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Audit Committee and Board Issues in the Aftermath of Enron
Arthur S. Berner
The recent media coverage of the ENRON crisis and the related Congressional investigations have combined to precipitate new discussions about the adequacy of corporate governance, accounting oversight and financial disclosures. As a result, there is a strong push afoot for new federal requirements in these areas primarily through new SEC regulations. We are again reminded that “bad facts make for bad law” and a crisis often leads to over reactions. Even so, boards of directors and their audit committees must struggle to figure out what all this means to them. While we believe it is still too early to definitively say what boards can learn from the ENRON crisis or how possible new federal requirements will impact them and their audit committees, we expect that for now, boards will want to go back over “the basics” in re-examining certain board policies and the inquiries that they direct to management and their professional advisors.
Corporate fiduciary duties call for directors to be vigilant and fully informed in carrying out their oversight responsibilities. Accordingly, below are the kinds of inquiries and policies that boards are likely to discuss and consider in light of ENRON and new regulatory requirements that may be just over the horizon. Boards should seek input from their management, auditor, legal counsel and other appropriate advisors in assessing these matters. After study and deliberation, directors should exercise their own independent business judgment in deciding whether their current conduct or policies should be modified.
1. INQUIRIES OF THE AUDITORS AND MANAGEMENT POST-ENRON
Below are the kinds of inquiries directed to auditors and management that audit committees may focus on in light of the current aftermath of ENRON.
1.1 Inquiry about the company’s accounting treatment and disclosures with respect to its “special-purpose” entities and other complex financing transactions.
1.2 Inquiry about major disagreements that management may have had with the auditors over any accounting issues.
1.3 Inquiry about accounting policies and practices of the company that would most likely be scrutinized by the SEC or another third party if any were so scrutinized.
1.4 Inquiry about whether there have been any articles, analysts’ reports or other credible third-party sources that are critical of the company’s accounting policies or financial disclosures.
1.5 Inquiry about whether the financial statements and disclosures comport with the disclosure requirements of the federal securities laws notwithstanding their conformity with accounting principles and practices.
1.6 Inquiry about whether there have been (i) any allegations of director or officer misconduct or corporate misconduct by the company (whether made by employees or third parties) or (ii) any violation or waiver or investigation of a violation of the company’s conflict of interest or internal control policies.
2. INQUIRIES OF OUTSIDE AND INSIDE LEGAL COUNSEL POST-ENRON
Below are the kinds of inquiries directed to legal counsel that audit committees may focus on in light of the current aftermath of ENRON.
2.1 Inquiry about major disagreements that may have occurred between legal counsel and management over the form or substance of any public disclosures or other legal matters.
2.2 Inquiry about whether there are any claims, government investigations or other legal matters that might significantly affect the financial statements or risk management.
3. BOARD POLICIES POST-ENRON
Below are the kinds of policies that boards of directors may focus on in light of the current aftermath of ENRON.
3.1 Rotation of external auditors on a regularly scheduled basis.
3.2 Restrictions in the retention of the external auditor for non-audit services and their compatibility to the independence of the external auditor.
3.3 Restrictions in the hiring of employees from the company’s auditor or outside law firm.
3.4 Restrictions on directors (or at least the members of the audit committee) and their affiliates and immediate family members from providing services to the company.
3.5 Increased number of meetings held by the audit committee and the time devoted by the committee to understanding financial statement issues and keeping abreast of accounting developments.
3.6 Need for separate legal counsel and accounting expertise for the audit committee.
We will continue to monitor developments regarding the duties of boards of directors and their audit committees in the aftermath of ENRON. This Client Alert has been prepared by the Corporate/Securities Practice Group of Haynes and Boone. If you have any specific questions or comments about its content, please contact Art Berner 713.547.2526 or Michael Boone 214.651.5552.