---

On April 1, 2003, the Securities and Exchange Commission (the "SEC") voted unanimously to adopt new rules (the "Final Rules") implementing Section 301 of the Sarbanes-Oxley Act of 2002 (the "Act") and directing the NYSE, Nasdaq and AMEX (collectively, the "SROs") to prohibit the listing of any security of a company that is not in compliance with certain audit committee requirements established by the Act.

The SROs must amend their listing standards to reflect the requirements of the Final Rules no later than December 1, 2003. The SROs are not prohibited from adopting more stringent requirements than those contained in the Final Rules and, in fact, are expected to be more stringent in certain respects.

Public companies whose securities are listed with an SRO must be in compliance with the relevant listing standards by the earlier of their first annual meeting after January 15, 2004 or October 31, 2004. Publicly traded companies that are foreign private issuers or small business issuers will not have to comply until July 31, 2005.

Overview

The Final Rules require the SROs to amend their listing standards to prohibit the listing of any security of a public company that does not comply with the following audit committee requirements:

• Each member of the audit committee must be independent.
• The audit committee must be directly responsible for the appointment, compensation, retention and oversight of the work of any independent auditor engaged for the purpose of preparing or issuing an audit report or related work or performing other audit, review or attest services for the company.
• The 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 concerns regarding questionable accounting or auditing matters.
• The audit committee must have the authority to engage independent counsel and other advisors, as it determines necessary.
• The company must provide appropriate funding for its audit committee.

Who is Covered by the Final Rules?

In general, the Final Rules only affect public companies that have a class of securities listed on a national securities exchange (e.g., NYSE) or listed in an automated interdealer quotation system of a national securities association (e.g., Nasdaq National or SmallCap Markets), commonly referred to as "publicly traded companies." The Final Rules do not apply to public companies whose securities trade on the OTC or National Quotation Bureau's Pink Sheets or Yellow Sheets. There are new disclosure requirements that apply to all public companies (see later discussion under "New and Revised Audit Committee Disclosures for SEC Filings").

Foreign private issuers or small business issuers must comply with the Final Rules; however, there are longer transition periods for each and certain foreign private issuers receive accommodations from the independence requirements for audit committees. Issuers of Asset-Backed Securities are excluded from the requirements of the Final Rules. Listings of security futures products and standardized options are also exempt under the Final Rules. The Final Rules do apply to closed-end investment companies and exchange-traded open-end investment companies but do not apply to exchange-traded unit investment trusts.

The Audit Committee Independence Requirements

The Final Rules require that each audit committee member of a publicly traded company be an independent member of the company's board of directors. Currently, the NYSE and the Nasdaq require listed companies to have only independent members serve on their audit committees with certain defined exceptions. The Final Rules narrow the list of exceptions.

The Final Rules establish minimum standards for being considered an independent audit committee member. The SROs must incorporate these standards into their listing requirements. In order to serve on an audit committee of a listed company, a director may not:

• Receive any consulting, advisory or other compensatory fee from the company or any its subsidiaries, other than fees for board or board committee service, or
• Be an affiliated person of the company or any of its subsidiaries.

Prohibition of Consulting, Advisory or Other Compensatory Fees

Currently, the NYSE does not have specific prohibitions against direct or indirect compensatory payments to audit committee members or their families. Nasdaq's current listing requirements prohibit direct and indirect compensatory payments exceeding certain dollar amounts. The Final Rules require the NYSE and Nasdaq to tighten their independence standards for audit committee members to prohibit:

• All compensatory payments, including consulting and advisory fees, to an audit committee member;
• Payments to spouses, minor children or stepchildren, or children or stepchildren sharing a home with the audit committee member; and
• Payments for services to law firms, accounting firms, consulting firms, investment banking firms or financial advisory firms in which audit committee members are partners, members, executive officers or hold similar positions.

Independence is not affected by ordinary course commercial business relationships between a company and an entity with which an audit committee member has a relationship. In addition, the Final Rules impose no limitations on the amount of fees that can be paid to a director for board and board committee service. When determining whether an audit committee member is considered "independent," the Final Rules only require that current compensatory arrangements are prohibited. The Final Rules do not disqualify an audit committee member from being considered "independent" based upon past compensatory arrangements; however, the SROs' revisions to their listing standards most likely will apply the prohibitions on compensation to payments made to an audit committee member in the present and for some period of time in the past. The Nasdaq's current prohibition against compensatory payments contains a minimum dollar threshold; but the Final Rules do not allow for de minimus exceptions.

Prohibited Relationships

The NYSE and Nasdaq listing requirements currently prohibit some direct and indirect relationships between audit committee members and their companies. The Final Rules mandate more stringent restrictions, including that an audit committee member must not be an "affiliated person" (other than a director) of the company. The definition of "affiliated person" is the same definition that is currently used in other areas of the federal securities laws (e.g., Rule 144 covering the resale of restricted securities and securities held by affiliates), with an additional safe harbor. An "affiliated person" is "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."Control" 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." Under the safe harbor, if an audit committee member is not an executive officer or beneficial owner of greater than 10% of the company's outstanding equity securities, the member is not deemed to be an affiliated person of the issuer. Failure to fit within the safe harbor does not necessarily mean that the person is an affiliate of the company. The particular facts and circumstances must be considered to determine whether the necessary element of "control" is present. Only executive officers, directors who are also employees of the company or its affiliates, general partners and managing members of an affiliate are automatically deemed to be affiliates. Passive, non-control positions, such as limited partners, and those that do not have policymaking functions, are not considered affiliates.

Exemptions from the Audit Committee Independence Requirements

Newly-Listed Companies

At the time a public company first lists its securities with an SRO, the company must have at least one independent audit committee member. Within 90 days of the company's initial listing, it must have a majority of independent audit committee members, and at the end of one year, it must have a fully independent audit committee.

Overlapping Board Relationships

An audit committee member who sits on the board of directors of both a parent and subsidiary is exempt from the "affiliated person" requirement if the person otherwise meets the independence requirements.

Loss of Independence for Reasons Outside the Person's Control

The Final Rules permit an SROs' listing standards to allow for an audit committee member who is no longer considered independent for reasons outside his or her reasonable control to remain an audit committee member if:

• The company notifies the SRO; and
• The audit committee member is replaced by the earlier of the company's next annual meeting or one year from the date that the audit committee member was no longer considered independent.

Foreign Government and Foreign Private Issuers

Foreign governments whose securities are publicly traded on an SRO are exempt from all of the requirements of the Final Rules. As with most of the Act, the Final Rules generally apply to foreign private issuers. However, the Final Rules do contain specific exemptions from the independence requirements for certain foreign private issuers:

• Foreign private issuers with a dual holding company structure where one of the holding companies is a listed public company are granted certain accommodations. There may be one audit committee for both holding companies and audit committee members will not be considered "affiliates" under the Final Rules because they are also serving as directors of both holding companies or any of either holding company's subsidiaries, as long as they would otherwise be considered independent.
• Non-management employees of a foreign private issuer may serve on the company's audit committee without violating the independence requirements if the employee is elected or named to the company's audit committee in accordance with the company's governing law or documents, an employee collective bargaining or similar agreement or other home country legal or listing requirements.
• One member of a foreign private issuer's audit committee may be a representative of an affiliate of the company, such as a controlling shareholder, if the "no compensation" prong of the independence requirements is satisfied, the member is only an observer and a non-voting member of the audit committee and the member is not an executive officer of the company.
• If a foreign government has significant shareholdings in a foreign private issuer, it and any of its representatives serving on the foreign private issuer's audit committee may be considered affiliates. However, one member of a foreign private issuer's audit committee may be a representative of a foreign government or foreign governmental entity, if the "no compensation" prong of the independence requirements is satisfied and the member is not an executive officer of the company.
• A foreign private issuer's audit committee may consist of a board of auditors or statutory auditors that are affiliated with the company if, among other things, that board operates under legal or listing provisions that are intended to provide oversight of the issuer's independent auditors and membership excludes executive officers of the company.

Audit Committee Oversight of Independent Auditors

The Final Rules require a publicly traded company's audit committee to be directly responsible for the appointment, compensation, retention and oversight of the work of any independent auditor engaged for the purpose of preparing or issuing an audit report or performing other audit, review or attest services for the company. The independent auditor must report directly to the audit committee, not management. Audit committee oversight of the independent auditor is not intended to conflict with any requirement that a company's shareholders elect, approve or ratify the selection of the independent auditor. Rather, the delineated powers reserved for the audit committee relate to the assignment of responsibility to oversee the auditor's work between the audit committee and management. If the company recommends or nominates an independent auditor for approval by its shareholders, the audit committee, not management, must be responsible for making the recommendation or nomination. In addition, if a company's jurisdiction of incorporation prohibits the board of directors from delegating to a committee the responsibility to appoint, compensate, retain or otherwise oversee the independent auditors, the audit committee must be granted advisory and other powers, including submitting nominations or proposals to the board, permissible by applicable corporate law.

Audit Committee Procedures for Handling Whistleblower's Complaints

A publicly traded company's 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 concerns regarding questionable accounting or auditing matters. The Final Rules do not provide guidance as to how such a system should be operated. The SEC avoided providing guidance because it believes a "one-size-fits-all" approach is not appropriate and an audit committee should develop procedures that are appropriate for its company.

Power to Engage Advisors

The Final Rules require a publicly traded company's audit committee to have the specific authority to engage independent counsel and other advisors, as it determines necessary.

No Restrictions on Funding

A publicly traded company must provide appropriate funding, as determined by the company's audit committee for payment of:

• Compensation to the company's independent auditor preparing or issuing an audit report or performing other audit, review or attest services for the company;
• Compensation to any advisors employed by the audit committee; and
• Ordinary administrative expenses of the audit committee.

New and Revised Audit Committee Disclosures For SEC Filings

Publicly traded companies that are relying on an exemption from the audit committee independence requirements must disclose their reliance in their annual reports filed with the SEC. Those companies subject to the proxy rules must also include the disclosure in their annual meeting proxy statements. Those who include the disclosure in their proxy statements may include the disclosure in their annual reports through incorporation by reference according to the same procedures for incorporating by reference executive compensation information from their proxy statements into their annual reports. Foreign governments, issuers of security futures products and standardized options, and asset-backed issuers and other similar "passive" issuers do not have to provide disclosure regarding their exemptions under the Final Rules.

Publicly traded companies must disclose the identities of the members of their audit committees in their annual reports filed with the SEC. Because this disclosure is currently required in the annual meeting proxy statements of public companies, publicly traded companies may incorporate by reference this disclosure into their annual reports, in the manner described above.

All public companies, including foreign private issuers, must disclose whether or not they have an audit committee financial expert on their audit committees. If a publicly traded foreign private issuer discloses that it does have an audit committee financial expert, the Final Rules require the foreign private issuer to disclose whether that person is independent according to the applicable SRO listing standard. If the foreign private issuer is not publicly traded on a SRO, it must choose a SRO standard of independence and disclose whether its expert satisfies the requirements of that standard.

Enforcement of Final Rules

The Final Rules require a publicly traded company to notify its SRO promptly after one of its executive officers becomes aware of any material noncompliance with any of the Final Rules' new requirements. The SEC also encourages the SROs to require the same notification for material noncompliance with any of the SROs' corporate governance requirements. The SROs' revised listing standards must contain procedures for a noncompliant company to cure a violation before being delisted.

Principles Versus Procedures

The Final Rules do not provide publicly traded companies and their audit committees with specific steps that must be taken to comply. The Final Rules set principles for companies to follow, but provide very little guidance as to how companies should revise their audit committee charters and select their independent audit committee members. Although the SROs may provide more specifics as they revise their listing standards in response to the Final Rules, publicly traded companies will have latitude to decide how best to implement the new requirements.