Audit Committees

Sarbanes Oxley has significantly raised the stature of the audit committees and requires them to have the competence, the independence and the knowledge to be capable of their fiduciary roles. In the past, directors and audit committees were protected, by the business judgment rule, from liability suits as long as they were taking decisions with due care, after evaluating all the material information and in good faith and honest belief that they were acting in the best interests of the company and its shareholders. The Sarbanes Oxley has raised the standards which are required before directors will be immune to law suits.

One recent case of use of an expanded set of standards for defense under the business judgment rule is the suit filed by shareholders against the CEO of Oracle and some of its Directors for insider trading. A group of Directors, members of a specially set up litigation committee, investigated the matter and came to the conclusion that the accused did not have access to non-public information for an insider trading charge to be valid. However, the shareholders counteracted by pointing out that the Directors of the committee were not independent; some of the committee members were professors at Stanford and some of the defendants were donors to the University or professors. The courts were willing to use soft criterion to judge whether the relationship could have biased their decisions.

At the same time, the audit committees have the means to act in better judgment. One important requirement of the current corporate governance laws is that they should have a financial expert capable of judging the quality of financial reporting by internal and external auditors. They are also expected to confer with external experts to come to their decisions.

In addition, audit committees now have greater access to information which flows to them directly without the mediation of the Chief Executive. A KPMG survey in the spring of 2002 found that nearly 19.2% of them were not receiving critical accounting information, judgments and estimates to ensure the quality of reporting. Following the Sarbanes Oxley Act, the audit committee is expected to seek information on the business, legal and financial risks besides keeping abreast of issues related to the competitive, regulatory and the economic environment of the company.

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