In the US a 'Blue Ribbon' Committee was established in September 1998 by The New York Stock Exchange and the National Association of Securities Dealers to make recommendations on strengthening the role of audit committees in overseeing the corporate financial reporting process.
The panel was formed in response to concerns expressed by the Chairman of the SEC about the adequacy of the oversight of the audit process by independent corporate directors.
In February 1999 the Committee published a ten-point plan to improve audit committee oversight.
Since then the SEC, US Stock Exchanges and the AICPA have published proposals to implement the plan (see AICPA and SEC websites). While some of the recommendations reflect UK thinking of the Cadbury and Hampel Committees, some go beyond the UK position and will tighten audit committee responsibilities and clarify their relationship with the external auditors.
In my view, both corporate governance and the effectiveness of the external audit will benefit as a result.
When the changes are fully implemented they should increase the effectiveness of the relationship between the audit committee and the external auditors in the US in the following respects:
there will be formal discussions regarding the quality of financial reporting. While some UK auditors discuss the clarity, consistency and completeness of the entity's accounting information contained in the financial statements this is not mandated and 'best practice' is not necessarily 'universal practice'; and
auditors will review quarterly reports.
In the UK most listed companies still do not have their interim financial information reviewed even though research suggests that interim reports often have a significant effect on share prices.
The following sets out a summary of the Blue Ribbon proposals along with the comparable position in the UK and Ireland.
1. Requirement for there to be independent audit committee comprised of solely independent directors.
This goes a little further than the Combined Code which requires an audit committee of at least three directors, a majority of whom should be independent.
2. Revised definition of an independent director - excludes those with a business relationship in last 5 years.
The definition of independent is broadly similar to that in the Combined Code.
3. Requirement that audit committees should comprise at least three members each of whom is financially literate.
The UK position is broadly similar - Combined Code Provision D.3.1 requires an audit committee of at least three non-executive directors.4. Audit committees to adopt (and publish) a written charter detailing responsibilities and duties.
Combined Code Provision D.3.1 requires the audit committee to have written terms of reference, which deal clearly with its authority and duties.
5. Annual disclosure of whether the audit committee satisfied its responsibilities to be mandated.
Although less specific the Listing Rules require statements on the application of the Hampel principles of corporate governance and compliance with the Combined Code.
6. Audit committee charter to specify that the outside auditor is ultimately accountable to the board of directors and the audit committee as representatives of shareholders and that these shareholder representatives have the ultimate authority and responsibility to select evaluate and where appropriate replace the outside auditor.
This proposal goes beyond Combined Code Provision D.3.2 which requires the audit committee to keep under review the scope and results of the audit and its cost effectiveness. To reflect this approach in the UK changes in company law might be necessary.
7. Requirement for a discussion with outside auditor regarding independence.
Although less specific the Combined Code Provision D.3.2 requires the audit committee to keep under review the independence and objectivity of the auditors.
8. Requirement for the outside auditor to discuss quality of financial reporting with the audit committee.
There is no similar requirement in the UK although such discussions are encouraged by APB's paper ' Communication between external auditors and audit committees'.9. Requirements for audit committees to make an annual statement that it believes that the financial statements are fairly presented in conformity with generally accepted accounting principles.
No equivalent to this proposal 10. Mandate auditor reviews of quarterly financial reporting.
Auditor reviews of interim statements are not mandated in UK.
As well as considering the specifics of the 'Blue Ribbon' proposals, it is also interesting to compare the difference in approach to achieving changes in corporate governance on the two sides of the Atlantic.
In the UK the emphasis has been on voluntary compliance with codes of best practice supplemented by disclosures in annual reports to 'inform' shareholders.
Some believe that this approach provides the optimal balance between shareholder protection and managerial freedom but acknowledge that the UK framework has taken the best part of a decade to finalise.
The US approach in contrast is rule driven and has been achieved in little over a year.
Determining which approach produces the 'best result' for the economy should keep researchers happy for years to come.
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