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Update on the Blue Ribbon Committee on Improving the Effectiveness of Audit Committees

Update on the Blue Ribbon Committee on Improving the Effectiveness of Audit Committees. Chicago CFO Advisory Council December 9, 1999. Objectives. Improve audit committee effectiveness Increase oversight diligence by audit committees

joelle-miller
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Update on the Blue Ribbon Committee on Improving the Effectiveness of Audit Committees

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  1. Update on the Blue Ribbon Committee on Improving the Effectiveness of Audit Committees Chicago CFO Advisory Council December 9, 1999

  2. Objectives • Improve audit committee effectiveness • Increase oversight diligence by audit committees • Reduce cases of improper financial reporting as a result of these improved audit committee practices.

  3. The Three Legged Stool of Financial Reporting 1. Company financial management 2. Board including the audit committee 3. External auditors Each has a role. Each has certain specialties and capabilities in terms of expertise, time and depth of familiarity.

  4. Blue Ribbon Panel Recommendations • SRO • SRO • SRO • SRO • Independence of Audit Committee Members - Self Regulating Org :SRO • Composition of Audit Committee • Qualifications of Audit Committee members • Adoption of Audit Committee Charter

  5. Blue Ribbon Panel Recommendations • SEC • SRO • SRO • Disclosure in Proxy Statement about Charter and compliance therewith • Outside auditor is accountable to Board of Directors • Outside auditors provide Audit Committee with written Statement on Independence

  6. Blue Ribbon Panel Recommendations • AICPA • SEC • SEC/AICPA • Outside auditors discuss with Audit Committee their judgement about quality of accounting principles • Audit Committee Letter in Annual Report • Quarterly SAS 71 reviews and discussion of results with Audit Committee

  7. Quarterly SAS Reviews and Discussions of Results with Audit Committee - #10 (SEC) • Requires that outside auditor conduct a SAS 71 interim financial review prior to company filing its Form 10-Q • Recommends that SAS 71 be amended to require outside auditors to discuss significant issues with at least the chairman of the Audit Committee, including: • significant adjustments • management judgements and accounting estimates • significant new accounting policies • disagreements with management

  8. ASB Actions • Proposed amending SAS 71 to require quarterly discussions with the AC prior to the filing of the 10-Q • Encourages this discussion prior to public announcement of interim results • The auditor would have to discuss the items described in SAS 61 or be satisfied that those matters have been discussed with the AC by management

  9. SEC Actions • Interim financial statements should be reviewed by independent auditors before filing 10-Q and 10-QSB.

  10. Audit Committee Letter in Annual Report - #9 (SEC) Letter should disclose whether or not: • Management has reviewed the audited financials with the Audit Committee, including a discussion of the quality of the accounting principles applied, etc. • The outside auditors have discussed with the Audit Committee their judgements regarding the quality of principles applied, etc.

  11. Audit Committee Letter in Annual Report - #9 (SEC) Letter should disclose whether or not: • Members of the Audit Committee have discussed information disclosed to them by management and outside auditors • The Audit Committee, in reliance on the above, believe that the company’s financials are fairly presented, in all material respects, in conformity with GAAP • It is recommended that the SEC adopt a “Safe Harbor” applicable to any disclosure in this recommendation

  12. SEC Actions • Proxy statements must include an AC report that discloses: • whether the AC reviewed and discussed certain matters with management and the auditors • whether the AC recommended to the Board that the audited financial statements be included in the Annual Report on Form 10-K or 10-KSB

  13. Outside Auditors Discuss with Audit Committee Their Judgement About Quality of Accounting Principles - #8 (AICPA) • Discuss quality, not just the acceptability of accounting principles as applied in financial reporting • Include: • clarity of financial disclosures • degree of aggressiveness or conservatism of accounting principles and underlying estimates • other significant management decisions regarding financial disclosures

  14. ASB Actions • The ASB has proposed amending SAS 61 which would require a discussion of the quality of accounting principles with the AC each year • The ASB deleted the terms “aggressive” and “conservative” due to the subjectivity of the terms

  15. Outside Auditors Provide Audit Committee with Written Statement on Independence - #7 (SRO) • Charter to specify that Audit Committee is responsible for obtaining a formal written Statement of Independence from outside auditors • Statement should delineate all relationships between auditor and company and be consistent with the Independence Standards Board (Standard 1)

  16. Outside Auditors Provide Audit Committee with Written Statement on Independence - #7 (SRO) • Audit Committee is responsible for actively engaging in a dialogue with the auditor with respect to any disclosed relationships or services that may impact the objectivity or independence of the auditor

  17. NYSE/SEC Actions • NYSE adopts this recommendation • SEC requires proxy statements to include audit committee report discussing whether the audit committee has received disclosures from independent auditors required by ISB Standard No. 1, and discussed with the auditors the auditor’s independence (these disclosures to be protected by safe harbor)

  18. Outside Auditor is Accountable to Board of Directors - #6 (SRO) • Charter to specify that outside auditor is ultimately accountable to Board of Directors and the Audit Committee as representatives of shareholders • The above representatives have ultimate authority and responsibility to select, evaluate and where appropriate replace the outside auditor or to nominate an outside auditor to be proposed for shareholder approval in Proxy

  19. NYSE Actions • Similar to current practices/NYSE adopts this recommendation

  20. Disclosure in Proxy of Charter and Compliance Therewith - #5 (SEC) • Company is required to have its Audit Committee disclose in its annual Proxy Statement whether Audit Committee has adopted a formal written Charter • Audit Committee to also state whether it satisfied its responsibilities in compliance with Charter

  21. Disclosure in Proxy of Charter and Compliance Therewith - #5 (SEC) • Charter is to be disclosed triennially in annual report or proxy and in any year after significant amendments are made to the Charter • It is recommended that SEC adopt a “Safe Harbor” applicable to all disclosures in this Recommendation #5

  22. SEC Actions • A copy of the AC charter should be filed with the SEC every 3 years • The SEC did NOT propose to require companies to disclose whether the AC was in compliance with its charter to avoid “skimpy, broadly-worded and vague charters” • SEC adopts safe harbor

  23. Adoption of Audit Committee Charter - #4 (SRO) • Adopt a formal, written Charter that is approved by the full board • Specify the scope of responsibilities and how those responsibilities are carried out, including structure, processes and membership requirements • Review and reassess the adequacy of the Charter on an annual basis

  24. NYSE Actions • NYSE adopts this recommendation • NYSE requires annual confirmation of any determination that board makes regarding the annual review of the charter

  25. Qualifications of Audit Committee Members - #3 (SRO)* • Audit Committee should be comprised of a minimum of three directors • Each member should be financially literate or become financially literate within a reasonable period of time after appointment • One member of Committee should have accounting or related financial management expertise * For Companies with market capitalization over $200 million

  26. NYSE Actions • NYSE adopts this recommendation, but REJECTS $200 million market cap recommendation • NYSE requires annual confirmation of any determination that board makes regarding the financial literacy of audit committee members and the accounting or financial management background of at least one audit committee member

  27. Composition of Audit Committee - #2 (SRO) • All listed companies with market capitalization above $200 million should have Audit Committee comprised solely of independent directors In addition to compliance with definition of independence (in Recommendation #1):

  28. Independence of Audit Committee Members - #1 (SRO)* Committee members are considered independent if they have no relationship with the corporation that may interfere with the exercise of their independence from management. * For Companies with market capitalization over $200 million

  29. Independence of Audit Committee Members - #1 (SRO) Examples of conflicts of independence are: • Director being employed by corporation (or affiliates) for current and any of the past 5 years • Director receiving compensation other than for Board service • Director being related to anyone who has been executive officer of the corporation in any of the past 5 years

  30. Independence of Audit Committee Members - #1 (SRO) Examples of conflicts of independence, continued: • Director being a principal or executive officer of an entity to which the corporation made or received payments in amounts that are significant to the corporation or entity • Director being employed as executive of another company where any of the corporation’s executives serve on that company’s Compensation Committee

  31. NYSE/NASD/AMEX Actions • Each exchange adopted a tougher definition of independence • Each provide for a “board override” for one member to be appointed to the AC who fails the definition of independent

  32. NYSE/NASD/AMEX Actions • NYSE/AMEX/NASDAQ companies should disclose certain information about any AC member who in not “independent”, as defined in listing requirements • Despite concerns, small businesses NOT EXEMPT from the new requirements

  33. Audit Committees Best Practices • The Audit Committees key role in monitoring the other component parts of the audit process • Independent communication and information flow with internal auditors • Independent communication and information flow with outside auditors

  34. Audit Committees Best Practices • Candid discussions with management, the internal auditor and outside auditors regarding issues implicating judgement and imparting quality • Diligent and knowledgeable membership

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