Sitting ducks and decoys: responding to the increased involvement -- and exposure -- of audit committees as a magnet for company information.

• Author: Ferrara, Ralph C.
• Position: Legal Brief - Complying with the Sarbanes-Oxley Act

This is the first in a series of columns that will review the new responsibilities, the questions raised, and what boards should do to comply with the Sarbanes-Oxley Act.

SECTION 301 of the SarbanesOxley Act contains many of the provisions relating to audit committees. These provisions clearly direct audit committees to become more involved in the process of financial disclosures and more knowledgeable about that process. They also attempt to lessen the potential for an outside auditor to collude with management to hide information from the board and, ultimately, the public. Section 301 makes the audit committee directly responsible for the hiring, compensation, and oversight of the company's outside auditors. Further, the audit committee must resolve any disputes or disagreements between the auditors and management regarding reporting issues. The outside auditor must also report to the committee: (i) all critical accounting policies and practices used; (ii) the ramification of the use of all alternative treatments of financial information as well as the auditor's preferred method; and (iii) any other material written communications between the accounting firm and management, including management letters and schedules of unadjusted differences.

Although the Act does not require that the audit committee include a financial expert, Section 407 directs the Securities and Exchange Commission to adopt rules requiring the company to disclose whether or not it has a financial expert. This expert will be expected to understand generally accepted accounting principles and financial statements, have experience with internal accounting controls, and have experience preparing and auditing financial statements of comparable companies. Now, theoretically, the audit committee will not only have all of the company's pertinent financial information, but it will also have the financial acumen to interpret it.

To further ensure that the audit committee confronts perceived problems, the Act mandates that the committee be completely independent. No member of the audit committee may be "affiliated" with the company or any subsidiary, nor shall she receive fees from the issuer other than in her capacity as a board member. This would exclude, among others, a director who is also a controlling stockholder or a controlling person of a controlling stockholder. Issues have also been raised as to whether a parent company director who also sits on a parent-controlled...