On October 6, 1999, the Securities and Exchange Commission (the "SEC") proposed new rules and amendments to existing rules "to improve disclosure related to the functioning of corporate audit committees and to enhance the reliability and credibility of financial statements of public companies." Specifically, the SEC's proposals include:
- requiring an independent public accountant to review a company's interim financial statements prior to the filing of Form 10-Q or Form 10-QSB with the SEC;
- requiring the audit committee to include a written report in the company's proxy or information statement stating (i) whether the audit committee has reviewed and discussed the audited financial statements with management and independent auditors and (ii) whether any information has come to the audit committee's attention which would result in the financial statements containing an untrue statement of material fact or omitting to state a material fact necessary to make the statements made, in light of the circumstances under which they were made, not misleading;
- requiring the company to disclose in its proxy or information statement whether their audit committee is governed by a charter, and if so, to include the written charter as an appendix to the proxy or information statement once every three years;
- requiring companies whose securities are quoted on the Nasdaq or listed on the New York Stock Exchange or American Stock Exchange to disclose information in their proxy statements about audit committee members who are not "independent," as defined in the respective listing standards; all other companies, including small business issuers, would be required to disclose whether any of its audit committee members are not "independent" and to disclose which definition of independence was used; and
- adopting a "safe harbor" for the information required to be disclosed to protect companies and their audit committee members from certain liabilities under the federal securities laws.
The SEC stated that the proposals were largely based on the recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees (the "Blue Ribbon Committee"). However, the SEC emphasized that a number of the proposed rules had been modified from the Blue Ribbon Committee's recommendations to address concerns about "certification" of financial statements, statements by the audit committee about compliance with its duties and increased liability for audit committee members. Comments on the proposed rules and amendments must be submitted to the SEC by November 29, 1999.
Certification of Financial Statements. According to the SEC, the Blue Ribbon Committee's recommendation suggested that the audit committee provide a GAAP "certification" of the financial statements. However, the SEC has "modified" this proposal in response to concerns that the audit committee must possess knowledge of all the nuances of GAAP to make such a "certification." The SEC stated that its proposal - which would require disclosure of whether any information has come to the audit committee's attention which would affect the credibility of the financial statements - recognizes that the audit committee will likely rely on the information provided by management and independent auditors, but also requires the audit committee members to ask "tough" questions during the financial reporting process.
Compliance with Audit Committee Duties. While the proposed rules would require disclosure about an audit committee's written charter, the SEC stated that its proposals do not require any statement about compliance with the charter (as was suggested by the Blue Ribbon Committee) or the adoption of a written charter, nor do they dictate the content of any audit committee charter.
Liability of Audit Committee Members. The SEC dismissed the idea that the proposed disclosure would result in greater liability for audit committee members. The SEC stated that "to the extent the proposed disclosure requirements would result in more clearly defined procedures for, and disclosure of, the operation of the audit committee, liability claims alleging breach of fiduciary duties under state law may actually be reduced." The SEC also proposed a liability "safe harbor" to cover the required disclosures. The "safe harbor" would mirror the protection afforded to compensation committee disclosure in proxy statements. In addition, the SEC would not consider the required disclosures to be "soliciting material" "filed" with the SEC subject to Regulation 14A or 14C or to the liabilities of Section 18 of the Securities Exchange Act of 1934 (the "Exchange Act") unless the company explicitly requests that it be treated as soliciting material or incorporates the information by reference into a document filed under the Securities Act of 1933 or the Exchange Act.
Other Proposals. The New York Stock Exchange, National Association of Securities Dealers, and American Stock Exchange also have filed with the SEC proposed rule changes to their respective listing requirements, including those pertaining to audit committees. See Notice of Filing of Proposed Rule Change by the New York Stock Exchange, Inc. Amending Audit Committee Requirements of Listed Companies, SEC Release No. 34-41980; File No. SR-NYSE-99-39; 64 Fed. Reg. 55514 (Oct. 13, 1999); Notice of Filing of Proposed Rule Change by National Association of Securities Dealers, Inc. Amending Nasdaq's Audit Committee Requirements, SEC Release No. 34-41982; File No. SR-NASD-99-48; 64 Fed. Reg. 55510 (Oct. 13, 1999); Notice of Proposed Rule Change by American Stock Exchange, LLC Amending the Exchange's Audit Committee Requirements, SEC Release No. 34-41981; File No. SR-Amex-99-38; 64 Fed. Reg. 55505 (Oct. 13, 1999). *
Audit Committee Disclosure, SEC Release No. 34-41987; File No. S7-22-99; 64 Fed. Reg. 55648 (Oct. 14, 1999).