Sound Audit Committee Governance

Dr. Earl R. Smith II
Managing Partner, The Federal Circle
DrSmith@Dr-Smith.com
Dr-Smith.com

One of the major challenges for any CEO is to understand the often-arcane language of the accounting profession. Many of the senior executives that I work with are not comfortable with ‘accountant-speak’. Some simply refuse to spend the time and effort learning the language. However, the days when that approach was a viable option are over. Executives – particularly CEOs – incur significant liabilities if they do not pay sufficient attention. The same is true for Chairmen. A board Chairman must understand the financial statements that the corporate auditors issue. The board as a whole is charged with reviewing them. Their principal resource for this review is the Audit Committee.
The motto of the Audit Committee should be, ‘check the checkers’. The mission of a corporate director serving on the Audit Committee is to follow sound governance practices in assessing the work others have completed. Although scrutiny by regulators has become more intense, the function of the Audit Committee has not changed. However, the enactment of the Sarbanes-Oxley Act of 2002 has caused many of the best practices of the best Audit Committees to become these ‘best practices’ as well.

A board of directors has the responsibility to safeguard and advance the interests of the stockholders of the company. The corporate charter and the corporate by-laws define the powers and responsibilities of the corporate board. They provide a legal framework for directors to conduct an assessment of the company, and to strategically plan to increase stakeholder value.

Directors will often establish sub-committees to ensure the board of directors receives accurate information. These sub-committees – acting as advisory boards – have broad powers to assist the board in carrying out its responsibilities. The Audit Committee is an advisory board charged with the responsibility for ensuring proper handling and reporting of corporate finances. The U. S. Congress passed the Sarbanes-Oxley Act of 2002 as a measure to stop the credibility gap between corporate America and investors. Sarbanes-Oxley provides a framework that can be an assessment tool to measure the performance of the Audit Committee as the guardian of corporate ethics.

The New York Stock Exchange and the National Association of Securities Dealers established a Blue Ribbon Committee. The study, “Improving the Effectiveness of Corporate Audit Committees” began in September 1998. The Committee issues its final assessment with recommendations in February 1999. The report identified many good governance practices. Some are now part of stock exchange listing requirements.

Some of the best practices of a sound audit committee include:

• Conduct an assessment of corporate leadership and actively engage in leadership development
• Supervise the corporation’s relationship with outside audit firm
• Approve all non-audit accounting work prior to work being awarded to the external auditor
• Conduct an assessment of the independent auditor regarding time pressures and the timing of audit procedures
• Approve any preliminary plans to hire any of the independent auditors into a high-level corporate position
• Assess the need to rotate senior audit personnel
• Assess the risk profile of the company and oversee all management compliance standards
• Periodically conduct an assessment of internal controls and discuss the results with internal and external auditors
• Conduct an assessment of the judgments and estimates of corporate finances made by management
• Assess corporate management’s compliance with the corporation’s code of ethics
• Conduct an assessment of corporate policies and regulations and managements compliance ratio

The Audit Committee has the responsibility of protecting the company’s reputation for high ethical standard and meeting reporting practices. Strong leadership by this advisory committee is a key to maintaining high governance standards and maintaining credibility with investors. Accurate corporate financial statements, and compliance with laws, regulations and stock exchange listing requirements professional governance and will often involve personal growth for new corporate directors. Since Sarbanes-Oxley, the Audit Committee’s role has been elevated to a regulator function for the corporation. Best practices increase the Audit Committee’s reach beyond regulatory compliance to areas of law and address the company’s compliance with important corporate policies and the corporation’s code of ethics.

Good governance depends on a strong audit committee and an understanding of ‘accountant-speak’ by key members of the board. Without that, the board will not be able to fulfill its fiduciary responsibility to the shareholders. The best way to establish a baseline is to run a board assessment. That will give the board a clear picture of the adequacy of its resourcing and organization in this important issue. If you want t learn more about board assessments, send me an e-mail and we will arrange a time to talk.

© Dr. Earl R. Smith II

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Related Articles:

• Good Governance – The Chairman’s Role
• Board Assessment – A Critical Part of Good Governance
• Corporate Board Dangers
• Good Corporate Governance – The Essential Nominating and Audit Committees
• Board of Directors – Financial Oversight

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