Audit Committee Disclosure
 
October 8, 1999
 

The Securities and Exchange Commission (SEC) has proposed new rules (Proposal) to improve disclosure relating to the functioning of corporate audit committees and to enhance the reliability and credibility of financial statements of public companies.

The SEC stated in the Proposal that it has seen a number of significant changes in the markets, such as technological developments and increasing pressure on companies to meet earnings expectations, that make it ever more important for the financial reporting process to remain disciplined and credible. The SEC believes that additional disclosures about a company's audit committee and its interaction with the company's auditors and management will promote investor confidence in the integrity of the financial reporting process. In addition, the SEC believes that increasing the level of scrutiny by independent auditors of companies' quarterly financial statements should lead to fewer year-end adjustments, and, therefore, more reliable financial information about companies throughout the reporting year.

Accordingly, the SEC has proposed to:

• require that companies' independent auditors review the financial information included in the companies' Quarterly Reports on Form 10-Q or 10-QSB prior to the companies filing such forms with the Commission;
• require that companies include reports of their audit committees in their proxy statements; in the report, the audit committee must state whether the audit committee has: (i) reviewed and discussed the audited financial statements with management; (ii) discussed with the independent auditors the matters required to be discussed by Statement on Auditing Standards No. 61, as may be modified or supplemented; and (iii) received certain disclosures from the auditors regarding the auditors' independence as required by the Independence Standards Board Standard No. 1, as may be modified or supplemented, and discussed with the auditors the auditors' independence;
• require that the report of the audit committee also include a statement by the audit committee whether, based on such review and discussions, anything has come to the attention of the members of the audit committee that caused the audit committee to believe that the audited financial statements included in the company's Annual Report on Form 10-K or 10-KSB, as applicable, for the year then ended contain an untrue statement of material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which they were made, not misleading;
• require that companies disclose in their proxy statements whether their audit committee has adopted a written charter and, if the audit committee has adopted a charter, to include a copy of the charter as an appendix to the company's proxy or information statement at least once every three years;
• require that companies whose securities are quoted on Nasdaq or listed on the American Stock Exchange (AMEX) or New York Stock Exchange (NYSE) disclose in their proxy statements certain information regarding any director on the audit committee who is not "independent," as defined in the applicable listing standard; small business issuers would not be required to comply with this requirement;
• require that all other companies, including small business issuers, disclose in their proxy statements whether, if they have an audit committee, the members are "independent" within the definition of the National Association of Securities Dealer's (NASD), AMEX's or NYSE's proposed amendments to their listing standards and which definition of independence was used; and
• create "safe harbors" for the information required to be disclosed under the proposals to protect companies and their directors from certain liabilities under the federal securities laws.

To view a copy of the Proposal, see www.sec.gov/rules/proposed/34-41987.htm.

In addition, the NYSE, AMEX and NASD have proposed rule changes to their listing standards. The NYSE, AMEX and NASD, among other things, have proposed to:

• require a more demanding definition of "independence" for audit committee members;
• require that audit committees include at least three members, comprised solely of "independent" directors who are "financially literate," with limited exceptions (under the AMEX's and NASD's proposed amendments to their listing standards, small business issuers must establish and maintain an audit committee composed of at least two members; a majority of the members must be independent directors);
• require that at least one member of the audit committee has accounting or related financial management expertise; and
• require that companies adopt a written audit committee charter that outlines certain specified responsibilities of the audit committee.

The American Institute of Certified Public Accountants (AICPA) also has proposed amendments to Statements on Auditing Standards (AICPA Amendments). The AICPA, among other things, has proposed to:

• require that the auditor discuss certain information relating to the auditor's judgments about the quality, not just the acceptability, of the company's accounting principles with the audit committees of the companies. The discussion would include matters relating to the consistency of application of the entity's accounting policies and the clarity, consistency, and completeness of the entity's accounting information contained in the financial statements and related disclosures. The discussion also is to include certain items that have a significant impact on the accounting information included in the financial statements, such as changes to accounting policies and unusual transactions;
• clarify that the accountant should communicate to the audit committee or be satisfied, through discussions with the audit committee, that matters discussed above have been communicated to the audit committee by the management when they have been identified in the conduct of interim financial reporting.
• Require the accountant to attempt to discuss with the audit committee the matters discussed above prior to the filing of the Form 10-Q or prior to a public announcement of interim information.

To view a copy of the AICPA Amendments, see www.aicpa.org/members/div/auditstd/amend.htm.