Few would disagree that we are in troubled economic times that many characterize as an earnings recession. Companies are facing the prospect of diminished earnings, layoffs, restructurings, bankruptcies or even dissolution. In an environment like this, audit committees must be particularly vigilant. It may be true that in tough times the tough get going, and that attitude is certainly desirable and may be what gets organizations through current difficulties. Nevertheless, this can lead to cutting corners and window dressing to cover up real problems. It's up to the audit committee to make sure that this doesn't happen and that the tough are going in the right direction.
One of the most important things the audit committee must do is to ensure that the financial projections and statements issued by the company are based on solid data. Companies are under great pressure to keep the value of their stock up by giving out good news. Analysts are unrelenting in their demands for improved earnings and management is pressured by its stockholders to meet these demands. In troubled times it is easy to slip into a mode of making things "look good". This short-term approach may take some immediate heat off management but it can have disastrous long-term consequences. The penalties for misleading markets, stockholders and regulators can be severe and can often lead to the demise of a good company.
The audit committee should be the ultimate guardian of ethical practices within any well-managed company that has established a sound corporate governance program. Hopefully, your audit committee has already set a "tone at the top" that makes it clear that only the highest ethical standards will be acceptable and that even seemingly minor things like taking of supplies or improper expense account items cannot be condoned. This tone must permeate the organization so that at every level it is clear that there is not tacit approval of any unethical practice, even one presumably taken with good intentions and without personal gain.
A good corporate tone should help minimize problems but in tough times more will likely be needed. The audit committee should send out a message reaffirming its position that it will not tolerate any action to make the company look good that involves manipulating numbers. Meetings with the CFO and Comptroller should be held frequently to see how events are unfolding and how financial results are shaping up. Audit committee members, with guidance from the external auditors, should make sure they are satisfied with the numbers to be used for public release.
It should be made very clear to management that statements and written releases that accompany financial statements and projections are to be based solely on the numbers and facts available and that all pertinent data, both positive and negative, should be fully disclosed. The audit committee and the full board must insist that facts not be misrepresented or omitted to put a positive spin on results or projections.
Audit committees should keep in mind that the larger and more far flung an organization is, the more difficult it becomes to monitor its finances. Members should not be shy about getting outside advice to help them formulate the right questions and to help them understand the answers. Also, it would be very useful for audit committees to have straightforward cash flow data to help them see that the cash balances track with earnings data.
The SEC has stated its position on audit committee responsibilities very clearly. As recently as February of this year, the SEC'S Chief Accountant, Lynn Turner, wrote an article in which he stressed the importance of quality, i.e., reliable information to ensure the integrity of equity markets. He also writes about the importance of audit committees in making sure that reliable information is forthcoming. He makes several valuable recommendations to help audit committees strengthen performance, including: holding regular meetings, insisting upon auditor accountability and independence, performing careful reviews of financials, and conducting self- reviews of the committee's policies and functioning.
The ball is clearly in the audit committee's court. If your committee isn't playing up to its potential, it may be time to bring in a new coach or even to field a new team.
James N. Clark, John E. Haupert, and Robert S. Roath are members of the Board of Advisors of Grace & Co. Consultancy, Inc. Prior to their respective retirements, Mr. Clark was Executive Vice President and CFO of The Western & Southern Life Insurance Company and is a member of their Board of Directors; Mr. Haupert was Treasurer of The Port Authority of New York and New Jersey; and Mr. Roath was CFO of RJR Nabisco Holdings Corp. and is Chairman of the Advisory Board of L.E.K. Consulting.
