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.