GOVERNANCE PARTNERS GROUP FINANCIAL REPORTING OVERSIGHT AUDIT COMMITTEE CONSIDERATIONS • Carefully review draft earning releases with attention to how operating results are described • Understand length of time between earnings releases and SEC filings and the status of the external auditors’ related work • Assess whether an event of finding could arise prior to the SEC filing date that could impact the results presented in the earnings releases • Discuss how management plans to record and disclose major developments occurring after the issuance of earnings releases • Pay attention to “special items” (e.g. material litigation contingency reserves) 23
GOVERNANCE PARTNERS GROUP FINANCIAL REPORTING OVERSIGHT EARNINGS RELEASES • Earnings releases include limited data (compared to SEC filings), generally Balance Sheet and Statements of Income and Cash Flow with comparisons to the comparable period of the preceding year • Committee meets to discuss and approve the draft earnings releases (usually via conference call) prior to the completion of the relevant financial statement audit or review 24
GOVERNANCE PARTNERS GROUP FINANCIAL REPORTING OVERSIGHT EARNINGS RELEASES • Committee should understand possible risks associated with having limited time to review earnings releases • Length of time between isusance of the preliminary earnings release and the filing of the related Form 10-K or Form 10-Q impacts the likelihood that a material subsequent event might occur 25
GOVERNANCE PARTNERS GROUP FINANCIAL REPORTING OVERSIGHT SPECIAL ITEMS • Quantified in press release – nonrecurring, one-time, unusual, special, etc. • Consistency is important – over time and in various media (website, press release, investor calls) • Company can provide data in tabular form • Tax effect of special items may be critical but sometimes overlooked 26
GOVERNANCE PARTNERS GROUP FINANCIAL REPORTING OVERSIGHT RISK IDENTIFICATION Business risk related to: • Business strategy and market position • Major customers and suppliers • Related parties • Capital structure and hedging transactions • Major transactions during the accounting period 27
GOVERNANCE PARTNERS GROUP FINANCIAL REPORTING OVERSIGHT RISK IDENTIFICATION Focus on complex, significant unusual events and changes in account balances to understand: • Business issues that exist • Critical accounting policies adopted by the Company • Significant assumptions used to establish accounting entries • Understand the Company’s financial statement closing process 28
GOVERNANCE PARTNERS GROUP FINANCIAL REPORTING OVERSIGHT RISK IDENTIFICATION – SUGGESTIONS • Field visits • Periodic meetings with financial management, external auditors and business unit leaders • Monitor analyst calls • Review analyst, rating agency and investment firm reports • Review competitor financial date 29
GOVERNANCE PARTNERS GROUP FINANCIAL REPORTING OVERSIGHT CRITICAL ACCOUNTING POLICIES • Summarized in MD&A and footnotes • Is application interpreted aggressively or conservatively? • Do policies reflect the substance of transactions? • What are competitors doing? • Are there any alternative methods? 30
GOVERNANCE PARTNERS GROUP FINANCIAL REPORTING OVERSIGHT CRITICAL ACCOUNTING POLICIES • Importance of advance planning for new standards • Accounting policy changes • Rationale for change • Effect on income, loan covenants, executive compensation plans • Investors/analysts reaction to change • Change in estimate versus change in accounting policy • Focused discussion of a specific policy at a particular meeting 31
GOVERNANCE PARTNERS GROUP FINANCIAL REPORTING OVERSIGHT ACCOUNTING ESTIMATES • Estimation areas involving a high level of judgment include: • Allowance for bad debts • Environmental reserves • Pension obligations • Obsolete inventory • Asset impairments • Income tax exposures • Restructuring reserves • Litigation reserves 32
GOVERNANCE PARTNERS GROUP FINANCIAL REPORTING OVERSIGHT ACCOUNTING ESTIMATES • Important for Committee to understand: • Key assumptions and variables used in making estimates • A range of estimates can result in significantly different results • The level of conservatism applied in the estimation process can dramatically influence estimate results 33
GOVERNANCE PARTNERS GROUP FINANCIAL REPORTING OVERSIGHT RELATED PARTY TRANSACTIONS • Related parties are: • Affiliates • Principal owners, management and their immediate families • Other parties subject to significant influence • Related party transactions can lead to a higher incidence of fraud • Financial management cannot presume that related party transactions are entered into on an arms length basis 34
GOVERNANCE PARTNERS GROUP FINANCIAL REPORTING OVERSIGHT RELATED PARTY TRANSACTIONS • The Company must disclose the nature and description of related party transactions and the amounts involved • Auditors must specifically evaluate the Company’s process for identifying and disclosing relatiohships and transactions with related third parties and communicate the results of that work to the Committee (PCAOB Auditing Standard No. 18, Related Parties) 35
GOVERNANCE PARTNERS GROUP FINANCIAL REPORTING OVERSIGHT MANAGEMENT DISCLOSURE COMMITTEES • Most public companies have management-level disclosure committee • Periodic internal financial certifications roll-up under this committee • Membership usually consists of the CFO, Controller, Internal Auditor, functional and business leaders, the Corporate Secretary, and Investor Relations, Legal and Compliance representatives • Some companies have the Disclosure Committee report to the Audit Committee committee 36
GOVERNANCE PARTNERS GROUP FINANCIAL REPORTING OVERSIGHT TRANSPARENCY IN DISCLOSURE • The complete story regarding a disclosure item should be clear • Disclosure of potential future events (or foreshadowing) is closely scrutinized by the SEC • Management Discussion & Analysis should be robust and more than a mere overview • Segment reporting is closely scrutinized by the SEC and heavily used by analysts 37
GOVERNANCE PARTNERS GROUP FINANCIAL REPORTING OVERSIGHT INTERACTION WITH REGULATORS • All SEC filers are reviewed on a 3-year cycle • SEC comment letters often question: • Segment reporting • Asset impairment testing • Tax allowances and uncertain tax positions • Early warning disclosures • Pension obligations • Revenue recognition • Financial derivatives valuations • Cash flow classification 38
GOVERNANCE PARTNERS GROUP FINANCIAL REPORTING OVERSIGHT INTERACTION WITH REGULATORS • Responses to SEC comment letters are published on EDGAR – they should be reviewed by the Audit Committee and the external auditors before they are submitted • The SEC will issue “pre - clearance letters” in cases where there is significant uncertainty regarding a position that a Company is considering with respect to its financial statements 39
GOVERNANCE PARTNERS GROUP OVERSIGHT OF EXTERNAL AUDITORS GENERAL PRINCIPLES • Under Sarbanes-Oxley, the Audit Committee is directly responsible for the appointment, compensation and oversight of a Company’s external auditor, and the external auditor reports directly to the Committee • Ongoing candid communication is critical • Periodic informal meetins are important 40
GOVERNANCE PARTNERS GROUP OVERSIGHT OF EXTERNAL AUDITORS GENERAL PRINCIPLES • Selection, reappointment, replacement and evaluation considerations include: • The auditing firm’s reputation, industry experience and international network • The lead partner’s business acumen and pragmatism • The ability of the engagement team to work with the Company’s management and financial staff • The ability to exercise independence 41
GOVERNANCE PARTNERS GROUP OVERSIGHT OF EXTERNAL AUDITORS REPORTING RELATIONSHIP TO AUDIT COMMITTEE Selection, reappointment, replacement and evaluation issues: • Candidate “beauty contests” can provide useful information • A change in the external auditor presents the following challenges: • Management time and attention • New auditing firm learning curve, personalities and re-interpretation of previously adopted accounting policies • Additional challenges are presented by lead partner rotation requirements; lead partner transitions require purposeful “shadowing” of departing lead partner 42
GOVERNANCE PARTNERS GROUP OVERSIGHT OF EXTERNAL AUDITORS REPORTING RELATIONSHIP TO AUDIT COMMITTEE • The External Auditor should consider the following key questions in connection with the Company’s auditing engagement: • What are the key business and audit risks? • How is materiality determined? • How does the Company determine its accounting “estimates”? • How is internal controls testing structured at the Company? • What is the Company approach to information technology issues? • Which subsidiaries and locations will be visited?? 43
GOVERNANCE PARTNERS GROUP OVERSIGHT OF EXTERNAL AUDITORS COMMUNICATIONS • Candid communications between the external auditor and the Committee and the Company’s CFO and Controller are essential for every audit or review • The external auditor’s specialists may become involved in communications with the Committee regarding unique topics or issues • The external auditor can provide the Committee with perspectives based on experience with other clients and the quality of the Company’s financial management and staff 44
GOVERNANCE PARTNERS GROUP OVERSIGHT OF EXTERNAL AUDITORS COMMUNICATIONS • The Audit Committee might engage in a discussion with the external auditor regarding the following questions: • Were proposed changes to the financial statements or press release not made? • What areas of financial reporting could be challenged by regulators? • What is the quality of reported earnings? • How capable is the Company’s finance team? • Is pressure being placed on financial reporting to achieve a desired outcome? • What areas of the audit take the most time and why? 45
GOVERNANCE PARTNERS GROUP OVERSIGHT OF EXTERNAL AUDITORS Management Representation Letters • The external auditor should highlight non-standard customized representations • The Audit Committee should inquire whether the external auditor encountered any difficulty in obtaining any specific representations 46
GOVERNANCE PARTNERS GROUP OVERSIGHT OF EXTERNAL AUDITOR DISAGREEMENTS WITH MANAGEMENT • The Audit Committee is required to resolve any disagreements between the external auditor and the Company’s management. In that process, the Audit Committee should: • Discuss the disagreement with management and the external auditor to understand each party’s viewpoint • Develop an understanding of the SEC’s viewpoint on the topic • Determine whether to consult with external advisors regarding the topic • Discuss options for resolution of the disagreement with management and the external auditors 47
GOVERNANCE PARTNERS GROUP OVERSIGHT OF EXTERNAL AUDITOR NON-AUDIT SRVICES • The Audit Committee must pre-approve of the following services to be performed by the external auditor: • Corporate tax return preparation • Corporate tax planning activities • Financial due diligence activities • Tax legislation advice • Transfer pricing analysis • Fraud and other investigations • Personal tax preparation services 48
GOVERNANCE PARTNERS GROUP OVERSIGHT OF EXTERNAL AUDITOR NON-AUDIT SERVICES • The Audit Committee will usually provide a blanket approval for certain categories of services up to a specified fee limit to be ratified at the next following Audit Committee meeting • The external auditor may not perform the following services: • Auditing its own work • Making management decisions • Serving as an advocate for the Company • Performing work with respect to which the external auditor has a potential conflict of interest 49
GOVERNANCE PARTNERS GROUP OVERSIGHT OF MANAGEMENT RELATIONSHIP WITH MANAGEMENT • The Audit Committee should interact with management with an appropriate degree of skepticism • The Committee should rigorously question management: • Were there any transactions that were entered into primarily to impace financial ratios or presentation of financial results? • Were any transactions recorded during the last few weeks of the quarter that did not occur earlier in the period? 50
GOVERNANCE PARTNERS GROUP OVERSIGHT OF MANAGEMENT RELATIONSHIP WITH MANAGEMENT • The Committee should rigorously question management: • Were any significant exceptions reported in the internal repsresntation letters? • What significant accounting judgment calls were made during the period? • What kind of input into accounting determinations does non-financial management have? • What areas present recurring challenges or problems? • What areas of accounting require the greatest time commitment of financial reporting personnel? • What pressures influence financial reporting? 51
GOVERNANCE PARTNERS GROUP OVERSIGHT OF MANAGEMENT RELATIONSHIP WITH MANAGEMENT • Management bench strength assessment • Committee discussions with CFO • • Perceptions based on personal interactions • • Confidential feedback from external and internal auditors • Focus on finance managers at higher risk and international locations • • Succession planning for CFO and Internal Auditor 52
GOVERNANCE PARTNERS GROUP OVERSIGHT OF MANAGEMENT RELATIONSHIP WITH MANAGEMENT • Audit Committee meetings with management • Attendance: • CFO, Controller, Internal Auditor, Tax Director • CEO, CAO, CIO, Business Leaders, CEO • Private sessions are critical • Informal meetings between board meetings help build the relationship between the Committee and Management 53
GOVERNANCE PARTNERS GROUP OVERSIGHT OF INTERNAL AUDIT ROLE AND STAFFING OF THE INTERNAL AUDIT DEPARTMENT • The role of the Internal Auditor has been evolving from being compliance focused to being value added focused. • Areas of Internal Audit focus: • Financial reporting and internal controls • Regulatory compliance - Environmental, Health and Safety • Investigations • Information Technology • Process re-engineering • Operational Efficiencies 54
GOVERNANCE PARTNERS GROUP OVERSIGHT OF INTERNAL AUDIT ROLE AND STAFFING OF THE INTERNAL AUDIT DEPARTMENT • The key to Internal Auditor effectiveness is empowerment by executive management • There should be agreement between executive management and the Audit Committee regarding the role of the Internal Auditor • The Internal Audit Department should conduct an annual planning and risk assessment meeting • A rotational approach to auditing locations is typically warranted and advisable 55
GOVERNANCE PARTNERS GROUP OVERSIGHT OF INTERNAL AUDIT STAFFING OF THE INTERNAL AUDIT DEPARTMENT • The Internal Auditor should be a member of the Company’s (financial) leadership team • The role of the Internal Auditor should be enterprise-wide • There should be an informal relationship between the Internal Auditor and the Audit Committee Chair • The Audit Committee should evaluate the Internal Audit Department’s staffing level and capabilities • An effective system for the evaluation of the Internal Audit Department should be developed and implemented 56
GOVERNANCE PARTNERS GROUP OVERSIGHT OF INTERNAL AUDIT STAFFING OF THE INTERNAL AUDIT DEPARTMENT • Coordination with External Auditor • Staffing Strategies • Rotation of sites audited • Outsourcing of certain audits to third parties • Challenges related to staffing for audits of non-US locations 57
GOVERNANCE PARTNERS GROUP OVERSIGHT OF INTERNAL AUDIT INTERNAL AUDIT REPORTING LINES AND LEADERSHIP • Communicating internal audit results • Executive summaries • Current period audits and findings reported at each meeting • Recommendation to implement an aging chart • Internal audit reporting lines • Most report directly to Audit Committee Chair • Most report administratively to the CFO 58
GOVERNANCE PARTNERS GROUP OVERSIGHT OF INTERNAL AUDIT INTERNAL AUDIT REPORTING LINES AND LEADERSHIP • Internal Audit Department leadership is very important • Drives the department’s effectiveness; must be objective and independent of management • Should portray a willingness not to “stand down” with respect to identified issues • The Audit Committee should play a role in hiring the Internal Audit Department leadership • Exit interviews are critical during transitions between Internal Audit Department leadership 59
GOVERNANCE PARTNERS GROUP OVERSIGHT OF INTERNAL AUDIT EVALUATING INTERNAL AUDITOR PERFORMANCE • CEO input is the starting point • External auditor input can be helpful • Management input provides a view of how the Internal Auditor is perceived internally 60
GOVERNANCE PARTNERS GROUP OVERSIGHT OF INTERNAL AUDIT EVALUATING INTERNAL AUDITOR PERFORMANCE • Questions to be addressed by the Audit Committee: • Is the focus of the Internal Auditor on the right areas? • Does management look to the Internal Auditor when issues arise? • Are reports provided by the Internal Auditor to the Audit Committee on a timely basis? • How independent does the Internal Auditor appear to be? • Is the Internal Auditor properly leveraging technology? 61
GOVERNANCE PARTNERS GROUP CORPORATE CULTURE AND COMPLIANCE TONE AT THE TOP • How should the Audit Committee evaluate the “tone at the top”? • Direct interaction with executive management • Employee surveys - can address satisfaction, working conditions and pressure to bend rules; broad employee participation is important • Upward feedback to be provided via the Human Resources Department • Employee complaints communicated via whistleblower hotline 62
GOVERNANCE PARTNERS GROUP CORPORATE CULTURE AND COMPLIANCE TONE AT THE TOP • How should the Audit Committee evaluate the “tone at the top” ? • Meet with middle-management finance personnel • Solicit input from internal and external auditors • Conduct private sessions with executive management • Evaluate the degree to which presentations to the Board are scripted and rehearsed 63
GOVERNANCE PARTNERS GROUP CORPORATE CULTURE AND COMPLIANCE OVERSIGHT OF COMPLIANCE PROGRAMS • Understand the design of the Company’s compliance program • Areas of high risk assessed • Key personnel involved • Internal reporting lines • Implementation challenges • Discuss effectiveness of various programs 64
GOVERNANCE PARTNERS GROUP CORPORATE CULTURE AND COMPLIANCE OVERSIGHT OF COMPLIANCE PROGRAMS • Periodically review the Company’s ethics policy and code of conduct • Address how standards differ from country to country • Meet with Chief Ethics Officer • Receive periodic briefings from Internal Auditor, Chief Risk Officer, General Counsel and executive management • Analyze incidents and trends over time 65
GOVERNANCE PARTNERS GROUP CORPORATE CULTURE AND COMPLIANCE OVERSIGHT OF COMPLIANCE PROGRAMS • Review statistics regarding code of conduct training • Understand results of employee certification process • Review planned remediation actions • Evaluate code and communications • Understand potential issues before they become complaints • Understand the role of the Internal Audit Department in aiding compliance 66
GOVERNANCE PARTNERS GROUP CORPORATE CULTURE AND COMPLIANCE CODES OF CONDUCT AND CONFLICTS OF INTEREST • Codes of Conduct • Expectations of behavior at and outside of work when conducting business • Employee responsibility for reporting misconduct • Process for disciplinary actions (warnings, corrective action, dismissal) • Confidentiality, fairness, honesty, integrity, use of company asssets, accountability for compliance with the Code • Conflicts of Interest Policies • Should be written and easy to understand and apply to everyone • Pertain to both real and apparent conflicts • Include disciplinary guidelines 67
GOVERNANCE PARTNERS GROUP CORPORATE CULTURE AND COMPLIANCE CODES OF CONDUCT AND CONFLICTS OF INTEREST • Whistleblower and Complaint Hotlines • Report to Audit Committee • Should set thresholds for immediate reporting • Administered by Corporate Compliance Officer and/or Internal Auditor • Significant allegations communicated quarterly • Annual summary to be reviewed by Audit Committee 68
GOVERNANCE PARTNERS GROUP RISK AND CONTROLS AUDIT COMMITTEE ROLE • Risk management is intertwined with a Company’s system of internal controls • Audit Committee traditionally focuses on financial reporting risks • Focus on compliance and other risks as well • Audit Committee needs to develop an agreement on specific risk management responsibilities 69
GOVERNANCE PARTNERS GROUP RISK AND CONTROLS AUDIT COMMITTEE ROLE • NYSE and other exchanges require discussion of risk management • Audit Committee is not required to be the sole governing body responsible for risk assessment and management • Audit Committee must discuss guidelines and policoies to govern process by which risk assessment and management is undertaken by the Company 70
GOVERNANCE PARTNERS GROUP RISK AND CONTROLS AUDIT COMMITTEE ROLE • Audit Committee must: • Identify whether the process is continuous • Understand how management identifies risks • Assess whether primary risk role is adequately staffed • Understand top identified risks • Understand the roles of the Internal Auditor and Chief Compliance Officer • Coordinate with other Board Committees engaged in similar activities (e.g. Risk Management Committee) 71
GOVERNANCE PARTNERS GROUP RISK AND CONTROLS KEY RISK AREAS, INCENTIVES AND FRAUD RISK • Areas of greatest risk: • Management override of controls • Outside service providers not subject to company controls • Integration of business, culture, ethics, systems following an acquisition • Implementation of restructuring activities • Information Technology issues (e.g. cyber-security breaches) • Bribery risk and violations of Foreign Corrupt Practices Act 72
GOVERNANCE PARTNERS GROUP RISK AND CONTROLS KEY RISK AREAS, INCENTIVES AND FRAUD RISK • Incentives can create fraud risk • CEO pressure is the greatest contributing factor • Financial targets can motivate bad behavior • Compensation plans can create inappropriate risk taking • Typical reasons for fraud: • To meet expectations • To conceal bad news • Personal gain • Pending sale/equity offering 73
GOVERNANCE PARTNERS GROUP RISK AND CONTROLS KEY RISK AREAS, INCENTIVES AND FRAUD RISK • Audit Committee Actions: • Understand scope of responsibility and maintain skepticism • Exercise oversight of the Company’s fraud risk assessment process and internal controls • Consider risk factors that create pressures and opportunities for employees to commit fraud • Assess management integrity and conduct 74
GOVERNANCE PARTNERS GROUP RISK AND CONTROLS KEY RISK AREAS, INCENTIVES AND FRAUD RISK • Audit Committee Actions: • Evaluate whistleblower complaints and tone at the top • Evaluate related party and non-routine transactions • Receive periodic reporting on fraud prevention programs • Assess the need to rotate CFOs at international locations • Be most alert during significant events (e.g. IPOs, acquisitions and divestitures) 75
GOVERNANCE PARTNERS GROUP RISK AND CONTROLS INFORMATION TECHNOLOGY RISKS • Accelerating pace of technological change and increasing role of IT in gaining competitive advantage create new risks • The Audit Committee needs to pay particular attention to IT risks when the Company: • Is in an industry where IT is a large part of the product/service offered • Processes a multitude of transactions and operates several different systems • Is implementing new major high cost technology systems • Is integrating systems of an acquired business 76
GOVERNANCE PARTNERS GROUP RISK AND CONTROLS INFORMATION TECHNOLOGY RISKS • Cloud computing has created a new set of information technology risks: • Third party hosting puts data outsource of Company controls • There are attendant privacy and security issues • There are sensitivities regarding customer data – because encryption is not fool-proof • Data back-up and recovery can be difficult 77
GOVERNANCE PARTNERS GROUP RISK AND CONTROLS CYBERSECURITY RISK • Cyber-security risk has arisen as a result of: • Increasing reliance by business on technology • The rise of new and advanced adversaries who probe for systemic vulnerabilities in IT systems • The rise of adversaries who have competitive, strategic, financial and political motives 78
GOVERNANCE PARTNERS GROUP RISK AND CONTROLS CYBERSECURITY RISK • Audit Committees should: • Understand which corporate officer is ultimately accountable for IT risks and whether this is documented and well understood at the Company • Assess whether this individual is sufficiently empowered and part of the leadership team • Agree on how often to meet and discuss cyber-security with the responsible individual 79
GOVERNANCE PARTNERS GROUP RISK AND CONTROLS CYBERSECURITY RISK • Audit Committees should: • Evaluate whether there is meaningful communication and dialogue regarding IT risks and cyber-security and provide feedback if the presentation of the materials is ineffective • Determine whether IT materials presented to the Board are prepared in a manner that enhances and maximizes the oversight function and, if not, request changes • Evaluate whether the cyber-security related information being presented to the directors enhance and maximize the oversight function 80
GOVERNANCE PARTNERS GROUP RISK AND CONTROLS CYBERSECURITY RISK • Audit Committees should: • Ask whether management took an overarching view of IT risks beyond basic cyber- security when considering reporting cyber-security related information to directors • Evaluate baseline metrics to understand the Company’s current cyber and IT environment and the gaps to achieving its desired cyber state • Discuss and agree on the prioritization of the most important metrics, with a focus on the top 10-15 81
GOVERNANCE PARTNERS GROUP RISK AND CONTROLS CYBERSECURITY RISK • Audit Committees should: • Continue to regularly re-evaluate cyber-metric reporting to directors, updating it for changes in the Company’s maturity, circumstances and current cyber environment • Consider the impact of changes to the Company’s operating environment and broader cyber community on current cyber-metric reporting and consider whether any changes are necessary 82
GOVERNANCE PARTNERS GROUP RISK AND CONTROLS BRIBERY/FCPA VIOLATION RISK • The Audit Committee must understand the Company’s susceptibility to bribery fraud: • A basic understanding of the FCPA and other anti-bribery laws is essential • Compliance and ethics programs mitigate risk • A clear understanding of the Committee’s scope of responsibility is important • Top challenges are local culture and customs, third party agents, distributors and resellers 83
GOVERNANCE PARTNERS GROUP RISK AND CONTROLS BRIBERY/FCPA VIOLATION RISK • Controls should include: • Making anti-bribery training an integral part of all acquisition integration activities • Implementing policies requiring review and pre-approval of entertainment gifts, marketing funds, consulting arrangements and contributions • Including employees, agents and resellers in training • Auditing of expense reports, marketing expenditures, commissions, discounts and fees to agents • Enforcing the consequences of improper behavior to send the right message 84
GOVERNANCE PARTNERS GROUP RISK AND CONTROLS CONSIDERATIONS DURING INVESTIGATIONS • Robust compliance programs are highly correlated to a measurable reduction in fraud exposure • Allegations arise from whistleblower hot-lines, internal audits, external audits or regulatory inquiries • Audit Committee should consider whether an investigation would be appropriate • Input from legal counsel, external auditors and other experts should be considered • External auditors have a duty to report issues to the SEC if the Company and Board do not investigate the issues 85
GOVERNANCE PARTNERS GROUP RISK AND CONTROLS CONSIDERATIONS DURING INVESTIGATIONS The Company should: • Take action quickly • Decide on the investigation team and to whom it will report (e.g. Board, Audit Committee or Special Committee of Directors) • Obtain agreement of external auditors to process and scope becasuse they must rely on the results • Consider the role of management involvement in the investigation so that they do not become absorbed by it • Obtain skilled legal counsle with relevant experience 86
GOVERNANCE PARTNERS GROUP RISK AND CONTROLS CONSIDERATIONS DURING INVESTIGATIONS • The Company should: • Use skilled advisors because internal resources may not be sufficient • Consider notifying investors and relevant regulators • Meet requirements to preserve documents and record the investigative work • Manage communications to the external world via a designated spokesperson • Take appropriate punitive/remedial action against responsible employees • Audit Committee should continuously monitor progress and be informed of findings 87
GOVERNANCE PARTNERS GROUP SPECIAL SITUATIONS ERRORS IN FINANCIAL STATEMENTS • The Audit Committee must be aware of potential errors in the financial statements that could be more than immaterial • If a conclusion is reached that an error is immaterial, contemporaneous documentation of the error is necessary • Intentional errors may be an illegal act and lower materiality thresholds 88
GOVERNANCE PARTNERS GROUP SPECIAL SITUATIONS ERRORS IN FINANCIAL STATEMENTS Restatements of Financial Statements: • Raise questions about integrity of reporting and internal controls • Divert management focus • Lead to significant legal, internal and external audit costs • Can require informing users that previous results should not be relied on • Can prohibit further filings until the investigation of the error is resolved, which may restrict ability to raise capital • Create uncertainty between the date the error is announced and the date the restated financial statements are filed • Can result in a drop of share price 89
GOVERNANCE PARTNERS GROUP SPECIAL SITUATIONS ERRORS IN FINANCIAL STATEMENTS • Areas subject to restatement: • Expense recording • Liabilities, payables, reserves and accrual estimates • Deferred compensation • Revenue recognition • Accounts and loans receivable • Tax provisions 90
GOVERNANCE PARTNERS GROUP AUDIT COMMITTEE PLAN OF WORK FIRST QUARTER • Identify agenda items for the coming year and prepare work plan • Confirmation of independence, review of performance, and appointment of independent auditors • Annual evaluation of Committee’s performance • Review Committee Charter and recommend any necessary changes • Year-end/Q4 financial results and press release • Approve 10-K filing 91
GOVERNANCE PARTNERS GROUP AUDIT COMMITTEE PLAN OF WORK FIRST QUARTER • Internal audit report for quarter • Independent auditor’s report for quarter and prior year end • Review related party transactions • Confirm any requests for waivers from Code of Conduct • Approve report of the Committee for inclusion in the proxy • Conduct executive session without management 92
GOVERNANCE PARTNERS GROUP AUDIT COMMITTEE PLAN OF WORK SECOND QUARTER • Q1 financial results and press release • Approve 10-Q filing • Internal audit report for second quarter • Independent auditors report – including management representation letter from annual audit • Review related part transactions • Confirm any requests for waivers of Code of Conduct • Conduct executive session without management 93
GOVERNANCE PARTNERS GROUP AUDIT COMMITTEE PLAN OF WORK THIRD QUARTER • Q2 financial results and press release • Approve 10-Q filing • Internal Audit report for third quarter • Independent auditors’ report for third quarter • Confirm auditor’s independence and performance, approve retention for current audit 94
GOVERNANCE PARTNERS GROUP AUDIT COMMITTEE PLAN OF WORK THIRD QUARTER Review auditor’s plan for year end audit, SOX audit and approve fees Review related party transactions Conform any requests for waivers from Code of Conduct Conduct executive session without management 95
GOVERNANCE PARTNERS GROUP AUDIT COMMITTEE PLAN OF WORK FOURTH QUARTER Q3 financial results and press release Approve 10-Q filing Internal audit report for quarter Independent auditor’s report for quarter Review related party transactions Confirm any requests for waivers of Code of Conduct Conduct executive session without management 96
GOVERNANCE PARTNERS GROUP SAMPLE AUDIT COMMITTEE MEETING AGENDA Consent Agenda 1. Liquidity Matters 2. Outstanding Legal Matters 3. Consent portion of audit firm agenda 4. Review of other matters, guided by the Checklist of Responsibilities from the Audit Committee Charter Discussion Agenda 5. Call to order 6. Approval of previous meeting minutes 7. Management update on 10-Q status 8. Auditor Report to Audit Committee 9. 10-Q review and approval 10. Press release review 11. Executive session with audit firm 12. Executive session with Internal Auditor 13. Adjourn 97
GOVERNANCE PARTNERS GROUP SPECIAL TOPICS SEC CONCEPT RELEASE • Focus on Audit Committee’s reporting of its responsibilities and activities with respect to its oversight of the Independent Auditor • Three main areas of disclosure • Audit Committee’s oversight of the Auditor • Audit Committee’s process for appointing or retaining the Auditor • Qualification of the audit firm and the engagement team 98
GOVERNANCE PARTNERS GROUP SPECIAL TOPICS SEC CONCEPT RELEASE • Committee’s process for appointing or retaining the Auditor • What is the typical or best process for evaluating the Auditor and deciding whether to retain the current Auditor? • If the Committee elects to change Auditors, how does or should a typical RFP process work? • How important are the audit fees in the Committee’s decision? • What roles are played by management, the Committee Chair and other members of the Committee? 99
GOVERNANCE PARTNERS GROUP SPECIAL TOPICS SEC CONCEPT RELEASE • Suggestion of disclosure of details regarding the Auditor • Would disclosure about the audit team’s experience, including the number of prior audit engagements performed and whether the were in the same industry, be useful? • Would disclosure of the names of individual audit partnes a good or bad thing for Audit Committees, or is it primarily an issue for the auditors? 100
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