Care and Diligence and Audit Committee Members

¶ … Care and Diligence and Audit Committee Members

"The duty of due diligence and due care has been defined, generally, as a requirement that each director and officers exercise the care which ordinarily prudent and reasonable persons would exercise under the same circumstances (Duty of Diligence and Due Care)."

The concept of due care and diligence is intended to hold those with a fiduciary responsibility to a standard of care that makes them responsible for knowing what a prudent person might have known. It remains the standard for determining legal duty.

In the financial and legal community, due care and diligence is expected when audit committee members exercise their responsibilities. Audit committees first came into being when the SEC recommended that publicly held companies establish them in 1972. Audit committee roles and responsibilities have since evolved over time. That evolution included the establishment in 1987 of six specific audit committee recommendations intended to deter fraudulent reporting. Then, in 1999, the Blue Ribbon Committee (BRC) on Improving the Effectiveness of Corporate Audit Committees made recommendations for improving audit committee effectiveness. Following those expansions, the BRC made recommendations that resulted in changes by NASDAQ, the NYSE, AMEX, and the SEC (Keinath & Walo, 2004).

In 2002 the role of audit committees expanded still further with the Sarbanes-Oxley Act that increased audit committees' responsibilities and authority. The SEC and stock exchanges then responded by proposing new regulations and rules to strengthen audit committees. The authors of the legislation moved to establish audit committee best practices. Keinath and Walo prepared a compilation of best practices that was organized into seven general categories, along with a comparison of best practices to disclosures of actual audit committee practices (Keinath & Walo 2004).

Analysis of Keinath and Walo's report show that audit committees have to significantly expand their responsibilities to just cover practices required by Sarbanes-Oxley and NASDAQ. Exhibit 5 from the report Audit Committee Responsibilities lists the following responsibilities:

Oversee the financial reporting process

Monitor choice of accounting policies and principles

Monitor system of internal control

Ensure open communication with management, internal auditors, external auditors, and the audit committee

Oversee hiring and performance of external auditors

Composition of the audit committee

Other requirements

Keinath and Walo (2004) concluded that audit committees were not then fulfilling oversight responsibilities for which they would soon be responsible, and those duties were expected to balloon. Additional implications of the study were that the audit committee was accountable to the shareholders it represented and must make significant improvements in their communication with and disclosure to shareholders. A final conclusion was that, in order to improve accountability to the shareholders, as recommended by the BRC, the audit committee should report whether the responsibilities assumed in the charter had actually been carried out. The inescapable conclusion to be drawn was that audit committee members must be ever more conscientious in the exercise of due care and diligence (2004).

As the role of the audit committee expanded in recent years, so did their responsibility to exercise due care and diligence. In a 2004 report, Nigh and Bevilacqua posited that mergers and acquisitions due diligence had "always been a good business practice. But in the wake of the Sarbanes-Oxley Act it [was] now essential." Tate offers a similar conclusion in his report The Annual Audit Committee Evaluation, pointing out that although an increasing number of the functions and responsibilities were specified by statute, rule or regulation, "an audit committee's standard of care remain[ed] significantly dependent on due diligence and prudent judgment."