1 Securities Exchange Act Release Nos. 41987 (October 7, 1999) 64 FR 55648 (October 14, 1999); 41981 (October
6, 1999) 64 FR 55505 (October 13, 1999); 41982 (October 6, 1999) 64 FR 55510 (October 13, 1999); and 41980
(October 6, 1999), 64 FR 55514 (October 13, 1999). Auditing Standards Board Exposure Draft, Amendments to
SAS 61 and SAS 71 (October 1, 1999).
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October 20, 1999
TO: ACCOUNTING/TREASURERS COMMITTEE No. 36-99
CLOSED-END INVESTMENT COMPANY COMMITTEE No. 36-99
SEC RULES COMMITTEE No. 81-99
RE: PROPOSALS INTENDED TO IMPROVE EFFECTIVENESS OF AUDIT
COMMITTEES
______________________________________________________________________________
The Securities and Exchange Commission, the New York and American Stock Exchanges,
Nasdaq and the Auditing Standards Board recently released rule proposals intended to improve the
effectiveness of corporate audit committees. These proposals are in response to recommendations of
the NYSE/NASD Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit
Committees issued earlier this year.
The SEC proposals require the audit committee to include a report in proxy statements
indicating whether it has reviewed the financial statements and discussed them with management and
auditors. The exchange rule proposals require audit committees to adopt a formal written charter and to
assess the adequacy of the charter annually. The exchange rule proposals also require that audit
committees be composed of at least three independent directors, each of which is financially literate, and
at least one of which has accounting or related financial management expertise. The ASB proposals
would amend Statements on Auditing Standards No. 61, Communication with Audit Committees ("SAS 61"), to
require the auditor to discuss certain information relating to the auditor's judgements about the quality,
not just the acceptability, of the company's accounting principles with the audit committee.
The SEC and exchange proposals described above apply to closed-end investment companies.
The SEC proposals do not apply to open-end investment companies, however, the Commission
requests comment on whether they should be applied to open-end funds. The ASB proposal described
above would apply to audits of all investment companies. Copies of the proposals are attached and are
summarized below.1
Comments on the exchange proposals are due by November 3. Comments on the SEC
proposals are due by November 29. Comments on the ASB proposal are due by November 30. If
you have any ideas or suggestions that you would like the Institute to consider including in its
comment letters on the SEC and the exchange proposals, please contact Marguerite Bateman at
202/326-5813 or bateman@ici.org before October 27. If you have any comments on the ASB
proposal, please contact Greg Smith at 202/326-5851 or smith@ici.org before November 12.
I. SEC Proposals
Audit Committee Report
Proposed new Item 306 of Regulation S-K and Item 7(e)(3) of Schedule 14A would require that
the audit committee provide a report in the company's proxy statement relating to an annual meeting at
which directors are elected. The report would disclose whether the audit committee has reviewed and
discussed the audited financial statements with management and discussed certain matters with the
independent auditors. Specifically, audit committees would be required to state whether:
The audit committee has reviewed and discussed the audited financial statements with
management;
the audit committee has discussed with the independent auditors the matters required to be
discussed by SAS 61;
the audit committee has received the written disclosures and the letter from the independent
auditors required by Independence Standards Board Standard No. 1, Independence Discussions
with Audit Committees ("ISB No. 1"), and has discussed with the auditors the auditors'
independence; and,
anything came to the attention of the members of the audit committee, as a result of the review
and discussions described above, that caused them to believe that the audited financial
statements included in the company's annual report contain an untrue statement of material
fact, or omit to state a material fact necessary to make the statements not misleading.
The amendments would require that the new disclosures appear over the printed names of each
member of the audit committee. The proposing release notes that the disclosures will help inform
shareholders of the audit committee's oversight with respect to financial reporting, and underscore the
importance of the audit committee's participation in the financial reporting process. Further, the
amendments are intended to reinforce the audit committee's awareness and acceptance of its
responsibilities.
The proposing release requests comment on whether the proposed disclosure would provide
useful information to shareholders, and would reinforce the audit committee's awareness and acceptance
of its responsibilities. The release also requests comment on whether additional disclosure should be
required regarding auditor independence.
Audit Committee Charters
The proposals would require companies to disclose in their proxy statements whether their audit
committee is governed by a charter. In addition, if the company has a charter, a copy of the charter
would have to be included as an appendix to the proxy at least once every three years. The release notes
that these disclosures should help shareholders assess the role and responsibilities of the audit
committee, and help focus committee members on their responsibilities.
The release requests comment on whether disclosure of the audit committee charter would be
useful to investors. As an alternative, would a plain English summary of the charter suffice? Should the
audit committee be required to disclose whether it has complied with the charter?
Safe Harbors
The proposals include "safe harbors" intended to address liability concerns associated with the
new disclosures. The safe harbors appear in proposed paragraph (c) of Item 306 of Regulation S-K and
paragraph (e)(v) of Item 7 of Schedule 14A. The release notes that to the extent the proposed disclosure
requirements would result in more clearly defined procedures for, and disclosure of, the operation of the
audit committee, liability claims alleging breach of fiduciary duties under state law actually may be
reduced.
Pre-filing Review of Quarterly Financial Statements
The proposals would amend Rule 10-01(d) of Regulation S-X to require that a company's
interim financial statements be reviewed by an independent public accountant prior to the company
filing its Form 10-Q with the Commission. The independent accountant would be required to follow
professional standards for review engagements, as established by generally accepted auditing standards.
Investment companies would not be subject to this pre-filing review requirement. However, the release
requests comment on whether a closed-end fund's semi-annual financial statements should be reviewed
by independent auditors before being sent to shareholders.
Application to Investment Companies
The release notes that the proposed audit committee disclosures would apply to closed-end
funds. Further, the proposals are intended to work in conjunction with the listing standards of the
exchanges that impose requirements on listed companies for their audit committees. Because mutual
funds are not subject to the listing standards of an exchange that require companies to have audit
committees, the Commission decided to exclude open-end funds from the proposals. However, the
release requests comment on whether any or all of the proposals should apply to investment companies.
II. Exchange Proposals
The NYSE, AMEX and NASD have proposed to amend their listing standards. The proposals
would require that: a) audit committees include at least three members, comprised solely of independent
directors who are financially literate; b) at least one member of the audit committee have accounting or
related financial management expertise; and c) companies adopt a written audit committee charter that
outlines certain specified responsibilities of the audit committee. Further, the proposed amendments
implement a more demanding definition of "independence" for audit committee members. The NASD
and AMEX proposals are substantially similar. However, the NASD/AMEX proposals differ in certain
respects from the NYSE proposal. These proposals are outlined below.
Composition/Expertise of Audit Committee Members
The exchange rule proposals require an audit committee of at least three members. Also, the
audit committee must be comprised solely of independent directors. The NYSE proposal requires each
audit committee member to be financially literate, as such qualification is interpreted by the company's
board of directors in its business judgement. Further, at least one member of the audit committee must
have accounting or related financial management expertise, as the Board of Directors interprets such
qualification in its business judgement. The NASD/AMEX proposal indicates that audit committee
members must be able to read and understand fundamental financial statements, and that at least one
member have past employment experience in finance or accounting, professional certification in
accounting, or other comparable experience or background. The proposed rules include an exception
whereby one non-independent director may serve on the audit committee, provided that the board
determines that it is required by the best interests of the corporation and its shareholders, and the basis
for the determination is disclosed in the proxy statement.
Audit Committee Charter
The exchange rule proposals require a formal, written audit committee charter. The charter
must specify: a) the scope of the committee's responsibilities, including structure, process and
membership requirements; b) that the outside auditor is ultimately accountable to the Board and the
audit committee; and, c) the committee's responsibility for receiving a formal written statement from the
outside auditor delineating all relationships between the auditor and the company, consistent with ISB
No. 1, and for taking appropriate action to ensure the independence of the outside auditor.
Independence of Audit Committee Members
The exchange proposals augment the current definition of independent director by specifying
certain relationships that would disqualify a director from being considered independent. Specifically,
the following directors would not be considered independent:
a director who is employed by the corporation or any of its affiliates for the current year or any
of the past three years;
a director who is a member of the immediate family of an individual who is, or has been in any
of the past three years, employed by the corporation or any of its affiliates as an executive
officer; and,
a director who is employed as an executive of another entity where any of the company's
executives serve on that entity's compensation committee.
The proposed rules specify certain business relationships between the director and the company (e.g.,
consulting relationships) which would not disqualify the director from being considered independent.
III. ASB Proposals
SAS 61, Communication with Audit Committees
Proposed amendments to SAS 61 would require the auditor to discuss certain information
relating to the auditor's judgments about the quality, not just the acceptability, of the company's
accounting principles with the audit committee of all SEC registered companies. This discussion would
include such matters as the consistency of application of the entity's accounting policies and the clarity,
consistency, and completeness of the entity's accounting information contained in the financial
statements and related disclosures. Further, the proposed amendments would encourage a three-way
discussion among the auditor, management, and the audit committee and introduce documentation
requirements to verify that the discussion took place. The proposed amendments to SAS No. 61 will be
effective for audits of financial statements for periods ending on or after December 15, 2000.
Gregory M. Smith
Director - Operations/
Compliance & Fund Accounting
Attachments