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(The article featured below is a selection from SEC No-Action Letter Weekly, which is available to subscribers of that publication.)

SEC Staff Allows Omission of Shareholder Proposals on Audit Firm Rotation as Ordinary Business

Two union pension funds have submitted 15 identical shareholder proposals in recent months asking that the companies’ audit review committees establish an audit firm rotation policy that requires audit firms to rotate off the engagement at least every seven years and remain off for a minimum of three years. In each instance, the Division of Corporation Finance has agreed with the companies that the proposals may be excluded from their proxy materials on the basis that they relate to ordinary business operations. The selection of independent auditors or, more generally, the management of the independent auditor’s engagement, are excludable under Rule 14a-8(i)(7), according to the staff.

The Sheet Metal Workers National Pension Fund noted that auditor independence is fundamental to the integrity of public company financial reporting. In a system where audit clients pay for-profit accounting firms to perform their audits, the fund said that every effort must be made to ensure the firms’ independence. Mandatory auditor rotation is one way to promote accounting firms’ independence, skepticism and objectivity, according to the fund.

The fund cited research on the terms of audit engagements which found that at the largest 100 companies, audit tenure averages 28 years. The fund said that ITT Corporation, one of the companies to receive the shareholder proposal, has paid its audit firm more than $79 million over the last seven years.

The fund wrote that systemic accounting fraud has led to numerous legislative and regulatory reforms to the audit process, including audit partner rotation requirements, limits on non-audit services and enhanced responsibilities for audit committees. Despite these reforms, the fund pointed to recent PCAOB investigations which have found that audit deficiencies may be attributable to a failure to exercise the required professional skepticism and objectivity.

The fund believes that mandatory audit firm rotation is an important next step in improving the integrity of the public company audit system by limiting long-term client-audit firm relationships that may compromise audit firm independence.

ITT and the other issuers sought no-action assurance from the SEC that the proposals could be omitted from their proxy materials in reliance on Rule 14a-8(i)(7). Some of the companies also sought to omit the proposals on additional grounds, which the staff found unnecessary to address. For example, Dominion Resources said the proposal conflicted with its proposal to have its shareholders ratify the appointment of the independent auditor at the same meeting. Dominion’s auditor has provided audit services to the company continuously for more than seven years.

The United Brotherhood of Carpenters Pension Fund asked the Commission to review the Division’s no-action responses in connection with its audit firm rotation proposals to Walt Disney, Hewlett-Packard and Deere & Company. The Division may present a request to the Commission for a review of any no-action responses that involve matters of substantial importance and where the issues are novel or highly complex.

The fund said that audit firm rotation may once have been a matter of ordinary business, but that no longer applies. Both the PCAOB and the European Union are considering auditor rotation policies to restore investor confidence in the audit process by enhancing auditor independence.

The Division applied the standard for Commission review to the fund’s request and determined not to present it to the Commission.

The other companies that received the proposal are American Electric Power Company, Dow Chemical, General Dynamics, Prudential Financial, Sprint Nextel, Baker Hughes, Alcoa, General Electric, U.S. Bancorp and Stanley Black & Decker.