Standards Related to Listed Company Audit Committees

Client Alert


To:   Our Clients and Friends
From:   Olshan Grundman Frome Rosenzweig & Wolosky LLP
Date:   April 21, 2003
Re:   Standards Related to Listed Company Audit Committees

On April 9, 2003 the Securities and Exchange Commission (the "SEC") released final rules implementing Section 301 of the Sarbanes-Oxley Act of 2002 (the "Act").  Section 301 instructs the SEC to direct the national securities exchanges and associations to prohibit the listing of any security of an issuer that is not in compliance with the audit committee requirements established by the Act.

Minimum Listing Standards

Under the new rules, national securities exchanges and associations are prohibited from listing any security of an issuer that is not in compliance with the following requirements:

  • all audit committee members must be independent;
  •  the audit committee must have direct responsibility for the appointment, retention, compensation and oversight of the independent auditor, which must report directly to the audit committee;
  • the audit committee must establish a formal complaint procedure providing for anonymous employee reporting of concerns regarding accounting, internal controls or auditing matters;
  • the audit committee must have the authority to engage independent counsel and other outside advisors as it deems necessary in carrying out its duties; and
  • the audit committee must have appropriate funding.


Each audit committee must be independent according to the following criteria specified under Section 10A(m) of the Securities Exchange Act of 1934 (the "'34 Act"):

  • members may not accept directly or indirectly any consulting, advisory or other compensatory fee from the company or its subsidiaries (other than board and committee fees);  [1] or
  • be an "affiliated person" of the company or any of its subsidiaries.

Audit committee service is precluded if the company makes such payments to spouses or minor children or stepchildren of the director, or payments for services to law firms, accounting firms, consulting firms, investment banks or financial advisory firms in which the director is a partner, member, managing director, executive officer or holds a similar position.  [2]  The independence requirement may be met even where there are other commercial relationships between the company and an entity with which a director has a relationship.  Independence is tested by current relationships without any "look back" period before appointment to the audit committee.  [3]

The final rules define an "affiliated person" consistently with its historical '34 Act definition: an "affiliate" of a person is "a person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with," the first person.  The term "control" is defined as "the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise."  The final rules provide for a safe harbor under which a person who does not beneficially own more than 10% of any class of voting securities and is not an executive officer is deemed not to control the company.  The rules also provide that an executive officer, employee-director, general partner or managing member of an affiliate of the company will be deemed to be its affiliate.  The rules exempt from the affiliated person restriction an audit committee member who sits on the boards of both a listed company and an affiliate if the director, except for sitting on both boards, otherwise meets the independence standards with respect to both entities.  With respect to newly listed companies, the rules provide an exemption requiring only one independent member of the audit committee at the time of the IPO, a majority of independent members within 90 days of the effectiveness of the registration statement and a fully independent committee within one year.

The final rules apply to issuers of any listed securities including debt securities and derivative securities with limited number of exemptions.  [4]  The rules apply equally to foreign and private issuers, although they provide for a limited number of exemptions for foreign private issuers. The rules also further empower the national securities exchanges and associations to promulgate additional requirements, provided that they are not inconsistent with those delineated above.

Responsibilities Relating to Auditors

The audit committee must be responsible for the hiring, firing, compensation and oversight of the issuer's independent auditors and the auditors must report directly to the committee.  The rules offer little practical guidance on the level of active oversight required by the audit committee, however, membership will surely require a heightened level of participation.

Procedures for Handling Complaints

The audit committee must establish procedures for the receipt, retention and treatment of complaints regarding accounting, internal accounting controls or auditing matters, including procedures for the confidential, anonymous submission by employees of concerns regarding questionable accounting or auditing matters.  Rather than mandating specific requirements, the SEC expects each audit committee to develop procedures customized to meet that individual company's needs.

Authority to Engage Advisors

A company's audit committee must have the authority to engage outside advisors, including accounting experts and legal counsel, as the committee deems necessary to carry out its duties.  Such a grant of authority does not preclude the audit committee from relying on the company's in-house or regular outside counsel, nor does it require an audit committee to retain independent counsel.

Disclosure requirements

Companies that utilize any of the exemptions applicable to audit committees must disclose this (or incorporate by reference this) in their annual reports.  Annual reports must also include or incorporate by reference the identities of the members of the audit committee.  Disclosure regarding audit committees provided in proxy and information statements is being updated to reflect the heightened requirements under the Act and securities exchange and association listing standards.

Timeline for Compliance

Each national securities exchange or association must provide the SEC with proposed amendments that comply with the final rules by July 15, 2003.  The SEC must approve final listing amendments by December 1, 2003.  All companies other than foreign private issuers and small business issuers must be in compliance with the new listing requirements by their first annual shareholders meeting after January 15, 2004 or October 31, 2004, whichever is earlier.  Listed foreign private issuers and small business issuers must be in compliance with the new listing rules by July 31, 2005.  A company must comply with related disclosure changes beginning with the reports covering the periods ending on or after (or proxy statements for actions occurring on or after) the compliance date for the listing standards applicable to that company.


These are only brief descriptions of the SEC's new rules.  This memorandum provides general information only and does not constitute legal advice that may be applied to any particular situation.  Please contact the Partners in our Corporate Department for further advice and assistance.

[1]  Compensatory fees do not include fixed amounts of compensation under a retirement plan (including deferred compensation) for prior service with a listed company if the compensation is not contingent on continued service.

[2] Audit services will not be precluded if the director is a limited partner, non-managing member or holds a similar position in the entity, in each case, having no active role in providing services to the company.

[3] Such other or prior relationships may bar independence under proposed NYSE and NASDAQ listing standards.

[4] An exemption exists from Rule 10A-3 for the listing of other classes of securities if a company already has a class of listed securities subject to the rule.  An exemption also exists for the listing of non-equity securities (other than non-convertible and non-participating preferred securities) of controlled and 50% or more owned subsidiaries of parent companies that have listed common equity subject to the rule.  Lastly an exemption exists for asset-backed issuers, foreign governments and passive trusts.

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