The Portable MBA in Finance and Accounting, 3rd Edition

The Board of Directors 523

Much survey information is available on board retainer fees, board meet-
ing fees, and compensation for committee chairs to help reach a balanced level
of compensation.

AUDIT COMMITTEE

The audit committee is responsible for ensuring that the company’s published
financial statements are presented fairly in conformance with generally ac-
cepted accounting principles (GAAP), and that the company’s internal control
system is effective. Furthermore, the audit committee deals with important
cases of alleged misconduct by employees, including violations of the company’s
code of ethics. It also ratifies the selection of the company’s external auditor.
All companies listed on major stock exchanges are required to have audit
committees, and most other corporations have them. The SEC requires at least
three members of the audit committee to be “financial literate or to become fi-
nancial literate within a reasonable period of time.”^2

Responsibility

Although the full board can delegate certain functions to the audit committee,
this delegation does not relieve individual board members of their responsibil-
ity for governance. In its 1967 decision in the BarChris case, the federal court
emphasized this fact:^3

Section 11 [of the Securities Act of 1933] imposes liability in the first instance

upon a director, no matter how new he is....He is presumed to know his re-

sponsibility when he became a director. He can escape liability only by using

that reasonable care to investigate the facts which a prudent man would employ

in the management of his own property.

Directors have directors’ and officers’ (D&O) insurance, but this only
partially protects them against loss from lawsuits claiming that they acted im-
properly. Recent decisions suggest that courts are increasingly willing to exam-
ine directors’ decisions. For example, the shareholders of Oxford Health Care
sued the company for misleading financial statements. Oxford’s stock price
thereupon fell by 50%, a $14 billion drop in market value. The company re-
portedly agreed to settle the case for $2.83 billion. In the 1990s, there were
more than 100 fraud actions annually against SEC firms and many more against
smaller firms.
Audit committee members walk a tightrope. On one hand, they want to
support the CEO—the person whom the board itself selected. On the other
hand, they have a clear responsibility to uncover and act on management in-
adequacies. If they do not, the entire board of directors is subject to criti-
cism at the very least and imprisonment at worst. Their task is neither easy
nor pleasant.