BoardMatters Quarterly, June 2012
What’s in your charter?
Questions for the audit committee to consider
- When was the audit committee’s charter was last modified?
- Does the charter define the responsibilities of the audit committee chair?
- Is the charter tailored to reflect company-specific needs or is the language largely boilerplate and applicable to any company in any industry?
- Has the committee updated the charter for its risk oversight responsibilities, including those in non-traditional risk areas?
While similar provisions appear in all charters, each audit committee should tailor its charter to meet the unique characteristics of its company.
A review of the audit committee charters of the largest companies
An audit committee charter summarizes the roles and responsibilities of the committee and outlines its scope, structure and processes.
Modern charters have their origins in U.S. Securities and Exchange Commission (SEC) and stock exchange listing rules that were intended to improve audit committee effectiveness. Charters were later standardized by the Sarbanes-Oxley Act of 2002. Charters must address the following at a high level:
|1||Audit committee membership criteria focused on independence and composition|
|2||The relationship between the audit committee and the independent auditor|
|3||Procedures regarding accounting, internal controls and audit matters|
|4||The authority of the committee to engage independent counsel and other advisors|
|5||Audit committee funding|
In general, audit committees must maintain and assess their charters annually and disclose their charters at least once every three years. These requirements help investors and regulators understand and evaluate an audit committee’s specific roles and responsibilities, as well as its approach to risk oversight.
Nearly half of Fortune 100 companies disclosed that they updated their audit committee charters in the last 18 months (see Figure 1). Also, most charters set the minimum number of audit committee meetings required per year, which is typically four (see Figure 2).
Figure 1: Last update to charter1
Figure 2: Minimum number of audit committee meetings required by the charter2
But in practice committees meet much more often. For S&P 100 companies in 2011, the median number of meetings was nine.3
We recently reviewed the current audit committee charters of the 92 publicly traded Fortune 100 companies. We looked at how the charters addressed more than a dozen topics related to audit committee members and their responsibilities, including:
- The responsibilities of the audit committee chair
- The appointment and removal of audit committee members
- The relationship between the audit committee and the head of internal audit
Our review shows that most charters go beyond the minimum requirements when defining the roles and responsibilities of audit committees. However, the language in these charters is largely boilerplate.
The SEC has acknowledged that while similar provisions appear in all charters, each audit committee should tailor its charter to meet the unique characteristics of its company, including size, industry and organization structure.
Some charters stand out by providing a more strategic perspective and purpose. Committees that create these charters use them to set the tone at the top for considering risk, and to communicate that “risk” may include non-traditional matters, such as corporate sustainability.
Most committees doing more than expected
The vast majority of audit committee charters go beyond the minimum requirements.
- Three-quarters state that revisions to the charter require approval from the board or governance committee. One-third of the charters require the committee to conduct a self-evaluation at least annually and to present the results to the board or governance committee. Involving the board or governance committee in charter revisions and the performance review produces greater board involvement.
- Two-thirds discuss that the committee may appoint and remove individual committee members, and some explicitly state that the board may remove the entire committee.
- Nearly half of the charters augment the audit committee’s basic authority to retain outside experts and advisors by emphasizing that the committee can conduct special investigations and/or has access to all personnel, books, records and facilities.
Where the biggest differences are — and potentially the greatest area for improvement
Some audit committee charters have significantly different language than other charters.
For example, while almost two-thirds of the charters discuss the chair selection process, only about a third of the charters we looked at spell out the responsibilities of the audit committee chair, and these issues are defined and outlined in ways that are unique to the companies.
It is important for charters to address the duties of the audit committee chair, given the expectations for the chair in setting committee agendas, managing information flow and working with other committees.
A little more than a dozen of the 92 charters included in our review tailor the discussion of risk management to the company’s specific circumstances, while the others rely on the standard language in regulatory and exchange listing requirements. And while audit committees frequently work with other board committees and business units, only about 10% formalize this interaction in their charters.
We also noted that less than one-quarter of the charters in our study give the audit committee oversight of compensation decisions for the head of internal audit. More than half of the charters provide a detailed discussion of the committee’s authority to review the appointment or removal of that individual.
Oversight of compensation is strongly tied to performance oversight.
While a handful of charters stood out by communicating higher expectations for accountability, engagement and performance, most of the charters we reviewed were inconsistent in addressing the full range of committee responsibilities.
The quality of each charter depends on the efforts of the specific audit committee and the extent to which the committee is active and engaged in developing and modifying the charter.
1 Based on disclosure on company websites; 2012 data as of 20 April.
2 Based on our April 2012 review of the audit committee charters of 92 publicly traded Fortune 100 companies.
3 Corporate Governance Practices and Trends, Fenwick & West LLP, 2011.