By Jared Kopel
On October 7, the SEC proposed new rules and amendments to current rules concerning the duties and functions of audit committees of corporate boards of directors. The proposals are largely based on the recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees.
In summary, the SEC's proposals would:
- require that independent auditors review the financial information included in Quarterly Reports on Form 10-Q or 10-QSB prior to filing with the SEC. The reviews would conform to the present requirements of SAS 71. (It should be noted that the BRC recommended that SAS 71 be amended to require that audit committees discuss with the auditors the matters covered in SAS 61, including significant adjustments, management judgments and accounting estimates, significant new accounting policies, and disagreements with management).
- require that companies include reports of their audit committees in their proxy statements stating whether the audit committee has reviewed and discussed the audited financial statements with management; discussed with the independent auditors the matters required to be discussed by SAS 61; and received the disclosures from the auditors regarding the auditors' independence as required by ISB Standard No. 1 (which is effective for all companies with fiscal years ending after July 15, 1999).
- require that the report of the audit committee also include a statement by the audit committee whether, based on such review and discussions with the auditors, anything has come to the attention of the members of the audit committee that caused the audit committee to believe that the audited financial statements in the Form 10-K or 10-KSB contained material misrepresentations or omissions. The proposal differs from the BRC's recommendation in an effort to address concerns that the BRC in effect was requiring audit committees to certify that the financial statements conform to GAAP. Nonetheless, while the proposed language acknowledges that the audit committee will be forming its belief based on discussions with the auditors and management, it is apparent that the proposal contemplates that the audit committee will thoroughly review the information it receives from the auditors and management. Although not specified in the proposal, the standard of materiality presumably will be that set forth in SAB 99 recently issued by the SEC.
- require that companies disclose in their proxy statements whether their audit committee has adopted a written charter and if the audit committee has adopted a charter, to include a copy of the charter as an appendix to the proxy at least once every three years.
- require that companies whose securities are listed on the NYSE, AMEX or quoted on NASDAQ disclose in their proxy statements certain information regarding any director on the audit committee who is not "independent" as defined in the applicable listing standard. (All other companies must disclose, if they have an audit committee, whether the members are "independent" based on the definition proposed by the BRC).
- create "safe harbors" for the information required to be disclosed under the proposals to protect companies and their directors from potential liability under the Federal Securities Laws. The safe harbors would track the treatment of compensation committee reports under Item 402 of Regulation S-K. Under the safe harbors, the additional disclosure would not be considered "soliciting material" or material that is "filed" with the Commission under Section 18 of the 1934 Act (unless the company specifically requests that the disclosure be treated as soliciting material, or specifically incorporates the disclosure by reference into a document filed under the 1933 or 1934 Acts).
- the proposal does not include the BRC's recommendation that audit committees of listed companies with market capitalizations over $200 million be comprised of at least three members, each of whom is "financially literate."
Despite the softening of the BRC's recommendation and the safe harbor, the SEC's proposal, if implemented, still could expand the potential liability of companies and their audit committees. For example, the safe harbor would not necessarily protect against claims that the audit committee failed to perform its duties satisfactorily; or claims that the mandated disclosure omitted information provided by the auditors indicating that the financial statements were materially inaccurate or that the auditors were not truly "independent." The additional responsibilities of the audit committees, combined with the disclosure requirements, raises the possibility that audit committee members will be held to a higher standard in meeting their duty of care.