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

Date01 April 2018
DOIhttp://doi.org/10.1002/jcaf.22326
Published date01 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

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