View From the Top: Interview With John J

Business Roundtable believes the basic interests of business closely parallel the interests of the American people, who are directly involved as consumers, employees, shareholders and suppliers. It focuses on issues it believes will have an effect on the economic well-being of the nation. The JofA recently sat down with John J. Castellani, Business Roundtable president, to discuss the group’s approach to the widespread changes in corporate governance following the passage of the Sarbanes-Oxley Act of 2002 and how the accounting profession can work more closely with the organization to bring about improvements.

JofA: Given the corporate scandals of the past two or three years, what is Business Roundtable doing to help restore confidence in the nation’s corporate governance system?

Castellani: Business Roundtable believes the United States has the best corporate governance, financial reporting and securities markets in the world. These systems work because public corporations have adopted best practices within a framework of laws and regulations. While there have been exceptions to the overall record of success, generally these systems have worked very well.

Following the collapse of Enron, Business Roundtable undertook an expedited review of its 1997 Statement on Corporate Governance —at the time its most recent statement on the subject—and released Principles of Corporate Governance in May 2002. The principles document makes specific recommendations designed to guide the continual advancement of corporate governance practices and enhance the ability of U.S. public companies to compete, create jobs and generate economic growth.

In November 2003 as part of its ongoing commitment to strengthening best practices in corporate governance, the association published Executive Compensation: Principles and Commentary , which addresses the design, implementation and oversight of executive compensation programs at publicly held corporations. In April 2004 it issued The Nominating Process and Corporate Governance Committees: Principles and Commentary, which offers guidance to public companies on empowering independent governance committees to oversee director nominations, board operations and corporate governance issues. Both of these build and expand on the foundation laid in the 2002 principles document.

JofA: Can you describe what impact Principles of Corporate Governance has had on the new listing standards at the New York Stock Exchange and the Nasdaq?

Castellani: Business Roundtable issued its principles in May 2002. The NYSE proposed its initial corporate governance listing standards in August 2002 and Nasdaq issued its proposals relating to independent boards and committees in October of that year. We believe the Roundtable’s principles document had a strong impact on these initiatives. Many of the points emphasized in the principles are reflected in the new listing standards, including the importance of an independent board of directors and key committees (audit, compensation and nominating/corporate governance).

In fact, the principles go beyond the NYSE and Nasdaq requirements that the board have a majority of independent directors, advocating that it have a “substantial majority” of directors who are independent—both in fact and appearance. Results of a Business Roundtable survey of member companies released in March 2004 showed 81% of responding companies have boards that are at least 80% independent and 99% have boards that are at least 60% independent.

JofA: Sarbanes-Oxley had an impact on corporate America, the accounting profession and businesses of all sizes. What critical changes has the act imposed on your CEO members and the companies they manage?

Castellani: Sarbanes-Oxley imposed a number of new responsibilities on audit committees, particularly with respect to overseeing a company’s relationship with its outside auditor. As a result they are taking a more active role in managing this relationship. The audit committee now is directly responsible for retaining, evaluating and overseeing the work of the outside auditor. In this regard audit committees are looking closely at the types of services the outside auditor provides and, as required by Sarbanes-Oxley, preapproving all such services. They also are responsible for establishing procedures to receive and handle complaints and concerns about accounting, internal accounting controls and auditing matters. In general we are seeing audit committees becoming more involved in legal compliance, and many of them are assuming a greater role in overseeing codes of conduct and compliance programs. The new NYSE and Nasdaq listing standards have further added to the responsibilities of audit committees.

In addition, Sarbanes-Oxley significantly increased federal regulation of the accounting profession. Like corporate America the profession has suffered in recent years from an erosion in investor confidence. The investing public can take comfort from the fact that, under Sarbanes-Oxley, a new, independent oversight organization—the Public Company Accounting Oversight Board (PCAOB)—is responsible for overseeing accounting firms that audit public companies, and firms will be subject to regular inspections by the PCAOB.

JofA: As Business Roundtable works with CEOs to restore confidence in boards of directors and company management, have there been any rough spots or changes in the relationships between company and auditor and the services the auditors perform?

Castellani: Significant changes began in 1999, following the issuance of a report by the blue ribbon committee on improving the effectiveness of corporate audit committees. In response to the recommendations in this report, the NYSE and Nasdaq revised their listing standards relating to audit committees. Sarbanes-Oxley put increased focus on the relationship between the company, the audit committee and the outside auditors and made clear the audit committee, not management, is responsible for overseeing a company’s relationship with the outside auditor. In the wake of Sarbanes-Oxley, audit committees are paying close attention to the independence of the outside auditor and to the services the auditor performs.

JofA: Corporate America must beef up its internal control capability. Can you comment on the impact this is having on corporations and the role auditors will play in monitoring the effectiveness of the internal control process?

Castellani: Internal controls are an important aspect of Sarbanes-Oxley. While companies previously had internal control systems in place, section 404 now requires management to report annually on the effectiveness of such controls, and the SEC rules under section 404 provide guidance to management on evaluating such controls. Section 404 also requires the outside auditor to attest to management’s report. Consistent with this requirement, the first new auditing standard the PCAOB filed with the SEC for approval requires the outside auditor to evaluate management’s assessment of the effectiveness of internal controls and also to issue an opinion on the effectiveness of internal controls. In response to comments received from Business Roundtable and others, the PCAOB made a number of changes to the auditing standard as it was originally proposed. However, it remains to be seen how the new standard will work in practice. The overall effect of section 404 is that companies and their auditors will be expending a lot of effort to assess, document and test the controls companies have in place and to determine whether changes in these controls are appropriate.

JofA: Your association has launched an initiative called the Business Roundtable Institute for Corporate Ethics. Can you describe this effort and how the accounting profession can participate in the process?

Castellani: The newly created institute is designed to solidify ethics in the decision making of every current and future business leader. Business Roundtable believes responsibility starts at the top. Since no law or regulation alone can guarantee adherence to sound principles and ethical behavior, our members want to provide leadership in this area and enhance the ability of business leaders to deal with ethical challenges. Part of what the institute will do is put leading professionals from the fields of ethics and business together with business school students. The Roundtable would welcome participation of the AICPA and the accounting profession in the institute’s program. Accounting professionals could make a valuable contribution by providing insight into the nature of their work and the ethical challenges they face in auditing public companies.

JofA: Shareholder activism is creating headlines every day. Groups such as Calpers are demanding more direct involvement in corporate boards of directors. How is Business Roundtable addressing this issue?

Castellani: It has been active on a number of fronts. It commented on several SEC rule proposals addressing the proxy process as it relates to the nomination and election of directors. It supported new SEC rules that expand the proxy disclosures companies must make about their director nominations processes and the procedures they have in place for shareholders to communicate with the board of directors. In contrast it opposed the SEC’s proposed director election rules, believing they would result in sweeping, harmful changes in corporate governance practices while failing to achieve the SEC’s objective of improving the proxy process at unresponsive companies.

In addition Business Roundtable believes increased shareholder activism has heightened the need for companies to communicate effectively with shareholders. Accordingly, in April the association submitted a rule-making petition to the SEC asking it to conduct a thorough review of the current system used to communicate with shareholders, which provides companies with only a limited ability to communicate directly with stockholders whose shares are held through brokers and banks. At the same time we have concerns that some of the actions that have been labeled “shareholder activism” really are instances of special interest groups pushing political agendas for purposes that are not for the benefit of the broad base of shareholders and that are not related to improving corporate governance.

JofA: We see many common interests between the accounting profession and Business Roundtable, particularly with respect to issues it’s managing on behalf of its members. Are there any other critical issues AICPA members should be aware of?

Castellani: Consolidation of the accounting profession is an issue both companies and auditors need to be concerned about. The ability of CPA firms to continue to provide nonaudit services also is an area of concern, in part due to consolidation of the profession, but also because Sarbanes-Oxley gives the PCAOB the authority to prohibit auditors from providing nonaudit services to public companies other than those listed in the statute to their audit clients. In addition the requirement to rotate lead and concurring audit partners is likely to pose challenges for companies and auditors alike as they work to provide for the transfer of institutional knowledge about audit clients and an orderly transition to new engagement leadership.

While Business Roundtable CEOs believe there has been a tremendous sea change in our system of corporate governance over the past two years, we recognize that we must continue to work to restore and maintain public confidence in our marketplace. We look forward to working with the AICPA toward that end.