\ The term ``registered public accounting firm'' is defined 
in section 2(a)(12) of the Sarbanes-Oxley Act. See 15 U.S.C. 
78c(a)(59). We anticipate that the Public Company Accounting 
Oversight Board will have established the registration of public 
accounting firms by the time the implementing listing rules are 
operative.
---------------------------------------------------------------------------

    [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.
    With the exceptions specified below, listed issuers must be in 
compliance with the new listing rules by the earlier of (1) their first 
annual shareholders meeting after January 15, 2004, or (2) October 31, 
2004. Foreign private issuers \32\ and small business issuers \33\ that 
are listed must be in compliance with the new listing rules by July 31, 
2005.
---------------------------------------------------------------------------

    \32\ 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.
    \33\ The term ``small business issuer'' is defined in Exchange 
Act Rule 12b-2 [17 CFR 240.12b-2] as a U.S. or Canadian issuer with 
less than $25 million in revenues and public float that is not an 
investment company. Such issuers are eligible to use Form 10-KSB (17 
CFR 249.310b) for their annual reports and Form 10-QSB (17 CFR 
249.308b) for their quarterly reports.
---------------------------------------------------------------------------

    In addition, the final rule amendments make several changes to our 
current disclosure requirements regarding audit committees.

II. Discussion

    Under section 3(a)(58) of the Exchange Act,\34\ as added by section 
205 of the Sarbanes-Oxley Act, the term audit committee is defined as:
---------------------------------------------------------------------------

    \34\ 15 U.S.C. 78c(a)(58).
---------------------------------------------------------------------------

    [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 will constitute the audit committee. If the entire board 
constitutes the audit committee, the new SRO rules adopted under 
Exchange Act Rule 10A-3, including the independence requirements, will 
apply to the issuer's board as a whole.
    In addition, because Exchange Act section 10A(m) imposes 
requirements that only apply to issuers listed on a national securities 
exchange or listed in an automated inter-dealer quotation system of a 
national securities association,\35\ the requirements of Exchange Act 
Rule 10A-3 only apply to issuers that are so listed. None of the 
requirements of section 10A(m) of the Exchange Act or Exchange Act Rule 
10A-3 apply to other reporting companies under section 13(a) \36\ or 
15(d) \37\ of the Exchange Act.\38\
---------------------------------------------------------------------------

    \35\ In this release, we refer to issuers that are listed on one 
or more of these markets as ``listed issuers.''
    \36\ 15 U.S.C. 78m(a).
    \37\ 15 U.S.C. 78o(d).
    \38\ Non-listed issuers should still refer to the disclosure 
updates adopted in this release, as those changes may provide 
greater flexibility to non-listed issuers in preparing the 
disclosures they already must make regarding audit committee member 
independence. See section II.G.3.
---------------------------------------------------------------------------

    Some commenters requested clarification regarding application of 
the rule to listed issuers organized as limited partnerships that do 
not have their own board of directors but instead rely on a managing 
general partner.\39\ We have added a clarification that in the case of 
a listed issuer that is a limited partnership or limited liability 
company where such entity does not have a board of directors or 
equivalent body, the term ``board of directors'' means the board of 
directors of the managing general partner, managing member or 
equivalent body.
---------------------------------------------------------------------------

    \39\ See, e.g., the Letter of Plains All American Pipeline, L.P.
---------------------------------------------------------------------------

A. Audit Committee Member Independence

1. Scope of the Requirement
    As early as 1940, the Commission encouraged the use of audit 
committees composed of independent directors.\40\ 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

[[Page 18791]]

this problem and to align corporate interests with those of 
shareholders.
---------------------------------------------------------------------------

    \40\ See note 18 above.
---------------------------------------------------------------------------

    Our final rules enhance audit committee independence by 
implementing the two basic criteria for determining independence 
enumerated in section 10A(m) of the Exchange Act, which are discussed 
in more detail below. Commenters expressed general overall support for 
the Commission's approach to implementing section 10A(m) of the 
Exchange Act. Advocates of investors in particular endorsed the 
Commission's proposals, though not all believed that section 10A(m) and 
the Commission's proposals went far enough.\41\ Several supported 
having the Commission mandate all independence requirements for listed 
issuers, not just those specified in Exchange Act section 10A(m), as 
compared to the proposed approach of building on additional SRO 
standards for independence. However, a substantial number of commenters 
did not support having the Commission replace the SROs' role in setting 
additional criteria, preferring to leave additional requirements to the 
SRO rulemaking process with appropriate Commission oversight.\42\
---------------------------------------------------------------------------

    \41\ See, e.g., the Letters of American Federation of Labor and 
Congress of Industrial Organizations et al. (``AFL-CIO''); 
California Public Employees' Retirement System (``CalPERS''); 
Council of Institutional Investors (``CII''); International 
Brotherhood of Teamsters (``Teamsters''); State of Wisconsin 
Investment Board (``SWIB''); Transparency International--USA.
    \42\ See, e.g., the Letters of American Bar Association 
(``ABA''); America's Community Bankers; American Bankers 
Association; American Institute of Certified Public Accountants 
(``AICPA''); Computer Sciences Corporation (``CSC''); Deloitte & 
Touche LLP (``Deloitte''); Letter on behalf of German Chief 
Financial Officers (``German CFOs''); New York Stock Exchange, Inc. 
(``NYSE''); PricewaterhouseCoopers LLC (``PwC''); Public Service 
Enterprise Group Incorporated (``PSEG''); Ralph S. Saul; Southern 
Company.
---------------------------------------------------------------------------

    As noted in the Proposing Release, in seeking to ensure appropriate 
levels of independence, we recognize that SROs currently restrict 
additional business or personal relationships.\43\ Further, several 
SROs are seeking significant improvements to tighten these 
requirements, in particular in the additional listing standards that 
are currently under consideration.\44\ We fully support the goals the 
SROs are trying to achieve through these ongoing efforts, and we are 
firmly committed to working with the SROs to ensure the success of 
these proposals. Many of the additional relationships that commenters 
requested the Commission include in the final rule are already 
restricted by existing SRO rules, or would be restricted under the new 
SRO proposals.
---------------------------------------------------------------------------

    \43\ See note 24 above.
    \44\ See note 27 above.
---------------------------------------------------------------------------

    We continue to believe that our specific mandate under section 
10A(m) of the Exchange Act, where independence is evaluated by 
reference to payments of advisory and compensatory fees and affiliate 
status, is best fulfilled by the final rule. These requirements 
standing alone do not, for example, preclude independence on the basis 
of other commercial relationships not specified in the final rule, and 
they do not extend to the broad categories of family members that may 
be reached by SRO listing standards. Instead, as proposed, our 
requirements build and rely on SRO standards of independence that cover 
additional relationships not specified in Exchange Act section 10A(m). 
Our final rule allows SROs flexibility to adopt and administer 
additional requirements of these sorts through SRO rulemaking conducted 
under Commission oversight and approval. As mentioned in the Proposing 
Release, we encourage SROs to review and adopt rigorous independence 
requirements in connection with their implementation of the standards 
in Exchange Act rule 10A-3. We will review the rules submitted by the 
SROs to implement Exchange Act rule 10A-3 so that they contain 
appropriate overall standards for audit committee independence.
2. Advising, Consulting or Compensatory Fees
    As for the two criteria for independence in Exchange Act rule 10A-
3, the first is that audit committee members are barred from accepting 
any consulting, advisory or other compensatory fee from the issuer or 
any subsidiary thereof, other than in the member's capacity as a member 
of the board of directors and any board committee.\45\ This prohibition 
will preclude payments to a member as an officer or employee, as well 
as other compensatory payments.\46\
---------------------------------------------------------------------------

    \45\ If the committee member is also a shareholder of the 
issuer, payments made to all shareholders of that class generally, 
such as dividends, will not be prohibited by this provision. Also, 
to conform the application of the compensatory fee prohibition with 
the affiliate prohibition, the final rule clarifies that the 
compensatory fee prohibition applies to fees from the issuer or any 
subsidiary thereof.
    \46\ The final rule does not specify any limits or restrictions 
on fees paid for capacity as a member of the board of directors or 
any board committee.
---------------------------------------------------------------------------

    To prevent evasion of the requirement, disallowed payments to an 
audit committee member includes payments made either directly or 
indirectly. The overwhelming majority of commenters supported our 
determination that barring indirect as well as direct compensatory 
payments is necessary to implement the intended purposes of Exchange 
Act section 10A(m).\47\ 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 financial advisory firms in which audit committee 
members are partners, members, executive officers or hold similar 
positions, as discussed in more detail below, are the kinds of 
compensatory payments that were intended to be precluded by Exchange 
Act section 10A(m). The final rules, therefore, mandate that indirect 
acceptance of compensatory payments includes payments to spouses, minor 
children or stepchildren or children or stepchildren sharing a home 
with the member. In addition, indirect acceptance includes payments 
accepted by an entity in which such member is a partner, member, 
officer such as a managing director occupying a comparable position or 
executive officer, or occupies a similar position (except limited 
partners, non-managing members and those occupying similar positions 
who, in each case, have no active role in providing services to the 
entity) and which provides accounting, consulting, legal, investment 
banking or financial advisory services to the issuer or any subsidiary.
---------------------------------------------------------------------------

    \47\ Compare, for example, the Letters of CalPERS; California 
State Teachers' Retirement System (``CalSTRS''); CSC; NYSE with the 
Letter of America's Community Bankers.
---------------------------------------------------------------------------

    Commenters generally supported the extent to which family members 
are included, although a few recommended an extension to additional 
members,\48\ and a few others recommended narrowing the family members 
covered.\49\ We continue to believe that an extension to all relatives 
is beyond the scope necessary to address the prohibitions in section 
10A(m), and we are adopting the family member formulation as proposed. 
Also, we agree with the commenters who argued that given the limited 
number of immediate family members affected, an exception for family 
members that are non-executive employees is not necessary.\50\
---------------------------------------------------------------------------

    \48\ See, e.g., the Letters of CalPERS and Marcus B. Elliott.
    \49\ See, e.g., the Letter of State Street Corporation (``State 
Street'').
    \50\ See, e.g., the Letter of NYSE.
---------------------------------------------------------------------------

    Several commenters requested additional guidance regarding the 
types of prohibited services in the ``indirect''

[[Page 18792]]

category.\51\ In particular, commenters were most concerned with the 
application of the prohibition to issuers or associated entities that 
provide financial services. To clarify application of the prohibition, 
the final rule specifies that the prohibition covers accounting, 
consulting, legal, investment banking or financial advisory services. 
Other commercial relationships are not covered by the final rule, 
although, as previously discussed, we expect that SROs will contain 
restrictions on additional services and activities in their own listing 
standards.\52\ For example, the prohibitions in Exchange Act Rule 10A-3 
do not include non-advisory financial services such as lending, check 
clearing, maintaining customer accounts, stock brokerage services or 
custodial and cash management services. Further, the final rule relates 
only to requirements for audit committee membership. They do not affect 
the ability of a director associated with an entity that provides such 
services to a listed issuer from otherwise serving on that issuer's 
board of directors, again to the extent other SRO rules permit such 
relationships.
---------------------------------------------------------------------------

    \51\ See, e.g., the Letters of American Bankers Association; AXA 
SA; Cleary, Gottlieb, Steen & Hamilton (``Cleary''); F.N.B. 
Corporation; Linklaters; National Association of Real Estate 
Investment Trusts; PwC; Greg Swalwell.
    \52\ As a result, we have declined the suggestion by some 
commenters to codify in the final rule that additional services are 
expressly permitted. See, e.g., the Letters of Curtis Thaxter 
Stevens Border & Micoleau LLC and Linklaters.
---------------------------------------------------------------------------

    Several commenters requested clarification regarding the types of 
positions that are covered at associated entities.\53\ The Proposing 
Release would have applied the prohibition where the audit committee 
member was a partner, member or principal or occupied a similar 
position with the associated entity. Some commenters questioned whether 
the prohibition extended to solely passive ownership positions, such as 
limited partners in a limited partnership and non-managing members of a 
manager-managed limited liability company that have no active role in 
providing services to the entity. Some thought the term ``principal'' 
was vague outside of organizations that specifically use that term. 
Others noted that while the formulation correctly indicated the 
Commission's intention to capture all partners or limited liability 
company members of a law firm, accounting firm, consulting firm or 
other professional organization, it was not clear how the formulation 
was to be applied to entities that do not have or use the term partners 
or members, such as certain investment banking firms organized as 
corporations.
---------------------------------------------------------------------------

    \53\ See, e.g., the Letters of Cleary; Cravath, Swaine & Moore 
(``Cravath''); Ford Motor Company; Linklaters; Sullivan & Cromwell 
(``S&C'').
---------------------------------------------------------------------------

    In response to these concerns, we have clarified that the list of 
covered positions includes partners and members (except for limited 
partners, non-managing members and those occupying similar positions 
who, in each case, have no active role in providing services to the 
entity), officers such as managing directors occupying a comparable 
position and executive officers (to address organizations that do not 
have partners and members) and others occupying a similar position. We 
believe extending the prohibition to any employee of an associated 
entity, as requested by some commenters, would be overly broad for 
purposes of Exchange Act Rule 10A-3, although SROs may require such an 
extension in their implementing rules.\54\ However, we do believe the 
formulation should include those persons, such as partners or members 
in professional organizations, regardless of control, whose 
compensation could be directly affected by the prohibited fees, even if 
they are not the primary service provider. Finally, we have deleted the 
term ``principal'' because we believe the reference to ``those 
occupying similar positions'' covers entities such as professional 
corporations that use the ``principal'' designation for positions 
similar to a partner in a partnership.
---------------------------------------------------------------------------

    \54\ See, e.g., the Letter of CII.
---------------------------------------------------------------------------

    The final rule, like our proposal, applies the prohibitions only to 
current relationships with the audit committee member and related 
persons. They do not extend to a ``look back'' period before 
appointment to the audit committee, although we expect the SROs to 
require such periods in their own listing standards. Similar to the 
comments regarding including additional independence standards in the 
final rule, the majority of commenters supported our proposal, arguing 
it is consistent with the language in Exchange Act section 10A(m) and 
the Commission's approach of building and relying on the SRO's 
independence standards that already include look back periods for a 
broad variety of relationships.\55\
---------------------------------------------------------------------------

    \55\ Compare, e.g., the Letters of ABA; AICPA; American Bankers 
Association; the Association of the Bar of the City of New York 
(``NYCBA''); CenturyTel, Inc.; CSC; Deloitte; New York State Bar 
Association (``NYSBA''); NYSE; PwC; Siemens AG with the Letters of 
AFL-CIO; CalPERS; CalSTRS; CII; James Fanto; Teamsters; Transparency 
International--USA.
---------------------------------------------------------------------------

    In the Proposing Release, we requested comment on whether we should 
explicitly clarify whether the prohibition on ``compensatory fees'' 
excludes compensation under a retirement or similar plan in which a 
former officer or employee of the issuer participates. Many commenters 
supported such a clarification.\56\ We believe such a clarification is 
appropriate particularly given that the rules apply only to current 
relationships, especially where the retirement compensation received is 
for prior service and is not contingent in any way on continued 
service. Accordingly, the final rule specifies that, unless an SRO's 
listing rules provide otherwise, compensatory fees do not include the 
receipt of fixed amounts of compensation under a retirement plan 
(including deferred compensation) for prior service with the listed 
issuer (provided that such compensation is not contingent in any way on 
continued service).\57\
---------------------------------------------------------------------------

    \56\ See, e.g., the Letters of ABA; AICPA; CenturyTel, Inc.; 
Deloitte; NYSE; Siemens AG; S&C.
    \57\ The requirement that the compensation be fixed precludes 
retirement payments that are tied to the continued performance of 
the relevant entity. The requirement that the compensation be fixed 
does not preclude customary objectively determined adjustment 
provisions such as cost of living adjustments.
---------------------------------------------------------------------------

    Exchange Act section 10A(m) prohibits the receipt of ``any'' 
consulting, advisory or compensatory fees. While the Sarbanes-Oxley Act 
specifically included a de minimis exception with respect to other 
requirements, such as the audit committee pre-approval requirements in 
Exchange Act section 10A(i)(1)(B),\58\ it provided no similar de 
minimis exception in Exchange Act section 10A(m), even though several 
SROs currently have such exceptions in their listing standards. 
Consistent with the express language in Exchange Act section 10A(m), 
our proposed rule did not contain a de minimis exception. Nevertheless, 
we requested comment on whether there should be such an exception. 
Several commenters, including those that represent investor groups, 
argued forcefully that no additional relationships should be exempted, 
including de minimis payments. They argued that the statutory mandate 
is clear, audit committee members should be truly independent, and even 
a de minimis level of payments would create the appearance of 
conflict.\59\ Several other commenters, primarily representing issuers 
and their advisors, supported some form of de minimis or immaterial 
exception, believing that issuers should have flexibility to pay some 
level of de

[[Page 18793]]

minimis or immaterial fees to make the requirement less 
restrictive.\60\
---------------------------------------------------------------------------

    \58\ 15 U.S.C. 78j-1(i)(1)(B).
    \59\ See, e.g., the Letters of CalPERS; CII; SWIB.
    \60\ See, e.g., the Letters of AICPA; America's Community 
Bankers; American Bankers Association; American Stock Exchange, Inc. 
(``Amex''); Cleary; Cravath; Ford Motor Company; NYCBA; PwC; S&C.
---------------------------------------------------------------------------

    We are not persuaded that such an exception is an appropriate 
deviation from the explicit mandate in Exchange Act section 10A(m). We 
believe the policies and purposes behind that section, and particularly 
the use of the term ``any'' when describing such fees in the statute, 
weighs against providing for such an exception. Further, given the 
narrow class of services covered by the final rule, the lack of a de 
minimis exception should be less necessary. Moreover, if the level of 
compensation that the member or associated entity receives is truly de 
minimis and immaterial, we are not persuaded that requiring an issuer 
to locate another provider so that the member can remain qualified for 
audit committee service would be overly burdensome. In section II.F.5, 
we provide a limited accommodation to address the concerns by some 
commenters regarding an audit committee member that ceases to be 
independent for reasons outside the member's reasonable control.
3. Affiliated Person of the Issuer or Any Subsidiary Thereof
    Consistent with the express requirement in Exchange Act section 
10A(m)(3)(B)(ii), the second basic criterion for determining 
independence is that 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. Consistent with the 
Proposing Release, we are defining 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 
\61\ and Securities Act rule 144,\62\ with an additional safe 
harbor.\63\ We are defining ``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.'' \64\ We are defining the term ``control'' consistent with 
our other definitions of this term under the Exchange Act \65\ 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.'' \66\ 
Commenters generally supported this approach.\67\
---------------------------------------------------------------------------

    \61\ 17 CFR 240.12b-2.
    \62\ 17 CFR 230.144.
    \63\ 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, the 
definition in Exchange Act Rule 10A-3 uses a definition for non-
investment companies consistent with our other definitions of 
``affiliate'' for non-investment companies.
    \64\ See Exchange Act Rule 10A-3(e)(1)(i).
    \65\ See, e.g., Exchange Act Rule 12b-2.
    \66\ See Exchange Act Rule 10A-3(e)(4).
    \67\ See, e.g., the Letters of ABA; Cleary; CSC; Matsushita 
Electric Industrial Co., Ltd. (``Matsushita''); PwC; Greg Swalwell.
---------------------------------------------------------------------------

    Our definition of ``affiliated person'' for non-investment 
companies, like our existing definitions of this term for these 
issuers, requires a factual determination based on a consideration of 
all relevant facts and circumstances. To facilitate the analysis on 
facts and circumstances where we are presumptively comfortable, we are 
adopting a safe harbor for that aspect of the definition of 
``affiliated person,'' with minor modifications from the original 
proposal.\68\ Under the safe harbor as adopted, a person who is not an 
executive officer or a shareholder owning 10% or more of any class of 
voting equity securities of a specified person will be deemed not to 
control such specified person.\69\ Many commenters supported the safe 
harbor and the certainty it will provide to non-affiliates.\70\ We have 
clarified in the final rule, in response to several commenter 
suggestions, that the ownership prong should be based on ownership of 
any class of voting equity securities, instead of any class of equity 
securities.
---------------------------------------------------------------------------

    \68\ See 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].
    \69\ The Proposing Release also would have included a 
requirement that the person not be a director. Several commenters 
pointed out that this requirement is ambiguous because all audit 
committee members would be directors and the affiliate prohibition 
would already exclude capacity as a director. Accordingly, that 
requirement has been removed in the final rule. Also, the final rule 
clarifies that the safe harbor is available not just for 
determinations with respect to the issuer, but to any ``specified 
person.'' Thus, it is also available for determinations with respect 
to subsidiaries of the issuer, which are also covered by the 
affiliate prohibition.
    \70\ See, e.g., the Letters of Cleary; CSC; Matsushita; Nippon 
Keidanren (Japan Business Federation); PwC; Greg Swalwell.
---------------------------------------------------------------------------

    The Proposing Release specified that those that cannot rely on the 
safe harbor would not be deemed to be or presumed to be affiliates. 
Those persons would need to conduct a facts and circumstances analysis 
of control. Nevertheless, some commenters and others reporting on the 
proposals were concerned that the 10% shareholder prong in the safe 
harbor somehow is, is implied to be, or would become viewed as an upper 
ownership limit for non-affiliate status.\71\ We have no intention of 
this being the case. While SROs in their listing rules could establish 
an upper ownership limit that would preclude independence, the safe 
harbor in Exchange Act Rule 10A-3 does not establish such a limit. The 
safe harbor is designed to identify a group of those that are not 
affiliates so as to provide comfort to those individuals or entities 
that no additional facts and circumstances analysis is necessary. It 
only creates a safe harbor position for non-affiliate status. Failing 
to meet the 10% ownership threshold has no bearing on whether a 
particular person is an affiliate based on an evaluation of all facts 
and circumstances. A director who is not an executive officer but 
beneficially owns more than 10% of the issuer's voting equity could be 
determined to be not an affiliate under a facts and circumstances 
analysis of control.
---------------------------------------------------------------------------

    \71\ See, e.g., the Letters of ABA; Cravath; National Venture 
Capital Association; The News Corporation Limited. See also Roberta 
S. Karmel, ``Federalization of the Law Regarding Audit Committees,'' 
New York Law Journal, vol. 229, p. 3 (Feb. 20, 2003).
---------------------------------------------------------------------------

    We continue to believe that a 10% ownership limit is an appropriate 
threshold to presume (along with the other aspects of the safe harbor) 
that a person is not an affiliate. Accordingly, we are not changing 
that threshold. However, the safe harbor does not in any way specify or 
imply that a certain level of share ownership automatically presumes 
that a person is an affiliate. To prevent further misconceptions, we 
have added an explicit paragraph to the final rule to reinforce these 
points.
    We received several comments regarding how beneficial ownership is 
to be determined for purposes of the safe harbor, as well as for other 
aspects of the rule, such as the multiple listing exception. 
Accordingly, we have included an instruction to the final rule to 
clarify that calculations of beneficial ownership are to be made 
consistent with Exchange Act rule 13d-3.\72\
---------------------------------------------------------------------------

    \72\ 17 CFR 240.13d-3.
---------------------------------------------------------------------------

    The proposed rules would have deemed a director, executive officer, 
partner, member, principal or designee of an affiliate to be an 
affiliate. While some commenters expressed specific

[[Page 18794]]

support for this formulation,\73\ several others believed the 
formulation was overly broad and would capture those who may not 
necessarily control the affiliate, such as outside directors of an 
affiliate.\74\ These commenters raised concerns similar to those raised 
regarding our proposal to include partners, members and principals in 
the compensatory fee prohibition. Many also were concerned that 
including the term ``designee'' could inadvertently mean that where 
there was a controlling shareholder, all directors that were elected, 
including those that met the independence requirements, could be 
considered ``designees'' of an affiliate and disqualified from service 
because the controlling shareholder had the power to elect all such 
directors.
---------------------------------------------------------------------------

    \73\ See, e.g., the Letter of PwC.
    \74\ See, e.g., the Letters of ABA; Cravath; S&C.
---------------------------------------------------------------------------

    After evaluating these comments, we are narrowing the formulation. 
Under the final rule, only executive officers, directors that are also 
employees of an affiliate, general partners and managing members of an 
affiliate will be deemed to be affiliates. The limitation on directors 
will exclude outside directors of an affiliate from the automatic 
designation. Also, the reference to executive officers, general 
partners and managing members of an affiliate includes the positions we 
intend to cover. This will help clarify that passive, non-control 
positions, such as limited partners, and those that do not have policy 
making functions, are not covered. The formulation for being deemed to 
be an affiliate is narrower than the formulation of covered positions 
for the indirect acceptance aspect of the ``no compensation'' prong due 
to their different purposes. We believe a wider formulation is 
necessary for the ``no compensation'' prong to capture those whose 
compensation is more directly linked to fees from the prohibited 
services but who otherwise do not hold executive positions. Finally, we 
have removed the term ``designee.'' However, consistent with our 
historical interpretations of the term ``affiliate,'' an affiliate 
could not evade the prohibitions in the rule simply by designating a 
third party representative or agent that it directs to act in its 
place.
    For issuers that are investment companies, we are adopting, as 
proposed, the requirement that a member of the audit committee of an 
investment company may not be an ``interested person'' of the 
investment company, as defined in section 2(a)(19)\75\ of the 
Investment Company Act.\76\ As described in the Proposing Release, 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. Commenters 
supported this substitution.\77\
---------------------------------------------------------------------------

    \75\ 15 U.S.C. 80a-2(a)(19).
    \76\ The ``interested person'' test will apply to business 
development companies, as well as registered investment companies. 
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].
    \77\ See, e.g., the Letters of ABA; Deloitte; the Investment 
Company Institute (``ICI'').
---------------------------------------------------------------------------

4. New Issuers
    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. As discussed in the Proposing Release, companies coming 
to market for the first time may face particular difficulty in 
recruiting members that meet the independence requirements. Before 
completion of 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 effectively if it can maintain historical 
knowledge and experience during the transition to public company 
status.
    As a result, we proposed an exemption for 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. We requested comment on 
whether this exemption should be extended. While not all agreed,\78\ 
the overwhelming majority of commenters believed the proposed exemption 
was too restrictive to address the potential problems new issuers may 
face.\79\ Particularly given the increased focus on board service in 
general, and audit committee service in particular, commenters argued 
that additional accommodations in both the length of the exemption and 
the number of members covered are necessary to not overly burden access 
to the capital markets.
---------------------------------------------------------------------------

    \78\ See, e.g., the Letter of SWIB.
    \79\ See, e.g., the Letters of ABA; AICPA; Amex; CalSTRS; 
Cleary; CSC; Deloitte; KPMG LLP; National Venture Capital 
Association (``NVCA''); NYCBA; NYSE; S&C Vinson & Elkins L.L.P.
---------------------------------------------------------------------------

    While we recognize these potential difficulties, we continue to 
believe that it is important to have at least some independent 
representation on the audit committee at the time of an initial 
listing, and that a majority of the committee and the full committee 
should reach the independence requirements as soon as practicable. 
Accordingly, to balance the concerns between the need for independence 
and the ability to recruit qualified candidates, we are adopting a 
revised exception for non-investment company issuers that requires at 
least one fully independent member at the time of an issuer's initial 
listing, a majority of independent members within 90 days, and a fully 
independent committee within one year.
5. Overlapping Board Relationships
    As discussed in the Proposing Release, many companies, particularly 
financial institutions and other entities with a holding company 
structure, operate or obtain financing 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 proposed an exemption from the 
``affiliated person'' requirement for a committee member that sits on 
the board of directors of both a parent and a direct or indirect 
consolidated

[[Page 18795]]

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.
    Commenters were nearly unanimous in their support for such an 
exemption.\80\ However, many commenters believed the exemption, 
particularly the requirement that the subsidiary must be both 
consolidated and majority-owned, was overly restrictive.\81\ Some 
companies may possess the requisite ownership to establish control, but 
may not consolidate the subsidiary due to particular accounting 
situations.\82\ Others may have the requisite control to consolidate by 
means other than ownership and therefore may not meet the ownership 
test. Several commenters were particularly concerned regarding 
unconsolidated 50% owned joint ventures, arguing that many of the 
reasons provided by the Commission for the exemption apply as well to 
such joint ventures where two parents exercise joint control.\83\ Other 
commenters noted that while the Commission's proposal addresses parents 
and subsidiaries, it did not provide similar accommodations for 
independent directors that serve on boards of sibling subsidiaries 
under common control of a parent, if such directors would be 
independent other than for the fact that the two sibling subsidiaries 
are affiliated through the parent.
---------------------------------------------------------------------------

    \80\ See, e.g., America's Community Bankers; American Bankers 
Association; CalPERS; CSC; Deloitte; NYSE; PwC; Southern Company; 
Greg Swalwell. But see the Letter of SWIB.
    \81\ See, e.g., the Letters of Dow Corning Corporation; Michael 
Groll; Kinder Morgan Energy Partners, L.P.; S&C.
    \82\ See, e.g., the Letter of Michael Groll.
    \83\ See, e.g., the Letter of Dow Corning Corporation.
---------------------------------------------------------------------------

    To address these concerns, we are expanding the exemption. Under 
the final rule, an audit committee member may sit on the board of 
directors of a listed issuer and any affiliate so long as, except for 
being a director on each such board of directors, the member otherwise 
meets the independence requirements for each such entity, 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 
each such entity. Under the revised exemption, audit committee members 
will still be required to be independent of the issuer and its 
affiliate, but the exemption will now apply regardless of the source of 
control.
    There are some foreign private issuers that operate under a dual 
holding company structure.\84\ Each holding company is a foreign 
private issuer organized in a different national jurisdiction. The 
holding companies together collectively own and supervise the 
management of one or more businesses conducted as a single economic 
enterprise. The holding companies do not conduct any business other 
than collectively owning and supervising such businesses. The boards of 
directors of these dual holding companies may have all, some or no 
members in common. The dual holding companies may have established a 
joint audit committee for the group consisting of directors from each 
dual holding company. The audit committee members of such entities 
would otherwise meet the independence requirements for the overall 
group, but could technically be considered affiliates, or as persons 
who are not directors, because of the particular structural form of the 
dual holding companies. We are providing an accommodation for such dual 
holding companies. First, where a listed issuer is one of two dual 
holding companies, those companies may designate one audit committee 
for both companies so long as each member of the audit committee is a 
member of the board of directors of at least one of such dual holding 
companies. Second, dual holding companies will not be deemed to be 
affiliates of each other by virtue of their dual holding company 
arrangements with each other, including where directors of one dual 
holding company are also directors of the other dual holding company, 
or where directors of one or both dual holding companies are also 
directors of the businesses jointly controlled, directly or indirectly, 
by the dual holding companies (and in each case receive only ordinary-
course compensation for serving as a member of the board of directors, 
audit committee or any other board committee of the dual holding 
companies or any entity that is jointly controlled, directly or 
indirectly, by the dual holding companies).
---------------------------------------------------------------------------

    \84\ See, e.g., the Letters of Reed Elsevier PLC; Royal Dutch 
Petroleum Company; Unilever PLC.
---------------------------------------------------------------------------

6. Other Requests for Independence Exemptions
    As discussed in section II.G.1 below, issuers availing themselves 
of exemptions from Exchange Act rule 10A-3 will generally have to 
disclose that fact. Apart from the two limited exemptions discussed in 
sections II.B.4 and 5 above and the exemptions for controlling persons, 
foreign governmental board representatives and non-management employee 
members of foreign private issuers discussed in section II.F.3.a below, 
we are not exempting other particular relationships from the 
independence requirements at this time.
    We noted in the Proposing Release that despite the existence of 
exemptions based on exceptional and limited circumstances in several 
existing SRO rules,\85\ section 10A(m) of the Exchange Act, as enacted 
by Congress, does not contain any such exemption. Nevertheless, we 
requested comment as to whether such an exemption would be appropriate. 
Commenters were split on this point, with the commenters representing 
investors and investor groups not supporting such an exemption, and the 
commenters predominantly representing SROs supporting the freedom to 
provide such exemptions.\86\ Some of the commenters that advocated 
against the exemption were concerned that the existing SRO exceptions 
have been or could be applied in practice more broadly than intended, 
though some commenters supporting such an exemption disputed this 
point. Consistent with our proposal, our final rules do not contain any 
exemptions based on exceptional and limited circumstances.
---------------------------------------------------------------------------

    \85\ 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 http://www.nyse.com, 
http://www.nasd.com and http://www.amex.com, respectively.
    \86\ Compare, e.g., the Letters of CalPERS; CII; CSC; Deloitte; 
PwC; SWIB, with the Letters of AICPA; Amex; The Nasdaq Stock Market, 
Inc. (``Nasdaq''); NVCA.
---------------------------------------------------------------------------

    We also announced in the Proposing Release that, 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 intend to entertain exemptions or waivers for particular 
relationships on a case-by-case basis.\87\ We requested comment on 
whether we should permit companies to request exemptive relief from the 
Commission or SROs on a case-by-case basis. Commenters also were split 
on this point, again with the commenters representing predominantly 
investors and investor groups not supporting case-by-case

[[Page 18796]]

relief.\88\ After carefully considering these comments, we still 
believe that general case-by-case exemptions would be neither 
appropriate nor consistent with the policies and purposes of the 
Sarbanes-Oxley Act. However, as requested by many commenters,\89\ the 
Commission has exemptive authority to respond to, and will remain 
sensitive to, evolving standards of corporate governance, including 
changes in U.S. or foreign law, to address any new conflicts that 
cannot be anticipated at this time.
---------------------------------------------------------------------------

    \87\ Similarly, Commission staff will not entertain no-action 
letter or exemption requests in this area.
    \88\ Compare, e.g., the Letters of AICPA; CalPERS; CII; CSC; 
NVCA; the Comptroller of the State of New York; PwC; SWIB, with the 
Letters of Amex; Deloitte; Ralph S. Saul; S&C.
    \89\ See, e.g., the Letters of Association of Private French 
Enterprises--Association of Large French Enterprises (``AFEP-
AGREF''); Cleary; Italian Association of Limited Liability Companies 
(``Assonime''); NYSE.
---------------------------------------------------------------------------

B. Responsibilities Relating to Registered Public Accounting Firms

1. Scope of the Requirement
    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.\90\ 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 promote auditor 
independence, 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.
---------------------------------------------------------------------------

    \90\ 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 [Pub. L. 107-204, Title II, 116 Stat. 
771-75].
---------------------------------------------------------------------------

    Accordingly, we are adopting as proposed the requirement that the 
audit committee of a listed issuer will need to 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 
performing other audit, review or attest services for the issuer, and 
the independent auditor will have to report directly to the audit 
committee.\91\ These oversight responsibilities include the authority 
to retain the outside auditor, which includes the power not to retain 
(or to terminate) the outside auditor. In addition, in connection with 
these oversight responsibilities, the audit committee must have 
ultimate authority to approve all audit engagement fees and terms.\92\
---------------------------------------------------------------------------

    \91\ In response to several commenters' questions, we have 
removed the phrase ``or related work'' from the final rule where 
describing the preparation and issuance of an issuer's audit report. 
We believe the reference to ``or other audit, review or attest 
services'' appropriately delineates the intention behind the phrase 
``or related work.''
    \92\ See also Release No. 33-8183 (Jan. 28, 2003). In response 
to several commenters' questions, these responsibilities are 
provided as examples and are not intended to be an exclusive list of 
responsibilities.
---------------------------------------------------------------------------

    Overall, commenters supported the requirement as proposed, 
believing additional specificity is not needed and flexibility should 
be given to the audit committee regarding the execution of these 
responsibilities, without rigid rules.\93\ A few commenters, however, 
suggested that we should limit the requirement to cover only certain 
registered public accounting firms that perform audit, review or attest 
services for the issuer, that we should limit the coverage of services 
specified by the proposal, or that we should clearly delineate which 
oversight responsibilities remain with management.\94\ We believe these 
specific decisions regarding the execution of the audit committee's 
oversight responsibilities, as well as decisions regarding the extent 
of desired involvement by the audit committee, are best left to the 
discretion of the audit committee of the individual issuer in assessing 
the issuer's individual circumstances. Accordingly, we are not limiting 
the oversight responsibilities provided by the statute and the 
proposal.
---------------------------------------------------------------------------

    \93\ See, e.g., the Letters of AICPA; CalSTRS; Financial 
Executives Institute (``FEI'').
    \94\ See, e.g., the Letters of Deloitte; Ernst & Young LLP 
(``E&Y''); PwC; State Street.
---------------------------------------------------------------------------

    Some commenters requested further clarification regarding the scope 
of the services included in the requirement, including ``audit, review 
or attest services.'' We believe these services encompass the same 
services covered in the ``Audit Fees'' category in an issuer's 
disclosure of fees paid to its independent public accountants. As 
discussed in our recent release revising the Commission's auditor 
independence requirements,\95\ this category includes services that 
normally would be provided by the accountant in connection with 
statutory and regulatory filings or engagements. In addition to 
services necessary to perform an audit or review in accordance with 
Generally Accepted Auditing Standards (``GAAS''),\96\ this category 
also may include services that generally only the independent 
accountant reasonably can provide, such as comfort letters, statutory 
audits, attest services, consents and assistance with and review of 
documents filed with the Commission. This approach does not affect the 
operation of other Commission rules regarding permissible services or 
preclude the audit committee from oversight or other involvement in the 
provision of audit-related or other permissible services.
---------------------------------------------------------------------------

    \95\ See Release No. 33-8183 (Jan. 28, 2003).
    \96\ See also section 2(a)(2) of the Sarbanes-Oxley Act which 
defines the term ``audit.''
---------------------------------------------------------------------------

    In the Proposing Release, we requested comment on whether other 
responsibilities not listed in Exchange Act section 10A(m) should be 
under the supervision of the audit committee, such as the appointment, 
compensation, retention and oversight of an issuer's internal auditor. 
Commenters were split on whether the Commission should mandate 
oversight responsibility regarding an issuer's internal auditor, with 
the majority not supporting action by the Commission at this time.\97\ 
Given this split, we are not extending the responsibility requirement 
to include such oversight.
---------------------------------------------------------------------------

    \97\ Compare, e.g., the Letters of Francisco J. Barragan; Melody 
Boehl; Marcus B. Elliott; Institute of Internal Auditors; and 
National Association of Corporate Directors with the Letters of ABA; 
Canadian Bankers Association (``CBA''); CSC; Deloitte; FEI; C.H. 
Moore, Jr.; Nasdaq; NYSBA; and NYSE.
---------------------------------------------------------------------------

2. Clarifications Regarding Possible Conflicts With Other Requirements
    We proposed adding an instruction to the rule to clarify that the 
requirements regarding auditor responsibility do not conflict with, and 
are not affected by, any requirement under an issuer'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 
requirements instead relate to the assignment of responsibility to 
oversee the auditor's work as between the audit committee and 
management. Commenters welcomed this

[[Page 18797]]

clarification.\98\ However, several commenters recommended extending 
the instruction to include other requirements in the rule, such as 
auditor compensation and termination, to address foreign requirements 
that vest these responsibilities with shareholders.\99\ We agree with 
these commenters that the same reasons that justify the clarification 
regarding auditor selection justify an extension to these other 
responsibilities. We also agree with those commenters that noted that 
the clarification should apply even if shareholders are not required to 
vote on the responsibilities, but voluntarily elect to do so.\100\
---------------------------------------------------------------------------

    \98\ See, e.g., the Letters of AICPA; The Treasury of the 
Government of Australia; CalPERS; Deloitte; Financial Services 
Agency of Japan (``FSA''); German CFOs; NYSE; PwC; Alexander Schaub; 
Telekom Austria AG.
    \99\ See, e.g., the Letters of Assonime; Canadian Bankers 
Association; Cleary; PwC; S&C.
    \100\ See, e.g., the Letter of Cleary.
---------------------------------------------------------------------------

    Accordingly, we are expanding the instruction. The revised 
instruction clarifies that none of the audit committee requirements in 
the final rule conflicts with, nor do they affect the application of, 
any requirement or ability under an issuer's governing law or documents 
or other home country legal or listing provisions that requires or 
permits shareholders to ultimately vote on, approve or ratify such 
requirements. In addition, we are adopting as proposed the further 
clarification that if such responsibilities are vested with 
shareholders, and the issuer provides a recommendation or nomination 
regarding such matters to its shareholders, the audit committee of the 
issuer, or body performing similar functions, must be responsible for 
making the recommendation or nomination.
    The proposed instruction also included a clarification that the 
requirement that the audit committee select auditors does not conflict 
with any requirement in a company's home jurisdiction that prohibits 
the full board of directors from delegating such responsibility to a 
committee. 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 or proposals to the 
full board. Several commenters noted that this instruction should be 
expanded to address other responsibilities in the final rule for the 
same reasons as those relating to shareholder approval.\101\ In some 
jurisdictions, boards may be prohibited from delegating such 
responsibilities to a committee, including the ability to submit 
nominations or recommendations to shareholders as called for in the 
instruction regarding shareholder approval of such matters.
---------------------------------------------------------------------------

    \101\ See, e.g., the Letters of Brazilian Securities Commission; 
Cleary; S&C.
---------------------------------------------------------------------------

    Accordingly, we are expanding the instruction to cover other 
situations where the board of directors may be prohibited from 
delegating responsibility to the audit committee, including the ability 
to submit nominations or recommendations to shareholders. The revised 
instruction clarifies that none of the audit committee requirements in 
the final rule, including the requirement that the audit committee 
provide recommendations to shareholders where such responsibilities are 
vested with shareholders, conflicts with any legal or listing 
requirement in an issuer's home jurisdiction that prohibits the full 
board of directors from delegating such responsibilities to the audit 
committee or limits the degree of such delegation. However, we continue 
to believe that in such an instance, the audit committee, or body 
performing similar functions, must be granted such responsibilities, 
which can include advisory powers, with respect to such matters to the 
extent permitted by law, including submitting nominations or 
recommendations to the full board of directors.
    Finally, some commenters noted that in some jurisdictions, the 
outside auditor can only be removed by court order upon specified 
circumstances.\102\ Other commenters noted that the government is 
required to select the outside auditor for some foreign private 
issuers. Similar to the previous instructions, we are providing an 
additional instruction to clarify that the requirements in the final 
rule do not conflict with any legal or listing requirement in an 
issuer's home jurisdiction vesting such responsibilities with a 
government entity or tribunal. Similar to the other instructions, in 
such an instance we believe the audit committee should be granted such 
responsibilities, which can include advisory powers, with respect to 
such matters to the extent permitted by law.
---------------------------------------------------------------------------

    \102\ See, e.g., the Letters of Aventis SA; Deloitte; France 
Telecom SA.
---------------------------------------------------------------------------

    Some commenters requested that we provide for these clarifications 
as explicit exemptions from the final rule. As noted previously, 
however, we believe that the rule's requirements relate to the 
assignment of such responsibilities as between the audit committee and 
management. They do not conflict with, and otherwise have no bearing 
on, the vesting of such responsibilities in other bodies such as 
shareholders or government entities. Accordingly, we believe it is more 
appropriate to clarify what the requirements do not apply to or 
conflict with in the form of an instruction rather than an exemption.
3. Application to Investment Companies
    We proposed to exempt investment companies from the requirement 
that the audit committee be responsible for the selection of the 
independent auditor. We proposed the exemption in light of section 
32(a) of the Investment Company Act,\103\ which requires that 
independent auditors of registered investment companies be selected by 
majority vote of the disinterested directors.\104\
---------------------------------------------------------------------------

    \103\ 15 U.S.C. 80a-31(a).
    \104\ 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 are excluding entirely from the requirements that we are adopting 
today. 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)].
---------------------------------------------------------------------------

    On January 28, 2003, we adopted amendments to our existing 
requirements regarding auditor independence.\105\ Those amendments 
require that the audit committee of a registered investment company 
pre-approve all audit, review, or attest engagements required under the 
securities laws, a requirement that was supported by the 
commenters.\106\ In order to conform the rules that we are adopting 
today to the auditor independence rules, we are removing the proposed 
exemption for investment companies from the requirements regarding 
selection of the auditor. As a result, the audit committee will be 
required to select the independent

[[Page 18798]]

auditor and, under section 32(a) of the Investment Company Act, the 
independent directors will be required to ratify the selection.
---------------------------------------------------------------------------

    \105\ See Release No. 33-8183 (Jan. 28, 2003).
    \106\ See, e.g., Letter of Investment Company Institute dated 
January 13, 2003, in response to Release No. 33-8154 (Dec. 2, 2002) 
[67 FR 76780], proposing auditor independence rules adopted in 
Release No. 33-8183 (Jan. 28, 2003).
---------------------------------------------------------------------------

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.\107\ The 
establishment of formal procedures for receiving and handling 
complaints should serve to facilitate disclosures, encourage proper 
individual conduct and alert the audit committee to potential problems 
before they have serious consequences.
---------------------------------------------------------------------------

    \107\ 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 listing standards called for by our final 
rules, each audit committee must establish procedures for:\108\
---------------------------------------------------------------------------

    \108\ Exchange Act rule 10A-3 is not intended to preempt or 
supersede any other federal or state requirements relating to 
receipt and retention of records.
---------------------------------------------------------------------------

    [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.

As proposed, we are not mandating specific procedures that the audit 
committee must establish. Commenters were split over whether specific 
procedures should be mandated. The minority, representing primarily 
consultants and other third-party providers of such services, as well 
as several commenters representing investors, believed the Commission 
should mandate specific procedures, and many advocated a national 
``one-size-fits-all'' approach.\109\ A substantial number of 
commenters, however, supported the Commission's approach of not 
mandating specific procedures, instead preferring to leave flexibility 
to the audit committee to develop appropriate procedures in light of a 
company's individual circumstances, so long as the required parameters 
are met.\110\
---------------------------------------------------------------------------

    \109\ See, e.g., the Letters of AuditConcerns, Inc.; CalPERS; 
Michael Chenkin; Confidential Communications Services, LLC; David 
Gold; The HR Hotline, Inc.; SWIB; Teamsters.
    \110\ See, e.g., the Letters of ABA; AICPA; American Bankers 
Association; Cleary; CSC; Deloitte; Edison Electric Institute; E&Y 
FEI; ICI; Nasdaq; The Network, Inc.; NYCBA; NYSBA; PSEG; PwC; Ralph 
S. Saul; State Street Corporation.
---------------------------------------------------------------------------

    Given the variety of listed issuers in the U.S. capital markets, we 
believe audit committees should be provided with flexibility to develop 
and utilize procedures appropriate for their circumstances. The 
procedures that will be most effective to meet the requirements for a 
very small listed issuer with few employees could be very different 
from the processes and systems that would need to be in place for 
large, multi-national corporations with thousands of employees in many 
different jurisdictions. We do not believe that in this instance a 
``one-size-fits-all'' approach would be appropriate. As noted in the 
Proposing Release, we expect each audit committee to develop procedures 
that work best consistent with its company's individual circumstances 
to meet the requirements in the final rule. Similarly, we are not 
adopting the suggestion of a few commenters that, despite the statutory 
language, the requirement should be limited to only employees in the 
financial reporting area.\111\
---------------------------------------------------------------------------

    \111\ See, e.g., the Letter of S&C.
---------------------------------------------------------------------------

    While the scope of the requirements generally includes complaints 
received by a listed issuer regardless of source, Exchange Act section 
10A(m)(4)(B) and the relevant portion of the rules referring to 
confidential, anonymous submission of concerns are directed to 
employees of the issuer. One commenter noted that investment companies 
rarely have direct employees.\112\ The commenter suggested that, for 
investment companies, the confidential, anonymous submission 
requirements should extend to employees of entities engaged by an 
investment company to prepare or assist in preparing its financial 
statements. We encourage the SROs to consider the appropriate scope of 
the requirement with regard to investment companies, taking account of 
the fact that most services are rendered to an investment company by 
employees of third parties, such as the investment adviser, rather than 
by employees of the investment company.\113\
---------------------------------------------------------------------------

    \112\ See the Letter of PwC.
    \113\ Compare Release No. 33-8185 (Jan. 29, 2003) (attorney 
employed by an investment adviser who prepares, or assists in 
preparing, materials for a registered investment company to be 
submitted to or filed with the Commission by or on behalf of the 
investment company is appearing and practicing before the 
Commission); Release No. 34-47262 (Jan. 27, 2003) (disclosure 
required of code of ethics applicable to the principal executive 
officer and financial officer of a registered management investment 
company, or persons performing similar functions, regardless of 
whether they are employees of the investment company or a third 
party).
---------------------------------------------------------------------------

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 questions that may arise regarding 
financial reporting and compliance with the securities laws. 
Accordingly, as proposed, the final rule specifically requires an 
issuer's audit committee to have the authority to engage outside 
advisors, including counsel, as it determines necessary to carry out 
its duties.\114\ Commenters supported this requirement as 
proposed.\115\
---------------------------------------------------------------------------

    \114\ As proposed, the requirement does not preclude access to 
or advice from the company's internal counsel or regular outside 
counsel. It also does not require an audit committee to retain 
independent counsel.
    \115\ See, e.g., the Letters of AICPA; CSC; Deloitte; FEI; ICI; 
PwC.
---------------------------------------------------------------------------

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, as proposed, the final rule requires the issuer to provide 
for appropriate funding, as determined by the audit committee, in its 
capacity as a

[[Page 18799]]

committee of the board of directors, for payment of compensation:
    [sbull] To any registered public accounting firm engaged for the 
purpose of preparing or issuing an audit report or performing other 
audit, review or attest services for the listed issuer;\116\ and
---------------------------------------------------------------------------

    \116\ Exchange Act section 10A(m)(6)(A) uses the phrase 
``rendering or issuing an audit report.'' For consistency, we have 
conformed the language in the final rule to the language used in the 
oversight requirement in Exchange Act section 10A(m)(2) which refers 
to ``preparing or issuing an audit report.'' Similarly, the final 
rule includes as proposed the phrase ``other audit, review or attest 
services.'' See section II.B.1 regarding a discussion of the scope 
of this formulation.
---------------------------------------------------------------------------

    [sbull] To any advisors employed by the audit committee.

This requirement will further the standard relating to the audit 
committee's responsibility to appoint, compensate, retain and oversee 
the outside auditor. It also will add meaning to the 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 its 
duties objectively 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.
    Commenters supported this requirement.\117\ We also requested 
comment on whether there should be limits on the amount of compensation 
that could be requested by the audit committee. The overwhelming 
majority of commenters did not support compensation limits, arguing 
that to do otherwise would subvert the intent of the requirement.\118\ 
These commenters argued that audit committee members' own fiduciary 
duties to the issuer and natural oversight by the board of directors as 
a whole over the audit committee would address any concerns over abuse. 
The final rule does not set funding limits.
---------------------------------------------------------------------------

    \117\ See, e.g., the Letters of AICPA; CalPERS; Deloitte; FEI; 
ICI; PwC.
    \118\ Compare, e.g., the Letters of ABA; Deloitte; E&Y FEI; PwC 
with the letters of Southern Company; CalPERS.
---------------------------------------------------------------------------

    Some commenters believed it would be appropriate to supplement the 
funding requirements.\119\ While the Commission's proposal would 
address the compensation of advisors, it would not provide assurance 
that the audit committee itself can obtain the funding it needs to 
carry out its duties. Specifically, these commenters believed the final 
rule should also state that the issuer must provide appropriate funding 
for ordinary administrative expenses of the audit committee. We find 
merit in this suggestion. An audit committee's effectiveness may be 
compromised if it is dependent on management's discretion to pay for 
the committee's expenses, especially when potential conflicts of 
interest with management may be apparent. Accordingly, the final rule 
provides that, in addition to funding for advisors, the issuer must 
provide appropriate funding for ordinary administrative expenses of the 
audit committee that are necessary or appropriate in carrying out its 
duties.
---------------------------------------------------------------------------

    \119\ See, e.g., the ABA Letter.
---------------------------------------------------------------------------

F. Application and Implementation of the Standards

1. SROs Affected and Implementation Dates
    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 final rule, will be required to issue or modify 
their rules, subject to Commission review, to conform their listing 
standards.\120\ The SROs are not precluded from adopting additional 
listing standards regarding audit committees, as long as they are 
consistent with Exchange Act rule 10A-3.
---------------------------------------------------------------------------

    \120\ An SRO that wished to do so could satisfy the requirements 
of the rule by requiring that a listed issuer must comply with the 
requirements set forth in Exchange Act rule 10A-3.
---------------------------------------------------------------------------

    To facilitate timely implementation of the requirements, we 
proposed compliance dates by when each SRO must provide to the 
Commission proposed rules and rule amendments to implement Exchange Act 
rule 10A-3, as well as by when such rules or rule amendments must be 
approved by the Commission. As proposed, SROs would have had until 60 
days after publication of our final rule in the Federal Register to 
provide proposed rules or rule amendments, and until 270 days after 
publication of our final rule to have such rules or rule amendments 
approved by the Commission. Commenters generally supported these 
compliance dates, although several requested additional time to submit 
the proposed rules and rule amendments.\121\
---------------------------------------------------------------------------

    \121\ See, e.g., the Letters of ABA; NYSE.
---------------------------------------------------------------------------

    In response to these comments, the SRO compliance dates we are 
adopting in the final rule are designed to facilitate timely 
implementation of the new requirements, while providing additional time 
for SROs to submit proposed rules or rule amendments. Under the final 
rule, each SRO must provide to the Commission proposed rules or rule 
amendments that comply with the requirements no later than July 15, 
2003. Final rules or rule amendments must be approved by the Commission 
no later than December 1, 2003.
    Regarding when listed issuers must be in compliance with the new 
listing rules, we proposed that 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. A few commenters 
believed the proposed implementation dates were adequate for issuers to 
make the necessary changes to their audit committees, arguing that 
timely implementation is key to restoring investor confidence and 
public trust.\122\ However, a substantial group of commenters 
recommended modifications and additional time for issuers to comply, 
for three primary reasons.
---------------------------------------------------------------------------

    \122\ See, e.g., the Letters of CalPERS; CII; CSC; ICI; PwC.
---------------------------------------------------------------------------

    First, commenters noted that the new requirements as proposed would 
become operative during the 2004 annual shareholder meeting period for 
most listed issuers.\123\ Given the importance of allowing issuers to 
identify, evaluate and recruit qualified directors, as well as the 
desirability of avoiding the burden and expense of requiring special 
shareholder meetings to elect those directors, commenters requested the 
ability to coordinate compliance with their annual shareholder meeting 
schedule, such as the first annual shareholders meeting after approval 
of the SRO implementing rules, which could occur after the original 
compliance date proposed by the Commission.
---------------------------------------------------------------------------

    \123\ See, e.g., the Letters of ABA; AFEP-AGREF; AXA SA; Cleary; 
German CFOs; Nippon Keidanren; JPMorgan Chase Bank; Matsushita.
---------------------------------------------------------------------------

    Second, several commenters requested additional time for compliance 
by foreign private issuers.\124\ The new SRO rules may represent the 
first time that some foreign listed issuers will be subject to such 
requirements. Some were concerned that the pool of candidates available 
in some countries that would be qualified to perform the functions 
required of audit committee members may be limited. As such, it may 
take additional time to locate and attract qualified directors.
---------------------------------------------------------------------------

    \124\ See, e.g., the Letters of Cleary; Davis Polk & Wardwell; 
Deloitte; European Federation of Accountants (``FEE''); PwC; Telekom 
Austria AG.
---------------------------------------------------------------------------

    Finally, several commenters requested accommodations for smaller 
listed

[[Page 18800]]

issuers.\125\ These issuers may need additional time to locate a 
sufficient number of qualified directors to meet the requirements. In 
addition, small business issuers that are listed on some markets, such 
as Nasdaq, have previously been exempt from listing requirements that 
require independence for the entire audit committee.\126\ Commenters 
requested an additional transition period for such companies to 
alleviate the potential burdens they may face.
---------------------------------------------------------------------------

    \125\ See, e.g., the Letters of ABA; Amex; Nasdaq.
    \126\ See, e.g., rule 4350(d)(2)(C) of the NASD's listing 
standards.
---------------------------------------------------------------------------

    In response to these concerns, we are adopting a revised set of 
implementation dates, with an extended date for foreign private issuers 
and smaller issuers. We are distinguishing listed issuers that are not 
foreign private issuers by size based upon whether they are a ``small 
business issuer,'' as defined in Exchange Act rule 12b-2. A small 
business issuer is a U.S. or Canadian issuer with less than $25 million 
in revenues and public float that is not an investment company.\127\
---------------------------------------------------------------------------

    \127\ Public float is the aggregate market value of a company's 
outstanding voting and non-voting common equity (i.e., market 
capitalization) minus the value of common equity held by affiliates 
of the company.
---------------------------------------------------------------------------

    Under the final rule, listed issuers, other than foreign private 
issuers and small business issuers, must be in compliance with the new 
listing rules by the earlier of (1) their first annual shareholders 
meeting after January 15, 2004, or (2) October 31, 2004. Foreign 
private issuers and small business issuers must be in compliance with 
the new listing rules by July 31, 2005. We believe these dates strike 
an appropriate balance between the need for timely implementation of 
the requirements and the ability of listed issuers to comply with the 
requirements without an unreasonable burden.
    As discussed in the Proposing Release, the OTC Bulletin Board 
(OTCBB), the Pink Sheets and the Yellow Sheets are not affected by 
Exchange Act rule 10A-3, and therefore issuers whose securities are 
quoted on these interdealer quotation systems similarly will not be 
affected, unless their securities also are listed on an exchange or 
Nasdaq.\128\ 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,\129\ the issuers whose securities are quoted on such systems do 
not have any filing or reporting requirements with the system.\130\
---------------------------------------------------------------------------

    \128\ The OTCBB is operated by The Nasdaq Stock Market, Inc., 
which is owned by the NASD. Information about the OTCBB can be found 
at http://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 http://www.pinksheets.com.
    \129\ See 17 CFR 240.15c2-11.
    \130\ 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.
---------------------------------------------------------------------------

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 final rule applies 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, will benefit from the increased 
financial oversight of an issuer that would result from a strong and 
effective audit committee.
    Despite the statutory language, a few commenters believed that debt 
securities and non-convertible preferred securities should be exempted 
in their entirety.\131\ As discussed above, we do not believe such a 
broad-based exemption is consistent with the language and the intent of 
section 10A(m). Effective oversight of financial reporting improves the 
quality and accuracy of such reporting. Quality and accurate financial 
reporting facilitates the proper pricing and liquidity of all 
securities on listed markets, regardless of type. While the Sarbanes-
Oxley Act made explicit distinctions between debt and equity securities 
in several different provisions,\132\ it made no such distinction in 
enacting Exchange Act section 10A(m). To avoid undue burden on listed 
issuers, including debt issuers, we have adopted several exemptions 
where consistent with the purposes and policies of section 10A(m) and 
the protection of investors, such as the overlapping board exemption 
discussed in section II.A.5 and the multiple listing exemption 
discussed below.
---------------------------------------------------------------------------

    \131\ See, e.g., the Letters of ABA; NYSE; S&C.
    \132\ See, e.g., section 501 of the Sarbanes-Oxley Act.
---------------------------------------------------------------------------

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 an issuer 
already was subject to the requirements in Exchange Act rule 10A-3 as a 
result of one listing, there would be little or no additional benefit 
from having the requirements imposed on the issuer due to an additional 
listing.
    In addition, companies often issue non-equity securities through 
controlled subsidiaries for various reasons. Requiring these 
subsidiaries, which often have no purpose other than to issue or 
guarantee the securities, to be subject to the audit committee 
requirements would add little additional benefit if the subsidiary is 
closely controlled or consolidated by a parent issuer that is subject 
to the requirements. Instead, imposing the requirements 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 are adopting as proposed an exemption from the 
requirements for listings of additional classes of securities of an 
issuer at any time the issuer is subject to the 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. Some commenters questioned conditioning the 
exemption on the listing of a class of common equity or similar 
securities.\133\ We proposed conditioning this exemption on the listing 
of a class of common equity or similar securities because these 
securities will most likely represent the primary public listing of the 
company and the applicable listing standards, including those required 
by our rules, would be likely to be the most comprehensive. We are 
persuaded that this approach is proper in respect of the listing of 
subsidiaries' securities, but it is not necessary in the case of 
multiple listings of the issuer itself. Therefore,

[[Page 18801]]

the exemption for additional classes of a listed issuer will apply if 
any class of securities of the issuer is listed on a national 
securities exchange or national securities association subject to these 
rules.
---------------------------------------------------------------------------

    \133\ See, e.g., the Letters of ABA; NYSBA.
---------------------------------------------------------------------------

    Of course, just as an SRO may adopt standards for audit committees 
that are stricter than those provided in Exchange Act rule 10A-3, they 
also may apply their listing standards, including those implementing 
Exchange Act rule 10A-3, to classes of securities where Exchange Act 
rule 10A-3 would not require it. For example, in the case of an issuer 
with a class of debt securities listed on an SRO subject to these 
rules, another SRO may condition listing by that issuer of its common 
equity securities on full compliance with that second SRO's listing 
standards regarding the requirements in Exchange Act rule 10A-3. 
Moreover, our rules do not embody a ``first in time'' principle, so 
that in the above example, once the class of common equity securities 
was listed on the second SRO subject to our requirements, unless SRO 
rules provide otherwise, the multiple listing exemption could be 
applied in respect of the debt securities listed on the first SRO.
    Also as proposed, we are extending the exemption to listings of 
non-equity securities by certain additional subsidiaries of a parent 
company, if the parent company is subject to the requirements as a 
result of the listing of a class of equity securities. We proposed 
having the exemption apply to non-equity listings by direct or indirect 
consolidated majority-owned subsidiaries of a parent company. While 
commenters uniformly supported the exemption,\134\ some believed that, 
for many of the same reasons discussed above regarding the independence 
exemption for overlapping boards of directors, the number of 
subsidiaries that would be covered by the multiple listing exemption 
was too restrictive.\135\
---------------------------------------------------------------------------

    \134\ See, e.g., the Letters of ABA; CalPERS; CSC; Edison 
International; Ford Motor Company; General Electric Company; General 
Motors Acceptance Corporation; NYSE; PSEG; PwC; Transamerica Finance 
Corporation (``TFC''); Southern Company.
    \135\ See, e.g., the Letters of ABA; Cingular Wireless; Corning 
Incorporated; Dow Corning Corporation; FEI; PwC; S&C TFC.
---------------------------------------------------------------------------

    In this instance, however, we believe that a greater degree of 
interest between the parent and the subsidiary is important. The 
multiple listing exemption will mean that, unless an SRO's rules 
provide otherwise, a publicly traded entity will not need to have any 
independent audit committee members or otherwise be subject to the 
audit committee responsibilities in Exchange Act rule 10A-3. It is more 
important in this instance to ensure that the parent company's audit 
committee is in the appropriate position to provide oversight for the 
financial reporting of the subsidiary. This is most likely to be the 
case if the parent consolidates the subsidiary into its own financial 
statements. Nevertheless, we also understand that a parent may possess 
the requisite ownership threshold, but may not consolidate the 
subsidiary due to particular accounting situations.\136\ Similarly, 50% 
owned joint ventures may not be consolidated by the two parents that 
exercise joint control.\137\
---------------------------------------------------------------------------

    \136\ See e,g., the Letter of Michael Groll.
    \137\ See, e.g., the Letters of Cingular Wireless; Corning 
Incorporated; Dow Corning Corporation; FEI; PwC.
---------------------------------------------------------------------------

    To address these concerns, we are expanding the exemption from the 
proposal to include listings of non-equity securities by a direct or 
indirect subsidiary that is consolidated or at least 50% beneficially 
owned by a parent company, if the parent company is subject to the 
requirements as a result of the listing of a class of its equity 
securities. However, as proposed, if the subsidiary were to list its 
own equity securities (other than non-convertible, non-participating 
preferred securities \138\), the subsidiary will be required to meet 
the requirements to protect its own public shareholders. The multiple 
listing exemption is available to U.S. subsidiaries if the parent is a 
foreign private issuer, even if the foreign parent is relying on one of 
the special exemptions for foreign private issuers (such as the board 
of auditors exemption). However, the special exemptions available to 
the foreign parent are of course not available to its U.S. subsidiary.
---------------------------------------------------------------------------

    \138\ Trust-preferred and similar securities also fall within 
this category.
---------------------------------------------------------------------------

b. Security Futures Products and Standardized Options

    The enactment of the Commodity Futures Modernization Act of 2000, 
or CFMA,\139\ addressed the regulation of security futures 
products.\140\ It permits national securities exchanges registered 
under section 6 of the Exchange Act \141\ and national securities 
associations registered under section 15A(a) of the Exchange Act \142\ 
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 \143\ 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.\144\
---------------------------------------------------------------------------

    \139\ Pub. L. No. 106-554, 114 Stat. 2763 (2000).
    \140\ 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.
    \141\ 15 U.S.C. 78f.
    \142\ 15 U.S.C. 78o-3(A).
    \143\ 15 U.S.C. 78q-1.
    \144\ 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.
---------------------------------------------------------------------------

    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.\145\
---------------------------------------------------------------------------

    \145\ However, the clearing agency may receive a clearing fee 
from its members.
---------------------------------------------------------------------------

    Recognizing these fundamental differences, we are adopting as 
proposed an exemption for 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 are adopting as proposed a similar exemption for 
the listing of standardized options issued by a clearing agency 
registered under section 17A of the Exchange Act.

[[Page 18802]]

3. Issuers Affected
a. Foreign Issuers
    As discussed in the Proposing Release, 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 their 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 
already maintain audit committees, and the global trend appears to be 
toward establishing audit committees.\146\ Thus, as proposed, the 
Commission's direction to the SROs will apply to listings by foreign 
private issuers as well as domestic issuers.
---------------------------------------------------------------------------

    \146\ 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 http://www.iosco.org); Egon Zehnder 
International, Board of Directors Global Study (2000) (available at 
http://www.zehnder.com); and KPMG LLP, Corporate Governance in 
Europe: KPMG Survey 2001/2002 (2002) (available at http://www.kpmg.com).
---------------------------------------------------------------------------

    However, as discussed in the Proposing Release, we are aware that 
the requirements may conflict with legal requirements, corporate 
governance standards and the methods for providing auditor oversight in 
the home jurisdictions of some foreign issuers. Even before we 
published the Proposing Release, several foreign issuers and their 
representatives had expressed concerns about the possible application 
of Exchange Act section 10A(m).\147\ The Proposing Release prompted 
many thoughtful comments from dozens of foreign private issuers and 
their representatives from around the world. These commenters expressed 
overwhelming support for the Commission's approach of providing 
tailored exemptions and guidance where the requirements of Exchange Act 
section 10A(m) could result in a direct conflict with home country 
requirements. In our final rules, we have attempted to address 
commenters' concerns regarding the specific areas in which foreign 
corporate governance arrangements differ significantly from general 
practices among U.S. corporations. In addition to the clarifications 
discussed in section II.B., we discuss these matters below.
---------------------------------------------------------------------------

    \147\ See, e.g., Petition for Rulemaking submitted by the 
Organization for International Investment, File No. 4-462 (Aug. 19, 
2002).
---------------------------------------------------------------------------

i. Employee Representation
    We understand that some countries, such as Germany, require that 
non-management employees, who would not be viewed as ``independent'' 
under the requirements, serve on the supervisory board or audit 
committee.\148\ 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 adopting as proposed a limited 
exemption from the independence requirements to address this concern, 
so long as the employees are not executive officers, as defined by 
Exchange Act rule 3b-7.\149\
---------------------------------------------------------------------------

    \148\ See, e.g., Co-Determination Act of 1976 
(Mitbestimmungsgesetz). The exemptions provided in the final rule 
are available to any foreign private issuer that meets their 
individual requirements. Examples provided in this release are meant 
to be for illustrative purposes only.
    \149\ Exchange Act rule 3b-7 [17 CFR 240.3b-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.
---------------------------------------------------------------------------

    Commenters expressed support for this exemption.\150\ Some 
commenters, however, recommended extending the exemption to include 
also non-executive employees that serve on the supervisory board or 
audit committee as a result of an issuer's governing law or documents 
or an employee collective bargaining or similar agreement. Under the 
final rule, non-executive employees can 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 the issuer's governing law or documents, an employee collective 
bargaining or similar agreement or other home country legal or listing 
requirements.
---------------------------------------------------------------------------

    \150\ See, e.g., the Letters of Allianz AG; Deutsches 
Aktieninstitut; German CFOs; NYSE; Alexander Schaub; Telekom Austria 
AG.
---------------------------------------------------------------------------

ii. Two-Tier Board Systems
    Some foreign private issuers have a two-tier board system, 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 is the body within 
the company best equipped to comply with the requirements. Our final 
rule clarifies that in the case of foreign private issuers with two-
tier board systems, the term ``board of directors'' means the 
supervisory or non-management board for purposes of Exchange Act rule 
10A-3. As such, the supervisory or non-management board can either form 
a separate audit committee or, if the entire supervisory or non-
management board is independent within the provisions and exceptions of 
the rule, the entire board can be designated as the audit 
committee.\151\ Commenters supported this clarification.\152\
---------------------------------------------------------------------------

    \151\ See note above and the accompanying text.
    \152\ See, e.g., the Letters of AFL-CIO; CalPERS; Deutsches 
Aktieninstitut; FEE.
---------------------------------------------------------------------------

iii. Controlling Shareholder Representation
    Controlling shareholders or shareholder groups are more prevalent 
among foreign issuers than in the U.S., 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. As proposed, we believe that a limited exception from the 
independence requirements can accommodate this practice without 
undercutting the fundamental purposes of the rule. We proposed that one 
member of the audit committee can 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.
    Several commenters requested that the exemption be extended. Some 
believed the 50% ownership threshold was too high, arguing that a 
shareholder can exercise control through lower levels of ownership or 
through non-

[[Page 18803]]

ownership means.\153\ Others requested the ability to have more than 
one representative if there is more than one controlling 
shareholder.\154\ A few objected to the observer-only status provided 
by the proposed exemption.\155\
---------------------------------------------------------------------------

    \153\ See, e.g., the Letters of ABA; Cleary; PwC; S&C.
    \154\ See, e.g., the Letter of AFEP-AGREF.
    \155\ See, e.g., the Letters of ABA; S&C.
---------------------------------------------------------------------------

    In response to commenters' concerns, we are making minor 
modifications to the exemption. We are expanding the types of 
controlling persons covered by the exemption, but we continue to 
believe that it is appropriate that such representatives have only 
observer status on, and not be a voting member or chair of, the audit 
committee. Under the final rule, an audit committee member can be a 
representative of an affiliate of the 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. As 
revised, this limited exception is designed to address foreign 
practices, assure independent membership and an independent chair of 
the audit committee and still exclude management from the committee. As 
the exemption is designed to provide only a limited accommodation for 
the practices of some foreign private issuers, we are not extending the 
exemption to domestic issuers, as requested by some commenters.\156\
---------------------------------------------------------------------------

    \156\ See, e.g., the Letters of Cleary; Duchossois Industries, 
Inc.; NYSE.
---------------------------------------------------------------------------

iv. Foreign Government Representation
    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 the final rule. 
To address foreign practices, we believe that foreign governmental 
representatives should be permitted to sit on audit committees of 
foreign private issuers. Commenters supported our proposal to exempt 
one member of the audit committee that is foreign government 
representative, provided the ``no compensation'' prong of the 
independence requirements is met and the member in question is not an 
executive officer of the issuer.\157\ As with the exemption for 
controlling shareholder representatives, this limited exception is 
designed to address foreign practices and still exclude management from 
the committee. However, some believed the exemption should not be 
limited to just one foreign government representative if the 
representatives are otherwise independent and are not executive 
officers of the issuer. Under the final rule, any audit committee 
member can 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.
---------------------------------------------------------------------------

    \157\ See, e.g., the Letters of ABA; Compania Cervecerias Unidas 
S.A. (``CCU''); France Telecom SA.
---------------------------------------------------------------------------

    We recognize that foreign governments may have varying arrangements 
relating to their state holdings. Some governments may hold shares 
directly, some through various branches or agencies, some through an 
institution organized under public law, and some by other entities. 
Several commenters believed the legal form of the entity that holds the 
governmental shareholdings should not be determinative.\158\ We agree. 
The exemption applies regardless of the manner in which the foreign 
government owns its interest.
---------------------------------------------------------------------------

    \158\ See, e.g., the Letters of Davis Polk & Wardwell; Telekom 
Austria AG.
---------------------------------------------------------------------------

v. Listed Issuers That Are Foreign Governments
    Several commenters also requested a specific exemption for listed 
issuers that are themselves foreign governments, as these issuers most 
likely would not be able to comply with the requirements. Accordingly, 
we are exempting in the final rule listed issuers that are foreign 
governments, as defined in Exchange Act rule 3b-4(a).\159\
---------------------------------------------------------------------------

    \159\ 17 CFR 240.3b-4(a). Under that definition, the term 
``foreign government'' means the government of any foreign country 
or of any political subdivision of a foreign country. The exemption 
encompasses all registrants that are eligible to register securities 
under Schedule B of the Securities Act.
---------------------------------------------------------------------------

vi. Boards of Auditors or Similar Bodies
    While as noted above there is a continuing 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 
in whole or in part separate from the board of directors.\160\ 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 rule 10A-3. 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 
proposed an exemption from certain of the requirements for audit 
committees for boards of auditors or statutory auditors of foreign 
private issuers that fulfilled the remaining requirements of the rule, 
if those boards operate under legal or listing provisions 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 were met.
---------------------------------------------------------------------------

    \160\ 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. We also 
understand that the Italian corporate governance regime provides for 
an independent board of statutory auditors (``Collegio Sindicale'') 
and the Brazilian corporate governance regime allows a Fiscal 
Council (``Conselho Fiscal''). See, e.g., the Letters of Assonime; 
Brazilian Securities Commission. As noted previously, the examples 
provided in this release are for illustrative purposes only. The 
exemption provided in the final rule for boards of auditors or 
similar bodies will be available to any foreign private issuer that 
meets the exemption's requirements because of the issuer's home 
country regime.
---------------------------------------------------------------------------

    Commenters expressed strong support for the exemption as an 
appropriate response to address the potential conflicts regarding these 
alternative structures.\161\ However, several suggested refinements to 
the technical wording in the proposed exemption to ensure that it 
properly covers the appropriate structures in various 
jurisdictions.\162\ Also, many requested removing the proposed 
requirement that the issuer must be listed on a market outside the 
U.S., as the board of auditor requirement often is a home country

[[Page 18804]]

legal requirement and not a listing requirement.\163\ Others believed 
that the exemption as proposed would not cover the unique situations in 
some countries where the board of auditors or similar body consists of 
one or more independent members of the board of directors in addition 
to one or more non-board members.\164\ Without a modification, these 
commenters believed issuers from such jurisdictions could not satisfy 
the exemption because of the requirement that the board of auditors 
must be entirely separate from the board of directors. The overwhelming 
majority of commenters did not believe a sunset provision for the 
exemption would be appropriate.\165\
---------------------------------------------------------------------------

    \161\ See, e.g., the Letters of ABA; Assonime; Baker & McKenzie; 
Brazilian Securities Commission; CalPERS; Cleary; FSA; Japan 
Corporate Auditors Association; Japanese Ministry of Economy, Trade 
and Industry; Nippon Keidanren; Matsushita; Nomura Holdings, Inc; 
NTT DoCoMo, Inc.; NYSE; ORIX Corporation.
    \162\ See, e.g., the Letters of ABA; Assonime; Baker & McKenzie; 
Brazilian Securities Commission; Cleary; ORIX Corporation; S&C.
    \163\ See, e.g., the Letters of ABA, Cleary; Internet Initiative 
Japan, Inc.; FSA; Japanese Ministry of Economy, Trade and Industry; 
Nippon Keidanren; Linklaters; NYSE; S&C.
    \164\ See, e.g., the Letters of Perusahaan Perseroan (Persero) 
PT Telekomunikasi Indonesia Tbk; S&C.
    \165\ Compare, e.g., the letters of ABA; FSA; Japanese Ministry 
of Economy, Trade and Industry; Nippon Keidanren; Japan Corporate 
Auditors Association; Matsushita; Nomura Holdings, Inc; NTT DoCoMo, 
Inc.; NYSE; ORIX Corporation with the letters of CalPERS; PwC.
---------------------------------------------------------------------------

    Accordingly, we are making several modifications to the exemption 
as adopted. Under the final rule, the listing of securities of a 
foreign private issuer will be exempt from all of the audit committee 
requirements if the issuer meets the following requirements:
    [sbull] The foreign private issuer has a board of auditors (or 
similar body), or has statutory auditors (collectively, a ``Board of 
Auditors''), established and selected pursuant to home country legal or 
listing provisions expressly requiring or permitting such a board or 
similar body;
    [sbull] The Board of Auditors is required to be either separate 
from the board of directors, or composed of one or more members of the 
board of directors and one or more members that are not also members of 
the board of directors;
    [sbull] The Board of Auditors are not elected by management of the 
issuer and no executive officer of the issuer is a member of the Board 
of Auditors;
    [sbull] Home country legal or listing provisions set forth or 
provide for standards for the independence of the Board of Auditors 
from the issuer or the management of the issuer;
    [sbull] The Board of Auditors, in accordance with any applicable 
home country legal or listing requirements or the issuer's governing 
documents, is responsible, to the extent permitted by law, for the 
appointment, retention and oversight of the work of any registered 
public accounting firm engaged (including, to the extent permitted by 
law, the resolution of disagreements between management and the auditor 
regarding financial reporting) for the purpose of preparing or issuing 
an audit report or performing other audit, review or attest services 
for the issuer; and
    [sbull] The remaining requirements in the rule, such as the 
complaint procedures requirement, advisors requirement and funding 
requirement, apply to the Board of Auditors, to the extent permitted by 
law.
    This revised formulation is designed to address the jurisdictions 
that provide for boards of auditors or similar structures. In all 
instances, the requirements described in the revised exemption are to 
apply consistent with home country requirements. We recognize that 
while these bodies are designed to provide independent oversight of 
outside auditors, they may not meet all of the same requirements or 
have all of the responsibilities set forth in Exchange Act rule 10A-3. 
This approach nonetheless is a preferable method of implementing the 
protections of the Sarbanes-Oxley Act against the backdrop of this 
particular category of conflicting home country governance framework.
    We have eliminated the requirement that the issuer must also be 
listed on a market outside the U.S. Also, we are not adopting a sunset 
date for the exemption. Finally, despite some commenters suggestions, 
we have not extended the relief to foreign private issuers that have 
audit committees. \166\
---------------------------------------------------------------------------

    \166\ See, e.g., the Letters of FSA; Japanese Ministry of 
Economy, Trade and Industry; Nippon Keidanren; Matsushita; Nomura 
Holdings, Inc; PwC; ORIX Corporation; S&C.
---------------------------------------------------------------------------

vii. Requests for Other Foreign Exemptions
    A foreign private issuer availing itself of the exemptions 
discussed in this section will be subject to specific disclosure 
requirements discussed in section II.G.1 below. Consistent with our 
proposal, there will be no other ability for an SRO to exempt or waive 
foreign issuers from the requirements. In adopting 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.\167\ We also understand that corporate governance 
structures throughout the world will continue to evolve, and that all 
future conflicts cannot be anticipated at this time. Accordingly, as 
requested by many commenters,\168\ the Commission has the authority to 
respond to, and will remain sensitive to, the evolving standards of 
corporate governance throughout the world to address any new conflicts 
that may arise with foreign corporate governance rules and practices 
that cannot be anticipated at this time.
---------------------------------------------------------------------------

    \167\ 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).
    \168\ See, e.g., the Letters of AFEP-AGREF; Assonime; Cleary; 
NYSE.
---------------------------------------------------------------------------

b. Small Businesses
    Section 10A(m) of the Exchange Act makes no distinction based on an 
issuer's size. As discussed in the Proposing Release, 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 there have been 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.\169\ The final rule, therefore, applies to listed issuers of 
all sizes as proposed.
---------------------------------------------------------------------------

    \169\ 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).
---------------------------------------------------------------------------

    The majority of commenters generally agreed with this approach and 
did not support lesser standards for smaller issuers.\170\ These 
commenters did not believe the requirements will impose a 
disproportionate burden on small issuers. A few commenters, however, 
were concerned that smaller issuers may have particular difficulty 
locating qualified audit committee candidates that will meet the 
independence criteria, especially given the implementation period 
proposed by the Commission.\171\ While these commenters advocated 
various approaches, such as an exceptional and limited circumstances 
exemption for smaller issuers or SRO authority to exempt individual 
small issuers on a case-by-case basis, most agreed that an additional 
initial implementation period would be appropriate for these issuers.
---------------------------------------------------------------------------

    \170\ See, e.g., the Letters of CalPERS; CBA; CSC; Deloitte; 
PwC.
    \171\ See, e.g., the Letters of ABA; Amex; Nasdaq.
---------------------------------------------------------------------------

    We recognize that because the final rule applies only to listed 
issuers, quantitative listing standards applicable to listed 
securities, such as minimum revenue, market capitalization and

[[Page 18805]]

shareholder equity requirements, will limit the size of issuers that 
will be affected by the requirements.\172\ However, we are sensitive to 
the possible implication for smaller issuers and for SROs that would 
like to specialize in securities of these issuers. As discussed in 
section II.F.1, we are providing an extended compliance period for 
listed issuers that are small business issuers. In addition, the 
modifications to several of the other exemptions in the final rule, 
such as the overlapping board exemption and the new issuer exemption, 
should provide additional flexibility to small and new issuers in 
meeting the requirements of the rule. Our approach of not mandating 
specific procedures for the auditor responsibility requirement and the 
complaint procedures requirement also should provide issuers 
flexibility in meeting these requirements.
---------------------------------------------------------------------------

    \172\ Examples of the types of quantitative standards necessary 
for initial and continued listings on the NYSE, Nasdaq and AMEX are 
available on their respective Web sites.
---------------------------------------------------------------------------

c. Issuers of Asset-Backed Securities and Certain Other Passive Issuers
    In several of our releases implementing provisions of the Sarbanes-
Oxley Act,\173\ we have noted the special nature of asset-backed 
issuers.\174\ 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 types of financial statements that other companies must file. Also, 
such entities typically are passive pools of assets, without a board of 
directors or persons acting in a similar capacity. Accordingly, we are 
excluding asset-backed issuers from the requirements as proposed. 
Commenters supported this exclusion.\175\
---------------------------------------------------------------------------

    \173\ See note above.
    \174\ The term ``Asset-Backed Issuer'' is defined in 17 CFR 
240.13a-14(g) and 240.15d-14(g).
    \175\ See, e.g., the Letters of CSC; Deloitte; NYSE.
---------------------------------------------------------------------------

    Several commenters advocated similar relief for additional types of 
securities that are issued by trusts where the trust's activities are 
limited to passively owning or holding (as well as administering and 
distributing amounts in respect of) securities, rights, collateral or 
other assets on behalf of or for the benefit of the holders of the 
listed securities.\176\ For example, issuers of royalty trust 
securities and trust issued receipts often meet such criteria. 
Structures such as royalty trusts act as mere conduits though which 
proceeds on the underlying assets are distributed to 
securityholders.\177\ For securities such as trust issued receipts, the 
receipts represent undivided beneficial ownership of the specified 
underlying securities that are held in the trust.\178\ Because such 
structures are similar to asset-backed issuers in that they do not have 
a board of directors or comparable persons from which to form an audit 
committee, the same policy reasons that exempt asset-backed issuers 
generally apply to such structures as well.
---------------------------------------------------------------------------

    \176\ See, e.g., the Letters of ABA; Nasdaq; NYSE.
    \177\ For a more detailed description of royalty trusts, see 
Staff Accounting Bulletin No. 47. Of course, the exemption we are 
establishing will not extend to structures that hold, in addition to 
the royalty interest, an interest in the operating company that 
actually owns the oil and gas properties, such as structures 
commonly known as Canadian income trusts. In these situations, the 
trustee often also delegates significant management decisions to an 
operating company, which in turn may delegate those decisions to a 
manager. The operating company often has a board of directors that 
is appointed by both the manager and the trust unit holders. We 
believe such structures should be treated in a manner similar to 
limited partnerships.
    \178\ For a further description of trust issued receipts, see, 
for example, rule 1200 of the AMEX's listing standards, rule 1200 of 
the NYSE's listing standards, and HOLDRs, SEC No-Action Letter (Sep. 
3, 1999) (the staff agreed not to recommend enforcement action to 
the Commission if, among other things, the trust did not register as 
an investment company under the Investment Company Act).
---------------------------------------------------------------------------

    We recognize that we cannot anticipate all of the various types of 
these entities that may seek a listing on a national securities 
exchange or national securities association. Under the final rule, SROs 
may exclude from Exchange Act Rule 10A-3's requirements issuers that 
are organized as trusts or other unincorporated associations that do 
not have a board of directors or persons acting in a similar capacity 
and whose activities are limited to passively owning or holding (as 
well as administering and distributing amounts in respect of) 
securities, rights, collateral or other assets on behalf of or for the 
benefit of the holders of the listed securities.
d. Investment Companies
    We proposed that the rule cover closed-end investment companies and 
so-called ``exchange-traded funds'' (``ETFs'') structured as open-end 
investment companies.\179\ We proposed to exclude ETFs structured as 
unit investment trusts (``UITs''). Two commenters argued that open-end 
ETFs should also be excluded from the rule.\180\ The commenters stated 
that the rule would impose unjustified competitive burdens on open-end 
ETFs in relation to both open-end investment companies that are not 
exchange-traded and ETFs structured as UITs.
---------------------------------------------------------------------------

    \179\ Business development companies are covered by the final 
rules.
    Investment companies may avail themselves of the general 
exemptions in Exchange Act Rule 10A-3(c) [17 CFR 240.10A-3(c)], if 
applicable. The independence exemptions of Exchange Act rule 10A-
3(b)(1)(iv)(A)-(E) [17 CFR 240.10A-3(b)(1)(iv)(A)-(E)] will not 
apply to investment companies.
    \180\ See the Letters of Amex; Barclays Global Investors, N.A.
---------------------------------------------------------------------------

    However, Exchange Act section 10A(m)(1) requires us to direct the 
SROs to prohibit the listing of any security of an issuer that is not 
in compliance with the enumerated audit committee standards. Thus, the 
statute is specifically addressed to issuers listed for trading on 
SROs, and, as a result, we believe that it would be inconsistent with 
the statute to exclude open-end ETFs from the rule. With regard to the 
exclusion for UIT ETFs, we note that UITs, like asset-backed issuers 
and unlike open-end ETFs, are not actively managed and do not have 
boards of directors from which audit committee members could be drawn.
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 standards on an ongoing basis. SROs 
are required to comply with statutory provisions and 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 proposed that SROs, 
as part of their implementing rules, must 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 requirements.\181\ The overwhelming majority of commenters 
supported this proposal.\182\ Accordingly, the final rule includes this 
requirement as proposed.
---------------------------------------------------------------------------

    \181\ 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 Exchange Act Rule 10A-3, to the extent SROs do not 
already provide for such a notice requirement. Commenters also 
expressed strong support for such a requirement.
    \182\ See, e.g., the Letters of Amex; CalPERS; CII; CSC; 
Matsushita; PwC; Transparency International-USA.
---------------------------------------------------------------------------

    We also requested comment on whether listed issuers should be 
required to disclose periodically to the

[[Page 18806]]

SROs whether they have been in compliance with the standards. 
Commenters were more mixed on this point. Several commenters supported 
periodic confirmation of compliance to SROs.\183\ Others believed it 
would be redundant to require periodic confirmations in addition to 
notice of actual breaches, and believed it should be left to the SROs 
to decide whether periodic confirmations should be included as part of 
their compliance monitoring procedures.\184\ Two national securities 
exchanges indicated they already require or intend to require such 
confirmations.\185\ We are not adopting a requirement that listed 
issuers must provide periodic confirmations of compliance to SROs at 
this time. However, we recognize, as many of the commenters did, that 
periodic confirmations can be part of an effective overall system for 
monitoring compliance with listing rules.
---------------------------------------------------------------------------

    \183\ See, e.g., the Letters of CalPERS; CII; PwC; Transparency 
International-USA.
    \184\ See, e.g., the Letters of CSC; Nasdaq.
    \185\ See the Letters of Amex; NYSE.
---------------------------------------------------------------------------

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 section 10A(m)'s audit committee standards, before imposition of 
such a prohibition. To effectuate this mandate, our final rule requires 
SROs to establish such procedures before they prohibit the listing of 
or delist any security of an issuer.\186\ As discussed in the Proposing 
Release, we believe that existing continued listing or maintenance 
standards and delisting procedures of the SROs generally will 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.\187\
---------------------------------------------------------------------------

    \186\ These procedures, of course, cannot include an extended 
exemption or waiver of the requirements apart from those provided 
for in Exchange Act Rule 10A-3.
    \187\ See, e.g., NASD rule 4800 Series and NYSE Listed Company 
Manual section 804.
---------------------------------------------------------------------------

    We requested comment as to whether the Commission should specify 
the maximum time limits for an opportunity to cure defects. Commenters 
were mixed on this point. Some supported having the Commission mandate 
specific time periods for the SROs, such as 30 days or 90 days.\188\ 
Others did not support specific time periods, again believing that it 
should be left to the individual SROs to decide the appropriate time 
periods given the differences of each market.\189\ We are not mandating 
specific time periods in the final rule. However, as mentioned in the 
Proposing Release, we expect that the rules of each SRO will provide 
for definite procedures and time periods for compliance to the extent 
they do not already do so.
---------------------------------------------------------------------------

    \188\ See, e.g., the Letters of CalPERS; CSC; PwC.
    \189\ See, e.g., the Letters of ABA; NYSE.
---------------------------------------------------------------------------

    Several commenters expressed concern regarding rare situations that 
may occur where an audit committee member ceases to be independent for 
reasons outside the member's reasonable control. For example, an audit 
committee member could be a partner in a law firm that provides no 
services to the listed issuer on which the member sits, but the listed 
issuer could acquire another company that is one of the law firm's 
clients. Without an opportunity to cure such a defect, the audit 
committee member would cease to be independent. Additional time may be 
necessary to cure such defects, such as ceasing the issuer's 
relationship with the audit committee member's firm or replacing the 
audit committee member. Accordingly, under our final rule, SRO 
implementing rules may provide that if a member of an audit committee 
ceases to be independent for reasons outside the member's reasonable 
control, that person, with notice by the issuer to the applicable 
national securities exchange or national securities association, may 
remain an audit committee member of the listed issuer until the earlier 
of the next annual meeting of the listed issuer or one year from the 
occurrence of the event that caused the member to be no longer 
independent.

G. Disclosure Changes Regarding Audit Committees

1. Disclosure Regarding Exemptions
    Exchange Act rule 10A-3 provides for certain exemptions. Because 
these exemptions will 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 are adopting as proposed a requirement that these 
issuers must disclose their reliance on an exemption and their 
assessment of whether, and if so, how, such reliance will materially 
adversely affect the ability of their audit committee to act 
independently and to satisfy the other requirements of Exchange Act 
rule 10A-3. Such disclosure will need to appear in, or be incorporated 
by reference into, annual reports filed with the Commission.\190\ The 
disclosure also will need to appear in proxy statements or information 
statements of issuers subject to our proxy rules for shareholders' 
meetings at which elections for directors are held.
---------------------------------------------------------------------------

    \190\ This disclosure is to be included in Part III of annual 
reports on Form 10-K [17 CFR 249.310] and 10-KSB (through an 
addition to Item 401 of Regulations S-K and S-B). Consequently, 
companies subject to the proxy rules will 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 will appear in new Item 16D.
    For foreign private issuers that file their annual reports on 
Form 40-F, the disclosure requirement will appear in paragraph (14) 
to General Instruction B.
    For registered investment companies, the disclosure will appear 
in Item 5(b) of Form N-CSR and Item 22(b)(14) of Schedule 14A.
---------------------------------------------------------------------------

    While two commenters \191\ did not believe the proposed disclosure 
would result in meaningful disclosure to investors, and several others 
did not support the assessment disclosure,\192\ commenters representing 
investors and investor groups and others uniformly believed the 
disclosure, including the assessment disclosure, would provide 
meaningful information to investors.\193\ The purpose of the disclosure 
is not to single out particular issuers or to imply that a particular 
listed issuer's home country regime is somehow less effective. Instead, 
the disclosure is designed to provide additional transparency to 
investors regarding the listed issuer's audit committee arrangements 
and the issuer's assessment of the effectiveness of those arrangements.
---------------------------------------------------------------------------

    \191\ See, e.g., the Letters of ABA; S&C.
    \192\ See, e.g., the Letters of Cravath; Nippon Keidanren; 
Matsushita; NTT DoCoMo, Inc.
    \193\ See, e.g., the Letters of CalPERS; CII; CSC; Deloitte; 
E&Y PwC; Teachers Insurance and Annuity Association `` College 
Retirement Equities Fund (``TIAA-CREF''); Transparency 
International-USA.
---------------------------------------------------------------------------

    We proposed that foreign private issuers availing themselves of the 
exemption for boards of auditors and similar structures would be 
required to file an exhibit to their annual reports stating that they 
are doing so. This exhibit would have been in addition to the 
disclosure required in the body of the report regarding the issuer's 
use of that exemption. Several commenters did not support the exhibit 
requirement, arguing that it would be unnecessarily

[[Page 18807]]

redundant of the disclosure in the report.\194\ To avoid imposing a 
duplicative requirement, we are not adopting the exhibit requirement.
---------------------------------------------------------------------------

    \194\ See, e.g., the Letters of ABA; Cleary; NTT DoCoMo, Inc.; 
ORIX Corporation.
---------------------------------------------------------------------------

    We proposed to exclude unit investment trusts from the disclosure 
requirements relating to their use of the general exemption for UITs. 
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. We also proposed to exclude issuers availing 
themselves of the multiple listing exemption from the disclosure 
requirements. These issuers, or their controlling parents, will be 
required to comply with the audit committee requirements as a result of 
a separate listing. Accordingly, disclosure of the use of that 
exemption will not serve the purpose of highlighting for investors 
those issuers that are different from most other listed issuers. The 
majority of commenters supported these proposals, and we are adopting 
them.\195\
---------------------------------------------------------------------------

    \195\ Compare, e.g., the Letters of ABA; CCU; General Electric 
Company; General Motors Corporation; General Motors Acceptance 
Corporation; Nasdaq; PSEG with the Letter of CalPERS.
---------------------------------------------------------------------------

    We requested comment on whether we should exclude additional 
issuers from the exemption disclosure requirement. Some commenters 
recommended excluding disclosure of additional exemptions, such as the 
exemptions for overlapping boards, security futures products, 
standardized options, securities issued by foreign governments and 
securities issued by Asset-Backed Issuers and similar passive 
issuers.\196\ For overlapping boards, issuers relying on that exemption 
will still be required to have independent directors, so disclosure of 
the exemption would not serve to highlight those issuers that are 
different from most issuers. Regarding security futures products, 
standardized options, foreign governments and Asset-Backed Issuers and 
similar passive issuers, like UITs, there would be little reason to 
believe that these issuers would have audit committees. Accordingly, we 
also are excluding listed issuers that rely on these exemptions from 
the disclosure requirement.
---------------------------------------------------------------------------

    \196\ See, e.g., the ABA Letter.
---------------------------------------------------------------------------

2. Identification of the Audit Committee in Annual Reports
    An issuer subject to the proxy rules of section 14 of the Exchange 
Act \197\ 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.\198\ As discussed in the 
Proposing Release, 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 adopting as proposed a requirement that 
disclosure of the members of the audit committee be included or 
incorporated by reference in the listed issuer's annual report.\199\ 
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 also are requiring 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.
---------------------------------------------------------------------------

    \197\ 15 U.S.C. 78n.
    \198\ See Item 7(d)(1) of Schedule 14A. Identical information is 
required with respect to nominating and compensation committees of 
the board of directors.
    \199\ Because this information will be included in Part III of 
annual reports on Forms 10-K and 10-KSB, companies subject to the 
proxy rules will 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, will continue to be required only in proxy or 
information statements that involve the election of directors.
---------------------------------------------------------------------------

    We are adopting as proposed 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 are adopting the 
requirement that these issuers must disclose if the entire board of 
directors is acting as the audit committee.\200\ We also are adopting 
similar changes for registered management investment companies.\201\
---------------------------------------------------------------------------

    \200\ In addition, we have added an instruction to Item 6.C. in 
Form 20-F that if the company is relying on the exemption in 
Exchange Act rule 10A-3(c)(3) because it has a board of auditors or 
similar body, the disclosure required by that Item with regard to 
the company's audit committee can be provided with respect to the 
company's board of auditors, or similar body.
    \201\ Item 22(b)(14) of Schedule 14A and Item 5 of Form N-CSR. 
Form N-CSR is 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. 25914 
(Jan. 27, 2003) [68 FR 5348].
---------------------------------------------------------------------------

    Commenters expressed support for these changes.\202\ Some 
commenters, however, recommended that listed issuers that are not 
required to provide disclosure of their reliance on one of the 
exemptions to the rule--such as a subsidiary relying on the multiple 
listing exemption, a foreign government issuer or an Asset-Backed 
Issuer or similar issuer--also should be excluded from the requirement 
to disclose whether or not they have a separate audit committee.\203\ 
According to these commenters, because these listed issuers need not 
disclose they are availing themselves of the exemption to the audit 
committee requirements, it would be anomalous to require these same 
listed issuers to disclose whether or not they have an audit committee. 
We are persuaded by these comments. Accordingly, we are excluding such 
issuers from this disclosure requirement. We are not making a 
corresponding change to Form N-CSR for registered management investment 
companies. We expect that registered management investment companies 
would only rarely, if at all, rely on the exemptions that trigger a 
disclosure requirement.\204\ We believe that in such an unusual case, 
it would nonetheless be appropriate for the investment company to 
disclose whether it has an audit committee.
---------------------------------------------------------------------------

    \202\ See, e.g., the Letters of ABA; CalPERS; CSC; PwC; 
Transparency International-USA.
    \203\ See, e.g., the Letters of Edison International; General 
Electric Company; TFC.
    Unit investment trusts are not required to provide disclosure of 
their use of the exemption under Exchange Act rule 10A-3(c)(6)(ii). 
See Exchange Act rule 10A-3(d). As proposed, UITs were not subject 
to any requirement that they disclose whether or not they have a 
separate audit committee, since UITs do not file proxy or 
information statements where action is to be taken with respect to 
election of directors, or Form N-CSR, where such disclosure would be 
made.
    \204\ These exemptions include those for listing certain 
securities of subsidiaries of a parent whose listed securities are 
subject to Exchange Act rule 10A-3, security futures products, 
standardized options, securities issued by asset-backed issuers, 
foreign governments and passive issuers. Exchange Act rule 10A-
3(c)(2), (4)-(7) [17 CFR 240.10A-3(c)(2), (4)-(7)].
---------------------------------------------------------------------------

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

[[Page 18808]]

respect to the election of directors.\205\ 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.\206\ 
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.\207\ 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.\208\ 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.\209\ Issuers whose 
securities are not listed on the NYSE or AMEX or quoted on Nasdaq also 
are required to disclose whether their 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.\210\
---------------------------------------------------------------------------

    \205\ See Item 7(d)(3) of Schedule 14A. These disclosure 
requirements were adopted in Release No. 34-42266 (Dec. 22, 1999).
    \206\ 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.
    \207\ See Items 7(d)(3)(ii) and (iii) of Schedule 14A.
    \208\ See Item 7(d)(3)(iv)(A)(1) of Schedule 14A.
    \209\ See Item 7(d)(3)(iv)(A)(2) of Schedule 14A.
    \210\ 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 final rule 
will 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 is therefore no longer 
necessary.
    Accordingly, as proposed, we are updating 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. 
Commenters supported these updates.\211\ If the registrant is a listed 
issuer, it will still be required to disclose whether the members of 
its audit committee are independent. The listed issuer must 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 are clarifying in the rules 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.
---------------------------------------------------------------------------

    \211\ See, e.g., the Letters of ABA; CalPERS; CSC; PwC.
---------------------------------------------------------------------------

    Non-listed issuers that have separately designated audit committees 
will still be required to disclose whether their audit committee 
members are independent. In determining whether a member is 
independent, these registrants will 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.\212\
---------------------------------------------------------------------------

    \212\ Such definition must include the requirements of Exchange 
Act section 10A-3. These issuers will 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 will be retained.
---------------------------------------------------------------------------

    In the Proposing Release, we proposed eliminating disclosure by 
listed issuers of use of an exceptional and limited circumstances 
exception in existing SRO listing standards. We did so because our 
rules do not provide a similar exception to the independence 
requirements mandated by Exchange Act rule 10A-3. However, it is 
conceivable that some SROs may retain an exceptional and limited 
circumstances exception for SRO independence requirements apart from 
those in Exchange Act rule 10A-3. We are therefore retaining disclosure 
of the use of such an exemption for standards apart from the 
requirements in Exchange Act rule 10A-3. We also are eliminating the 
exclusion of small business issuers from this disclosure requirement, 
as it is conceivable that such an exception could extend to these 
issuers as well.
    Issuers must comply with the new disclosure changes regarding use 
of exemptions, identification of the audit committee in annual reports 
and the independence disclosure updates beginning with reports covering 
periods ending on or after (or proxy or information statements for 
actions occurring on or after) the compliance date for the listing 
standards applicable to the particular issuer. If the issuer is not a 
listed-issuer, it should use the date that would apply as if it was a 
listed issuer. Until such dates, issuers should continue to comply with 
existing Items 7(d)(3)(iv) and 22(b)(14) in their proxy and information 
statements, if applicable.
    Several commenters advocated additional disclosure regarding a 
board's determination of an audit committee member's independence apart 
from that currently required.\213\ Several of the additional SRO 
listing standards currently under consideration by the Commission would 
require such disclosure by listed issuers.\214\ We intend to analyze 
these proposals and the SRO rules implementing Exchange Act 10A-3 to 
determine if any additional disclosure in this area would be 
appropriate.
---------------------------------------------------------------------------

    \213\ See, e.g., the Letters of AFL-CIO; AICPA; Amex; Deloitte; 
PwC; Transparency International-USA. However, for commenters that 
did not support such expanded disclosure, see, e.g., the Letters of 
ABA; Southern Company.
    \214\ See note 27 above.
---------------------------------------------------------------------------

4. Audit Committee Financial Expert Disclosure for Foreign Private 
Issuers
    In our release adopting the disclosure requirements for audit 
committee financial experts, we expressed our intention to revisit the 
disclosure requirements regarding the independence of audit committee 
financial experts of foreign private issuers.\215\ Specifically, we 
noted that in conjunction with the adoption of rules implementing 
Exchange Act section 10A(m), we would revise the audit committee 
financial expert disclosure requirements that apply to foreign private 
issuers such that the concept of ``independence'' under the section 
10A(m) rules would be consistent with the concept of ``independence'' 
under the audit committee financial expert disclosure requirements. 
Therefore, we are now adopting amendments to the audit committee 
financial expert disclosure provisions as they apply to foreign private 
issuers. If the foreign private issuer is a listed issuer, the 
amendments require the foreign private issuer to disclose whether its 
audit committee financial expert is independent, as that term is 
defined by the SRO listing standards applicable to that issuer.\216\ If 
a foreign private issuer is not a listed issuer, it must choose one of 
the SRO definitions of audit committee member independence that have 
been approved by the Commission

[[Page 18809]]

in determining whether its audit committee financial expert, if it has 
one, is independent. It must also disclose which definition was used. 
Foreign private issuers need not comply with these disclosure 
requirements until July 31, 2005.
---------------------------------------------------------------------------

    \215\ See Release No. 33-8177 (Jan. 23, 2003).
    \216\ See revised Item 16A of Form 20-F and revised paragraph 8 
to General Instruction B of Form 40-F.
---------------------------------------------------------------------------

    Also in that release, we noted our intention to address the 
treatment of a foreign private issuer with a board of auditors or 
statutory auditors under home country legal or listing provisions. 
Specifically, we requested comment as to whether and, if so, how 
foreign private issuers with boards of auditors or similar bodies or 
statutory auditors should comply with the audit committee financial 
expert disclosure requirements. We received several comments both 
supporting and opposing application of such disclosure requirements to 
issuers with such bodies. One commenter suggested that the audit 
committee financial expert's expertise should be related to home 
country generally accepted accounting principles (``GAAP''), even if 
the issuer's primary financial statements are filed with the Commission 
in conformity with U.S. GAAP. We believe that the intent of section 407 
of Sarbanes-Oxley Act is to strengthen audit committee oversight of the 
preparation and audit of financial statements that are presented to 
U.S. investors, and thus we continue to believe that the audit 
committee financial expert's expertise should be related to the body of 
generally accepted accounting principles used in the issuer's primary 
financial statements filed with the Commission. We do, however, 
acknowledge the differing regulatory structures of foreign 
jurisdictions. Therefore, we have added a sentence to the instructions 
to the audit committee financial expert disclosure provisions to 
clarify that, for purposes of those provisions, the term ``audit 
committee'' means the board of auditors or similar bodies or statutory 
auditors, if the issuer meets the criteria specified in new rule 10A-
3(c)(3).\217\
---------------------------------------------------------------------------

    \217\ See revised Instruction 3 to Item 401(h) of Regulation S-K 
and revised Instruction 3 to Item 16A of Form 20-F.
---------------------------------------------------------------------------

H. Application to the Commission's Auditor Independence Rules

    Similar to the issues addressed by the multiple listing exception 
discussed in section II.F.2.a, some commenters raised an issue with 
respect to the audit committee pre-approval requirements contained in 
the Commission's auditor independence rules.\218\ Those rules require 
that the issuer's audit committee pre-approve audit and non-audit 
services provided to the issuer and its consolidated subsidiaries \219\ 
by the independent accountant. However, to the extent that a 
consolidated entity contains more than one issuer, some have indicated 
that it is not clear whether the parent company audit committee's pre-
approval of the services to be provided by the independent accountant 
would satisfy the pre-approval requirements for the separately-issued 
financial statements of a subsidiary which also is an issuer.\220\
---------------------------------------------------------------------------

    \218\ See Release No. 33-8183 (Jan. 28, 2003).
    \219\ In accordance with the Commission's rules on auditor 
independence, the issuer's audit committee is required to pre-
approve audit and non-audit services for the issuer and all of its 
consolidated subsidiaries whether those subsidiaries are separate 
issuers or not.
    \220\ For example, some entities may be issuers as a result of 
registered debt outstanding.
---------------------------------------------------------------------------

    The Commission believes that the audit committee of the parent 
company that controls another entity within the consolidated group can 
perform the pre-approval function for the parent company and any 
consolidated subsidiaries both with respect to the consolidated 
financial statements and with respect to the financial statements of 
any consolidated subsidiary that also is an issuer. However, the 
Commission also understands that there may be instances where such 
entities have their own audit committees. In those situations, we would 
not expect that both audit committees be responsible for pre-approving 
the services that are provided by the auditor. Rather, the relevant 
facts and circumstances surrounding the engagement or relationship 
should be evaluated to determine which audit committee is in the best 
position to review the impact of the service on the auditor's 
independence.
    As noted at the beginning of section II, the definition of the term 
``audit committee'' in Exchange Act section 3(a)(58) provides that 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 will 
constitute the audit committee.\221\ Moreover, as discussed in section 
II.F.3.a.vi, certain foreign jurisdictions permit many of the functions 
normally performed by audit committees to be performed by a board of 
auditors or similar body which is separate in whole or in part from the 
issuer's board of directors.
---------------------------------------------------------------------------

    \221\ See note above and the accompanying text.
---------------------------------------------------------------------------

    In either of these situations, commenters have asked how issuers 
should comply with the audit committee pre-approval requirements 
established by the Commission in its rules on auditor independence. 
While the Commission's rules on auditor independence require that the 
audit committee pre-approve audit and non-audit services provided by 
the independent accountant, those rules do not require that companies 
establish separately-designated audit committees. If an issuer chooses 
to do so or fails to form a separate committee, the entire board of 
directors will constitute the audit committee and may perform the pre-
approval function for the issuer.\222\ Furthermore, consistent with the 
intent of Exchange Act rule 10A-3(c)(3), in situations where the issuer 
has a board of auditors or similar body as allowed by law or listing 
requirements of that jurisdiction, such board or body may perform the 
audit committee pre-approval function required by the Commission's 
rules on auditor independence.
---------------------------------------------------------------------------

    \222\ However, as previously discussed, if the issuer is a 
listed issuer and its entire board constitutes the audit committee, 
the new SRO rules adopted under Exchange Act Rule 10A-3, including 
the independence requirements, will apply to the issuer's board as a 
whole. See note 34 above and the accompanying text.
---------------------------------------------------------------------------

    The Commission also reminds registrants and their auditors that the 
Commission's rules require that auditors communicate certain 
information to the audit committee.\223\ The same body responsible for 
pre-approval of audit and non-audit services also should be the body to 
whom these required communications are made by the issuer's auditor.
---------------------------------------------------------------------------

    \223\ Auditors are required to communicate the following 
information to the issuer's audit committee: (1) All critical 
accounting policies and practices used by the issuer, (2) all 
alternative accounting treatments of financial information within 
GAAP related to material items that have been discussed with 
management, including the ramifications of the use of such 
alternative treatments and disclosures and the treatment preferred 
by the accounting firm, and (3) other material written 
communications between the accounting firm and management of the 
issuer. See Rule 2-07 of Regulation S-X [17 CFR 210.2-07].
---------------------------------------------------------------------------

III. Paperwork Reduction Act

A. Background

    The amendments described in this document contain ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995 (``PRA'').\224\ We published a notice requesting 
comment on the collection of information requirements in the Proposing 
Release, and we submitted these requirements to the Office of 
Management and Budget (``OMB'') for review in accordance with the 
PRA.\225\ As discussed in Part II

[[Page 18810]]

above, we received several comment letters on the proposals. We have 
made several changes to the proposals in response to these comments 
which will reduce the incremental burden associated with the final rule 
and rule amendments. Accordingly, we are revising our previous burden 
estimates.
---------------------------------------------------------------------------

    \224\ 44 U.S.C. 3501 et seq.
    \225\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.
---------------------------------------------------------------------------

    The titles for the collections of information are:
    (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.

B. Summary of Amendments

    Under our amendments, 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 changes 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 amendments, we are adopting several limited 
exemptions from the requirements to address the special circumstances 
of particular issuers. If an issuer were to avail itself of one of 
these exemptions, it would need to disclose this fact and its 
assessment of whether, and if so, how, such reliance will materially 
adversely affect the ability of the audit committee to act 
independently and to satisfy the other requirements of the final rule. 
Such disclosure will need to appear in its proxy or information 
statement for shareholders' meetings at which elections for directors 
are held. The disclosure also will need to appear in, or be 
incorporated by reference into, the annual reports of these companies 
filed with the Commission. We are excluding issuers from these 
disclosure requirements for reliance on certain exemptions, such as the 
overlapping board exemption, the multiple listing exemption and the 
exemption for exchange-traded UITs, foreign government issuers and 
Asset-Backed Issuers and similar issuers. Collectively, we call these 
changes the ``Exemption Disclosure.''
    Under our amendments, listed issuers also will be required to 
disclose the names of the members of their audit committee, or that 
their entire board of directors is acting as their audit committee, in 
their annual reports. Listed issuers that will be excluded from the 
Exemption Disclosure will also be excluded from this disclosure, except 
for issuers relying on the overlapping board exemption. We call these 
changes the ``Identification Disclosure.''
    Finally, we are adopting several updates to existing disclosure 
requirements regarding audit committees to reflect our amendments and 
changes made by the Sarbanes-Oxley Act. We call these 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 is 
mandatory. There will be no mandatory retention period for the 
information disclosed, and responses to the disclosure requirements 
will not be kept confidential. We do not believe that the imposition of 
these disclosure changes will alter significantly the number of 
respondents that file on the affected forms.
    In addition to the above, our final rule adopts, as proposed, a 
requirement that SROs must 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 will be minimal. For the most part, we 
believe that listed issuers are already required to make the type of 
disclosure contemplated by this requirement, 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 requirements are ``usual and customary'' 
activities for listed issuers.\226\
---------------------------------------------------------------------------

    \226\ See 5 CFR 1320.3(b)(2).
---------------------------------------------------------------------------

C. Summary of Comment Letters and Revisions to Proposals

    We requested comment on the PRA analysis contained in the Proposing 
Release. We received no comments in response to this request. While we 
have adopted the disclosure amendments substantially as proposed, some 
of the changes we have made in the final rules will reduce the number 
of listed issuers that will be required to make the required 
disclosure. For example, we have excluded additional issuers from the 
Exemption Disclosure. These changes will reduce the burden on these 
registrants. Accordingly, we are revising our PRA reporting and cost 
burden estimates.

D. Revisions to PRA Reporting and Cost Burden Estimates

    As a result of the changes described above, the reporting and cost 
burden estimates for the collections of information have changed. For 
purposes of the PRA, we now estimate that the annual incremental 
paperwork burden for all companies to prepare the disclosure that will 
be required under our amendments will be approximately 401 hours of 
personnel time and a cost of approximately $62,400 for the services of 
outside professionals. We derived these estimates first by estimating 
the total amount of time it will take for a company to prepare the 
required disclosure. The Disclosure Updates simply update the 
disclosure requirements to reflect our amendments and changes to 
terminology made by the Sarbanes-Oxley Act. We do not believe these 
changes will change the burden required by this disclosure. The 
Exemption Disclosure will require only a minimal additional statement 
by issuers that avail themselves of one of the exemptions in Exchange 
Act rule 10A-3. We estimated that the Exemption Disclosure will add 
0.25 hours per affected filing. The Identification Disclosure will 
require a company to disclose either the members

[[Page 18811]]

of its audit committee, or a brief statement that the board of 
directors of the issuer is acting as the audit committee. We estimated 
that the Identification Disclosure will add 0.25 hours per affected 
filing.
    The Exemption Disclosure and Identification Disclosure apply only 
to listed issuers. Accordingly, not all issuers will be required to 
make the 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.\227\ Each of 
these listed issuers, except for certain issuers relying on exemptions, 
will be required to at least provide the basic Identification 
Disclosure in their annual report. Some of these listed issuers also 
will need to make the Exemption Disclosure.\228\ We have increased the 
number of issuers that will not need to make the Exemption Disclosure.
---------------------------------------------------------------------------

    \227\ We derived this estimate from 2002 data from the Standard 
& Poors Research Insight Compustat Database and the Commission's 
2001 annual report.
    \228\ With respect to investment companies, the independence 
exemptions will not be available. A general exemption will be 
applicable to UITs, but UITs are excluded from Exemption Disclosure 
requirements. We anticipate that only a negligible number of 
investment companies will fall under the other general exemptions. 
Accordingly, we anticipate that the reporting burden imposed by the 
Exemption Disclosure requirements on listed investment companies 
will 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 will appear in a maximum of 
one report per affected issuer. As the information will 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 directors are to be 
elected), or in item 5 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 
reduced the number of affected reports on Forms 10-K, 10-KSB and N-CSR 
to account for this assumption.\229\ Further, we assume that the 
Identification Disclosure is already provided in these proxy or 
information statements,\230\ and the burden hours for this disclosure 
by these filers therefore has already been assigned to Schedules 14A 
and 14C. Accordingly, we estimated that the Identification Disclosure 
will not affect the burden for Schedules 14A and 14C.
---------------------------------------------------------------------------

    \229\ 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.
    \230\ See Item 7(d)(1) of Schedule 14A.
---------------------------------------------------------------------------

    The tables below illustrate the revised 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 disclosure. We have based our 
estimates of 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.\231\ 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 at an average cost of 
$300 per hour.\232\ 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.
---------------------------------------------------------------------------

    \231\ We estimate that 5% of listed issuers will be required to 
provide disclosure regarding the new issuer exemption in Exchange 
Act Rule 10A-3(b)(iv)(A). This is based on a weighted average of the 
number of listed companies that went public over the last three 
years.
    \232\ 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.

                     Calculation of the Incremental Burden of the Exemption Disclosure \233\
----------------------------------------------------------------------------------------------------------------
                                                              Total                                     $300
                                  Affected   Incremental   incremental   75% company       25%      professional
                                  responses   hours/form     burden                   professional      cost
                                        (A)          (B)   (C)=(A)x(B)  (D)=(C)x0.75  (E)=(C)x0.25   (F)=(E)x300
--------------------------------
20-F...........................   292 \234\         0.25            73            18            55    $16,500.00
40-F...........................     7 \235\         0.25             2             1             2       $600.00
10-K...........................    54 \236\         0.25            14            11             4     $1,200.00
10-KSB.........................    22 \237\         0.25             6             5             2       $600.00
14A............................   271 \238\         0.25            68            51            17     $5,100.00
14C............................    17 \239\         0.25             4             3             1       $300.00
    Total......................  ..........  ...........           167            89            81    $24,300.00
----------------------------------------------------------------------------------------------------------------


                     Calculation of the Incremental Burden of the Identification Disclosure
----------------------------------------------------------------------------------------------------------------
                                                              Total                                     $300
                                  Affected   Incremental   incremental   75% company       25%      professional
                                  responses   hours/form     burden                   professional      cost
                                        (A)          (B)   (C)=(A)x(B)  (D)=(C)x0.75  (E)=(C)x0.25   (F)=(E)x300
--------------------------------
20-F...........................     0 \240\         0.25             0             0             0         $0.00
40-F...........................   134 \241\         0.25            34             9            26     $7,800.00
10-K...........................       1,073         0.25           268           201            67    $20,100.00
                                      \242\
10-KSB.........................   430 \243\         0.25           108            81            27     $8,100.00
N-CSR..........................   113 \244\         0.25            28            21             7     $2,100.00

[[Page 18812]]

 
14A............................     0 \245\         0.25             0             0             0         $0.00
14C............................     0 \246\         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 filings under the Securities Act and the Exchange Act. 
The disclosure changes will 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.
---------------------------------------------------------------------------

    \233\ 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).
    \234\ This figure is based on our estimate of the total number 
of affected responses by listed issuers.
    \235\ This figure is based on our estimate of the total number 
of affected responses by listed issuers.
    \236\ 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.
    \237\ 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.
    \238\ This figure is based on our estimate of the total number 
of affected responses by listed issuers.
    \239\ This figure is based on our estimate of the total number 
of affected responses by listed issuers.
    \240\ Issuers that file their annual report on Form 20-F are 
already required to identify the members of their audit committee.
    \241\ This figure is based on our estimate of the total number 
of affected responses by listed issuers.
    \242\ 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.
    \243\ 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.
    \244\ 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 5 information would be incorporated by 
reference from a proxy or information statement.
    \245\ We estimate that proxy statements on Schedule 14A are 
already required to identify the members of their audit committee.
    \246\ We estimate that information statements on Schedule 14C 
are already required to identify the members of their audit 
committee.
---------------------------------------------------------------------------

IV. Cost-Benefit Analysis

    The amendments 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 our amendments.

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 will 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 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.
    The amendments described in this document respond directly to the 
requirements in section 10A(m) of the Exchange Act. In addition, our 
amendments include several additional provisions, such as:
    [sbull] Revising 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] Requiring a company availing itself of one of the 
exemptions from the requirements to disclose that it is doing so;
    [sbull] Updating existing disclosure requirements regarding audit 
committees to reflect changes made by the amendments and the Sarbanes-
Oxley Act; and
    [sbull] Revising the disclosure requirements regarding the 
independence of audit committee financial experts for foreign private 
issuers.

B. Benefits

    One of the main goals of the Sarbanes-Oxley Act is to improve 
investor confidence in the financial markets. The amendments in this 
document are among many required by the Sarbanes-

[[Page 18813]]

Oxley Act.\247\ 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 amendments are 
designed to further greater accountability and to improve the 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. Commenters overwhelmingly supported the benefits 
of the amendments and the importance of audit committees to the 
financial reporting process. Further, as the Blue Ribbon Committee on 
Improving the Effectiveness of Corporate Audit Committees summarized 
regarding its own recommendations for audit committees:
---------------------------------------------------------------------------

    \247\ See note 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.\248\
---------------------------------------------------------------------------

    \248\ See note above.

    In addition, we are requiring 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 are requiring a listed issuer that has 
not 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. Also, if a company relies on one of the exemptions to 
the requirements, some minimal additional disclosure will be required. 
In our final rules, we are excluding certain issuers from these 
disclosure requirements to reduce overall burdens consistent with 
investor protection. We also are making several updates to existing 
disclosure requirements regarding audit committees and audit committee 
financial experts to reflect the final rule and changes made by the 
Sarbanes-Oxley Act.
    As a result of these disclosure changes, investors will 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. 
The overwhelming majority of commenters, including many representing 
investor groups, expressed strong support for the changes, believing 
they provide important information for investors.

C. Costs

    SROs not in compliance with the standards will 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. If the standards 
have the effect of causing companies to delist or forego listing of 
their securities, SROs will lose trading volume. The 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 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 will need to comply with the audit committee standards if 
they wish to have their securities listed on a national securities 
exchange or national securities association. This may require one-time 
costs by companies to spend additional time and incur additional costs 
in establishing or 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 will 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 new 
requirements. If additional independent directors were 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 will be prohibited under the final 
rule, 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 incurs expenses or engages independent 
counsel or other advisors where it could not do so previously, there 
will be additional costs for the payment for such expenses and 
advisors. Companies also may incur additional ongoing expenses if they 
decide to increase the size of their boards in response to the 
requirements. In addition, the incremental cost of future director 
searches to replace an audit committee member may likely be higher as a 
result of the additional independence requirements.
    We believe that as a result of many current SRO listing 
standards,\249\ the Commission's audit committee disclosure 
requirements adopted in 1999,\250\ 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,\251\ and professional standards that require 
communications between the auditor and audit committees on auditor 
independence issues,\252\ many companies currently

[[Page 18814]]

have audit committees. However, these audit committees may not meet all 
of the requirements of the final rule. Smaller companies may constitute 
a larger representative share of issuers that do not meet the 
requirements, particularly the independence requirements. However, we 
recognize that because the requirements 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. Nevertheless, we are providing an additional 
transition period for smaller issuers to alleviate some of the 
potential burdens they may face. We are also providing an additional 
transition period for foreign issuers. Companies that do not currently 
meet the requirements will 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.
---------------------------------------------------------------------------

    \249\ See note 24 above.
    \250\ See note 25 above.
    \251\ See, e.g., Item 4 of Form 8-K [17 CFR 249.308] and Item 
304 of Regulation S-K [17 CFR 229.304].
    \252\ See, e.g., 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 are adopting 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. Commenters expressed overwhelming support for 
these exemptions which will alleviate unnecessary costs and burdens 
companies may face without any attendant loss in investor protection. 
Companies that perceive the requirements as too onerous could be 
dissuaded from seeking or maintaining a listing for their securities, 
which could impact capital formation and negatively impact the 
transparency and liquidity of its securities.
    We requested comment on the type, amount and duration of these 
costs. We received no specific data in response to our request. We have 
no reliable basis for estimating the actual number of companies that 
will face increased costs as a result of Exchange Act Section 10A(m) or 
the amount of such costs.
    With respect to the disclosure changes 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 estimated that the incremental 
impact of our disclosure changes will result in a total cost of 
$112,525 for all affected companies.\253\
---------------------------------------------------------------------------

    \253\ 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 401 internal burden hours and $62,400 in external 
costs. Assuming a cost of $125/hour for in-house professional staff, 
the total cost for the internal burden hours would be $50,125. Hence 
the aggregate cost estimate is $112,525 ($50,125 + 62,400). 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).
---------------------------------------------------------------------------

    In formulating the final amendments, we considered several 
regulatory alternatives that would be consistent with the specific 
mandate required by section 10A(m) of the Exchange Act. For example, we 
considered the propriety of excluding all foreign issuers, issuers of a 
particular size or additional classes of securities, but we determined 
that such an exclusion would not be appropriate or consistent with the 
policies underlying the Sarbanes-Oxley Act. The overwhelming majority 
of commenters agreed with this approach. 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 
independence requirement. While the majority of commenters supported a 
safe harbor, some did not want a safe harbor for fear any thresholds in 
the safe harbor would be viewed as a ceiling that would disqualify a 
director from serving on the audit committee. In considering the 
uncertainty that may arise in determining whether a person is an 
``affiliated person,'' we have adopted a safe harbor from the 
definition of affiliate for non-investment companies. However, to add 
clarity we have added explicit language specifying that the thresholds 
in the safe harbor are not designed to be viewed as an upper limit on 
permissible levels.
    We have also adopted other limited exemptions to alleviate some of 
the burdens companies may face where consistent with the Sarbanes-Oxley 
Act and investor protection. We have expanded these exemptions in a 
number of instances, where consistent with the Sarbanes-Oxley Act and 
investor protection, to alleviate unnecessary burdens and expenses. We 
believe the final rule reflects an appropriate balance between 
investors and investor groups who advocated more stringent requirements 
and issuers and their representatives who requested a much larger 
expansion of the exemptions.

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

    Section 23(a)(2) of the Exchange Act \254\ 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.
---------------------------------------------------------------------------

    \254\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    The amendments represent the implementation of a Congressional 
mandate. They are intended to increase the independence and 
effectiveness of listed company audit committees. We anticipate these 
requirements will 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, the 
requirements 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 fewer 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 and investors to lose liquidity or 
the benefits of trading in a U.S. market. 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.
    Section 2(b) of the Securities Act,\255\ section 3(f) of the 
Exchange Act \256\ and section 2(c) of the Investment Company

[[Page 18815]]

Act \257\ 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 amendments are designed to 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 requirements could have 
certain indirect negative effects, such as inconsistent application 
across all competitors. In addition, the requirements, 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.
---------------------------------------------------------------------------

    \255\ 17 U.S.C. 77b(b).
    \256\ 15 U.S.C. 78c(f).
    \257\ 15 U.S.C. 80a-2(c).
---------------------------------------------------------------------------

    If a company found the requirements too onerous, it could be 
dissuaded from accessing the U.S. 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 are 
adopting several limited exemptions from the requirements to alleviate 
some of the burdens companies may face where consistent with investor 
protection. For example, the limited exemption for new public companies 
is intended to counteract any disincentive the requirements may have on 
a company's willingness to access the public capital markets.
    We requested comments on these analyses in the Proposing Release. 
We received no comments in response to these requests.

VI. Final Regulatory Flexibility Analysis

    This Final Regulatory Flexibility Analysis, or FRFA, has been 
prepared in accordance with the Regulatory Flexibility Act.\258\ This 
FRFA involves new rules and amendments 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. 
An Initial Regulatory Flexibility Analysis (``IRFA'') was prepared in 
accordance with the Regulatory Flexibility Act \259\ in conjunction 
with the Proposing Release. The Proposing Release included the IRFA and 
solicited comments on it.
---------------------------------------------------------------------------

    \258\ 5 U.S.C. 601.
    \259\ 5 U.S.C. 603.
---------------------------------------------------------------------------

A. Need for the Amendments

    We are adopting new Exchange Act rule 10A-3 to comply with the 
mandate of the Sarbanes-Oxley Act and new section 10A(m)(1) of the 
Exchange Act. The amendments 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, the amendments change 
current disclosure requirements regarding audit committees to increase 
the transparency of these committees. We believe that these amendments 
will help to improve the quality and accountability of financial 
disclosure and oversight of the process by qualified and independent 
audit committees.

B. Significant Issues Raised by Public Comment

    We received no comments in response to the IRFA.

C. Small Entities Subject to the Amendments

    The amendments 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)\260\ 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.\261\ The amendments also will directly 
affect national securities associations. No affected national 
securities association is a small entity, as defined by 13 CFR 121.201.
---------------------------------------------------------------------------

    \260\ 17 CFR 240.0-10(e).
    \261\ 17 CFR 240.11Aa3-1.
---------------------------------------------------------------------------

    The amendments 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.\262\ 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.\263\ We estimate that less than 
225, or approximately 3%, of the issuers that are not investment 
companies,\264\ and less than 25, or approximately 4% of the issuers 
that are investment companies,\265\ are ``small entities'' for purposes 
of the Regulatory Flexibility Act that possibly could be affected by 
the amendments.
---------------------------------------------------------------------------

    \262\ See Exchange Act rule 0-10(a).
    \263\ See note above.
    \264\ We derived this estimate from the Standard & Poors 
Research Insight Compustat Database.
    \265\ We derived this estimate from information compiled by 
Commission staff.
---------------------------------------------------------------------------

D. Reporting, Recordkeeping, and Other Compliance Requirements

    Under the amendments, 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 will need to comply with these standards if they 
wish to have their securities listed on a national securities exchange 
or a national securities association. The rules will 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.\266\ However, not all of the audit 
committees of these small entities may comply with the new 
requirements. A small entity whose board or audit committee does not 
comply with the new requirements will

[[Page 18816]]

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.
---------------------------------------------------------------------------

    \266\ 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 incurs expenses or engages independent 
counsel or other advisors where it could not do so previously, there 
will be additional costs for the payment of these expenses and 
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 rules. Small entities subject to 
the proxy rules are already required to disclose most of the 
information affected by our amendments 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 final rules and amendments or how much it would 
cost to comply. We recognize that because the amendments 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 and number of 
issuers that will be affected by the requirements.

E. Agency Action To Minimize Effect on Small Entities

    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 the amendments, 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.\267\ However, we are sensitive to the costs and 
burdens that will be faced by small entities. We have endeavored 
through the amendments to alleviate the regulatory burden on all listed 
issuers, including the small proportion of small entities that will be 
affected, while meeting our regulatory objectives.
---------------------------------------------------------------------------

    \267\ See note above.
---------------------------------------------------------------------------

    We believe that a blanket exemption for small entities from 
coverage of the requirements is not appropriate and inconsistent with 
the policies underlying the Sarbanes-Oxley Act. Similarly, we believe 
that different compliance requirements for small entities also would 
interfere with achieving the primary goal of the amendments to increase 
the competency and effectiveness of audit committees for all companies 
with listed securities. The majority of commenters generally agreed 
with this approach and did not support lesser standards for smaller 
issuers overall. These commenters did not believe the requirements will 
impose a disproportionate burden on small issuers. We recognize that 
because the requirements 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.
    Other commenters, however, were concerned that smaller issuers may 
have particular difficulty locating qualified audit committee 
candidates that will meet the independence criteria, especially given 
the implementation period proposed by the Commission. While these 
commenters advocated various approaches, such as an exceptional and 
limited circumstances exemption for smaller issuers or SRO authority to 
exempt individual small issuers on a case-by-case basis, most agreed 
that an additional implementation period would be appropriate for these 
issuers. We are sensitive to the possible implication for smaller 
issuers and for SROs that would like to specialize in securities of 
these issuers. The final rule provides an extended compliance period 
for listed issuers that are small business issuers. In addition, the 
modifications to several of the other exemptions in the final rule, 
such as the overlapping board exemption and the new issuer exemption, 
should provide additional flexibility to small and new issuers in 
meeting the requirements of the rule. Our approach of not mandating 
specific procedures for the auditor responsibility requirement and the 
complaint procedures requirement should give issuers additional 
flexibility in meeting these requirements. Given the fact that the 
requirements will impact such a small number of small entities, we are 
not aware of how to further clarify, consolidate or simplify these 
amendments for small entities.
    The amendments use performance standards in a number of respects. 
As noted above, we are not specifying the specific procedures or 
arrangements an issuer or audit committee must develop to comply with 
the standards. 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 statutory mandate. 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 are not using that authority at this 
time for small entities.

VII. Effective Date

    The final rules and amendments are effective on April 25, 2003. The 
Administrative Procedure Act, or APA, generally requires that an agency 
publish an adopted rule in the Federal Register 30 days before it 
becomes effective.\268\ This requirement, however, does not apply if 
the agency finds good cause for making the rule effective sooner.\269\ 
The Commission believes that it is appropriate to waive the full 30-day 
advance publication of the new rule and amendments. The Sarbanes-Oxley 
Act requires the rules to be

[[Page 18817]]

effective by April 26, 2003. We have been working with the SROs to 
implement the statutory requirement in an orderly fashion. However, 
because of the extended compliance dates, a notice period of less than 
30 days should not prejudice anyone. Under the final rule and 
amendments, SROs are not required to submit proposals implementing the 
directive in Exchange Act rule 10A-3 until July 15, 2003. The rules 
based on those proposals must be approved by the Commission by December 
1, 2003. Listed issuers do not have to comply with the new listing 
rules until their first annual shareholders meeting after January 15, 
2004, at the earliest, and small business issuers and foreign private 
issuers will have additional time to comply. Issuers need not comply 
with the disclosure changes until reports covering periods ending on or 
after (or proxy or information statements for actions occurring on or 
after) the compliance date for the listing standards applicable to the 
listed issuer. Because of this delay before any action is required as a 
result of the rules, the Commission finds good cause to make the new 
rules and amendments effective on April 25, 2003.
---------------------------------------------------------------------------

    \268\ 5 U.S.C. 553(d).
    \269\ Id.
---------------------------------------------------------------------------

VIII. Statutory Authority and Text of Rule Amendments

    The amendments contained in this document are being adopted under 
the authority set forth in sections 2,\270\ 6,\271\ 7,\272\ 8,\273\ 
10,\274\ 17\275\ and 19\276\ of the Securities Act, sections 3(b), 10A, 
12, 13, 14, 15, 23 and 36\277\ of the Exchange Act, sections 8,\278\ 
20,\279\ 24(a),\280\ 30\281\ and 38\282\ of the Investment Company Act 
of 1940 and sections 3 and 301 of the Sarbanes-Oxley Act.
---------------------------------------------------------------------------

    \270\ 15 U.S.C. 77b.
    \271\ 15 U.S.C. 77f.
    \272\ 15 U.S.C. 77g.
    \273\ 15 U.S.C. 77h.
    \274\ 15 U.S.C. 77j.
    \275\ 15 U.S.C. 77q.
    \276\ 15 U.S.C. 77s.
    \277\ 17 U.S.C. 78mm.
    \278\ 15 U.S.C. 80a-8.
    \279\ 15 U.S.C. 80a-20.
    \280\ 15 U.S.C. 80a-24(a).
    \281\ 15 U.S.C. 80a-29.
    \282\ 15 U.S.C. 80a-37.
---------------------------------------------------------------------------

Text of Amendments

List of Subjects

17 CFR Parts 228, 229, 240 and 249

    Reporting and recordkeeping requirements, Securities.

17 CFR Part 274

    Reporting and recordkeeping requirements, Securities, Investment 
Companies.

0
In accordance with the foregoing, Title 17, Chapter II of the Code of 
Federal Regulations is amended as follows.

PART 228--INTEGRATED DISCLOSURE SYSTEM FOR SMALL BUSINESS ISSUERS

0
1. The general authority citation for Part 228 is revised 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, 80b-11 and 7202.

* * * * *

0
2. Amend Sec.  228.401 by adding paragraph (f) to read as follows:


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

* * * * *
    (f) Identification of the audit committee. (1) If you meet the 
following requirements, provide the disclosure in paragraph (f)(2) of 
this section:
    (i) You are a listed issuer, as defined in Sec.  240.10A-3 of this 
chapter;
    (ii) You are filing either an annual report on Form 10-KSB (17 CFR 
249.310b), or a proxy statement or information statement pursuant to 
the Exchange Act (15 U.S.C. 78a et seq.) if action is to be taken with 
respect to the election of directors; and
    (iii) You are neither:
    (A) A subsidiary of another listed issuer that is relying on the 
exemption in Sec.  240.10A-3(c)(2) of this chapter; nor
    (B) Relying on any of the exemptions in Sec.  240.10A-3(c)(4) 
through (c)(7) of this chapter.
    (2)(i) 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.
    (ii) 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.

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

0
3. The general authority citation for Part 229 is revised 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), 80b-11, and 7202, unless otherwise noted.
* * * * *

0
4. Amend Sec.  229.401 by:
0
a. Revising Instruction 3 to paragraph (h); and
0
b. Adding paragraph (i).
    The additions and revisions read as follows:


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

* * * * *

Instructions to Item 401(h)

* * * * *
    3. In the case of a foreign private issuer with a two-tier board of 
directors, for purposes of this Item 401(h), the term board of 
directors means the supervisory or non-management board. In the case of 
a foreign private issuer meeting the requirements of Sec.  240.10A-
3(c)(3), for purposes of this Item 401(h), the term board of directors 
means the issuer's board of auditors (or similar body) or statutory 
auditors, as applicable. Also, in the case of a foreign private issuer, 
the term generally accepted accounting principles in paragraph 
(h)(2)(i) of this Item means the body of generally accepted accounting 
principles used by that issuer in its primary financial statements 
filed with the Commission.
* * * * *
    (i) Identification of the audit committee. (1) If you meet the 
following requirements, provide the disclosure in paragraph (i)(2) of 
this section:
    (i) You are a listed issuer, as defined in Sec.  240.10A-3 of this 
chapter;
    (ii) You are filing either 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 Exchange Act (15 U.S.C. 78a et 
seq.) if action is to be taken with respect to the election of 
directors; and
    (iii)You are neither:
    (A) A subsidiary of another listed issuer that is relying on the 
exemption in Sec.  240.10A-3(c)(2) of this chapter; nor

[[Page 18818]]

    (B) Relying on any of the exemptions in Sec.  240.10A-3(c)(4) 
through (c)(7) of this chapter.
    (2)(i)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.
    (ii) 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.

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

0
5. The authority citation for Part 240 is revised to read in part 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, 80b-11, and 7202, unless otherwise noted.
* * * * *

0
6. 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 (15 U.S.C. 7202):
    (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, in accordance with the provisions of this section, 
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, in accordance with the provisions of this 
section, 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 a listed 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. Such rules 
also may provide that if a member of an audit committee ceases to be 
independent in accordance with the requirements of this section for 
reasons outside the member's reasonable control, that person, with 
notice by the issuer to the applicable national securities exchange or 
national securities association, may remain an audit committee member 
of the listed issuer until the earlier of the next annual shareholders 
meeting of the listed issuer or one year from the occurrence of the 
event that caused the member to be no longer independent.
    (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, and listed issuers must be in 
compliance with those rules, by the following dates:
    (A) July 31, 2005 for foreign private issuers and small business 
issuers (as defined in Sec.  240.12b-2); and
    (B) For all other listed issuers, the earlier of the listed 
issuer's first annual shareholders meeting after January 15, 2004, or 
October 31, 2004.
    (ii) Each national securities exchange and national securities 
association must provide to the Commission, no later than July 15, 
2003, proposed rules or rule amendments that comply with this section.
    (iii) Each national securities exchange and national securities 
association must have final rules or rule amendments that comply with 
this section approved by the Commission no later than December 1, 2003.
    (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; provided that, where 
a listed issuer is one of two dual holding companies, those companies 
may designate one audit committee for both companies so long as each 
member of the audit committee is a member of the board of directors of 
at least one of such dual holding companies.
    (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 any subsidiary thereof, 
provided that, unless the rules of the national securities exchange or 
national securities association provide otherwise, compensatory fees do 
not include the receipt of fixed amounts of compensation under a 
retirement plan (including deferred compensation) for prior service 
with the listed issuer (provided that such compensation is not 
contingent in any way on continued service); 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 any subsidiary thereof, 
provided that, unless the rules of the national securities exchange or 
national securities association provide otherwise, compensatory fees do 
not include the receipt of fixed amounts of compensation under a 
retirement plan (including deferred compensation) for prior service 
with the listed issuer (provided that such compensation is not 
contingent in any way on continued service); or
    (B) Be an ``interested person'' of the issuer 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) For an issuer listing securities pursuant to a registration 
statement under section 12 of the Act (15 U.S.C. 78l), or for an issuer 
that has a registration statement under the Securities Act of 1933 (15 
U.S.C. 77a et seq.) covering an initial public offering of securities 
to be listed by the issuer, where in each case the listed issuer was

[[Page 18819]]

not, immediately prior to the effective date of such registration 
statement, 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)):
    (1) All but one of the members of the 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 such registration statement; and
    (2) A minority of the members of the listed issuer's audit 
committee may be exempt from the independence requirements of paragraph 
(b)(1)(ii) of this section for one year from the date of effectiveness 
of such registration statement.
    (B) An audit committee member that sits on the board of directors 
of a listed issuer and an affiliate of the listed issuer is exempt from 
the requirements of paragraph (b)(1)(ii)(B) of this section if the 
member, except for being a director on each such board of directors, 
otherwise meets the independence requirements of paragraph (b)(1)(ii) 
of this section for each such entity, 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 each such 
entity.
    (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 the issuer's governing law or documents, an 
employee collective bargaining or similar agreement or other home 
country legal or listing requirements.
    (D) An audit committee member 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 an affiliate of the foreign private issuer or a 
representative of such an affiliate;
    (2) The member has only observer status on, and is not a voting 
member or the chair of, the audit committee; and
    (3) Neither the member nor the affiliate is an executive officer of 
the foreign private issuer.
    (E) An audit committee member 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. 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 
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.
    (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:
    (i) Compensation to any registered public accounting firm engaged 
for the purpose of preparing or issuing an audit report or performing 
other audit, review or attest services for the listed issuer;
    (ii) Compensation to any advisers employed by the audit committee 
under paragraph (b)(4) of this section; and
    (iii) Ordinary administrative expenses of the audit committee that 
are necessary or appropriate in carrying out its duties.
    (c) General exemptions. (1) At any time when an issuer has a class 
of securities that is listed on a national securities exchange or 
national securities association subject to the requirements of this 
section, the listing of other classes of securities of the listed 
issuer on a national securities exchange or national securities 
association is not subject to the requirements of this section.
    (2) 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, the listing of classes of securities of a 
direct or indirect consolidated subsidiary or an at least 50% 
beneficially owned subsidiary of the issuer (except classes of equity 
securities, other than non-convertible, non-participating preferred 
securities, of such subsidiary) is not subject to the requirements of 
this section.
    (3) The listing of securities of a foreign private issuer is not 
subject to the requirements of paragraphs (b)(1) through (b)(5) of this 
section if the foreign private issuer meets the following requirements:
    (i) The foreign private issuer has a board of auditors (or similar 
body), or has statutory auditors, established and selected pursuant to 
home country legal or listing provisions expressly requiring or 
permitting such a board or similar body;
    (ii) The board or body, or statutory auditors is required under 
home country legal or listing requirements to be either:
    (A) Separate from the board of directors; or
    (B) Composed of one or more members of the board of directors and 
one or more members that are not also members of the board of 
directors;
    (iii) 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;
    (iv) Home country legal or listing provisions set forth or provide 
for standards for the independence of such board or body, or statutory 
auditors, from the foreign private issuer or the management of such 
issuer;
    (v) Such board or body, or statutory auditors, in accordance with 
any applicable home country legal or listing requirements or the 
issuer's governing documents, are responsible, to the extent permitted 
by law, for the appointment, retention and oversight of the work of any 
registered public accounting firm engaged (including, to the extent 
permitted by law, the

[[Page 18820]]

resolution of disagreements between management and the auditor 
regarding financial reporting) for the purpose of preparing or issuing 
an audit report or performing other audit, review or attest services 
for the issuer; and
    (vi) The audit committee requirements of paragraphs (b)(3), (b)(4) 
and (b)(5) of this section apply to such board or body, or statutory 
auditors, to the extent permitted by law.
    (4) 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.
    (5) 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.
    (6) The listing of securities of the following listed issuers are 
not subject to the requirements of this section:
    (i) Asset-Backed Issuers (as defined in Sec.  240.13a-14(g) and 
Sec.  240.15d-14(g));
    (ii) Unit investment trusts (as defined in 15 U.S.C. 80a-4(2)); and
    (iii)Foreign governments (as defined in Sec.  240.3b-4(a)).
    (7) The listing of securities of a listed issuer is not subject to 
the requirements of this section if:
    (i) The listed issuer, as reflected in the applicable listing 
application, is organized as a trust or other unincorporated 
association that does not have a board of directors or persons acting 
in a similar capacity; and
    (ii) The activities of the listed issuer that is described in 
paragraph (c)(7)(i) of this section are limited to passively owning or 
holding (as well as administering and distributing amounts in respect 
of) securities, rights, collateral or other assets on behalf of or for 
the benefit of the holders of the listed securities.
    (d) Disclosure. Any listed issuer availing itself of an exemption 
from the independence standards contained in paragraph (b)(1)(iv) of 
this section (except paragraph (b)(1)(iv)(B) of this section), the 
general exemption contained in paragraph (c)(3) of this section or the 
last sentence of paragraph (a)(3) 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 
for purposes of this section:
    (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, the person specified.
    (ii)(A) A person will be deemed not to be in control of a specified 
person for purposes of this section if the person:
    (1) Is not the beneficial owner, directly or indirectly, of more 
than 10% of any class of voting equity securities of the specified 
person; and
    (2) Is not an executive officer of the specified person.
    (B) Paragraph (e)(1)(ii)(A) of this section only creates a safe 
harbor position that a person does not control a specified person. The 
existence of the safe harbor does not create a presumption in any way 
that a person exceeding the ownership requirement in paragraph 
(e)(1)(ii)(A)(1) of this section controls or is otherwise an affiliate 
of a specified person.
    (iii) The following will be deemed to be affiliates:
    (A) An executive officer of an affiliate;
    (B) A director who also is an employee of an affiliate;
    (C) A general partner of an affiliate; and
    (D) A managing member of an affiliate.
    (iv) For purposes of paragraph (e)(1)(i) of this section, dual 
holding companies will not be deemed to be affiliates of or persons 
affiliated with each other by virtue of their dual holding company 
arrangements with each other, including where directors of one dual 
holding company are also directors of the other dual holding company, 
or where directors of one or both dual holding companies are also 
directors of the businesses jointly controlled, directly or indirectly, 
by the dual holding companies (and, in each case, receive only 
ordinary-course compensation for serving as a member of the board of 
directors, audit committee or any other board committee of the dual 
holding companies or any entity that is jointly controlled, directly or 
indirectly, by the dual holding companies).
    (2) In the case of foreign private issuers with a two-tier board 
system, the term board of directors means the supervisory or non-
management board.
    (3) In the case of a listed issuer that is a limited partnership or 
limited liability company where such entity does not have a board of 
directors or equivalent body, the term board of directors means the 
board of directors of the managing general partner, managing member or 
equivalent body.
    (4) 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.
    (5) The term dual holding companies means two foreign private 
issuers that:
    (i) Are organized in different national jurisdictions;
    (ii) Collectively own and supervise the management of one or more 
businesses which are conducted as a single economic enterprise; and
    (iii) Do not conduct any business other than collectively owning 
and supervising such businesses and activities reasonably incidental 
thereto.
    (6) The term executive officer has the meaning set forth in Sec.  
240.3b-7.
    (7) The term foreign private issuer has the meaning set forth in 
Sec.  240.3b-4(c).
    (8) 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, an officer such as a managing 
director occupying a comparable position or executive officer, or 
occupies a similar position (except limited partners, non-managing 
members and those occupying similar positions who, in each case, have 
no active role in providing services to the entity) and which provides 
accounting, consulting, legal, investment banking or financial advisory 
services to the issuer or any subsidiary of the issuer.
    (9) The terms listed and listing refer to securities listed on a 
national securities exchange or listed in an

[[Page 18821]]

automated inter-dealer quotation system of a national securities 
association or to issuers of such securities.

Instructions to Sec.  240.10A-3

    1. The requirements in paragraphs (b)(2) through (b)(5), 
(c)(3)(v) and (c)(3)(vi) of this section do not conflict with, and 
do not affect the application of, any requirement or ability under a 
listed issuer's governing law or documents or other home country 
legal or listing provisions that requires or permits shareholders to 
ultimately vote on, approve or ratify such requirements. The 
requirements instead relate to the assignment of responsibility as 
between the audit committee and management. In such an instance, 
however, if the listed issuer provides a recommendation or 
nomination regarding such responsibilities to shareholders, the 
audit committee of the listed issuer, or body performing similar 
functions, must be responsible for making the recommendation or 
nomination.
    2. The requirements in paragraphs (b)(2) through (b)(5), 
(c)(3)(v), (c)(3)(vi) and Instruction 1 of this section do not 
conflict with any legal or listing requirement in a listed issuer's 
home jurisdiction that prohibits the full board of directors from 
delegating such responsibilities to the listed issuer's audit 
committee or limits the degree of such delegation. In that case, the 
audit committee, or body performing similar functions, must be 
granted such responsibilities, which can include advisory powers, 
with respect to such matters to the extent permitted by law, 
including submitting nominations or recommendations to the full 
board.
    3. The requirements in paragraphs (b)(2) through (b)(5), 
(c)(3)(v) and (c)(3)(vi) of this section do not conflict with any 
legal or listing requirement in a listed issuer's home jurisdiction 
that vests such responsibilities with a government entity or 
tribunal. In that case, the audit committee, or body performing 
similar functions, must be granted such responsibilities, which can 
include advisory powers, with respect to such matters to the extent 
permitted by law.
    4. For purposes of this section, the determination of a person's 
beneficial ownership must be made in accordance with Sec.  240.13d-
3.


0
7. Amend Sec.  240.14a-101 by:
0
a. Adding a sentence to the end of paragraph (d)(1) of Item 7;
0
b. Revising paragraph (d)(3)(iv) of Item 7; and
0
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(i) of 
Regulation S-K (Sec.  229.401(i) of this chapter).
* * * * *
    (3) * * *
    (iv)(A) If the registrant is a listed issuer, as defined in Sec.  
240.10A-3:
    (1) 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.
    (2) If the listed issuer's board of directors determines, in 
accordance with the listing standards applicable to the listed issuer, 
to appoint a director to the audit committee who is not independent 
(apart from the requirements in Sec.  240.10A-3) because of exceptional 
or limited or similar circumstances, disclose the nature of the 
relationship that makes that individual not independent and the reasons 
for the board of directors' determination.
    (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 registered pursuant to 
section 6(a) of the Act (15 U.S.C. 78f(a)) or a national securities 
association registered pursuant to section 15A(a) of the Act (15 U.S.C. 
78o-3(a)) 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

0
8. The general authority citation for Part 249 is revised to read as 
follows:

    Authority: 15 U.S.C. 78a, et seq., and 7202, unless otherwise 
noted.
* * * * *

0
9. Amend Form 20-F (referenced in Sec.  249.220f) by:
0
a. Revising the Instruction to Item 6.C;
0
b. Revising paragraph (a)(2) of Item 16A;
0
c. Revising instruction 3 to Item 16A; and
0
d. Adding Item 16D.
    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.
    3. If the company has a board of auditors or similar body, as 
described in Exchange Act Rule 10A-3(c)(3) (17 CFR 240.10A-3(c)(3)), 
the disclosure required by this Item 6.C. with regard to the company's 
audit committee can be provided with respect to the company's board of 
auditors, or similar body.
* * * * *

[[Page 18822]]

Item 16A. Audit Committee Financial Expert

* * * * *
    (a)(1) * * *
    (2) If the registrant provides the disclosure required by paragraph 
(a)(1)(i) of this Item, it must disclose the name of the audit 
committee financial expert and whether that person is independent, as 
that term is defined in the listing standards applicable to the 
registrant if the registrant is a listed issuer, as defined in 17 CFR 
240.10A-3. If the registrant is not a listed issuer, it must use a 
definition of audit committee member independence of a national 
securities exchange registered pursuant to section 6(a) of the Exchange 
Act (15 U.S.C. 78f(a)) or a national securities association registered 
pursuant to section 15A(a) of the Exchange Act (15 U.S.C. 78o-3(a)) 
that has been approved by the Commission (as such definition may be 
modified or supplemented) in determining whether its audit committee 
financial expert is independent, and state which definition was used.
* * * * *

Instructions to Item 16A

* * * * *
    3. In the case of a foreign private issuer with a two-tier board of 
directors, for purposes of this Item 16A, the term board of directors 
means the supervisory or non-management board. In the case of a foreign 
private issuer meeting the requirements of 17 CFR 240.10A-3(c)(3), for 
purposes of this Item 16A, the term board of directors means the 
issuer's board of auditors (or similar body) or statutory auditors, as 
applicable. Also, in the case of a foreign private issuer, the term 
generally accepted accounting principles in paragraph (b)(1) of this 
Item means the body of generally accepted accounting principles used by 
that issuer in its primary financial statements filed with the 
Commission.
* * * * *

Item 16D. 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 16D unless you are using this form 
as an annual report.
* * * * *

0
10. Amend Form 40-F (referenced in Sec.  249.240f) by:
0
a. Revising paragraph (8)(a)(2) of General Instruction B; and
0
b. Adding paragraph (14) to General Instruction B.
    The additions and revisions 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

* * * * *

B. Information To Be Filed on This Form

* * * * *
    (8)(a)(1) * * *
    (2) If the registrant provides the disclosure required by paragraph 
(8)(a)(1)(i) of this General Instruction B, it must disclose the name 
of the audit committee financial expert and whether that person is 
independent, as that term is defined in the listing standards 
applicable to the registrant if the registrant is a listed issuer, as 
defined in 17 CFR 240.10A-3. If the registrant is not a listed issuer, 
it must use a definition of audit committee member independence of a 
national securities exchange registered pursuant to section 6(a) of the 
Exchange Act (15 U.S.C. 78f(a)) or a national securities association 
registered pursuant to section 15A(a) of the Exchange Act (15 U.S.C. 
78o-3(a)) that has been approved by the Commission (as such definition 
may be modified or supplemented) in determining whether its audit 
committee financial expert is independent, and state which definition 
was used.
* * * * *
    (14) Identification of the Audit Committee. (a) If you meet the 
following requirements, provide the disclosure in paragraph (b) of this 
section:
    (1) You are a listed issuer, as defined in Exchange Act Rule 10A-3 
(17 CFR 240.10A-3) of this chapter;
    (2) You are using this form as an annual report; and
    (3) You are neither:
    (i) A subsidiary of another listed issuer that is relying on the 
exemption in Exchange Act Rule 10A-3(c)(2) (17 CFR 240.10A-3(c)(2)); 
nor
    (ii) Relying on any of the exemptions in Exchange Act Rule 10A-
3(c)(4) through (c)(7) (17 CFR 240.10A-3(c)(4) through (c)(7)).
    (b)(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 Exchange Act 
Rule 10A-3(d) (17 CFR 240.10A-3(d)) regarding an exemption from the 
listing standards for audit committees.
* * * * *

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

0
11. 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.
* * * * *

0
12. Form N-CSR (referenced in Sec. Sec.  249.331 and 274.128) is 
amended by:
0
a. Removing the phrase ``Items 4 and 10(a)'' from General Instruction D 
and in its place adding ``Items 4, 5 and 10(a)'';
0
b. Removing the phrase ``The information required by Item 4'' from 
General Instruction D and in its place adding ``The information 
required by Items 4 and 5''; and
0
c. Adding Item 5 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 5. Audit Committee of Listed Registrants

    (a) If the registrant is a listed issuer as defined in 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.
    (b) 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.

[[Page 18823]]

    Instruction. The information required by this Item is only required 
in an annual report on this Form N-CSR.
* * * * *

    By the Commission.

    Dated: April 9, 2003.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-9157 Filed 4-15-03; 8:45 am]
BILLING CODE 8010-01-P