How to Really Make Audit Committees More Effective

Business Lawyer

Volumn 54, Issue 3, 1999, Pages 1097-1111

  Olson, John F ^a  

^a Gibson Dunn and Crutcher LLP   (United States)

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EID: 0033466617     PISSN: 00076899     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (46)

1. REPORT AND RECOMMENDATIONS OF THE BLUE RIBBON COMMITTEE ON IMPROVING THE EFFECTIVENESS OF CORPORATE AUDIT COMMITTEES (1999) [hereinafter MILLSTEIN/WHITEHEAD REPORT], reprinted (without appendices) in 54 BUS. LAW. 1067 (1999) [hereinafter Millstein/Whitehead Report]. Editor's note: Any reference to the Millstein/Whitehead Report's appendices will be to the report as originally published by the committee and to the page numbers therein.
2. Pub. L. No. 95-213, 91 Stat. 1494 (1977) (codified as amended in scattered sections of 15 U.S.C.).
3. See 15 U.S.C. § 78m(b)(2) (1994).
4. See Sentencing Reform Act of 1984 § 217(a), 28 U.S.C. §§ 991-998 (establishing the duties of the U.S. Sentencing Commission); U.S. SENTENCING GUIDELINES MANUAL (1997).
5. REPORT OF THE NATIONAL COMMISSION ON FRAUDULENT FINANCIAL REPORTING, app. I, at 179-81 (1987).
6. Federal Deposit Insurance Corporation Improvement Act of 1991 § 112, 12 U.S.C. § 1831m(g)(1)(A), (j)(1) (1994 & Supp. III 1997).
7. PRINCIPLES OF CORPORATE GOVERNANCE: ANALYSIS AND RECOMMENDATIONS § 3.05 (Proposed Final Draft 1992).
8. COMMITTEE OF SPONSORING ORGS. OF THE TREADWAY COMM'N, INTERNAL CONTROL - INTEGRATED FRAMEWORK (1992).
9. PUBLIC OVERSIGHT BD., DIRECTORS, MANAGEMENT, AND AUDITORS - ALLIES IN PROTECTING SHAREHOLDER INTERESTS (1995).
10. The author is a member of the Blue Ribbon Commission on Audit Committees which is conducting the Center for Board Leadership/NACD study. A report by this commission is expected to be issued by mid-summer 1999.
11. See supra note 1.
12. See, e.g., Am. Stock Ex. Guide (CCH) ¶ 10,021 (requiring that listed companies have at least two independent directors and that an audit committee be established, a majority of the members of which must be independent); Nat'l Ass'n of Sec. Dealers Manual (CCH) Rule 4460(c)-(d) (requiring that listed companies maintain a minimum of two independent directors on the board of directors and that an audit committee be maintained, a majority of the members of which must be independent directors); N.Y.S.E. Listed Company Manual § 303.00 (requiring that listed companies have at least a two-member audit committee composed solely of independent directors).
13. Millstein/Whitehead Report, supra note 1, at 1081, 1082 (Recommendations 2 and 3).
14. See generally id. at 1070-76 (containing recommendations for increasing the independence and effectiveness of the audit committee).
15. See, e.g., State Teachers Retirement Bd. v. Fluor Corp., 654 F.2d 843, 851-53 (2d Cir. 1981) (holding that the plaintiff did not have an implied right of action for violation of stock exchange listing agreement and company manual based on corporation's failure to notify exchange of construction contract); Pittsburgh Terminal Corp. v. Baltimore & Ohio R.R., 509 F. Supp. 1002, 1015-17 (W.D. Pa. 1981) (holding that a listing agreement between a corporation and a stock exchange did not create third-party-beneficiary rights in investors), aff'd in part, rev'd in part on other grounds, 680 F.2d 933 (3d Cir. 1982). Cf. Sparta Surgical Corp. v. National Ass'n of Sec. Dealers, 159 F.3d 1209, 1213 (9th Cir. 1998) ("It is undisputed . . . that a party has no private right of action against an exchange for violating its own rules . . . .") (citation omitted); Spicer v. Chicago Bd. of Options Exch., Inc., 977 F.2d 255, 259-61 (7th Cir. 1992) (reenforcing the notion that § 6(b) of the Securities Exchange Act of 1934 (1934 Act) permits registration of a national securities exchange only if the exchange meets certain conditions and does not grant investors a private right of action against the exchange or exchange members for violating its own rules).
16. Cf. Millstein/Whitehead Report, supra note 1, at 1083, 1087-88 (Recommendations 5 and 9).
17. 17 C.F.R. § 240.14a-8 (1998).
18. See, e.g., General DataComm Indus., Inc., SEC No-Action Letter, 1998 WL 883796 (Dec. 9, 1998).
19. In re Caremark Int'l Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996).
20. See id. at 970 ("[A] director's obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system, which the board concludes is adequate, exists . . . .").
21. See infra note 35 (citing cases).
22. See MILLSTEIN/WHITEHEAD REPORT, supra note 1, app. C (presenting five sample audit committee charters).
23. Pub. L. No. 104-67, 109 Stat. 737 (1995) (codified in scattered sections of 15 U.S.C.).
24. See 15 U.S.C. § 78j-1 (Supp. III 1997) (setting forth the PSLRAs audit requirements). See generally Jonathan C. Dickey, The New Auditor Responsibilities Under the Private Securities Litigation Reform Act, CORP. GOVERNANCE ADVISOR, May-June 1996, at 4; Harvey L. Pitt et al., More than "Classical GAAS": Audits and Corporate Illegality Under the Litigation Reform Act, in 28TH ANN. INST. ON SEC. REG., at 269 (PLI Corp. Law & Practice Course Handbook Series No. B4- 7141, 1996); Harvey L. Pitt & David B. Hardison, New Reporting Obligations for Outside Auditors, NAT'L L.J., Mar. 25, 1996, at B4.
25. See 15 U.S.C. § 78j-1 (Supp. III 1997) (setting forth the PSLRAs audit requirements). See generally Jonathan C. Dickey, The New Auditor Responsibilities Under the Private Securities Litigation Reform Act, CORP. GOVERNANCE ADVISOR, May-June 1996, at 4; Harvey L. Pitt et al., More than "Classical GAAS": Audits and Corporate Illegality Under the Litigation Reform Act, in 28TH ANN. INST. ON SEC. REG., at 269 (PLI Corp. Law & Practice Course Handbook Series No. B4-7141, 1996); Harvey L. Pitt & David B. Hardison, New Reporting Obligations for Outside Auditors, NAT'L L.J., Mar. 25, 1996, at B4.
26. See 15 U.S.C. § 78j-1 (Supp. III 1997) (setting forth the PSLRAs audit requirements). See generally Jonathan C. Dickey, The New Auditor Responsibilities Under the Private Securities Litigation Reform Act, CORP. GOVERNANCE ADVISOR, May-June 1996, at 4; Harvey L. Pitt et al., More than "Classical GAAS": Audits and Corporate Illegality Under the Litigation Reform Act, in 28TH ANN. INST. ON SEC. REG., at 269 (PLI Corp. Law & Practice Course Handbook Series No. B4- 7141, 1996); Harvey L. Pitt & David B. Hardison, New Reporting Obligations for Outside Auditors, NAT'L L.J., Mar. 25, 1996, at B4.
27. Millstein/Whitehead Report, supra note 1, at 1083 (Recommendation 5).
28. MILLSTEIN/WHITEHEAD REPORT, supra note 1, app. C at 68. Although the committee did not "formally endorse" the sample audit committee charters set forth in Appendix C to the report, the sample charters were "advance[d] . . . as illustrations of charters that have been developed as models or employed in actual practice." Id., app. C. at 55.
29. Millstein/Whitehead Report, supra note 1, at 1086 (Recommendation 8).
30. MILLSTEIN/WHITEHEAD REPORT, supra note 1, app. C at 69; see supra note 26 (discussing impact of sample charters).
31. MILLSTEIN/WHITEHEAD REPORT, supra note 1, app. C at 61, 66; see supra note 26 (discussing impact of sample charters).
32. Executive Compensation Disclosure, 57 Fed. Reg. 48,126, 48,138-39 (1992) (codified in part in 17 C.F.R. pts. 228, 229), amended by Executive Compensation Disclosure, 57 Fed. Reg. 53,985 (1992).
33. Millstein/Whitehead Report, supra note 1, at 1087-88 (Recommendation 9).
34. Ira M. Millstein, Introduction to the Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees, 54 BUS. LAW. 1057, 1065 (1999).
35. See, e.g., DEL. CODE ANN. tit. 8, §§ 102(b)(7), 145 (Supp. 1998).
36. See, e.g., Blakely v. Lisac, 357 F. Supp. 255, 263-67 (D. Or. 1972) (requiring a standard of care of defendants in accordance with their degree of involvement as the company's officers, directors, underwriters, and financial and technical advisors); Feit v. Leasco Data Processing Equip. Corp., 332 F. Supp. 544, 578 (E.D.N.Y 1971) (holding inside directors, accountants, and underwriters to a higher duty of reasonable investigation than that of outside directors); Escott v. BarChris Constr. Corp., 283 F. Supp. 643, 696-97 (S.D.N.Y 1968) (rejecting the defendant-underwriters' argument that the standard of diligence for the reasonably prudent underwriter should be solely that of a reasonably prudent director).
37. See, e.g., AUSA Life Ins. Co. v. Dwyer (In re JWP Inc. Sec. Litig.), 928 F. Supp. 1239, 1259-61 (S.D.N.Y 1996) (denying summary judgment to a defendant audit committee accused of being "willfully blind" in its supervision of a fraudulent independent auditor); In re MTC Elec. Techs. Shareholders Litig., 898 F. Supp. 974, 980 (E.D.N.Y 1995) (denying the dismissal motion of defendant audit committee members who "were charged with overseeing the conduct of MTC's accountants"), vacated in part, 993 F. Supp. 160 (E.D.N.Y 1997); Tischler v. Baltimore Bancorp., 801 F. Supp. 1493, 1501-02 (D. Md. 1992) (finding possible validity in a negligence claim against outside directors by virtue of their "special knowledge" of the banking industry and real estate market); Greenfield v. Professional Care, Inc., 677 F. Supp. 110, 114-15 (E.D.N.Y 1987) (denying dismissal motions of defendants assigned to monitor auditing and other company functions); Dubowski v. Ash (In re AM Int'l Inc. Sec. Litig.), 606 F. Supp. 600, 605 (S.D.N.Y 1985) (finding a sufficient complaint against defendant audit committee members who were responsible for reviewing an independent auditor but who were not officers). See also Syracuse Television, Inc. v. Channel 9, Syracuse Inc., 273 N.Y.S.2d 16, 27 (Sup. Ct. 1966) (reasoning that the scope of directors' duties to the corporation is dependent upon their management roles).
38. Millstein/Whitehead Report, supra note 1, at 1082-83.
39. Id. at 1087-88 (Recommendation 9).
40. Securities fraud claims must specify each statement alleged to have been misleading, the reasons why the statement was misleading, and, if the allegation is made on information and belief, must state with particularity all facts upon which that belief is based and which give rise to an inference that the defendant acted with the required state of mind. See 15 U.S.C. § 78u-4(b)(1)-(2) (Supp. III 1997).
41. See supra note 10 and accompanying text.
42. See 17 C.F.R. § 229.305 (1998).
43. Regulation of Securities Offerings, 63 Fed. Reg. 67,174, 67,320-22 (1998) (to be codified at 17 C.F.R. pt. 240) (proposed Dec. 4, 1998).
44. One commentator has even suggested that the certification proposed in Recommendation 9 of the Millstein/Whitehead Report may require audit committees to undertake an activity that would be in violation of state laws that require the licensing of any person who certifies as to the reliability of financial information. Letter from B.W. Vick, Vick & Co. L.L.P., to John F. Olson, Gibson, Dunn & Crutcher, LLP (Feb. 15, 1999) (on file with The Business Lawyer, University of Maryland School of Law); see GA. CODE ANN. §§ 43-3-21, -23, -35 (Supp. 1998).
45. See generally Michael Connor, Regulators Target Bookkeeping Tricks, WASH. POST, Dec. 25, 1998, at B10.
46. Millstein/Whitehead Report, supra note 1, at 1081.