Centre Main

6 November 2003

 

John Stevenson, Secretary
Ontario Securities Commission
20 Queen Street West
Suite 1900, Box 55
Toronto, Ontario M5H 3S8

 

Denise Brosseau, Secretary
Commission des valeurs mobilieres du Quebec
Tour de la Bourse
C.O. 246, 22e etage
Montreal, Quebec
H4Z 1G3

 

Re: Multilateral Instrument 52-110-Audit Committees

 

Dear Mr. Stevenson and Ms. Brosseau:

 

The Canadian Advocacy Committee (CAC) of the Association for Investment Management and Research (AIMR)1 is pleased to respond to the request for comments on the Canadian Securities Administrators' (CSA) Multilateral Instrument 52-110, Audit Committees (Proposal). The CAC represents members of AIMR and its eleven Member Societies and Chapters across Canada. The CAC membership includes portfolio managers and other investment professionals in Canada who review regulatory, legislative, and standard setting developments affecting investors, investment professionals, and the capital markets in Canada.

 

Summary Position

 

We believe that a company's audit committee fulfills an important role in serving as a type of "watchdog" for irregularities and potential improprieties in the financial reporting process. In addition, the role of the committee to oversee the relationship between an issuer and its external auditor helps to ameliorate conflicts of interest that may arise in this relationship. Thus, we strongly support the requirements in this Proposal that audit committee members be independent and financially literate. We believe that such requirements are responsive to current concerns about a company's internal review processes and general issues of investor confidence.

 

Accordingly, we also support the proposed provisions that would require an issuer to disclose whether it has appointed a financial expert to its audit committee, and if not, why not. As discussed below, we believe that those holding the CFA designation meet, in spirit and intent, the requirements of a financial expert. AIMR formally requests that the CSA officially recognize CFA charterholders as meeting such requirements for purposes of this Proposal.

 

Discussion

 

Independence Requirements
 Under the Proposal, each member of the audit committee must be independent and "financially literate". We agree with both conditions, which lie at the heart of this Proposal. Although there is no express discussion in the Proposal of who at the issuer is responsible for making this determination, we presume and urge that this be explicitly delegated to the independent directors of the board. We recommend that the CSA provide clarification of this responsibility in the final rule.

 

Purview of Committee
 Part 2 of the Proposal gives the audit committee three primary responsibilities:

 

  • Overseeing the work of the external auditors that are engaged to prepare or issue an audit report or related work;
  • Pre-approving all non-audit services to be provided to the issuer or its subsidiary entities by its external auditors or the external auditors of the issuer's subsidiary entities; and
  • Reviewing the issuer's financial statements, MD&A and earnings press releases before they are publicly disclosed by the issuer.

 

We agree that these three areas, as well as the other responsibilities listed in Part 2 of the Proposal are appropriate. We recommend, however, that the final rule provide other examples of areas that fall within the audit committee's purview, including, for example, the review of executive expense accounts.

 

Financial Expert
 Among other things, Part 5 of the Proposal requires an issuer to disclose whether or not a "financial expert" is a member of its audit committee. As the Proposal recognizes, some issuers may have difficulty finding qualified financial experts to serve, in light of the definition of "audit committee financial expert". While we believe that the existence of a financial expert enhances the audit committee's ability to adequately perform its job, we do not disagree with the approach to require disclosure of, rather than mandate the existence of, a financial expert on an audit committee. We believe it is necessary when there is not an "audit committee financial expert" that issuers disclose the reason for this lack.

 

We also agree that a financial expert should bring more than specific experience or qualifications to the work of the audit committee. Companion Policy 52-110CP notes that in addition to determining that a person possesses an adequate degree of knowledge and experience to qualify as a financial expert, "an issuer should also ensure that the candidate embodies the highest standards of personal and professional integrity." We wholeheartedly support this additional qualification.

 

Recognition of CFA Charterholders as Financial Experts
 We believe that a strict reading of the requisite experience/expertise required under the Proposal may well overly limit the pool of candidates, and overlook individuals who bring exactly the type of analytical skills and professional expertise that Multilateral Instrument 52-110 seeks to have in audit committee deliberations. Accordingly, given the emphasis on high ethical standards, along with the role the financial expert is intended to serve, we formally request that the CSA explicitly recognize those holding the Chartered Financial Analyst® (CFA®) designation as meeting the standard of financial expert.

 

We can appreciate the CSA's reluctance to create a "bright-line" test for defining financial expert where only certain professions or designations are named. We believe, however, that providing examples of who would qualify will provide additional and helpful guidance to the board of directors in making its determination, and will likely result in a broader range of people serving in this capacity.

 

In particular, we note the following elements to be considered by the Board of Directors in considering whether an individual possesses the requisite characteristics to qualify as a financial expert, and their relevance to the experience and expertise that CFA charterholders offer:

 

  • An understanding of financial statements and the accounting principles used by the issuer to prepare its financial statements;
  • The ability to assess the general application of accounting principles in connection with the accounting for estimates, accruals and reserves;
  • Experience preparing, auditing, analyzing or evaluating financial statements that present a breadth and level of complexity of accounting issue that are generally comparable to the breadth and complexity of issues that can reasonably be expected to be raised by the issuer's financial statements, or experience actively supervising one or more persons engaged in such activities;
  • An understanding of internal controls and procedures for financial reporting; and
  • An understanding of audit committee functions.

 

We strongly believe that the CFA examination program addresses all components of the financial expert definition contained in this proposal. By the time one is awarded the CFA designation, he or she has mastered the fundamentals of financial analysis, including generally accepted accounting principles, and financial statements. This mastery requires the ability to apply accounting principles and analyze financial statements that include, for example, accounting estimates, accruals, and reserves. Through the CFA examination program, the CFA charterholder also learns to ask the "hard" questions when conducting financial analysis; part of the training involves developing an approach where financial presentations are not accepted at face value, but must be supported through solid and valid analysis that the information being presented fairly presents the financial condition of the company.

 

In order to be considered for the CFA designation, a candidate must have accrued at least three years of acceptable professional experience in financial analysis, investment management, securities analysis, and other similar areas. To obtain the CFA designation, a candidate in the program must pass a rigorous series of exams on a broad spectrum of subjects relevant to the knowledge required of a financial expert under this proposal. Included in the range of subjects that must be mastered before award of the charter are:

 

  • Ethical and professional standards;
  • Economics;
  • Financial statement analysis;
  • Analysis of equity investments;
  • Analysis of debt investments;
  • Analysis of derivatives;
  • Quantitative methods; and
  • Analysis of alternative investments.

 

Moreover, other regulatory areas, such as fiduciary duties, disclosures of conflicts, personal trading, misrepresentations, insider trading, suitability of investments, supervisory responsibility and trade allocation are all tested repeatedly at each of the three levels of the CFA exam.

 

A fuller description of the CFA examination program and requirements for obtaining the CFA designation is provided in Attachment A to this letter.

 

In addition to possessing the knowledge that qualifies charterholders as financial experts, the CFA charterholder brings an additional commitment to high ethical standards that is central to addressing the concerns giving rise to this Proposal. The CFA examination program tests an individual's ability to apply knowledge of applicable laws and regulations, as well as the AIMR Code of Ethics and Standards of Professional Conduct (Code and Standards) to recognize and avoid unprofessional practice and violations of standards where issues may not be clear (e.g., conflicts of interest, compensation, inside information, corporate governance, proxies, and the "prudent expert rule").

 

To remain in good standing and retain the right to use the CFA designation, charterholders must comply with the AIMR Code and Standards in their day-to-day practice in the investment industry, or risk losing their charter. As a rule, charterholders must attest annually in writing to compliance with this strict Code and Standards. Sanctions for failure to report and for non-compliance with the Code and Standards include reprimands, suspensions, and revocation of the right to use the CFA designation and AIMR membership.

 

We urge the CSA to explicitly recognize groups and designations that fully meet, both in terms of substance and spirit, the financial expert definition. Otherwise, we fear that issuers will hesitate to consider well-qualified individuals for fear that, judged in hindsight, their selection may be called into question. While leaving the discretion to the Board of Directions to make its determinations in accordance with the factors outlined in the Proposal's definition, we thus encourage the CSA to include in its final rule examples of specific groups or designations that should be acceptable determinations.

 

Venture Issuer Exemption
 Under the Proposal, audit committees of venture issuers would not have to comply with the independence and financial literacy requirements, as well as the Part 5 disclosure requirements. We question this decision. We understand that certain companies may experience more difficulty than others in creating a fully independent audit committee. However, given the significant role that impartiality plays in audit committee decision making, we believe that at least a majority of audit committee members should be independent. We also recommend that venture issuers be required to honor the same disclosure requirements that are applicable to other issuers.

 

Conclusion

 

We generally agree with the proposed measures that require audit committees to have members that are independent and financially literate. We also agree with the provision that would require issuers to disclose whether a financial expert serves on the committee. As discussed above, we encourage the CSA to note in its final rule designations of professions that generally would meet the criteria set forth in the definition, and that qualify as acceptable experts. Specifically, we believe that the CFA designation is precisely the type of designation that embodies the elements that meet in substance and spirit the purpose of having a financial expert on the audit committee.

 

We appreciate the opportunity to comment on the Canadian Securities Administrators Notice of Proposed Multilateral Instrument 52-110, Audit Committees. If we can provide additional information, please do not hesitate to contact David Yu at 416.597.5416, davidyu.cfa@sympatico.ca, or Linda Rittenhouse at 434.951.5333, linda.rittenhouse@cfainstitute.org.

 

Sincerely,

 

David L. Yu, CFA,
Canadian Advocacy Committee Co-Chair 		Linda L. Rittenhouse
Staff, AIMR Advocacy

 

1 With headquarters in Charlottesville, VA, and regional office in Hong Kong and London, the Association for Investment Management and Research® is a non-profit professional organization of more than 67,200 financial analysts, portfolio managers, and other investment professionals in 116 countries of which 54,940 are holders of the Chartered Financial Analyst® (CFA®) designation. AIMR's membership also includes 127 affiliated societies and chapters in 46 countries.