Corporate Practice Series Portfolio No. 49-6th, Audit Committees, covers the establishment and maintenance of effective audit committees after the Sarbanes-Oxley Act of 2002 as well as the historical development of audit committees prior to 2002. The portfolio also discusses two influential documents: the Report & Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees and the study commissioned by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO Report). The response to these reports by the Securities and Exchange Commission and by the major stock markets is analyzed. The potential liability of audit committee members is also considered. Major policy and procedural issues facing today’s audit committee are explained as well as the functions and the responsibilities of a typical committee. Finally, the particular situation of audit committees of insured depository institutions and not-for-profit entities is examined and the role of audit committee counsel is reviewed.
Portfolio 49-6th: Audit Committees I. Introduction II. Audit Committee Provisions of the Sarbanes-Oxley Act of 2002 and Recent Developments A. Definitions B. Three Provisions Directly Affecting Audit Committees 1. Section 202 of Sarbanes-Oxley 2. Section 301 of Sarbanes-Oxley a. SEC implementing rules 3. Section 407 of Sarbanes-Oxley C. Independence of Audit Committee Members 1. Scope of the requirement a. Advising, consulting, or compensatory fees b. Affiliated person of the issuer or any subsidiary thereof 12 2. Exemptions from audit committee member independence a. New issuers b. Overlapping board relationships c. Dual holding companies d. Other requests for independence exemptions e. Opportunity to cure defects 3. Responsibilities of the audit committee a. Oversight b. Procedures for handling complaints c. Authority to engage advisers; funding 4. Affected foreign issuers a. Employee representation b. Two-tier board systems c. Controlling shareholder representation d. Foreign government representation e. Listed issuers that are foreign governments f. Boards of auditors or similar bodies g. Other exemptions 5. Investment companies 6. Disclosure changes regarding audit committees a. Disclosure regarding exemptions b. Identification of the audit committee in annual reports c. Updates to existing audit committee disclosure requirements d. Application to foreign private issuers 7. SEC audit committee disclosure rule adopted as of December 1, 2003 D. NYSE Corporate Governance Rules 1. Summary 2. Director independence 3. Executive sessions 4. Nominating/corporate governance committee requirements 5. Compensation committee requirements 6. Audit committee requirements 7. Audit committee member requirements 8. Audit committee charter requirements 9. Internal audit function 10. Corporate governance guidelines 11. Code of business conduct and ethics 12. CEO certification and notification 13. Public reprimand letters 14. Public access website 15. Exceptions E. NASDAQ Corporate Governance Rules 1. Summary 2. Director independence 3. Annual proxy statement disclosure 4. Meetings of independent directors 5. Compensation and compensation committee requirements 6. Nomination of directors and nominating committee requirements 7. Audit committee requirements 8. Audit committee charter requirements 9. Audit committee responsibility and authority 10. Code of business ethics and conduct 11. Related party transactions 12. Notification of non-compliance 13. Going concern qualifications 14. Exceptions III. The Audit Committee Report IV. Auditor Independence Rules A. Importance of Auditor Independence B. SEC Independence Rules C. Per Se Prohibited Non-Audit Services 1. Permitted non-audit service—tax services 2. Audit committee pre-approval of services provided by auditor 3. Audit partner 4. Partner rotation 5. Employment relationships 6. Compensation 7. Auditor communication with audit committee 8. Disclosures to investors of services provided by the auditor 9. Indemnification of auditors 10. Variable interest entities 11. PCAOB auditor independence rules V. Audit Committee Policy and Procedural Issues VI. Functions and Responsibilities A. Minimum Responsibilities of Public Company Audit Committees B. Five Significant Issues for Public Company Audit Committees C. Flexibility and Uniqueness D. Ultimate Responsibility E. Six Primary Functions 1. Pre-approval of the outside auditors a. Experience b. Personnel c. Scope of services available d. Audit costs 2. Review of overall audit plan 3. Review and evaluation of financial statements 4. Review of external audit 5. Review of internal audit 6. Review of internal accounting controls F. Additional Functions 1. Factors influencing the assignment of additional functions a. The company’s needs b. The company’s organizational structure c. Coordination with other board committees d. Time commitment and availability of audit committee members 2. Eight additional functions a. Review of financial press releases, proposed guidance to securities analysts, reports to shareholders, and quarterly filings b. Establish and monitor codes of conduct to foster a culture of honesty and ethics c. Review of conflicts of interest d. Review of perquisites e. Review of sensitive payments f. Review of settlements and claims g. Performance reports h. Risk oversight VII. Potential Liability of Audit Committee Members A. State Law Fiduciary Duties B. Differential Liability 1. State law and differential liability 2. Federal securities law and differential liability C. Federal Securities Law and Control-Person Liability D. The Signature Requirement E. Sarbanes-Oxley and Related SEC and Stock Market Rules Lead to Increased Liability 1. The audit committee report 2. Audit committee charter 3. Safe harbor provision 4. Independence requirements F. SEC Enforcement Actions Against Audit Committee Members G. Insulating Directors From Potential Liability as Audit Committee Members 1. Indemnification 2. Elimination of duty of due care
3. Good faith reliance 4. Liability insurance for directors and officers 5. Procedures illustrating due care VIII. The Blue Ribbon Committee and COSO Reports . Introductory Material A. The Former SEC Chairman's 1998 Speech 5 B. The Blue Ribbon Committee Report on Improving the Effectiveness of Corporate Audit Committees C. Financial Literacy D. The COSO Report on Fraudulent Financial Reporting: 1987 to 1997 E. Auditing Standards Board Changes F. Other Developments IX. Responses of the Major Stock Markets to the Blue Ribbon Committee and COSO Reports: 1999 to 2001 . Introductory Material A. NASDAQ/AMEX Audit Committee Rule 1. Audit committee charter 2. NASDAQ/AMEX audit committee structure B. New York Stock Exchange Audit Committee Rule: Pre-2003 1. Independence 2. Audit committee charter and structure X. Response of the SEC to the Blue Ribbon Committee and COSO Reports: 1999 to 2001 . Introductory Material A. SEC Audit Committee Rules: Adopted 1999 to 2001 1. Audit committee report 2. Proxy and information statement disclosure 3. Pre-filing quarterly reviews 4. Extension of Item 302(a) to a wider range of companies B. SEC Auditor Independence Requirements: Adopted 1999 to 2001 1. Background 2. Empirical studies C. Staff Accounting Bulletins Nos. 99, 100, and 101 1. SAB No. 99—Materiality 2. SAB No. 100—Restructuring and Impairment Charges 3. SAB No. 101 as amended—Revenue Recognition in Financial Statements a. Policy and other disclosures b. Transition guidance D. Other Developments: 1999 to 2001 XI. Doctrinal Thrust: Pre-1999 A. The Corporate Governance Phenomenon B. Practical Benefits 1. Enhancement of the company's financial reporting practices 2. Enhancement of auditor communication and independence 3. Enhancement of the company's internal accounting controls 4. Enhancement of management XII. Evolution of the Audit Committee: Pre-1999 . Introductory Material A. Changing Expectations of Director Responsibility B. Legislative Action 1. Federal 2. State C. The Treadway Commission 1. The Treadway Commission Report 2. Impact and effectiveness: Pre-1999 3. The Cadbury Report D. Regulatory and Quasi-Regulatory Agencies 1. The Securities and Exchange Commission: Pre-1999 a. SEC disclosure rules: Pre-1999 b. Genesis of the SEC's interest c. SEC encouragement d. Views of SEC members e. SEC response to the Treadway Commission—adoption of audit committees and audit committee reports: Pre-1999 f. Enforcement proceedings: Pre-1999 (1). Expanded review by independent accountants (2). Formation of oversight committees (3). Use of special auditors (4). Expanded annual reviews (5). Appointment of a new financial officer (controller) 2. The NYSE: Pre-1999 3. The American Stock Exchange: Pre-1999 4. The American Institute of Certified Public Accountants a. SAS No. 61 b. Genesis c. 1993 recommendations of the Public Oversight Board d. 1994 recommendations of the Public Oversight Board e. 1995 recommendations of the Public Oversight Board 5. The American Bar Association: Pre-1999 6. The American Law Institute: Pre-1999 7. National Association of Securities Dealers: Pre-1999 XIII. Insured Depository Institution Audit Committees A. House Report on FDICIA B. Section 36(g)(1) of the FDIC Act C. Annual Reports D. Annual Independent Audits E. Section 36(f) of the FDIC Act F. Audit Committee Review of Annual Report G. Review of Quarterly Reports H. Qualification of Accountants I. Enforcement Actions J. Notice of Termination of Services K. Report to the Independent Auditor L. Reports to Regulatory Agencies M. Insured Subsidiaries of Holding Companies N. Covered and Exempt Financial Institutions O. Large Institutions P. Final FDIC Guidelines and Interpretations Q. Civil Monetary Penalties R. Following Sound Procedures S. March 5, 2003, FDIC Financial Institution Letter T. March 4, 2005, FFIEC Proposed Interagency Advisory U. Office of Comptroller of the Currency: Board/Audit Committee Oversight Worksheet XIV. Not-for-Profit Entities A. IRS Form 990 B. Excerpts from “Nonprofit Governance in the Wake of Sarbanes-Oxley” 1. The genesis of Sarbanes-Oxley 2. Does Sarbanes-Oxley apply to nonprofits? 3. The composition of the audit committee 4. Duties of the audit committee 14 a. Selection of the outside auditor b. Rotation of the lead audit partner c. Whistleblowing procedures 5. Restrictions relating to non-audit services 6. Certifications by officers; auditor attestation reports 7. Loans to officers 8. Code of ethics for senior financial officers 9. Conclusion C. Excerpts from “The Impact of Enron and Its Progeny Upon Nonprofit Board Responsibility and Financial Accountability” 1. Financial reporting and disclosure 2. Conclusion XV. Role of Counsel to the Audit Committee A. The Need for Counsel B. Choice of Counsel 1. In-house counsel 2. Outside corporate counsel 3. Counsel with no pre-existing relationships C. Duties of Counsel XVI. Summary of the Sarbanes-Oxley Act of 2002 . Introductory Material A. Public Company Accounting Oversight Board 1. Establishment of the PCAOB 2. Registration with the PCAOB 3. Auditing, quality control, and independence standards and rules 4. Inspections of registered public accounting firms 5. Investigations and disciplinary proceedings 6. Foreign public accounting firms 7. SEC oversight of the PCAOB 8. Accounting standards 9. Funding B. Auditor Independence 1. Non-audit services 2. Audit partner rotation and reports to audit committee 3. Conflicts of interest 4. Study of mandatory rotation of registered public accounting firms C. Enhanced Corporate Governance Requirements 1. Audit committee requirements 2. Prohibition on loans to insiders D. CEO/CFO Certifications 1. Section 302 certification requirements 2. Independent auditor assessment 3. Section 906 certification 4. SEC rules related to certifications E. Enhanced Disclosure Requirements 1. Financial disclosure requirements 2. Section 16 disclosure requirements a. Shortened time period for filing §16 reports b. Mandated filing of §16 reports via EDGAR 3. Internal control report 4. Disclosure of adoption of and changes in code of ethics 5. Real time disclosure F. Enhanced SEC Review of Public Company Reports G. Attorney Rules of Professional Responsibility H. Prohibition on Insider Trading During Benefit Plan Blackout Periods I. Corporate and Criminal Fraud Accountability 1. Prohibitions 2. Bankruptcy law amendments 3. Judicial code amendments 4. Sentencing guidelines amendments 5. Prohibition against retaliation J. White-Collar Criminal Penalty Enhancements 95 1. Attempts and conspiracies to commit criminal fraud 2. Criminal penalties for mail and wire fraud 3. Increased criminal penalties for ERISA violations 4. Sentencing guidelines 5. Establishment of fund for the benefit of victims of securities violations K. Corporate Fraud/Accountability 103 1. Alteration of documents 2. Improper influence on conduct of audits 3. Forfeiture of certain bonuses and profits 4. Temporary freezes of payments to officers, directors, and other employees 5. Sentencing Commission review 6. Prohibitions on securities law violators serving as officers and directors 7. Increased penalties for 1934 Act violations 8. Retaliation against informants L. Extension of Statute of Limitations for Private Actions M. Analyst Conflicts of Interest N. Sense of the U.S. Senate Regarding Tax Returns