Blue Chips Leading on a Red Hot Issue: Audit Committee Communication

In my post last month, I discussed a few hot spots in corporate disclosure. One of these is audit committee communication. And why is this issue hot? One reason -- in my view and in the view of many others -- is that there's plenty of room for improvement in this area. Regulators worldwide are keenly interested in such improvement, as are companies, their auditors, and their investors. Let's take a closer look at what the situation is and what can be done.

The Key Role of Audit Committees

The audit committee has always been an important part of a company's board of directors. But that importance reached new heights in 2002, with the passage of the Sarbanes-Oxley Act (SOX).

SOX made audit committees responsible for hiring, overseeing, and compensating the external auditor. The law also established that all members of the audit committee must be independent, and that at least one audit committee member must have financial expertise -- or the board must explain why that's not the case.

With these changes, the audit committee has become a hub for coordinating many financial reporting communications, as it has primary reporting lines from management and the external auditor. It also has a critical relationship with internal auditors.

No surprise, the CAQ's members -- external auditors -- tell us a strong audit committee is a vital element in delivering a high quality audit.

The State of Audit Committee Communication

If audit committees are so important, how are they doing? I believe the large majority of audit committees in the U.S. are performing their duties well. But I also think that the public, especially investors, doesn't get enough information demonstrating this important work.

So it seems more effective disclosure is in order. In particular, investors and others could learn more, via the audit committee report, about what audit committees do and how they do it.

To be sure, many audit committees already provide investors robust information. In fact, recent studies of audit committee reporting from Deloitte and EY show that a number of audit committees of public companies of various sizes already voluntarily are embracing disclosures that go beyond the minimum requirements of regulators and security exchanges.

But we can do better.

Companies Lighting the Path Ahead for Audit Committees

Fortunately for us, there are plenty of examples of audit committees that are doing better -- at companies like Coca-Cola, General Electric, and Pfizer.

McDonald's too. The audit committee for the Oakbrook, Ill. fast-food chain excels, for example, when it comes to providing relevant information about how the audit committee oversees the external auditor. Consider the following, from the McDonald's 2013 proxy statement:

…The Committee is responsible for the engagement of the independent auditor and appointed [Independent Auditor] to serve in that capacity during 2012 and 2013. In that connection, the Committee:

• reviewed [Independent Auditor's] independence from the Company and management, including
• [Independent Auditor's] written disclosures described above;
• reviewed periodically the level of fees approved for payment to [Independent Auditor] and the pre- approved non-audit services it has provided to the Company to ensure their compatibility with [Independent Auditor's] independence; and reviewed [Independent Auditor's] performance, qualifications and quality control procedures.

Among other matters, the Committee also:

• reviewed the scope of and overall plans for the annual audit and the internal audit program;
• consulted with management and [Independent Auditor] with respect to the Company's processes for risk assessment and risk management;
• reviewed and approved the Company's policy with regard to the hiring of former employees of the independent auditor;
• reviewed and approved the Company's policy for the pre-approval of audit and permitted non-audit services by the independent auditor;
• received reports pursuant to the Company's policy for the submission and confidential treatment of communications from employees and others about accounting, internal controls and auditing matters;
• reviewed with management the scope and effectiveness of the Company's disclosure controls and
• procedures, including for purposes of evaluating the accuracy and fair presentation of the Company's financial statements in connection with certifications made by the CEO and CFO;
• reviewed significant legal developments and the Company's processes for monitoring compliance with law and Company policies; and
• reviewed the Company's related person transactions.

This kind of specificity illuminates the important role of the audit committee -- to the benefit of investors and others. You can find many more examples of top companies leading the way in a report, Enhancing the Audit Committee Report: A Call to Action, published last fall by the Audit Committee Collaboration. In the Collaboration are the National Association of Corporate Directors, the Association of Audit Committee Members, Inc., the Directors' Council, Corporate Board Member, the Center for Audit Quality, and Tapestry Networks.

What Can You Do Now?

The Call to Action is intended to be the start of an ongoing dialogue around this issue. We are not suggesting that audit committees do more work, just consider whether they can better communicate about the great work they are doing. You can join the conversation and support the effort. Organizations and individuals that want to officially indicate support or the Call to Action in principle should visit www.auditcommitteecollaboration.org.

By becoming a supporter, you are not agreeing to including every idea in the audit committee report. You are simply registering your support for a key concept: audit committee reporting can and should be strengthened.