Deputizing directors: The last act?


The SEC'S rule revisions on auditor independence suggest additional prudent safeguards be put in place.

IN NOVEMBER 1998, then-SEC Chairman Arthur Levitt called for the strengthening of the audit committee process as part of his now well-known "numbers game" speech. Since then, corporate directors have been urged to wade through blue ribbon committee reports, SEC staff accounting bulletins, compliance checklists and charters in the wake of ensuing SEC and stock exchange rules -- all with a view to assessing the new duties and risks posed by this new regulatory regime. In an earlier column [Summer 2000], we characterized these efforts as the SEC's attempt to "deputize" audit committee members.

The latest move towards deputizing directors came last fall. In November, the SEC adopted revisions to its auditor independence standards that went into effect in February. Although aimed at updating the agency's antiquated independence rules and addressing issues raised by the explosive profitability of non-audit services, these revisions create burdens that once again land in the lap of corporate audit committee members as a result of the interplay of these changes with the 1999 adoption of various audit committee disclosure rules.

Background: In December 1999, the SEC issued new rules requiring that the annual proxy statement include a report from the committee stating whether it reviewed the audited financial statements and discussed them with management, recommended that the board include the financials in the company's annual report, and addressed financial reporting process and (here's the unexpected rub) independence issues with the auditors. At the time, the independence-related communications between the auditor and the committee appeared to be framed by the requirements of ISB Standard No. 1, mandating that the auditor assure the company in writing that it considered itself independent and disclose all of its other relationships with the company that might bear on its independence.

The New Rules: To audit committee members, the SEC's revisions to its auditor independence rules are noteworthy for at least two reasons. First, the revised rules reflect the formal adoption of an appearance standard for auditor independence; that is, one holding that independence is impaired if a reasonable investor with knowledge of all of the relevant facts and circumstances would conclude that the auditor is not capable of exercising objective and impartial...

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