October 23, 2003

Completed My Set of Audit

Like collecting baseball cards, we have completed a set of sample audit committee evaluations by obtaining one from each of the Big 4. Subscribers of can review these samples in our “Audit Committee Portal.”

When putting together a committee evaluation, I believe its important to not overwhelm directors with too many questions. Quality over quantity. Its also important to have company-specific questions, particularly questions that probe into the committee’s performance for handling critical matters that arose over the past year. The principal purpose of the evaluation process is continuous improvement.

Two different sets of directors should evaluate the committee, those on the committee and those not on the committee – although questions for those not on the committee often are part of the overall board evaluation. Note that under the PCAOB’s proposal regarding internal control attestations, the independent auditor would be required to evaluate the audit committee’s performance (see paragraphs 56-59 of the proposed standard)! [I find it odd that I haven’t seen a single client memo on this proposal yet, arguably the most important rulemaking of the year.]

Forced and Sudden Auditor Rotation

One of the side effects of the absolute prohibition of certain non-audit services in Section 301 of Sarbanes-Oxley is that a company might suddenly find itself without an auditor with little warning. There is no materiality standard or safe harbor in Section 301 for these prohibitions. Changing an auditor is expensive as the new auditor has to exert a lot of effort to get up to speed and – more often than not – a change results in a restatement.

The first example of this dilemma comes from the Royal Bank of Canada, which had one of its two auditors (Canadian companies often have two auditors, a practice that is now changing) because it performed $200k (Canadian dollars) of non-audit services at a foreign subsidiary.

Audit committees are responsible for ensuring they don’t have this messy – and expensive – situation on their hands. This can be quite a challenge for multinational companies with dozens of audit firms to oversee in far flung places (the Big 4 have loose affiliations with audit firms all over the world that share the same brand name, but really have separate operations – one of the issues implicated by the PCAOB trying to regulate the Big 4 as if they were really only 4 firms).

For subscribers – thanks to Marilyn Mooney of Fulbright & Jaworski – we have posted a nifty chart that audit committees can use to keep track of the various types of audit/non-audit services performed by the independent auditor (its at the bottom of the memo which resides in our “Audit Committee Portal”).

SEC Adopts Amendments to Rule 10b-18 Safe Harbor

At its open Commission meeting yesterday, the SEC adopted changes to the Rule 10b-18 safe harbor. Rule 10b-18 provides a safe harbor from certain market manipulation violations under Rule 10b-5 for issuer repurchases of its common stock that meet certain conditions regarding the manner, timing, volume and price of repurchases.

Thanks to Mike Holliday, based on the oral comments made at the meeting, it appears that the changes include:

– elimination of the exclusion of block purchases from the volume limitation of 25% of the average daily trading volume (ADTV) so that block purchases will now have to be included in the 25% test; block purchases will also be included in the ADTV determination. The modifications adopted will provide a limited block purchase exception that would permit one block trade per week (probably of greatest value to small issuers).

– exclusion of repurchases from the safe harbor during the period from the time of public announcement of a merger, acquisition or similar transaction involving a recapitalization until the completion of such transaction. This would appear to expand the present wording which excludes from the safe harbor a purchase made “pursuant to a merger, acquisition, or similar transaction involving a recapitalization.”

– expansion of merger exclusion from the safe harbor, but the SEC said it was also adopting a limited exception (e.g. whatever activity the issuer had during the 3 months prior to announcement of a merger would be permitted after announcement of the merger. In other words, the issuer could mirror the activity during the 3 prior months. It will be necessary to see exactly how this exception is worded in the adopting release.

– adoption of new disclosure requirements that will require a tabular presentation of information on all purchases of any class of registered equity securities by the issuer or any “affiliated purchaser” as defined in Rule 10b-18, whether public or private purchases, and whether or not the purchases were made under the Rule 10b-18 safe harbor conditions. The table and related footnote information are required in Forms 10-Q and 10-K. The purchase information is required to be presented on a monthly basis for each quarter. The 10-K would report information for the fourth quarter. In addition to information about purchases, certain information about publicly announced repurchase plans or programs is required, including whether the issuer still intends to purchase under the plan or program. This latter point on future intent was opposed by some commenters, but it appears it was retained in the new requirements as adopted.