Audit Committee Composition, Meeting Practices, and Education
Audit Committee Brief
The composition, meeting practices, and education of audit committees are generally recognized as essential components of their effectiveness. Many committees periodically assess the optimal mix of members, taking into account regulations and requirements; the evolution of the business; and the competencies, diversity, time commitments, tenure, and rotation of their members. Audit committees may consider the practices discussed further in this brief related to the number and manner of meetings, the involvement of specialists and management, and meeting materials when planning their activities for the year.
Overview of regulations and requirements
Most audit committee charters include composition requirements. The Sarbanes-Oxley Act and the NYSE and NASDAQ listing rules require that all audit committees consist of at least three members and that all members be independent.1 Independence is an important attribute for audit committees to perform an objective assessment of management and the financial statements and related audit reports, and should be reviewed continuously.
Although all committee members must be financially literate, the NYSE and NASDAQ rules require at least one member to have accounting or financial management expertise. The SEC does not require one member to be an audit committee financial expert, but requires disclosure of whether there is one, and if so, the individual’s name. If there is no expert, the company must disclose this and explain why.
Composition: skills, experience, diversity, and leadership
As a leading practice, audit committees may be composed of members with varied backgrounds and occupations as well as experience in an area important to the business, such as financial reporting, auditing, industry insight, risk management, or technology. To fulfill the
committee’s primary responsibilities, all members should be financially literate and capable of understanding the financial reporting issues and complexities arising from the company’s business activities. It is not unusual for a majority of the members to have finance, accounting, or legal backgrounds. Audit committees should also consider including industry or other specialists to shed light on complexities unique to the company or its industry.
It is also important that committee members be inquisitive and prepared to challenge the positions of management, the independent auditor, and the internal auditor. They should have a clear understanding of the financial reporting and their responsibility to exercise oversight of the independent auditor relationship and be ready to ask probing questions of both management and the independent auditor.
Audit committee financial expert
The SEC defines an audit committee financial expert as an individual with these attributes:
• An understanding of financial statements and generally accepted accounting principles (GAAP)
• The ability to assess the application of GAAP in connection with the accounting for estimates, accruals, and reserves
• Experience preparing, auditing, analyzing, or evaluating financial statements that present a breadth and level of complexity of accounting issues similar to those expected to be raised in the registrant’s financial statements, or experience in actively supervising those conducting such activities
• An understanding of internal controls and procedures for financial reporting
• An understanding of the audit committee’s functions.
The rule states that the attributes may be acquired by:
• Education and experience as a principal financial officer, principal accounting officer, controller, public accountant, or auditor, or experience in positions that involve similar functions
• Experience actively supervising a principal financial officer, principal accounting officer, controller, public accountant, auditor, or someone performing similar functions
• Experience overseeing or assessing the performance of companies or public accountants with respect to the preparation, auditing, or evaluation of financial statements
• Other relevant experience.
Ethnic and gender diversity are among the additional attributes that may be considered to provide the committee with a range of perspectives, and these attributes are increasingly receiving attention among regulators and shareholders, at least as they pertain to boards as a whole. France and Norway have instituted quotas requiring boards in those countries to consist of at least 20 percent and 40 percent female members, respectively. However, diversity is broader than ethnicity and gender and also encompasses the range of experience of members.
Although audit committees must have at least three members, the board determines the appropriate number. The optimal number of members will vary based on factors such as the company’s size and industry, as well as the nature of its business. According to the 2011 Board Practices Report jointly sponsored by The Society of Corporate Secretaries & Governance Professionals and Deloitte, 61 percent of audit committees have three or four members, while 39 percent have five to nine members. An odd number of members may help prevent a tie vote on issues.
The audit committee chairperson provides an essential voice in setting the tone for the committee and ensuring its effectiveness. He or she should exhibit strong leadership and governance skills and work well with the other members, management, the internal auditors, and the independent auditor. The chairperson is often elected by the full board, but may also be selected through a majority vote by the audit
committee. According to the 2011 Spencer Stuart Board Index2, 39 percent of audit committee chairs are active or retired company chief executive officers or other top leaders. An additional 21 percent are active or retired chief financial officers, treasurers, or financial managers.
The survey notes that the share of active top executives heading audit committees has declined to 11 percent since peaking in 2003 at 28 percent. Taking their place are active chief financial officers, treasurers, and financial executives, who chair 21 percent of audit committees, up from 10 percent in 2006.
0 5 10 15 20 25 30 35 40
Audit committee chairperson
Retired or active chair/president/CEO
Retired or active financial executive/CFO/treasurer
Public accounting executive
Investor/investment manager
Other corporate executive
Other
39%
21%
11%
8%
7%
14%
Time commitment and rotation
Consideration should be given to the amount of time audit committee members need to devote to the role. In the Spencer Stuart survey, 66 percent of respondents said that their audit committees met eight or more times per year. Each prospective member should evaluate the demands on his or her time before accepting the assignment.
The NYSE rules on required disclosures state, “If an audit committee member simultaneously serves on the audit committee of more than three public companies, the board must determine that such simultaneous service would not impair the ability of such member to effectively serve on the listed company’s audit committee and disclose such determination either on or through the listed company’s website or in its annual proxy statement, or if the company does not file an annual proxy statement, in its annual report on Form 10-K filed with the SEC.” As a result, many audit committees have instituted restrictions on the number of audit
committees members can serve on. According to the 2011 Board Practices Report, 51 percent of public companies restrict participation on other organizations’ audit committees. Among those imposing limits, 43 percent limit their members to two additional audit committees, and 42 percent permit three additional audit committees.
Oversight responsibilities of the audit committee evolve in response to regulatory, economic, and reporting developments, and, thus, it is important to periodically evaluate the committee’s composition to respond to emerging needs. Careful succession planning can help the committee stay up to date on complex accounting and financial reporting issues. Committees should strive to maintain a balance of new and experienced members. The 2011 Board Practices Report notes that 20 percent of public companies have established a policy to rotate committee membership. Too much turnover can impair effectiveness, but fresh perspectives from members with a diverse range of skills can be a significant asset.
0 10 20 30 40 50 60
Public companies restricting service on other audit committees
51%
49%
Impose restrictions
No explicit restrictions
Up to two additional committees
Up to three additional committees
Other restrictions
15%
42%
43%
Among those companies with restrictions:
Meeting practices
Two-thirds of public companies hold from one to four in-person
meetings per year, while one-third hold five to nine in-person meetings.
According to the 2011 Board Practices Report, 85 percent of public companies have not changed their meeting frequency since last year.
Sixty-seven percent of respondents said that meetings require between two and three hours. In addition to the in-person meetings, about 80 percent meet one to four times annually via conference call, while the other 20 percent hold five to nine such calls per year. Only 6 percent of respondents considered meetings held by phone to be different than in-person meetings for proxy purposes.
The survey also found that 60 percent of audit committees hold a separate meeting to review the earnings release versus the quarterly reviews, while 40 percent combine the meetings.
Determining who should attend committee meetings is another important consideration. According to the survey, 84 percent of audit committees meet with management at all or almost all meetings. The majority of respondents reported that the head of internal audit and the chief financial officer regularly attended. Other attendees may include general counsel, the chief executive officer, and the chief compliance officer.
The 2011 Board Practices Report revealed that audit committees may choose to invite specialists to the meeting. While 28 percent of audit committees never engage specialists for matters on their agenda, 50 percent do so about once per year. Experts in areas such as tax, valuation, and mergers and acquisitions can provide essential information above and beyond the normal discussion items.
In addition to the frequency of meetings, effectiveness hinges on the preparation and interaction of each member. The audit committee chairperson is typically responsible for setting the tone and agenda, but each member needs to diligently prepare and actively participate to make the meeting successful. Meeting materials should include all presentations and other materials that will be covered at the meeting, and should be provided at an appropriate level of detail for an audit committee member. These materials should be sent at least several days in advance to allow sufficient time for members to review.
Meet one to four times annually via conference call Hold five to nine conference calls every year xxxx% xxxx%
Hold one to four in-person meetings
Hold five to nine in-person meetings
Number of in-person meetings per year
Number of conference calls
0 10 20 30 40 50
Involvement of specialists
Frequently (more than five meetings)
Sometimes (two to four meetings)
Rarely (once a year)
Not at all
Don’t know
2%
18%
50%
28%
2%
20%
80%
33%
67%
Executive sessions are also highly important for audit committees. The NYSE’s corporate governance rules state, “To promote open discussion among the non-management directors, companies must schedule regular executive sessions in which those directors meet without management participation. Regular scheduling of such meetings is important not only to foster better communication among
non-management directors, but also to prevent any negative inference from attaching to the calling of executive sessions.”
During these meetings, committee members can pose questions or concerns regarding management, the independent auditors, resources, or other issues associated with the financial and internal control
reporting environment.
Education
The NYSE listing standards require board education to be addressed in the company’s corporate governance guidelines. Boards and audit committees should use a needs-based approach to determine the specific topics in a continuing education program.
Given the enhanced focus on the responsibilities of boards and audit committees, continuing education for directors is an area of increasing importance. According to the 2011 Board Practices Report, 71 percent of boards receive in-house training from management, 60 percent of directors are reimbursed for attending public forums or peer group sessions, and 21 percent receive in-house education from a third party.
Public forums on corporate governance are offered by many
professional services firms, universities, and not-for-profit organizations.
Benefits include the opportunity to meet with peers and share experiences, and these programs can be invaluable for gaining
knowledge from experts on trends in corporate governance. However, boards should be careful not to rely completely on public programs designed for a broad audience, because they may not address the dynamics of a specific company and its industry. An increasingly
popular option is a customized program of continuing education. When designing such a program, the board should identify risks and complex issues facing the organization.
For the audit committee, the focus is more specific, centered on its role to exercise primary oversight of the independent auditor relationship and management’s financial reporting process. Training activities often cover financial reporting and accounting issues important to the company, such as critical accounting policies, regulatory mandates, and internal controls. Self-assessment tools, such as Deloitte’s assessment tools, help to identify specific areas for educational focus.
0 10 20 30 40 50 60 70 80
Director training
71%
60%
21%
% of boards receiving in-house training from management
% of directors reimbursed for attending public forums or peer group sessions
% receiving in-house education from a third party
In addition to continuing education, the company should consider orientation programs for new directors and audit committee members.
Materials may include information on the company’s history and operations, corporate governance, regulatory matters, recent SEC filings, industry trends, accounting policies and practices, company policies and the code of ethics, and major business and financial risks.
According to the 2011 Board Practices Report, 74 percent of
respondents noted they had formal onboarding education training, and 99 percent of those respondents said the onboarding process was a live, in-house session led by an individual on the board or a staff member of the organization.
Conclusion
Audit committees are responsible for determining that their
composition and activities fully comply with regulatory requirements and legislative developments. Beyond these responsibilities, there are several steps that can be considered to continuously strengthen the committee’s effectiveness. Through a self-assessment process, the committee can evaluate whether the individual and collective
knowledge and time commitment of committee members is sufficient to respond to specific industry, business, technical, and reporting issues.
Additional Resources
• Audit Committee Resource Guide (Deloitte)
• Audit Committee Leading Practices and Trends (Deloitte)
• 2011 Spencer Stuart Board Index (Spencer Stuart)
• 2011 Board Practices Report (Deloitte and Society for Corporate Secretaries)
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