Audit committees aren’t just about auditing anymore. Today, they have responsibilities that go far beyond review and acceptance of the company’s financial disclosures. Audit committees play an increasingly important role during crisis situations—particularly those that involve allegations of fraud. Having the responsibility for dealing with allegations of misconduct or other illegal acts is one matter; understanding what must be done when a crisis arises is another.
Among a committee’s most important responsibilities in the post-Sarbanes-Oxley era is handling allegations regarding improprieties or irregularities with accounting, internal accounting controls over financial reporting, or auditing matters. The audit committee’s additional responsibility is to establish a process to accept confidential submission of employee concerns about questionable accounting or auditing matters —the so-called whistleblower hotline. These areas can be particularly tricky for directors. While every allegation should be taken seriously, numerous unsubstantiated claims are par for the course, making the job even more difficult.
Among the most challenging circumstances an audit committee may face are an allegation of an illegal act brought against the company as an entity itself, or individually against members of senior management.
Examples of illegal acts include fraudulent financial reporting through improper accounting, improper or intentionally inadequate disclosures, and violations of corruption and bribery laws—including the U.S. Foreign Corrupt Practices Act (FCPA). In a down economy, concerns over fraudulent reporting generally increase. FCPA cases have been on the rise for the last few years.
An Ounce of Prevention
An audit committee can play a key role in mitigating potential crises due to allegations of illegal acts by requiring the appropriate “tone at the top” from senior management. It can also act as an overseer of management’s efforts to design, implement, and evaluate a system of internal controls over financial reporting, as well as an integrated anti-fraud program to prevent, detect, and respond to allegations or instances of fraud or misconduct. Such an integrated anti-fraud program may include a code of conduct, a fraud risk assessment, training for employees, and process-specific preventative controls. In addition to the preventative elements, an effective antifraud program usually has complementary detective elements designed to uncover fraud and misconduct when they occur. Examples of these detective elements include:
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Channels that accept anonymous complaints or allegations of fraud, misconduct, or illegal acts. These are referred to as “whistleblower hotlines,” but the reporting mechanisms are not necessarily limited to call-in telephone numbers.
Practically speaking, no audit committee maintains day-to-day oversight of the operations of its company. That job belongs to management. There are means, however, by which audit committees can enhance the effectiveness of existing detective controls by being actively engaged in their oversight responsibilities.
A well-prepared audit committee could have a pre-approved response plan or protocol for addressing allegations of fraud and could obtain and review periodic activity reports of anonymous reporting channels for misconduct. In addition, by maintaining direct lines of communication with multiple members of senior management, the audit committee ensures that it will not rely on any one source for information about important management issues.
