How audit committees should work;

              How Audit Committees should Work
by A.A. SOMMER, JR./Chairman, SEC Advisory Committee on Corporate Disclosure
II has been suggested thai the ac-counting portions of the Foreign Cor-rupt Practices Act represent one of the most massive and widespread intru-sions of the government into the process of corporate governance that has yet occurred. Thai may be a flight overstatement, but there is no ques-tion that it represents a new tool in the hands of the SEC. That the SEC is going to utilize these powers is obvious. What is of concern to everyone in-volved in the process of corporate governance is what will be required as a result of these new demands. And among those people, obviously, are corporate directors.
What are the concerns of directors? Since I am on two audit committees myself, I believe I have more than a passing interest in the subject.
There is no question that everyone involved in the corporate community has a responsibility for maintaining accurate information concerning a firm's assets and operations. The chief executive officer has it. The board of directors has it. And the auditors have a responsibility, as well.
However, it seems to me that the literature being developed for direc-tors has been very abstract, much too general, and grossly unrealistic. We need a clear, simple, more precise answer to what one can reasonably expect from a board of directors in regard to internal controls.
Let me try to put those statements into some sort of perspective, First, many are losing sight these days of the fact that internal controls constitute only one of many problems that directors and management must deal with. Interna) controls, one might even
say, are not a director's major respon-sibility. His major responsibility, in my eyes, is to monitor the management of the company—to make sure that the company functions in an effective, economic fashion, producing goods and services and earning a profit.
The second proposition thai I would spotlight is that there are general rules that govern the manner in which cor-porate directors must meet their com-mitments; and the rules with regard to internal controls are no different than those with regard to other areas of directorial responsibility. Directors must be apprised of how to fulfill these newly defined responsibilities. And they must be guided by those who are in the best position to do so—namely, outside counsel, outside auditors, and to some extent the internal audit staff and the chief financial officer
My final proposition is that in this day, when there is considerable pres-sure upon corporations to include on their boards people who may not have financial sophistication, the problem of internal controls should be ex-plained to the board—and even to the audit committee—in very basic, very simple terms.
The Board's Role
Now, let's relate the general rules that govern directors to this whole prob-lem of records and controls. Most corporation laws today speak of the board of directors as managing the corporation. But everybody knows that that doesn't mean what it says. What it really means is that they are there to monitor management. They are to review what management is doing. They are in some areas to direct
management. But they are not to be involved in the day-to-day running of the company, nor in the day-to-day implementation of internal control systems. Specifically, they should par-ticipate in developing the objectives of the corporation, they should help de-termine whether or not the objectives are reasonable, and they should re-view whether or not those objectives are being met.
There is much involved in this, of course. There is the accountability of the corporation to its shareholders, to its employees, to the SEC, and to the communities in which it operates. The shareholders, of course, are at the core of this entire process. They are the ones whose money is at stake, and they are the principal body to whom accountability must be directed.
Now, how does the monitoring by directors impact the problem of inter-nal controls? I have read some litera-ture that suggests that the outside directors, and more particularly the audit committee, should become in-volved in the day-to-day implementa-tion of internal controls. I would hope that is not the law. It is management's responsibility to establish and operate the internal control system, just as it is management's role to develop man-ufacturing facilities and a sales capaci-ty. 1 he outside director's responsibility is to oversee this, which includes a monitoring responsibility for the fi-nancial side of the business. And a part of that financial side, the reporting side of the business, involves the integrity of internal controls.
Now, what does that mean? What do directors actually have to do? I'm not going to give you a litany of steps
I i