15 June 2012

FEE recommends improvements to the functioning of audit committees

In 2010 and 2011, the EC took a number of initiatives to strengthen corporate governance and, in particular, audit committees. FEE generally supports the Commission’s proposals, along with other proposed measures aimed at enhancing the role of the audit committee, and the FEE Discussion Paper on The Functioning of Audit Committees (see below) aims at putting these initiatives into perspective.

A strong and competent audit committee is part of the overall sound corporate governance system in a company. The corporate governance system is in place to ensure the quality of the financial information provided by the company as well as contributing to minimising financial, operational and compliance risks within the company.

Experiences with the functioning of audit committees vary across Europe. This is mainly due to distinct legislative traditions in various countries which have led to differences in corporate governance structures as well as in the functioning of audit committees.

The requirements related to audit committees according to the 2006 Statutory Audit Directive have set out some common ground for audit committees and their functioning. Over the last couple of years, audit committees have found their place in the general governance structures of European public interest entities. Experience within audit committees is increasing and certain areas for further improvement are becoming apparent.

FEE President, Philip Johnson, says: “FEE believes that strong audit committees are essential for the quality of financial information provided by companies. Based on national experiences, improvements could be achieved by clarifying the competences and the responsibilities of the audit committee and the reporting to and from the audit committee. This would be beneficial to companies and their stakeholders and would ensure an improvement in the quality of financial reporting, overall internal control and risk management.”

Stimulating closer cooperation throughout the audit engagement, especially the exchange of high quality information between audit committees and the external auditor, will be of great benefit to the company and to the external auditor. To this extent, and considering that one or more members of an audit committee are often trained accountants, FEE is aiming at enlarging and widening the debate regarding the functioning of audit committees.

Deadline for comments on this discussion paper is 28 September, 2012.

Regarding the composition, the independence and the competence of audit committee members:

1. FEE recommends that it is further clarified that the audit committee acts as a subcommittee of the board.
2. FEE recommends that all members of the audit committee are non-executive directors, regardless of whether the member is appointed by the board or by the shareholders. This would implicitly entail that management or even the CFO of the company is not to be a member of the audit committee, neither to chair the audit committee.
3. FEE supports the EC proposals to require that the majority of the members of the audit committee to be independent as well as requiring that the chair of the audit committee is independent.
4. FEE recommends that the collective competence of the audit committee should reflect the appropriate skills needed to carry out the work in a responsible manner. This would reflect the collective responsibility that the audit committee has, and would be an appropriate principles-based approach, which also gives due consideration to the complexity of the company as a whole. This also impacts the decision on what the appropriate number of members in the audit committee should be.
5. FEE recommends that more guidance is provided as to what is understood as “competence”. Such guidance could for instance indicate that a university degree in economy or finance, a professional qualification from a relevant professional organisation or significant professional and practical experience in accounting and/or auditing qualify as “competence” for an audit committee member.
6. FEE recommends that the audit committee is sufficiently diverse in its membership based on the principle of “the best person for the job”. In this approach, due care should be given to the competences, qualifications and the collective responsibilities of the audit committee, whether or not this entails more differences in gender, background, age, ethnicity, etc.
7. Regarding responsibilities of the audit committee: FEE recommends that the responsibility of the audit committee vis-à-vis the board and other board committees is clarified. This should include guidance on delegation of decision-making power and coordination between board committees and in relation to obtaining additional advice on specific matters from external parties, such as from the external auditor.
8. FEE supports the EC proposal to reinforce the audit committee’s evaluation of internal control, internal audit and risk management functions, and recommends that the practical discharge is further specified, especially in relation to the evaluation of the efficiency and effectiveness of internal control and risk management. Such clarification should include references to review of judgements of key or critical accounting policies and estimates. This will also enforce the tools available for the audit committee, including making the clear link between internal control, internal audit and risk management.
9. FEE recommends that the audit committee carries out regular assessments of:
   1. The cooperation between the external auditor and the audit committee. This assessment should be based on criteria developed by the audit committee that can support an efficient tender process.
   2. Self-assessment of its own work and functioning. The self-assessment should preferably include an assessment of possible improvements regarding the relationship with the board and other board committees. The audit committee should have sufficient resources at its disposal to carry out such assessments.
10. FEE recommends that the appointment of the auditor is done in a principles based manner that is easily applicable by companies. This will facilitate the selection process led by the audit committee to be efficient and will limit the company’s costs incurred for the appointment of the external auditor as much as possible.

Press release

Discussion Paper

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