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Audit committees need high-level participation

Good audit committees do not happen by accident. They require the full participation of all the major players – the members, the finance director, the financial controller and chief accounting officer, the internal and external auditors – as well as the full support of the company’s chairman and chief executive. Meetings need to be well planned – meaning an annual calendar setting out when recurring matters will be covered, appropriate papers going out to all on time, and proper briefing and preparation by the audit committee chairman – if the committee is to stand any chance of working well. The audit committee chairman must be sufficiently “plugged in” to the finance players across the group to be provided with the necessary antennae and imbue confidence in his judgement, and must also maintain sufficiently deep relationships with the FD, the chairman and the chief executive to enable a dialogue with complete openness and confidentiality.

But things don’t always work out that way. Papers can arrive late or incomplete. The necessary pre-meeting briefings can be overlooked. The committee can be seen as purely a compliance function. And relationships can break down in any of those circumstances. One of the most dramatic such examples I witnessed was when the audit committee chairman, a QC, cross-examined both the FD and the external audit partner as if in court, referring them to his various exhibits A, B and C – including marked paragraphs of accounting standards and the draft annual report. It was the first time the chairman and FD had even discussed the issues. In another dramatic committee meeting, the FD tabled a new set of draft annual accounts, prepared overnight using different accounting policies from those in the draft accounts previously circulated. The audit committee chairman was then put under pressure to adopt these radically different accounts that morning because “we are committed to announcing our results tomorrow”. Had he insisted on a delay to properly consider what was being proposed, the subsequent decline and fall of the company into the clutches of its bankers following covenant breaches might have been averted – or the consequences of that run-in could have been lessened. Both instances certainly provided high drama and excitement, but neither were the ideal way of doing things.

I think the best example of audit committee behaviour diverging from the words it uses to describe itself is when I was given a draft of an annual report on corporate governance to review and then witnessed the committee’s review of its compliance with the Combined Code. In the first case, I read what could have been a description of the best corporate governance in the country – which was strange, given the company’s list of blatant non-compliances, the dismissive attitude of its chairman to anything relating to governance, and the breakdown in controls most starkly evidenced by major accounting restatements and banking covenant breaches.

The Code compliance review was proceeding nicely until someone in attendance asked: “Is that really true?” He highlighted several instances of flagrant failings in the process for the appointment of new directors. This led to a discussion of other aspects of board and director behaviours, which became a tipping point in the relationship between the board and the chief executive, who never regained the respect of his non-executives. In one sense, this was an example of governance working – but by accident, not design. Needless to say, the draft was rewritten to describe the reality rather more closely. And I have many more examples of audit committee malfunctions that I’ll explore in these pages over 2011, from risk management to whistleblowing.

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