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(continued)
16 Corporate Accountability: The New Environment



Exhibit 1.2 (Continued)
carries out those responsibilities, including structure, processes, and membership require-
ments, and (ii) review and reassess the adequacy of the audit committee charter on an an-
nual basis.

Recommendation 5
The Committee recommends that the Securities and Exchange Commission (SEC) pro-
mulgate rules that require the audit committee for each reporting company to disclose in
the company™s proxy statement for its annual meeting of shareholders whether the audit
committee has adopted a formal written charter, and, if so, whether the audit committee
satisfied its responsibilities during the prior year in compliance with its charter, which
charter shall be disclosed at least triennially in the annual report to shareholders or proxy
statement and in the next annual report to shareholders or proxy statement after any sig-
nificant amendment to that charter.
The Committee further recommends that the SEC adopt a “safe harbor” applicable to
all disclosure referenced in the Recommendation 5.
Our final group of recommendations addresses mechanisms for accountability
among the audit committee, the outside auditors, and management:

Recommendation 6
The Committee recommends that the listing rules for both the NYSE and the NASD re-
quire that the audit committee charter for every listed company specifiy that the oustide au-
ditor is ultimately accountable to the board of directors and the audit committee, as
representatives of shareholders, and that these shareholder representatives have the ulti-
mate authority and responsibility to select, evaluate, and, where appropriate, replace the
outside auditor (or to nominate the outside auditor to be proposed for shareholder approval
in any proxy statement).

Recommendation 7
The Committee recommends that the listing rules for both the NYSE and the NASD
require that the audit committee charter for every listed company specify that the audit
committee is responsible for ensuring its receipt from the outside auditors of a formal
written statement delineating all relationships between the auditor and the company,
consistent with Independence Standards Board Standard 1, and that the audit committee
is also responsible for actively engaging in a dialogue with the auditor with respect to
any disclosed relationships or services that may impact the objectivity and independence
of the auditor and for taking, or recommending that the full board take, appropriate
action to ensure the independence of the outside auditor.

Recommendation 8
The Committee recommends that Generally Accepted Auditing Standards (GAAS) re-
quire that a company™s outside auditor discuss with the audit committee the auditor™s
judgments about the quality, not just the acceptability, of the company™s accounting prin-
ciples as applied in its financial reporting; the discussion should include such issues as the
clarity of the company™s financial disclosures and degree of aggressiveness or conser-
vatism of the company™s accounting principles and underlying estimates and other signif-
icant decisions made by management in preparing the financial disclosure and reviewed by
Recent Developments in Corporate Accountability 17



the outside auditors. This requirement should be written in a way to encourage open, frank
discussion and to avoid boilerplate.

Recommendation 9
The Committee recommends that the SEC require all reporting companies to include a let-
ter from the audit committee in the company™s annual report to shareholders and Form 10-
K Annual Report disclosing whether or not, with respect to the prior fiscal year: (i)
management has reviewed the audited financial statements with the audit committee, in-
cluding a discussion of the quality of the accounting principles as applied and significant
judgments affecting the company™s financial statements; (ii) the outside auditors have dis-
cussed with the audit committee the outside auditors™ judgments of the quality of those
principles as applied and judgments referenced in (i) above under the circumstances; (iii)
the members of the audit committee have discussed among themselves, without manage-
ment or the outside auditors present, the information disclosed to the audit committee de-
scribed in (i) and (ii) above; and (iv) the audit committee, in reliance on the review and
discussions conducted with management and the outside auditors pursuant to (i) and (ii)
above, believes that the company™s financial statements are fairly presented in conformity
with Generally Accepted Accounting Principles (GAAP) in all material aspects.
The Committee further recommends that the SEC adopt a “safe harbor” applicable to
any disclosure referenced in this Recommendation 9.

Recommendation 10
The Committee recommends that the SEC require that a reporting company™s outside
auditor conduct a SAS 71 Interim Financial Review prior to the company™s filing of its
Form 10-Q.
The Committee further recommends that SAS 71 be amended to require that a report-
ing company™s outside auditor discuss with the audit committee, or at least its chairman,
and a representative of financial management, in person, or by telephone conference call,
the matters described in AU Section 380, Communications With the Audit Committee,
prior to the filing of the Form 10-Q (and preferably prior to any public announcement of
financial results), including significant adjustments, management judgments and account-
ing estimates, significant new accounting policies, and disagreements with management.


Source: Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees,
Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of
Corporate Audit Committees (New York: The Blue Ribbon Committee on Improving the
Effectiveness of Corporate Audit Committees, 1999), pp. 10“16.




self-regulatory organizations (SROs) issued proposed rules and changes to the
SRO™s listing standards. Finally, in December 1999, the SEC, the SRO™s, and the
AICPA™s Auditing Standards Board adopted new rules, listing standards, and au-
diting standards for improving the effectiveness of audit committees. Exhibit 1.3
contains a flow chart that delineates the items to meet the new SEC disclosure
rules, the SRO™s listing standards, and professional auditing standards.
Exhibit 1.3 New Requirements and Disclosure Rules for Audit Committees:
A Flow Chart
Start



Noncompliance with the size
Is the
requirement (18-month transition
audit committee
No period from December 14, 1999):
composed of three
Independence impaired (Effective
independent
for year 2000 proxy statement
directors?*
and meeting”NYSE only)
Note A


Yes


Is the Noncompliance with the
audit committee financial knowledge requirement
No
composed of independent (Effective for year 2000
directors who are finan- proxy statement and
cially literate? meeting”NYSE only
Note B


Yes


Does the
Noncompliance with the
audit committee
No written charter requirement
have a writen charter
(6-month transition period from
issued by the board
December 14, 1999)
of directors?
Note C


Yes


Has the
audit committee Noncompliance with the
No
addressed the required annual certification requirement
disclosures to the (NYSE) and one-time certification
appropriate stock (Nasdaq/AMEX)
exchange?
Note D

Yes

(to opposite page)


Notes: A. If the board of directors determines in its business judgment that the relationship (e.g., certain
business relationships and/or one nonindependent member relationship) does not interfere with the direc-
tor™s exercise of independent judgment, then independence is not impaired.
B. The board of directors determines in its business judgment whether each member of the audit committee
is financially literate. Based on the board™s business judgment, at least one member must have accounting
or related financial management expertise.
C. Each listed company must have an audit committee charter that guides its activities.
D. Each listed company (NYSE) is required to furnish a written certification letter, submitted annually,
affirming the aforementioned points in A, B, and C. Nasdaq/AMEX listed companies require a one-time
certification with respect to A, B, and C above.
E. After December 15, 2000, the SEC requires proxy statement disclosure of a report from the audit com-
mittee indicating whether the committee: (1) reviewed and discussed financial statements with management
and the external auditors; (2) discussed with the external auditors matters required by SAS No. 61;



18
(from preceding page)




Has the
audit committee
No
prepared a report to be Noncompliance with the SEC
included in the annual proxy statement disclosure
proxy statements?
Note E


Yes


Has the
audit committee
No
discussed the items Noncompliance with the SEC
covered by SAS No. 61 rule regarding SAS No. 61
with the external
auditors?
Note E

Yes


Has the
audit committee
responded to the No No SEC rule, listing standard by
external auditors™ required the stock exchange(s) or auditing
review of quarterly standard has been violated
financial
statements?
Note F

Yes

Document the activities of
the audit committee.**


(3) received a written letter from the external auditors required by ISBS No. 1 and discussed independence
issues; and (4) based on the aforementioned review and discussions, recommended to the board that the
audited financial statements be included in the company™s annual SEC 10-K report. Additionally, after
December 15, 2000, the SEC requires proxy statement disclosures of whether the audit committee is gov-
erned by a written charter, and if it is, each registrant must attach a copy to the proxy statement once every
three years. Finally, each SEC registrant is required to disclose in its proxy statements whether audit com-
mittee members are independent and provide information about members that are not. (See Note A above).
F. Starting with the fiscal quarter ending on or after March 15, 2000, SEC rules mandate that the external
auditors review the quarterly financial statements prior to the filing of Form 10-Q or 10-QSB. In its 1987
report, the National Commission on Fraudulent Financial Reporting (NCFFR) recommended that “the audit
committee oversight responsibilites undertaken on behalf of the board of directors extend to the quarterly
reporting process. The audit committee should review the controls that management has established to pro-
tect the integrity of the quarterly reporting process. This review should be ongoing” (p. 48). In February
1999, the Blue Ribbon Committee reaffirmed the NCFFR™s position (p. 16).
*
The SEC approved amendments to the NYSE, NASD, and AMEX listing standards that require all audit
committee members to be independent; however, one nonindependent member can serve on the committee.
See Order Approving Proposed Rule Change SEC Release No. NYSE 34-42233, SEC Release No. NASD
34-42231, and SEC Release No. AMEX 34-42232.
Source: This flow chart, prepared by Louis Braiotta, Jr., is included and adopted from an article by
Robert W. Rouse and Mark R. Borrelli, “Audit Committees in an Era of Increased Scrutiny.” CPA
Journal 70, No. 6 (June 2000), pp. 30“31. Copyright © 2000 by the New York State Society of
Certified Public Accountants, 530 Fifth Avenue, New York, NY 10036-5101. All rights reserved.
**
It may be advisable to have in-house general counsel review the above documentation as well as a
review by outside legal counsel.



19
20 Corporate Accountability: The New Environment


In January 1999, the Public Oversight Board agreed to sponsor the Panel on
Audit Effectiveness. The major objective of the panel was to review and evaluate
ways to improve independent audits in the financial reporting process and to as-
sess the impact of recent trends on the public interest. In August 2000, the panel
issued its report and recommendations. With respect to audit committees, the
panel made these recommendations:
2.88 The Panel recommends that audit committees increase the time and attention

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