Report of the NACD Blue Ribbon Commission on the Audit Committee

Letter from the Co-Chairs

Effective oversight of financial reporting— even in times of growth and relative calm— is no simple matter for an audit committee. Add in a global financial crisis, economic recession and uncertainty, sweeping regulatory reforms, and unprecedented expectations by investors and regulators for transparency and accountability, and you have one of the most demanding, challenging—and vital—roles in Corporate America.

It’s not a stretch to say that the financial and economic crisis and ensuing volatility and uncertainty in the United States and global markets have put audit committees, and the financial reporting systems they oversee, through a gauntlet. To be sure, some were well prepared—likely buoyed by systems and processes put into place following the Sarbanes-Oxley Act of 2002. Others were less prepared—and the crises exposed critical gaps in their financial reporting systems, oversight processes, or both.

Investors’ and regulators’ expectations of audit committees have always been high; but the demands and challenges facing audit committees have perhaps never been greater: complex accounting rules and regulations, innovative financial instruments, the global nature of businesses, product innovation, pressures on companies to meet expectations and stay competitive—there is little that doesn’t impact a company’s financials. And, as one seasoned audit committee chair often reminds us: If it’s complicated and requires a lot of time and detailed focus, it usually lands on the audit committee’s plate.

This paper is not intended to be a comprehensive manual or treatise on the duties and responsibilities of the audit committee (which is readily available from numerous sources today). Rather, drawing on the experiences and insights of our Blue Ribbon Commission (Commission) members, as well as the thoughtful work and writings of others in the business, audit, and governance arenas, including the NACD National Audit Committee Chair Forum, it is intended to offer practical perspectives, suggestions, and leading practices on what makes an audit committee effective.

No single approach will work best for every audit committee; but we believe the perspectives and leading practices outlined in this report (including ten guiding principles) will help audit committees and boards—as well as auditors, managers, and others—drive the financial reporting process to provide investors, regulators, and the market with a clear and accurate picture of the company’s performance, risks, and prospects.

Dennis R. Beresford
Michele J. Hooper

Overview and Recommendations

A More Focused and Intense Oversight

Today, in 2010, there is clearly a more focused and intense oversight taking hold in many boardrooms. Oversight, by and large, is very different than it was just a few years ago. Whether it’s the nature of their interactions with management, discussions in executive sessions, or review of earnings releases and quarterly and annual financial reports, boards and audit committees are applying greater focus and intensity to their oversight activities.

We see leading audit committee members taking a more active role in developing their committee’s agenda and determining its information requirements, deepening their relationships with management and auditors, and seeking firsthand knowledge of their business and its risks.

This more engaged approach to oversight is essential to addressing the expectations of investors, regulators, rating agencies, the media, and audit committees themselves that the audit committee is carrying out its responsibilities effectively and bringing value and insight to the oversight process. Is the audit committee getting the right information at the right time? Is the committee’s agenda focused on what matters most? Does the committee adhere to its charter? Are its members qualified and willing to challenge management and ask the hard questions? Do the committee’s activities produce greater transparency and long-term value?

To help articulate this new era of oversight and build on tried and true audit committee practices, the members of this Commission shared their years of accumulated experience and knowledge as audit committee chairs and board members, business leaders, auditors, governance experts, and academics engaged in the study and improvement of corporate governance.

• This report also draws on the work of the 1999 Report of the NACD Blue Ribbon Commission on the Audit Committee and the subsequent 2004 update of the report, which articulated a number of bedrock principles and practices that are as relevant and valuable today as they were then.
• In Chapter1, we review the audit committee’s responsibilities and membership requirements—a quick primer.
• Chapter 2 covers audit committee leadership and composition—ultimately, it comes down to people.
• Chapters 3 and 4 address key areas of oversight: financial reporting, risk management, and internal and external auditors—all vital for quality financial reporting and disclosures.
• Chapter 5 focuses on setting the agenda and making the most of meetings—Is the audit committee focused on what’s most important?
• Lastly, Chapter 6 discusses the following ten principles to help guide audit committees— and the management and audit professionals supporting them—in their oversight of the financial reporting process:
  1. Be proactive in focusing the agenda on what’s important—financial reporting risk— and make the most of audit committee meetings.
  2. Insist on transparency, both external transparency and internal transparency—among the audit committee, management, and the internal and external auditors.
  3. Focus closely on external financial communications—beyond the 10-K and 10-Q.
  4. Question the continuing validity of key assumptions that underlie critical accounting judgments and estimates, and be up-tospeed on key financial reporting issues and developments affecting the company.
  5. Assess the audit committee’s role in the oversight of risk management—with an eye to clarifying the scope.
  6. Set and manage clear expectations for the external and internal auditors.
  7. Make sure the chief financial officer (CFO) and the entire finance organization, as well as internal audit, have what they need to succeed, and be sensitive to the strains on these organizations.
  8. Assess the tone at the top and throughout the organization, including the effectiveness of compliance and anti-fraud programs.
  9. Help link change and risk management— and monitor critical alignments (controls, risks, etc.)
  10. Take a hard look at the audit committee’s effectiveness—including its composition and leadership—and find ways to continuously improve.

We conclude our report with important questions that get to the crux of an audit committee’s effectiveness.