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The Audit Committee Functions 77


S-Ox Section 409”Real Time Issuer Disclosures
Section 13 of the Securities Exchange Act of 1934 (15 U.S.C. 78m), as amended by
this Act is amended by adding at the end the following:
(l) REAL TIME ISSUER DISCLOSURES”Each issuer reporting under section
13(a) or 15(d) shall disclose to the public on a rapid and current basis such additional
information concerning material changes in the financial condition or operations of
the issuer, in plain English, which may include trend and qualitative information and
graphic presentations, as the Commission determines, by rule, is necessary or useful
for the protection of investors and in the public interest.47


SEC Final Rules”Standards Relating to Listing Company Audit Com-
mittee On April 9, 2003, the SEC issued a release that mandates changes in the
SROs listing standards. As directed by the Sarbanes-Oxley Act of 2002, the SEC
issued a directive to the SROs to prohibit the listing of any security of an issuer
that is not in compliance with the audit committee requirements mandated by the
Sarbanes-Oxley Act. These requirements relate to:

• The independence of audit committee members
• The audit committee™s responsibility to select and oversee the issuer™s inde-
pendent accountant
• Procedures for handling complaints regarding the issuer™s accounting practices
• The authority of the audit committee to engage advisors
• Funding for the independent auditor and any outside advisors engaged by the
audit committee48

In an effort to tighten the inde-
Audit Committee Member Independence
pendence requirements for audit committee members, the SEC final rules con-
tained two criteria:49

1. Audit committee members are barred from accepting any consulting, advisory
or other compensatory fee from the issuer or any subsidiary thereof, other than
in the member™s capacity as a member of the board of directors and any board
committees;50 and
2. Audit committee members of an issuer that are not an investment company
may not be an affiliated person of the issuer or any subsidiary of the issuer



47
Ibid., Sec. 409.
48
Securities and Exchange Commission, Release No. 38-8220, Standards Relating to Listing Com-
pany Audit Committee (Washington, DC: SEC, April 9, 2003).
49
For further information regarding the SRO™s proposed additional standards, see SEC Release No.
34-47672.
50
More specifically, disallowed payments to an audit committee member include payments made di-
rectly or indirectly. See SEC Release No. 33-8220 for examples of relationships. Also, de minimis ex-
ception for independence is non-existent and will be removed from the listing requirements.
78 Audit Committees: Basic Roles and Responsibilities


apart from his or her capacity as a member of the board and any board
committee.51

To in-
Responsibilities Relating to Registered Public Accounting Firms
crease investor confidence in the audit process, the SEC adopted the requirement
that the audit committee of a listed issuer will be directly responsible for the ap-
pointment, compensation, retention, and oversight of the work of any registered
public accounting firm engaged for the purpose of preparing or issuing an audit re-
port or performing other audits, or review or attest services. The independent au-
ditor will report directly to the audit committee.52

Each audit committee must establish
Procedures for Handling Complaints
procedure for:

• The receipt, retention, and treatment of complaints received by the issuer re-
garding accounting, internal controls or auditing matters
• The confidential, anonymous submission by employees of the issuer of con-
cerns regarding questionable accounting or auditing matters

The SEC pointed out that audit committees should be provided with flexibil-
ity to develop and utilize procedures appropriate for their circumstances.

The SEC™s final rule requires audit commit-
Authority to Engage Advisors
tees to have authority to engage outside advisors, including accounting and legal
experts. Hence this rule supports the SEC™s position that the audit committee must
have the necessary resources to fulfill its function.

The SEC™s final rule on funding requires the issuer to provide for
Funding
payment of compensation to:

• Any registered public accounting firm engaged for the purpose of preparing or
issuing an audit report or performing other audit, review, or attest services
• Any advisor employed by the audit committee

The final rule does not set funding limits. Finally, the final rule provides that the
issuer must provide funding for the ordinary administrative expenses of the audit
committee.

51
The SEC defines “affiliate” and “affiliated person” as a person that directly or indirectly, through
one or more intermediaries, controls, or is controlled by, or is under common control with, the person
specified. Under the final rule, only executive officers, directors who are also employees of an affili-
ate, general partner, and managing members of an affiliate, will be deemed to be affiliates. Moreover,
the limitation on directors will exclude outside directors of an affiliate as well as individuals with pas-
sive, noncontrol positions, and non-policymaking functions. For further information on investment
company issuers and new issuers, see the aforementioned release number.
52
With respect to clarifications regarding possible conflicts with other requirements, see the release for
such matters as the application of noncountry laws or listing requirements for the appointment of laws
or listing requirements for the appointment of the independent auditors. However, if the issuer provides
a recommendation or nomination for the independent auditors, then the audit committee (or body per-
forming similar functions) must be responsible for making the recommendation on nomination.
The Audit Committee Functions 79


In addition to the listing or delisting re-
Compliance and Curing Defects
quirement, for issuers not in compliance with the standards, the SEC adopted a
final rule stating that the SROs must require a listed issuer to notify the applicable
SRO of any material noncompliance with the audit committee requirements.
With respect to the SEC™s final rule on curing defects, the SROs are required
to establish procedures before they prohibit the listing of or delist any security of
an issuer. The SEC believes that the SRO™s existing continued listing procedures
will suffice.53

Disclosure Changes Regarding Audit Committees”Disclosure Regard-
ing Exemptions The SEC requires issuers to disclose their reliance on an ex-
emption and their assessment of whether, and if so, how such reliance will
materially adversely affect the ability of their audit committee to act indepen-
dently and to satisfy the other requirements. Such disclosure will need to appear
in, or be incorporated by reference into, annual reports filed with the Commission.
The disclosure also will need to appear in proxy statements or information state-
ments for shareholders™ meetings at which elections for directors are held.54

In an effort to
Identification of the Audit Committee in Annual Reports
readily determine basic information about the composition of a listed issuer™s
audit committee, the SEC requires that disclosure of audit committee members be
included or incorporated by reference in the issuer™s annual report. Additionally,
if a listed issuer does not have an audit committee, then it must disclose that the
entire board of directors is acting as the audit committee.

Regarding the indepen-
Updates to Existing Audit Committee Disclosure
dence disclosure for audit committees, all national exchanges and national securi-
ties associations will need to have independence standards for audit committee
members, not just the NYSE, AMEX, and Nasdaq.
Nonlisted issuers that have separately designated audit committees still will be
required to disclose whether their audit committee members are independent.
Such issuers may choose any definition for audit committee independence of a na-
tional securities exchange or national securities association that has been approved
by the Commission.

Audit Committee Financial Expert Disclosures for Foreign Private Is-
suers55 A foreign private listed issuer must disclose whether its audit commit-
tee™s financial expert is independent, as defined by the SRO listing standard
applicable to that issuer, the issuer may choose one of the SRO definitions of audit

53
See the text of the release regarding rare situations that may occur when the audit committee mem-
ber ceases to be independent as well as SRO implanting rules.
54
The SEC™s final rule on listed issuers that are not required to provide disclosure on their reliance on
one of the exemptions to the rule, such as a subsidiary relying on multiple listing exemption, a foreign
government issuer, or an asset-backed issuer are excluded from the requirement to disclose, whether
they have a separate audit committee or not.
55
For additional information regarding proposed rule changes by the New York Stock Exchange, see
SEC Release No. 34-47672, Sections 303A (6) and 303 A (7).
80 Audit Committees: Basic Roles and Responsibilities


committee independence (SEC approval) to determine whether its audit commit-
tee financial expert, if it has one, is independent.


THE EXTERNAL AND INTERNAL AUDITING PROCESS
The Nature of External Auditing
External auditing is the process not only of examining the financial statements but
also of testing the underlying accounting records of the company. The examination
is conducted by the independent auditors, who express an objective opinion re-
garding the fairness of presentation of the financial statements. The audit exami-
nation is conducted within a predetermined set of generally accepted auditing
standards that are promulgated by the Auditing Standards Board, formerly named
the Auditing Standards Executive Committee of the American Institute of Certi-
fied Public Accountants (AICPA).56 Since the audit examination is performed by
certified public accountants who are independent of the company™s management,
the objective opinion of the independent auditing firm strengthens the reliability
and credibility of the company™s financial reporting practices.
More specifically, corporate management has full responsibility for the finan-
cial statements because such statements represent a report on management™s stew-
ardship accountability to its outside constituencies. The Auditing Standards Board
of the AICPA asserts:

The financial statements are management™s responsibility. The auditor™s responsibil-
ity is to express an opinion on the financial statements. Management is responsible
for adopting sound accounting policies and for establishing and maintaining internal
control that will, among other things, record, process, summarize, and report trans-
actions (as well as events and conditions) consistent with management™s assertions
embodied in the financial statements. The entity™s transactions and the related assets,
liabilities, and equity are within the direct knowledge and control of management.
The auditor™s knowledge of these matters and internal control is limited to that ac-
quired through the audit. Thus, the fair presentation of financial statements in con-
formity with generally accepted accounting principles is an implicit and integral
part of management™s responsibility. The independent auditor may make suggestions
about the form or content of the financial statements or draft them, in whole or in
part, based on information from management during the performance of the audit.
However, the auditor™s responsibility for the financial statements he or she has au-
dited is confined to the expression of his or her opinion on them.57

Increasingly, management™s responsibilities for financial statements are typi-
cally acknowledged in a Report of Management in the annual stockholders™ report,
which states in part:


56
As noted in Chapter 13, the name of this committee has been changed to the Auditing Standards
Board. However, the former name of this group will be used in connection with the appropriate State-
ments on Auditing Standards as discussed in the text.
57
AICPA, Professional Standards, U.S. Auditing Standards/Attestation Standards, Vol. 1 (New York:
AICPA, 2003), AU Sec. 110.03.
The External and Internal Auditing Process 81


Report of Management
Management of Wal-Mart Stores Inc. is responsible for the integrity and objectivity
of the financial statements and other information presented in this report. These fi-
nancial statements have been prepared in conformity with accounting principles gen-
erally accepted in the United States. The preparation of financial statements requires
certain estimates and judgments, which are based upon currently available informa-
tion and management™s view of current conditions and circumstances.
Management has developed and maintains a system of internal and disclosure controls,
including an extensive internal audit program. These controls are designed to provide
reasonable assurance that the Company™s assets are protected from improper use and
that Wal-Mart™s accounting records provide a reliable basis for the preparation of fi-
nancial statements. We continually review, improve and modify these systems and
programs in response to changes in business conditions and operations and the recom-
mendations made by Wal-Mart™s internal and external auditors. We believe that the sys-
tem of internal and disclosure controls provides reasonable assurance that Wal-Mart™s
assets are safeguarded and that the financial information disclosed is reliable.
Our Company was founded on the belief that open communications and the highest
standard of ethics are necessary to be successful. Our long-standing “open door”
communication policy helps management be aware of and deal with issues in a
timely and effective manner. Through the open door policy all Associates are en-
couraged to inform management at the appropriate level when they are concerned
about any matter pertaining to the Company.
Wal-Mart has adopted a Statement of Ethics to guide our Associates in the continued
observance of high ethical standards such as honesty, integrity and compliance with
the law in the conduct of the Company™s business. Familiarity and compliance with
the Statement of Ethics is periodically reviewed and acknowledged in writing by all
management Associates. The Company also has in place a Related Party Transaction
Policy. This policy applies to all Officers and Directors of the Company and requires
material related party transactions to be reviewed by the Audit Committee of the
Board of Directors. Annually, the Company™s Officers and Directors report material
related party transactions to the Company and Officers acknowledge their familiar-
ity and compliance with the policy.
We retain Ernst & Young LLP, independent auditors, to audit the Company™s finan-
cial statements. Their audits are performed in accordance with generally accepted
auditing standards. We have made available to Ernst & Young LLP all financial
records and related data.
The Board of Directors, through the activities of its Audit Committee consisting
solely of outside directors, provides oversight of the process of reporting financial in-
formation. The Committee stays informed of the financial condition of the Company
and regularly reviews its financial policies and procedures, the independence of the
Company™s independent auditors, its internal accounting controls and the objectivity
of its financial reporting. Both the Company™s independent auditors and the internal
auditors have free access to the Audit Committee and meet with the Committee

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