Few roles are as demanding in the boardroom as chairing the audit committee. That said, the audit committee provides an ideal venue to understand the company, its operations and its challenges. And so, if you are new to the audit committee and have been asked to chair it, what should you be thinking about early in your tenure?
The Basic Blocking and Tackling
Understand how the financial reporting works. This includes meeting key individuals in the finance department, understanding critical accounting policies and ensuring that you get an appreciation for the areas requiring the most judgment. Review the company’s key annual and quarterly filings with the SEC. Review recent press releases and listen to a sample of archived analyst calls to get a better sense of what information the company is focusing on when it reports results, and how market observers are viewing the company. Also understand the status of any open issues: comment letters from the SEC that the company is addressing, the status of any major new accounting standards the company is implementing, and reporting considerations for significant transactions being undertaken. The CFO, controller, chief accounting officer and external audit partner will all play roles in helping you get a deeper appreciation of the financial reports your committee is responsible for overseeing.
Meet with the external audit partner. The external audit partner can be a great resource to you as you transition into your chair role. Get an appreciation for his or her experience, not only with the company, but also within the industry and in dealing with the types of issues the company faces. The audit partner can also provide useful insight into how the company functions, where the reporting risks are and the bench strength of both the finance department and the internal audit function. Additionally, he or she may have perspectives on how the audit committee could be more effective. Understand how the partner ensures that the right team is available to serve the client—particularly important if you have geographically diverse operations.
Use your staff support. Who from the company (corporate secretary, internal audit director, controller or other individual) is assigned to help you with agendas, meeting materials, and general scheduling? Whom can you call with questions? When and where are the meetings, what topics do they typically cover and how long do they usually run? Are there any constraints (such as schedules for other committee meetings) on how long your meetings can run?
Differentiators for Effectiveness
Focus on critical aspects of risk management. This may be the most significant challenge: How can your audit committee play a central role in risk management without being tagged to oversee all areas of risk within the company? One way is to think of your role as an air traffic controller: knowing what the key risks are and allocating each of them to be overseen by the appropriate committee or the full board. Then you can focus your agendas over the year on overseeing the key risks assigned to the audit committee. Obviously, the audit committee takes the lead in areas such as risk relating to financial reporting. Your committee is also likely to find itself assigned oversight of compliance risks, and perhaps IT and privacy risks, too.
On a related note, you’ll want to think about the best ways for your committee to interact with the compensation committee, as focus grows on the link between risk and compensation. The better the audit committee understands the performance metrics the compensation committee tags to incentive pay, the better the audit committee can monitor the integrity of those metrics—in particular, by focusing on whether the ability to achieve performance targets significantly affects management’s financial reporting judgments. This sharing of information between the two committees is especially critical if there is no cross-committee membership.
Forge strong ties with your internal auditors. Internal audit can be the eyes and ears of the audit committee—giving you an objective view of issues facing the company. But it can do that only if you have the right leadership in the internal audit function and if the audit committee supports internal audit’s effectiveness. Get a sense of how company executives and your external auditors view internal audit.
Also get to know the internal audit director and form your own opinion on his or her effectiveness. Understand how internal audit uses its resources and what additional assurance it could provide if it had more resources. Set aside time for periodic, informal contact with internal audit. Be clear that you are open to hearing about any serious issues, including sensitive ones. Many chairs aim for regular between-meeting contact—a call or coffee—to keep the communication lines open.
Tackle the tough stuff. It’s human nature to focus time and attention on the items we already understand and can grasp easily. It takes discipline to ensure the more challenging issues are included in your agenda.
Identify what these issues are—they may, for example, relate to IT security, derivative transactions, complex technical accounting issues or treasury operations. Ask for more in-depth information on these areas. If they represent major risks, consider relevant training sessions for the entire committee. Insist on getting the information in plain English.
Summing It Up
Don’t go it alone. It’s likely you’re in the chair role because you qualify as an audit committee financial expert. That doesn’t mean you need to have all the answers or that you should ask all the questions. Ensure that all your committee members have a voice. Consider involving them in some of your between-meeting discussions—particularly if there is a reporting issue you’re monitoring. And watch for the dynamics in the meetings themselves, recognizing that it can be difficult to build a cohesive committee when you’re only together five or six times a year in a fairly scripted setting. It might mean privately soliciting views from each director after the meeting, especially if a member has been largely silent during the meeting. It definitely means insisting on time for executive sessions of just the committee members, so that committee members have an alternative venue for sharing what they’re thinking. Consider occasionally visiting one-on-one with committee members between meetings to better understand what issues they are concerned about.
As you work with your committee over time, you’ll develop a better appreciation for the additional information you and your committee members need. You can determine if additional training sessions would be appropriate. You also may identify additional skill sets or experience that would be useful, and that ultimately may dictate a shift in committee composition.
At the end of the day, the committee’s effectiveness is largely up to you. Ensure that you have the relationships, information and members you need to effectively fulfill all the committee’s responsibilities.
The Transition to Chair
If you’re fortunate enough to have been a member of the audit committee before assuming the chair role, your task is easier. You already understand the financial reporting process and the players. And you’ll already have a view on how the meetings should run and whether the materials could be improved. You may also have a perspective on the committee membership.
But you might not have realized just how much the chair did between meetings. You’ll want to schedule time to meet separately with the internal and external auditors and with key members of the finance team, to solidify those relationships. You’ll want to identify areas to dig deeper, and start tailoring the committee’s agenda to reflect your vision.
Catherine L. Bromilow is a partner in the corporate governance group at PricewaterhouseCoopers LLP.
ADDITIONAL COVERAGE IN THE BOARDROOM GUIDE FOR THE NEW DIRECTOR: