The Role Of Audit Committees

Audit committees have an even more important role to play in corporate governance since the passage of the SarbanesOxley Act. Each audit committee should have a written charter that addresses the committee’s essential functions, purposes, and organization.

The charter provision explaining the committee’s purpose should state that it is:

• To assist board oversight of the integrity of the company’s financial statements, company compliance with legal and regulatory requirements, external auditor’s qualifications and independence, and the performance of the company’s internal audit function and external auditors; and

• To prepare an audit committee report as required by the SEC to be included in the company’s annual proxy statement; or

• For NASDAQlisted companies, to oversee the accounting and financial reporting processes of the company and the audits of the financial statements of the company.

The charter provision on the composition of the committee should include that:

• The committee shall be comprised of at least three members, each of whom the board of directors has determined is independent under Exchange Act Rule 10A3 and the rules of the relevant securities market in which the company’s securities trade; and

• Each member is “financially literate” as determined by the board of directors in its business judgment and is able to read and understand fundamental financial statements, including a company’s balance sheet, income statement, and cash flow statement; and

• That at least one member shall have accounting or related financial management expertise as determined by the board of directors in its business judgment, past employment experience in finance or accounting, requisite professional certification in accounting or any other comparable experience or background that results in the individual’s financial sophistication.

The charter provision on the committee’s duties and responsibilities should state that they include:

• Reviewing the appointment and replacement of the director of the internal audit group;

• Discussing the company’s annual audited financial statements and quarterly financial statements (including the specific disclosures under “Management’s Discussion and Analysis of Financial Condition and Results of Operations”) with management and the external auditors;

• Discussing earnings releases and the financial information and earnings guidance provided to analysts and rating agencies (which discussions may occur after the disclosure of such information and may be general; i.e., covering only the types of information to be disclosed and the type of presentation to be made);

• Preapproving, or adopting appropriate procedures to preapprove, all audit and nonaudit services to be provided by any accounting firm;

• Meeting periodically in separate sessions with each of management, the internal auditors (or other personnel responsible for the internal audit function) and with the external auditor;

• Reviewing with the external auditors and internal audit group any audit problems or difficulties with management’s response, including any restrictions on the scope of the audit activities or access to requested information and any significant disagreements with management;

• At least annually in connection with the committee’s evaluation of the external auditor’s qualifications, performance and independence, to obtaining and reviewing a report by the external auditor describing the firm’s internal qualitycontrol procedures, any material issues raised by the most recent internal qualitycontrol review, or peer review, of the firm, or by any inquiry or investigation by governmental or professional authorities, within the preceding five years, regarding one or more independent audits carried out by the firm, and any steps taken to deal with any such issues, and all relationships between the external auditor and the company;

• Discussing with the external auditor any disclosed relationships between the external auditor and the company or services that may affect the objectivity and independence of the external auditor;

• Taking, or recommending that the board of directors take, appropriate action to oversee the independence of the external auditor;

• Establishing clear hiring policies for employees or former employees of the external auditor;

• Discussing policies with respect to risk assessment and risk management;

• Establishing procedures for the receipt, retention and treatment of complaints received by the company regarding accounting, internal accounting controls or auditing matters, and for the confidential, anonymous submission by company employees of concerns regarding questionable accounting or auditing matters;

• Reporting regularly to the board of directors any issues that have arisen with respect to the quality or integrity of the company’s financial statements, the company’s compliance with legal or regulatory requirements, the performance and independence of the company’s external auditor or the performance of the internal audit function; and

• Preparing an annual evaluation of the audit committee.

The charter provision on the committee’s authority and resources should include that it is to:

• Be directly responsible for the appointment, compensation, retention, and oversight of the work of the external auditors (including the resolution of disagreements between management and the external auditors regarding financial reporting), who shall report directly to the committee; and

• Appoint and set the compensation of such special or independent counsel, accountants or other experts as the committee deems necessary or appropriate to discharge its duties and responsibilities.