BLUE-RIBBON PANEL ISSUES ITS 10 COMMANDMENTS

Although modestly described as recommendations, the report of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees is likely to have a widespread effect, thanks to the panel's distinguished members and backers: The New York Stock Exchange and the National Association of Securities Dealers formed it last September amid SEC Chairman Arthur Levitt's concernsexpressed publicly and frequentlyabout the audit process. And testifying before the committee were two dozen organizations, including the AICPA, FEI, ISB and IMA. Issued after weeks of testimony and deliberations, the 71-page report has at its center 10 recommendations for strengthening the independence of the audit committee and making it more effective. Briefly, the panel recommends that

1. The NYSE and NASD adopt strict definitions of independence for directors serving on audit committees of listed companies.
2. The NYSE and NASD require larger companies to have audit committees composed entirely of independent directors.
3. The NYSE and NASD require larger companies to have financially literate directors on their audit committees.
4. The NYSE and NASD require each company to adopt a formal audit committee charter and to review its adequacy annually.
5. The SEC require each company to disclose in its proxy statement whether it has adopted an audit committee charter as well as other information.
6. Each NYSE and NASD listed company state in the audit committee charter that the outside auditor is ultimately accountable to the board of directors and the audit committee.
7. All NYSE and NASD listed companies ensure their charters mandate that their audit committees communicate with the outside auditors about independence issues, in accordance with ISB regulations.
8. GAAS require that the outside auditor discuss with the audit committee the qualitynot just the acceptabilityof the accounting principles used.
9. The SEC require the annual report to include a letter from the audit committee clarifying that it has reviewed the audited financial statements with management as well as performed other tasks.
10. The SEC require the outside auditor to perform an interim review under SAS no. 71, Interim Financial Information, before a company files its form 10-Q.

What's it all about?
Levitt called the 10 points a pragmatic program of progressive changes that are designed to be implemented quickly. How can, or should, the report be translated into action? The Journal spoke with John P. McAllister, CPA, PhD, professor of accounting and chairman at the Michael J. Coles College of Business, Kennesaw State University, Kennesaw, Georgia. The report's analogy of a three-legged stoolaudit committee, company financial management and outside auditoris insightful, he said. However, he found daunting the report's challenge to the audit committee to be first among equals. He said, This would involve a tremendous paradigm shift in the world of financial reporting, noting that audit committees, unlike the other two groups, work only part-time. I don't see how these recommendations can be quickly implemented.' For CPAs, McAllister thought recommendation 8quality vs. acceptabilityespecially important. For example, existing GAAP seems to permit immediate writeoff of acquired, in-processR&D projects. But does that result in a logical accounting for the economic situation at hand? Fortunately for the profession, he said, rule 203 in the AICPA Code of Professional Conduct allows GAAP departures to prevent misleading statements. That rule is an open door for continued discussion on this topic.

Assisting the blue-ribbon panel was Michael R. Young, a partner of the Willkie Farr & Gallagher law firm, long the AICPA's outside counsel. In an interview with the Journal, Young said he saw the report as leading to a cultural change. For example, once the outside auditors have detected a fraud, it's gone pretty far. Managementspecifically, the internal audit departmenthas to be on the lookout for the type of problems that led to the recent highly publicized accounting frauds. And audit committees will change: Their members will have to realize they have a serious responsibility. The timid may have anxiety about serving, but the courageous will embrace the challenge with earnestness and enthusiasm.

Copies of the report are available online in PDF format at www.nyse.com and www.nasd.com.