Post Office Box 123
Mobile, Alabama 36601
November 30, 1999
Mr. Jonathan G. Katz
U. S. Securities and Exchange Commission
450 Fifth Street, N. W.
Washington, D. C. 20549-0609
Re: File No. S7-22-99
Audit Committee Disclosure Release No. 34-41987
Dear Mr. Katz:
On behalf of the Audit Committee of the Northrop Grumman Corporation Board of Directors, I would like to express our appreciation for the opportunity to comment on the Commission's proposals to improve the effectiveness of corporate audit committees. We support the Commission's commitment to promote quality financial reporting and to improve the effectiveness of corporate audit committees.
To give you some perspective on my background, I am a former Congressman, having spent 20 years in the House of Representatives, and am currently the Chairman of the Audit Committee for Northrop Grumman Corporation. I have also served on other boards including duty for many years as Chairman of the Audit Committee of the Southern Company, and have been a practicing attorney since leaving Congress in 1985.
The report of the Blue Ribbon Committee on Improving Effectiveness of Corporate Audit Committees pointed out, and the SEC Release of Proposals on this subject reiterated, that the primary role of an audit committee is one of oversight and monitoring. Preparation of financial statements is the responsibility of management, and it is the responsibility of the independent auditors to examine and opine on the financial statements.
Portions of the Commission's proposed rules could be construed as changing the role of the audit committee from oversight and monitoring to management and certifying as a financial expert. I agree that to properly fulfill its oversight and monitoring role, the committee should be composed of independent directors and should follow a process thatincludes discussions with company management and the internal and independent auditors. However, it seems to me that the regulation of the background requirements for directors on this committee, as proposed by the stock exchanges, along with specifying how often and when they should meet with the independent auditors, creates an audit committee that has a higher standard than other committees of the board. This higher standard could create the perception of a different class of directors making it more difficult for companies to find directors willing to serve on audit committees.
I offer the following comments on specific portions of the commission's proposal:
A. Pre-Filing Independent Review of Form 10-Q. The timely issuance of accurate financial information greatly benefits public markets. The maintenance of books and records and the preparation of financial statements are the responsibility of management. In line with today's market sensitivity to events, once management is satisfied with interim financial reports it is important to get the information out to the market.
It has been my experience on Northrop Grumman's Audit Committee that when company management, the internal auditors or the independent auditors become aware of any matter that should be discussed with the audit committee in a timely manner, we are contacted even if a meeting had not been previously scheduled. The Audit Committee discusses financial issues throughout the year at its regular meetings, and the full Board receives a briefing on financial results from the CFO at each board meeting. The internal and independent auditors attend all Audit Committee meetings, including private discussions that typically follow without corporate management present. As Chairman of the Audit Committee, I report to the Board of Directors after each Audit Committee meeting on all matters of importance that come before the Committee.
I support a review of interim financial statements by independent auditors prior to the filing of Form 10-Q, provided that the content and extent of the reviews do not expand beyond that currently required by SAS 71. I believe the extent of the review should be determined by the independent auditor and concurred with by management and the audit committee. These reviews can be helpful in ensuring that quarterly financial statements are reliable within the context of interim unaudited financial statements. I do not believe, however, that these reviews or discussions between the independent auditor and the audit committee should be mandated.
I do not feel that a mandatory meeting of the audit committee prior to the release of earnings or the filing of Form 10-Q is warranted. The committee should be able to rely on the judgment of the experts - the independent auditors - to notify them ifthey have any issues with the interim financial statements to be included in the normal 10-Q filings. Again, the primary responsibility of the audit committee is oversight and monitoring. Timely reporting of issues to management and the board is part of the independent auditor's responsibilities on the engagement.
B. Audit Committee Report. I am not opposed to including a report by the audit committee that discusses the processes it followed in performing its oversight responsibilities. I am, however, opposed to the audit committee giving negative assurance on the financial statements included in the Form 10-K filing.
The fact that the Commission has excluded the reference to GAAP from the proposed audit committee report does not change the nature of the requirement that the audit committee give assurances that are implied in the independent auditor's report. A majority of the board of directors and the chief accounting officer sign the Form 10-K, and the independent auditor opines on the financial statements included therein. The audit committee process of oversight and monitoring can provide comfort that there are qualified people involved in the process, but it would require a prodigious effort to acquire the underlying data and perform adequate verification of the facts to be able to certify, or give negative assurance on the quality of the disclosures by management. I do not believe shareholders gain any additional benefit from the proposed negative assurances by the audit committee.
C. Independence of Audit Committee Members. I concur that the audit committee should be composed of independent directors. I also agree that a disclosure should be made when a corporation has a circumstance where it feels that it is in the best interest of the company and its shareholders that a director who is not independent under the proposed exchange rules serve on the committee. I do not agree with the Stock Exchange proposal that would dictate the background and type of experience an audit committee member should have. The concept that the stock exchanges could grade the financial literacy of an audit committee member is bothersome. I believe it is the responsibility of the nominating committee of the board of directors to ensure that the collective background and experience of the audit committee members provides sufficient knowledge of financial accounting and reporting to meet their responsibilities.
It is possible that directors could face additional liability based on charges that the audit committee members lack the financial literacy for their positions on the committee and that the board was negligent in its assessment of an individual's qualifications for appointment to the audit committee. This also might create the appearance of a different class of director with a higher exposure, thereby discouraging otherwise qualified members from serving on the audit committee. The requirement of having at least one member of an audit committee have afinancial background would be beneficial, but I believe the exchanges and the Commission should recommend this as a "best practice" rather than a mandate.
I concur with the assessment that, in order to have sound corporate governance, a strong, independent audit committee is essential to protect the interest of all shareholders. The best way to achieve a constructive financial reporting environment is to ensure that the process of oversight and monitoring results in timely, forthright discussions among all constituents including management, internal and external auditors, and the audit committee members. Mandated procedures or activities thattake on the appearance of form over substance will not add value to the public reporting of financial information.
In conclusion, on behalf of the Audit Committee of the Northrop Grumman Corporation Board of Directors, I commend the Commission for its effort to improve the audit committee function and appreciate this opportunity to comment on the Proposals.
cc: New York Stock Exchange
Eleven Wall Street
New York, NY 10005
Attention: Richard A. Grasso
Chairman & CEO
National Association of Securities Dealers
1735 K Street, NW
Washington, DC 20006-1500
Attention: Frank G. Zarb
Chairman and CEO