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September 2004 Sarbanes-Oxley raises the bar for board members Reforming how public companies’ boards of directors function is causing many private entities to raise their standards as well Scandals involving public companies have been all-too-frequent news items in recent years, with crises ranging from audit failures and management lapses to outright corporate collapses. Congress’s response, in the form of the Sarbanes-Oxley legislation, has not only changed the way in which certified audits are conducted but also has imposed new duties and pressures on the boards of directors of publicly traded companies. But what does this mean to you, as a board member of a closely held corporation or a not-for-profit organization? The Sarbanes-Oxley law itself is not applicable per se, but expectations are changing at all levels of board governance, and some of the Sarbanes-Oxley principles are becoming the standard of good governance for all boards, large or small. Here are some thoughts on those good governance topics that are on the agenda in most boardrooms these days. Popular reforms The audit committee. It has long been standard practice for the board of directors (rather than management or staff) to select the firm that audits the company’s books. In theory, that makes perfect sense; after all, the audit is performed for the benefit of the shareholders (or, in the case of a not-for-profit organization, the membership), and the board members are the shareholders’ elected representatives. In practice, however, particularly in smaller organizations, the line separating the board and upper management can get blurry, and employees may have partial or complete decision-making power in hiring the auditors and receiving their report and recommendations. This is why the Sarbanes-Oxley legislation has mandated a separate audit committee for public company boards, and many private corporations are following suit. In many cases, the audit committee engages the auditors, defines the scope of the examination, and receives the audit report at the conclusion of the engagement without management being present. Also, the audit committee may be charged with reviewing overall areas of organizational risk, not merely financial risk. Audit committee members should be financially literate. If the board itself lacks members with sufficient expertise, the membership of an audit committee can be rounded out with non-board independent members. Code of ethics. Increasingly, companies are adopting statements of principles that formalize their ethical standards. Once put in place, a code of ethics should be internally distributed from top to bottom. Periodically, key management members are asked to confirm in writing that they have not personally violated the code of ethics and that they are not aware of any violations among the employee group. Whistle-blower protection. Some companies are also adopting a whistle-blower policy to provide a vehicle for employees to notify the appropriate parties of alleged illegal or unethical actions. While an internal party is usually designated to receive the whistleblower complaints, the board (or its audit committee) can exercise an oversight role by annually reviewing any notifications and the corrective actions taken. Attention to basics While discussing such reforms as audit committees, codes of ethics, and whistleblower policies, it is also useful to review some basic board governance principles. Whether your directorship involves a for-profit or not-for-profit entity, these concepts should prove equally valid. Collective authority. A board of directors has authority only when it acts as a group. No individual member should exercise direction or control of staff or management except when acting at the direction of the board. Direction of CEO. A board’s sole employee is typically the chief executive officer, who in turn has responsibility for other hiring and organizational operations. Accordingly, the CEO is the only employee whom the board directs, and the CEO should be the sole conduit for board interactions with lower-level employees. Board accountability. As was mentioned earlier, a board of directors is directly accountable to the organization’s ownership. Does your board center its decision making on this fiduciary role? A good board focuses on its duty as the representative of ownership and assures that mechanisms – e.g., quarterly or annual financial reports, annual meetings, and periodic management reports – are in place for communication and accountability to that group. Board evaluation. Most boards recognize the need to annually evaluate the performance of the CEO. But are established procedures and performance standards in place to assist with that evaluation, and do all board members participate in the process? Further, does the board ever evaluate its own performance? An annual self-evaluation often causes the board to pay more attention to its own work plan and its strategic leadership of the organization. Organizational outcomes. Finally and most important, good boards obsess about outcomes. For example:
It is the board’s job to set the company’s course, and it is the employees’ job to move the company forward on that course. While oversight of operations is part of the board’s duties, too many boards do little else, keeping an overly critical eye on employee actions and ignoring their role of setting strategic direction. How effective is your board? Serving on a board that follows good governance practices can be a stimulating and rewarding experience. If you are a member of a board that has lost its focus or is not properly fulfilling its fiduciary duties, the influence of Sarbanes-Oxley might help you take a critical look inward and implement needed reforms. Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market. |
