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When the Securities and Exchange Commission began requiring companies to disclose whether or not they have financial experts on their audit committees, Costco Wholesale Corp. board members did not sweat the process, recalls CFO and board member Richard Galanti. They simply asked their audit-committee chairman, Charles Munger, to consider accepting the title. He agreed.
"I don't think there was a lot of magic to it," says Galanti. As president of Berkshire Hathaway–owned Wesco Financial Corp. and sidekick to Berkshire CEO Warren Buffett, Munger easily fit the SEC requirements for the role, which had broadened out over the rulemaking process. And although one member may have been designated the expert, says Galanti, "we feel all the members of the audit committee add to the process. [Munger] provides his full share of comments," he adds, "but the other two aren't sitting around doing nothing."
Two years ago, the SEC was hoping for a little magic with its new disclosure rule. At the time, it seemed like a promising way to guarantee audit committees would detect accounting fraud more effectively than their counterparts had at the likes of Enron, WorldCom, and Adelphia. Few companies would want to be caught without an expert, the thinking went, and so they would hire in new talent — namely, CFOs and former audit partners—to shake up their audit committees.
Today, it's not apparent that the rule has changed disclosure or governance in any meaningful way. While nearly all Fortune 500 companies claim to have an expert, according to CFO's review of their proxy information, more than half of the approximately 850 people named as experts are the archetypal board member: a current or former CEO. Persons fitting the "ideal" remain few and far between. About 16 percent were formerly CFOs, while 8 percent were once public auditors. Only 7 percent — 63 people — are current or recently retired finance chiefs.
Of course, titles can be deceptive. The CEO at one company may be more financially savvy than the CFO at another, while a long-retired executive may have rustier skills than a former title would imply. However, the companies reviewed by CFO do not even attempt to convince shareholders that their experts meet the SEC's requirements, relying instead on generic biographies and boilerplate disclosure language. "In many cases, it's far from clear why a particular individual meets the letter and spirit of the SEC law," says Joseph Carcello, director of research for the University of Tennessee's Corporate Governance Center. "In the interest of transparency, shouldn't we be able to tell if they meet the requirements?"
To that end, CFO did its own rating of the Fortune 100's experts, based on additional research that included calling companies to ask for justification of experts with ambiguous qualifications. While those ratings paint a fairly bright picture — 26 companies had at least one expert who rated an A, while only 9 companies got Fs — the qualifications of many experts remain a mystery. Says Carcello: "It makes a skeptic ask, 'Are companies not disclosing the information because their experts don't have the right backgrounds?'"
What's more, there seems to be little incentive for companies to step up their efforts. Many agree with Galanti's assessment that the expert is indistinguishable from other audit-committee members. "In my experience, I have not found a particular burden as a financial expert," says retired AT&T vice chairman (and former CFO) Charles Noski, who is Microsoft Corp.'s audit-committee chair and one of two financial experts on the committee. Governance experts "look at a lot of different indicators [to assess the quality of audit committees], but we see no evidence that [designating a financial expert] is a significant one," adds Nell Minow of corporate-governance research firm The Corporate Library. Even the SEC doesn't seem to care. While its reviewers check for the disclosure statement, "there's no qualitative analysis of the disclosures," says a source familiar with the process.
Creating a Gray Area
Some believe the rule was doomed to fail from the start. Section 407 of the Sarbanes-Oxley Act of 2002 directed the SEC to require public companies to report annually whether they have an audit-committee "financial expert," a term the SEC was also supposed to define. In its initial definition, the SEC said an expert should have past experience preparing or auditing financial statements, among other criteria, thereby making CFOs and auditors about the only folks who could fit the bill.
By the time the rule was finalized, however, corporate complaints had broadened the definition so that sages like Alan Greenspan and Warren Buffett — along with nearly anyone else who had ever touched a financial statement — could theoretically qualify. (Buffett is on Coca-Cola's audit committee but is not its designated expert, while Greenspan gave up his board affiliations when President Reagan appointed him to the Federal Reserve Board in 1987.)
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