Sarbanes Does Not Change a Director's Right of Reliance on Officers and Accountants

John P. Beavers
September 2002

Our lead article describes how the Sarbanes-Oxley Act expands the oversight role of the audit committee to become the ultimate recipient of numerous reports and other communications.

Although the Congressional intent was not to create additional liabilities under federal law for independent directors, the numerous reports and communications required to flow to audit committees and independent directors will not only increase the knowledge of these independent directors, but also increase their liability under state corporate laws. The increased knowledge will likely increase the degree of care that directors must take in order to comply with their fiduciary duty of care under state law.

However, nothing in Sarbanes-Oxley changes the right of reliance of independent directors upon officers and professionals. Under all state corporation laws, the role of directors is to direct the management of, and not to manage, the corporation. Directors perform this role by delegating. Almost all state corporation laws like Ohio’s entitle directors, in performing their duties, to delegate to and rely upon:

• Officers and employees as to matters which the directors reasonably believe the officers are reliable and competent; and
• Professionals such as public accountants as to matters which the directors reasonably believe are within the person's professional or expert competence.

An audit committee may continue to delegate to and rely upon officers and employees, especially the CFO and the internal auditor as to matters for which the audit committee has reason to believe that these officers and employees are reliable and competent. An audit committee may also continue to rely upon the independent auditor as to matters which the audit committee reasonably believes are within the auditor’s professional competence. Audit committees should ask the CFO, internal auditor and the independent auditor to:

• Regularly contribute to the agenda for audit committee meetings;
• At least annually at the beginning of each year determine the scope of engagement (including audit and any non-audit services), fees and other terms of the engagement, and work to be performed by the independent auditor for the year;
• At least annually at the beginning of the year identify and explain critical accounting policies for the year;
• Immediately bring to the audit committee’s attention any discrepancies in internal controls or disagreements between management and either the internal or independent auditor;
• Immediately bring to the audit committee’s attention any attempt by any director or officer to interfere or obstruct implementation of internal controls or the independent auditor’s examination and auditing process;
• At least quarterly review with the audit committee key performance measures from each of the quarterly and annual financial statements, comparing results to budget and prior year results, explaining nonrecurring transactions and their impact and explaining key measures with respect to each statement;
• At least quarterly review with the audit committee Management’s Discussion and Analysis of the financial statements;
• At least annually review management’s evaluation of the effectiveness of internal controls and the independent auditor’s attestation of that evaluation;
• At least annually review the independent auditor’s audit report, including the areas of emphasis, the measures used for determining materiality, the risks assessed in the process, the audit testing performed, any proposed significant audit adjustments, any disagreements with management, any consultation or reliance on independent auditors and conclusions regarding the presentation of the financial statements.

Finally, audit committees should remember that they are relying on a three-legged stool: the CFO, the internal auditor, and the independent auditor. Rather than rely on just one of the legs, the committee should to the extent possible design their agenda so they can relay upon all three. Any questions asked of one of the three should be asked of the others. Although consistent responses will validate the audit committee’s reliance, different responses will trigger additional inquiry by the committee, including possible inquiry of additional experts.

The audit committee’s right of reliance on others for these matters is subject to the committee’s having reasonable grounds to believe that, with respect to officers and employees, they are reliable and competent in those matters and, with respect to the independent auditor, the matters are within its professional competence. In any case of doubt, the audit committee should consult with independent legal counsel for guidance as to its right of reliance. The fees of any independent counsel for such advice are required to be paid by the company.