Are Audit Committees Really Independent of Management?

A reader – who is a partner at a Big 4 firm – sent this to me awhile ago and I dug it out this week:

Question for you. Why is it OK for audit committee members to be selected and paid by management? Why is it OK that they are paid in the stock of the Companies that they govern? Considering the fact that the SEC has such disdain for the slightest perception of a lack of independence on the part of the auditors that report “directly” to the Audit Committees, it is odd that the governing body can be owners of the company as well. [By the way, let’s be real, management hires the auditors. The audit committees just accept it.]


Time to jump in – These questions feel rhetorical but I’ll take a stab at answering them anyway. If you look at a brief history of audit committees, you’ll see that the idea goes back nearly as far as the Securities and Exchange Acts of ’33 and ’34, first being endorsed by the NYSE in 1939. The SEC first made the recommendation that public companies compose their audit committees of independent directors in 1972. That was followed by the NYSE’s requirement for audit committee members to be independent in 1977. What does all this mean? Basically, it appears that it’s okay that management selects and pays audit committee members because it’s always been done that way. Similarly, it’s okay to pay them in stock because companies have always issued shares to directors, regardless of their respective committees. As far as who “hires” the auditors, our source has a better frame of reference than I but this probably varies from company to company. While many companies have audit committees that have no problem throwing their weight around, there are others whose members probably couldn’t find cash on a balance sheet.

Anyway, our source has some ideas:

If the regulators want to create a TRUE independent structure, why not create an Audit Committee Oversight Board (or the ACOB), and pay these members in shares of a Mutual Fund that’s tied to the overall performance of the stock market? Audit Committee members should be overseen by the SEC – perhaps indirectly by this ACOB. Now – this would empower the Committees, empower the auditors even further, and empower the shareholders of Companies with the knowledge that the Audit Committees were truly independent of management. This would be a stunning show of real governance in corporate America. Wouldn’t this be a true step toward preventing further financial crashes in America? What do you and your readers think?

I like the progressive ideas presented but if there’s one thing I’ve learned from the massive amount of media I’ve consumed in the last 2+ years, it’s this – the ideal regulation and what it politically feasible are often miles apart and in the process of reconciling those differences, the final product is not at all what was intended. The SEC (who hasn’t exactly been on top of their game the last few years) is already fighting for every nickel and no amount of litigation releases will get representatives like Darrell Issa to back down from cutting their budget. Thus, a regulatory agency with shaky credibility has an uphill battle.

So would an Audit Committee Oversight Board, compensation changes and other reforms to the process be a “true step toward preventing further financial crashes”? Maybe. But as long as “fiscal responsibility” continues to be a political talking point, the SEC won’t have the ability to suggest reforms until we have another crisis and chances are, they’ll be the scapegoats…again.

A reader – who is a partner at a Big 4 firm – sent this to me awhile ago and I dug it out this week:

Question for you. Why is it OK for audit committee members to be selected and paid by management? Why is it OK that they are paid in the stock of the Companies that they govern? Considering the fact that the SEC has such disdain for the slightest perception of a lack of independence on the part of the auditors that report “directly” to the Audit Committees, it is odd that the governing body can be owners of the company as well. [By the way, let’s be real, management hires the auditors. The audit committees just accept it.]

Time to jump in – These questions feel rhetorical but I’ll take a stab at answering them anyway. If you look at a brief history of audit committees, you’ll see that the idea goes back nearly as far as the Securities and Exchange Acts of ’33 and ’34, first being endorsed by the NYSE in 1939. The SEC first made the recommendation that public companies compose their audit committees of independent directors in 1972. That was followed by the NYSE’s requirement for audit committee members to be independent in 1977. What does all this mean? Basically, it appears that it’s okay that management selects and pays audit committee members because it’s always been done that way. Similarly, it’s okay to pay them in stock because companies have always issued shares to directors, regardless of their respective committees. As far as who “hires” the auditors, our source has a better frame of reference than I but this probably varies from company to company. While many companies have audit committees that have no problem throwing their weight around, there are others whose members probably couldn’t find cash on a balance sheet.

Anyway, our source has some ideas:

If the regulators want to create a TRUE independent structure, why not create an Audit Committee Oversight Board (or the ACOB), and pay these members in shares of a Mutual Fund that’s tied to the overall performance of the stock market? Audit Committee members should be overseen by the SEC – perhaps indirectly by this ACOB. Now – this would empower the Committees, empower the auditors even further, and empower the shareholders of Companies with the knowledge that the Audit Committees were truly independent of management. This would be a stunning show of real governance in corporate America. Wouldn’t this be a true step toward preventing further financial crashes in America? What do you and your readers think?

I like the progressive ideas presented but if there’s one thing I’ve learned from the massive amount of media I’ve consumed in the last 2+ years, it’s this – the ideal regulation and what it politically feasible are often miles apart and in the process of reconciling those differences, the final product is not at all what was intended. The SEC (who hasn’t exactly been on top of their game the last few years) is already fighting for every nickel and no amount of litigation releases will get representatives like Darrell Issa to back down from cutting their budget. Thus, a regulatory agency with shaky credibility has an uphill battle.

So would an Audit Committee Oversight Board, compensation changes and other reforms to the process be a “true step toward preventing further financial crashes”? Maybe. But as long as “fiscal responsibility” continues to be a political talking point, the SEC won’t have the ability to suggest reforms until we have another crisis and chances are, they’ll be the scapegoats…again.

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