Audit Committee Requirement Memo
Description
manattmanatt | phelps | phillipsFriends and ClientsTo:Manatt, Phelps & Phillips, LLPFrom:June 1, 2003Date:Audit Committee Requirements and Independent AuditorsSubject:Public Company Audit Committees and Independent AuditorsThe Sarbanes-Oxley Act of 2002 (the “Act”) imposes extensive regulation upon publiccompany audit committees and their independent auditors. The Act, and its implementingregulations, enhance audit committees’ responsibilities and duties and clarify the scope ofservices that an accounting firm can provide to an audit client while retaining its status as an“independent” accountant. Set forth below is a general summary of various provisions of the Actand final implementing regulations relating to independent auditors and public company auditcommittees.Listing Requirements Applicable for Audit Committees.On May 20, 2003 the SEC adopted final rules requiring the self-regulatory organizations,including the New York Stock Exchange, the American Stock Exchange and Nasdaq (the“SROs”), to prohibit the listing of any security of an issuer whose audit committee does notsatisfy the following requirements:1. Responsibilities. Each audit committee, not management, must be directlyresponsible for:• the appointment, retention, compensation and oversight of theissuer’s public accounting firm employed for preparing or issuingan audit report or related work or performing other audit, review orattest services for the issuer; and• the resolution ...
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| Publié par | Undoe |
| Nombre de lectures | 55 |
| Langue | English |
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manatt
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Albany
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Los Angeles
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Mexico City
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Monterrey
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New York
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Orange County
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Palo Alto
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Sacramento
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Washington, D.C.
To:
Friends and Clients
From:
Manatt, Phelps & Phillips, LLP
Date:
June 1, 2003
Subject:
Audit Committee Requirements and Independent Auditors
Public Company Audit Committees and Independent Auditors
The Sarbanes-Oxley Act of 2002 (the “Act”) imposes extensive regulation upon public
company audit committees and their independent auditors.
The Act, and its implementing
regulations, enhance audit committees’ responsibilities and duties and clarify the scope of
services that an accounting firm can provide to an audit client while retaining its status as an
“independent” accountant.
Set forth below is a general summary of various provisions of the Act
and final implementing regulations relating to independent auditors and public company audit
committees.
Listing Requirements Applicable for Audit Committees
.
On May 20, 2003 the SEC adopted final rules requiring the self-regulatory organizations,
including the New York Stock Exchange, the American Stock Exchange and Nasdaq (the
“SROs”), to prohibit the listing of any security of an issuer whose audit committee does not
satisfy the following requirements:
1.
Responsibilities
.
Each audit committee, not management, must be directly
responsible for:
•
the appointment, retention, compensation and oversight of the
issuer’s public accounting firm employed for preparing or issuing
an audit report or related work or performing other audit, review or
attest services for the issuer; and
•
the resolution of disagreements between management and the
accountants regarding financial reporting.
The accounting firm must report directly to the issuer’s audit committee, not the
full Board of Directors.
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2.
Independence
.
Each member of an issuer’s audit committee must be a member of
the Board of Directors of the issuer and be independent.
“Independent” means
that an audit committee member may not, except in his or her capacity as a
member of the audit committee or the Board of Directors, or any other Board
committee upon which that person serves,
•
accept directly or indirectly any consulting, advisory, or other
compensatory fee from the issuer or an affiliate of the issuer; or
•
be an affiliated person of the issuer or any affiliate of the issuer.
Prohibited indirect payments would include payments for services to law firms,
accounting firms, consulting firms, investment banks or similar entities in which audit committee
members are partners, members or principals. In addition, prohibited indirect payments would
include payments to spouses, minor children, or stepchildren or children sharing a home with the
Audit Committee member.
The final rule applies only to current relationships, with no “look
back.”
However, the SROs are free to adopt more stringent rules and expected to have look back
periods.
The SEC has exempted from the independence requirements, issuers who are
newly public, with a phase-in of the independence requirements over a 1 year period at which
time all of the audit committee members must be independent.
Furthermore, the SEC has specifically provided that audit committee members
who serve on the Board of Directors of a direct or indirect subsidiary corporation may still be
considered independent so long as that audit committee member would be considered
independent at the subsidiary level (aside from his or her seat on the parent’s Board of
Directors).
3.
Whistleblower Procedures
.
Each audit committee must establish procedures for
•
receiving, retaining and treating complaints received by the issuer
relating to accounting, internal accounting controls or auditing
matters; and
•
the anonymous, confidential submission by employees of the
issuer of concerns regarding questionable accounting or auditing
matters.
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4.
Hiring of Experts
.
Each
audit committee must be vested with the authority to
hire independent counsel and other advisers (including accounting firms), as is
necessary to carry on its duties, and the issuer is required to provide appropriate
funding for those advisors.
If any of the foregoing conditions for listing are not met by a company, an executive
officer of the
company is required to notify the applicable exchange or Nasdaq promptly after
becoming aware of any material noncompliance with the proposed requirements.
Proposed rules from certain of the SRO’s are currently out for comment. Generally, listed
issuers will be required to comply with the new listing standards by the date of their first annual
shareholders meeting after January 15, 2004, but in no event later than October 31, 2004.
In the
interim, the board of directors should
•
review the composition of the audit committee;
•
evaluate member qualifications;
•
review the audit committee charter (discussed below); and
•
consider options (technology, third-party, etc) in handling anonymous
complaints.
Responsibilities of Accounting Firms
Registration and Regulation
.
The Act requires every accounting firm that prepares or
issues, or participates in the preparation or issuance of any audit report for an issuer, to register
with the Public Company Accounting Oversight Board (the “PCAOB”) established by the Act.
The registration must take place by September 30, 2003 (180 days after the SEC’s certification
of the PCAOB, which was on April 25, 2003). Following the SEC’s certification of the PCAOB,
we advise all audit committees to subsequently obtain a quarterly representation letter from the
accounting firms preparing or participating in the preparation of their audit reports that the firms
are registered in good standing with the PCAOB.
Prohibited Non-Audit Services
.
Furthermore, effective May 6, 2003, the Act and its
implementing regulations specifically prohibit accounting firms (or employees thereof), which
perform any required audit for an issuer to contemporaneously provide to that issuer, certain
non-audit services.
If an issuer has an existing contract in place for nonaudit services on May 6,
2003, the issuer will have 12 months to exit that contract and still preserve the independence of
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the auditor.
The SEC’s intent is to prohibit any service or scenario that reasonably could create
one or more conflicts.
The prohibitions are based on the principles that an accounting firm
should not (i) audit its own work; (ii) function as a part of management of the audit client; or (iii)
act as an advocate of the audit client.
The prohibited non-audit services are:
•
bookkeeping or other services related to the issuer’s accounting records or
financial statements of the audit client;
•
financial information systems design and implementation;
•
fairness opinion, appraisal or valuation services or contribution in-kind reports;
•
actuarial services;
•
internal audit outsourcing services;
•
management functions;
•
human resources;
•
broker dealer, investment adviser or investment banking services;
•
legal services; and
•
expert services unrelated to the audit.
The PCAOB may specify additional services which an accounting firm is prohibited from
providing to its audit clients.
We recommend that audit committees review the scope of services
currently provided by the issuer’s accounting firm and discuss with the accounting firm
terminating any of the prohibited services identified above.
Audit committees should note that
the prohibitions do not govern non-audit services when provided to non-audit clients.
Permissible Non-Audit Services
.
An accounting firm may engage in any non-audit
service, including tax services, not prohibited by the Act, only if the service is approved in
advance by an issuer’s audit committee as described below. The SEC has taken the specific
position that an audit committee should be aware that classifying a service as a “tax service”
does not mean that the service may still not be within one of the prohibited service categories or
may not result in the impairment of auditor independence.
Accordingly, the accounting firm and
audit client should be aware of the principles articulated above in determining whether a tax
service is a permissible non-audit service.
For example, the formulation of tax strategies (i.e. tax
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shelters) designed to minimize a company’s tax obligations may require an accountant to audit
his or her own work, to become an advocate for a client’s position on novel tax issues or to
assume a management function.
In addition, the SEC has specifically indicated that representing
an audit client in court would impair the independence of that accounting firm.
In each case,
such service would conflict with the overriding principles upon which the prohibited services
were identified, and, therefore, would not be a permissible non-audit activity an accounting firm
could engage in while performing audit functions for a client.
Audit Partner Rotation
.
Every lead partner and concurring partner on the audit
engagement team are required to rotate off an audit engagement after five consecutive years.
Other partners who have responsibility for decision-making on significant auditing, accounting
and reporting matters that affect the financial statements or who maintain regular contact with
management and the audit committee are required to rotate off an audit engagement after seven
consecutive years.
The rotation off must be for at least two consecutive years.
Independence Requirements.
In order to be considered “independent,” auditing firms
may not provide audit services to an issuer if the Chief Executive Officer, Chief Financial
Officer, Chief Accounting Officer or controller was employed by the auditor and worked on the
issuer’s audit. In addition, an auditing firm will not be considered independent if any personnel
receives compensation directly based on non-audit services provided.
Accordingly, cross-selling
of services to an issuer will be prohibited.
Preapproval of Audit Committees
After May 6, 2003, the audit committee of every public issuer (whether or not the issuer’s
securities are traded on any exchange or Nasdaq) will be required to preapprove all engagements
in connection with the audit, review or attestation of reports required under the securities laws.
Permissible non-audit services must be approved either (i) by the audit committee before the
accounting firm is engaged by the issuer or its subsidiaries or (ii) pursuant to preapproval
policies and procedures established by the audit committee, provided the audit committee is
informed of each such service at its next scheduled meeting.
The authority to grant preapprovals
may be delegated to one or more members of the audit committee, so long as any decision of
such designated director is presented to the full audit committee for its approval at its next
scheduled meeting.
The preapproval requirement is waived for certain de minimum services. In order to
qualify under this de minimus exception: (i) the aggregate amount of all such services must not
constitute more than five percent (5%) of the total amount of revenues paid by the issuer to its
auditor during the fiscal year in which the services are provided; (ii) the services were not
recognized by the issuer at the time of engagement to be non-audit services and (iii) such
services are promptly brought to the attention of the audit committee and approved prior to
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completion of the audit by the audit committee or by one or more members of the audit
committee who are members of the Board of Directors to whom the audit committee has
delegated authority to grant such approval.
The SEC is proposing to require disclosure of the
audit committee’s preapproval policies and procedures in either proxy statements or annual
reports.
To facilitate compliance with these provisions of the Act, we recommend that each audit
committee designate by resolution the Chairman of the audit committee as the sole person
(outside of the full committee) with the authority to preapprove all permissible nonaudit services
not otherwise approved by the full audit committee.
In addition, we recommend that all audit
committees, at their next regularly scheduled meeting after preapproval by the Chairman, ratify
and specifically identify the scope of nonaudit services to be provided by the auditor and confirm
that the provision of such services will not result in the auditor (i) auditing its own work; (ii)
functioning as a part of management or as an employee of the audit client; or (iii) acting as an
advocate of the audit client.
Review of Reports to Audit Committees
In addition, the Act requires every auditor registered with the PCAOB to immediately
report to the audit committee, in addition to any disclosures required by Generally Acceptable
Accounting Standards:
•
all critical accounting policies and practices;
•
all alternative treatments of financial information within generally
accepted accounting principles that have been discussed with management
officials of an issuer, ramifications of the use of such alternative
disclosures and treatments and the treatment preferred by the accounting
firm; and
•
other material written communications between the auditor and
management of the issuer, such as any management letter, reports on
observations and recommendations on internal controls, engagement
letter, independence letter or schedule of unadjusted differences.
We recommend that each audit committee, no less than quarterly, schedule this required
report from its auditors on its meeting agendas once the registration procedures for the PCAOB
have taken effect.
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Financial Expert
On January 23, 2003, the SEC issued final rules to implement the provisions of SOX
which require all issuers to disclose whether or not one of the members of the issuer’s audit
committee is an “audit committee financial expert.”
As redefined by the SEC, the “audit committee financial expert” is a person who has the
following attributes:
•
an understanding of financial statements and generally accepted accounting
principles;
•
an ability to assess the general application of such principles in connection with
the accounting for estimates, accruals and reserves;
•
experience preparing, auditing, analyzing or evaluation financial statements that
present a breadth and level of complexity of accounting issues that are generally
comparable to the breadth and complexity of issues that can reasonably be
expected to be raised by the registrant’s financial statements, or experience
actively supervising one or more persons engaged in such activities;
•
an understanding of internal controls and procedures for financial reporting; and
•
an understanding of audit committee functions.
A person can acquire such attributes through any one or more of the following means:
•
education and experience as a principal financial officer, principal accounting
officer, controller, public accountant or auditor or experience in one ore more
positions that involve the performance of similar functions;
•
experience actively supervising a principal financial officer, principal accounting
officer, controller, public accountant, auditor or person performing similar
functions,
•
experience in overseeing or assessing the performance of companies or public
accountants with respect to the preparation, auditing or evaluation of financial
statements; or
•
other relevant experience.
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In making its determination about whether an individual has the requisite qualifications to
be considered a financial expert, the Board of Directors should evaluate the totality of an
individual’s education and experience, including the duties and responsibilities held by such
person.
The fact that a person previously has served on an audit committee does not, by itself,
justify the Board of Directors in “grandfathering” that person as an audit committee financial
expert.
Similarly, the fact that a person has experience as a public accountant or auditor, or a
principal financial officer, controller or principal accounting officer or experience, in a similar
position, does not, by itself, justify the Board of Directors in determining the person to be an
audit committee financial expert.
The Board of Directors should also consider any disciplinary
actions to which a potential expert is, or has been, subject in determining whether that person
would be a suitable audit committee financial expert.
Companies will be required to identify annually (commencing with each annual report
filed on or after July 15, 2003 [small business issuers must comply for annual reports filed after
December 15, 2003]) whether or not it has at least one “audit committee financial expert” on its
audit committee and, if so, the name of the audit committee financial expert and whether the
expert is independent of management.
A company that does not have an audit committee
financial expert will be required to disclose this fact and explain why it does not have such an
expert.
The mere designation of someone as an audit committee financial expert will not impose
any duties, obligations or liability on the person that are greater than those imposed on any other
audit committee member.
If the Board of Directors determines that one of its members meets the definition of audit
committee expert, but does not have appropriate professional experience, then the Board of
Directors is required to disclose the basis for its determination that such person is an audit
committee financial expert in its filings where the audit committee financial expert is identified.
Based on the SEC’s rules, we recommend that every Board of Directors review the
composition of its audit committee to determine if one or more of its members meets the
definition of an “audit committee financial expert.” If the Board of Directors determines that one
or more members of its Audit Committee does not qualify as an audit committee financial expert,
we recommend that the Board consider begin the process of investigating potential candidates
for service as the audit committee financial expert.
Improper Influence on Audits
The Act specifically prohibits directors, officers and persons acting under their respective
direction from coercing, manipulating, misleading or fraudulently inducing any independent
public or certified accountant in the performance of their audit or review of the financial
statements if that person know or should have known such action could, if successful, result in
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rendering those financial statements materially misleading.
This would apply to a public
company’s current auditors, as well as previous auditors who may need to give a consent or
reissue a prior audit report.
In addition, this prohibition applies to not only a review of annual
financial statements, but also, among other things, improperly influencing an auditor during the
review of interim financial statements or in connection with the issuance of a consent to the use
of an auditor’s report.
The SEC has also specifically indicated that whether or not someone is acting at the
direction of a director or officer encompasses a larger universe of persons than simply persons
who are supervised by that director or officer.
Accordingly, someone may be acting at the
direction of an officer or director even if they are not under the control of that officer or director,
such as a vendor or creditor who, under the direction of an officer or director, provides false or
misleading information to an auditor.
The SEC is given sole authority to enforce these provisions through civil proceedings.
Accordingly, the Act does not authorize any private right of action (i.e., shareholder lawsuit) for
violation of this provision of the Act.
Retention of Audit Records
For audits and reviews completed after October 31, 2003, the SEC is requiring
accounting firms who audit or review an issuer’s financial statements to retain certain records
relevant to that audit or review.
These records include workpapers and other documents that
form the basis of the audit or review, and memoranda, correspondence, communications, other
documents and records (including electronic records), which are created, sent or received in
connection with the audit or review, and contain conclusions, opinions, analyses, or financial
data related to the audit or review.
These records must be retained for seven (7) years after the
auditor concludes the audit or review of the financial statements.
Review of Audit Committee Charter
The provisions of the Act indirectly necessitate that all issuers engage in a continuing
review of their audit committee charters to ensure that they meet the requirements of the Act as
the Act’s provisions are implemented.
Counsel should be consulted to review any proposed
changes to the audit committee charters.
Those charters, as revised, should then be formally
approved both by the issuer’s Board of Directors and audit committee.
We believe most
companies are awaiting the finalization of listing standards and adoption of final rules prior to
revising their audit committee charters in their entirety so that multiple revisions to the charter
will not be necessary.
To the extent charter changes are required to comply with SOX, those
should be made on an as needed basis.
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In addition, the federal proxy rules require public companies to file their audit committee
charters with their annual proxy statements every three years.
We recommend that if material
changes are made to the audit committee charter, that the new charter be filed with the next
subsequent proxy solicitation relating to the election of directors.
Contact Us
We are available to assist companies in reviewing and revising a company’s existing
audit committes charters for compliance with the Act, as necessary.
We can also assist
companies in developing audit committee procedures and policies for compliance with the Act.
We intend to continue to provide you with updates as the SEC implements the many
provisions of Sarbanes-Oxley.
If you have any questions or comments, do not hesitate to contact
the following Manatt, Phelps & Phillips, LLP partners who are members of our Sarbanes-Oxley
working group:
Orange County
Los Angeles
Palo Alto
Washington, D.C.
New York
John Stoner
714-371-2527
jstoner@manatt.com
Richard Maire
310-312-4168
rmaire@manatt.com
T. Hale Boggs
650-812-1358
hboggs@manatt.com
Greg Gehlmann
202-463-4334
ggehlmann@manatt.com
Peter F. Olberg
212-830-7217
polberg@manatt.com
Gordon Bava
310-312-4205
gbava@manatt.com
David Pike
650-812-1365
dpike@manatt.com
William Quicksilver
310-312-4210
wquicksilver@manatt.com
Blase Dillingham
310-312-4159
bdillingham@manatt.com
Craig Miller
650-812-1386
cmiller@manatt.com
20070590.6
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