SARBANES-OXLEY
ACT 2002 - AUDIT COMMITTEES
HAROLD
S. SMALL, J.D., CPA, and AEP
Last month’s column discussed provisions of
the Sarbanes-Oxley Act of 2002 (“the Act”) which relate to whistleblowers,
employment agreement review, and records retention and destruction
policies. Another area that requires
significant consideration is that of Audit Committees given the new landscape
created by the Act.
The Act requires that within 270 days after
July 30, 2002, that the Securities and Exchange Commission (“SEC”) issue rules
federalizing requirements for the composition and responsibilities of public
company audit committees. Under the Act,
audit committees are to be comprised of independent, unaffiliated directors and
they may not accept any consulting, advisory or other compensatory fees from
the company other than compensation for serving on the audit committee. The audit committee according to the Act is
to be directly responsible for the appointment, compensation and oversight of
the outside auditors of the company, who are to report
directly to the audit committee and not to management.
The Act requires that audit committees
establish procedures for reviewing and processing complaints regarding
accounting, internal controls or auditing matters. It also requires that audit committee
establish procedures for confidential and anonymous submission by employees of
their concerns about questionable accounting or auditing practices. In addition, audit committees will now have
the authority to retain independent lawyers and advisors to assist them in
fulfilling their obligations of helping to ensure that the company is engaged
in sound financial practices.
In addition, the Act requires disclosure in
periodic reports that the audit committee has at least one financial expert on
it, or an explanation as to why it does not.
The SEC was required to promulgate a rule relating to same within ninety
(90) days, and it has done so. The
proposed rule, which is now subject to comment, indicates that the company
shall disclose the “... number and names of persons that the board of directors
has determined to be the financial experts serving on the company’s audit
committee; and whether the financial expert or experts are ‘independent’ (as
defined in Section 10A (m)(3) of the Exchange Act, and
if not, an explanation of why they are not.”
The SEC indicates that although the Act does no specifically require the
disclosure of the number of names of the financial experts, it believes that
such disclosure requirements are appropriate.
The SEC states that “The primary benefit of
having a financial expert serving on a company's audit committee is that the
person, with his or her enhanced level of financial sophistication or
expertise, can serve as a resource for the audit committee as a whole in
carrying out its functions...” The fact
that there are financial experts on the audit committee does not (according to
the SEC) “... decrease the duties and obligations of other audit committee
members or the board of directors.” The
SEC continues stating that “...the role of the financial expert is to assist
the audit committee in overseeing the audit process, not to audit the
company.” In addition,
the SEC states that it “... intend[s] to propose rules directing the national
securities exchanges and national securities association to require a company
to have a completely independent audit committee as a condition to listing.”
The SEC has gone one step further in
addressing oversight issues relating to limited liability companies and
partnerships when it states: “Some companies do not have boards of directors
and therefore do not have board audit committees. For example, some limited
liability companies and limited partnerships that do not have a corporate general
partner may not have an oversight body that is the equivalent of an audit
committee. It may be important to investors to be aware that such entities do
not have such oversight bodies. Therefore, we do not propose to exempt these
entities from the proposed financial expert disclosure requirements. If a
limited liability company or limited partnership does not have a similar
oversight body, it must explain that its organizational structure does not
provide for such a body and that it therefore does not have an audit
committee.”
For the purposes of determining a
“financial expert,” the following guidance has been provided in the form of
attributes (in addition to education, experience, and other issues) of such a
person: (a) an understanding of
generally accepted accounting principles (“GAAP”) and financial statements; (b)
experience applying GAAP in connection with the accounting for estimates,
accruals, and reserves; (c) experience preparing or auditing financial
statements that present accounting issues generally comparable to those raised
by the company; experience with internal controls and procedures for financial
reporting; and an understanding of audit committee functions. The board of directors of the company must
evaluate the totality of an individual’s education and experience. The fact that a person previously served on
an audit committee does not, by itself, justify the appointment of that person
as a financial expert under the proposed definition. It is the overall mix of attributes, education
and experience that must be looked to by the Board of Directors. The SEC rejected the use of a “bright-line”
test for financial expert determination that would have eliminated all elements
of subjectivity.
Because this area is still subject to review
and revision, careful consideration must be given to decisions in this area
both before and after the Rules become final.
Also, as you can imagine, there is a great deal of additional
information about this area, but space does not allow for a full discussion and
the comments indicated above are to provide the reader with familiarity with
the area and actions that may be needed in formulating an audit committee.
THE FOREGOING CONCEPTS AND IDEAS
ARE GENERAL STATEMENTS AND ARE INTENDED TO PROVIDE CONCEPTS FOR CONSIDERATION
IN BUSINESS AND TAX PLANNING. CAREFUL
CONSIDERATION NEEDS TO BE GIVEN BY THE USER REGARDING THE USE AND APPLICATION
OF THE CONCEPTS. YOUR
LEGAL AND TAX COUNSEL SHOULD BE CONSULTED BEFORE THE IMPLEMENTATION OF ANY OF
THE IDEAS INDICATED HEREIN. SHOULD YOU
HAVE QUESTIONS REGARDING THIS MATTER, HAROLD S. SMALL, ESQ., CAN BE REACHED AT
Copyright
Harold S. Small 2007. All rights reserved.