|EXECUTIVE SUMMARY |
| WITH THE ADVENT OF SARBANES-OXLEY, CPAs ARE LIKELY to receive more invitations to serve on the audit committees of corporate boards of directors. Before accepting these offers, accountants should make sure they are ready for the time commitment and other responsibilities that come along with them.
MANY CPAs WILL BE ASKED TO SERVE AS THE AUDIT committee’s financial expert. This individual should have an understanding of GAAP and financial statements, experience preparing, auditing, analyzing or evaluating statements that show a level of complexity similar to the company’s and an understanding of internal controls, financial reporting procedures and audit committee functions.
INDUSTRY EXPERTISE IS AN IMPORTANT QUALIFICATION for audit committee service. For certain specialized industries CPAs may need to devote extra time to gain a working understanding of the business and its competitors.
SERVING ON AN AUDIT COMMITTEE INVOLVES a significant time commitment, including preparing for meetings as well as attending them. Preparation time depends on the responsibilities in the audit committee’s charter and the resources available to help it do its job.
BEFORE MAKING A FINAL DECISION TO JOIN an audit committee, CPAs should be sure to read the sections of Sarbanes-Oxley pertaining to audit committees as well as the company’s audit committee charter, speak to current and former committee members and evaluate their own independence from the company and its management.
|STEPHEN A. SCARPATI, CPA, CLU, ChFC, is a senior managing partner at 180 Management in New York City. He heads the firm’s audit committee advisory service. His e-mail address is email@example.com . |
orporate America is only beginning to feel the impact of the Sarbanes-Oxley Act of 2002. Not surprisingly, one consequence of this legislation is that CPAs, particularly those who are retired from public practice or those in industry, are often sought after to serve on boards of directors of both public and private companies. It is particularly critical for the long-term economic confidence of the nation that American businesses attract and retain talented individuals to serve on their boards’ audit committees. Now that the SEC has issued its definition of “audit committee financial expert,” even more companies are seeking CPAs as board members.
Serving on an audit committee can be professionally rewarding. For many accountants, it provides an opportunity to contribute a lifetime of experience in a challenging new business environment. Many CPAs find the intellectual interaction with other corporate leaders to be a pleasant addition to their careers. This experience, however, is not universal. For some, the benefits do not justify the personal commitment, media spotlight and legal liability that potentially accompany audit committee service. A few have resigned their positions while others simply do not accept offers to serve. This article outlines some key factors and practical issues CPAs contemplating service on an audit committee should consider before joining. In addition, “ Six Points to Ponder When Invited to Join an Audit Committee ” offers guidance from CPAs who serve on corporate boards and their insights into the decision of whether to join a board and its audit committee.
SEC rules implementing section 407 of Sarbanes-Oxley require a company to disclose whether it has at least one “financial expert” serving on its audit committee and, if so, the expert’s name and whether he or she is independent of management. A company that does not have such an expert on its audit committee must disclose this fact and explain why.
|It makes sense that corporate America would look to CPAs to satisfy this new requirement because the SEC defines a financial expert as someone with
An understanding of GAAP and financial statements.
The ability to assess the general application of these principles in connection with accounting for estimates, accruals and reserves.
Experience preparing, auditing, analyzing or evaluating financial statements that present a breadth and level of complexity of accounting issues that are generally comparable with the breadth and complexity of issues the company’s financial statements might reasonably raise or experience actively supervising one or more persons engaged in such activities.
|Directors and Ethics
Some 81% of companies have conducted ethics and compliance training for their employees.
Only 27% have held any such training sessions for their boards of directors.
About 55% of the executives surveyed say their directors are not engaged enough in major ethical issues involving the company.
Source: Conference Board survey of ethics, human resources and legal officers, www.conference-board.org .
An understanding of internal controls and financial reporting procedures.
An understanding of audit committee functions.
Under SEC rules, a person must have acquired these attributes by any one or more of the following means:
Education and experience as a principal financial officer, principal accounting officer, controller, public accountant or auditor.
Experience actively supervising one of the above or someone performing similar functions.
Experience overseeing or assessing the performance of companies or public accountants regarding the preparation, auditing or evaluation of financial statements.
Other relevant experience.
CPAs in both public practice and industry typically have these attributes and qualify as audit committee financial experts. However, CPAs need to consider a number of other issues and factors when contemplating an offer to serve on an audit committee.
|By design, board members frequently are drawn from a wide spectrum of industries and professions. This diversity adds valuable perspective when assessing corporate strategy, overseeing management and evaluating operating performance. New members without the requisite industry background must devote extra time and effort to gain a working understanding of that business. Certain industries, however, have higher degrees of specialization, uniqueness or regulation than others, and the “learning curve” could be considerably longer.
For more specialized industries, audit committee members in particular often need to devote extra time to understanding the financial implications of a company’s circumstances. Take, for example, the insurance industry. All insurance company audit committee members need to understand issues such as
Statutory accounting. Prescribed by the National Association of Insurance Commissioners, this method of accounting differs significantly from GAAP.
State regulation. These rules are unique to each of the 50 states. Most insurance companies typically do business in multiple states.
Actuarial considerations. The methods and assumptions actuaries use for pricing and reserve valuation criteria.
For many CPAs, the amount of time required to effectively serve is the primary consideration in deciding whether to accept an audit committee assignment. Three major factors—the committee charter, meeting preparation and available resources—influence the time commitment.
|Audit Committee/Director Resources
The AICPA has created an “audit committee matching system” (ACMS) for members who are interested in serving on the audit committee or board of directors of a public, private, not-for-profit or public-interest entity. AICPA members can register with the ACMS at www.aicpa.org . Organizations looking for audit committee members will be able to visit the ACMS and search for candidates. Both parties are responsible for their own due diligence.
The AICPA is also creating an audit committee tool kit, including forms and checklists, to help make a committee actionable. The kit will be available late in the third quarter or early in the fourth quarter of 2003. Its availability will be announced through The CPA Letter and the AICPA Weekly Update and other means. The kit will be supported by a Web site within www.aicpa.org called the Center for Audit Committee Effectiveness. All tools will be downloadable from the Web site, and users are encouraged to tailor them to their own needs.
In early 2004 the AICPA also expects to launch an audit committee competency model within the AICPA Competency Self-Assessment Tool. The model will allow audit committee members, and those in the organization that work closely with them, to assess their skills—an important step in understanding the committee’s effectiveness.
Audit committee charter. This document sets out the group’s responsibilities, authority and specific duties. Typically, an audit committee oversees and monitors a company’s financial accounting and reporting process, its internal controls system and the external audit process.
It’s quite possible members may have other responsibilities as well. The biggest variable in establishing the extent of audit committee oversight is whether other board committees exist to handle related financial matters. For example many boards of directors have a finance committee, which exercises general oversight over the company’s financial programs. Certain financial services institutions also may have a committee to supervise investment policies and procedures. The absence of such committees may add to the audit committee’s workload and increase the time commitment of its members.
Preparation. An audit committee typically meets between four and eight times a year. The actual time attending these meetings usually is dwarfed by the time a member must spend to prepare for them. A common boardroom debate revolves around the volume and level of detail of information and materials management provides to committee members prior to meetings. Not long ago a six-member audit committee at one large company debated the issue, with three members wanting to reduce the level of detail from management and the other three asking for more. While this might seem unusual, it highlights the fact that a review of financial statements, independent accountant communications, internal audit reports, management reports and correspondence all take place before the meeting and require considerable preparation time. Conscientious members arrive at audit committee meetings prepared to address key issues and to ask the right questions.
Resources. Section 301 of Sarbanes-Oxley specifically addresses the issue of audit committee resources. It says, “Each audit committee shall have the authority to engage independent counsel or other advisors, as it determines necessary to carry out its duties.” That section also says, “Each issuer shall provide appropriate funding to the audit committee.”
Not every audit committee has the time, skills and experience to handle every problem that comes its way, particularly if the company faces unusual, difficult or contentious issues. Increasingly, proactive audit committees are augmenting their collective member expertise by:
Obtaining training and education on current issues affecting the company.
Engaging their own industry and financial experts.
Hiring legal counsel for the committee.
As committees strive to assess risk, determine the adequacy of controls and understand key business drivers, they often seek outside advice to ensure they are asking the right questions. Not only does this provide important incremental expertise, it also eases the burden on individual committee members who might otherwise have to devote extra time and effort on their own.
Many CPAs will be asked to serve as the audit committee financial expert. By virtue of their financial skills, acumen, training and background, CPAs are in an excellent position to grasp key issues quickly and make leadership contributions to audit committees. This also could include serving as committee chair. In this role, CPAs would have additional responsibilities, the most significant being setting the group’s agenda.
Establishing the committee agenda requires considerable judgment. After consulting with senior management, other audit committee members, board members, the internal audit director, the independent audit partner and others, the chairperson must cull through myriad events, business situations, reports, projects and governance issues that potentially could be brought before the committee, weed out those that waste valuable committee time, home in on high-risk areas and rank topics worthy of committee consideration. CPAs contemplating audit committee membership should keep in mind that serving in a leadership role, including as chairperson of the committee, would not be unusual.
Audit committee members have a fiduciary duty to the company and to its shareholders. Accordingly, legal liability is a major concern for CPAs considering joining a board of directors. While directors can ease those concerns somewhat by securing adequate directors & officers insurance coverage as well as by retaining legal counsel and other experts to advise them, the liability is a reality prospective directors must weigh before accepting an invitation to join a board and its audit committee. When researching the company, CPAs not only have to review the entity’s financial statements and products but also investigate its corporate reputation, management practices and business ethics.
In its final rule on audit committee disclosure, the SEC noted that in adopting the new rules and amendments, “we do not intend to subject companies or their directors to increased exposure to liability under the federal securities laws, or to create new standards for directors to fulfill their duties under state corporation law.” The SEC went on to say that it did not believe the disclosure requirements would result in increased liability exposure or create new standards. It remains to be seen whether one of the long-term consequences of Sarbanes-Oxley is to increase or decrease litigation. Nevertheless, from the viewpoint of an individual director, legal liability is—and will remain—a major boardroom concern.
||PRACTICAL TIPS TO REMEMBER |
CPAs considering joining the audit committee of a corporate board of directors should make sure they understand the industry the company operates in, particularly if it is one with special considerations, such as the insurance industry.
Be aware that audit committee service can involve a time commitment that goes beyond the hours spent attending meetings. This includes reading reports and other materials prepared by management, reviewing financial statements, internal audit reports and correspondence from the company’s external auditors.
Before accepting an offer to join an audit committee, CPAs should make sure they and their firm are independent of the company and its management. The requirements in Sarbanes-Oxley make it particularly important to check for any real or apparent conflicts of interest.
Prospective committee members should research the company thoroughly before accepting an invitation to serve as a director. This includes reading prior annual reports, talking to current and past board members, speaking with employees and interviewing the company’s external auditors.
Before deciding whether to accept an offer to join an audit committee, CPAs should take these steps:
Learn the law. Understand the required roles, responsibilities and duties. Read the sections of Sarbanes-Oxley that pertain to audit committees. The AICPA Web site, www.aicpa.org , is an excellent resource.
Research the industry. Get to know the industry in which the company operates. (A good place to start is to obtain material from industry associations and review the Web sites of the company’s major competitors.) Use this information to determine the extent to which your skills and experience can be helpful and to figure out how much effort you will need to devote to learning the business.
Read the company’s audit committee charter. Understand the committee’s assigned breadth of responsibilities and whether there are incremental duties over and above those of traditional audit matters.
Speak to current and former committee members. Ask them how long they have served, their background, how much time they devote to committee service, their perspective on the key issues affecting the company and what additional resources are available to the committee.
Estimate your time commitment. Make your own estimate of how much time you will need to devote to carry out the duties to your satisfaction and that of the company. Make sure the requirements fit comfortably with your own personal situation.
Evaluate your independence. Are you, your firm and your other clients independent of the company whose audit committee you want to join? CPAs should check carefully to make sure they have no conflicts of interest before joining the board.
Armed with this information, CPAs can make an informed decision on whether they want to become part of the new vanguard in corporate governance Sarbanes-Oxley has created.
|Six Points to Ponder When Invited |
to Join an Audit Committee
Audit committee membership can be an awesome responsibility. This is particularly true since the advent of Sarbanes-Oxley. Here are some suggestions from board members that CPAs should evaluate before accepting a company’s invitation to join its audit committee.
1 Make sure you research the company well. CPAs should go far beyond the company’s annual reports and other financial data, according to accountants who sit on audit committees today. With cases like Enron, experts say the importance of firsthand, in-depth knowledge of the company’s culture can’t be overrated. “Is management straightforward and forthright?” asks CPA Michael Bernstein of Geller & Co. in New York City. “Does it set a positive tone in carrying out its responsibilities?” Bernstein, who manages Geller’s finance and accounting outsourcing group, recently accepted an appointment as audit committee chairman of a $50 million drug company, Bradley Pharmaceuticals, in Fairfield, New Jersey.
If staffers hesitate to speak up when queried, Bernstein says a red light should go off. “I suspect a problem if I have difficulty getting candid responses,” he says. Bernstein also suggests CPAs interview the prospective company’s audit firm at length. Among the questions Bernstein asked Bradley’s auditor, Grant Thornton, was its opinion of the capabilities of the corporation’s top financial officers and staff and whether it knew of any reason why he shouldn’t join the board’s audit committee.
2 Don’t be afraid to raise negative issues. CPAs should talk to outside professionals, directors and lawyers to see whether there are any reasons why they shouldn’t join the audit committee. Don’t be afraid to explore negative issues, although you may want to experiment with your choice of words, since even sensitive areas can be approached with diplomatic language. Candidates should do a thorough search to reveal any litigation issues the company is facing. This information is available by contacting the company’s legal counsel or its independent auditors, who should have a confirmation from management as of the latest audit date about any legal issues the company faces. Edwin H. Ruzinsky, CPA, urges accountants to “question the motivation of other directors for joining (or leaving) the board, examine their backgrounds, analyze where they fit in, and their integrity and quality. If that attitude had prevailed in the past in corporate America,” Ruzinsky says, “we wouldn’t be in this state.” It’s fair game for the prospective director not only to respond to questions at any interview session but also to ask them of the company’s existing directors.
CPA Robert Waxman says prospective board members should listen for “pat phrases” when employees respond to questions. “If everything is centered on ‘Mr. Big’, you may have a virtual dictatorship. Are there cronies, cousins or other related parties on the board? Do some dominate and others cower?” One board member told Waxman during an interview, “If you’re going to challenge the president, they don’t want you on the board.” Waxman says he had to ask himself, “Does anyone ever challenge the president?” Perhaps more important, he had to ask himself whether he wanted to serve on that company’s board of directors. In this case, the answer was no; Waxman didn’t join the company’s board.
3 Familiarize yourself with the company’s industry. Despite 45 years in accounting (15 in positions of financial responsibility in the publishing industry and almost 30 years in public practice), Ruzinsky stuck to the fields he was most familiar with—medicine and publishing—in choosing the three boards he agreed to sit on after he retired from Deloitte & Touche in 1996. Ruzinsky says to be fully committed to all, he wouldn’t agree to sit on more than four at one time.
In addition to two not-for-profit groups (which don’t currently come under Sarbanes-Oxley), Ruzinsky sits on the board of Media Sciences International Inc., a public company that manufactures consumables for color workgroup printers and is traded on the American Stock Exchange. As past president of the New Jersey state board of accountancy, Ruzinsky feels confident enough to be the sole member of Media Sciences’ audit committee who meets the Sarbanes-Oxley requirements for a financial expert.
Ruzinsky cautions that prospective directors can never be too careful in checking out a company. Despite previously serving as a consultant to Dowden Health Media, a small private medical publisher, Ruzinsky still met with Dowden’s CEO at least four or five times before taking on the chairmanship of its audit committee.
4 Examine the company’s directors & officers (D&O) insurance. Gerry S. Weidema, CPA, says she felt a higher degree of comfort in weighing the risk of sitting on a bank board, as opposed to a nonbank public company, since banks are subject to a higher level of scrutiny, coming under the watchful eye of bank regulators and the Comptroller of the Currency. Yet, she still considered the liability protection offered by the bank’s D&O insurance a vital area of concern before deciding to serve as a director.
Weidema says prospective directors should study a variety of factors that go beyond whether the board is properly insured, including a company’s internal policies. She recently traveled to New York City for a seminar for audit committee members conducted by New York University’s Directors Institute at the New York Stock Exchange. Weidema says she found the trip worthwhile because of the case histories and panel discussions the seminar included. “I learned the most important thing a director can do is to keep probing and asking questions,” she says. “If you don’t understand something, ask, don’t assume. That word should be out of your vocabulary. That advice really stood out.”
She notes that at Banknorth, a regional bank in Portland, Maine where she is a director, “no one is ever made to feel stupid. It’s my job to ask questions. If management doesn’t have the answers, it gets them for me. The company has a terrific internal audit department that follows up and gets back to us quickly.”
5 Make sure you are up to the job. CPAs who are considering accepting offers of corporate directorships should have
Both an accounting and a finance background.
The energy to execute the responsibilities.
The ability to deal with the heightened risk of knowing the SEC and the public hold all board members—
especially those on the audit committee—to a higher standard of conduct.
The tenacity to confront senior management and directors on difficult issues.
Time is a big factor that many novices underestimate. Weidema is cofounder and partner in Weidema & Lavin, a two-person accounting firm in Hampton, New Hampshire, that specializes in tax services for small businesses. She became Banknorth’s first female audit committee chairperson in April and estimates the demand on her time—without meetings—at a minimum of 5 to 10 hours a month. In addition, the committee meets six to eight times a year for about three to four hours, not including her travel time to the company’s Maine headquarters.
Weidema had served as a nonvoting ad hoc member of the audit committees of several banks that were predecessors to the $26 billion Banknorth. As a result, she says, she was “very comfortable” about joining Banknorth’s audit committee when it extended the invitation to her.
6 Evaluate the downside—and the opportunities. While Ralph Ward of boardroominsider.com and author of Saving the Corporate Board says there aren’t yet any statistics available on the number of CPAs serving on audit committees, most experts agree that large accounting firms do not actively offer their partners for audit committee seats. “Even where the board position is with a nonaudit client, you want your partners to spend 100% of their time on firm matters,” says Robert Waxman, founding partner of Corporate Finance Advisory in New York City and chairman of the New York State society of CPA’s global accounting and auditing committee. Plus, Waxman adds, “there are bound to be conflicts of interest with the firm. And why have your partners be subject to possible litigation?”
Waxman expects that, since section 301 of Sarbanes-Oxley now provides for the funding of outside advisers, more audit committees will engage experienced CPAs to offer advice on financial accounting and audit matters. Also, notes Waxman, NPO audit committees are expressing an interest in complying with several Sarbanes-Oxley requirements, and some expect pressure on state regulators to require certain NPOs to comply with some Sarbanes-Oxley-like requirements. Already sitting on one NPO’s board and another’s audit committee, Waxman says he has begun to actively seek election as a director of a public company. With experience in a CPA practice focusing on investment banking, mergers and acquisitions, accounting for derivatives and hedging, SEC filings and compliance and foreign GAAP, Waxman believes he is ready to serve on an audit committee.
—Maureen Nevin Duffy is a freelance business writer in New Jersey. She is the editor and publisher of the Corporate Governance Fund Report, www.cgfreport.com , and the newly launched CG Rate Monitor.