'Financial Experts' Beware!

Sitting on the audit committee can be a tough job. Wearing the “financial expert” hat is even more of a challenge, and just one of the many regulatory interventions that have made life difficult at times for board members. Supporters predicted that as time went on, provisions of the Sarbanes-Oxley Act of 2002 (Sarbox*) would become old hat and boards could get back to the business at hand.

That hasn’t happened. Five years later, the Audit Committee Financial Expert (ACFE) designation is still causing headaches. While other provisions of Sarbox, like 404, have created the most controversy and subsequent clarifications from regulators, the ACFE provision has only been given cursory attention. In fact, many questions remain on what defines a financial expert, not to mention what is needed to keep the designation up to date. And then there is the potential for liability. It hasn’t happened yet, but you can bet that at the first hint of trouble, the plaintiff’s bar is going to challenge the credentials of some incumbent ACFEs.

Indeed, section 407 of Sarbox, which requires public companies to disclose in their 10K whether their audit committee includes a financial expert—and if not, why—is one of the more challenging provisions of the Act. Sarbox spells out a complex schema for a financial expert’s qualifications.

A draft SEC regulation implementing this Sarbox provision was put out for comment in October of 2002 and went into effect in July of 2003. In response to a flood of comments on the rule proposal, some ameliorating adjustments were made in the final rule. For example, the “financial expert” term was repositioned as “audit committee financial expert”(ACFE), or “ack-fee” as it is known, to distinguish it from the long-familiar expertise concept that is embedded in securities regulation. The SEC also made some moderating adjustments to qualify as a financial expert under the final rule, although the Commission had limited latitude in light of the clear-cut attributes for ACFE qualifications spelled out in Sarbox. (See “Do you Have What it Takes,” page 51, for the full list of final requirements.)

Lingering Questions

Public boards have been confronted with the dilemma of tagging one (or more) of their audit committee members as an ACFE or confessing that their audit committees lack this special expertise. Notably, it is the responsibility of the board of directors—not management—to designate ACFEs; thus, if a designated audit committee member does not qualify as an ACFE, the other directors who made that designation may have actionable accountability for a significant misrepresentation.

Directors have been confronted with difficult imponderables when trying to deal with this challenge and paramount among them is the proper interpretation of each of the five skill-sets required for the ACFE designation. For example, what depth and how widespread is the needed “understanding” of Generally Accepted Accounting Principles (GAAP)? In reality, does “understanding” require a “working knowledge” of GAAP or something less? Is an ACFE expected to keep current on new accounting pronouncements? Should an ACFE be able not only to understand (and explain) the company’s financial statements as well as to understand (and explain) the major principles employed in those statements, such as pension plan accounting and accounting for retiree benefit obligations, environmental reserves, taxes, and contingencies? Should his or her “understanding” of GAAP include the issues pending before the Financial Accounting Standards Board? Given this “understanding GAAP” requirement, is the pool of potential ACFEs who may be qualify) realistically limited to CPAs and CFOs? If other audit committee members are to qualify, then on what basis?

What experience satisfies the requirement involving the preparation or auditing of financial statements? The SEC did broaden this skill-set requirement in the final rule by adding experience “analyzing or evaluating” financial statements. The expected experience must involve “actually working directly and closely with financial statements” that present accounting issues generally comparable to those raised by the company’s financial statements. Supervisory experience may qualify, but it must be “hands- on” experience.

To what extent is “general currency” a consideration; that is, would experience at an early stage of an audit-committee member’s career satisfy the skill-set requirement, or does that requirement contemplate an involvement that is more or less “recent?” When does a retired CFO’s experience become stale?