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Even before Facebook Inc.'s stunning $119 billion stock market loss July 26, investors had targeted the company’s board for lax oversight, not supporting directors in a proxy vote, and trying to force the board to be more involved in steering the social media giant.
Proxy adviser Glass Lewis and other institutional investors suggested that Facebook’s audit committee, charged with overseeing the company’s regulatory risk and compliance, was asleep at the wheel while controversy after controversy rained down on the company related to the abuse of Facebook users’ data.
“The audit committee has failed to effectively fulfill its obligations to shareholders,” Glass Lewis said in a May report to shareholders.
Facebook addressed some of those concerns and updated the responsibilities of its audit committee in June. But the investor scrutiny underscores the elevated role that audit committees play in the financial markets today. Sixteen years ago, before the Sarbanes-Oxley Act became law, that wasn’t the case.
Audit committee members—those corporate directors who oversee public companies’ financial reporting—are still adjusting to the law and the auditing landscape it shaped.
Under the law, which serves as the foundation for public company auditing in the U.S., audit committees have built relationships with their auditors. They are publicly disclosing how they decide which auditor to hire. And they have fewer sleepless nights thanks to more reliable financial information.
The workload has increased along with the committees’ responsibilities, and the skills that members bring to the table has also evolved.
Investors are paying closer attention to who serves on audit committees, any relationships they might have with the company or its executives, and the discussions they have, or don’t have, in the board room.
While much has changed, there is still room to improve, audit professionals told Bloomberg Tax.
Audit committees should be more aggressive and probe deeper—asking tougher questions of both management and auditors, including on independence matters and relationships between management and the audit team, Doug Carmichael, who served as the PCAOB’s first chief auditor, told Bloomberg Tax.
The committees haven’t taken full advantage of their oversight authority to hire their own consultants and do their own due diligence. While they hire outside help to respond to fraud allegations, they should be more proactive, said Carmichael, who now teaches at Baruch College in New York City.
“If you think your best question is ‘Have you told me everything I should know?’, then you‘re not doing your job,” Carmichael said.
The 2002 SOX law made it clear that the auditor answered to the committee, not management. But that goal hasn’t been fully achieved, said Jeff Johanns, a former PricewaterhouseCoopers LLP audit partner who now teaches at the University of Texas at Austin.
CEOs still have too much influence over the daily work of auditors as well as deciding who serves on the audit committee, he said.
“Audit committee members should not have a pre-existing relationship with the CEO. They shouldn’t have stock-based compensation,” Johanns said.
“If you have a strong audit committee, they are going to make sure there is a strong auditor. And that’s good for investors,” said Cindy Fornelli, executive director of the Center for Audit Quality, formed several years after SOX became law.
“We feel very strongly that audit committees are a key component of audit quality,” she told Bloomberg Tax.
Investors also recognize the role of the committees and rely on them, Fornelli said.
The center also tracks audit committee proxy disclosures—important information that sheds light on how the committee performs its oversight role. More committees are making key disclosures detailing how they hire an auditor, how they set the audit fees, and whether they annually assess their external auditor, Fornelli said.
Expertise among committee members has also grown over the years, Fornelli said.
SOX requires at least one committee member to have financial expertise or to disclose to investors that the committee lacks such experience. Most committees today have at least one member that meets that requirement. Many have to two or more qualified members, Fornelli said.
Audit committees existed before the law, but SOX emphasized the audit committee’s work—which includes managing regulatory risk, reputational risk, and the integrity of the financial reports—a duty members take seriously, said John Lanaway, who serves on the audit committee for the global manufacturing company, CNH Industrial NV.
“It was a transformative event,” Lanaway told Bloomberg Tax.
Chris Nicholson, who served as the auditor for a large public company at the time SOX became law, said that meetings have doubled in length since then because there is more to talk about and the discussions are more in-depth, he told Bloomberg Tax.
It’s no longer unusual for the audit chair to pick up the phone and talk directly to the lead auditor, and to talk frequently, said Nicholson, who serves on the audit committees for Old Dominion National Bank and Lekela Power.
The seemingly small change signifies how the relationships between the committee and the audit team have grown with greater independence from management.
“The needle has moved significantly thanks to SOX,” said Rob Fryer, who consultants on audit committee responsibilities, about the comittee-auditor relationship. “For me that is the most crucial change.”
Sarbanes-Oxley has also made the committee’s job a little less stressful by providing more reliable financial information, said Fryer, who chairs the committee for Shanta Gold Ltd., a mining company traded publicly in the U.K.
“The raw numbers you get, unaudited, are more likely to be accurate in the first place,” he told Bloomberg Tax. “The quality of the audit work has been raised.”
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