President's Commentary

The Vital Importance of the Board and the Audit Committee

The accounting profession’s current crisis of confidence has led to the broader questioning of key components of the U.S. capital markets—disclosure rules, analysts’ actions, the responsibilities of outside directors and the ability and will of the accounting profession to protect investors and preserve the integrity of our capital markets. All of these items serve as checks and balances for each other, making it critically important that they remain on equal footing. While CPAs, members of the press and politicians talk about the need to regulate the accounting profession, I believe the regulators simultaneously should focus on the system of corporate governance, specifically the board of directors and its audit committee.

The National Association of Corporate Directors (NACD) recently reissued its “Report of the NACD Blue Ribbon Commission on Director Professionalism.” Since its initial release in 1996, the report points to evidence that suggests the professionalism of corporate boards has increased, driven to some extent by the Securities and Exchange Commission (SEC) and stock exchange requirements for audit committees. The report makes recommendations in four areas—responsibilities, processes, selection and evaluation. However, it recognizes that all companies are unique and that the directors must determine their own governance.

The General Accounting Office issued Government Auditing Standards Amendment No. 3, “Independence,” on Jan. 25, which states that “The audit organization’s independence is enhanced when it also reports regularly to the entity’s audit committee.” In a separate but related matter, Comptroller General David M. Walker, Secretary of the Treasury Paul H. O’Neill, Office of Management and Budget Director Mitchell E. Daniels and Office of Personnel Management Director Kay Coles James, who sit on the Principals of the Joint Financial Management Improvement Program, have agreed that the 24 major departments and agencies covered by the Chief Financial Officers Act should have audit committees. The scope, structure and timing of this new requirement will be determined over the next several months. Part of this process will include determining the role these audit committees might play in connection with nonaudit services.

In today’s turbulent environment, board members must look at their roles and take them more seriously. The job has changed; now members must put in the time and energy to stay abreast of both internal and external developments affecting a company.

Beyond legal requirements—the duties of care and loyalty—boards define their responsibilities, while bearing in mind that in a for-profit environment their main objective is to enhance corporate profit and shareholder gain. Once a board agrees on its responsibilities, it should document them in a charter or set of guidelines.

The NACD Blue Ribbon Commission’s list of key board responsibilities include the following:

• Approving corporate philosophy and mission
  
• Reviewing and approving management’s strategic and business plans
  
• Reviewing and approving financial objectives, plans and actions, including significant capital allocations and expenditures
  
• Ensuring ethical behavior and compliance with laws and regulations
  
• Monitoring corporate performance against strategic and business plans
  
• Reviewing and approving material transactions not in the ordinary course of business
  
• Selecting, monitoring, evaluating, compensating and replacing, if necessary, the chief executive officer (CEO) and other senior executives, and ensuring succession
  
• Assessing its own effectiveness in fulfilling these and other board responsibilities
  
• Performing other functions prescribed by law or governing documents.

The NACD report describes fundamental steps that can be adopted to ensure that directors fulfill their responsibilities. They include:

Establishing a governance committee comprised only of independent directors who nominate directors and monitor board performance.

Creating independent leadership roles that include either a non-CEO board chair or an independent board leader so that critical functions requiring independence, such as CEO compensation, are fairly addressed.

Influencing the agenda by helping to set it.

Determining effective independent selection and compensation methods, covering both the CEO and directors, making sure the best and brightest are attracted and retained, and that suitable independent directors are available to serve on key committees.

Requiring stock ownership that aligns directors’ and shareholders’ interests.

Establishing an evaluation process that includes regular formal evaluations of the CEO, the board and individual directors.

Holding executive sessions that allow private discussions of issues and concerns to be held at regularly scheduled sessions only for independent directors.

Accessing independent advice by participating with management in selecting outside professionals to advise both the board and management, and retaining the right to hire outside counsel or advisors directly.

Selection: Who Should Serve as Directors

Director selection should be driven by both the board’s and the company’s needs. The board should select new directors with needed skills, who exhibit the following characteristics:

• Integrity and accountability—possessing high ethical standards
  
• Informed judgement—ability to provide wise, thoughtful counsel
  
• Financial literacy—ability to understand financial statements and evaluate financial results
  
• Mature confidence—valuing teamwork and respecting others’ ideas
  
• High performance standards—demonstrating a history of achievement
  
• Independence—allowing effective oversight of management
  
• Commitment—willingness to put in the necessary time, stay abreast of current developments, and ensure other commitments don’t interfere.

Audit Committee

The charge of the board’s audit committee is to provide oversight over the financial reporting process. Members must possess a clear understanding of the company’s financial reporting practices, and they must protect retirement plans and ensure auditor independence. However, audit committee members should also play an important role in overseeing compliance with laws and regulations, corporate behavior, physical and information security, and broad-based risk management processes. Audit committees need to have the expertise to understand the wide-ranging impacts of actions and take care that safety, confidentiality, privacy, contingency planning and related actions make sense in the context of their company’s environment.

Audit Committee Support

The independent auditor should support the audit committee. Beyond the required disclosures and communications, auditors should develop an annual engagement. We should contract with audit committees to make clear our role in supporting them as they discharge their fiduciary responsibilities. Additionally, because our audit partners are rewarded for audit performance, we should share our partner evaluation and compensation policies with client audit committees to establish complete trust and confidence.

The board of directors and especially audit committee members are vital safeguards to the American financial system. Consequently, they must adopt a proper “tone at the top” and be willing to enforce strong governance and ethical principles. w

president@nysscpa.org