Following on from the recent scandals at companies like Carillion, Patisserie Valerie and Metro Bank, there is an increasing public focus on audit committees and their oversight of the preparation and audit of financial statements. There is also a wider movement involving the CMA, the recommendations of the Kingman Review, and the Brydon review covering audit committee scrutiny, audit sector reform and the creation of a new independent regulator, the Audit, Reporting & Governance Authority (ARGA) to implement a stronger enforcement regime. 

With this backdrop, at a round table event held at ICAEW in March 2019, a group of Audit Committee members and advisers focused on a number of key themes which can help ensure a more effective Audit Committee (AC). These included culture, self-evaluation, training, experience and networking.

Culture, accountability and effectiveness

• Culture is hard to critique. Carillion and Patisserie Valerie operated in totally distinct sectors, yet both were victims of bad culture. Attendees felt that they could feel bad culture and that it was often clear upon their first encounter with members of an organisation. Equally, they could also clearly identify a good culture. What was more difficult was identifying negative cultural elements in organisations where the culture was neither outstanding nor poor. 

• One possible indication of the culture of an organisation can be the levels of transparency. Negative elements of culture can be identified through red flags such as challenge being unwelcome, or engagement with relevant stakeholders being uncommon (e.g. why did that shareholder exit / what causes employee turnover?). Attendees felt an effective AC could navigate various organisational cultures and doing that required utilising different technical and personal skills. 

• Attendees agreed that the primary AC role is to hold management and the external auditor accountable and to test their assurances. Those assurances are important for the AC to be able to ultimately recommend that the board sign off on the accounts. AC members need to be able to look management in the eye and test the preparation and presentation of the numbers. One incentive to challenge should be protecting reputation. With increased focus on ACs, failure to do so can have a devastating impact to both individual AC members and the Company's reputation, as evidenced by the Carillion fallout. 

Self-evaluation

• Attendees acknowledged self-evaluation can enhance effectiveness. Best practice for self-evaluation is set out in the FRC's Corporate Governance Code which requires those boards to (i) self-evaluate annually, and (ii) have an external evaluation every 3 years. Attendees were asked by way of a show of hands, how many had taken part in a self-assessment. Around 70% of attendees had done so (although only one attendee had undertaken an external evaluation), and believed this was an effective exercise for identifying skill gaps. 

• Attendees also highlighted the importance of evaluating meetings. A discussion between AC members immediately after a meeting can enable real time reflection on, for example, how the meeting went; what could have been done better; and, for the presenters, who performed well and who may need some guidance. This discussion can provide a critical opportunity for AC members to discuss how they perceive their own challenge is landing, and whether, for example, they felt management were being defensive and, if so, why. 
  
  
• It was also felt important for AC members to spend more time together outside meetings, although travel schedules and lengthy agendas frequently get in the way. Web conferencing was mentioned as an increasingly valuable tool to help facilitate this, as well as for executive and technical briefings.

Training and Skills

• Skill gaps can be addressed through professional development, and the level of additional training received as AC members had varied greatly, from extensive, to none. It was pointed out that companies often focus on “induction” for new board members but not “induction” for new committee members, where specialist knowledge is required. Again, greater use can be made of special non-executive briefings outside AC meetings. An environment of continuous self-improvement can also contribute to a positive culture.
  
• Also, one attendee highlighted the soft skills associated with transitioning from an executive to a NED as a key area for development, often overlooked in induction programmes. Balancing the need to know enough to challenge but trusting the executive team to manage. 

Diversity

• Attendees agreed that ensuring rotation and monitoring composition and succession, to ensure the AC is aligned with the company's strategy, are important elements of ensuring AC effectiveness. In addition, it enables the AC to promote its own diversity, culture of challenge, and be part of the board's role in setting the tone from the top.

Engagement with Senior Management

• ACs can be masters of their own destiny by controlling the information they receive (which ideally should be the same information management are using to prepare and present the numbers). Meeting and talking to employees of varying levels of seniority can help AC members to understand in a more meaningful way the information presented to them, leading to a more constructive management challenge. It can also dilute reliance on technology, and give a real feel for whether the information prepared and presented by management is truly reflective of performance. 

• The process around challenge and scrutiny is key, particularly in relation to numbers generated by algorithms and data (produced by management and confirmed by auditors – internal as well as external) as real value can be added by understanding the method as well as the outcome. Attendees felt that the AC should encourage the auditors to apply a similar critique when they undertake their own review.

Experience and Qualities of an effective AC member

• Sector experience is helpful but generally not a pre-requisite for AC membership (except in certain sectors, such as financial institutions). Some of the high profile fall outs have related directly to industry specific issues, such as risk weighted assets at Metro Bank and the booking of long term contracts at Carillion. To be effective in the role, AC members need broad sector experience, coupled with a specific set of professional and personal skills. 

• Attendees noted that it was important to be able to rely on a network of other NEDs with sector experience both as NEDs and previously as executives. One noted that there are real benefits in AC members getting together with a neutral facilitator. Experience in the role as a NED contributes to being an effective AC member, but is not essential. Attendees felt that being able to draw on prior experiences helped manage the AC's contribution to the board and role as gatekeeper of the financial statements. 

• The AC as a whole needs to be diverse with a complementary range of experience and skills, including the ability to understand what the company needs now and will need in the future (e.g. an understanding of relevant industry technologies - such as technology for financial institutions). An appropriate skillset will consist of both technical and personal elements which mean that the AC as a whole (and each individual member) will have the gravitas and ability to provide appropriate challenge, which remains the key to an effective audit committee.
  
  
  Tom Quincey
  Associate
  Baker McKenzie
  
  David Alexander
  MD, Daart Solutions
  Daa.risk@gmail.com