Magazine article The CPA Journal

Regulating Audit Committees

Magazine article The CPA Journal

Regulating Audit Committees

Article excerpt

When the managements of Enron and Waste Management conspired with their Arthur Andersen auditors to mislead investors with fraudulent financial statements, where were their audit committees?

Congress enacted the Sarbanes-Oxley Act of 2002 (SOX) in direct response to these and other corporate financial frauds and related scandals. SOX mandated certain significant reforms to public companies' governance structures andregulatoiy oversight of their independent auditors. As a consequence, independent auditors- now subject to the PCAOB's regulatory oversight-report directly to an audit committee (or die board of directors) rather than to management The audit committee engages auditors and is responsible for overseeing the conduct of the audits and the entire financial reporting process. In addition, SOX made audit committees responsible for whistleblowing. SOX provides very little else, however, with respect to the duties and responsibilities of audit committees. The following is a look inside what SOX is and what it isn't-at least not yet--with regard to audit committees.

The SOX Effect

According to SOX section 205, issuers without listed securities are not compelled to have an audit committee. If they do not have one, the board of directors is responsible for oversight of the financial reporting process and the relatively few specific audit committee duties SOX sets forth. Under SOX section 301, however, the SEC directed the national securities exchanges and associations to require issuers to maintain audit committees that comply with certain requirements of the act (as a condition for listing its securities)-among them, that audit committee members may not be members of management. Consequently, the SEC adopted Rule 10A-3 (Release 33-8220).

But did SOX and Rule 10A-3 go far enough to define the responsibilities of audit committees or to assure that they are effective in carrying them out? In 2008, six years after SOX was enacted, it was learned that Bernard L. Madoff Investment Securities LLC, a nonissuer registered broker/dealer, had secretly bilked investors out of $65 billion over a period of 18 years in the largest Ponzi scheme ever known. The Madoff firm had been submitting required annual reports to the SEC on Form X-17A-5. Those reports contained financial statements purportedly audited by a tiny firm with only one active accountant that was not subjected to peer review (because it fraudulently represented to the AICPA that it did not do audits). Because the auditor invested with Madoff, he was not even independent as required under both AICPA and SEC rules. Madoff s firm had no functional audit committee, because it was not required to have one.

Isn't it time for somebody to provide real regulation and oversight of audit committees of both issuers and nonissuer broker/dealers?

The 2015 SEC Concept Release

On July 1, 2015, the SEC issued a concept release, "Possible Revisions to Audit Committee Disclosures" (Release 33-9862, 34-75344, File S7-13-15). The release's underlying premise is: "[tjhe Commission's disclosure rules for this area may not result in disclosures about audit committees and their activities that are sufficient to help investors understand and evaluate audit committee performance, which may in turn inform those investors' investment or voting decisions." The following thoughts are based largely on this author's comment letter sent to the SEC on July 31, 2015, in response to the release.

It is clearly, albeit subtly, pointed out in the summary in section IH of the release that current requirements applicable to audit committees are weak and inadequate with respect to the objective of helping investors evaluate audit committee performance. Although the additional potential disclosure requirements set forth in the release may potentially afford some improvements over the status quo, this author believes that the proposal falls far short of the mark. Enhanced disclosure requirements can be only a small step in the right direction, no matter how extensive they are. …

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