Recommendations Proposed to Improve Audit Committees

Exchanges Respond to SEC Request for Prompt Feedback

By James L. Craig, Jr., CPA

The Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees released its report on February 8 that recommended ten steps for audit committees to improve the quality of financial reporting. The chairs of the New York Stock Exchange and the National Association of Securities Dealers formed the committee, which consists of executives from the business, financial, and accounting communities, at the request of the Securities and Exchange Commission.

SEC Chairman Arthur Levitt has championed efforts to improve the quality of financial reporting since last fall. He strongly encouraged a tight 90-day time frame for the blue ribbon committee to make its recommendations when the SEC and the exchanges announced the group.

"Quality means attempting to deal appropriately and honestly with the huge gray area of discretion left by GAAP," said Ira Millstein, senior partner of Weil
Gotshal & Manges LLP, who co-chaired the committee with John C. Whitehead, former deputy secretary of state and retired co-chairman of Goldman Sachs & Co.

At the heart of the report is a requirement that the audit committee of listed companies with a market capitalization above $200 million (or a more appropriate measure for identifying smaller-sized companies as determined jointly by the NYSE and NASD) must have at least three directors, all of whom are independent and financially literate, and one who has accounting and related financial management expertise. The report further outlines the committee's definition of an independent director.

The committee's recommendations mirror the tone of a 1994 Public Oversight Board report on auditor independence in two areas. First, that the audit committee charter specify that the outside auditor is ultimately accountable to the board of directors and the audit committee as representatives of the shareholders. Second, that generally accepted auditing standards be modified to require a company's outside auditor to discuss with the audit committee the auditor's judgments about the quality, not just the acceptability of the company's accounting principles.

Those in the financial community who criticized the POB report's recommendations because they were only suggestions of best practices will note that the blue ribbon committee seeks to mandate its proposals in SEC rules and through the self-regulatory systems of listing requirements and professional standards.

The report recommends an SEC rule that would require all SEC registrants to engage their outside auditors to conduct SAS 71 Interim Financial Reviews prior to filing 10Q forms. The committee also proposes an amendment to SAS 71 to require that the companies' outside auditors discuss with the audit committees the results of the SAS 71 reviews prior to filing the 10Q and preferably before public announcement of earnings.

The SEC has final authority on rules proposed by the exchanges. Chairman Levitt gave the impression that the SEC would not stand quietly on the sideline while various self-regulatory bodies decide on implementation steps. The blue ribbon committee also stressed the involvement of the financial community in the process.

"Quality financial accounting and reporting can only result from effective interrelationships among relevant corporate participants. We view our recommendations as an integrated set of objectives; a mosaic to enhance the financial reporting and oversight process," Co-chair Whitehead said.

See the Society's website, www.nysscpa.org, for a summary of the recommendations. For a copy of the 71-page report, call the NYSE at (212) 656-2017 or NASD at (202) 728-8340, or visit the exchanges' websites at www.nyse.com and www.nasd.com. Watch future issues of The Trusted Professional for updates on the recommendations' implementation. *