Audit Committee Update: The Hot Seat Gets Hotter
from
July/August 2002
by Randy Myers
On paper, audit committee service today implies no more risk or responsibility than it did six months ago. Then again, on paper Enron Corp. was once a fantastically profitable company.
The Enron failure cast a spotlight on corporate accounting practices that is sufficiently intense to bead the brow of virtually every person in the financial-reporting chain, from finance executive to internal auditor, from external auditor to outside director serving on the audit committee. In short, audit is a hot seat suddenly grown hotter.
“There is clearly a heightened sense of vigilance,” says Barbara Hackman-Franklin, chair of the audit committees at Dow Chemical Co. and Aetna Inc. and a member of the audit committees at MedImmune Inc., Milacron Inc., and Watson Wyatt & Co. “There are more probing questions, meetings are typically taking longer, and with that comes a heightened sense of vulnerability.”
Just two years ago the Securities and Exchange Commission, the New York Stock Exchange, and the National Association of Securities Dealers handed down new requirements for who could serve on audit committees and what kinds of qualifications they would need to do the job. Among the guidelines, committees were required to have at least three outside directors who were “financially literate”—meaning that they could read and interpret financial statements—and one of the three had to be a so-called expert in financial matters, such as an accountant or a chief financial officer. The audit committee was also obliged by the SEC to publish a summary of its own in the proxy statements, signed by each member of the committee and declaring whether it had reviewed and discussed audited financial statements with management and outside auditors. “I thought when the new requirements went into effect, that was an elevation of responsibility and liability,” says Franklin, the president and CEO of her own international consulting and investing firm, Barbara Franklin Enterprises. “I think Enron has changed the landscape yet again.”
It’s not that Enron has created new legal responsibilities for directors, but simply that it has intensified public pressure on them to do the job for which they were hired. In other words, it is no longer enough to merely follow the letter of the law—vetting audits, reviewing public financial reports, and assessing overall corporate accounting practices. Instead, directors are expected to ferret out problems.
“You really need to develop a protocol for discharging your duties,” says attorney Joseph Del Raso, a partner in the commercial-law department at Pepper Hamilton LLP in Philadelphia. “As a member of the audit committee, you’re not the auditor—you’re not in there rolling up your sleeves and running the numbers; you have to believe the auditors are doing that. But you do have to assure the integrity of the financial reporting. You have to ask the auditors, ‘What did you see that may concern you? What are we doing that may not be in accordance with generally accepted accounting principles? Where are we moving into gray areas? And where do you have a disagreement with management?’”
To ensure candid conversation, the audit committees Franklin serves on schedule a series of private sessions with the external auditors, the internal auditors, and the company’s own senior financial managers. Each committee meets in private as well.
The new sense of risk weighing on audit committee members is perhaps best reflected in the cold-blooded calculus of insurance underwriting, which has sent the cost of directors’ and officers’ liability insurance soaring since Enron’s bankruptcy filing late last year. (See “D&O Costs More,” page 26.) “There are so many things directors are responsible for that I wonder how any director sitting on more than one or two boards can possibly fulfill the position and not worry about their legal exposures,” says Fred Podolsky, a senior executive with the insurance broker Willis Group Holdings Inc. in New York City. “They are expected to be almost superhuman in today’s environment. And at the end of the day, they are responsible for the rise and fall of the corporate ship.”
That responsibility means directors must not only know what course the captain is steering, but also what the mechanics in the engine room are doing to make sure the ship has enough fuel and power to reach its destination. It is not a job for the meek, and, in hindsight, it never was.
