Benchmarking the Audit Committee

Article excerpt

Board of directors audit committees continue to be the subject of heightened public expectations for greater corporate accountability. This year, new audit committee requirements for banks and savings institutions, mandated by the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), went into effect that are likely to increase the personal and professional exposure of committee members subject to the act. Further, a more sweeping reform of private-sector corporate governance was put forward in the Report of the National Commission on Fraudulent Financial Reporting--the Treadway commission's recommendations--which admonished audit committees to be "vigilant, informed, diligent, and probing in fulfilling their oversight responsibilities."

THREE STUDIES

Given the increased demand for greater corporate accountability, CPAs should consider three recent reports that identify bench marks for judging audit committee effectiveness.

* A U.S. General Accounting Office (GAO) survey of 40 of the largest U.S. banks' audit committee chairpersons. The survey was intended to support the need for legislation to reform the regulatory oversight of insured financial institutions.

* My study of audit committee functions that were specifically disclosed in the proxy statements or annual reports of the 251 largest publicly held U.S. corporations. The sample included all companies in all industries ranked both in the top 300 in revenue and at the same time in the top 400 in assets.

* A body of "best practice" recommendations for audit committees approved by the American Law Institute (ALI), a professional organization of practicing attorneys, judges and law school deans and professors. Since 1980, ALI has engaged in a comprehensive, far-reaching project to define the principles of corporate governance.

AUDIT COMMITTEE INDEPENDENCE

Independence from senior management is widely recognized as an important characteristic of effective audit committees. In the GAO survey, bank audit committee chairpersons ranked independence as the most important factor affecting the effectiveness of their committees' oversight. At the same time, however, 7.3% of the largest corporations publicly disclosed their audit committee chairperson had other business relationships with them that potentially impaired their independence. It appears few, if any, outside directors were chosen for their independence.

Korn Ferry International's annual survey of directors found the most sought-after personal characteristic of a director from a board chairperson's or chief executive officer's point of view was a supportive personality. Outside directors who are "idealistic, assertive, or eager to play the devil's advocate" were of less interest. The survey also found chairpersons' recommendations were the most fruitful means of identifying potential outside directors despite the existence on many boards of a nominating committee.

One likely reason for the lack of attention to independence is the flexibility of New York Stock Exchange rules for large publicly held corporations' audit committee appointments. Even persons with obvious conflicts of interest, including a corporation's consultants, significant vendors, major lenders and investment bankers as well as partners of the law firm representing it, can serve on or even chair its audit committee.

STATUTORY GUIDANCE ON INDEPENDENCE

FDICIA mandates that all insured depository institutions with assets of more than $500 million have an independent a committee as of this year, which affects an estimated 1,000 banks and savings associations. FDIC guidelines direct such institutions' boards to select only outside directors who are independent of management. Boards must consider relationships such as those of officers, employees (or their relatives) as well as investors, creditors or trustees.

The ALI report recommends outside directors be "free of any significant relationship" with the senior executives of the corporation. …