The Daunting Role of the Audit Committee: 21 Actions to Take Before Serving or While Serving on an Audit Committee

• Date: 01 April 2018
• Author: Eric James Burton,Sandy Benson
• DOI: http://doi.org/10.1002/jcaf.22326
• Published date: 01 April 2018

57

© 2018 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.22326

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The Daunting Role of the Audit

Committee: 21 Actions to Take

Before Serving or While Serving

on an Audit Committee

Sandy Benson and Eric James Burton

INTRODUCTION

The audit com-

mittee serves a vital

role in the oversight

of the financial

reporting process and

in promoting investor

confidence. The role

and responsibilities

of audit committees continue

to evolve. The Sarbanes-

Oxley Act of 2002 and addi-

tional requirements of listing

exchanges have enlarged the

expectations placed on audit

committees. Court rulings

have broadened those expecta-

tions as well.

In this three-part article,

the authors cover some of

the legal challenges faced by

audit committee members in

fulfilling these expectations.

A review of these legal issues

provides an opportunity to

understand the current land-

scape in order to aid audit

committee members in accom-

plishing their important role.

This article features three

legal cases in which investors

claimed audit committee mem-

bers violated federal securities

laws or breached duties owed

under state laws. In each case,

the court initially accepted

the allegations against audit

committee members as true to

decide if the litigation could

continue.

• Part I: Five Keys in Guard-

ing the External Auditors

describes a case (Lernout

& Hauspie) involving an

alleged corporate

fraud perpetrated

by senior officers

that resulted in

an international

scandal and bank-

ruptcy. Lawsuits

against multiple

defendants fol-

lowed, including

claims by investors that

the audit committee did

not properly oversee the

external auditors. The

case points out that the

audit committee is the

vital overseer of the exter-

nal audit process, and as

such, their responsibility

includes overseeing the

work of the independent,

external auditors.

• Part II: Five Easy-to-

Overlook Considerations

in Risk Oversight concerns

various recalls by General

Motors arising from faulty

ignition switches r esulting

Few responsibilities in corporate governance

may look more daunting at this moment than

that of service on the audit committee of a public

company. But perhaps no form of governance

service is more important or valuable (Lipton

et al., 2008). © 2018 Wiley Periodicals, Inc.

Editorial Review

58 The Journal of Corporate Accounting & Finance / April 2018

DOI 10.1002/jcaf © 2018 Wiley Periodicals, Inc.

in a total of approximately

$1.5 billion charges against

earnings through the first

and second quarters of

2014. Shareholders con-

tended that the board

transferred some, but not

all, of the risk responsibili-

ties to the audit commit-

tee making it possible for

this defect and its poten-

tial effect on the finan-

cial statements not to be

reported to the board. The

plaintiffs also claimed the

board’s decision was not

in good faith because the

audit committee was over-

loaded with bankruptcy

issues when the transfer

occurred.

• Part III: Eight Compliance

Points to Keep in Mind

deals with a case (In

re Veeco) in which the

audit committee allegedly

received, but ignored, signs

that the company was vio-

lating federal export laws.

The violations were poten-

tially significant because

70% of the company’s

revenues stemmed from

export sales. An exhibit to

this part alerts the audit

committee to some of the

issues it may face in inves-

tigating fraud. Together,

these cases raise consid-

erations of the role of the

audit committee

in risk oversight and com-

pliance, as well as the

workload of the audit

committee.

Each of the three parts in

the article provides key insights

for audit committee members.

These suggestions may also aid

board members in establishing

and reviewing responsibilities

among various committees.

While the article focuses on

public company requirements,

the suggestions may be relevant

for nonprofit and private com-

panies. The article concludes

with a summary of 21 key

actions to take before agreeing

to serve or while serving on an

audit committee.

The authors’ insights

discussed here are not a sub-

stitute for obtaining profes-

sional advice. The authors

are not rendering accounting,

legal, or other professional

advice. Before making any

decision or taking any action,

consult a qualified profes-

sional adviser.

PART I: FIVE KEYS IN

GUARDING THE EXTERNAL

AUDITORS

Effective oversight of the

financial reporting process is

fundamental to preserving the

integrity of our markets…The

audit committee, composed of

members of the board of direc-

tors, plays a critical role in pro-

viding oversight over and serving

as a check and balance on a

company’s financial reporting

system (SEC, 2003).

A clean audit does not

relieve the audit commit-

tee of its duty to oversee the

auditor. It is important to

pay careful attention to the

admonitions of the auditors

and heed any warning signs.

In the following case, the

auditors reported concerns

of cash collections from the

strategic partners and rev-

enues recognized from the

company’s Korean operations.

The external auditor reported

that at least nine transactions

in the second quarter of 1999

were questionable. The chair

of the Audit Committee also

received a confidential letter

from the auditor stating that

a limited review of the third

quarter financial statements

was not complete because of

outstanding revenue recogni-

tion issues in Korea and cash

collection issues from the stra-

tegic partners. In addition, the

auditor had been persistently

recommending the implemen-

tation of a system of internal

controls. Despite these warn-

ing signs, the audit committee

overlooked the issues. The

court determined that an out-

side director who is an Audit

Committee member is in a

position to approve a corpo-

ration’s financial statements,

and thus, can be “presumed”

to have the power to direct

or cause the direction of the

management and company

policies related to the con-

tents of reports signed. This

presumption may satisfy the

requirement for “control” for

purposes of § 20 (a) liability

under the Exchange Act. The

court refused to dismiss the

shareholder claims.

Example Case: The In re

Lernout & Hauspie Securities

Litigation Case

Overview. The first case

illustrates the vital role of the

audit committee in its duty to

oversee the independent audi-

tors. SEC Rule 10A-3(b)(2)

requires the audit committee of

each listed issuer to be directly

responsible for the oversight

of the work of the external

auditor. What does oversight

mean? This case suggests that

the audit committee must not