Assignment 2 ACG6657
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2-1AuditCommitteeDisclosure.pptxAudit Committee Disclosure Rule (Release No. 34-42266 - SEC 1999)
Background
As discussed in the Proposing Release, given the changes in our markets, such as the increasing number of investors entering our markets and changes in the way and speed with which investors receive information, it is vitally important for investors to remain confident that they are receiving the highest quality financial reporting. …
One challenge is that companies are under increasing pressure to meet earnings expectations. We have become increasingly concerned about inappropriate "earnings management," the practice of distorting the true financial performance of the company.
Role of Audit Committees
The changes in our markets and the increasing pressures on companies to maintain positive earnings trends have highlighted the importance of strong and effective audit committees. Effective oversight of the financial reporting process is fundamental to preserving the integrity of our markets.
Audit committees play a critical role in the financial reporting system by overseeing and monitoring management's and the independent auditors' participation in the financial reporting process. Audit committees can, and should, be the corporate participant best able to perform that oversight function.
Increased Liability to Directors?
While almost all of the commenters that provided comment letters on the Proposing Release supported our goals of improving disclosure about audit committees and enhancing the reliability and credibility of financial statements, many commenters suggested alternative approaches to achieving those goals. …
the concern most frequently expressed was that as a result of the new requirements to provide certain disclosures in a report, audit committees may be exposed to additional liability, and that consequently it may be difficult for companies to find qualified people to serve on audit committees.
Safe Harbor
… As we discussed in the Proposing Release, we do not believe that improved disclosure about the audit committee and increased involvement by the audit committee should result in increased exposure to liability.
Consequently, we believe that this modification, together with the safe harbors, should further alleviate concerns about increased liability exposure, while promoting our goal of improving the financial reporting process.
Should rules be the same for all companies?
Some commenters expressed concern about applying the new requirements to small businesses, particularly the interim financial review requirement. We have considered those comments carefully.
We think that improvements in the financial reporting process for companies of all sizes is important for promoting investor confidence in our markets.
In this regard, because we have seen instances of financial fraud at small companies as well as at large companies, we think that improving disclosures about the audit committees of small and large companies is important. …
Reviews of Interim Financial Statements
We are adopting [amendments] … to require that a company's interim financial statements be reviewed by an independent public accountant prior to the company filing its Form 10-Q or 10-QSB ...
… the reviews required will facilitate early identification and resolution of material accounting and reporting issues because the auditors will be involved earlier in the year.
Early involvement of the auditors should reduce the likelihood of restatements or other year-end adjustments and enhance the reliability of financial information. In addition, as a result of changes in the markets, companies may be experiencing increasing pressure to "manage" interim financial results.
Inappropriate earnings management could be deterred by imposing more discipline on the process of preparing interim financial information ….
Big 5 already require quarterly reviews
… we understand that the five largest U.S. accounting firms and other firms have policies to require that their clients have reviews of quarterly financial statements as a condition to acceptance of the audit.
Consequently, those firms already have implemented the new requirement for the companies that are audited by those firms.
Independence Standards Board (ISB)
We are adopting new [rules] … that require the audit committee to provide a report in the company's proxy statement. …
Audit committees must state whether:
the audit committee has reviewed and discussed the audited financial statements with management; …
the audit committee has received the written disclosures and the letter from the independent auditors required by ISB Standard No. 1, as may be modified or supplemented, and has discussed with the auditors the auditors' independence.
Disclosures in Proxy Statement
… The disclosures are required in the company's proxy statement because they could have a direct bearing on shareholders' voting decisions, and because the proxy statement is actually delivered to shareholders and is accessible on the SEC's web site. …
Audit Committee Charter
We are adopting, as proposed, the requirement that companies disclose in their proxy statements whether their audit committee is governed by a charter, and if so, include a copy of the charter as an appendix to the proxy statement at least once every three years. …
The new disclosure regarding audit committees' charters should help shareholders assess the role and responsibilities of the audit committee.
“Boilerplate”
We believe that audit committees that have their responsibilities set forth in a written charter are more likely to play an effective role in overseeing the company's financial reports.
The amendments, however, will not require companies to adopt audit committee charters, or dictate the content of the charter if one is adopted.
Several commenters expressed concern that the requirement to attach the charter would result in boilerplate charters.
We believe that it is useful for shareholders to know about the responsibilities and the duties of audit committees, and while it is inevitable that some of the same provisions will appear in charters of different audit committees, we encourage companies to tailor the charters to their specific circumstances.
Audit Committee Director Independence
As early as 1940, the Commission encouraged the use of audit committees composed of independent directors ...
Further, as the Blue Ribbon Committee noted, ". . . common sense dictates that a director without any financial, family, or other material personal ties to management is more likely to be able to evaluate objectively the propriety of management's accounting, internal control and reporting practices."
Exceptional situations
… Under the revised listing standards of the NYSE, AMEX, and NASD, under exceptional and limited circumstances, companies may appoint to their audit committee one director who is not independent if the Board determines that membership on the committee by the individual is required by the best interests of the corporation and its shareholders, and the Board discloses, in the next annual proxy statement subsequent to such determination, the nature of the relationship and the reasons for that determination.
We are adopting, as proposed, the requirement that companies whose securities are listed on the NYSE or AMEX or quoted on Nasdaq that have a non-independent audit committee member disclose the nature of the relationship that makes that individual not independent and the reasons for the Board's determination to appoint the director to the audit committee. Small business issuers are not required to comply with this requirement.
Different listing standards
… We are also adopting, as proposed, the requirement that companies, including small business issuers, whose securities are not listed on the NYSE or AMEX or quoted on Nasdaq, disclose in their proxy statements whether, if they have an audit committee, the members are independent as defined in the NYSE's, AMEX's, or NASD's listing standards, and which definition was used.
These companies would be able to choose which definition of "independence" to apply to the audit committee members in making the disclosure. Whichever definition is chosen must be applied consistently to all members of the audit committee. …
Cost estimates
… We believe the costs associated with these amendments would derive principally from the disclosure obligations – we are not placing any substantive requirements on audit committees or their members. At the proposing stage, we estimated that the additional disclosure contemplated by the amendments would, on average, require less than three-fourths of a page in a company's proxy statement, based on the staff's experience with proxy statements, and analogous cost estimates.
A financial printing company informed the staff that this disclosure would not likely increase the printing cost because up to three-fourths of a page can normally be incorporated without increasing the page length by reformatting the document. The printer reported that adding one more page could increase costs by about $1,500 for an average sized company.
