VideoBarbara Hackman Franklin says that when she has asked auditors to comment on a company's accounting practices, they speak more freely about those that are conservative than those that are aggressive. But she expects that the SEC's recommendations will help "smoke out aggressiveness."
Another recommendation that will put auditors on the spot concerns having the audit committee obtain a written statement from the external auditing firm on its nonaudit and consulting assignments with the company. Again, Franklin says she has been asking for this information for several years. In one company for which she chairs the audit committee, the policy is that if the consulting fees amount to more than 50 percent of total fees on a three-year rolling average, it's time to take a closer look. "It's a judgment call about how much consulting is too much before the auditors' independence is impaired," she explains.
The major accounting firms say they welcome examination of their nonaudit relationships with their audit clients--to clear the air, if nothing else. "There's been a lot of questioning of auditor independence lately, and whether the audit opinion is worth anything," concedes Greg Jonas, managing director of financial assurance at Arthur Andersen LLP. "That's not good for the auditing profession."
Who's Liable?
Whether additional responsibilities are good for the audit committee or whether they will simply increase directors' liability is another growing concern. After all, says attorney Joseph Weiss, in the New York office of law firm Weiss & Yourman, "The audit committee is a natural target." But is there really a correlation between companies with defective audit committees and companies that are targeted for accounting irregularities and shareholder lawsuits?
At the very least, plaintiff and defense attorneys alike report that when they work on fraud cases, they often find that the audit committee was asleep at the switch. "I can't say the [accounting] problems would have gone away in situations in which there was an active audit committee," says attorney John Olson, "but they may have been detected and tended to before litigation was filed."
In CFO's survey of 150 proxies, we came across 17 companies that were the subject of recently filed shareholder suits alleging some form of accounting chicanery. And in 9 of those cases, there was evidence that the audit committee either met too infrequently to be effective or had members with questionable ties to the company, while the 8 others appeared, on the surface, to be doing their jobs well.
Perhaps the most egregious example is Telxon Corp., which is under SEC investigation for overbooking revenues and was hit with shareholder litigation in February. At the Akron, Ohio, maker of wireless information systems, three of the five audit-panel members have obvious conflicts: John Cribb is a retired executive who left the company in 1995; Robert Goodman, senior partner in a Cleveland law firm, is general counsel; and Norton Rose was paid more than $300,000 for consulting services between 1996 and 1998.
Nevertheless, none of the three Telxon directors was named as a defendant in the shareholder suits filed against the company--and audit committee members rarely are in other cases. Plaintiff attorneys say the decision depends on whether an audit-director sold stock during the class period, not whether the committee practices were faulty. "Just being on the audit committee doesn't necessarily create the inference that you know about the fraud," says Reed Kathrein of the San Francisco law office of Milberg Weiss Bershad Hynes & Lerach LLP. "Insider selling creates the inference that you had adverse information and acted on it."
In theory, audit committees that abide by the SEC's proposals will be safer from litigation, though the higher standards will certainly encourage greater scrutiny by plaintiff lawyers. "The liability has always been there," says Joseph Weiss, "but the egregious examples lately place a greater focus on the work they're doing to give investors assurance."
Whither Audit Committees?
For the blue-ribbon panel's proposals to have any force, it will need a little help from its friends. The SEC must come up with new disclosure rules, the AICPA must come up with new auditing standards, and the stock exchanges must enact new listing standards. And with Arthur Levitt looking to maintain momentum for his campaign against accounting irregularities, he has indicated that he wants to see action sooner rather than later.
"He hopes that each group will act before we're too late into the spring," says the SEC's Goldschmid.
Yet for all the apparent shortcomings of audit committees today, the SEC's effort has generated concern about adding more duties than a typical audit committee can handle and setting inflexible standards that discourage committee participation. Says Rick Fleming, the executive vice president and CFO of USG Corp., a manufacturer and distributor of building materials in Chicago, who supports the effort of the blue-ribbon panel, "The recommendations are getting a lot of review, and some will be subject to a lot of public comment--not because of the theory involved, but because of the practicality of some of them."
Even more unsettling is the question of whether the audit committee will soon find itself in a watchdog position it can't fulfill. Rather than blunt accounting trickery and curtail fraud, the current push to improve committee effectiveness could simply raise expectations higher than is warranted.
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