AUDIT COMMITTEE –
PROACTIVE, REACTIVE OR COSMETIC
[EFFECTIVENESS]
1.0 Introduction
1.1 Audit Committees [AC] have been generally established in various organizations be they Government or Non-Government Organizations, Commercial or Others. They are established voluntarily or in compliance with the constitution or under rules under which they are established or mandated under specific laws of the country. Organizations that seek external funding or manage public funds or are subject to the relevant regulatory authorities are generally mandated to establish AC. The main objective of establishing AC is that the investing public, financiers and the regulatory authorities need some assurance about the internal controls, their implementation and effectiveness in the organizations’ operations and management. It is generally mandated that the AC will be composed mainly of independent members with high level of integrity and ethical behavior. This article will make reference to public companies that are listed on the Malaysian Stock Exchange known as Bursa Malaysia. However the principles are generally also applicable though with some modifications in other countries.
2.0 Statutory Requirements
2.1 The Stock Exchange [‘Exchange’] listing requirements make it mandatory for companies seeking listing on the ‘Exchange’ to appoint an AC. The objective is to ensure that the companies comply with the specified accounting standards, financial reporting standards and disclosure policies developed and administered by the ‘Exchange’. Also the companies are expected to follow certain practices aimed at maintaining appropriate standards of corporate responsibility, integrity and accountability to shareholders and the investing public. These are consistent with the ‘Exchange’s commitment to encourage high standards of corporate disclosures to enable a level playing field. The listing requirements normally also prescribe the minimum number of members of AC and those who may not be appointed to the AC such as those with criminal records. It may be further mandated that the AC will include representatives from disciplines such as member with professional accountancy qualification and that the majority of the members shall be Independent and Non-Executive.
2.2 The main statutory functions of the AC, among other functions, would normally include the follows:
[a] To review with the external auditor [Auditor], the audit plan and his evaluation of systems of internal accounting controls and audit reports. Also to review the assistance given by officers to the Auditor, scope and result of the internal audit procedures; the balance sheet and profit and loss account received and to submit them to the Board of Directors (BOD) and any related party transactions and such other functions as may be agreed by the AC and BOD;.
[b] To nominate’ persons as Auditors;
[c] Auditor has the right to appear and be heard at AC meetings and subject to be called by the AC. On request of the auditor, AC meeting shall be called to consider any matter the Auditor believes should be brought to the attention of the directors or shareholders; and
[d] To regulate its own procedures.
3.0 Audit Committees in ‘Exchange’ Listed Companies
3.1 The Annual Reports [AR] issued by the listed companies, among other matters especially the past financial performance and results achieved, with statements accompanied with relevant notes and plans for future progress, also generally faithfully reproduce some of the requirements of the relevant regulatory sections. Others will provide detailed profiles with photographs of the members of the AC and key management members and provide additional information pertaining to terms of reference, functions, number of meetings held and the attendance during the financial year. Also reproduced are the statements pertaining to corporate governance and internal controls. Also included are Statement of Directors’ Responsibility, Statutory Declaration and External Auditor’s Certificate. This appears to be the extent of compliance of the prescribed requirements of the ‘Exchange’.
3.2 The AR does not provide any information regarding the views of the AC on the progress achieved by the company especially in the case of any losses suffered or written off, high provisions for bad debts, impairment in value of assets or investments, individual investment and performance of subsidiaries & associated companies especially those that are dormant or those that may have suffered heavy losses. Other aspects include findings of any reviews undertaken by the Internal Audit Department on the implementation of the approved audit plan, evaluation of systems of internal controls on accounting and other relevant processes/procedures, periodical financial statements or any other important matters agreed with the BOD/Management and any aspect agreed with the external auditors undertaking the statutory audit.
3.3 It is impossible for the shareholders, especially the minority shareholders, to ascertain whether the objectives and the commitment given to the ‘Exchange’ and the relevant regulatory authorities as envisaged in the prescribed regulations have been achieved. Further there is also no way for minority shareholders to ascertain whether the ‘Exchange’ or the relevant regulatory authorities are satisfied with the compliance of the approved statutory requirements.
4.0 Audit Committees
4.1 I have personally attended the AGM/EGM of over forty companies listed in the Malaysian Stock Exchange including companies who are in the top ten companies and are deemed to be corporate leaders. The following situations were observed from the contents of the AR and also from the way the meetings were conducted.
[a] The AC members are selected from the BOD who are voted in by the shareholders at the AGM/EGM. However their selection is dependent on the voting power of the substantial shareholders who may generally also represented on the Board. Further their fees and perks are also indirectly determined by the BOD as it is apparently only a formality that the quantum of fees is subject to approval of the shareholders attending the General Meetings. In rare cases where the attending shareholders were to reject the quantum of fees at the AGM the amounts are subsequently approved as a poll is called for where the substantial shareholders were to cast their vote. Thus though the AC members may be classified as ‘independent’ it is not possible to ascertain or verify whether they do act ‘independently’.
[b] The composition of the AC is generally made of those who have retired either from the pubic or private sectors. The basis of appointment is stated to be that the persons are knowledgeable, prominent members of the society, of high ethical standards and bring with them expertise, experience and ‘connections’ that would bring benefit to the company. The inclusion of a member with financial expertise is mandatory for membership of the AC. However, the regulatory authorities appear to have deemed that it not important that AC members poses knowledge that is relevant to the core activities of the company.
[c] The AC members normally consist of four to six persons who may meet between four to six times in a year. Thus the maximum time spent to discharge their responsibilities varies from 100 to 200 man-hours [based on eight hours per person per meeting] in a year... Further in most cases the AC members may also hold several directorships in addition to managing their own companies/firms not to mention memberships of other organizations including sports organizations. This it is doubtful if the AC members are able to discharge their responsibilities or contribute their expertise as AC members effectively
[d] It is doubtful if the AC members with their limited knowledge are equipped to ask questions that are relevant to the core activities of the company’s operations and finances. Thus it may be reasonable to assume that the AC members may be over dependent on the Management and be over trusting and thereby failing in their duties as intended.
[e] All companies provide fixed monthly directors’ fees to AC members who may also enjoy some high value non-monetary benefits and perks that are provided. It has been observed that some companies may also offer options to AC members to subscribe for shares under the ‘Employees Share Option Scheme’ commonly referred to as ESOS under which those allotted such options can opt for these shares, subscribe and acquire them at rates that in most cases have been observed to be more than 15% below market prices. The options are generally exercised during periods when the share prices are on an uptrend [in a ‘bull’ market’] but these options are rarely exercised during periods when the market is on a down trend or when the company is expected to be heading for major losses that would be disclosed. Another cause of the share price increase could be due to anticipated dividends/bonuses that are to be declared from profits that are projected to be higher and also expected receipt of major contracts [for construction companies] or substantial orders for companies products/services. Advance knowledge of these vital aspects and the exercising of ESOS options could be perceived to be ‘conflict of interest’.
[f] The limitations of the AC members would also contribute to the AC members being over dependent on the External Auditors who limit their statutory audit to finance orientated compliance audit. Consequently their certificate only expresses an opinion that accounting standards as approved by the professional organizations and mandated by the regulatory authorities have been complied with. Even in cases when they may have discovered any major irregularity this is forwarded to the Management/BOD and thus the shareholders & investing public would not be aware of any impending financial disaster.
4.2 The above comments are on the Malaysian Stock Exchange. However it is understood that the situation in other developing countries may be substantially similar.
5.0 Recommendations
5.1 It is suggested for relevant authorities to make it mandatory for the AC to provide a detailed report of the audit done on their scope of duties and their findings, recommendations given, their implementation, their effectiveness and benefits derived. This should include information pertaining to the monitory value of equity participation in subsidiary/associate companies on individual basis and also the individual financial performance of each of the subsidiary/associate companies. This is particularly important in the case of corporate leaders where the number of subsidiary/associate companies number in tens and hundreds with financial implications that could be in hundreds of millions. It is equally important as some of the major companies have operations in several foreign countries. These subsidiary/associate companies including those in foreign countries could be substantial contributors to the profits or losses of the company. Also the findings of the External Auditor should be extended to the AC and should be incorporated in the proposed report of the AC.
5.2 It should be mandatory that the AC members poses expertise and knowledge that is relevant to the core activities of the company. This is particularly true in the case of companies such as those involved in construction, manufacturing, etc. where the amounts involved may be in hundreds of millions or billions.
5.3 Directorships in companies should be limited to enable the members of the BOD including AC so as to ensure that the members are in a position to devote sufficient time and contribute their expertise to enable them to discharge their responsibilities effectively. Their involvement in several companies in addition to their personal businesses/firms and other activities such as memberships in other organizations like sports, political, professionals, etc should be taken into account to ascertain their eligibility for membership of BOD/AC and ability to contribute positively to effective operations. Further the period of membership should be prescribed to be a minimum of say three to five years with reasonable quantum of remuneration including perks in whatever name it may be called.
5.4 Present regulations may require BOD members to attend short duration courses on corporate governance that may not be sufficient. AC members should be required to enhance their knowledge on a continuous basis in respect of the core activities of the companies to enable them to function effectively. This training must be extended to the staff of the IAD as they are the ones who do the practical audit and provide the AC the ammunition that would enable it to be effective as intended and protect it from any accusations of negligence and possible legal action by investors who may have suffered losses that may be attributed to investments based on the quality of the AC reports..
6.0 Conclusions
6.1 The shareholders can make the necessary enquiries from BOD but the normal comment generally given is that the contents of the AR are in compliance with the prescribed regulations. The member of the AC may also usually respond with the remark that they are independent and non-executive and have taken the necessary steps to protect the interest of the shareholders especially the minority shareholders. Unfortunately there is no means to verify the validity of the assurances given by the BOD. Further the AC members may not provide the required level of confidence to the investing public especially the minority shareholders. Similarly the audit certificate of the external auditors is also of minimal benefit to the minority shareholders though it is stated to be in compliance with the statutory requirements.
6.2 It is evident that the AC in its present format may not be effective as is envisaged by the regulatory authorities, the investing public and the society. It is my perception that the AC may not be effective due to the under mentioned reasons.
6.3 The regulatory authorities in all countries regularly voice loudly the need for transparency, corporate governance, ethics and other moral values. However it is not possible to ascertain how these are practiced and enforced. It may be noted that it is a rare occurrence where an AC members has been subject to legal action in the event of any fraud in the company whose accounts were subject to the scrutiny of the appointed AC members.
6.4 The fact that the status of the AC is very high as shown in the organization charts of the companies and other organizations it may be perceived that the AC is intended to contribute effectively. However, the present status indicates that the AC serves to be more cosmetic than of any real value. The AC should be pro-active and not be re-active instead of sitting on its high pedestal with minimum or token accountability for its appointment.
It will need the joint effort of the regulatory authorities, the investing public, the Audit professional organizations and AC members to strive to make the AC effective as intended, respected and honorable.
This would remove the perception that the
AC is a cosmetic entry in the organization chart of companies/organizations
And make positive contribution to the operations of the companies/organizations.
************************************************************************
GSK/Mar 07
E-mail: gursharan38@gmail.com sharwant38@yahoo.com
The opinions, beliefs and viewpoints expressed by the various authors and forum participants on this web site do not necessarily reflect the opinions, beliefs and viewpoints of AuditNet®
