Audit's Cautious Watchdogs

J. Michael Cook, audit committee chair for a pair of giant companies, spent two mornings in a row last week going over the year-end close and financial release for one of them. First, he talked by phone with two audit-firm partners, then with the CFO.

The call to the audit partners — "to make sure we were in sync about it all" — probably wouldn't have taken place in the time before the Sarbanes-Oxley Act, he says. Then, management handled such communications. "Now, though, it's a normal part of the process."

Indeed, the last five years have created a brand new normalcy for audit committees, once seen as a uniformly inert component of the governance system. Generally, the panels get high marks for how they've stepped in where the CEO once ruled: maintaining the relationship with the auditor. But not always.

A survey that represented the first half of a corporate governance study by Boston College and Northeastern University accounting professors — titled Auditor Experiences of Corporate Governance in the Post Sarbanes-Oxley Era"" — found that while audit committees no longer play the "passive, ritualistic role" they had pre-2002, many hadn't gotten the message when it comes to key roles like dispute resolution and appointing and dismissing the audit firm. At a large number of companies, management is still "the driving force" in those areas."

It's natural for the CEO to only grudgingly cede that responsibility to the audit committee, says Jeffrey Cohen of BC, one of the professors who authored the study. "The auditor really likes to resolve problems with management, rather than dealing with the audit committee," he says. "In my opinion, it's because the audit requires a lot of information from management, and the better you can resolve things with management, the better the relationship will be in the future."

Saying One Thing, Doing Another
Cook, the former Deloitte & Touche CEO whose heads Eli Lilly's and Comcast's audit committees, agrees that some other companies have been resistant to giving more of that power to the board. "It has to do with financial management and their confidence," he says. Fearing a loss of control, some managers have told the audit committee it was in charge, "then gone back to their office and said to the auditor, 'You work for us; we don't want you going right to the audit committee.'" But the companies he serves — he's also on the board at International Flavors & Fragrances — are among the vast majority that he believes have adapted well to having a stronger audit panel.

Since Sarbanes-Oxley, "it's much clearer today that there's a three-legged stool formed by the audit committee, the auditor, and management," he says. (At some companies, he notes, internal audit adds a fourth leg that can be equally effective.) "The legs have to be about the same length, or the stool will tumble over. There has to be a good relationship among the parties."

Before, the auditors "were not connected side-by-side with the audit committee," as he sees it. They dealt with the committee through corporate management. So that means that, from company to company, the degree of change can be "subtle," as he views it.

These managements argue: "The auditors need a full relationship with the audit committee, but don't leave us out." Still, "in some instances, from what I've heard it's gone too far, and the audit committee leg of the stool has gotten too important," with management not having enough say.

The Committee of Last Resort
Not to worry, suggests Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware. Audit committees have gained a much stronger hand in general these days, he says. "And many more committees have been willing to put the audit out for bids, to deliver more for the company."

The big limitation to such bidding, he adds, is that "you've got four firms," after the contraction of the old Big 8 in recent years. "But the old relationships, where once you had an auditor in place, it was there forever [because of close ties to management], that's not true anymore."

What's taken its place — Mike Cook calls it the three-legged stool — is still searching for the right balance in such areas as dispute resolution and the hiring and firing of auditors. "I think it's quite important that, just because Sarbanes-Oxley says the audit committee hires and fires, it doesn't say anywhere that you leave out the CFO," he asserts.

For most disputes, "my view is that the audit committee ought to be a court of last resort," according to Cook. "If they have a legitimate, unresolvable difference of opinion, then the audit committee ought to get involved. But there aren't too many committees that have the independent capability" to deal with the collision of opinions. And sometimes, "you must look to outside experts" for an answer. What he doesn't want, early in a dispute, is for the company to say: "We'll get Cook to resolve that for us." He adds, "I doubt that I would have the expertise, if they can't find it on their own."

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