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Accordingly, a good understanding of how an audit committee should work is critical to the financial professionals who are part of the issuer's internal and external audit teams. The focus of this article is not on the legal requirements of the audit committee charter, constitution of its membership and other regulatory requirements, but to suggest how to improve the function of and coordination with the audit committee.
The SEC has specifically recognized that how audit committees function may vary from company to company and reporting issuers need flexibility to determine all of the specific duties and functions of each particular audit committee. Accordingly, the SEC proposals do not tell audit committees what specific duties they must carry out or how to function, nor do they regulate the substance of the discussions between the audit committee and management or the independent accountants. Nor do these SEC proposals require disclosure of the substance of those discussions.
Recently, especially in light of the Enron scandal, the SEC's Chief Accountant has furnished guidance on what he considers helpful to the proper and effective functioning of an audit committee. An audit committee must have three important qualities:
The agenda control should cover the following areas
Perhaps the most important function is that the audit committee diligently discharge its function to ensure the integrity of the issuer's financial statements through perseverance, earnestness, attention to detail, and thoroughness. To do this, the audit committee should be proactive in analyzing information it receives from management and have a full understanding of the key accounting issues for that particular company. Would the financial statements have been different if the independent auditor prepared them without any input from management? Do the financial statements furnish all of the information needed by existing and potential shareholders in order to be in a position to make an intelligent investment decision. Also, would the issuer have followed the same internal audit procedures if the partner in charge of the outside auditor were in fact the CEO
Finally, audit committee members must devote sufficient time to obtain an adequate understanding of what the company's financial statements represent. Members of the audit committee must have enough interest and time to be a position to consult with outside counsel and experts, if necessary, and to ask the tough questions to be able to assess whether or not the answers it receives make sense and are correct for that issuer. Merely meeting for two or three hours a year is clearly insufficient.
Recent cases are also instructive on the proper interaction and relationship between the independent auditors and the audit committee. Comparing Smith ex rel. Estates of Boston Chicken Inc. v. Arthur Andersen LLP, 175 F. Supp.2d 1180 (D.Ariz. 2001) with Official Committee of Unsecured Creditors of Color Tile v. Investcorp S.A., 80 F. supp. 2d 129 (S.D.N.Y. 1999) demonstrates the importance of the independent auditor making full disclosure of its accounting concerns to all members of the audit committee. Because the trustee for Boston Chicken was able to allege that certain members of the audit committee were "innocent," the accounting firm could not raise the in pari delicto* defense.
Exclusive of SEC enforcement actions to hold an outside accounting firm liable for securities fraud under 10b-5, plaintiff(s) must allege and prove that the independent auditor was an actual participant, rather than an aider or abettor. Also, by fully informing all members of the audit committee of the accounting problems and/or disagreements with management, the independent auditor can have an ally in the audit committee, which can help in persuading management to properly account for a certain disputed item or transaction. This is especially true now that the SEC has insisted that the members of the audit committee be totally independent, or in the case of a company reporting under Regulation SB, at least a majority of the members of the audit committee are independent.
If you need further information about the specific legal requirements applicable to the audit committee for your company under the revised listing requirements of your exchange or NASDAQ, please do not hesitate contact me at hechtlawoffice@aol.com. We hope this article will be of assistance in helping financial professionals to properly coordinate with and use the newly empowered audit committees to ensure full and fair disclosure of financial and related information to the investing public and the SEC.
* In pari delicto (Latin): Both parties are equally at fault. The usual use of this phrase is "in pari delicto, potior est conditio possidentis" which means that where both parties in a dispute are equally at wrong, the person in possession of the contested property will retain it (ie. the law will not intervene). Source: Lawinfo.com
2002 Smartpros Ltd. All Rights Reserved.
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