No one knows better than an accountant the precise value of trust. For registered funds especially, trust is so critical that boards are required by law to maintain a committee for ensuring their financial integrity.
At their most effective, audit committees encourage shareholders to trust a fund’s financial statements through active oversight of audits, financial reporting, and, in some cases, valuation and pricing. Last year’s implementation of the new valuation rule increased the degree to which many fund boards depend on audit committees to keep their books honest.
It’s not easy to maintain the high standards that make an audit committee effective, however, according to contributors who said a committee’s success depends in large part on the performance of the audit-committee chair and the committee’s financial expert — roles that are often occupied by the same trustee.
A provision in the Sarbanes-Oxley Act of 2002 requires that boards identify which committee members have sufficient expertise in accounting or financial reporting to qualify as “audit committee financial experts.” Under the rule, if a board chooses not to have a financial expert, it must explain that decision to shareholders as part of its annual report.
Within the industry that requirement is widely considered implicit pressure to hire financial experts, according to Jay Baris, a partner at Sidley Austin LLP.
“People read it as the SEC encouraging this as a practice,” Baris said. “As a practical matter, the audit committee financial expert is so common now that some funds don’t want to have to explain why they don’t have one.”
Sarbanes-Oxley doesn’t, technically, require that boards hire a financial expert, though 96% of fund complexes do have at least one trustee designated as an audit committee financial expert, according to a 2021 study by the Independent Directors Council.
Hiring financial experts was popular even before Sarbanes-Oxley, though the rule spurred many boards that had not yet adopted the practice to do so, Baris said.
In 2004, one year after the rule went into effect, the IDC found only 89% of boards had an audit committee financial expert. That figure jumped to 97% by 2008.
Paul Kraft, a partner at Deloitte who participates in fund audits and leads audit committee trainings for trustees, said he had never worked with a fund board that didn’t have an audit committee financial expert.
Despite the diversity of approaches boards take toward governance issues such as mandatory retirement and trustee specialization, nearly every board counts among its members at least one former auditor, CFO, or accountant. It’s not uncommon for larger boards to have several.
“That’s sort of table stakes, to make sure you have that person,” Kraft said.
The legacy of Sarbanes-Oxley has ensured a steady demand for fund trustees with backgrounds in auditing and financial reporting, even as appetite still fluctuates for experts from fields like cybersecurity. It is common for a board to recruit a former auditor specifically to sit on, and usually lead, the audit committee, according to Brian Gallagher, an independent trustee of the Columbia Funds.
During the search that resulted in Gallagher’s 2018 appointment, the board described its ideal candidate as a retired partner from a “Big Four” accounting firm who had asset management experience and could eventually chair the Columbia audit committee, he said.
That description fit Gallagher, who had overseen audit strategy at Deloitte’s investment management practice, and he has chaired or co-chaired the funds’ audit committee ever since he joined the board.
“My expectation is that I’ll always be on the audit committee,” Gallagher said. “I understand that to be why I was brought on.”
In addition to letting boards check a box in fund disclosures, an expert perspective can help boards navigate nuanced issues with greater confidence. A trustee with relevant professional experience may be able to think critically about information others may not know to question.
“If you’re not familiar with it, you might defer more to how it’s being presented to you,” Gallagher said.
Experts can’t sit on their laurels
Gathering the right mix of expertise will set up any audit committee to succeed — unless it fails to maintain a culture of active oversight. Even an impressively credentialed audit committee can stagnate if members become complacent or allow management to withhold access to personnel and resources.
With industry developments constantly unfolding, no trustee can expect to remain an expert in their field without continuing education, and an audit chair should encourage committee members to stay up to speed, according to Kraft.
“A pitfall would be not to focus on education,” Kraft said. “That probably would be a good practice, to think of it that way, if you’re the chair of the audit committee, to make sure that the directors are getting educational opportunities and kind of making sure they get some amount of hours in a year.”
If the committee members decide they need to consult with outside experts or management personnel like a chief risk officer or chief information security officer, the audit chair should be “making sure they’re getting access, and it’s not being limited in any way, shape or form,” he said.
Overall, the audit committee chair should aim to ensure that the issues under their purview receive fair and thoughtful discussion from a well-equipped group of trustees so that the wider board can rely on their conclusions.
“I think it sort of culminates into a well-thought-out agenda that has the right topics that are important to the committee and their roles and responsibilities, as well as making sure for those topics they have the right people in the room to talk to those topics, and then create an environment whereby there’s a robust discussion,” Kraft said.
While they may occasionally appoint subcommittees and assign them tasks, the audit chair’s job is not to order their committee members around, according to Carla Teodoro, a partner at Sidley Austin.
“I think of having an audit committee as very much a collaborative process, where there’s no delegation from the chair to somebody else. I think of them working always as sort of a cohesive unit together,” Teodoro said.
Rather than recreate a corporate hierarchy where they are the boss, audit chairs should view themselves as “servant-leaders” whose goal is to serve the group, according to Eileen Kamerick, lead independent director and former audit chair of the Legg Mason closed-end funds.
“You have influence, rather than authority,” Kamerick said. “The best way to exert your influence is to understand that you’re there to be helpful to your peers and to drive the effectiveness of the committee as a whole.”
To this end, some boards impose term limits on their committee chairs, so that no trustee becomes too comfortable presiding over their colleagues.
Boards that don’t rotate their audit chairs may run the risk of allowing meetings to stagnate as one chair dominates the discussion.
“I’ve seen situations where there’s a chair of a committee that’s been there too long,” Kraft said. “I think they become more dominant in that role and the committee members maybe feel less comfortable challenging things and asking questions just because the person’s been in the role for 10 years.”
The Columbia Funds board has a three-year term limit for committee chairs, although Gallagher received a second term as audit committee chair following a board reorganization in 2021. He expects his time as chair to conclude next year but plans to remain as a committee member.
To Gallagher, who also espouses a collaborative style of leadership, being the audit chair means making sure the committee can thoroughly discuss the items on its agenda, even if it takes more time.
“I’d like to make sure that the issues are addressed. I’d like to make sure that if people have questions, they have the opportunity to ask the questions,” he said. He added that the Columbia board knew not to schedule anything too soon after his audit committee meetings.
“On occasions we might run over. And that’s fine.”