Emerging Issues

The Audit Committee of the Future

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It is no secret that audit committees play an important role for boards of public companies, a role that has expanded significantly over the past decade following the adoption of the Sarbanes-Oxley Act of 2002 (“SOX”) and the financial turmoil of the Great Recession. In April 2016, the Center for Audit Quality (“CAQ”) and the John L. Weinberg Center for Corporate Governance at the University of Delaware convened a panel of experts to discuss the current state of audit committees and possible enhancements for the future. The June 2016 edition of CAQ Insights reports on the findings of this panel and offers a look into the next chapter for public company audit committees. While the expert panel agreed that the current approach in the U.S. regarding audit committee composition and expertise has been successful, the consensus was that in the ever-evolving public company landscape, there is still room for additional enhancements.

The Securities and Exchange Commission (“SEC”) issued a concept release in July 2015 on audit committee effectiveness that included a number of questions regarding possible ways to enhance both audit committee effectiveness and improve disclosure about audit committee activities provided to investors. The concept release also included speeches by SEC Chair White and other senior SEC officials who have focused on the need for strong, effective audit committee members.  In a December 2015 speech at the 2015 AICPA National Conference, Chair White discussed the role and responsibilities of the audit committee, including growing concerns about the increasing demands on audit committee members. Chair White noted that, “the increasing workload may dilute an audit committee’s ability to focus on its core responsibilities: selecting and overseeing the independent auditors; internal controls and auditing; setting up an appropriate system for the receipt and treatment of complaints about accounting; and reporting to shareholders.”  Chair White further noted the need to have strong, qualified audit committee members, stating, “just meeting the technical requirements of financial literacy may not be enough to fully understand the financial reporting requirements or to challenge senior management on major, complex decisions.”

At its April 2016 meeting, the expert panel revisited the history of the current requirement for disclosure of whether or not a public company’s audit committee has an “audit committee financial expert”, or “ACFE”, a requirement imposed by SOX. The rule on ACFEs adopted by the SEC in 2003 includes, in the definition of what constitutes an ACFE, specific subject matter attributes and stipulates the manner in which the ACFE acquired such expertise. The panel concluded that the current approach “has worked – today’s audit committees include, as members, more chief financial officers, audit partners, controllers – people who have actually experienced how to control risk and how to reflect it in good public company reporting.”  According to research from the CAQ and Audit Analytics, in 2015, the audit committees of 51% of Fortune 500 companies included three or more ACFEs.  Even so, the expert panel reported five recurring themes on ways to further enhance and strengthen audit committees:

  1. Tightening the definition of ACFE. The panel discussed carefully tightening the definition in a way that did not impose excessive requirements regarding board expertise and considered the uniqueness of each company’s situation but nonetheless required an appropriate background and knowledge of GAAP to instill appropriate rigor in the audit process.
  2. Enhancing voluntary audit committee disclosure. The panel noted the need for transparency in corporate governance. Following the themes in the SEC’s July 2015 concept release, the panel believes that additional voluntary disclosure, including disclosure about the attributes of the audit committee and why each member is on the committee, is a critical first step to improving communications around audit committee composition and expertise.
  3. Fostering robust communication and engagement. The panel noted that healthy channels of communication with the auditor, the internal auditor, the CFO and the controller are very important skills for the audit committee, in addition to communications with investors through the disclosure process.
  4. Prioritizing continuing education. The panel stressed the need for ongoing education for audit committee members, especially given the rowing complexity of accounting standards and financial reporting rules.
  5. Addressing the “kitchen sink” challenge.  Finally, the panel echoed the concerns expressed by Chair White regarding the additional responsibilities that are dumped into the “kitchen sink” of the audit committee, noting that audit committees should not lose track of the fact that the core function of the audit committee is financial reporting.

See the full report from the Center for Audit Quality here.