Page 63 - Encyclopedia of Business and Finance

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Audit Committees

committees have an important role in helping boards of East, and the Asia/Pacific region have adopted require-
directors avoid litigation risk because such committees ments for audit committees for their listed companies. As
provide due diligence related to financial reporting. worldwide financial markets expand and more companies
are listed on major stock exchanges in different countries,
the international investing public’s demand for consistent
REQUIREMENT FOR AUDIT
COMMITTEES and equal oversight protection through the use of audit
committees will continue. In addition, international
Audit committees have long been seen as an important investors are concerned about the quality of corporate
group in ensuring greater corporate accountability in the
governance because of the impact of financial collapses
United States. The value of such committees has been
and alleged frauds on securities markets. In response, to
noted by the U.S. Congress, the U.S. Securities and
more effectively attract foreign equity investment, a num-
Exchange Commission (SEC), the New York Stock ber of stock exchanges around the world have adopted
Exchange (NYSE), and the American Institute of Certi-
audit committees to increase transparency and compe-
fied Public Accountants. Audit committees are required
tence in the management of their listed member compa-
by the NYSE, American Stock Exchange (AMEX), nies.
and National Association of Securities Dealers (NAS-
DAQ/National Market System issuers).
ORGANIZATION AND STRUCTURE
Prior to changes imposed by the passage of the
OF AUDIT COMMITTEES
Sarbanes-Oxley Act of 2002, other major efforts were
directed at the betterment of audit committees. One such The Sarbanes-Oxley Act of 2002 explained that the term
effort was the publication of the Report and Recommenda- audit committee means:
tions of the Blue Ribbon Committee on Improving the Effec- (A) a committee (or equivalent body) established by
tiveness of Corporate Audit Committees in 1999. There and amongst the board of directors of an issuer
followed, in the same year, new rules and disclosures for the purpose of overseeing the accounting and
related to audit committees by the NYSE, NASDAQ, and financial reporting processes of the issuer and
AMEX. audits of the financial statements of the issuer;
Notwithstanding earlier events, in 2001 with the dis- and
closure of a number of major accounting scandals (e.g.,
(B) if no such committee exists with respect to an
Enron and WorldCom), questions were raised about the issuer, the entire board of directors of the issuer.
effectiveness of audit committees. As a result, the U.S.
Congress passed the Sarbanes-Oxley Act and the SEC Section 301 of the act contains an amendment to
adopted final rules amending the securities laws. Such Section 10A of the Securities Exchange Act of 1934,
actions have had an impact on audit committees. In which relates to independence of audit committee mem-
response, the self-regulatory organizations (such as NYSE, bers. The requirement is stated in these words:
AMEX, and NASDAQ) enacted amendments to their
INDEPENDENCE—
listing standards with respect to the role and responsibili-
ties of audit committees within the corporate governance (A) IN GENERAL—Each member of the audit
framework. Hence, the major thrust of these reforms is to committee of the issuer shall be a member of the
create a new legal and regulatory environment and corpo- board of directors of the issuer, and shall other-
rate governance framework. The goal is to restore investor wise be independent.
confidence through an efficient securities market system. (B) CRITERIA—In order to be considered to be
The events noted have led to a number of audit com- independent for purposes of this paragraph, a
mittee best practices becoming federal statutes. Audit member of an audit committee of an issuer may
committees, as a result of the changes, must adhere to not, other than in his or her capacity as a mem-
higher standards in corporate accountability to ensure the ber of the audit committee, the board of direc-
quality of financial information and investor protection tors, or any other board committee—
against accounting scandals. The Sarbanes-Oxley Act has (i) accept any consulting, advisory, or other com-
mandated significant changes in how boards and their pensatory fee from the issuer; or
audit committees can meet their oversight responsibilities
(ii) be an affiliated person of the issuer or any
in both the auditing and financial reporting areas.
subsidiary thereof.
In addition to the presence of audit committees in
companies listed on U.S. stock exchanges, a number of Boards of directors form their audit committees by
stock exchanges in Canada, Europe, Africa, the Middle passing a board resolution or by amending corporate

40 ENCYCLOPEDIA OF BUSINESS AND FINANCE, SECOND EDITION