Rules for Enhancing Audit Committee Effectiveness
December 15, 1999
Today the Commission will consider adopting new rules to improve public disclosure about the functioning of corporate audit committees and to enhance the reliability and credibility of financial statements of public companies. The disclosures will help inform investors about the oversight role of audit committees in the financial reporting process. In addition, by requiring companies to have their auditors review quarterly financial statements, the amendments should facilitate early identification and resolution of significant accounting issues.
Outgrowth of Strategy To Safeguard Quality of Corporate Financial Reporting
The amendments are part of the Commission's continuing efforts to improve the quality of financial reporting. In his September 1998 speech entitled The Numbers Game, Chairman Arthur Levitt set forth an action plan to address certain abuses in financial reporting, better known as "earnings management." These rule amendments represent further progress on that plan.
These new rules are part of a broader effort by the New York Stock Exchange, the American Stock Exchange, the National Association of Securities Dealers, and the accounting profession to improve the oversight of financial reporting by corporate boards. Proposals for action by each of the different groups were set forth in the Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees. The Blue Ribbon Committee was a group of distinguished business, accounting, and securities professionals led by John Whitehead, former Co-Chairman of Goldman, Sachs & Co., and Ira Millstein, a Senior Partner of Weil, Gotshal & Manges.
Rules Designed to Improve Disclosure of Oversight Process
In brief, these rules would require that:
- companies' interim financial statements be reviewed by independent auditors before companies file their Forms 10-Q and 10-QSB with the Commission;
- companies provide in their proxy statements a report from the audit committee that discloses whether the audit committee reviewed and discussed certain matters with management and the auditors, and whether it recommended to the Board that the audited financial statements be included in the Annual Report on Form 10-K or 10-KSB for filing with the Commission;
- companies disclose in their proxy statements whether the audit committee has a written charter, and file a copy of their charter every three years;
- companies whose securities are listed on the NYSE or AMEX or are quoted on Nasdaq disclose certain information about any audit committee member who is not "independent." All companies must disclose, if they have an audit committee, whether the members are "independent." Independence is defined in the listing standards of the NYSE, AMEX and NASD.
Transition Rules to Allow Considered Implementation
The rules being considered for adoption also will provide a transition period to allow companies sufficient time to comply with the new rules. Interim auditor reviews will begin with the fiscal quarter ended March 15, 2000, and compliance with the other new requirements will begin after December 15, 2000.
Parallel Actions by Securities Markets and Audit Profession
The Commission's new rules build upon rule changes proposed by the NYSE, the AMEX, and the NASD, which were also part of the recommendations of the Blue Ribbon Committee. These amendments to the listing standards were approved today by the Commission. Those rules:
- define "independence" more rigorously for audit committee members;
- require audit committees to include at least three members and be comprised solely of "independent" directors who are financially literate;
- require companies to adopt written charters for their audit committees;
- give the audit committee the right to hire and terminate the auditors;
- require at least one member of the audit committee to have accounting or financial management expertise.
In October of this year, the AICPA's Auditing Standards Board proposed to require independent auditors to discuss with the audit committee the auditors' judgment about the quality, and not just the acceptability under Generally Accepted Accounting Principles, of the company's accounting principles as applied in its financial reporting. The Commission expects the ASB to act on that initiative soon.
For additional information, contact Meridith Mitchell at (202) 942-0900, or W. Scott Bayless or Robert Burns at (202) 942-4400.