My name is Olivia Kirtley. I am a Board member and Chair the Audit Committees for three publicly traded companies, including ResCare, Inc. and Alderwoods Group, both NASDAQ companies, and Lancer Corporation, which is listed on the American Stock Exchange. I am also recently retired as the Chief Financial Officer of Vermont American Corporation in Louisville, Kentucky and past Chair of the Board of the AICPA. My remarks today will focus primarily on matters of corporate governance. However, I want to begin by discussing the importance of advice received from external auditors based on my experience as a CFO and an audit committee member.
There are a number of areas outside the scope of the financial statement audit in which a company’s independent CPA is in the best position to offer advice, which presents no conflict to the auditor’s role. This advice benefits the company and its shareholders rather than compromising the integrity of the audit. In addition, a ban on the use of services of this nature can significantly inhibit small and mid-size growth companies that may not have this expertise in house. Banning auditors from performing non-audit services for their audit clients will also have a negative impact on the larger economy. Costs will rise when businesses are required to contract and train multiple providers of services most efficiently provided by one firm. Efficiency will suffer as current practices are altered to adhere to new mandates and companies are prohibited from contracting with providers of their choice. Business decisions will suffer from the loss of expertise now provided by the auditor’s deep knowledge of the businesses they audit.
With a significant amount of many executives’ personal wealth that are based on short-term financial targets, the potential exists for some to sacrifice a company’s long-term health and well-being for short-term gains. We believe two items in this area are worthy of further consideration: (1) requiring the disgorgement of executive bonuses paid on the basis of grossly inaccurate financial statements, a concept for which the President has expressed support, and (2) encouraging the compensation committee of the board to review the incentives driving executive compensation for balance between short and long term financial and non-financial goals.
Audit Committee Composition
We all know that the work of audit committees has become more difficult and demanding, and it certainly is under more public scrutiny. Moreover, the expanding complexity of issues that audit committees are called upon to address has caused the board to place greater reliance on the audit committee with respect to technical accounting, reporting and auditing oversight. In recent years, audit committees have been the subject of much study and attention; just two years ago, new rules were issued by the SEC and the stock exchanges addressing the independence and experience of audit committee members.
A primary focus has been the financial acumen of audit committee members. In this regard, the Blue Ribbon Committee on the Effectiveness of Corporate Audit Committees (Blue Ribbon Committee) recommended that corporate audit committee members be financially literate but only one member must have accounting or related financial sophistication or expertise. But what is "financial literacy"? Presently, the definition is nebulous, at best, with two different market regulators adopting different, yet vague, definitions that may not be sufficient to meet shareholders’ increasing expectations.
Although it is not currently required, we recommend that the listing authorities consider requiring the majority of audit committee members to have accounting or related financial sophistication or expertise, in order to minimize the reliance on one committee member. If a member lacks sufficient expertise, he or she may not understand the issues, know the questions to ask, or have a basis for considering the adequacy of the response provided. In light of the increasing complexity of the tasks, we also believe that consideration should be given to requiring at least one CPA with appropriate technical or industry expertise to serve on the audit committee and, if this is not possible, then audit committees should be encouraged to seek outside assistance or input on a regular basis from someone other than the auditor or management.
Audit committee work, like public accounting work, requires significant judgment. It is not an exact science. Accounting and financial sophistication or expertise will not guarantee that mistakes in judgment will never be made, but it certainly should mitigate the risks.
Communications with the Audit Committees
The Blue Ribbon Committee also cited a need for improved and more frequent communication between audit committees and the independent auditors that would cover such important areas as estimates and judgments, internal controls, significant risks, the clarity of the company’s disclosures and the degree of aggressiveness or conservatism of the company’s accounting principles. In addition, the Panel strongly supported more pro-active audit committees and a stronger relationship between the board (and their audit committees) and the independent auditors. In response to these recommendations, new auditing standards and revisions to audit committee charters have created a framework for such enhanced communications to occur on a regular basis.
Another reform that would further strengthen the effectiveness of the audit committee, however, would be to require audit committees to hold separate executive sessions, on a periodic basis, with financial management, independent auditors, and internal auditors. The use of executive sessions as a fact-finding tool is indispensable, providing an environment where (1) committee members are able to probe more deeply to assure they are fully informed regarding risks, issues and judgments, and (2) participants are given the opportunity to confidentially voice concerns they might not otherwise express.
Quarterly Financial Reviews by Audit Committees
Current standards place significant emphasis on the annual audit, but what about the rest of the year? Generally, a quarterly review is required to be performed by the independent auditor, and the market regulators recently implemented a requirement that the review results be discussed with the audit committee, or at least the chair of the committee, prior to the release of earnings. Much like the haziness of the "financial literacy" requirement, however, these limited interim review requirements are not universally understood by Board members, audit committee members or investors.
Unlike the detailed work of an annual audit, a quarterly review primarily involves auditor inquiries of officers and others involved in the company’s financial reporting function, a "high-level" review of significant transactions, and some analytical procedures. It is not an audit. One must ask if this is sufficient to meet the needs of investors in the fast-paced, ever-changing business environment in which companies operate, with numerous transactions and decisions occurring throughout each quarter. The requirements of quarterly reviews should be reviewed for sufficiency in meeting the need of investors for information on an ongoing basis.
Audit Committee Interaction with the Internal Audit Function
Increasing attention is being given by audit committees to the benefit and value that internal auditors can provide. Given the role internal audit departments play within a company, and their exposure to the many financial and non-financial areas in the company, we believe that internal auditors should have a direct reporting responsibility to the audit committee, and provide independent communications with the audit committee. If an internal audit function is in place, senior management should not be able to terminate the head of an internal audit department without audit committee approval.
Recent Audit Committee Rulemaking
It is critical to note that significant audit committee rules and regulations have taken effect over the last two years as result of the Blue Ribbon Committee’s recommendations. During that time period, the SEC and stock exchanges have implemented other measures including requiring formal audit committee charters and requiring audit committees to be composed of all members meeting the financial literacy requirements. These new requirements must be given time to work. In my experience, I have seen significant improvements in the effectiveness of audit committees since the new requirements have been implemented. Although we have outlined several suggestions for audit committee reform, we must resist the temptation to layer on too many additional rules for audit committees and the corporate governance process before allowing recent audit committee requirements to have an impact.
Thank you for the opportunity to appear before this Committee.
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