The Audit Committee – Increased Attention on a Critical Function

The audit committee plays a key role in corporate financial governance, and lately there has been a pronounced interest from regulators and commentators on the more extensive responsibilities of this important committee. At a recent workshop we attended, and in numerous other conversations with experts, we increasingly hear how seriously regulators are focusing on the role of the audit committee and their increased emphasis on accountability for this role. Carol Stacey, the Chief Accountant of Corporate Finance at the SEC, went so far as to say that the audit committee is responsible for the integrity of a company’s financial statements. This heightened attention on the role of the audit committee underscores the need for you and your board of directors to have the appropriate focus on the key factors related to audit committee success: having a clear and concise charter, recruiting and retaining the right audit committee members, allocating the needed time and resources to accomplish key objectives and obtaining the right external counsel and continued education as appropriate.

Clearly outlining the charter and purpose of the audit committee is essential. Guidance can be found by reviewing exchange requirements (NYSE, Nasdaq and AMEX) and specific instructions of the SEC. In general, the key responsibilities of the audit committee include oversight of the integrity of the financial statements; compliance with legal and regulatory requirements; evaluation, retention and oversight of independent auditors and the audit process; oversight of internal auditors; and resolution of issues.

A strong audit committee must have qualified board members. Regulations mandate that those on the audit committee satisfy the following key criteria: a more stringent test for independence than other independent board members; limitation on the boards on which an audit committee member serves; and specific financial expertise needed for the role. An actively involved audit committee comprised of board members with the requisite financial expertise is critical to be effective and to deal with the complexity involved in today’s financial and legal issues.

There is no question that membership on an audit committee is time consuming and this has to be a major consideration in proposing and/or accepting membership to this committee. According to a J.D. Power and Associates survey, audit committee chairs spend between 50 to 150 hours per year on their audit committee obligations and a Deloitte & Touche survey revealed that the average number of meetings of audit committee doubled after the enactment of Sarbanes-Oxley. Audit committee members have to prioritize their duties and allocate necessary time and resources to fulfill their commitments most effectively.

While a well-qualified audit committee is mandatory for public companies, we believe it is just as important for private companies to establish a strong audit committee as well since it puts in place the processes needed for a firm that may at some point seek a public listing.

All board members should understand the business model, financial condition and risk profile of the company on whose board’s they serve. This requirement is amplified for the audit committee. If necessary, the audit committee should seek counsel from independent advisors. There are resources available for continuing education as to current developments in finance, accounting and regulatory issues. The company’s outside auditor can be enlisted to provide appropriate updates related to accounting changes. It is also advisable to understand and periodically review D&O insurance policies and indemnification issues.

The audit committee role will continue to be significant as regulatory bodies focus on creating greater accountability for the financial function both at the management and board levels. As investors, we always evaluate board and committee level effectiveness. We counsel our portfolio companies to conduct annual performance evaluations with an eye toward maintaining the highest level of effectiveness in accordance with all relevant regulations. For additional thoughts on the audit committee and how to ensure that your committee is well-organized, focused on the right issues and effective, feel free to contact your GA team.