Covering Yourself on the Audit Committee
from
September/October 2005
by Michael T. Matraia
When it comes to documenting board meetings, less is more, right? Before Sarbanes-Oxley, many held this view. These days, however, meaningful record-keeping must be a top priority for boards looking to fulfill their duties and shield themselves from potential litigation.
If we’ve learned anything in the post-Enron era, it is this: The Securities and Exchange Commission, the Department of Justice, and fired-up investors have their sights set on executives and board members. Just look at the roughly $40 million that WorldCom and Enron directors agreed to pay out of their own pockets in settlements.
For audit committees especially, given their compliance role as financial overseers, documentation takes on added import. Thanks to Sarbanes-Oxley, audit committees have more authority and independence than ever before. Yet with greater power comes increased responsibility—and a heightened risk of being called on the carpet. Documentation does more than provide a record of an audit committee’s work. The very act of recording brings much-needed discipline to the oversight process, helping to ensure that the committee fulfills its duties. In the event of fraud allegations, documentation can rebuff plaintiffs’ claims that the audit committee was partly to blame. It can also pick up where fading memories leave off.
Historically (and somewhat misguidedly), audit committees have avoided written details, fearing criticism for steps they did not take. But legal-liability standards do not require perfection. They merely require diligence, which adequate documentation can prove. Audit committees—and boards overall—that are doing their jobs have nothing to fear from documentation. Those that are slacking should take lessons from several prominent court cases.
In the Enron case, the court ruled that board and committee meeting minutes were too vague to support plaintiffs’ claims that the board members had direct knowledge of fraud. Yet in denying directors’ motion to dismiss, the judge stated that the minutes were vague enough to suggest “negligent failure to ask more questions or investigate the corporation’s affairs in greater depth”—thereby allowing plaintiffs to make their other claims.
In the Walt Disney Co. derivative case, shareholders are demanding that directors repay the company $262 million for failing to monitor the hiring and firing of president Michael Ovitz. The court, in refusing to dismiss the case, noted that only one and a half pages of board minutes addressed Ovitz’s hiring, which hindered the directors’ ability to establish that they acted with due care.
The question for audit committees, therefore, is not whether to document. The question is how. While there is no one correct way, keeping minutes is a good starting point—provided they eschew the historical precedent of making it difficult to figure out what really happened. Minutes must move beyond the cryptic to the concrete. The corporate secretary, who sits in on the meetings, should prepare the minutes soon thereafter, with the audit committee making sure the notes accurately reflect what transpired.
Admittedly, documentation creates something of a Catch-22. Issues that an audit committee might be reluctant to have on the record—questions about shady accounting, for example—are precisely the ones that must be documented and addressed. In such cases, the minutes should describe the steps that the committee took to investigate and resolve them.
This, though, is only the beginning. For truly effective documentation, an audit committee should also prepare written reports to the full board of directors, articulating the ways in which it is satisfying its charter. These shouldn’t be blow-by-blows of every meeting and all the steps taken (who’s got the time to read a corporate equivalent of War and Peace?). Rather, the reports should serve as executive summaries detailing the committee’s actions, recommendations, and conclusions.
Proper documentation allows an audit committee to demonstrate the active role it plays as company watchdog. Fueled by Sarbanes-Oxley, audit committees are flexing more muscle, stepping off the sidelines to pose tough questions of management and auditors. But merely asking the tough questions isn’t enough. Unless you document your actions, one of two things will happen: Either you won’t remember taking them, or no one will believe you did.
*A former auditor with Deloitte & Touche LLP, attorney Michael Matraia is in private practice in Worcester, Massachusetts, as independent counsel to audit committees.
