Nicholas Gomez, Contributor 
Nicholas Gomez
THE MAIN thrust of emerging governance
initiatives lies in establishing clear responsibilities for the major actors within the corporate system and understandably, the role of the board of directors has been given considerable attention. In fact, corporate governance literature is making it increasingly clear that setting the 'right' tone is fundamentally the responsibility of the board and not of management.
The fiduciary responsibility of the board of directors is to protect the assets of shareholders and pursue growth in the company's value. Quite a number of corporate failings have been on account of ineffectiveness at the board level.
Directors can no longer afford to be seen as a group of individuals there merely to rubber stamp decisions taken by executive management. This modus operandi is being forced out by legislative reforms which call directors to take greater responsibility for the financial running of their companies.
The complexity of doing business in the 21st century means that shareholders must be represented by a well resourced board consisting of directors with the right combination of talent, integrity, communication skills and an ability to think strategically.
THE AUDIT COMMITTEE IS THE ENGINE OF AN EFFECTIVE BOARD
The boards of most listed companies are able to properly fulfil their ever increasing responsibilities through its sub committees. The typical ones are the Nomination, Compensation and Audit Committees. Existing and proposed governance codes recognise each of these committees as central to effective board performance. However, it is the audit committee that has received the vast majority of attention in recent times. This is related to the belief that flawed financial reporting processes have played a significant part in a number of corporate scandals. In an earlier article we made the point that an effective audit environment is critical to a properly functioning governance system. This responsibility falls under the purview of the audit
committee.
Internationally, legislation and stock exchange listing requirements mandate audit
committees for all public companies with the stated purpose of overseeing the financial reporting process and audit function (internal and external). The requirement that listed companies have Audit Committees is also in place in Trinidad, Jamaica and Barbados. As corporate reform advances, Audit Committee members must become intimately aware of the specific requirements stipulated under the regulatory rules applicable within their jurisdiction. Audit Committees might also consider going beyond these requirements if it will mean more transparent reporting and effective risk management.
Best practices dictate that Audit Committees have a written charter which clearly outlines significant duties and responsibilities. Given an increasingly legislative context, companies are encouraged to obtain the input of legal counsel when developing and amending its Audit Committee Charter. The typical Charter is usually developed around the headings; organisation and composition, purpose, duties & responsibilities and meetings.
EMERGING AUDIT COMMITTEE BEST PRACTICES
In fulfilling its duties and responsibilities the Audit Committee has at its disposal a number of mechanisms inclusive of; independent external auditors, an internal audit function, and other experts as necessary. The Audit Committee must use these resources in a cohesive manner so as to ensure that the financial reporting process is sufficiently thorough and transparent. Let us consider some of the key duties of today's Audit Committees.
One responsibility being given to the Audit Committee by modern legislation is the authority to hire, terminate and compensate public accounting firms for the conduct of an independent audit of the financial statements. External auditors must therefore report directly to the Audit Committee - not to the entire Board, and certainly not to management. Audit Committees are expected to take due care in ensuring that selected firms are independent and appropriately qualified. In the Caribbean while the Audit Committee is certainly involved in the process of auditor selection, the ultimate responsibility for hiring and de-hiring lies with the shareholders.
Today, Audit Committees have an important role to play in ensuring auditor independence. Legislative reforms are now requiring that the Audit Committee pre-approve all audit and non-audit services performed by the auditor. The principle here is that the Audit Committee must approve those services that it is satisfied will not impair auditor independence.
The Audit Committee is also responsible for addressing critical accounting issues as they arise. Competency in this area is of paramount importance. This point was brought home clearly in the Enron scandal as it is believed that the company's Board and Audit Committee did not have an understanding of a number of accounting treatments being adopted by management and accepted by the company's auditors.
It is for this reason that requirements for a minimum level of financial and accounting expertise among the Audit Committee members are being established. Further, it is not uncommon for disagreements to arise between company management and the external auditors. It is the Audit Committee that must address and resolve these issues and they should have the capacity to do so. On occasion, these matters may be complex and the Audit Committee may invoke their right to retain independent advisors as necessary. International Auditing Standards requires that independent advisors communicate with the external auditors in these circumstances.
Finally, one of the most involving aspects of the SOX legislation is the requirements placed on company management and the external auditor regarding internal controls. The CEO and CFO are required to accept responsibility for and attest to the effectiveness of internal controls. This is covered by Section 302 which also requires management to disclose to the auditor and the audit committee deficiencies in internal controls and fraud involving employees.
MANAGEMENT'S REPORT
Section 404 of the Act requires that the external auditor attest to management's report on internal controls. Audit committees operating in jurisdictions where such rules apply must be convinced in the adequacy of internal controls and the disclosure process being used by management to properly satisfy these requirements. Onerous legislative responsibilities make it critical that Audit Committees are supported by qualified, independent and reputable external audit providers as well as a highly skilled and independent internal audit team.
Caribbean companies and their directors ought to familiarise themselves with best practices and not wait for them to be required by reforms. There are a number of self assessment tools and questionnaires that can be used to gauge the effectiveness of Audit Committees.
Next Week: Internal Audit as an Important Tool of the Audit Committee
Nicholas Gomez is the leader of Assurance & Advisory Business Services at Ernst & Young Caribbean (EYC). EYC is a regional firm providing assurance, tax and business advisory services to a diverse portfolio of clients. This article forms part of a series presenting on governance issues and emerging best practices in the Caribbean context. Email address: Nicholas.Gomez@tt.ey.com. Article researched by Burt Bushell, Business Analyst
Taken from the Financial Gleaner, Friday, September 30, 2005.
