The Sarbanes-Oxley Act and SEC rulemaking have placed a duty on public companies to determine if their audit committees contain a financial expert and disclose this in their financial statements. If a company decides that its audit committee does not have at least one financial expert, the firm must tell investors the reasons why. Companies must also disclose the name of the expert and whether the expert is independent of management.

With only a limited transition period for compliance, it is not too soon for companies to begin making this assessment. Companies must comply with the audit committee financial expert disclosure requirements in their annual reports for fiscal years ending on or after July 15, 2003. Recognizing that smaller businesses may have the greatest difficulty attracting qualified audit committee financial experts, the SEC will allow small business issuers to comply in their annual reports for fiscal years ending on or after December 15, 2003.

According to the SEC, the primary benefit of having a financial expert serving on the audit committee is that the person, with his or her enhanced level of financial sophistication, can serve as a resource for the audit committee as a whole in carrying out its functions that are so important to good corporate governance.

Sarbanes-Oxley and the SEC rules detail five specific attributes an audit committee member must have in order to be considered an expert. The member must understand generally accepted accounting principles and have the ability to assess the general application of GAAP in connection with the accounting for estimates, accruals and reserves. The member must also have experience preparing, auditing, analyzing or evaluating financial statements that present complex accounting issues, as well as an understanding of internal controls and procedures for financial reporting. Finally, the member must understand audit committee functions.

In addition, the SEC requires that the member must have acquired such attributes in a specific way. The attributes must be acquired by education and experience as a principal financial officer, principal accounting officer, or auditor or experience actively supervising such persons. The attributes can also be acquired by experience overseeing the performance of companies or public accountants with respect to the preparation, auditing or evaluation of financial statements, or by other relevant experience. Under the rules, if a person qualifies as an expert by virtue of possessing "other relevant experience," the company must briefly list that person's experience.

Thus, the SEC's definition of an audit committee financial expert has two prongs. The first part details the attributes that an audit committee financial expert must possess, while the second part discusses the means by which a person must acquire the necessary attributes.

Bear in mind that the financial expert must possess all five attributes. The fact that the audit committee as a whole collectively possesses the five requisite attributes does not satisfy the requirement.

The SEC rules give the company's board of directors in its entirety the duty of determining if the audit committee has a financial expert within its ranks. For foreign private issuers with a two-tier board, the supervisory or non- management board must make the determination.

In order to assist companies, the SEC has granted a safe harbor under which the mere designation of the audit committee financial expert would not impose a higher degree of individual responsibility on that person, nor would the designation decrease the duties of other audit committee members or the board of directors. This safe harbor clarifies that any information in a registration statement reviewed by the audit committee financial expert is not "expertised" unless such person is acting in the capacity of some other type of traditionally recognized expert. Similarly, because audit committee financial experts are not experts for purposes of Section 11 of the Securities Act, they are not subject to a higher level of due diligence with respect to any portion of the registration statement.

It must be remembered that the role of the financial expert is to assist the audit committee in overseeing the audit process, not to audit the company. A conclusion that a financial expert is an "expert" for purposes of Section 11 might suggest a higher level of due diligence than is consistent with the audit committee's oversight duties.

This column solely reflects the views of its author, and should not be regarded as legal advice. It is for general information and discussion only, and is not a full analysis of the matters presented.

 

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