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  • Generally Accepted Auditing Standards (GAAS) require that outside auditors discuss with Audit Committee the auditors judgement about the quality, not just the acceptability of the Company’s accounting principles as applied in its financial reporting
  • Recommends that SEC require all companies to include Audit Committee Letter in their Annual Report to shareholders and 10-K

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    • Improve audit committee effectiveness
    • Increase oversight diligence by audit committees
    • Reduce cases of improper financial reporting as a result of these improved audit committee practices.
    Audit Committee Effectiveness
  • Warning Signs for Risk of Financial Fraud
    • Unusual results or trends relative to industry
    • Overt pressure by CEO on Operating Heads to “Make the Numbers”
    • Unrealistic earnings expectations by financial community fueled by management’s unrealistic growth goals
    • Complex organizational structures or transactions
    • Inexperienced management in concert with rapid growth rate
    • Frequent organizational changes and high turnover of senior management
    • Autocratic management and inappropriate “Tone at the Top”
    Warning Signs for Risk of Financial Fraud
    • Excessive or inappropriate performance based compensation
    • Ongoing or prior investigations by regulators or others
    • Untimely reporting and responses to Board and Audit Committee
    Warning Signs for Risk of Financial Fraud
  • Earnings Management SEC Perception
    • Overstatement of “Big Bath” charges
    • Misuse of acquisition accounting
    • Creation and use of “Cookie Jar” reserves
    • Premature revenue recognition
    • Improper deferral of expenses
    • Misuse of materiality concept
  • Chairman Levitt’s Action Steps
    • Request Public Oversight Board to review effectiveness of audits
    • Establishes Blue Ribbon Panel on Audit Committees
    • SEC makes inquiries of companies that report significant write-offs in 1998
    • Detailed review of accounting issues on registration statements filed with the SEC
    • SEC staff to issue Accounting Bulletins on: Revenue Recognition, Recording of Reserves and Materiality
    • Formation of Earnings Management Task Force by Division of Corporate Finance and close coordination with Enforcement Division
    • Requests AICPA to review rules on Auditor Independence - creation of Independence Standards Board
    Chairman Levitt’s Action Steps
    • Independence of Audit Committee Members
    • Composition of Audit Committee
    • Qualifications of Audit Committee members
    • Adoption of Audit Committee Charter
    Blue Ribbon Panel Recommendations
    • SRO
    • SRO
    • SRO
    • SRO
    • Disclosure in Proxy Statement about Charter and compliance therewith
    • Outside auditor is accountable to Board of Directors
    • Outside auditors provide Audit Committee with written Statement on Independence
    Blue Ribbon Panel Recommendations
    • SEC
    • SRO
    • SRO
    • Outside auditors discuss with Audit Committee their judgement about quality of accounting principles
    • Audit Committee Letter in Annual Report
    • Quarterly SAS 71 reviews and discussion of results with Audit Committee
    Blue Ribbon Panel Recommendations
    • AICPA
    • SEC
    • SEC/AICPA
  • Independence of Audit Committee Members - #1 (SRO)* Committee members are considered independent if they have no relationship with the corporation that may interfere with the exercise of their independence from management. FEI supports this provision, but suggests that “exceptional and limited” cases of important directors be allowed to serve if the full Board finds it in the best interest of the Company. Exceptions would then be disclosed in the proxy. * For Companies with market capitalization over $200 million
    • Director being employed by corporation (or affiliates) for current and any of the past 5 years
    • Director receiving compensation other than for Board service
    • Director being related to anyone who has been executive officer of the corporation in any of the past 5 years
    Independence of Audit Committee Members - #1 (SRO) Examples of conflicts of independence are:
    • Director being a principal or executive officer of an entity to which the corporation made or received payments in amounts that are significant to the corporation or entity
    • Director being employed as executive of another company where any of the corporation’s executives serve on that company’s Compensation Committee
    Independence of Audit Committee Members - #1 (SRO) Examples of conflicts of independence, continued:
    • All listed companies with market capitalization above $200 million should have Audit Committee comprised solely of independent directors
    • FEI supports this provision
    Composition of Audit Committee - #2 (SRO) In addition to compliance with definition of independence (in Recommendation #1):
    • Audit Committee should be comprised of a minimum of three directors
    • Each member should be financially literate or become financially literate within a reasonable period of time after appointment
    • One member of Committee should have accounting or related financial management expertise
    • FEI supports this provision.
    Qualifications of Audit Committee Members - #3 (SRO)* * For Companies with market capitalization over $200 million
    • Adopt a formal, written Charter that is approved by the full board
    • Specify the scope of responsibilities and how those responsibilities are carried out, including structure, processes and membership requirements
    • Review and reassess the adequacy of the Charter on an annual basis
    • FEI supports this provision
    Adoption of Audit Committee Charter - #4 (SRO)
    • Company is required to have its Audit Committee disclose in its annual Proxy Statement whether Audit Committee has adopted a formal written Charter
    • Audit Committee to also state whether it satisfied its responsibilities in compliance with Charter
    Disclosure in Proxy of Charter and Compliance Therewith - #5 (SEC)
    • Charter is to be disclosed triennially in annual report or proxy and in any year after significant amendments are made to the Charter
    • It is recommended that SEC adopt a “Safe Harbor” applicable to all disclosures in this Recommendation #5
    • FEI supports this provision.
    Disclosure in Proxy of Charter and Compliance Therewith - #5 (SEC)
    • Charter to specify that outside auditor is ultimately accountable to Board of Directors and the Audit Committee as representatives of shareholders
    • The above representatives have ultimate authority and responsibility to select, evaluate and where appropriate replace the outside auditor or to nominate an outside auditor to be proposed for shareholder approval in Proxy
    • FEI generally supports this so long as there is no limitation on the ability of the Board to specifically delegate responsibilities it deems appropriate.
    Outside Auditor is Accountable to Board of Directors - #6 (SRO)
    • Charter to specify that Audit Committee is responsible for obtaining a formal written Statement of Independence from outside auditors
    • Statement should delineate all relationships between auditor and company and be consistent with the Independence Standards Board (Standard 1)
    Outside Auditors Provide Audit Committee with Written Statement on Independence - #7 (SRO)
    • Audit Committee is responsible for actively engaging in a dialogue with the auditor with respect to any disclosed relationships or services that may impact the objectivity or independence of the auditor
    • FEI supports this but does not want to see the restrictions on corporations’ ability to hire accounting firm personnel
    Outside Auditors Provide Audit Committee with Written Statement on Independence - #7 (SRO)
    • Discuss quality, not just the acceptability of accounting principles as applied in financial reporting
    • Include:
    Outside Auditors Discuss with Audit Committee Their Judgement About Quality of Accounting Principles - #8 (AICPA)
    • clarity of financial disclosures
    • degree of aggressiveness or conservatism of accounting principles and underlying estimates
    • other significant management decisions regarding financial disclosures
    • FEI does not support this recommendation because:
    Outside Auditors Discuss with Audit Committee Their Judgement About Quality of Accounting Principles - #8 (AICPA)
    • Very concerned that this moves the audit committee out of oversight role and into management’s and the auditor’s role
    • A THREE-WAY DISCUSSION should take place on the most appropriate accounting policies between the audit committee, management and the outside auditor
    • Letter should disclose whether or not:
    Audit Committee Letter in Annual Report - #9 (SEC)
    • Management has reviewed the audited financials with the Audit Committee, including a discussion of the quality of the accounting principles applied, etc.
    • The outside auditors have discussed with the Audit Committee their judgements regarding the quality of principles applied, etc.
  • Audit Committee Letter in Annual Report - #9 (SEC)
    • Members of the Audit Committee have discussed information disclosed to them by management and outside auditors
    • The Audit Committee, in reliance on the above, believe that the company’s financials are fairly presented, in all material respects, in conformity with GAAP
    • It is recommended that the SEC adopt a “Safe Harbor” applicable to any disclosure in this recommendation
    Letter should disclose whether or not:
  • Audit Committee Letter in Annual Report - #9 (SEC)
    • FEI opposes this requirement because it is putting the Audit Committee into an audit and attest function as opposed to an oversight function.
    • The proposal would be supported under the following conditions:
    • Eliminate requirement for audit committee to affirm compliance with GAAP - not AC’s job.
    • Include details on how it carried out its responsibilities as addressed in recommendation #4.
    • Requirements in #4 and #9 should be combined
  • Quarterly SAS Reviews and Discussions of Results with Audit Committee - #10 (SEC)
    • Requires that outside auditor conduct a SAS 71 interim financial review prior to company filing its Form 10-Q
    • Recommends that SAS 71 be amended to require outside auditors to discuss significant issues with at least the chairman of the Audit Committee, including:
    • significant adjustments
    • management judgements and accounting estimates
    • significant new accounting policies
    • disagreements with management
  • Quarterly SAS Reviews and Discussions of Results with Audit Committee - #10 (SEC)
    • FEI’s concern is that NO PROVISION is
    • made for cost/benefit considerations
    • - we agree the auditor should at all times have access to the audit committee if the need arises
    • Certain provisions seem bureaucratic and unwarranted. Will add to “going through the motions” syndrome.
    • Audit committees that are “going through the motions” of oversight without exercising strong, independent and objective oversight on behalf of the shareholders.
    Problem Identified
    • Economy, free market and incredible liquidity - no doubt, but structural factors too
    • Independent accounting standards
    • Audited financial statements certified by independent third parties
    • High standards of corporate financial reporting
    • System of corporate governance
    • Legal system and highly evolved corporate, securities case law
    • Incredible evolution of facilitators - rating agencies, analysts, investment and commercial bankers
    What Makes America’s Capital Markets so Great?
    • Participants
      • Shareholders
      • Board of Directors
      • Management and employees
      • The Public
    Corporate Governance in America
    • To ensure that the corporation operates in the best interests of its shareholders
    • Representative methodology
      • Annual election of directors
      • Major matters require the vote of shareholders
        • issuance of stock, mergers, changes to bylaws
    • Boards operate through committees
      • audit, compensation, nominating, executive, finance
    Goals of Corporate Governance
  • The Three Legged Stool of Financial Reporting 1. Company financial management 2. Board including the audit committee 3. External auditors Each has a role. Each has certain specialties and capabilities in terms of expertise, time and depth of familiarity.
    • The Audit Committees key role in monitoring the other component parts of the audit process
    • Independent communication and information flow with internal auditors
    • Independent communication and information flow with outside auditors
    Audit Committees Best Practices
    • Candid discussions with management, the internal auditor and outside auditors regarding issues implicating judgement and imparting quality
    • Diligent and knowledgeable membership
    Audit Committees Best Practices