Comment letters push for tighter definition of audit committee financial expert

Several comment letters submitted to the SEC in recent months pressed the market regulator to revisit a rule from the Sarbanes-Oxley Act of 2002 that was intended to shore up company boards’ supervision of financial reporting.

The letters are asking the agency to rewrite its rule for audit committee financial experts and impose stricter limits for the expert qualification, mostly out of concern that the current definition in Item 407 of Regulation S-K is too broad and allows people who do not fully grasp the significance of some important financial reporting issues to sit on audit committees. The rule was mandated by Section 407 of Sarbanes-Oxley and says public company boards must have at least one person who meets the description of financial expert.

“Individuals designated as an audit committee financial expert should have substantive experience in accounting or auditing,” wrote University of Tennessee accounting professor Joseph Carcello, a member of the SEC’s Investor Advisory Committee (IAC), in a Nov. 22, 2016, comment letter in response to Release No. 33-10198, Request for Comment on Subpart 400 of Regulation S-K Disclosure Requirements Relating to Management, Certain Security Holders, and Corporate Governance Matters. The preliminary rulemaking document deals with the disclosure requirements in Subpart 400 of Reg S-K, which address executive pay, investments held by officers and directors, directors’ independence from management, and the board’s responsibilities for corporate governance. Comments were due Oct. 31, but the SEC has continued to receive comment letters beyond deadline.

When the SEC adopted the definition, the commission said the guidance outlined in Sarbanes-Oxley about the qualifications for an audit committee’s financial expert proved to be controversial. As the SEC wrote the financial expert rule, it at first proposed that a “financial expert” would mean a person who has, through education and experience, an understanding of U.S. GAAP, financial statements, financial reporting controls, and an audit committee’s role in financial reporting and governance.

But most comment letters said the definition was too restrictive, and the SEC responded with wording that would allow directors with less well defined roles in financial reporting qualify as financial experts.

In the 14 years since Sarbanes-Oxley was enacted, some financial reporting professionals, like former FASB Chairman Dennis Beresford, have criticized the broad definition. He questioned how many audit committee members really understand complex accounting and auditing matters and wondered how many are prepared to monitor their companies’ implementation of major U.S. GAAP standards, like the FASB’s standard for revenue recognition, or grasp the significance of the SEC’s recent focus on the widespread use of non-GAAP measures.

“Investors may well be receiving a false sense of security in many cases through belief that all identified [audit committee financial expert] are true accounting and auditing experts,” wrote Beresford, who has chaired the audit committees for some public companies.

Anne Sheehan, director of corporate governance with the California State Teachers’ Retirement System (CalSTRS), said the SEC could solve the problem by reconciling its definition of a financial expert to Sarbanes-Oxley’s requirements.

“We agree with SOX that the expertise necessary to be qualified as an audit committee financial expert should come from specified accounting or auditing positions from a position involving the performance of similar functions versus what is currently required,” Sheehan wrote on Oct. 31. “There are too many examples where companies would have benefitted from a more stringent definition of audit committee financial expert. Specifically with the prevalence of non-GAAP reporting and the complexity of financial reporting, CalSTRS recommends the SEC strengthen the definition criteria for an audit committee financial expert and align it with the requirements of SOX.”

A Big Four accounting firm agreed.

“Consistent with an objectives-oriented disclosure approach, the revised definition of [audit committee financial expert] should retain the five attributes of financial expertise without prescribing any specific work experience, titles, or roles necessary to have accomplished those attributes,” the firm wrote on Nov. 30. “Instead, the board of directors should be allowed to exercise judgment in evaluating whether the experience of a member has been sufficient to attain all five attributes of financial expertise.”

That firm also recommended that the SEC revise Item 407 and require an annual assessment of the status of an audit committee member as a financial expert based on changes in the company’s business, as well as developments in accounting, auditing, financial reporting, and internal controls.

For more information on this topic, or to learn how Baker Tilly accounting and assurance specialists can help, contact our team.


We have partnered with Thomson Reuters to issue our monthly SEC Accounting Update. Please feel free to contact Baker Tilly at accounting@bakertilly.com if you have any questions related to these articles or Baker Tilly's Accounting and Assurance Services. © 2016 Thomson Reuters/Tax & Accounting. All Rights Reserved.