New Corporate Governance Listing Standards

Committee Listing Standards

Section Four:

New Audit Committee Composition Listing Standards

Section Five:

New Audit Committee Responsibility Listing Standards

Section Six:

Closing Considerations

Appendices:

Appendix A: Audit Committee Checklist for

A-1

New Sarbanes-Oxley and NYSE and NASDAQ Listing Requirements Appendix B: Sample Audit Committee Charter

A-7

This booklet contains general information only and does not constitute, and should not be regarded as, legal or similar professional advice or service. This booklet is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect you or your business. Any such decision or action should be taken only on the advice of a qualified professional advisor.

This booklet was prepared based on information available as of March 1, 2004 and is subject to change as interpretive guidance is issued by the Securities and Exchange Commission, the New York Stock Exchange, or NASDAQ. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future.

Neither Deloitte & Touche LLP, Deloitte Touche Tohmatsu, nor any of their affiliates or related entities shall have any liability or responsibility to any person or entity with respect to the use of or reliance on this booklet. All companies should consult with legal counsel regarding the adoption and applicability of the various requirements presented.

Section One

Introduction

During the past two years, U.S. corporations and the invest- ing public have witnessed unprecedented developments in corporate governance. The congressional proceedings that gave rise to the Sarbanes-Oxley Act of 2002 and the ensuing implementation of that legislation brought many reforms to the financial reporting system.

Although these reforms were significant, they were public comments and various amendments submit- only one component of a broader effort to restore

ted by the SROs, the SEC approved the new corpo- public confidence in the capital markets.

rate governance listing standards on November 4, 2003.

In a February 2002 speech, Harvey Pitt, then chair- man of the Securities and Exchange Commission

The new standards of the NYSE and NASDAQ (SEC), called for national self-regulatory organiza-

include a range of requirements affecting boards tions (SROs), such as the New York Stock Exchange

of directors, certain board committees, and man- (NYSE) and NASDAQ, to critically review their list-

agement. For instance, both sets of standards: ing standards and propose modifications to

n Require that a majority of the board be com- enhance the corporate governance of listed com-

posed of independent directors panies. In August 2002, the NYSE submitted its

“Corporate Governance Rule Proposals” to the SEC. n Strengthen the criteria for an independent direc- NASDAQ presented its “Corporate Governance

tor determination

Proposals” for consideration by the SEC in a series of submissions in the fall of 2002. After reviewing Proposals” for consideration by the SEC in a series of submissions in the fall of 2002. After reviewing

Because the new audit committee listing standards

executive compensation in the hands of the inde-

were well publicized in their proposed form and

pendent directors

some time has passed since the SEC’s final

n Require separate meetings for non-management

approval, most companies have already begun

or independent board members

implementation. This handbook outlines imple- mentation steps for consideration based on com-

n Require a code of business conduct/ethics for all

mon practices we have observed and contains ref-

directors, officers, and employees.

erences to a variety of resources that may help

Among other provisions, the new NYSE standards

companies comply with the standards.

require companies to establish and disclose corpo-

This handbook is provided for informational pur-

rate governance guidelines that address specified

poses only. It does not constitute, and should not

criteria, and the new NASDAQ standards require

be regarded as, legal advice. Companies should

companies to make a public announcement if they

consult with legal counsel regarding the applicabil-

receive an audit opinion with a going-concern

ity and implementation of the new listing stan-

emphasis.

dards. The actions we have set forth for considera-

In addition to the various general governance prac-

tion reflect what we believe are accepted practices

tices covered, the new listing standards modify a

that will continue to evolve, and do not represent

number of audit committee requirements, includ-

conclusions on what steps should be taken by com-

ing composition criteria and responsibilities. This

panies, their boards, or others. References to other

handbook was developed by Deloitte & Touche LLP

resources should not be construed as endorsements

(Deloitte & Touche) to assist audit committee mem-

of those resources.

bers in understanding the new requirements that

Unless otherwise noted, this handbook focuses on

will affect them and their companies.

the requirements of general SEC filers. Requirements may differ for investment compa- nies, voluntary filers, and foreign filers.

The handbook is based on information available as of March 1, 2004, and is subject to change as inter- pretive guidance is issued by the NYSE, NASDAQ, or SEC.

Structure of the Handbook

This handbook is formatted to provide easy access to infor- mation on a particular audit committee requirement. Section Three discusses deadlines for compliance.

Section Four provides an overview of the SROs’ audit committee composition criteria, and Section Five focuses on the responsibilities assigned to the audit committee by the new listing standards of the SROs. Section Six includes other general consid- erations.

Many of the resources and tools discussed through- out the handbook are available on Audit Committee Online, a Deloitte & Touche Web site tailored to the needs of audit committee members. If you are not a registered user of Audit Committee Online and would like access to the site, go to www.auditcommittee.com. When prompted for your user name, type your full e-mail address. Your ini- tial password, which is case-sensitive, will be “acon- line.” You will then be prompted to complete a brief form and change your password. If you have difficulty accessing the site, please contact your Deloitte & Touche partner or send an e-mail to corpgovernance@deloitte.com.

Footnotes showing the Web site menu path will assist you in locating materials on Audit Committee Online. The menu paths provided are as of March

1, 2004; if you have trouble locating an item, please send an e-mail to corpgovernance @deloitte.com .

Two of Deloitte’s most frequently used audit commit- tee tools are included as appendices. Appendix A is a checklist highlighting the incremental audit com- mittee requirements imposed by the new NYSE and NASDAQ listing standards and by the Sarbanes- Oxley Act. For information concerning ongoing audit committee compliance requirements that pre- date adoption of the new listing standards please refer to Audit Committee Online. Appendix B is a sample audit committee charter which incorporates the new audit committee requirements of the Sarbanes-Oxley Act and the new corporate gover- nance listing standards. These resources can be used to assist companies in determining remaining actions that may be necessary or appropriate in satisfying the new requirements.

Section Two

Section Three

Timeframe and Applicability of Compliance with New Audit Committee Listing Standards

In general, listed companies must comply with the new audit committee requirements and the other corporate governance requirements by the first annual shareholders’ meeting occurring after January 15, 2004, but no later than October 31, 2004.

Many of the new responsibilities assigned to the The new standards also provide transition periods audit committee under the new NYSE listing stan-

for companies listing in conjunction with an initial dards require that the audit committee charter be

public offering, companies in bankruptcy, and com- modified to reflect the responsibilities by the date of

panies listing upon transfer from another market. the 2004 annual shareholders’ meeting, but not later

All companies should consult with legal counsel to than October 31, 2004, as opposed to requiring exe-

determine compliance timeframes and the applica- cution of the responsibilities by such date. The NAS-

bility of the new listing standards. DAQ standard requiring public announcement of a

“going concern” qualification became effective November 4, 2003, and the NASDAQ rule requiring audit committee review and approval of related- party transactions became effective January 15, 2004.

Section Four

New Audit Committee Composition Listing Standards

Before the Sarbanes-Oxley Act was enacted, both SROs had requirements for audit committee composition based on rec- ommendations contained in the 1999 report of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees.

The NYSE’s pre-existing standards require audit to the audit committee or within a reasonable committees to be composed of at least three mem-

period after appointment. The pre-existing stan- bers, all of whom are independent. Each member

dards also require at least one member of each must be “financially literate,” as interpreted by the

NASDAQ audit committee to be “financially sophis- business judgment of the company’s board, or must

ticated.” NASDAQ indicates that financial sophisti- become financially literate within a reasonable

cation may be obtained through past employment period after appointment to the committee. At

experience in finance or accounting, requisite pro- least one member must have “accounting or relat-

fessional certification in accounting, or any other

ed financial management expertise,” again as comparable experience or background, including interpreted by the board.

current or past employment as a CEO, CFO, or NASDAQ’s pre-existing standards also require audit

other senior officer with financial oversight respon- committees to be composed of at least three mem-

sibility.

bers, all of whom are independent. Rather than adopting the NYSE’s “financially literate” standard, NASDAQ employed its own standard, which requires that each member be able to read and understand financial statements upon appointment

The SROs are generally retaining their pre-existing requirements in the new standards, with a number of clarifications and modifications. Both SROs’ new standards also incorporate the criteria for audit committee member independence set forth in the final rules to implement Section 301 of the Sarbanes-Oxley Act, as embodied in Exchange Act Rule 10A-3(b)(1).

In addition, all listed companies are required to affirm that each audit committee member is inde- pendent under its SRO’s new, enhanced definition applicable to all directors generally. In general, this requires a finding that a director does not have any direct or indirect material relationship with the company or any relationship covered by any series of “bright line” tests contained in the SRO’s defini- tion of independence. The “bright line” tests bar a finding of independence when a director or a director’s family member has (or had, within a “look-back” period) specified relationships with the listed company. These include employment by the company, certain relationships with its auditor, receipt of non-director compensation in excess of the stated threshold, and other specified business dealings and relationships.

NYSE. The new standards clarify that the NYSE does not require the audit committee to include a per- son who satisfies the definition of “audit commit- tee financial expert” as defined by the SEC’s final rules to implement Section 407 of the Sarbanes- Oxley Act (Item 401(h) of Regulation S-K). However, a person designated by the board to be an audit committee financial expert is presumed to possess the accounting or related financial man- agement expertise required by the NYSE’s pre- existing standards. Companies that do not have an audit committee financial expert serving on their audit committee must disclose why.

As provided for in Exchange Act Rule 10A-3(a)(3), the NYSE permits listed companies time to cure a deficiency in their audit committee composition. If an audit committee member is no longer inde- pendent for reasons outside the member’s reason- able control, he or she may remain on the commit- tee until the earlier of the next annual sharehold- ers’ meeting or one year from the occurrence of the event that caused the member to cease to be independent. A company using this cure period is required to notify the NYSE.

The new NYSE listing standards also indicate that if an audit committee member simultaneously serves on the audit committees of more than three public companies and the listed company does not limit the number of audit committees on which its mem- bers serve, the board is required to determine whether such simultaneous service impairs the member’s ability to serve on its audit committee effectively. This determination must be disclosed.

NASDAQ. The new NASDAQ standards eliminate the grace period under its pre-existing standards, which allowed audit committee members to learn to read and understand financial statements “with- in a reasonable period of time” after appointment. Under the new standards, audit committee mem- bers must be able read and understand financial statements at the time they are appointed.

Like the NYSE, NASDAQ does not require there to

be an “audit committee financial expert” resident on the audit committee. Again, the standards clari- fy that a director who is deemed to be an audit committee financial expert is presumed to have the requisite financial sophistication required of at least one audit committee member by NASDAQ’s pre-existing listing standards. Companies that do not have an audit committee financial expert serv- ing on their audit committee must disclose why.

Unlike the NYSE, which requires all audit commit-

Actions to Consider. All direct and indirect rela-

tee members to satisfy all applicable independence

tionships that a company may have with any audit

standards, the new NASDAQ listing standards allow

committee member, or with any member of the

one non-independent director to serve on the

committee member’s family, should be reviewed to

audit committee, in “exceptional and limited” cir-

ensure that all committee members meet the

cumstances, provided that:

appropriate criteria for service, under both the

n The director complies with the independence

Sarbanes-Oxley Act independence requirements

requirements of Section 10A(m)(3) of the

and the applicable SRO’s director independence

Exchange Act

standards. Accordingly, a number of companies have circulated new questionnaires to all their

n The director’s service in such capacity is deemed

audit committee members to assess their independ-

necessary by the board to serve the best interests

ence under the new criteria. Because changes in

of the company and its shareholders, and

facts, circumstances, and business relationships may

n The director is not a current officer or employee

alter the independent status of an audit committee

of the company or a family member of any such

member, consideration should be given to monitor-

person.

ing ongoing independence.

Service in this capacity is limited to two years, and

Although the SROs have clarified that an audit

the member may not serve as audit committee

committee financial expert is not required by the

chair. If a company chooses to take advantage of

new listing standards, the vast majority of compa-

this accommodation, it must disclose the nature of

nies have at least one such member. A November

the relationship and the board’s reasons for its

2003 survey of 90 of Deloitte & Touche’s largest

determination.

public audit clients indicated that, of the compa- nies whose boards had completed the determina-

NASDAQ recognizes two situations in which a list-

tion process, all had determined that at least one

ed company has time to cure a deficiency in its

member met the definition of an audit committee

audit committee’s composition. First, if an audit

financial expert. Emerging practice and bench-

committee member is no longer independent due

marking information on this topic is available in

to reasons outside his or her reasonable control,

the Audit Committee Financial Expert Designation

the member can remain on the committee until

and Disclosure Practices Survey, which is available

the earlier of the next annual shareholders’ meet-

through your Deloitte & Touche partner or on

ing or one year from the occurrence of the event

Audit Committee Online. 1

that caused the member to cease to be independ- ent. Second, if the company does not comply with the requirements due to a vacancy on the commit- tee and the first cure period is not being used, the company has the same period in which to cure the deficiency. A company opting for either of these cure periods is required to contact NASDAQ imme- diately after becoming aware of the event or cir- cumstance giving rise to the compliance failure.

1 Audit Committee Online menu path: 1) select “Audit Committee Roles and Responsibilities” from the home page, 2) select “Financial Literacy,” 3) select “Deloitte Perspectives”

Section Five

New Audit Committee Responsibility Listing Standards

This section summarizes the audit committee responsibilities set forth in the new NYSE and NASDAQ corporate governance listing standards.

The following tables for each responsibility includ- Because many of the NYSE requirements are

ed in the new listing standards contain: emerging or common practices, NASDAQ-listed n The requirement, outlined at the top of the table

companies may want to consider implementation of certain NYSE requirements.

n Which SRO includes the requirement in its new standards

A discussion of the requirement n Actions for consideration n Resources that can help companies address the

new requirement.

AUDIT COMMITTEE REQUIREMENT:

RESOURCES AND TOOLS: Execute the responsibilities assigned to the audit committee by the final rules to implement Section

APPLICABLE SRO:

NYSE and NASDAQ

The Audit Committee Resource Guide 2

301 of the Sarbanes-Oxley Act

suggests several tools and resources to

DISCUSSION OF THE REQUIREMENT:

assist in implementing the Section 301 As directed by the SEC in its final rules to implement Section 301 of the Sarbanes-Oxley Act, the SROs incorporated both the

requirements. Other items to consider audit committee member independence criteria discussed in Section Four and the responsibilities set forth in those rules.

include:

Exchange Act Rule 10A-3(b)(2), (3), (4), and (5) requires the audit committee to: ■ “Engaging Independent Counsel,” ■ Appoint, compensate, retain, and oversee the work of the independent auditor

from the AICPA Audit Committee Toolkit, assists audit committees in

■ Have authority to engage outside advisors understanding the process of engag- ■ Have authority to compensate outside advisors and the independent auditor

ing counsel and other advisors. This publication is available free of charge

■ Establish and maintain procedures for: at http://www.aicpa.org/Audcommctr/ • The receipt, retention, and treatment of complaints regarding accounting, internal accounting controls, or auditing matters

toolkits/homepage.htm. • The confidential, anonymous submission by company employees of concerns regarding questionable accounting or auditing

■ Deloitte & Touche’s Questions that matters.

Boards Should be Asking Regarding Ethics and Compliance Programs is

ACTIONS TO CONSIDER:

available through your Deloitte & Because the final rules to implement Section 301 of the Sarbanes-Oxley Act essentially mirror the act itself and it has been more

Touche partner or on Audit than a year since the legislation became law, most companies are well down the path of implementing these requirements;

Committee Online. 3 however, steps for consideration in implementation can be found in Deloitte & Touche’s Audit Committee Resource Guide,

2 which can be obtained through your Deloitte & Touche partner or on Audit Committee Online. The “Risks and Controls” and “External Audit” pages of Audit

Committee Online contain a general discussion of these topics.

2 Audit Committee Online menu path: 1) select “Audit Committee Roles and Responsibilities” from the home page, 2) select “Audit Committee Processes and Procedures” 3 Audit Committee Online menu path: 1) select “Risk and Controls” from the home page, 2) select “Risk Oversight,” 3) select “Deloitte Perspectives”

AUDIT COMMITTEE REQUIREMENT:

RESOURCES AND TOOLS: Maintain a formal written charter addressing prescribed items

APPLICABLE SRO:

NYSE

■ The AICPA Audit Committee Toolkit,

DISCUSSION OF THE REQUIREMENT:

which is available free of charge at http://www.aicpa.org/Audcommctr/

Pre-existing NYSE standards, which arose in response to the report of the Blue Ribbon Committee, require audit committees to toolkits/homepage.htm , includes a have a formal written charter that addresses certain items and is reviewed at least annually. The new NYSE standards require a

matrix to assist in preparing the number of new provisions to be included in the charter. Specifically, it must address the following:

audit committee charter. It also ■ The committee’s purpose, which, at a minimum, must be to assist the board in its oversight of:

includes an audit committee self- evaluation tool.

• The integrity of the company’s financial statements ■ Deloitte & Touche created a sample • The company’s compliance with legal and regulatory requirements

charter (presented in Appendix B) • The independent auditor’s qualifications and independence

which incorporates the requirements • The performance of the company’s internal audit function and the independent auditor

of the new corporate governance listing standards and the Sarbanes-

■ Its responsibility to prepare an audit committee report, as required by the SEC, for inclusion in the proxy statement

Oxley Act.

■ An annual evaluation of the audit committee’s performance ■ Various audit committee perform- ■ The duties and responsibilities of the committee, which, at a minimum, include those established by the final rules to implement

ance assessment tools, including Section 301 of the Sarbanes-Oxley Act, as well as the additional responsibilities discussed in the remainder of this section.

tools focused on financial literacy evaluation, are available on Audit

The charter must be posted to the company’s public Web site. Committee Online. 4

ACTIONS TO CONSIDER:

Many companies have been viewing their audit committee charters, modified for the requirements of the Sarbanes-Oxley Act, as working drafts pending SEC approval of the SRO corporate governance listing standards; these working drafts should now be finalized if companies have not already done so. The audit committee, legal counsel, and management should review the audit committee charter and make any necessary modifications by the date of the company’s 2004 annual shareholder’s meeting, but not later than October 31, 2004. Most companies will want to have the audit committee charter, revised to reflect the require- ments of the new listing standards, in place in time to describe it in the proxy statement.

The new standards do not specifically mandate the form or nature of the annual audit committee performance evaluation. Assessments could be structured in a number of ways, including an evaluation of the audit committee by the entire board, by a third party, and/or by the committee itself. In addition, some companies are conducting individual assessments of each audit com- mittee member. It is up to the audit committee and the board, in consultation with legal counsel, to determine how the assess- ment should be structured, how formal and detailed it should be, and how it should be documented.

4 Audit Committee Online menu path: 1) select “Audit Committee Roles and Responsibilities” from the home page, 2) select “Financial Literacy,” 3) select “Deloitte Perspectives”

AUDIT COMMITTEE REQUIREMENT:

RESOURCES AND TOOLS: Maintain a formal written charter addressing prescribed items

APPLICABLE SRO:

NASDAQ

■ The AICPA Audit Committee Toolkit, which is available free of charge at

DISCUSSION OF THE REQUIREMENT:

http://www.aicpa.org/Audcommctr/ Pre-existing NASDAQ standards, which arose in response to the report of the Blue Ribbon Committee, require audit committees to

toolkits/homepage.htm , includes a have a formal written charter that addresses certain items and is reviewed at least annually. The new NASDAQ standards require

matrix to assist in preparing the that a number of provisions be included in the audit committee charter. Specifically, the charter must address the following:

audit committee charter. ■ The committee’s purpose of overseeing the accounting and financial reporting processes of the company and the audits of its

■ Deloitte & Touche created a sample financial statements

charter (presented in Appendix B) ■

which incorporates the requirements The scope of the audit committee’s responsibilities and how it carries out those responsibilities, including structure, processes,

of the new corporate governance and membership requirements

listing standards and the Sarbanes- ■ The audit committee’s responsibility for:

Oxley Act.

• Ensuring its receipt from the outside auditor of a formal written statement delineating all relationships between the auditor and the company, consistent with Independence Standards Board Standard No. 1

• Actively engaging in a dialogue with the auditor with respect to any disclosed relationships or services that may affect the objectivity and independence of the auditor

• Taking, or recommending that the full board take, appropriate action to oversee the independence of the outside auditor ■ The responsibilities outlined by the final rules to implement Section 301 of the Sarbanes-Oxley Act, as discussed previously in this section.

ACTIONS TO CONSIDER:

Many companies have been viewing their audit committee charters, modified for the requirements of the Sarbanes-Oxley Act, as working drafts pending SEC approval of the SRO corporate governance listing standards; these working drafts should now be finalized if companies have not already done so. The audit committee, legal counsel, and management should review the audit committee charter and make any necessary modifications by the date of the company’s 2004 annual shareholder’s meeting, but not later than October 31, 2004. Most companies will want to have the audit committee charter, revised to reflect the require- ments of the new listing standards, in place in time to describe it in the proxy statement.

AUDIT COMMITTEE REQUIREMENT:

RESOURCES AND TOOLS: The audit committee charter must address the committee’s responsibility to obtain and review a

APPLICABLE SRO:

report from the independent auditor describing certain items related to quality, quality control, ■ The AICPA Audit Committee Toolkit,

NYSE

and independence

which is available free of charge at http://www.aicpa.org/Audcommctr/

DISCUSSION OF THE REQUIREMENT:

toolkits/homepage.htm, includes a At least annually, the audit committee must obtain and review a report by the independent auditor describing:

series of questions to assist in evalu- ating the independent auditor.

■ The firm’s internal quality-control procedures ■ To provide audit committees with

■ Any material issues raised by the most recent internal quality-control review, peer review, or any inquiry or investigation con- the type of information of greatest ducted by governmental or professional authorities during the preceding five years with respect to independent audits carried

interest when they are considering out by the firm, as well as steps taken to deal with any such issues

the appointment of the independ- ■ All relationships between the independent auditor and the company

ent auditor, Deloitte & Touche pub- lished IQ: Sustaining Integrity &

This report will help the audit committee evaluate the auditor’s qualifications, performance, and independence. The evaluation Quality. This booklet offers an should consider the qualifications of the lead partner, as well as the opinions of management and the company’s internal auditor.

overview of our practices in areas The report should also be used in ensuring the regular rotation of the lead audit partner and in considering rotation of the audit

such as technical consultation, risk firm itself. The committee should present its conclusions with regard to the independent auditor to the full board. The audit com-

management, independence, and mittee charter must include a provision addressing these requirements.

professional development. Your

ACTIONS TO CONSIDER:

Deloitte & Touche partner can pro- vide a copy, or one can be obtained

In the current environment, audit committees are performing even more thorough reviews of the audit firm’s qualifications and on Audit Committee Online. 5 performance. Due diligence conducted by audit committees typically includes both formal and informal inquiries, including consid-

eration of any prior evaluations of the client service team’s performance. Of course, reviews will vary by company size, complexity ■ Deloitte & Touche also maintains of operations, degree of centralization, global reach, and the expectations of audit committee members.

information on common practices employed in assessing the auditor’s performance. Please contact your Deloitte & Touche partner for more information.

5 Audit Committee Online menu path: 1) Select “External Audit” from the home page, 2) select “Audit Quality,” 3) select “Deloitte Perspectives”

AUDIT COMMITTEE REQUIREMENT:

RESOURCES AND TOOLS: The audit committee charter must address the committee’s responsibility to discuss annual audited

APPLICABLE SRO:

The audit committee will want to dis-

financial statements and quarterly financial statements with management and the independent

NYSE

cuss certain questions regarding key

auditor

balances and trends with manage-

DISCUSSION OF THE REQUIREMENT:

ment and the independent auditor. These questions will vary based on the

The audit committee must discuss the company’s annual audited financial statements and quarterly financial statements with man- company’s industry and performance, agement and the independent auditor. Such discussions must also address disclosures under “Management’s Discussion and

as well as the composition of the Analysis of Financial Condition and Results of Operations.” The audit committee charter must include a provision addressing these

financial statements. Questions for requirements.

consideration can be found in:

■ The appendix of Deloitte & Touche’s Most audit committees are probably meeting this requirement. To the extent necessary, the audit committee calendar should be

ACTIONS TO CONSIDER:

booklet entitled IQ: Quality of reviewed to ensure that adequate time is allocated to this responsibility.

Earnings, which is available on Audit Committee Online 6 or through your Deloitte & Touche partner

■ The appendix of Deloitte & Touche’s booklet entitled IQ: Quality of

Financial Position—The Balance Sheet and Beyond, which is available

on Audit Committee Online 7 or through your Deloitte & Touche partner.

6Audit Committee Online menu path: 1) select “Financial Reporting” from the home page, 2) select “Transparency in Financial Reporting,”3) select “Deloitte Perspectives”

7Audit Committee Online menu path: 1) select “Financial Reporting” from the home page, 2) select “Off-Balance-Sheet Derivatives and Related-Party Arrangements,” 3) select “Deloitte Perspectives”

AUDIT COMMITTEE REQUIREMENT:

RESOURCES AND TOOLS: The audit committee charter must address the committee’s responsibility to discuss the company’s

APPLICABLE SRO:

earnings press releases, as well as financial information and guidance provided to analysts and rat- ■ For a discussion of the SEC’s final

NYSE

ings agencies

rules to implement the Section 401 non-GAAP financial measures provi-

DISCUSSION OF THE REQUIREMENT:

sions of the Sarbanes-Oxley Act, The audit committee must discuss earnings press releases, as well as financial information and earnings guidance provided to analysts

audit committees can refer to our and ratings agencies. These discussions may be in general terms, and the audit committee need not discuss each earnings report or

brochure entitled Non-GAAP piece of earnings guidance in advance of its release. Rather, the audit committee may discuss the types of information to be disclosed

Financial Measures. This publication and the types of presentations to be made. In its review, the audit committee should pay particular attention to the use of any “pro

is available through your Deloitte & forma” or adjusted non-GAAP information. The audit committee charter must include a provision addressing these requirements.

Touche partner or on Audit Committee Online. 8

ACTIONS TO CONSIDER:

■ Meeting the Street: A Discussion of The audit committee should consider what protocols it will employ in fulfilling its oversight obligations regarding earnings press releas-

Earnings and Other Guidance es, as well as financial information and earnings guidance provided to analysts and ratings agencies. For example, a number of compa-

Provided to Investors, a white paper nies now make it a practice to have audit committee members review earnings press releases before they are issued. In its discussion of

published by Financial Executives press releases and earnings guidance, the audit committee will want to seek confirmation that an appropriate legal review has been

International and Deloitte & Touche, completed covering the accuracy and completeness of the disclosure, including any obligation to report on trends, as well as compli-

provides more information on cur- ance with the company’s policies concerning the issuance of forward-looking statements and the completeness of any related dis-

rent and emerging trends in this claimers included in the disclosure. In addition, the committee will want to be mindful of the SEC’s rules under Section 401 of the

area, the types of forward-looking Sarbanes-Oxley Act regarding the use of non-GAAP financial measures. In this regard, the audit committee might also consider asking

information typically provided, exist- certain questions of management regarding the use of non-GAAP and pro forma financial measures in earnings press releases, filings

ing guidance, and insight into com- with the SEC, and other public releases of information. These could include:

panies that no longer provide earn- ■ Does management have an established policy for the determination of non-GAAP/pro forma financial measures?

ings estimates. This publication is available through your Deloitte &

■ What non-GAAP/pro forma financial measures are used? Touche partner or on Audit ■ Is the non-GAAP/pro forma financial measure permitted under the applicable rules for SEC filings?

Committee Online. 9 ■ What is the underlying rationale and usefulness of the non-GAAP/pro forma financial measures used? Are the non-GAAP/pro forma

■ The National Investor Relations measures consistent with those used by peers and competitors in the industry?

Institute has various publications on ■

company policies and practices con- Are all non-GAAP financial measures reconciled to appropriate GAAP measures? cerning the public disclosure of finan-

■ What is the difference in earnings per share under the GAAP and non-GAAP financial measures? cial information. The materials are ■ Did the company meet analyst expectations for earnings per share using non-GAAP/pro forma financial measures, but not using

available at http://www.niri.org/publi- GAAP financial measures?

cations/bookstore/bookstore_ main.cfm .

■ Is the company in a net loss position when GAAP financial measures are used, but in a net income position when non-GAAP/pro forma financial measures are used?

■ When reconciling from non-GAAP to GAAP financial measures, are there only subtractive adjustments? Stated differently, has man- agement only included non-GAAP adjustments that increase income? If so, are there non-GAAP adjustments that would decrease

income that should have been highlighted to ensure the financial information is not misleading? 8 Audit Committee Online menu path: 1) select ■ Is management comfortable that no material facts have been omitted or misrepresented?

“Financial Reporting” from the home page, 2) select “Transparency in Financial Reporting,” 3)

■ Are changes made to the non-GAAP/pro forma financial measures used from period to period? If so, do these changes enhance non- select “Deloitte Perspectives” GAAP/pro forma adjusted earnings for the current period?

9 Audit Committee Online menu path: 1) Select With respect to earnings guidance provided to analysts and ratings agencies, some companies—including Gillette, Coca-Cola,

“Financial Reporting” from the home page, 2) McDonald’s, and AT&T—have announced that they are no longer providing quarterly or annual earnings estimates. This decision must

select “Transparency in Financial Reporting,” 3)

be weighed heavily and considered by management with the assistance of appropriate legal counsel. The audit committee can partici- select “Resources & Best Practices” pate in this process by conducting an independent evaluation.

RESOURCES AND TOOLS: The audit committee charter must address the committee’s responsibility to discuss policies with

AUDIT COMMITTEE REQUIREMENT:

APPLICABLE SRO:

NYSE ■ The Report of the NACD Blue

respect to risk assessment and risk management

Ribbon Commission on Risk

DISCUSSION OF THE REQUIREMENT:

Oversight: Board Lessons for Turbulent Times examines how to

The audit committee must discuss policies with respect to risk assessment and risk management. The NYSE states that it is the job identify material risks, how specific of the CEO and senior management to assess and manage the company’s risk exposures; however, given the audit committee’s

committees can play a role in risk role in overseeing the financial reporting process, the NYSE standards require the audit committee to discuss the guidelines and

oversight, and how and when to policies that govern risk assessment and risk management. Accordingly, the audit committee should discuss the company’s major

engage outside advisors. The report financial risk exposures and the steps management has taken to monitor and control such exposures. Although the NYSE notes

is available at www.nacdonline.org. that the audit committee is not required to be the sole body responsible for risk assessment and management, the audit commit-

tee charter must include a provision addressing these requirements. ■ Risk Infrastructure, which is avail- able on Audit Committee Online,

summarizes the eight elements of Audit committees should become familiar with major financial risk exposures, as well as the processes through which the company

ACTIONS TO CONSIDER:

risk infrastructure as outlined in the manages and addresses such risks, through discussions with management and others responsible for risk management. Audit com- 10 COSO framework.

mittee members’ knowledge of the company, the industry, the economy, and the general business environment should help in ■ Extended Enterprise and Risk identifying potential risk areas.

Management, a 2002 supplement to The following questions may help audit committee members gain a better understanding of the risk management infrastructure:

Corporate Board Member magazine, features comments from corporate

■ How does the company determine the extent and type of acceptable risks? executives and accounting profes- ■ How does the company monitor management processes and systems for various types of business risk?

sionals on the changing face of risk management. It explores the board’s

■ Does the company have early-warning indicators to identify risks? role in monitoring risk and suggests ■ How does management keep current with the changing strategic environment and what key business risks are appearing?

best practices as companies strive to enhance their risk intelligence. The

■ How does management ensure that key risks are mitigated properly? supplement is available through your Deloitte & Touche partner or on Audit Committee Online. 11

10 Audit Committee Online menu path: 1) select “Risk and Controls” from the home page, 2) select “Risk Oversight,” 3) select “Background & Current Developments”

11 Audit Committee Online menu path: 1) Select “Risk and Controls” from the home page, 2) select “Risk Oversight,” 3) select “Deloitte Perspectives”

AUDIT COMMITTEE REQUIREMENT:

RESOURCES AND TOOLS: The audit committee charter must address the committee’s responsibility to meet separately, periodi-

APPLICABLE SRO:

cally, with management, with the internal auditor, and with the independent auditor ■ NYSE Suggested questions for manage- ment and the internal auditor can

DISCUSSION OF THE REQUIREMENT:

be found in the Report of the NACD Periodically, the audit committee must meet separately with management, the internal auditor, and the independent auditor. The

Blue Ribbon Commission on Audit audit committee charter must include a provision addressing this requirement.

Committees: A Practical Guide, which is available at www.nacdon-

ACTIONS TO CONSIDER:

line.org.

Most audit committees already hold private sessions with these parties each quarter. Audit committees that have not adopted this

A document entitled “The Audit policy may want to consider making it an objective, because quarterly private sessions can facilitate timely discussion and more

Committe Meeting with External timely resolution of sensitive and/or material issues that can have an adverse impact on the company. To the extent necessary, the

Auditors,”which discusses considera- audit committee calendar should be reviewed to ensure that adequate time is allocated to this responsibility.

tions for private sessions with the independent auditor, is available on Audit Committee Online. 12

AUDIT COMMITTEE REQUIREMENT:

RESOURCES AND TOOLS: The audit committee charter must address the committee’s responsibility to review with the

APPLICABLE SRO:

NYSE

■ The AICPA Audit Committee Toolkit

independent auditor any audit problems or difficulties and management’s response

includes a document addressing com-

DISCUSSION OF THE REQUIREMENT:

munication with the independent The audit committee must review with the independent auditor any audit problems or difficulties and management’s response. The

auditor. It is available free of charge audit committee charter must include a provision addressing these requirements. In addition to addressing significant disagreements

at http://www.aicpa.org/ with management and difficulties the auditor encountered in the course of the audit work, this review should include restrictions on

Audcommctr/toolkits/homepage.htm. the scope of the auditor’s work or on access to requested information. The audit committee may also want to review the following:

■ More information on Deloitte’s ■

approach to communicating with Accounting adjustments, material or otherwise, that were noted or proposed by the auditor but were “passed” by management

the audit committee is available in ■ Communications between the audit team and the audit firm’s national office with respect to auditing or accounting issues

the “External Audit” section on Audit Committe Online 13

■ “Management” or “internal control” letter issued, or proposed to be issued, by the audit firm to the company. The audit committee should also discuss the responsibilities, budget, and staffing of the internal audit function with the independent

auditor.

ACTIONS TO CONSIDER:

Because the professional standards of independent auditors and the Sarbanes-Oxley Act set forth similar requirements, audit com- mittees are already fulfilling this standard to some degree, particularly as it relates to disagreements with management, account- ing adjustments, and management or internal control letters.

12 Audit Committee Online menu path: 1) select “External Audit” from the home page, 2) select “The Audit Committee/Auditor Relationship,” 3) select “Resources & Best Practices” 13 Audit Committee Online menu path: 1) select “External Audit” from the home page, 2) select “The Audit Committee/Auditor Relationship,” 3) select “Deloitte Perspectives”

AUDIT COMMITTEE REQUIREMENT:

RESOURCES AND TOOLS: The audit committee charter must address the committee’s responsibility to set clear hiring policies for

APPLICABLE SRO:

employees or former employees of the independent auditor

NYSE

More information regarding the Sarbanes-Oxley Title II rules related to

DISCUSSION OF THE REQUIREMENT:

conflicts of interest arising from an The audit committee must set clear hiring policies for employees or former employees of the independent auditor. The audit com-

employment relationship between mittee charter must include a provision addressing this requirement.

partners and employees of the inde- pendent auditor and their attest

ACTIONS TO CONSIDER:

clients can be found on Audit Pursuant to Title II of the Sarbanes-Oxley Act, the SEC has implemented new rules with respect to auditor independence. Among

Committee Online. 14 other things, these rules address the possibility of employees and partners of audit firms accepting certain employment positions

with audit clients. The audit committee’s establishment of hiring policies is another protective measure. Such policies should com- ply with the final rules to implement Title II of the Sarbanes-Oxley Act. In addition to considering compliance with the Sarbanes- Oxley Act requirements, there are other matters the audit committee might consider in drafting the policy. These include:

■ Will the policy apply only to the positions included in the final rules to implement Title II of the Sarbanes-Oxley Act or will the policy apply to other positions?

■ Will there be a blanket ban on hiring from the independent auditor at either the corporate level or around the world? ■ If hiring from the independent auditor is permissible, will approvals be required from management, the audit committee, and/

or others within the company? ■ Will the policy apply equally to subsidiaries/operations in non-domestic markets?

AUDIT COMMITTEE REQUIREMENT:

APPLICABLE SRO:

The audit committee charter must address the committee’s responsibility to report regularly to the board of directors NYSE

DISCUSSION OF THE REQUIREMENT:

The audit committee must report to the board of directors regularly. These reports should include discussion of any issues that arise with respect to the quality or integrity of the company’s financial statements, the company’s compliance with legal or regula- tory requirements, the performance and independence of the independent auditor, or the performance of the internal audit func- tion. The audit committee charter must include a provision addressing these requirements.

ACTIONS TO CONSIDER:

Most audit committees already have a process for reporting to the board on a regular basis. To the extent possible, the audit com- mittee might consider a report at each board meeting or distributing the minutes of the audit committee meetings to all direc- tors. Furthermore, the audit committee and board might consider establishing a process for timely communication of any urgent or sensitive matters to the board between meetings.

14 Audit Committee Online menu path: 1) select “External Audit” from the home page, 2) select “Auditor Independence”

AUDIT COMMITTEE REQUIREMENT:

RESOURCES AND TOOLS: The audit committee charter must address the committee’s responsibility to review certain other mat-

APPLICABLE SRO:

ters/analyses ■ The audit committee may want to

NYSE

DISCUSSION OF THE REQUIREMENT:

refer to Deloitte & Touche’s Integrity & Quality series to assist in deter-

The audit committee must review: mining the appropriate questions to ■ Major issues regarding accounting principles and financial-statement presentations, including any significant changes in the compa-

pose regarding significant account- ny’s selection or application of accounting principles; major issues as to the adequacy of the company’s internal controls; and any

ing issues, estimates, judgments, and initiatives. These questions can be

special audit steps adopted in light of material control deficiencies

found in:

■ Analyses prepared by management and/or the independent auditor setting forth significant financial reporting issues and judgments • The appendix of our booklet enti- made in connection with the preparation of the financial statements, including analyses of the effects of alternative GAAP methods

tled IQ: Quality of Earnings, which on the financial statements

is available through your Deloitte ■ The effect of regulatory and accounting initiatives, as well as off-balance-sheet structures, on the financial statements.

& Touche partner or on Audit Committee Online 15

The audit committee charter must include a provision addressing these requirements. • The appendix of our booklet enti-

ACTIONS TO CONSIDER: