Commentary: Audit Committees' New Duck-and-Cover

By Emily Thornton

President George W. Bush is urging Corporate America to win back investors' trust post-Enron with greater accountability. But if the first trickle of corporate proxy statements this year is any guide, such exhortations aren't cutting much ice. The real watchword seems to be cover your backside.

The tipoff is in the reports of audit committees of corporate boards. They are supposed to affirm that the books are legit, that the audit was thorough, and that the auditors have no flagrant conflicts of interest. Yet this year, one company after another is beefing up disclaimers saying that their committees aren't responsible if the books turn out to be cooked.

Financial-services companies are leading the charge. Riggs National Corp. (RIGS ) says its audit committee does not guarantee that its financials adhere to generally accepted accounting principles. Merrill, Lynch & Co. (MER ) moved a similar statement to its audit report from the committee's charter buried in the back of its proxy last year. Meantime, despite Washington's jawboning, the audit committees of Goldman Sachs (GS ), Liz Claiborne (LIZ ), and Hershey Foods (HSY ) have kept lengthy warnings that say their conclusions basically don't confirm anything--not even that their companies have adequate internal controls.

The committees at AOL Time Warner Inc. (AOL ) and Waste Management Inc. (WMI ) added new language to make it crystal clear they base their recommendations solely on the word of management and the auditors. "It is an explicit statement of what has always been the case," says David P. Steiner, Waste Management's general counsel. "It doesn't change our audit committee's duties, responsibilities, or legal liabilities."

It's fair for members of audit panels to point out that their oversight has its limits. After all, a company's executives do prepare the financial statements, and its auditors are the first line of scrutiny. Still, committee members are expected to know enough to ask tough questions and should feel enough confidence in the answers to vouch for the firm's internal controls, financial statements, and audit process.

That's not something they can shrug off at will. It's a legal responsibility, enshrined in Securities & Exchange Commission regulations and stock market listing standards over the past several years. Companies cannot list on the New York Stock Exchange, Nasdaq, or the American Stock Exchange without proof that an independent audit committee is overseeing their auditors. "Attempts to abdicate responsibility completely with disclaimer language go too far," says Toby S. Myerson, a partner at law firm Paul, Weiss, Rifkind, Wharton & Garrison.

Some companies--and their lawyers--say they're helping shareholders by being up front about audit panels' limitations. They also argue that it's unreasonable to expect part-time committee members to shoulder the onerous legal responsibility of vouching for a multinational's labyrinthine accounts. It's difficult enough to convince members to expose their reputations and pocketbooks to risk, especially since directors' insurance covers only limited amounts of legal liability. Besides, audit-panel chairmen typically earn only $10,000 more than other directors, who are paid $94,000 on average and rarely get anything extra.

Some experts argue that laws must be changed to shift panels' prime interest from self-protection to assuring shareholders that financials are accurate. "If you create a [legal] regime where people are more concerned about passing a test to avoid liability, then you have accomplished nothing," says Charles M. Elson, professor of corporate governance at the University of Delaware. "Today, the law is form over substance."

Writing boilerplate disclaimers is the polar opposite of accepting greater accountability. That will come only when audit committees are staffed by executives with the time and the will to ask tough questions--and the guts to stand by their recommendations.

Thornton covers finance from New York.

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